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April 03, 2024

Wednesday Morning Rant


Pass Through?

An increasingly common theme over the past several years has been the imposition of progressive policies on the business world. There is the normal alphabet soup of acronyms and terms associated with this. DEI and ESG are the most common, but there are also the old standbys of "climate conscious" and similar older phrases that have been displaced by the new DEI/ESG environment. The progression of DEI and ESG through the business world has many causes, but one cause is institutional demands.

It is pointed out endlessly that much of this profit-destroying - and more importantly, culture-destroying - activity is approved by institutional shareholders. When asking, "who owns Company X," the answer "the usual suspects" typically applies. Alphabet's top three shareholders are Vanguard, Blackrock and State Street. Ford's top three are ... Vanguard, Blackrock and State Street. Proctor and Gamble? Same. This is common. Look at any stock and the odds are good that several of a dozen or so companies make appearances in the top 5 shareholders.

Those institutions own the shares, but they don't own those shares for their own benefit or with their own capital. Vanguard isn't sitting on and investing $8 trillion of its own money and assets. The money and assets belong to Vanguard's customers. Vanguard and others like it aggregate their own customers' capital, make investment decisions, etc. - and wind up as the owners of record and gain enormous institutional power because they get to vote those shares as they see fit. The major investment houses get to direct corporate policy across publicly-traded companies, but they don't actually own many shares in their own right.

What would happen if those those votes were transferred to the customers who own the capital? Would a pass-through voting scheme within the investment houses help break institutional power? What would happen if share votes were proportionally allocated to the fund's actual capital owners based on the share of fund capital that the customer owns, then aggregated for final voting by the institution?

For example, the investment house informs its customers of an election, provides the ballot and vote recommendation (they are advisors, after all) and the customer votes or doesn't. For votes returned, the investment house aggregates them to determine how it must vote the shares held by the investment house. For unreturned ballots (the fund investor does not vote), the vote is not cast. If owners of only 25% of a fund's capital return ballots, then only 25% of fund's shares in the company get voted.

Most shares will probably go unvoted in this scheme and institutional power remains where it is, except with more paperwork. Where it would make a potential difference, however, is during controversy. If an investor or interest group wants to see changes in a company's board, they don't have to break the institutions - they just have to market and argue their case to the real shareholders. What changes could we possibly have already seen at the likes of AB-InBev, Meta, Disney and the like if the actual owners of institutional capital got a say in the vote?

It's entirely possible that such a scheme would be a nightmarish disaster with loads of unintended consequences that make everything worse, even possibly concentrating institutional power thanks to non-returned ballots. There are many obvious potential downsides to a change like this, and likely a whole mess of liability that would need to be sorted out, and plenty of opportunity for fraud.

But pass-through voting or something like it could possibly help break the institutional stranglehold on corporate governance. What else might?

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posted by Joe Mannix at 11:00 AM

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