A new restaurant opens in your town and you decide to try it. One of two things happens next: 1) You like the restaurant and you decide you will try it again sometime, or 2) You don’t like the restaurant and you won’t go back again.
Voting With Your Feet
The second option – deciding not to go back there again – is a version of Voting with your Feet. You register your displeasure with the restaurant by not going back there again. If enough other people don’t go there, the restaurant will either improve to win people back or not improve and go out of business. Then maybe someone else will buy the restaurant and it will be good again.
Stocks
Stocks act in a similar way, even more efficiently. You buy stock in a company. If you like it, meaning presumably that the price goes up, then you hold onto it, or maybe buy some more. If you don’t like it, you might sell it. If enough people sell it, the price will trend down, and management will notice. Maybe management will change something and the price will head back up. In the stock market world, you vote with your feet by selling your stock or by not buying it in the first place.
Proxy
Stocks have another way for owners to affect change that restaurant patrons don’t: Stock owners vote every year on the composition of the Board of Directors. This is because stock owners actually own the company, whereas restaurant patrons don’t. (What if you could vote on how a restaurant was run or what was on the menu? That might be fun!)
If you think management is doing a good job, then you probably will vote to keep the Board in place. If you disagree with management but still own the stock, then you might reject the current Board. The threat of shareholder revolt and the pressure to keep performing well helps to keep management focused and its collective eye headed in the right direction.
Peltz
In October of this year, Procter & Gamble announced that it had beaten back a bid by maverick investor Nelson Peltz to win a board seat by a very slim margin. Peltz wanted to affect change at P&G and sought a board seat in order to do so. Peltz tried to convince enough other P&G owners to back his bid but he fell just short. Time will tell if Peltz gets his desired changes at P&G despite his losing the board seat bid.
Index Funds
One thing that was interesting about the Peltz bid was that the various index funds that owned P&G were collectively divided over whether Peltz should win his bid. Index funds were the three largest P&G shareholders. State Street and BlackRock sided with Peltz but Vanguard voted against him. (Wall Street Journal, October 19, 2017). I don’t know why each fund voted the way they did, but I think it was unusual that the top three shareholding funds were divided. Most of the time fund owners will vote with current management.
IMO
The point I am making is that an index fund or ETF investor typically doesn’t have an opportunity to effect a direct change in management. They have ownership in the ETF, not in the underlying company. An owner of stock in a company, however, does have the direct opportunity to change the company, either by selling (voting with their feet) or by voting in a proxy. This opportunity to vote is a major thing to lose by choosing to own funds rather than owning individual stocks. If you own a fund, you indirectly own the underlying stocks and you can only hope that your fund manager feels the same way you do about a certain company within the fund if a proxy battle such as Peltz’ P&G battle occurs. But, you gain the diversity of owning a basket of companies rather than just one individual company. There are always trade-offs with anything you do.