The Risks and Rewards of Shareholder Voting
Bottom Line: There is a collective action problem with shareholder voting that the use of proxy advisors does not solve. Regulators, shareholders, and managers should always be extremely wary of any proposal to increase the use of shareholder voting as a decision-making tool.
A collective action problem lies at the heart of shareholder voting leading to uninformed votes. Rational investors are compelled not to invest in being informed when voting because the expected payoff from making such an investment is simply not adequate.
The use of proxy advisors does not solve the collective action problem of shareholder voting faced by institutional investors. Proxy advisors exist in an industry where there is a clear mandate to produce low cost, low-value voting recommendations within a resource-constrained business environment.
Shareholder wealth maximization is not necessarily the only or even its primary objective of shareholder voting. The strategy of using stakeholder preferences, especially client preferences, may create significant bias in voting recommendations.
In general, it will always be more profitable for shareholders to use their limited resources to invest in stock valuation, such as the fundamental analysis provided by equity analysts, than to spend their resources on costly high-value voting recommendations.
There is strong evidence that the two major proxy advisor firms utilize a low-cost, low-value (not truly informed) approach to the creation of voting recommendations, leading to imprecise recommendations.
The strategy of mitigating governance risk with the creation of voting recommendations, whether used by proxy advisors or investor stewardship teams, is a one-size-fits-all approach that leads to the creation of voting recommendations that are not very informed or precise, at least in terms of enhancing shareholder value.
The SEC’s recently proposed rule changes for shareholder proposals, which according to the SEC’s own analysis will most likely have the effect of significantly reducing the annual number of shareholder proposals submitted to public companies, is a reasonable reaction to the risks of shareholder voting. Keeping shareholder proposals and the potential voting on them to a minimum should be considered desirable.
Shareholder voting is a necessary component of corporate governance. However, it does have many risks which cannot be ignored. Because shareholders can generally be uninformed, shareholder voting has the potential for opportunistic voting with uncertain objectives. Such decision-making must be kept at a minimum.
Read the full comment letter here.