Yes or no: What Vanguard looks for in proposals

Vanguard updated its proxy voting guidelines this year to state that it would ‘evaluate each proposal on its merits and may support those where we believe there is a logically demonstrable linkage between the specific proposal and long-term shareholder value of the company.’ What was the typical reaction from issuers when you engaged with them on this development?

The general reaction to the change was seeking to find out what was behind it. Our framing for why we made the change was that we wanted to clarify in what situations we would support a proposal. The language we had before for the most part put environmental and social proposals in a broad category of things that we felt fell under management’s purview – and, as a general matter, we tended not to support proposals on those topics.

If you read between the lines on the guidelines, we had always had the framing that we would support things where we felt they were additive to shareholder value. The changes to the guidelines really reinforced that and made it much more explicit. The message now is framed in terms of ‘These are the things we are likely to support’ – and things we are likely to support are those proposals where there’s a demonstrable link between the actual proposal on the ballot and long-term shareholder value.

Another important part of that discussion with companies and other interested parties was that even where the particular proposal itself did not clear the hurdle for support – [in other words,] where we could not establish this logically demonstrable link between the proposal itself and long-term shareholder value – often the topics animating the proposal were things that we thought were important and would therefore engage with the company on, irrespective of our voting decision.

As an example, we considered a sustainability proposal at one company in the current proxy year. This particular company had opportunities to do more than it was doing on the sustainability front – based on what its peers had already done and based on what some of the specific risks facing this company appeared to be.

The proposal that was presented, however, was extremely broad [and] I don’t think the concept of materiality appeared anywhere, so it was one we did not support, based largely on the absence of any notion of materiality. We did, however, engage with the company on the topic of sustainability and the opportunities we saw for it to do more from a disclosure standpoint.

Part of our narrative has long been – and continues to be – that voting is really only one piece of the puzzle. Companies’ engagement with their shareholders is a very meaningful and – in our view – growing part of the long-term relationship we’re going to have with companies and of our opportunity to effect change that is in the long-term shareholders’ best interests.

Climate change, for example, presents opportunities as well as risks for companies. Presumably that is part of your thinking?

Risk and opportunity are two sides of the same coin, so what may be a risk for one company may be an opportunity for another – and that is absolutely part of the discussion. I think the focus of a lot of the discussion, particularly in the climate space, is creating more transparency on specific risks to the long-term sustainability of a company’s value proposition, and ensuring those risks are appropriately disclosed to the market in a consistent and comparable fashion, so that the market can appropriately value the company’s assets.

[We are] largely an index investor so one of the things that’s really important to us is that at each point in time, the market value of a company’s stock fully reflects the risks it is exposed to, from whatever source.

We want to make sure that when we’re buying we’re not paying too much and when we’re selling we’re not receiving too little. The hook for us in a lot of this discussion is ensuring that disclosure supports the pricing efficiency in the market.

With that in mind, shareholder proposals on climate change passed at three companies this year, despite board opposition. Does the wording they used align with what you are looking for?

The fundamental hurdle for a proposal to clear – for us – is this notion of a logically demonstrable link between the proposal itself and long-term value. Whether it’s on climate or any other issue that arises through this channel, the hook for us is not an ideological one. We’re not investing on our own account – we’re investing on behalf of 20 million shareholders globally. [They] likely have a range of points of view [so] the hook for us is always going to be the economic one.

What are some of the best practices you have seen from issuers in terms of engagement?

There are a number of things we have seen evolve over the last several years. Among them is increasing participation in the engagement process by directors. In the past year, somewhere between 25 percent and 30 percent of our engagements with portfolio companies have included independent members of the board.

That’s a helpful development for us because the directors are ultimately the people who serve on investors’ behalf. [It gives us] the opportunity to convey directly to members of the board our points of view on important issues, as well as gain their perspectives directly on the way they think about important issues like executive compensation [and] succession at the board level, not just at the management level.

Those are discussions that are more difficult – and certainly in some instances more awkward – to have with members of the management team, particularly in instances when we have significant questions or concerns about executive compensation, when frankly the last people we want to talk to are the recipients of that compensation. We’d much rather talk to the folks responsible for the decisions behind that compensation. But even where there aren’t significant issues or concerns, having directors participate has value over time, we think.

Another important sub-development is that when we’re meeting with both directors and management it is increasingly common for the management team members to excuse themselves toward the end of the meeting and give us the opportunity to talk exclusively to independent members of the board. We think that’s a fantastic practice. The directors are the ones who serve on our behalf and the opportunity to converse directly with them independent of management is a helpful development for us, even where there aren’t any explicit issues or concerns.

The second trend in engagement that’s been brewing over the last couple of years is better and more consistent integration between the investor relations (IR) people and the folks in the corporate secretary’s office in terms of meeting with us in our role as index investors. For many companies, index funds were not even on the IR call sheet. We were going to buy and sell the stock based on membership in the index, not based on any particular enthusiasm or lack thereof for a particular company. So to the extent that investor relations viewed its role as interacting with the active management community, in many cases we had relatively little interaction with it.

The consequence of that in many instances was discussions with significant portfolio companies that were focused much more narrowly on corporate governance but lacking the context of the company’s strategy and an ongoing business story that investor relations is so capable of delivering. What we’re seeing more and more is tighter integration between the corporate secretary and IR in conducting those communications with investors. That’s been very helpful for us.

Does that include having governance professionals in meetings or on calls during engagements, or just having them prepare management and the board?

It’s helpful in either context. Understanding the degree to which there are going to be dimensions of corporate governance that are of interest to us might help a company determine whether it makes sense or adds value to have somebody from the corporate secretary’s office in that discussion.

Part of this is also a function, at least in our experience, of company size. The more companies skew to the larger end, the more likely they’ve got someone in a dedicated governance role. The more into the mid-cap and small-cap space we get, the higher the likelihood that the corporate secretary hat is just one of many worn by the same person.

Having that balance of familiarity with the corporate governance and operations of the board, as well as having the broader strategic story seen through the investor relations lens, is helpful to us.

This article originally appeared in the Corporate Secretary special edition on shareholder engagement. Click here to view the full issue.