Analyzing Global Proxy Voting Practices

Posted by Michael McCauley, Florida State Board of Administration, on Saturday April 14, 2012 at 9:10 am
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Editor’s Note: Michael McCauley is Senior Officer, Investment Programs & Governance, of the Florida State Board of Administration (the “SBA”). This post is based on an excerpt from the SBA’s 2012 Corporate Governance Report by Mr. McCauley, Jacob Williams and Lucy Reams. Mr. Williams and Ms. Reams are Corporate Governance Manager and Senior Corporate Governance Analyst, respectively, at the SBA.

Fiscal year 2011 witnessed the SBA’s shift from domestic and foreign asset classes, to a combined global equity portfolio, with a heavier international equity weighting and a more balanced U.S. exposure. With the recent structural changes, the proportion of SBA assets invested in foreign equity markets will continue to rise, and a significant proportion may be managed internally. In 1998, for foreign equities was 7.6 percent, rising to 12.7 percent by 2003, and 18.8 percent by the end of fiscal year 2010. Upon completion of the transition to a combined global equity asset class, foreign equities composed 33 percent of FRS assets as of October 2011. As a percent of the equity asset class, foreign shares account for 56 percent and U.S. shares for 44 percent.

Coinciding with this shift, the SBA realigned its international proxy voting practices, bringing foreign voting decisions ”in-house” to match domestic SBA voting practices.

Previously, external asset managers were responsible for voting international proxies associated with SBA shares held in their funds. Since the SBA assumed this responsibility, votes are now cast by SBA staff—based on our own Corporate Governance Principles & Proxy Voting Guidelines and meeting specific research from our proxy research providers.

Prior to adopting internal voting of global proxies, the SBA worked with GovernanceMetrics International (formerly known as The Corporate Library) to analyze external global proxy voting practices currently in place. The purpose of the GovernanceMetrics International (GMI) vote audit was to evaluate the external managers’ proxy voting activities, as well as to benchmark those voting decisions against similar SBA votes and those of a major corporate governance research provider. The vote audit examined aggregate voting results and voting by each individual manager, while benchmarking external manager voting against SBA internal voting decisions. The vote audit was completed in March 2010 and consisted of a sample of nine of the SBA’s externally managed foreign equity portfolios, comprising approximately $9 billion in total assets.

While the managers adhered to responsible voting practices, it was natural to find that among the sample of managers a variety of voting strategies were in place. SBA staff determined it was more efficient to align its international voting practices by transitioning to in-house proxy voting. Under the new practice, 29 global accounts, along with 25 domestic accounts, are now voted in accordance with the SBA’s Corporate Governance Principles and Proxy Voting Guidelines.

Upon implementation of in-house voting of global proxies in April 2011, proxy meeting volume approximately doubled in the April-May time frame, the high volume U.S. proxy season. While volumes are highest during this period, a more defined contrast from domestic proxy voting was more apparent as the U.S. season wound down. When compared with year prior domestic voting totals, monthly proxy volume increased by as much as 250 percent in the second half of 2011. As U.S. meeting totals began to subside, peak-season voting trends in global markets became more distinct. Just as currency traders experience a 24-hour trading day, global proxy voting seemingly eliminates any notion of a traditional ”off-season.”

SBA monthly proxy voting totals have always peaked in May, corresponding with the most popular month for U.S. and many foreign country annual general meetings. For SBA holdings, May 2010 charted 1,402 meetings voted internally. With the addition of foreign votes in the spring of 2011, May 2011 votes increased to cover 2,385 meetings, a 70 percent increase. The share of those May 2011 meetings conducted by U.S. companies was 54 percent. Other than this peak month for U.S. companies, SBA proxy voting is now a majority, or even a super majority, of international meetings. While this represents a more balanced depiction of the global market, the transition is notable. For instance, SBA proxy voting in September 2010 encompassed 95 meetings, with approximately 90 percent of those based in the U.S. One-year later, SBA votes totaled 367 in September 2011, with the U.S./international breakdown now reversed, as only 18 percent of meetings that month were domestic.

The shift to include global proxy voting has created a general change in mindset. With the majority of votes now centered on global proxies, the exception has become the norm. Voting in 80 different countries, with 80 different sets of governance practices, now means that special cases predominate. In hindsight, the still complex U.S. system of governance seems at least more patterned.

Review of International Proxy Voting

In 2011, the Council of Institutional Investors (”CII”) produced a primer on international proxy voting that covered many of the key challenges and obstacles encountered as funds seek to manage increasingly global portfolios. The study included a survey of General Member funds (employee benefit funds, foundations, and endowments) with 37 funds responding. Of funds responding, 49 percent delegated non-U.S. voting responsibility to money managers, 30 percent executed votes through proxy advisors, and only 24 percent of funds voted foreign shares utilizing in-house staff (total exceeds 100 percent as some respondents utilize more than one method). For domestic voting, more funds voted in-house (41 percent), or through proxy advisors (49 percent), than delegated to money managers (16 percent).

The contrasting methods of implementing proxy voting for domestic and non-U.S. shares reflect many factors unique to international markets. CII chose eight international target markets for specific review of potential barriers which may impede voting efficiency. Many of the same factors were apparent to SBA staff throughout 2011 as our transition to global voting occurred. Share blocking issues, even in developed markets such as Switzerland or Finland, were prevalent. Late disclosures were past cutoff dates in certain markets, while disclosures were very limited in others. Power of attorney issues were also increasingly prevalent in certain markets. While these issues were not excessively burdensome, they did serve as frictions to a timely or fully disclosed proxy vote in all countries.

The importance of strong country governance and the corresponding benefits, were highlighted in a recent governance survey titled Corporate Governance in Emerging Markets: A Survey. Researchers Claessens and Yurtoglu found that, ”better corporate frameworks benefit firms through greater access to financing, lower cost of capital, better performance, and more favorable treatment of all stakeholders… Evidence also shows that voluntary and market corporate governance mechanisms have less effect when a country’s governance system is weak.”

The survey also identifies key channels through which corporate governance impacts corporations and countries: 1) Increased access to external financing by firms. This in turn can lead to greater investment, higher growth, and greater employment creation; 2) a lowering of the cost of capital and associated higher firm valuation. This makes more investments attractive to investors, also leading to growth and more employment; 3) better operational performance through better allocation of resources and better management. This creates wealth more generally; 4) good corporate governance can be associated with a reduced risk of financial crises. This is particularly important, as highlighted recently again, given that financial crises can have large economic and social costs; and 5) good corporate governance can mean generally better relationships with all stakeholders. This helps improve social and labor relationships and aspects such as environmental protection, and can help further reduce poverty and inequality.

The SBA foresees a continuation of the trend toward various cross- border actions, comprehensive regulatory benchmarking, and comparative shareowner activism by institutional investors across the globe and in wildly different capital markets. Whether it was the investor outrage shown by non- Japanese investors at the board of Olympus Corporation (not to mention the actions by its former non-Japanese CEO), or bold proxy access filings made by Norges Bank at several U.S. companies, shareowners are increasingly global in their approach to corporate governance and their pursuit of responsible investing. For the first year in its history, the SBA voted more non-U.S. proxies than it did for its domestic holdings, and the focus on developing and frontier markets continues unabated.

Key Observations as SBA Global Proxy Voting Exposure Increases

Engagement is increasingly important, even as the investing universe continues to expand. A global marketplace is, by necessity, an interaction among market participants. Both active and passively managed investment portfolios require active governance communication of best practices. Ideally, countries and market participants will adopt more advanced governance characteristics as interaction, communication, and capital flows become increasingly flexible.

Collaboration and communication with peers, governance networks, and regulators is necessary to effectively accomplish engagement on a global scale. Our interaction with communities such as ICGN, GIGN, and CII’s Ad-hoc International Committee has provided an invaluable network, greatly increasing awareness of global governance trends, best and worst practices, outliers, and special situations.

The shift away from “home-bias” produces increased complexity, along with increased potential reward.

A constant balancing act is created when weighing historical governance practices of a given country versus established U.S. governance principles. The timeliest example may be reflected by Japan’s system of director selection, largely dominated by affiliated directors or company management. Strict adherence to U.S. guidelines would result in constant votes in opposition to Japanese directors on the basis of a lack of independence. While this seems extreme and likely ineffective, the Olympus scenario has reminded all of the need to press for increased board independence and transparency.

Reducing country-specific voting frictions are essential. Whether it be share-blocking, sub-custodian communication gaps, or end-to-end vote confirmations, certain procedures create undue constraints on market efficiency.

Company disclosure remains a key concern. Many emerging markets, having been “discovered”—now require a corresponding increase in timely company disclosure regarding directors and proxy issues.

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