Corporate Democracy and the Intermediary Voting Dilemma

Abstract

Corporate governance is changing. For the past two decades, the focus of shareholder voting and engagement was deconstructing impediments to shareholder power and increasing managerial accountability. The goal of these interventions was to increase firm value by reducing agency costs. Increasingly, however, environmental and social issues have risen to the fore. This new focus is arguably more about values than value.

This Article is the first to argue that, because of this shift, institutional intermediaries—namely, pension and mutual fund managers—can no longer vote and engage on the affairs of their portfolio companies without seeking the input of the pension-plan participants and mutual-fund shareholders who are their beneficiaries. We argue that the fiduciary duties of fund managers compel them to seek this input. We further argue that regulators should supplement existing fiduciary standards by adopting formal requirements that managers of mutual funds and pension funds seek input from their beneficiaries on their views, reflect those views in both their engagement efforts and their votes, and publicly disclose how they have complied.

At the same time, we caution against an approach in which fund managers shirk their intermediary role by implementing pass-through voting or rigidly voting in proportion to the preferences expressed by their beneficiaries. Instead, fund managers should engage in informed intermediation—a stewardship process in which they continue to exercise voting power over the securities in the portfolios that they manage and retain discretion in how to incorporate the input they receive from fund beneficiaries. This enables professional fund managers to use their sophistication and experience to translate beneficiary preferences—which might be incomplete, vague, and contradictory—into individualized and informed votes at each of their portfolio firms. It also preserves the ability of fund managers to leverage the economic power of dispersed beneficiaries consistent with their historical success in reducing the traditional collective action problems associated with shareholder voting. In reconceptualizing the role of intermediaries, this approach maintains the benefits of intermediation while better aligning intermediary stewardship with beneficiary best interests.

Keywords: Corporate governance, fiduciary duty, mutual funds, pension funds, institutional investors, shareholder voting, environmental, social & governance, ESG, shareholder activism, retail investors, intermediaries, securities regulation, fund management, agency, socially responsible investing

JEL Classification: G23, G28, K22