Social Responsibility Resolutions.

• Author: Hirst, Scott

1. INTRODUCTION II. SHAREHOLDER VOTING & SOCIAL RESPONSIBILITY RESOLUTIONS A. Shareholders B. Shareholder Voting C. Social Responsibility Resolutions III. DISTORTIONS IN SOCIAL RESPONSIBILITY RESOLUTIONS A. Voting on Social Responsibility Resolutions B. Heterogeneity in Voting on Social Responsibility Resolutions C. Distortions in Social Responsibility Resolutions D. Should Fiduciaries Consider Investor Preferences? IV. UNDISTORTING SOCIAL RESPONSIBILITY RESOLUTIONS A. Investor Sorting by Mutual Fund Voting Policy 1. Informational Problems 2. Insufficient Options 3. Switching Costs 4. New Investors B. Voting According to Investor Preference C. The Impact of Undistorted Social Responsibility Resolutions V. Conclusion I. INTRODUCTION

   Shareholders exert significant influence on the social and environmental behavior of U.S. corporations. Shareholders vote on social and environmental resolutions, which I refer to as 'social responsibility resolutions,' that are put forward at corporations. The success or failure of social responsibility resolutions influences the social and environmental behavior of those corporations. The largest shareholders are institutional investors--mutual funds, investment advisers, and pension funds. When they vote on social responsibility resolutions, they do so as fiduciaries for their own investors. This article considers two questions: Do the votes of institutions on social responsibility resolutions follow the interests of their own investors? And do the votes of institutions on social responsibility resolutions follow the preferences of their own investors? The article puts forward evidence that they do not, and considers whether this is a problem, and how it could be addressed. The stakes are high: if institutional investors voted on social responsibility proposals as their own investors preferred, corporate behavior on social and environmental matters might be much closer to what investors, and society, would prefer.

   Voting has long been recognized as one of the primary rights of shareholders. (1) Shareholders vote to elect the board of directors of the corporation, as well as on fundamental corporate transactions and changes to the corporate charter. (2) Shareholders can also vote on precatory resolutions put forward by other shareholders, including those included in the corporation's proxy statement by shareholder proposals, as required by the Securities and Exchange Commission (SEC). (3) This article focuses on social responsibility resolutions, those requesting that corporations take certain actions on social and environmental matters.

   If a sole investor or a small group of investors held shares in a corporation directly, they could coordinate and vote to cause the board of directors to act in their preferred manner. However, the number of investors in U.S. public corporations is very large, making coordinated action difficult. Some of these investors own shares in corporations directly, but the overwhelming majority invest through institutional investors--mutual funds, investment advisers, and pension funds. Each of these institutions invests in corporations as a fiduciary on behalf of these investors. Because these investors invest through intermediaries that make voting decisions on their behalves, there is a possibility that the voting decisions may not reflect their interests, or their preferences. In examining this issue, this article focuses on voting by mutual funds, not only because mutual funds hold the largest proportion of equity of U.S. corporations, but also because they are the only type of institution for which voting data is widely available. The fiduciary duties of mutual fund directors and investment advisers are generally interpreted as requiring them to vote on resolutions at portfolio corporations, in the best interests of their investors. (4)

   A consideration of the voting records of mutual funds suggests that the way some mutual funds vote on social responsibility resolutions may represent a distortion of either the interests or the preferences of their investors. First, votes of different mutual funds on social responsibility resolutions diverge widely, even among mutual funds that are likely to have very similar investors with very similar interests. If there is a way to vote on these resolutions that reflects the best interests of these investors, some mutual funds appear to be voting wrongly on many resolutions. Second, this article provides evidence that the way that many mutual funds vote on resolutions may differ from the views of a majority of their own investors. Because funds vote 'all-or-nothing' for, against, or abstain, even where funds vote the way a majority of their investors are likely to prefer, there will be a divergence from the preferences of a minority of their investors.

   Even if this is the case, does it matter that mutual fund votes may not follow the preferences of their investors? This is open to debate. If mutual funds can determine better than their own investors what is in the interests of those investors, then this distortion may be optimal. Alternatively, if corporations can determine for themselves the actions that will maximize value on the matters being considered, then the preferences of investors may be irrelevant. However, if it is considered valuable for corporations to follow the wishes of their investors, then these distortions may represent a significant problem, as they result in corporations being less likely to act as their ultimate investors would prefer. Many resolutions requesting action on environmental and social matters may fail where investors would prefer that they pass. Corporations are less likely to take requested actions where resolutions fail. And proponents are less likely to bring resolutions at other corporations, or bring other kinds of resolutions, given that such resolutions attract less support than they otherwise would. Public officials that consider the results of resolutions as a proxy for investor preferences on these matters will receive distorted information, and may be less likely to take action themselves.

   This Article does not attempt to offer a conclusion regarding whether distortion constitutes a problem, or even whether it is taking place. However, in the event that distortion is taking place and is considered a problem, the article considers the alternatives for resolving the problem. One possible solution is for investors to choose mutual funds that vote in the ways that they prefer. This already takes place to limited extent when investors invest in "socially responsible investment" funds. However, socially-responsible investment funds represent a small percentage of aggregate funds invested, and there are significant impediments to widespread sorting among mutual funds, including very limited investor access to the information necessary to make such decisions. The alternative is for mutual funds to consider the preferences of their investors when determining voting policies and decisions. In order to represent investors with preferences representing a minority of investment in the fund as well as those representing a majority, mutual funds could adopt policies whereby they would split their vote in proportions consistent with the preferences of their investors. Vote splitting is currently rare, but as a practical matter it is likely to be relatively straightforward for these well-resourced institutions.

   The next step in this debate should be for further consideration of the preferences of investors. The data used in this Article to draw conclusions about investor preferences is limited and imperfect; the investment industry--with the encouragement of the SEC--should undertake their own analysis to determine whether their voting differs from how their investors would prefer, and whether this represents a problem.

   The remainder of this Article is structured as follows. Part II describes the background to shareholder voting on social responsibility resolutions. Part II.A. considers the composition of "shareholders," and describes how they are predominantly institutional investors--mutual funds, investment managers and pension funds--that invest on behalf of U.S. households, the ultimate investors in U.S. corporations. Part II.B. considers shareholder voting, including the rules that apply to mutual fund voting, and the resolutions that are voted on by shareholders. Part III provides empirical evidence of mutual fund voting on social responsibility resolutions. Part III.B. highlights the divergence of voting among mutual funds, and the potential issues this raises. Part III.C. considers evidence of likely investor preferences to draw conclusions about how mutual fund votes may not represent the preferences of their investors, and Part III.D. considers arguments whether or not this distortion constitutes a problem. If distortion is considered to be a problem, Part IV examines two alternatives approaches for undistorting shareholder voting, and explains how this may have a significant impact on the social and environmental behavior of U.S. corporations.

2. SHAREHOLDER VOTING & SOCIAL RESPONSIBILITY RESOLUTIONS

   1. Shareholders

      Although some proportion of the equity of public corporations is owned by individuals and households directly or through brokers, the significant majority of equity of most corporations is beneficially owned by institutional investors--mutual funds, investment advisers and pension funds. Each of these institutions are fiduciaries for their own beneficiaries. According to the U.S. Federal Reserve's quarterly accounts as of the end of 2014, of approximately $29.8 trillion in equity of U.S. corporations, 35% was owned directly by households and non-profit organizations, 14% was owned by pension funds (split approximately equally between public and private pension funds), 24% was held by mutual funds, 6% by insurance companies, and 20% was held by...