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Some ideas to solve the index fund and corporate governance dilemma

Index funds and voting shares
Bonus: Index Funds Are Great for Investors, Risky for Corporate Governance

Here is a couple of great reads on the issues with index funds and voting. To summarize, as index funds gain a greater proportion of shares, the voting power they possess is meaningful. Unfortunately, index funds do not care to take sides in important voting measures. For instance, as the bonus article describes, the Elliott Management vs. Arconic board of directors battle was likely extended because the largest shareholders (the index funds) did not want to voice a strong opinion. And this becomes problematic because the voting shareholders (the index funds) are asset managers for Arconic. Thus it becomes a conflict of interest for them to vote on this matter (in most cases they just vote for the status quo). And quite frankly, even if there was not a conflict of interest, their due diligence is close to non-existent so any vote would be uninformed.

More importantly, I think John Cochrane is on to something about the voting and non-voting shares. Non-voting shares would be perfect for index funds. While they might be able to get schemed out of money, I don’t think this would be a common occurrence. For instance, voting shareholders could vote for a higher dividend for voting shares than non-voting shares. But this would likely lead to public distrust and a lower share price. I can appreciate the notion that having a vote is the only way to guarantee you will get paid, but any type of shenanigans such as deliberately harming fellow shareholders will not sit well with those shareholders.

The other three options to solve this problem from the bonus article are 1) encourage index funds to rely on corporate governance experts, 2) create legal incentives for index funds to focus on corporate governance, or 3) encourage passive investors to abstain from voting.

Categories: Uncategorized

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