And John Bogle Wept
Among the many drums that Vanguard founder John Bogle has beaten over his long career has been one that sounds the alarm regarding the role that mutual funds play in corporate governance. Or, more specifically, the role they should play.
Long before, during, and after the most recent market crisis, Bogle has taken fund managers to task for their lax attitude toward corporate governance. Too often, he's argued, fund managers -- who collectively own roughly a quarter of all stock -- have been passive overseers of the corporations they own, rubber stamping management proposals with seemingly little thought or concern for the linkage between their votes and the creation of corporate value over the long term.
If you or I own shares of ABC corporation and don't give a whit about corporate governance, that's one thing. But the stock that fund managers oversee is owned and managed on behalf of the investors in their funds. Thus, Bogle argues that mutual fund managers have a duty to vote their shares with an eye on the long-term interests of those investors. Unfortunately, the evidence shows that such an attitude is all-too-rare in the mutual fund industry.
Which is why a recent report published by the American Federation of State County and Municipal Employees (AFSCME) must have been particularly poignant for Bogle, for it fingered the firm he founded as the industry's greatest enabler of high CEO pay.
Mutual funds, of course, own corporate equities. That ownership, in turn, entitles them to votes in corporate proxies, allowing them to weigh in on things such as board membership, mergers and acquisitions, or executive compensation.
The latter issue is what has attracted the most attention over the past decade or so, as CEO pay reached previously-unthinkable heights. Rewarding corporate managers for a job well done is one thing, but in far too many instances CEOs were paid exorbitant salaries for middling (or worse) performance.
Which brings us to the AFSCME report, which examined the proxy votes of the 26 largest mutual fund managers on a selection of corporate compensation-related proposals. The report found that the fund managers supported management-sponsored compensation packages 80 percent of the time, voted against shareholder proposals to rein in pay 52 percent of the time, and voted in favor of directors who failed to gain "significant voting support by shareholders" for compensation-related reasons 55 percent of the time.
Further, the report found that the three largest mutual fund managers -- Vanguard, Fidelity, and American Funds, who combined oversee nearly 60 percent of the assets of all 26 firms in the study -- were much more likely to vote against shareholder proposals and in favor of the directors.
Of this group, the report found that Vanguard was the biggest "pay enabler," voting with management in 90 percent of the votes examined, followed by BlackRock and ING. At the other end of the spectrum, Dimensional Fund Advisors, Dreyfus, and Oppenheimer were the biggest "pay constrainers" of the firms included in the study.
It's worth noting that the study's authors -- who, in all honesty, have their own interests -- chose which proxy votes to include in this analysis; those which they deemed to be controversial. Further, in response to similar criticism in the past, managers such as Fidelity and Vanguard have said that their preferred method in dealing with these issues is to have direct contact with corporate management, which isn't reflected in this sort of analysis.
Be that as it may, it's noteworthy that there seems to be a rather strong correlation between the amount of assets these managers oversee and their ranking, with the larger managers earning lower marks.
Bogle has often argued that this phenomenon is a reflection of fund managers' unwillingness to risk offending the management of a large corporation, who may be (or may become) a client of the firm.
Perhaps that's true, but the reality is that the reasons behind mutual fund laxity in corporate governance likely have less nefarious underpinnings. One of the problems is that as executive compensation has grown, many pay packages that would have seemed outrageous in previous eras have lost their shock value. Twenty or thirty years ago, it would have been unthinkable to endorse a $20 million compensation plan for a CEO. Today, unfortunately, such amounts are unremarkable, and often fail to shock the conscience absent truly terrible managerial performance.
Secondly, it's hard to build a compelling cost-benefit rationale for taking a strong stand on executive compensation. If a large fund manager decides to draw a line in the sand and vote against any compensation package over a certain dollar amount, the cost of such a stance is real and calculable -- they'll irk a lot of very powerful corporate executives, who may in turn decide to pull any of their corporate pension or retirement assets from that firm. The benefit? That's hard to define, because those packages are likely to garner enough support to pass anyway.
Finally, the fact of the matter is that the executives of these fund management firms are themselves very well compensated. They'd be loathe to have outsiders mucking around in their own compensation (indeed, in many instances that compensation is not disclosed), so it's not entirely shocking that they'd feel that compensation matters are best handled by the corporation's board of directors.
But to the extent that these factors explain the status quo, they do not excuse it. For executive compensation serves as a proxy for all the failures of modern corporate governance; failures which played no small role in the most recent crisis, and which ultimately detract from the long-term returns that investors earn. But they do explain why it will be so hard to alter the current culture.
What can you do? Let your mutual fund managers know that you're monitoring their approach to corporate governance (fund managers are required to disclose on their websites how they voted every proxy in every firm they own), and encourage people like John Bogle to continue to hold fund managers' feet to the fire.
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