Environmental & Social Voting at Index Funds

Abstract

How should index funds vote? This difficult, fact-dependent question is more important than ever due to index funds’ growing dominance. By voting one-quarter of shares at large public companies, just three index funds increasingly control American corporate governance. Nowhere is this control more acute than in the case of environmental and social (“E&S”) voting. The “Big Three” funds—Vanguard, BlackRock, and State Street—have the power to determine the fate of the bulk of E&S proposals.

This Article demonstrates that, despite a considerable marketing focus on their E&S efforts, overall support for E&S proposals is low at the Big Three. In the 2018-2019 proxy season, the Big Three supported between 7.1% and 22.7% of such proposals. Other funds supported E&S proposals at far higher rates (e.g., Deutsche Bank at 77.9%) and far lower rates (e.g., Dimensional at 0%).

Given that funds have a fiduciary duty to vote in the “best interests” of their investors, which fund got it right? The surprising answer is that no one knows—not even the funds themselves. Only by blind luck could these funds, which make no serious attempts to discern investors’ preferences, be accurately reflecting investors’ interests with their voting behaviors.

Ultimately, this Article concludes that it is a convenient myth that index fund stewardship teams are even marginally constrained by the “best interests” standard when voting on E&S proposals, and likely other proposals as well. The truth is that these index funds, possessing the power to decide the fate of most E&S proposals, can do as they wish with that power. The status quo urgently needs change to ensure that index funds, the new arbiters of global corporate governance, are truly acting in investors’ best interests. This Article proposes that such change should come in the form of greater input from index fund investors.

Keywords: Index funds, ESG, stewardship, passive investing, corporate governance, engagement, agency problems, institutional investors, shareholder voting, big three

JEL Classification: K2, K22, G3, G23, G28, G3, G34