In his 1914 collection of essays called Other People’s Money and How the Bankers Use It, Louis Brandeis argued that powerful men such as J.P. Morgan leveraged unbalanced control of the public’s assets to their own benefit. Over one hundred years later, not much has changed. If Brandeis were alive today, you can be sure that he would be advocating for new systems of financial accountability for those on top of the financial hierarchy.
The world now has more stock owners than ever before. Increased ownership is a triumph for the free markets, but it also diminishes the influence of individual investors. While John Pierpont “J.P.” Morgan can use his influence to stuff the board of directors of Standard Oil with “Morgan Men,” John the UPS driver might not even realize that he owns a small piece of Exxon stock in his 401(k) plan. In fact, if John the UPS driver owns Exxon stock through a mutual fund, he lacks a single vote to determine the board of directors.
The very funds that make it possible for average investors to access the capital markets also carry the responsibility to vote their shares. But many question whether institutional fund companies take this responsibility seriously. Institutional ownership has grown by leaps and bounds, from 6.8 percent in 1945 to more than 60 percent today. The fund company has become the so-called “legal owner,” and the role of folks like John the UPS driver is relegated to that of “beneficial owner.” This means that the fund company retains the power and influence of ownership, but it is still considered an agent of the beneficial owner.
Delegating investment management offers many potential benefits to the majority of investors who lack the time and expertise to understand and respond to corporate matters. As aggregators of many investors, some fund companies are very powerful. For example, Vanguard, Black Rock, Fidelity, and State Street are the largest shareholders of Apple Inc., the world’s biggest company by market value.
However, fund companies have generally been accused of being more content to quietly side with corporate management than to stick up for their investors. This has not stopped the founder of The Vanguard Group, John C. “Jack” Bogle from becoming an outspoken critic of his own industry for failing to live up to their responsibilities as stewards of other people’s property.
Bogle points to spiraling executive compensation as a symptom of a larger problem. As Bogle explains in The Clash of the Cultures, since 1980 executive compensation has risen twice as fast as the earnings growth rate at America’s large corporations. During that time, CEO compensation relative to average worker pay started at a ratio of 42-to-1 and now stands at 320-to-1. Fund companies have been largely silent about this trend until recently forced to make their opinion public on so-called “say-on-pay” votes.
Fund Companies Have Conflicts of Interest
Investors have every right to question whether a fund company like Fidelity can cast an impartial vote on an executive compensation package while those same corporate executives are deciding whether to invest their 401(k) and pension plan assets with Fidelity. Recent studies suggest that the largest fund companies exhibit the most corporate-friendly voting patterns. Neither group has much incentive to criticize the other, and Bogle calls this moral hazard a “happy conspiracy.”
If all corporate management teams were always looking out for the best interests of their shareholders, you would expect more common outcry when their close friends and family members were offered positions on the board of directors. Or when executives award themselves the promise of an overly generous golden parachute in the event of acquisition. But executive elites have little reason to follow best practices in corporate governance if the shareholders fail to demand it.
Without significant outside pressure, I don’t expect fund companies to respond to Jack Bogle’s calls for increased fiduciary support of shareholders.
Investment Advisors Lack Motivation
Registered investment advisors (RIAs) have a fiduciary duty to serve the best interests of their clients, but most of them are largely silent on issues of corporate governance. Fund companies are required by the SEC to vote proxies on behalf of those who entrust their investments to them, but RIAs are under no such obligation. Most state explicitly on their ADV disclosure that they do not vote proxies and leave the responsibility with their investors. These firms have determined that the benefit of voting individual share proxies is not worth the effort and liability.
My attempts to inspire RIAs to work together in pursuit of a more robust shareholder advocacy effort suggests that this group is not ready. In 2014, I wrote the headline article for our association journal titled RIAs and Corporate Governance: Ready to Take the Lead? and the editor was very excited but I am still waiting for the first comment from a practitioner. This was followed up by a shareholder advocacy seminar given to our 2015 NAPFA national conference which received a similar response.
Like the fund companies, I don’t expect to see much movement on corporate governance issues until investors start demanding it. This begins by developing awareness and asking some penetrating questions of your investment managers. One preliminary question is simple: “Please share with me what you are doing to manage my shareholder voting rights.”