Expressive Voting and Irrational Outcomes in Corporate Elections.

• Author: Tingle, Bryce

Introduction I. The Assumption of Rational Self-Interest in Academic Discussions of Shareholder Voting II. Ignorance in Political Voting III. Irrationality in Political Voting IV. The Empirical Literature around Shareholder Voting A. The Value Investors Place on Their Vote B. Ordinary Uncontested Director Elections C. Majority Voting D. Voting in Contested Director Elections E. Voting on Corporate Governance Matters IV. Revisiting the Academic Debate Conclusion: The Scope of Corporate Democracy Introduction

For the last several years, financial market elites have generally held two opinions that they have assumed, without much inspection, do not conflict. The first is that the voting results in favour of Brexit and Donald Trump, both enormously unpopular in London and New York respectively, may not reflect careful, informed processes undertaken by the electorate. (1) These electoral outcomes may instead be the result of voters who have few incentives to engage in the hard work of policy analysis and information gathering. They may make decisions in the voting booth that provide them with the private pleasures of mood affiliation, tribalism, resentment, and xenophobia. (2) (New York and London may be wrong, but this view has been widely held.) The second opinion is that the voting behaviour of shareholders is of a completely different kind.

Just three decades or so ago, shareholders had very limited voting rights. For nearly all of the twentieth century, managers were largely independent of shareholder voting power, except for the most basic fact that they might lose their offices if their failures became notorious. (3) As an American court noted in 1988, shareholder voting was understood to be "a vestige or ritual of little practical importance." (4) But not long thereafter, Canada, the United States, and the United Kingdom began to give shareholders increasing voting power over areas that used to fall wholly within board discretion. (5) This has produced an enormous body of academic legal journal articles debating the merits of the shareholder franchise. (6)

The debates among corporate law scholars are based on the assumption that when shareholders come to their voting decisions, it is by way of processes that are rationally calculated to promote certain corporate outcomes. For the most part, this means we assume shareholders vote in ways designed to improve the financial performance of their investments, but it could also mean that some investors vote in ways designed to improve environmental and social outcomes. This assumption of voter rationality is not taken for granted by political scientists. Their research on voting in civic elections shows that votes are often cast for expressive reasons unrelated to voters' self-interest or desired outcomes. The almost non-existent marginal value of a single vote means that voters feel free to collect and process information in ways that make themselves feel good. This article argues that the empirical literature around shareholder voting shows the same thing: shareholders give their voting rights almost no value, vote in ways that do not reflect the economic performance of the company, do not vote for directors as if the individual in question matters, vote in ways that contradict their economic views (measured by looking at their trading decisions), and their voting decisions are driven by empirically questionable and often deliberately ineffective corporate governance practices.

The first Part of this article will discuss the way that all parties to current academic debates about the shareholder franchise assume shareholders vote rationally. The second Part examines the political science literature on voter ignorance. The third Part examines the political science literature on voter irrationality. The fourth Part looks at whether the well-established political science research is applicable to shareholder voting by examining the empirical evidence on the following topics: shareholders' valuation of their voting rights, shareholder behaviour in uncontested director elections, shareholder behaviour in majority voting situations, shareholder voting in contested director elections, and shareholder voting on corporate governance matters. In all of these areas, the empirical literature strongly suggests that shareholder voting behaviour resembles the predictions generated by the political science literature. The fifth Part of the article revisits the academic debate to see what remains in light of the evidence on how shareholders process information and vote irrationally. The final section proposes a direction (but only a direction) for reform.

1. The Assumption of Rational Self-Interest in Academic Discussions of Shareholder Voting

   Current academic discussions about shareholder voting have a settled format. First, arguments begin by pointing out that, in Easterbrook and Fischel's now classic formulation, the shareholders' residual interest in the corporation gives them "the appropriate incentives ... to make discretionary decisions ... The shareholders receive most of the marginal gains and incur most of the marginal costs. They therefore have the right incentives to exercise discretion." (7)

   This formulation of shareholder incentives gives rise to a large and heterogeneous debate over whether the economic interests of the shareholders are actually aligned with those of the corporation. The range of possible conflicts is broad. Do some important firm constituencies' interests (such as customers, employees, and suppliers) conflict with those of the shareholders? (8) Are shareholders' economic incentives too short-term? (9) Are there conflicts in which long-term shareholders take advantage of short-term shareholders, or sophisticated shareholders take advantage of unsophisticated shareholders? (10) Do public pension fund managers advance corporate governance agendas designed primarily to appeal to their political masters? (11) Do union pension funds use their power tactically to advance their position at the bargaining table? (12) Do mutual funds reflexively support management to avoid alienating the individuals who decide what fund options will be provided to employees? (13) What about the conflicts between shareholders and debtholders (who, after all, are now the actual suppliers of capital to America's largest companies)? (14) The important thing to note in this vast literature is the universally shared assumption that the shareholders' economic interests will drive their voting behaviour and thus corporate outcomes.

   The second point made in virtually all discussions around shareholder voting is the collective action problem. This is usually couched in terms that again recall Easterbrook and Fischel's point that "[w]hen many are entitled to vote, none of the voters expects his votes to decide the contest. Consequently none of the voters has the appropriate incentive at the margin to study the firm's affairs and vote intelligently." (15) Evidence in favour of this proposition is adduced, usually in the form of the transparent reluctance of shareholders to vote (16) or engage in related activities. (17) Counter-arguments consist of pointing out that it must make economic sense for some categories of investors (particularly large institutions) to vote if doing so improves the corporate governance, and thus the economic outcomes, of portfolio companies. (18) Alternatively, some authors argue that market institutions such as proxy advisors and mandated disclosure reduce the cost of investors informing themselves. (19) Imposing legal obligations on institutions to vote their shares has also been assumed to render this issue moot (at least by the regulators), as institutions now vote as a matter of course. (20) Again, this literature is underpinned by the belief that shareholder voting, if properly informed, is (or could be) a valuable method of advancing shareholders' economic interests and improving operational firm outcomes.

   The final locus of discussion on voting concerns institutional investors' economic incentives, which are evaluated and generally found to be wanting. As Professor Coffee observes, the "expected gains from most such governance issues are small, deferred, and received by investors, while the costs are potentially large, immediate, and borne by money managers." (21) A closely related argument is that institutional money managers worry primarily about their portfolio's relative performance against other funds or index benchmarks. As gains from shareholder voting are received by their competitors equally, they will choose to devote their resources instead on the activities--such as picking stocks and executing trading strategies--that will allow them to differentiate themselves and attract investment. (22) Counter-arguments involve pointing to classes of investors, such as activist hedge funds, that create economic incentives for themselves to intelligently make use of their (and other shareholders') voting power. (23) Proxy advisors have similarly created a business model that arguably incentivizes them to give well-informed voting advice. (24) As with the other loci of debate around voting, both sides assume that if the shareholders did devote the resources--or could follow those, like activists, who do devote the resources to inform themselves--then they would vote in value-maximizing ways.

   This assumption that voting behaviour is rationally related to economic incentives is the engine that keeps the entire debate running. Both sides take it as an article of faith. As one recent Canadian Securities Administrators (CS

   1. Staff Notice puts it, "shareholder voting is ... fundamental to, and enhances the quality and integrity of, our public capital markets." (25) Another Notice puts it this way: "Institutional investors are increasingly engaged in advancing good corporate governance in companies, and one of the ways by which they do so is...