ES Votes That Matter

By | August 13, 2021

Attention to and interest in environmental and social (ES) issues increased exponentially in the past decade by concerned citizens worldwide, governments, regulators, individual investors, and intermediaries such as mutual funds. The number of ES funds more than doubled over the past few years, and the amount invested through them grew even more. These ES funds typically favor investments in ES-friendly firms, they incorporate ES factors into their financial analysis or engage with firm management to influence their policies toward a more ES-oriented approach. Consequently, one can expect ES funds to be at the forefront of the promotion of ES-related agendas and to have a favorable approach toward such agenda items when they are on the ballot. Market observers have nonetheless claimed that many of these funds fail to vote on corporate proposals in harmony with their advertised goals, and the Securities and Exchange Commission (SEC) has increased scrutiny over their voting policies and practices to assess whether they align with investors’ best interests.

In our recent paper, we study how ES funds vote on ES proposals, i.e., whether they vote according to their advertised goal and fiduciary responsibility. The short answer is yes, ES funds are more supportive of ES proposals than non-ES funds, on average. But while some ES funds are offered by families, such as Calvert or Domini, that have traditionally been well known for their ES approach towards investing, the growing demand for ES investment options has attracted new players into the market that now offer ES funds together with their more traditional funds (non-ES funds). This raises the question of whether ES funds offered by families that are not ES oriented (non-ES families), such as Blackrock, Vanguard, and Fidelity, will vote according to their clients’ best interests, or rather, the family preferences. We find that ES funds in non-ES families are more supportive of ES proposals than non-ES funds in non-ES families, on average, suggesting that they comply with their fiduciary duty in regard to voting. But averages might conceal other relevant information about how mutual funds vote, so we take a closer look by analyzing the voting pattern of funds for different voting outcomes.

Importantly, we find that ES funds in non-ES families are very supportive of ES proposals that fail or pass by large margins, while their votes are more aligned with their families when the proposal is close to the 50% approval threshold, i.e., when their votes matter the most. This voting pattern allows them to have a voting record of high average support for ES proposals, consistent with the funds’ stated goals, while at the same time, voting against ES proposals in a manner consistent with family preferences when the proposal is contested.

Given the objective of this study, the categorization of both funds and their families into ES and non-ES is critical. For the categorization of funds, we rely on funds’ names and consider ES funds those whose name contains an ES-related string such as “sustainable,” “green,” “impact,” or “climate” (we also read the prospectuses and find that ES funds identified using this set of strings incorporate ES-related goals in their investment objectives or principal investment strategy). We categorize fund families into ES and non-ES based on the preferences revealed by their past support for ES proposals. For instance, in 2017, the aggregate support for ES proposals over all the funds of BlackRock, Dimensional Fund Advisors, or Vanguard is less than 6%, and therefore, these families are considered non-ES. Calvert, Domini, and Pax World voted in favor in more than 70% of the times. They are classified as ES-families. We obtain similar classification of families and results when we estimate family preferences over ES using the W-NOMINATE algorithm (Poole and Rosenthal, 1985McCarty, Poole, and Rosenthal, 1997) that provides a spatial representation of family ES preferences over a straight line, which has been previously used by Bolton, Li, Ravina and Rosenthal (2020) to estimate investors ideology.

The following figure summarizes the main results of the paper. It shows funds’ support for ES proposals for different types of funds as a function of the voting outcomes.

The figure shows that ES funds in ES families provide higher support for ES proposals for all possible voting outcomes (dashed grey line), while non-ES funds in non-ES families provide the lowest support (solid orange line). More interesting, ES funds in non-ES families are very supportive of ES proposals when overall support is under 30% (in fact, they are more likely to vote “for” than the average investor, represented by the 45-degree line), but their rate of favorable votes falls below average for proposals with higher support. Furthermore, the plot for this category reveals a U-shaped relationship centered around the 50% approval rate, consistent with funds voting strategically, changing the sign of their vote in response to the expected voting outcome. This contrasts with the (almost) monotonically increasing patterns exhibited by the other three groups of funds obtained from the intersection of fund and family categories, where there are no conflicts between funds’ advertised goals and their family objectives.

The figure also presents other interesting results. First, the average support for ES proposals by non-ES funds in ES families (solid grey line) is significantly higher than the support of ES funds belonging to non-ES families for almost all voting outcomes. This relation suggests that family preferences are a strong driver of funds’ votes on ES proposals. Second, ISS, the proxy advisory firm, is generally very supportive of ES proposals (dash dot line), and it recommends voting in favor of all proposals that receive overall support above 30%.

More formally, we estimate alternative specifications using data on funds votes on each proposal, which allows us to use a rich set of fixed effects at the fund, family, meeting, and proposal level to minimize potential concerns that our results could be explained by omitted variables. Specifically, we compare support for ES proposals of ES fund in non-ES families in contested (voting outcome between 40% and 60%) and uncontested proposals (voting outcome between 30% and 40% or 60% and 70%). While we choose non-ES funds in non-ES families as the main control group, our results also hold when using ES and non-ES funds in ES families, consistent with the previous figure. In our baseline specification, we find that within non-ES families, their ES funds are 36.9% more likely to support an uncontested proposal than non-ES funds but that the difference drops by 9.9% for contested proposals, i.e., a 26.8% decrease in support.

In addition, we estimate the regressions separately for active and index funds, as the literature documents significant differences in engagement and governance between them. Because index funds compete to a higher degree on fees, they might afford less resources and lack incentives to engage on governance research and vote strategically. Consistently, we find that the strategic voting pattern of ES funds in non-ES families is predominantly explained by actively managed funds, as opposed to index funds. In fact, in contested ES proposals support by active ES funds is virtually the same to that of non-ES funds of the same families.

We zoom in on the strategic behavior using more saturated specifications to analyze how ES funds in non-ES families vote within meetings and within the same types of proposals as a function of the voting outcome. First, we change the baseline specification to exploit variation in support for ES proposals by the same fund voting at the same shareholder meeting in contested and uncontested ES proposals. The results show that when two ES proposals are on the ballot at a given meeting, ES funds in non-ES families are more likely to support the ES proposals that is less likely to be contested, which suggests that strategic voting takes place within meeting. We then examine differential support by the same fund for the same type of ES proposal (e.g., political contributions disclosures, sustainability reporting) when the outcome is contested and when it is not. The results suggest that ES funds in non-ES families are more likely to support a given proposal type when the outcome is less likely to be contested while opposing contested ones. These results highlight an additional relevant aspect of funds’ behavior: these active funds do not follow one-size-fits-all voting policies on ES issues but rather change their support for the same type of proposal as a function of the voting outcome.

Further evidence indicates that our results are not likely to be explained by business ties or direct engagement between fund families and firms. First, we exploit variation in support within the same family in the same meeting which allows us to control for variables that are fixed within firm and family at the time of the meeting and find that the results are qualitatively the same. Second, we use shareholder-sponsored governance proposals as a placebo test, because if the results are driven by other omitted factors, we should find a similar result in this type of proposal. We do not find evidence of strategic voting in this case, which suggests that business ties or engagement are not likely to explain our results. The results also shows that ES and governance proposals differ in the type of frictions that they generate and that good governance practices might be promoted by all funds regardless of their investment objective.

Finally, this voting pattern is unique to ES funds in non-ES families, rather than a generalized approach used by all ES funds. We still find evidence of strategic voting when we use ES funds in ES families as an alternative control group (which is also clear from the figure above). This result is important because it suggests that this voting pattern is unique to ES funds in non-ES families, rather than a generalized approach used by all ES funds which would likely invalidate our interpretation that the results are explained by a conflict between funds’ advertised goals and family preferences. Several additional analyses presented in the paper confirm that our results are robust to alternative definitions of contested proposal, ES and non-ES families, ES funds, treatment of abstentions, among others.

To summarize, our findings show that while ES funds are more supportive of ES proposals than non-ES funds, those offered by families that are non-ES oriented might inflate their average support by voting in favor of proposals that are either very likely to fail or very likely to pass. When the proposal is contested, however, they align their votes with family preferences. This behavior is unlikely to be consistent with investors’ expectations and with those funds’ fiduciary responsibilities since recent evidence suggests that ES fund investors are driven by social and environmental preferences even when these objectives might imply sacrificing financial returns.

The results of our study have implications relevant for regulators and investors alike. For regulators, the results of this study suggest that the current regulatory framework requiring disclosure of proxy voting does not always “illuminate potential conflicts of interest and discourage voting that is inconsistent with fund shareholders’ best interests” (SEC Rule 30b1-4). Acting Chair Allison Herren Lee has acknowledged the limitations of the current disclosure framework in a recent speech. If funds’ transparency and adherence to their stated objectives are important, then monitoring and perhaps publishing their voting records on contested votes might be useful. For investors, we show that while a fund’s stated ES objectives affect its average voting pattern, the identity and preferences toward ES of the family to which it belongs are equally important. In fact, on ES votes that matter the most, fund family ideology is more important. ES funds in non-ES families are able to look good on average while not following their stated objective when it counts. This is clearly relevant to investors who care about investing responsibly and improving the ES policies of the firms in which they invest.

Roni Michaely is a Professor in Finance at the University of Hong Kong.

Guillem Ordonez-Calafi is a Lecturer in Finance at the University of Bristol.

Silvina Rubio is a Lecturer in Finance at the University of Bristol.

This post is adapted from their paper, “ES Votes That Matter” available on SSRN.

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