Some thoughts on shareholder voting
A complex issue, better viewed in a holistic than in a mechanistic manner. This (long) essay covers how a business owner, not renter, thinks about and acts on this issue.
Something terrible happened this week. Shareholders voted down Siddhartha Lal’s reappointment as MD at Eicher Motors over a compensation quibble. As someone who turned a near-defunct company into one of India’s finest franchises, creating $ 10 billion value along the way, Mr Lal deserved better. To not reappoint someone who figures in top 1% of Indian value creators is a travesty, irrespective of technicalities in question. To avoid such errors, as well as others of the opposite kind, it’s worth diving into topic of shareholder voting, more generally.
Views and actions depend on context, which can vary significantly between ours and that of a more typical shareholder. This essay will separately address both viewpoints, starting from the latter.
Typical shareholder context:
Proxy advisory firms are a force for good
Despite improvements, broader context is unfriendly to minority shareholders of listed companies. On one side, there’s no paucity of promoters who take minority shareholders for a ride. Sound governance norms are yet to be established or become widespread. On the other side, a typical institutional investor holds hundreds of stocks, with an average holding period of a year. A renter has little incentive to maintain the house. Between dodgy promoters and transient shareholders, governance suffers. Regulators have done a commendable job of legislating stricter shareholder-approval norms for material changes. However, fragmented short-termist shareholders are unable or unwilling to evaluate thousands of proposals across too many companies held for too little time. Last part is a global problem, not unique to India. It’s likely worse in developed economies where lack of promoter makes agency problems more severe.
Proxy advisory firms were created to fill this gap and have done a good job at it. In our experience, as a paid user of their services, proxy advisory firms are run by fine people who have a thoughtful, systematic approach to evaluating proposals that come up for shareholder voting. Their recommendations are sensible and reasoning is transparent. Investors and even companies, on average, are better off listening to their advice. Many companies apply a “What would proxy advisory firms think” filter even before tabling proposals for voting. Corporates are better informed about best practices on many issues (e.g. auditor rotation, board member tenure). To avoid aforementioned kind of embarrassment, where a reasonable proposal is shot down, companies have become more proactive in explaining rationale behind their proposals. System-level governance has materially improved thanks to proxy advisory firms.
But there’s an unsolvable problem at the heart of any ‘advisory’ business. Messy-world decisions are judgment-based not rule-based. There is no right answer to the question of how much Mr Lal’s deserves to be paid, although he’s evidently invaluable. Even if such things can be parameterized, parameters are context-specific, not universal. Fixing compensation at a certain percentage of profits can be too generous for many and too stingy for a few. Other proposals are also matters of subjective judgment: board composition, managerial remuneration, capital allocation. It is impossible for any outsider to improve quality of board deliberations by following a checkbox approach to board constitution and tenure (separately, boards are overrated in general). Proxy advisory firms get this unsolvable problem mostly, but not entirely, right.
Proxy advisory firms have no choice but to be rule based, in coming up with internally consistent recommendations across thousands of proposals. To their credit, they view rules as guidelines with some flexibility. They incorporate idiosyncratic considerations and invest time in understanding management rationale behind specific proposals. However, across dozens of resolutions from hundreds of companies, discretion is limited. On balance, they (rightly) err on side of being rule-based. Across thousands of proposals they provided voting recommendations for, they likely got it right over 95% of the time. That’s way better than most processes in messy world, including ours. However, any rule-based method will occasionally shoot down reasonable proposals, like the one we started with. While this trade-off can be minimized, it can never be eliminated. Universal laws governing type-1 and type-2 errors are inviolable.
A shareholder who straddles hundreds of businesses, shuffling them every year or so, is best served by mechanically following proxy advisory firms’ recommendations. However, this is not the preferred approach for an investor who thinks in terms of owning select businesses for years. For a long-term investor, proxy advisory firms’ recommendations are an input into a decision, not the decision itself. Such investors are better served by adding a layer of case-by-case judgment to 3rd party recommendations. That leads to how we approach this topic.
Business owner context:
Voting is one part of much broader association, better viewed holistically than transactionally.
We own thirty businesses, not hundreds. We have owned two-thirds of these for a decade or so. We intend to stay co-owners indefinitely. There is long track record of earned trust and demonstrated competence, before and after investing. With few businesses to focus on, there is depth of understanding, across business and governance. There is a history of actions and discussions to draw upon.
Approach for this context is different from that for a more typical shareholder context. Analytically, dealing with few businesses enables judgment-based reactions, not rule-based ones. Each situation can be studied in depth. Intangible, idiosyncratic, subjective factors can be incorporated into a more holistic decision. Philosophically, decadal association allows any action to be viewed as part of an ongoing association, not in isolation. Managerial decisions and shareholder reactions are part of ebbs and flows of a long partnership, not transactional up/down votes. This context is analogous to long-term relationships in life outside business.
Each association is a happy, mutually beneficial, long-term relationship underpinned by trust and respect. Disagreements are differences of opinion, not breaches of trust. Individual issues are to be framed against broader context of sound businesses run by decent partners trying to do what’s right for all concerned. Reactions are subtle and measured, not binary and extreme. Voting is one part of interactions with those running the business, far from the most important one.
In fifteen years of studying shareholder resolutions, it’s hard to recall a single proposal that was egregious. An overwhelming majority were reasonable. Reasonable doesn’t mean flawless or that we agree 100%. Reasonable means that it falls on a spectrum of things that management has earned the right to do, and don’t hurt minority shareholders in any material way. Even occasional ones that fell outside this spectrum were disagreements on business judgment with rather than poor governance (e.g. buyback at high price or uncomfortably large acquisition). There may have been occasional errors of judgment, but no breaches of trust.
Where do proxy advisory firms fit in, against this context? Recommendations are an input, not as an answer, best assimilated in spirit, not in letter. They are parsed through our own prism of materiality and reasonableness. While recommendations are black and white (yes or no), our views are grey, in line with how messy world actually is (Yes, but; Not ideal, but not unreasonable). Some recommendations are ‘small stuff’, dealing with technical violations. While it’s good practice to rotate an auditor or director after earth has gone around the sun N times, N+1 is not calamitous. Often, managements are fine making the change but want more time. In any case, counting on such stuff to ensure good governance is like believing we got Covid from pangolins. Some recommendations are where there is no right answer, like on compensation. Good management is invariably underpaid and bad management is always overpaid. We have never had a single conversation around managerial compensation with any company we have been associated with. This is best left to those running the business.
How about big stuff? Our larger disagreements with management have been around strategic decisions or capital allocation: inappropriate M&A; overpriced buybacks; diversification (always unjustified); other distractions from core; imprudent deployment of surplus funds (i.e. yield-chasing); inadequate dividends; needless fund-raising; conflicts of interest. While some of these figure in shareholder voting proposals, many don’t. Even the ones that do are holistic discussions on risk, not yes/no votes. Oddly, some of these get ringing endorsement from proxy advisory firms (e.g. ‘transformational’ acquisition), while we view them as catastrophic for long term health of business. It’s also noteworthy that such errors of judgment impact all shareholders including promoters, not just minority shareholders.
So, what’s our approach to shareholder resolutions?
Don’t sweat the small stuff. These could be less critical issues or what is less than ideal in a procedural/technical sense. As in personal life, nagging and nitpicking aren’t good for either party or for the relationship. We are unlikely to even bring these up for discussion, let alone vote against these. Unless this sort of thing repeats often, these are best viewed with a sense of proportion.
On subjective matters, defer to management judgment. Those best placed to make a decision should make it. While investors and commentators are a pretentious lot, we have neither expertise nor skin in the game to decide compensation, senior management tenure or succession. Those running the business should be free to foster a conducive operating environment without being second guessed or constrained. There could be rare exceptions where something egregious is proposed, but these are best handled as exceptions to a default setting of trust.
If there is disagreement on big stuff, table concerns in private. The idea is to express a viewpoint, along with rationale, and better understand differences. It is not to demand a specific course of action. Again, actions are best left to those in charge, with most skin in the game. While we table concerns only where an action falls under a historic pattern with poor odds, we recognize that we could be wrong. We recognize that promoters’ interests are aligned to ours and that promoters have more at stake than we do. As long as there’s an open discussion of differences, we are fine continuing as co-owners while disagreeing on specific matters. To stretch the relationship analogy, living with disagreements is a feature not a bug.
Never rebuke or embarrass in public. Point is to table differences and understand each other’s perspective, not to berate in public. That’s not good for any relationship, personal or professional. There is neither joy nor benefit in shooting down a formal proposal tabled with good intent. We will never act in a way that precipitates such an outcome. Decades back, my former employer (Intel) had a policy called ‘disagree but commit’ for how employees were to handle decisions made without consensus. We may disagree, but we are fully committed to the people and businesses we invest in.
In rare, extreme cases, move on. Occasionally, developments force us to abandon our permanent owner mindset. These mostly have to do with irredeemable erosion in competitive position or balance sheet. Sometimes, they can be triggered by a specific action. Bet-the-company acquisition or indefensible diversification are illustrations. When it crosses the line, we sell and move on. We vote with our feet and money, not with a pen.
While no analogy is perfect, professional long-term relationships aren’t that different from personal ones. They are best approached using discretion and judgment. View everything in context, in spirit and with a sense of proportion. Avoid nitpicking or nagging on small stuff. Discuss big stuff openly but privately. Recognize that reasonable people can differ but stay in partnership. Defer to judgment of those best placed to make decisions, as far as possible. Never berate or embarrass in public. At the extreme, if it’s irredeemably broken, quietly move on.
Naturally, above approach is not for a renter who is indiscriminate in what is bought and impatient about how long it’s held for. For renters, whose returns are functions of luck and sentiment, neither governance nor shareholder voting may even matter. Renters are better off outsourcing judgment on such matters to proxy advisory firms, who do a good job of it. However, above approach is applicable to anyone who thinks of investing as buying into sound businesses run by decent people, to be held for a reasonable period. Even if conclusions are different, method has relevance.
Proxy advisory recommendations are like credit ratings (without conflict of interest, since former make money from investors, not companies). They reduce complex real-world judgment into simplified categories to ease decision-making. However, assessing credit risk or merit of managerial decisions is a matter of fuzzy judgment, not bucketing into BBB or AA (or For or Against). Messy world is grey, with a lot more ‘yes, but’ than pure ‘yes’ or ‘no’. While advisory firms do a good job, they are meant to be an aid to investment decisions, not a substitute. Advisories do not absolve shareholders of responsibility for their voting decisions. Shareholder voting falls squarely under the gamut of investment judgment. Both words matter. Buck stops at investment professionals. Judgment cannot be taken out of the equation.