Voting and the laws of unintended consequences

It would be fair to say that the importance of shareholder voting has enjoyed an increasingly higher profile in recent years, not least in response to the financial crisis. Just within the UK investment context, initiatives such as the Myners Principles, the Stewardship Code, the 2006 Companies Act, the Hedge Funds Standards Board Code, UCITS IV and of course the UN PRI all make various efforts to make voting more important or easier (or both). Regulators, industry bodies, NGOs and even the press have placed ever greater focus on voting. You might therefore find it surprising to find a proxy voting agency blog piece asking the question: “Why is it being made so important?”

Well, that’s because in our busy, 24/7/365 world, sometimes we don’t have time to consider what is actually the core issue here. Of course voting is important, but only as a part of a holistic investment process. If we don’t put voting in this wider context, we run the risk of attributing importance for the wrong reasons and, worse still, acting upon them. This applies not just to the quality of voting decisions (the argument of this piece) but also the quality of the voting process itself.

The over-selling of frankly impossible home-loans deals (mortgages) in the US, leading to the ‘sub-prime’ mortgage crisis is a case in point. There was an increasing need for affordable housing. Mortgage lenders and agents were incentivized to make housing affordable by lending ever greater amounts to the point where, in one notable anecdote in Michael Lewis’ book ‘The Big Short’, a Mexican fruit picker in California who had no English and an income of $14,000 was given a 100% mortgage of $724,000. The importance of the mortgage arrangement fee was made more important than the health of the loan simply because the mortgage lender (especially the unscrupulous one) was able to sell on the default risk through ever-complex financial alchemy, so that the ultimate bearer of that risk literally had no idea what it was until they found out both too late and the hard way. Lenders and their agents could earn massive sales bonuses without bearing any downside risk on the quality of the product they were selling.

We run the risk of the same thing happening in voting. If we make voting so important that everyone thinks it must be done, we lose sight of what its value actually is. And it’s not the act of voting that’s important of course, it’s the quality of decisions the votes convey. Here’s the unintended consequence of viewing voting as ‘mandatory’: If voting increases without a concomitant increase in investor-led thinking behind the voting, then the influence that increased voting brings falls under the control of someone who’s not an investor.

That makes advisors who are unaccountable in terms of investment risk and return in the middle very powerful, deciding important questions not just about corporate governance strategy, structure and remuneration, but also outright investment decisions such as takeovers, mergers and share capital (and all manner of other issues which company law deem important enough that shareholders must be consulted). Is this the way investors make buying and selling decisions, following advisor recommendations, some of whom have target companies as clients too? Perhaps those buying CDOs on the back of triple A credit ratings might have done once upon a time, but that era is now defunct.

As an industry, we must be vigilant to ensure that more voting is accompanied by considered use of voting rights within the wider investment process. This isn’t about DIY, it’s simply about adequate job management. Many of those mortgage lender agents who enjoyed some very good years until 2007 are now out of a job. Why? Because eventually the table at which they were feasting collapsed under the weight of the food they demanded – they were incentivised by a systemic failure to not care about the very market their long term futures actually depended upon.

Voting is important not because regulators say it is, but because considered use of voting rights contributes to value preservation and growth. If owners don’t take hold of that, someone else will do so for them, and will stand to profit handsomely from it at the cost of owners who should benefit from being in control themselves.

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