Sunday Brunch: proxy voting should be part of engagement and value creation.
Proxy voting can be made better. This is important for all investors. Two foundations should be, better linking voting outcomes to long term value creation, and making proxy voting an integral part of the corporate engagement process.
“Companies see proxy voting mainly as a legal obligation rather than a meaningful engagement tool. At the same time, investors often approach it as a low-priority, box-ticking exercise” Beyond the Blame Game: Why the Proxy System Needs to Change FCLT Global 2024.
Proxy voting is about the resolutions that shareholders are asked to give their views on every year at the company AGM. These include appointing directors & auditors, and approving the accounts. Plus sometimes making advisory votes on sustainability strategies etc.
To many investors proxy voting is boring admin. But they could not be more wrong ! Proxy voting should be part of every shareholders company engagement process.
And I would go a step further. Given that good governance is an important contributor to long term value creation, investors should be using all the tools they have at their disposal to make sure that the companies they are invested in are well run. This is investing 101. And so making the proxy voting system work better makes good investing sense.
Let's start from the basics. As shareholders we might own the company, but we don't run it. Management do this, watched over by a board of directors. So, how do we as shareholders oversee and critique what management are doing with our money? If you are Blackrock (or another big shareholder) you probably meet with senior management on a regular basis, and maybe even meet the chair/board.
But for everyone else we have to use other points of leverage. One of the best ones we have is proxy voting. All companies have to offer us the opportunity every year to vote. It doesn't matter how many shares we own, we get to vote. If the company is not being run the way we want, this is our opportunity to have our say.
But, as with all communication, just voting is not enough. It has to be part of a wider engagement process.
For proxy voting to be effective companies need to understand why we are voting the way we do. For this process to work, we need to start expressing our 'concerns', probably via Investor Relations, really early in the process. It usually starts with a question - why is the company doing (or not doing) something? By the time we get to the vote, it's possible that the company has been persuaded and we have no need to vote against. Or, we might feel that not enough disclosure and progress has been made, and so we need to start to escalate our engagement - reflected in our voting.
This means that proxy voting is a key part of how we express our views on how the company is being run, and a key element in how we set out the 'extra' disclosures we need them to make that would allow us to make informed investment decisions.
It's pretty widely agreed that the current proxy voting system doesn't work as well as it could. So how can we make it work better? This is where a recent report from FCLT Global entitled Beyond the Blame Game: Why the proxy voting system needs to change comes in. They have spoken to companies and investors, and not only diagnosed the problems but also come up with some possible improvements.
Matthew Leatherman
Beyond the blame game - why the proxy voting system needs to change
If you care about active investment management this report is well worth a read. And even if your interest in investment is only via passives, I would argue you still need to care. Without proper governance by asset managers and asset owners, how do we encourage companies to focus on value creation and making their business models sustainable? Informed proxy voting should be an integral part of this.
I am going to largely skip over the criticisms of the current system they highlight and move straight to their suggestions for improvements. But before I do I want to highlight one comment that will probably resonate with many investors, and those who work in investor relations....
"the system has devolved to a point at which investors and companies simply go through the motions of voting"
So how do we make the system work better? Because quite frankly the alternative (having no real say unless you are the larger investors) is unappealing?
The report has two sets of suggestions. The first are focused on making the costs more manageable. One alternative is to use machine learning/AI to identify those votes that need further analysis and thought. I can see some merit in this. Other suggestions I find less palatable - such as reducing the votes to cover only director elections, and raising the standard for shareholder proposals. The danger here is that we end up reducing the value of proxy voting even further, which is likely to accelerate its decline.
Which brings us to the second set of suggestions, making the proxy voting process more valuable. Again my views on these are mixed. Some, such as 'engage before voting' I wholeheartedly support. Others also have merit, such as requiring companies to give more notice of the detail of the votes to be proposed. As they say .... 'it's untenable to protest that research on the votes by investors is poor, when time constraints may be a contributor to why it's that way'.
But I would argue that there is another issue we also need to address, how asset managers see proxy voting in the context of their own investment processes. As the report says :
"investors generally believe that proxy voting does not affect their long term investment process in any attributable way, so they limit their efforts"
In many ways this point lies at the crux of how we can make proxy voting work better. If asset managers and asset owners see how the votes are linked to long term value creation by the companies, then they are more likely to be engaged in the process.
Like me you might not agree with all of the suggestions they make in the report. But we need to acknowledge that the current system could be made better. I would argue that the first step is to better link voting outcomes to long term value creation. And the second step is to view the proxy voting process as being an integral part of our wider corporate engagement process, rather than an end in itself. Yes, cost matters, but achieving lowest cost should not be the objective.
One last thought
If we are to improve the link between proxy voting outcomes and long term value creation, then we all need to improve our understanding of how accounting reporting relates to sustainability. We discussed one example of this, how current financial reporting effectively ignores the investments that create the majority of a company's financial value - their intangible assets (including many environmental, social and governance factors), in a recent blog.
Steven Bowen
Please read: important legal stuff.
