In a recent speech, Vanguard Chair and CEO William McNabb III shed light on the firm’s view of shareholder engagement for public company boards. McNabb noted that “Vanguard investors collectively own about 5% of every publicly traded company in the United States and about 1% of nearly every public company outside of the U.S.” Despite a preconceived notion held by some that the firm is indifferent on corporate governance issues, McNabb said that Vanguard cares “[a] lot!” This is partly driven by the firm’s long term focus, particularly with its index funds where the firm’s “favorite holding period is forever.”
McNabb shared Vanguard’s principles on corporate governance:
- “Independent oversight and, more broadly, appropriate board composition . . . is the single most important factor in good governance.”
- “Management should be accountable to the board. The board should be accountable to shareholders.”
- Voting rights should be aligned with economic interests so that one share equals one vote without special share classes.
- Directors should be elected annually and there should be “minimal anti-takeover devices.”
- “The majority of executive pay should be tied to long-term shareholder value.”
He focused his remarks on a sixth principle: the importance of shareholder engagement. He explained that the firm regularly reaches out to companies in which its funds are invested to create dialogues on important issues. This March, the firm sent 500 letters to independent chairs and lead directors to discuss these six principles. The firm had also signaled its intention to increase involvement in corporate governance issues by announcing in January that it would begin to publish more information regarding how it votes its shares in its portfolio companies.
He suggested that boards should be “crystal clear” about their expectations and thinking on important issues. For example, Vanguard finds it helpful when companies detail in written guidelines the type of qualifications that a company seeks in its board members and its method of assessing both individual and aggregate board tenure. Additionally, “a framework to raise important questions and have meaningful discussions between boards and investors” can “help facilitate a level of self-awareness for boards.” By supplying this information, a company can “provide as much context as [it] can and invite the discussion. Because investors are going have these questions anyway. In the absence of additional context, they may draw their own conclusions.”
McNabb also suggested that boards should embrace activism and even “think like an activist.” This includes an effort to “understand where their companies might be different or might be perceived as different” to determine if these differences are justifiable as strengths. He argued that the board’s perspective should not be only informed by management: “Management comes in, gives you a presentation, and tells you why this is the right strategy. If that’s all you’ve got, shame on you.”
He suggested that “healthy and vibrant” boards operate with a “functional paranoia.” and ask:
- Where should we be pushing harder or taking costs out? What are the management team’s blind spots?
- What are the board’s blind spots?
- And how do we correct that? Some boards bring in sell-side analysts that have a “sell” on the company to tell them what they’re missing.
To improve shareholder engagement, McNabb recommended the Shareholder-Director Exchange Protocol, a “a 10-point guide for public company boards and shareholders that determines when shareholder and director engagement is appropriate and how to make these engagements valuable and effective.” He also encouraged boards to form shareholder relations committees and suggested that directors may find a benefit in receiving perspective on industry outlook from Vanguard’s portfolio managers.
McNabb said that the firm listens carefully to the companies in which it invests and also encourages those companies to be aware of Vanguard’s perspective on important issues. Despite the binary nature of a shareholder vote, effective shareholder engagement allows the shareholder to “fill in those shades of gray between ‘absolutely for’ and ‘absolutely against.’”