null Episode 16: Proxy Voting: The Power of the Shareholder
Double Take podcast

Episode 16: Proxy Voting: The Power of the Shareholder

00:55:04
Double Take podcast Audio Responsible Investing Equity Multi-Asset Index
March 2021
Episode 16: Proxy Voting: The Power of the Shareholder

Our latest episode of Double Take explores how proxy voting, when approached with the utmost diligence, can align shareholder and management interests, increase transparency and encourage long-term change that benefits all stakeholders. We also examine the role of proxy advisors and activist investors and how ESG concerns have evolved the proxy voting environment. 

Rafe Lewis: Hello and welcome to episode 16 of Double Take. I'm your co-host, Rafe Lewis, Mellon's director of investigative investment research.

Jack Encarnacao: And I'm your other cohost and investigative researcher, Jack Encarnacao. And upon us, the annual rite of spring that so many investors await with bated breath, proxy voting season. I can hear the crowds roaring at the mere mention of it. I hope I don't sound too sarcastic, but there's much change afoot in proxy world. Proxy votes are looked to as potential ways to achieve broader equity goals. The conversation is evolving well beyond voting yay or nay on a company's board members. So we felt it was a particularly good time to dive in and give you folks the latest.

Rafe: You know call me wonky Jack, but I'm actually pretty jazzed to get into this. We have two great guests to explore what's happening in proxy land. First, we have Mellon's own John Bailer, a senior portfolio manager at the firm for nearly three decades and the chair of Mellon's proxy voting committee. And we also have a proxy voting scholar and researcher, Paul Calluzzo, who's formal title is associate professor of finance at the Smith School of Business at Queens University in Canada.

Jack: If I bait my breath any longer, you'll need to call an ambulance Rafe. So let's get right to it. First up, John, John, welcome to Double Take. It's great to have you.

John Bailer: Yeah, great to be here. Thanks guys.

Jack: Our pleasure. So before we hit you with questions, let me just quickly give our fair listeners some context for the discussion if they're not intimately familiar with the topic today. Put simply, proxy voting allows shareholders a chance to directly express their desire to change the governance and decision-making of a given public company. For many, many decades, the overwhelming focus of these votes seems to have been on governance, particularly approving who serves on company boards and the compensation and incentivization of CEOs to do right by shareholders. If you own something, you expect to have some say in what happens to it, right? Well proxy, Rafe, is the mechanism that shareholders have to do that.

Rafe: Yeah, and I would say more recently as investors have increasingly trained their sights on the environmental and social impacts of public companies, the ESG topic we harp on constantly here, proxy voting has begun to reflect those concerns too, just a little. So John let's hand you the baton at that moment. In your opinion, what can shareholders really achieve via proxy voting and does real change more importantly ever come?

John: Yeah, well those are great questions and I am a big believer and the committee is a big believer that we can have a change and we can influence outcomes as we engage with management. So I'll just give you a little sense of how we approach proxy voting. We believe that the same analysis and engagement that we apply to our investment activities should be applied to proxy voting. So we are fundamental bottoms up investors. We analyze our companies in great detail. We believe that that same analysis and engagement should be involved in the proxy voting process. So I think that's an important point to make to start off this conversation. So what can we achieve in proxy voting? I really think there's three main things that we can achieve. One, we have the ability to align the interests of shareholders with that of the board and company management.

John: Two, we can encourage transparency and disclosure. And I think that's a really important point that we're voting on many times, especially with shareholder proposals. And then very importantly, it gives us the opportunity to engage with company management and encourage long-term thinking that benefits all stakeholders. And we're big believers that if a company is looking out over the longer term, they're doing the right thing for all their stakeholders, not only their shareholders, but their employees, their customers, and the environment. So that's an important three points that we have that we feel like we can achieve through the proxy voting process.

Rafe: That is really interesting. I'm just learning something just now about my own firm I didn't even understand, which is that you guys are conducting a fundamental bottoms up research when it comes to proxy voting. Can you just give our listeners a sense of what that actually entails?

John: Yeah, so we look at thousands of proxies a year and importantly, when we get these proxies that are coming to the committee and we're looking through them, we're doing a lot of analysis. A big part is the compensation analysis. And we've got a proprietary compensation slide deck that we look through that looks at the TSR, the total shareholder return of that stock versus its peer group. We also look at the length of the compensation, how much performance-based compensation versus time-based compensation. And this is all condensed in a very easy to understand three page usually slide deck. What else it gives us, the slide deck, is the understanding of what ISS and Glass Lewis, two firms that we hire on the outside, that gives us their opinion on what their perspective is on a shareholder proposal or a say on pay vote, which is the compensation vote that we can vote on for the majority of companies.

John: And then what we do as well is if there's anything that's controversial, we reach out to the portfolio manager that owns the stock or the analyst that covers the stock and we'll engage with them to see what their perspective is on any given issue that is coming before the proxy committee. So we're doing a lot of that analysis in conjunction with the investors at our firm. And we do think that makes us very unique versus a lot of other proxy committees, we're all investors and we do engage with the PMs and the analysts that actually own the stock.

Jack: Yeah, that's interesting. And I'm glad John, that you mentioned two of the key proxy advisory firms. We're going to talk a lot more about the role they play in the proxy process in the second half of our episode with Paul, but I'd like to hone in on executive compensation and say and pay. How have you seen the way CEOs pay change in your career? Are the goals that are asked to achieve changing? What incentive structure do you think is most effective for CEOs?

John: Yeah, so a lot changed in 2010 with the passing of the Dodd-Frank Wall Street Reform Act. And that created a rule that companies needed to have a say on pay vote. The majority of companies that we look at have the say on pay vote on an annual basis. So one of the biggest things that we vote on and the reason we have this compensation dashboard is the compensation for management teams. And we think that's incredibly important because we believe compensation does drive behavior for management teams. So it's a really important vote that we have on an annual basis for the majority of our companies. And to give you a sense, we vote against around 45% of those say on pay votes. So we still believe that the compensation could be better aligned with performance on 45% of the companies that we vote on because we voted against them over the last year.

John: And peers vote against three to 10%. So really, we stand out in terms of how much we vote against that say on pay proposal, the compensation of managements. But I would say that we are looking for pay that that is tied to performance. And ideally, I like pay that's tied to total shareholder return. It's so difficult to know whether a management team is doing well or not based on other factors, whether it's revenue growth or earnings per share, some of that can be manipulated. I know Elizabeth Warren has been talking about share buybacks can manipulate earnings per share growth. I'm actually a fan of buybacks. I think there's other reasons you do buybacks, but that is a possibility. You could buy back a lot of your shares and your earnings could stay the same, but your earnings per share, if that's a metric that is getting measured on the compensation plan could be going higher just because you're buying back shares not because you're increasing the net income of a firm.

John: So importantly, we're looking at a lot of those metrics on how compensation is tied to total shareholder return. The other thing we're looking for is the performance that are performance based versus time-based. So we want for our large cap companies, we want two thirds of that compensation plan to be performance based. When we say performance based, what we're talking about are PSUs, performance shareholder units, or options, we include both of those as performance-based ways to compensate management teams. On the other hand, RSUs, restricted stock units, are time-based. And so management teams will get those irrespective of how the stock price does or how some of the other metrics that are tied to performance, and that's the type of compensation that we want to have lower and lower. And so that's the majority of times and why we vote against managements because they don't have enough of that performance-based compensation. And those are the two big areas that we're focused on.

Rafe: So John, a lot of that is us expressing our satisfaction or dissatisfaction as kind of a nudge to management teams and to boards, they don't necessarily have to listen to this. But we do have a real binding vote as shareholders when it comes to approving or voting down candidates for company board seats. And so I guess what I'm wondering is how can proxy votes help ensure that board members aren't just rubber stamps for the CEO and that they actually feel some pressure to listen to shareholders and cast votes on company plans accordingly?

John: Yeah, so that's a great point. So these say on pay votes are an advisory vote. Management doesn't have to listen to the shareholders. But management does. What you'll see is if there is a low percentage that a management team gets on that say on pay vote. They usually go out and reach out to shareholders to ask them, "Why did you vote against our say on pay?" And if they don't do that, if they're not engaging with the clients, the shareholders that they have, then what will happen is we will start to vote against the directors. We'll start to vote, we'll start with voting against the chairman of the compensation committee. And if they don't change their behavior, we'll start voting against other members on the board. And at the end of the day, to your point, what's really important, what managements really care about is keeping those director jobs.

John: And so when we start voting against the directors, that really gets the company's attention, and that's really the major power we do have as shareholders is to vote against those directors. And that's usually when change happens when we start to do that. But once again, it is a good message when you're voting against that say on pay and they have a low threshold on the approval. It does start to create some change. Usually what the companies, the poorly performing companies, the poorly managed companies, there is no change. And then that's why we step it up to vote against the directors.

Jack: Generally speaking, John, there doesn't seem to be a lot of regular turnover on corporate boards, but why do you think that is? And should there be more?

John: Yeah, so one of the things that we have in place is a tender threshold. So we believe there should be good diversity on boards. We think there should be tenure diversity, we think there should be gender diversity, and we also believe there should be racial diversity. Diversity on thought on boards is a key component on a successful management or a successful way to evaluate how the management team of a company is doing in the terms of the shareholders. And obviously the directors are acting in the shareholders’ interests. So we do believe that the tenure is important. We use the threshold of 12 years. So we're looking for a board that has an average tenure of 12 years or less. And we really do think that helps with this whole concept of an entrenched board that is rubber stamping management's decision. If you have less than 12 years of average turnover, we think that that leads to less entrenchment on board. So we do take that seriously, and we do have that threshold in place as we're looking at tenure on boards.

Rafe: John, from the insane power outage situation in Texas as a result of crazy winter weather to wildfires in California, we in everyday life in the United States and around the world, I think are starting to feel climate change. And a lot of the climate crisis is created by emissions from public companies. So I guess the question is can and should climate change be addressed by proxy voters?

John: So my belief is it should be, it's an important consideration that I think shareholders have in analyzing individual companies. The way we look at it on the committee is that it's a risk for many of our companies, climate change. And so we're looking for shareholder proposals that ask for more disclosure. We don't want it to be too prescriptive. We want management teams to have some flexibility in terms of how they address climate change in their individual unique circumstances. But we do believe that shareholders have the right to have more disclosure on the risks that are involved in climate change in terms of the company's business. So we have shareholder proposals come before us on climate change, and that's really what we're looking for, we're looking for areas where a company can be more transparent about the risks.

John: And there's no doubt, there was a lot of climate change proposals last year, was about 160 climate change proposals. We think that's going up over the next few years. We think climate change is an important consideration that we as active investors need to have when you evaluate our companies and that we need to encourage from a proxy voting standpoint more transparency in terms of disclosing those risks to shareholders.

Jack: Yeah, disclosure are very important on this particular topic. Do you think, John, we're going to see more ESG climate related shareholder proposals make it to an actual vote, get some traction, get attention of boards? We see headlines like Edelman, which is a global communications firm recently surveyed a lot of investors and found that 69% of them want executive comp to be linked to achieving ESG targets for example. Do you expect more and more of this?

John: I would definitely expect more and more of those type of shareholder proposals, and we have to take a look at them on a case by case basis. We don't have any rules specifically around tying compensation to shareholder goals. At the end of the day, I'm the biggest fan of total shareholder return and tying compensation against that. But each individual shareholder proposal and proxy vote, we'll analyze and determine whether it makes sense for that company or not.

Rafe: John, in the last decade or so, we've seen a real rise in dual class share structures. What does that mean for us institutional investor types and how can we express our pleasure or displeasure at this trend via proxy?

John: Yeah, so that's a good question. And we do have a good debate on the proxy committee on whether dual class structures make sense. And we do have a good debate within the firm. There are small cap companies that have come in front of the proxy committee where we reached out to our portfolio manager who owns the stock and the analyst that own the stock to get the reasons why. We've had lengthy discussions with the chairman of a lot of these firms and the CEO of a lot of these firms to determine whether a dual class structure makes sense. I would say just in a broad sense, I don't believe in dual class structures, I think each shareholder should have one vote and you shouldn't have a group of shareholders that have 10 or 20 super voting majority chairs.

John: I just don't think that is a good way to run a public company. If it's a private company, you can do whatever you want. But if you're asking for shareholders capital, I think each shareholder should have one vote. But that being said, we do look at these instances where you have a shareholder proposal on getting rid of the dual class structure or having a sunset provision of the dual class structure. And we'll evaluate them on a specific proxy basis. We don't have a rule that says we're going to vote against every single dual class structure, but it's a high hurdle when we're discussing it on the proxy committee to have us agree on a dual class structure.

John: There are some cases where it's a really young firm, maybe they're worried about getting taken over, and we want to give them a little more time to be run as more like a private company with that super majority shares. Well we'll give them let's say three years after the IPO, but once again, we really encourage companies to have a sunset provision in that case, if that's the time they need to start to become a bigger company and a more well-established company, they're investing in the business heavily. Maybe you don't want to have any activists come in there in the first few years as a public company. But other than that, we really encourage one vote for one share.

Jack: John, there's a long standing debate about whether a given company should have the same person as its chairman and its CEO. And that's been the case at some of America's biggest and most successful companies, yet it can introduce big risks that there's no check on the CEO's behavior and decisions when it's structured that way. Where do you come down on that?

John: Yeah, so this is a change. We used to, back a few years ago, we used to allow to have an independent chairperson as long as there was one that was independent on the board that had some authority to make some decisions. We used to allow companies to have this combination of CEO and chairman, but we changed that a few years ago, and our belief now, and also ISS has been recommending against the combination of the CEO and chairman as well. And we believe that you should have an independent voice that represents shareholders, and that should be at the chairman level. And I think in that case, sorry about that. So let me answer that question again, as my Bloomberg goes off. I'll put it on mute. So anyways, so in terms of the CEO and chairman combination, our belief is there should be a separation between the CEO and chairman.

John: We believe there needs to be an independent voice that represents all shareholders. And if that chairman is part of the management committee at the firm, that's not an independent voice, and it's particularly important to us to know that there is a independent person that is representing the shareholders. So even in the biggest firms and CEOs that we really think are doing a great job for their companies, we have been encouraging over the last year to separate that the CEO and chairman, and that is a change from what we've done in the past.

Rafe: Last one, John, we have seen in the last several weeks and months that retail investors can exert amazing influence on the public markets now. This whole meme Robinhood Reddit trade that we talked about in our prior episode. So here I am, retail investor at home, I'm opening up my mail, I see the proxy envelope show up. And in years past, probably just tossed it in the recycling bin. But is that naive? Is that misguided? Should retail investors actually be taking time and voting proxy themselves? What's your advice to the folks out there?

John: Yeah, so my advice is absolutely, it's a little bit like voting on the presidential election. Every vote counts. And I know I personally, the stocks I own personally, I vote all my proxies and I know there's a lot to go through when you look at all that proxy information you get before a vote. But I really think that it's important, one for retail investors, as well as institutional investors to read through those proxies and understand how managements are getting compensated. What are some of the shareholder proposals that are out there? What are some of the risks that people are talking about? I think it helps you become a better investor in the company that you own.

John: And I think everybody should vote their shares, and have a voice in how the companies you own perform their duties. And I think that's something that I have to remind CEOs, which is they don't own the company. You as a shareholder owns the company and you have a lot of power and by voting your proxy votes, you're exerting that power to encourage change at the company you own. So I would highly recommend that every retail investor vote the proxies.

Jack: As important a consideration as ever, proxy voting on the table this week on Double Take. John from Mellon, we thank you so much for joining us and sharing your takes on what's changing out there.

John: Thank you.

Jack: Okay, that was a lovely little interlude. Welcome back folks. As promised, joining us to dive still deeper into the shareholder public company relationship is Paul Calluzzo, associate professor of Finance at the Smith School of Business at Canada's one and only Queens University. Paul's research focuses heavily on corporate governance, shareholder activism, and proxy voting. Paul, welcome.

Paul Calluzzo: Thank you for having me. It's going to be a pleasure to talk about this topic with you guys.

Rafe: Well, Paul, I have to tell you as a graduate of the University of Toronto, I do feel obligated to extend you my absolute warmest of welcomes, even though I suppose you guys were something of an arch rival at Queens. But I have to say, I'm increasingly nostalgic for my days in The Great White North lately. So thanks for joining us.

Paul: Yeah, thanks for having me. And I'll say to University of Toronto, that some of the researchers that I most admire are there. It's a really fantastic institute.

Rafe: Now that I'm not there.

Jack: Lovely. So, we're all comfortable here. This is good. And let's dive right into it if we can, Paul.

Jack: Most institutional investors have massively diverse holdings, typically thousands upon thousands of different tickers yet every April and May when proxy voting season comes around, they're expected to cast informed votes on boards of directors and votes on pressing questions of the day on behalf of their clients.

Jack: So maybe we can set the table a little. Is there any evidence to you to suggest it's worth the time and effort, which of course equal money, for money managers to get up to speed and cast informed votes on all of these different holdings?

Paul: I think that it depends is the answer to that. There is increasing research that for some institution, investors that meet certain criteria they, yes, it can make sense for them to invest in research, the research of casting more informed votes.

Paul: So some of the things that are associated with who it might be worth it for, to do that research are those with larger holdings and larger stakes. So if you're just a bigger company, you're going to have more of an economies of scale to invest into a research team, to become informed on those issues.

Paul: And then also if you hold large individual stakes in companies, then that's where the cost of investing in the research for that specific company can start to be less than the benefit that you get by holding a lot of shares. If you cast a vote in the right direction, you could make profits from that vote.

Paul: If that vote leads to better governance, which then in turn leads to the stock price going up. But at the flip side of that is I think for the majority of institutional investors, aren't those really big players, and they might not have the resources to have these big research teams and that their individual stakes in each company isn't necessarily going to be enough to make a big difference on the voting outcome. If you just have 0.1% of the total ownership of the company, that's not often going to be the marginal vote that changes the outcome. So for a lot of those firms, it doesn't actually make sense to invest into the proxy voting process. And I think that's why you see the rise of proxy advisors to help fill that void of sort of information creation by almost by all of these smaller players pooling their money together. They almost are able to capture some of those economies of scale by hiring proxy advisers, who then have that specialization to be able to hopefully help those institutions become informed about the votes by outsourcing the research to them.

Rafe: No, that's very interesting, Paul. So, they're outsourcing that and those proxy advisors may or may not, I guess, perfectly match up with the kind of institutional ethos of the client who's using them, right? Like they may be expressing their will, or maybe it's not a perfect match, but let's complicate it even a little more right in the past decade or so passive investors, be they index fund managers, ETF managers, what have you, they've become a majority of the assets under management and the public markets, at least in the United States. And I think this has pretty massive implications for the topic we're talking about. So I'll just throw a for instance, out here 40 years ago, if an investment house owned a big slug of an oil company, I think you can rest assured that they believed in the company's product regardless of any nasty effects on the environment and that kind of thing. But if you spin it forward to today, I mean these passive shareholders are only there because the oil company stock is in say the S&P 500© or the Russell 2000©, some index. And so what I wonder is, has this altered the dynamics and maybe more importantly, the outcomes of proxy voting?

Paul: So I think that there's a few dimensions of this. One is, even looking at that 40 year old example. It's both that the investor could have potentially believed in the oil company, but there's also the fact that they have an intimate knowledge of the oil company. They've done really thorough research so that when a slate of votes on the oil company's future is ahead of them, they can then make an informed vote in each of those individual topics. And I think that's also something that you lose with an index company. Not only do they not necessarily believe in the company, but they are probably not informed in any way about the company. So that is one pressure, certainly to make investors less informed and make it more difficult to cast and inform proxy vote. But there's another side of it, which is this idea it's sometimes called the wall street walk, which is that if you're a big investor in a company that actively owns that company that you believe in, but then there's something that happens to undermine the foundation of that belief, say that it's poor governance.

Paul: You then have two choices. You can either try to cast proxy votes that change the path of that company, or you can just sell your shares and that selling of shares can exert pressure, but it also, for the management of the company to change, but it can also undermine the proxy voting process because people who are unsatisfied with the company, instead of creating change, just leave. It's kind of like in a political election where people say if the outcome of the election isn't as I like it, I'm going to go move and I'm in Canada now, but the classic line in the U.S. is I'm going to move to Canada.

Paul: So I think with index funds, it's actually a powerful pressure for them to care about the proxy voting process is that they don't have that wall street walk as an option. They can't sell their shares when they're unhappy. And there's actually some research that shows because they don't have this option. They're more incentivized to invest in the proxy voting process, even though their baseline knowledge about the companies might be lower than active investors because they can't leave. They invest more in the proxy voting process and they actually cast more informed votes and can have a positive effect on the corporate governance outcomes of the firm, as a result.

Jack: You mentioned, Paul, that the difficulty of keeping track of all of these different names and being able to do deep dive research on the questions of the day, be it board directors, or be it questions about the future direction of the company, gave rise to your advisors, the firms that step in proxy advisors and sort of guarantee, or at least represent that they've done a lot of the work you would have done, if you had the resources and time as a shareholder, they've answered a lot of the questions that would occur to you, if you would have dove deeply into it. It strikes me too that there's a distinct possibility that that would lead to a lot of group think, right? That there would be a lot of deference to the proxy advisors. And that perhaps sometimes particularly with the changing psychology of the investor in and around ESG matters that sometimes where the proxy advisor recommends sort of you place your bets or place your votes, or how to think about something, it might not align with how you see the world changing and how you see investing changing.

Jack: I know you've done quite a bit of work on this question. Can you speak to the state of play there?

Paul: Yeah. Well, I think there's been a pervasive criticism of proxy advisors. Do you want to, maybe?

Jack: Yeah, just start over again. Just take a pause and go ahead.

Paul: Sure. So I think there has been a pervasive concern about proxy advisors and one, are they acting in the best interest of their clients, the institutional investors, but also given the dispersion and sort of interest of institutional investors do their one size fit all recommendations, both aligned to the diverse shareholder base of institutional investors, but also to the diverse types of companies. So a criticism of the proxy advisors is that they are overwhelmed in a lot of the same way that institutional investors might be overwhelmed. So they have say 10,000 companies globally that they're making recommendations for. And then if you look at about 10 proxy votes in each firm, that's a hundred thousand votes that they have to provide recommendations towards each year, and they're overwhelmed. And how that overwhelm natures manifest is that they'll have very broad guidelines that say, if there's a vote to declassify boards of directors, we're going to support that if there's a certain vote about, say on pay, which is about managerial compensation, given these very sort of cut and dry characteristics, we're going to either support or recommend to our clients to vote against it.

Paul: And I think the concern is, is that a lot of times that sort of blanket recommendations are inferior to the firms, the institutional investors, excuse me, that do their own research and get that nuance. That because in a lot of the answers to these big questions in finance is that it depends in what instances could certain governance policies be good, in what instances can certain governance policies be bad. And you only know that when you do a deep dive into the firms at play, and that's sort of a place that there's been a concern about this group think of the proxy advisors that they're too powerful, and that they're not necessarily representing what's in the best interests of their clients, the institutional investors, but they're actually just pushing forward what's in their own best interests, which is to generate revenue by providing recommendations to the most number of clients, but at the least internal costs in their own research.

Paul: And I think that also speaks, you brought up ESG, but I think with ESG, it becomes a issue of sort of weighing this classic belief of the goal of a company is to maximize the value to shareholders against this sort of evolving belief that it's not just about the shareholders and profits, but it's also about other stakeholders. And that's really a very investor specific idea. You have some specific institutional investors and funds that focus on ESG issues and then other even have something called sin funds that focus kind of tried to take the other side of that bet and focus on sort of anti ESG firms. And it can be tricky for proxy advisors. If they're casting one recommendation per vote to sort of satisfy their different clients and know sort of which way the wind's going on what the public's demand for those ESG issues are.

Rafe: Well, Paul, it's funny that you're bringing up ESG in this context because we've done a lot of work at Mellon that suggests that the ESG ratings firms also are very similar to the proxy advisors in the sense that it's very tough to have a one size fits all approach there. And it's hard to know exactly how much work is going into their recommendations and their analysis. And we have found by doing our own deep dive fundamental work, that we can pretty much get out ahead of the third party, ESG raters and form our own opinion, which might lead to a better outcome for us because we got ahead of the curve a little, but, if we just stick on ESG for a second, I guess what I wonder is just kind of writ large here. ESG has become a much more influential area of risk analysis and investing over the last decade. And I'm just wondering plain and simple because of ESG, have we seen different outcomes and changes in the whole proxy voting process and environment?

Paul: But, we see, I have some projects now that are looking more specifically relating to ESG and the proxy voting process. And you do see increases for example, with climate related ESG. In just the past few years, there has been an increase in the number of proposals related to climate. And a lot of those proposals come from there's two types of shareholder proposals, management, sponsored shareholder proposals and shareholder sponsored proxy proposals. I'll try to say that again. I'll take a pause and just do that part again. So in the past few years, there has been an increase in proposals related to for example, climate change. And that's a topic that's sort of, I think, more in the public domain of expressing concern. And there's two pads where a proxy voting proposal gets put onto the ballot. One is if management sponsors the proposal and the other shareholders sponsoring the proposal.

Paul: So as there's more big institutions that are concerned about say climate change or other ESG issues, they can sponsor proposals. And then also as there's more sort of internal research that focuses on the potential value added of those proposals, there's certainly a path that they can vote in the direction for those ESG issues that then puts pressure on the management of those firms. And by doing their own research provides a counterbalance to one size fits all approaches that proxy advisors might, might take. And I think the other thing to think about these proxy advisors, they really one term thrown around about them that my colleague on a lot of this research recently mentioned was that they're preference aggregators, they want to be expressing what are the preferences of their clients in a lot of cases for things like ESG. So if they see that there's a sea change in clients, preferring votes in a certain direction on ESG issues, they're going to be responsive. So it goes in both ways, the institutions are responsive to the proxy advisors recommendations. But if the proxy advisors see institutions starting to in mass vote in certain directions on certain issues in future iterations of those votes. So every year a lot of the proxy advisors put out a list of the guidelines that sort of guide their voting recommendations, they might modify those voter recommendations depending on how institutions have sort of revealed their preferences.

Rafe: There's circularity there. Like what Jack was talking about with the Echo chamber.

Paul: Absolutely.

Jack: Yeah. Yeah. And, when it comes to proxy voting, Paul, it seems, you have the votes for board of directors. You have votes on specific issues. As you look at these two items, are we seeing any evidence that corporate boards are becoming more responsive to proxy votes? Like how would they respond if 10% withhold or abstained from voting, has their response to that changed in recent years?

Paul: I think that's an outstanding research question that I would be interested in exploring. The most recent sort of examination that threshold was from a 2009 paper. If you published in 2009, you're probably using data that's a couple of years stale because of the length of the publication process. And what they found was that threshold of becoming responsive in director elections is about 20%. So if 20% of voters express displeasure in a certain director's decisions or actions, once that 20% thresholds are reached, and that's 20% of shareholders saying, we're so unhappy with the director, we're going to just refuse to vote for them or vote against them or abstain from the vote. And that sort of, because of a quirk of how director elections work, that there's not really a for or against vote, the nuance of which is a little bit complicated, but the research shows that when company management, both the board of directors and the CEO see displeasure in the sort of director election process of getting a lot of against votes, they'll actually change policy, not only on perhaps the board governance, but on other issues at the firm.

Paul: So that there's a spill over from those board votes into other issues at the firm. And I think that then announced the outstanding question is if in 2009, the threshold was 20%, could there be more response? So some firms that are more responsive that even if they had 10% against, that they'll respond and change their ways. That to me, would be a sign of good governance. And I think that's an outstanding research question is what is sort of the dispersion of that threshold across different firms and has it changed over time? And then I think there's a related question, which is that, say there's a climate proposal. And a lot of the climate proposals are sponsored by shareholders and to sort of pass, they need not, it's not continuous, but it's a hard vote threshold or vote requirement where say 50% of the votes need to be for that proposal for management to consider it.

Paul: And I should add that all of these shareholder proposals are non-binding. So if management really wanted to, they could just say, you know what, even though it passed, that's really going to hurt the company. We're not going to be bound by that vote. We're going to do our own thing. If they did that, there could be repercussions in other ways to management like a shareholder activist might see that as an opportunity where management isn't acting in the shareholder interests and target the firm to change management's outlook. But I think a question to go back to your original question as the responsiveness of firms. I think something that the research hasn't looked into deeply that I would be interested in, or other researchers I think would be interesting to look at is just say a climber proposal got 45% support. So it didn't reach that 50% threshold, but there is a lot of shareholders that are expressing their concern about the climate path of the firm or on a different, this would be applicable to all ESG issues.

Paul: And I think the question then is, is management at least still somewhat responsive, does management see, okay, we have a split shareholder base, maybe we should compromise and take some measures, maybe not as far as the original proposals, but at least take some measures to be responsive to that group of our shareholder base. That really cares about this issue. And if you look at, for example, shareholder activism, which is a sort of a subset of the governance mechanisms through which shareholders can change the firm, related also to proxy voting, and this is where someone like a big hedge fund or Carl Icahn would be example, they buy stakes in the firm, but they're usually buying stakes somewhere between five and 10%. And even with that five to 10% stake, they can create real change in the firm. And I think that that speaks to this question then. If you have 40% of the shareholders expressing certain beliefs, in some cases, that must be enough for management to put pressure on management to also make changes. But I think the research is still outstanding on actually convincingly linking those two.

Rafe: Paul, I'm glad you brought up activist investors because, as you see firms like ours here at Mellon, others that are getting increasingly laser focused about how to most effectively deploy their proxy votes and get the results that they're looking for. And many of us, by the way, have, especially in our small and mid-cap portfolios positions that are quite large as a percentage of float in some of those companies, just because of the amount of money we have under management, I wonder, is it a meaningful distinction anymore to even be talking about activist investors and more traditional institutional money managers?

Paul: I think that they can still be important. And I think maybe the analogy that I would want to draw is that we're in an electric, excuse me, election season in the U.S. and if you're a campaign manager of an election, you would look at sort of the electoral map and then make strategic decisions on how to allocate your resources so that you wouldn't necessarily spend money in an area where you're already blowing out the opponent or where the opponent's already blowing you out. Because in those situations, on the margin at vote, in the sort of informed direction, isn't going to make a difference in the outcome. Where you want to expend your resources is where the vote is close, where the outcome is uncertain, and then your vote could actually be the deciding vote. And I think that one of the ways in the vast majority of shareholders elections, they're blow out. So as an example, the average management sponsor proposal gets something like 92% support.

Paul: So you want to find the situations where it's not going to be a blowout, where your vote is really going to matter where it can make a difference. And I think that one value of shareholder activists is even though they own five to 10% of the firm. They can sort of lead bigger groups of shareholders. So I have a paper on this, and there's a body of literature on this called Wolfpack activism where multiple activists will target the same firm. And that can be both the big hedge fund activists. And then they sort of bring along a lot of institutional investors, or it could be several individual hedge fund activists that also still, almost every firm has some level of institutional ownership that work with those activists. And I think that once you're talking about then 20, 30% of a block voting in a certain direction, that could be a signal to other institutional investors like Mellon of where your votes are going to make the biggest difference.

Paul: So I think in that capacity to sort of signal the most important votes that activists could make a difference. So that's one dimension. I think activists can also make a difference. I was talking earlier where the management isn't responsive to shareholder needs. So there are still instances where the governance of the firm is poor, the pervasive throughout finance is something known as the principal agency problem where the management is the agent of the shareholders, and they're going to do things sort of to enrich themselves or to entrench themselves in their position. And I think the shareholder activists can be sort of the first person to lead the charge, to try to overcome those poor managers. And I think that they've become increasingly important in a world in sort of the 1980s, there used to be more of an M&A market where if a firm was poorly governed, these big act, excuse me, or acquirers would do mergers and acquisitions and take over the firm and replace management, but in lieu of a big mergers and acquisitions market, the shareholder activists can serve a similar purpose of identifying firms that are poorly governed.

Paul: And then with sort of, the coordination or the Alliance with institutional investors lead to real substantial change in the firm, because there was really hard for an institution like Mellon, even if they own 2% in a firm it's really hard to be that first mover to say, this manager's not being responsive. We're going to take things to remedy that with just 2% of the... Or 1% of the firm, it's hard to really invoke that change. So the shareholder activist, could be the first person to sort of step forward and say, send a signal that we're going to invest in making a change in this firm.

Jack: We dug pretty deep on the rise of passive investors, but there's another growing shareholder category out there. We're talking about the retail investor. We read more and more these days about youngish investors making trades, the UNAP well named after a certain Dennison of Sherwood forest and Nottingham let's say, and it became pretty clear during the pandemic lockdowns that stock trading became an effective stand in for even like sports gambling, hard to know if that lasts, but let's play it through when it comes to proxy voting. These retail shareholders typically hold such a de minimis percentage of the float. As you were talking about that it's hardly worth spending time and effort to cast a shareholder ballot. Is there any evidence to suggest that that might change? Is there anyone out there trying to aggregate the power of all these retail investors and maybe harness it to influence public company governance?

Paul: Yeah. Well, I think that any shareholder, there's a lot of moving parts in this. One, is that any shareholder who's trying to make change in a firm, I was just talking about a shareholder activist might try to win allies of institutional investors. And I think that the calculation that goes on in their head is that if you have another block holder that owns a big proportion of the shares, then you only have one sort of channel of communication. You need to give it to that one person, and then you'll win over a big block. The problem with retail investors is, as you said, they own so little, you're not going to be calling up somebody who owns, 70 shares of some big oil company to try to get them to go to the direction of the direction you're going to go in. But there are other channels that you can sort of with a bullhorn, tried to communicate to a lot of investors at once. I think traditionally the media has played that role, but increasingly social media has played that role. So that there's some research coming out.

Paul: One of my colleagues, Evan Dudley looks at the role of social media in various financial aspects associated with investment. And what I think his research sheds light on is the potential for these social media outlets to act as a magnet phone and coordinate a lot of investors all at once. And I think when you think about these retail investors that use apps on their phone to trade, a lot of those social media platforms also have apps on their phone. They might get one notification from the trading platform, another notification from the social media platform that maybe they follow the same firm on both. And there is the potential for, I think, social media, maybe even more so now than traditional media to influence those shareholder, those retail shareholder votes. But I think you still would need somebody to sort of take that first step and make the investment in the campaign to change the firm.

Paul: Because if you're an investor that sort of trades on one of these app based platforms, you probably don't own enough shares in the company that making an investment in a proxy voting campaign is going to be cost-effective. But if a big shareholder already owns a lot of shares on the phone, that might be their path to win over some of these retail investors. But this is all speculative that the research hasn't yet linked these various channels together. But I do think there's the potential there to coordinate them. Much like we've seen evidence on coordination among bigger investors.

Rafe: And for example, the Arab spring and how social media played a key role there. Well, Paul, this was fascinating. Thank you so much for joining us on double-take really enjoyed it.

Paul: No, it's been my pleasure and I had a great time talking to you both as well.

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