Document Type

Article

Publication Title

Harvard Business Law Review

Abstract

Shareholder voting has become an increasingly important focus of corporate governance, and mutual funds control a substantial percentage of shareholder voting power. The manner in which mutual funds exercise that power, however, is poorly understood. Because of the economic structure of mutual funds, there are particular reasons to be concerned about the extent to which mutual funds may seek to economize on the cost of their voting decisions by employing short cuts or delegating voting decisions to proxy advisors. These concerns, if true, hamper the potential effectiveness of regulatory reforms such as proxy access and say on pay. This Article analyzes mutual fund voting decisions in uncontested director elections—an area in which the likelihood that funds will employ voting short cuts is high because the information costs of informed voting are high, and the stakes are low. We find evidence that mutual funds use various cost-saving measures but that the incidence of implicitly delegating voting authority ISS is less than commonly believed, especially for larger funds. Only a small proportion of mutual funds as measured by asset size appear to vote in “blind reliance” on ISS recommendations. Although ISS recommendations are extremely important, their importance seems to take the form of identifying problematic directors, forming a focal point around which funds may consider withholding their votes. Most funds do not appear, however, to follow these recommendations automatically. To the contrary, as measured by asset size, more funds seem to blindly follow management recommendations than blindly follow ISS. We examine, in more detail, the voting behavior of the three largest mutual fund families: Vanguard, Fidelity, and American Funds. Together these three families account for more than one third of total mutual fund assets. We find that with respect to uncontested director elections the funds in these families vote largely in lockstep. Voting decisions of the three fund families differ substantially both from each other and from ISS recommendations. This is strong evidence of heterogeneity in the voting behavior of mutual funds in director elections. Finally, we examine the factors associated with high “withhold” votes in director elections. Although an ISS “withhold” recommendation is a key factor in triggering a high “withhold” vote, the effectiveness of the recommendation is limited unless it is combined with an additional factor. We identify four significant additional factors: a “withhold” vote by Fidelity, the director missing 25% of board meetings, the company having ignored a shareholder resolution that received majority support, and a Vanguard “withhold” vote on outside directors with business ties to the company. Our findings suggest steps that companies and directors should take to reduce the likelihood of receiving a high “withhold” vote.

First Page

35

Volume

3

Publication Date

2013

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