Index funds now control half the U.S. stock mutual-fund market, giving the biggest funds enormous power to influence decisions and demand better returns at the companies in which they invest trillions of dollars.
But the leading U.S. index fund firms, BlackRock Inc., Vanguard Group and State Street Cor.p, rarely use that clout. Instead, they overwhelmingly support the decisions and pay packages of executives at the companies in their portfolios, including the worst performers, according to a Reuters analysis of their shareholder-voting records.
The three fund firms, for instance, supported doubling the pay of the chief executive at California utility PG&E Corp. after its stock plummeted over potential liability from maintenance problems linked to California wildfires. The funds supported big pay packages for executives at beauty products company Coty Inc. – including nearly US$500,000 for their children’s tuition – as the company struggled to digest its acquisition of Procter & Gamble Co.’s beauty business. And all three cast pivotal votes against the proposed reform of splitting the CEO and chairman roles at General Electric Co. after a decade of poor performance.
Such votes reflect a larger trend of deference to management, according to an analysis of proxy voting at 300 of the worst-performing companies in the Russell 3000 Index, as measured by three-year returns through the end of 2018. The analysis was conducted for Reuters by shareholder-voting data firm Proxy Insight.
The study looked at the 300 worst performers who held proxy votes in 2018. It found that BlackRock voted with management 93 per cent of the time, followed by Vanguard at 91 per cent and State Street at 84 per cent during the proxy year ended June 30, 2018. The analysis showed that the three index-fund firms supported management at the worst-performing Russell 3000 firms only slightly less often than they did for all companies in the index, regardless of performance.
“If we think that informed and engaged shareholders play an important role in disciplining company management, the rise of index investing is a problem,” said Dorothy Lund, a law professor at USC’s Gould School of Law and an author of several published corporate-governance studies.
Actively managed funds also routinely support management in proxy ballots. But their voting records are not directly comparable with those of index funds because active managers routinely signal their displeasure with company management by simply dumping a stock or never buying it. Index funds, by contrast, are prevented from active trading by their own rules because they aim to match, rather than beat, the market. They are required to own all the companies in the index they track, such as the Russell 3000 or the S&P 500 – high-flyers and dogs alike.
That leaves proxy voting as the primary leverage for index-fund firms to hold companies accountable for practices that undermine shareholders’ interests, such as exorbitant executive pay. But the index providers face powerful disincentives in confronting management at the companies in their portfolios, industry experts said.
With no mission to outperform market indices, the funds lack a financial incentive to ensure that portfolio companies are well-run, Prof. Lund said. Their business models also rely heavily on recruiting everyday investors away from actively managed mutual funds with the promise of lower fees. And large companies – such as the ones in major stock indexes – are key to acquiring new customers for the big fund firms: BlackRock, Vanguard and rival firms count on corporations to offer their funds to employees in retirement plans, which often limit the options workers can select.
Those vital business relationships mean index funds treat their portfolio companies more like clients, Prof. Lund said in an interview.
“The problem is going to be greater as these index funds get more money,” she said.
The index-fund firms say they take seriously the watchdog role that institutional investors have historically played in the stock market. Proxy voting, they say, is only a small part of their regular engagement with companies, and they prefer to address problems privately.
“Continuing to have a dialogue without airing all of our dirty laundry” helps maintain long-term relationships, said Glenn Booraem, who oversees Vanguard’s proxy voting and its interaction with portfolio companies.
BlackRock said it talks or e-mails with executives and directors – sometimes for years – before voting against them. “A vote against management is a sign of a failed engagement,” Michelle Edkins, who oversees BlackRock’s proxy voting, said in an interview.
“It’s wrong to measure the effectiveness of BlackRock’s investment stewardship efforts solely by our proxy voting record,” BlackRock said in a statement. “That fails to recognize our process of engaging directly with companies to enhance the long-term value of our clients’ assets.”
BlackRock, State Street and Vanguard all declined requests to discuss their votes on specific proxy proposals at poor-performing firms, or to provide details of their private interventions at laggard companies. State Street declined to make executives available for comment.
“We use our voice and vote to influence companies on long-term governance and sustainability issues,” State Street spokeswoman Olivia Offner said in an e-mail.
Proxy votes on proposals by the company or its shareholders influence key issues of executive pay, director appointments and strategic plans, along with a company’s actions to address controversial issues such as climate change or gender pay equity.
BlackRock opposed executive pay just 3 per cent of the time in 2018 at Russell 3000 companies and Vanguard opposed pay 5 per cent of the time, according to Proxy Insight. State Street funds did not support pay 9 per cent of the time in that group of companies, according to Proxy Insight. The figure includes a small number of abstentions by State Street.
Compare that with the United States’ largest public retirement funds. The US$378-billion California Public Employees’ Retirement System opposed executive pay 53 per cent of the time in the first seven months of 2019 at U.S. companies, according to its latest report.
The US$210-billion New York State Common Retirement Fund opposed executive pay packages 27 per cent of the time last year at U.S. companies, a spokesman for the fund said. The US$200-billion retirement system run by the Florida State Board of Administration voted against executive compensation 64 per cent of the time among 2,226 U.S. companies during the twelve months ended June 30, Jacob Williams, the system’s corporate governance manager, told Reuters.
Some activist investors cite the low rate of negative votes by top investors as a reason for the persistence of unpopular corporate practices, such as rich executive compensation and poor disclosure of climate impacts. Median CEO pay rose 25 per cent to US$12.1-million in 2018 from US$9.7-million in 2014 at the 500 largest publicly-traded U.S. companies by revenue, according to the latest disclosures analyzed by executive pay researcher Equilar.
Company leaders usually won’t even discuss an issue unless about a third of investors cast opposing votes, said Tim Brennan, who until June oversaw proxy votes and resolutions as chief financial officer for the Unitarian Universalist Association.
“The votes definitely matter,” he said.
CalPERS investment director Simiso Nzima said CEO pay design would improve if other big investors voted more critically.
“Talking to companies behind the scenes on this particular issue is a bit like trying to boil the ocean,” Mr. Nzima said.