Saturday, December 7, 2019
One of the biggest corporate law battles today concerns the appropriate role of institutional investors – and especially mutual funds – in corporate governance. There has been increasing concern expressed in the academy that mutual funds – especially index funds – don’t have sufficient incentives to oversee their portfolio companies, and/or that mutual fund complexes have become so huge that they dominate the economy. The concerns are rising to a level where the funds themselves are responding; witness, for example BlackRock’s attempted defenses here and here. And, of course, we have the SEC’s sneak attack on institutional power via proposed regulation of proxy advisors.
Which is why I found Fatima-Zahra Filali Adib’s new paper, Passive Aggressive: How Index Funds Vote on Corporate Governance Proposals, so interesting. She studies index fund voting behavior and contribution to corporate value by focusing on the “close call” votes, i.e., ones that narrowly pass or narrowly fail. She finds that index fund support is associated with value enhancement, and that these votes are not dictated by the proxy advisors (rebutting arguments that institutions blindly follow advisor recommendations). On the other hand, she also finds that ISS recommendations are not well correlated with value-enhancement, at least on the “close calls” – a point supporting the claim that proxy advisors do not know what they’re doing.
Also, fascinatingly – in direct response to those who claim that index funds do not have resources or incentives to devote to corporate governance – she concludes that funds allocate more resources to the “close call” proposals, apparently in anticipation that these are the ones where their votes will be pivotal. Her proxy for resource allocation is the fact that the fund voted against management (which suggests more attention to the issue). Bottom line is, funds are more likely to vote with management if they are “busy” – i.e., there are a lot of other proposals that require fund managers’ attention – but they are not more likely to vote with management, no matter how busy they are, if the vote is a close call. The voting behavior also suggests that index funds identify problem firms and continue to devote resources to them over time.
Anyway, that’s just a summary – there’s a lot here to dig into.