Are Shareholder Votes Rigged?

Laurent Bach and Daniel Metzger are Assistant Professors of Finance at the Stockholm School of Economics. This post is based on their recent paper.

Shareholder voting is increasingly used to settle governance issues, such as compensation, in a transparent and democratic way. Yet, it is well known that corporate elections do not even closely resemble political elections of modern democracies (Bebchuk, 2007). Managers of public corporations have considerably greater ability to constrain the set of choices made available to voters. They also have more discretion over the amount and the quality of information that voters can access. What is somewhat less known is that the management of big U.S. corporations also has an extraordinary advantage in the campaigning process as it holds privileged access to the identity of voters and to partial vote tallies in real time. In the paper entitled Are Shareholder Votes Rigged?, we show that many corporations have been using this privilege to fight shareholder proposals that have a good chance to obtain a majority and impose substantial governance reforms. We call these kinds of corporate behavior “vote rigging” because, contrary to regular campaign activities, managers may affect the voting results so precisely that the defeat of shareholder proposals appears to be the result of luck rather than managerial action.

We use a statistical approach to establish the existence of vote rigging. Analyzing voting results on shareholder proposals on corporate governance in large U.S. companies between 2003 and 2016, we document an abnormal share of shareholder proposals that are won with a small margin by management. Since 2003, there have been about 75% more shareholder proposals rejected by a margin of one percent of shares outstanding than proposals that were approved by a similarly narrow margin. As a result, there is a large and discontinuous drop in the density of voting results on these proposals exactly at the majority threshold of each proposal. These anomalies in the distribution of voting results reveal that there are substantial effects of vote rigging on the success rate of shareholder proposals. Using counterfactual distributions, we estimate that about 11% of those proposals that have been rejected by a margin of less than 10% of the votes would have passed if management had not been able to affect the voting results.

This evidence is even more alarming as management engages in vote rigging particularly when the content of the proposal is substantial. We show that this vote management is stronger for proposals that have good chance of being implemented conditional on obtaining a majority and when the proposal is on a topic that is largely supported by proxy advisors, but typically opposed by management (such as the removal of classified boards or the introduction of majority voting).

How are managers able to fine-tune the final voting results to their advantage? While we cannot fully answer this question, we show several ways in which management may use its privileged access to information on the ongoing voting process. For instance, management can encourage non-voters to support the management’s views in the election. Consistent with this, we find that the turnout rate is abnormally high for proposals that are eventually closely rejected by the voters. Moreover, we find that CEOs are much more likely to exercise their stock option plans to obtain additional voting rights ahead of shareholder meetings in which shareholder proposals are subject to a close contest between management and the proponents. Another method employed by the management is to convince some shareholders to make voting decisions that go contrary to their usual guidelines. We find that, on average, mutual funds, and especially the largest ones, act as a counterweight to management and tend to vote more against management when eventually management narrowly wins a vote. This means that the voters who contribute to the bias in voting results are prevalently not funds but instead retail investors or corporate insiders.

Our findings have some policy implications for the debate on the design of the shareholder voting process. Some flaws in the current organization of votes in the U.S., such as votes not being counted (by early closing or mistake), have already been documented by other scholars (Kahan and Rock, 2008), and there are ongoing discussions on whether or not communications with shareholders should be made easier and more transparent. Our research provides additional input to this debate by suggesting that the information privilege given to issuing companies contributes significantly to management entrenchment. This does not mean that withdrawing access to such information would per se be an improvement, since corporations have originally been given this voting information to make sure the views of disparate shareholders are gathered quickly enough to guarantee the efficiency of business decision-making. Fortunately, recent technological advances such as the blockchain technology have been brought forward to address many of these issues and may prove to be a powerful tool for reforming the current voting system (Yermack, 2016).

The full paper is available for download here.

References

Bebchuk, L., 2007. The Myth of the Shareholder Franchise. Virginia Law Review, 93(3), 675-732. (Discussed on the Forum here).

Kahan, M. and Rock, E., 2008. Hanging Chads of Corporate Voting, The. Geo. LJ, 96, p.1227.

Yermack, D., 2015. Corporate Governance and Blockchains, National Bureau of Economic Research. (Discussed on the Forum here).

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