A new shareholder advocacy group has been formed, the Main Street Investors Coalition. The Coalition aims to mitigate the adverse effects created by the concentration of shareholder voting power that now resides in the hands of mutual fund advisors. This concentration has developed because of the growing popularity of index mutual funds and the industry practice of delegating shareholder voting rights to their advisors.
Shareholder voting, when it is done with the intent of maximizing the wealth of all shareholders, is an important component of efficient corporate governance. According to the Delaware Supreme Court, “[w]hat legitimizes the stockholder vote as a decision-making mechanism is the premise that stockholders with economic ownership are expressing their collective view as to whether a particular course of action serves the corporate goal of stockholder wealth maximization.”
However, advisors such as BlackRock, Vanguard, and State Street, now control, without having any economic interest in the underlying shares, the voting rights associated with trillions of dollars worth of equity securities. I refer to this as “empty voting”, a phenomenon that creates the potential for advisors to use their empty votes to act opportunistically at the expense of the 100 million retail investors who have entrusted them with their funds. This not only puts the legitimacy of shareholder voting at risk, but also increases the potential for non-wealth maximizing activism.
Unfortunately, this risk has already been realized. Despite their use by super successful companies like Google, Facebook, and Berkshire Hathaway, mutual fund advisors have joined forces with public pension funds to vigorously advocate for the elimination of dual class shares. They have also supported public pension funds in their crusade to implement proxy access at many public companies. Incidentally, public pension funds hold more than $4 trillion of assets that can potentially be invested in index funds.
But this is only the beginning. Based on the most recent Larry Fink letter to CEOs (discussed on the Forum here), it should be expected that as mutual fund advisors increase their level of shareholder activism, it will not necessarily be aimed at wealth maximization. The focus will instead be on demanding that companies serve all corporate stakeholders and identify a “social purpose,” no matter the impact on the risk adjusted returns provided retail investors. While this policy is perhaps helpful in garnering new clients for advisors and supporting the goals of non-profit corporations, it is one that advisors have no right to make their retail investors a party to.
Such an activist agenda does not represent the actual preferences of most mutual fund investors, including retail investors who hold shares through mutual funds. The Coalition believes that the overwhelming majority simply want to earn the highest risk adjusted financial return possible and believe that issues of activism should be resolved in the political arena, not in the capital markets. Moreover, I doubt that any of these retail investors have ever been asked to sign off on or even know about the activism that their mutual fund advisors engage in.
As a means to achieve the highest financial rate of return, investors must defer to the board of directors and executive management. Their decision-making authority are a creation of corporate law and serve as the two most informed loci of decision making authority in a corporation. Shareholders, for the most part, are uninformed in the sense that they do not truly understand the workings of the companies.
These uninformed shareholders include mutual fund advisors. After all, how can corporate governance departments of these advisors, composed of maybe 20 to 30 workers, be truly knowledgeable of any one company when they are annually responsible for making perhaps 170,000 votes at around four thousand U. S. public companies?
On its face, shareholder activism is not objectionable. Whether they are wrong or right, shareholders have a right to express their feelings about the activities of the companies they invest in. However, when activism is accompanied by a concentration of voting power that makes it almost a fait accompli, trumping the decision making of the board and executive management, then there is a problem. These activities by shareholders which lead to inefficient corporate decision-making are what Zohar Goshen and Richard Squire would call “principal costs.”
In general, such heavy-handed activism creates real burdens for targeted companies, uncertainty for other public companies that may one day be their targets, and reduced opportunities for retail investors to invest in the growing number of private companies who avoid or delay going public because of such activism. It is shareholder empowerment at its worst. We do not need mutual fund advisors participating in these activities.
The Coalition’s primary approach to reducing these principal costs is to educate retail investors about the harm caused by this concentration of voting power, and to encourage them back into the business of voting. It will explore multiple options to give retail investors back the vote including the implementation of new platforms that will allow them to provide standing voting instructions for the stocks they directly or indirectly own.
In essence, the Coalition will try to find ways to reunite voting rights with those who actually take the economic risk, the retail investor, an important and laudable goal.