Opt-In Stewardship: Toward an Optimal Delegation of Mutual Fund Voting Authority
Corporate ownership around the world rests largely in the hands of institutional intermediaries. Even in U.S., once a bastion of retail investors, individuals now routinely invest through mutual funds, especially index funds. As a result, mutual funds own about one-third of the total U.S. stock market, and the “Big Three” fund families—Blackrock, Vanguard, and State Street—are the largest blockholders in the vast majority of large publicly traded companies. Recognizing that they these institutions have become a focal point of corporate governance power, policymakers worldwide have pressed mutual funds to engage with the companies they own. Many countries have gone so far as to adopt stewardship codes for institutional investors.
In Opt-In Stewardship: Toward an Optimal Delegation of Mutual Fund Voting Authority, I step back to address the fundamental questions raised by these developments. These include the basic issues of whether, when, and how institutional intermediaries ought to vote on behalf of their investors. What should investors expect from intermediaries with respect to voting? What should mutual funds be able to presume about their investors’ interests? Over what matters should funds exercise discretionary voting authority? And how should intermediaries vote when they do exercise discretion?
My paper argues that institutional voting authority ought to depend upon: (1) whether the fund intermediary possesses a comparative information advantage, and (2) the ability of the fund to assume a common investor purpose. The strongest case for mutual fund voting is one in which high-quality information is produced and the fund is able to assume a common investor purpose. The case for mutual fund voting is weaker when low quality information is produced or where funds cannot assume a common investor purpose.
Applying this framework to real life voting situations, the principal context in which mutual funds ought to exercise voting discretion is in "contests"—that is, proxy fights and M&A. In contests, meaningful information is produced, and the mutual fund has a comparative advantage over ordinary investors in analyzing this information. As importantly, in contests, the mutual fund intermediary can assume a common interest on the part of its investors.
The opposite situation is presented by environmental and social proposals. There mutual funds are not presented with meaningful information nor are they able to assume a common purpose on the part of their investors. Fortunately, unlike contests, there is no reason to suppose that management is conflicted in assessing environmental and social proposals. Mutual funds should therefore defer to management’s recommendation when voting on environmental and social issues. However, investors with differing objectives should be given an opportunity to opt out, either ex ante (through special funds) or ex post (through a form of pass-through voting).
Governance issues are distinguishable from both contests and from environmental and social proposals. Like contests (and unlike environmental and social issues), mutual funds can assume a common investor purpose with respect to governance. Investors will favor governance reforms that increase corporate value and oppose governance changes that decrease it. Also like contests (and unlike environmental and social issues), a manager’s recommendation with respect to governance reforms may be tainted by her own interests. Managers can be expected to disfavor governance reforms that restrict their authority or reduce their tenure. However, considering the unproven link between governance and performance, mutual funds do not have a comparative informational advantage in voting intelligently on governance. Therefore, in the absence of meaningful information concerning the effect of a given governance reform on the performance of a specific firm, mutual funds should abstain from voting on governance proposals. Instead, the votes should either be passed-through to investors or not voted at all.
My paper argues that these structures can (and should) be implemented through private ordering, between mutual funds and their investors, without governmental intervention. However, in many jurisdictions, including the U.S., government regulations may need to be modified to order to make private ordering possible. Furthermore, the theoretical framework articulated in my paper should guide policymakers in jurisdictions that either have adopted or are considering adopting stewardship codes.