Previous research on shareholder voting has placed most of the emphasis on the role of institutional shareholders. In our recent study, however, we provide evidence that managers strategically rely on the support offered by retail shareholders to ensure that their agenda passes and to communicate strong overall shareholder support during times of poor performance.
Our study is designed around the introduction of electronic proxy delivery. In 2007, the Securities and Exchange Commission (SEC) implemented rules allowing for electronic delivery of proxy materials. The revised system allows firms to choose between the traditional, mailed “full-set delivery” of proxy materials and the “notice-only” option, which only requires a mailed notification informing shareholders of the internet availability of proxy materials. The new notice-only option is designed to cut substantial costs of delivering proxy materials, but the adoption of the new rules has had unintended consequences. We find that notice-only delivery of proxy materials significantly reduces the voting response rate; this effect is primarily driven by the lower likelihood of response from retail shareholders. These findings are consistent with concerns expressed by the SEC in 2008. Since then, the SEC has made continuous efforts to revise the initial rules so that it can increase the response rates for the notice-only delivery method. However, the issue has been persistent in our sample period.
These initial findings on response rates are subject to endogeneity concerns. Unobservable characteristics, such as advance publicity for certain matters on an upcoming ballot, may attract retail shareholders while simultaneously influencing management to choose full-set delivery. We address this potential concern by using a unique difference-in-differences test around the 2010 amendments to NYSE Rule 452. These amendments limit brokers’ ability to vote on behalf of retail investors in uncontested director elections. This rule change therefore represents an exogenous shock to the incentives of managers to earn support from retail shareholders, while having no effect on the voting patterns in matters that might have endogenously influenced our initial findings. Consistent with our expectation, we find that the choice of delivery method has a significantly greater impact on response rates after these amendments, particularly in firms that have a large retail shareholder presence. The increased response rate observed when firms opt for full-set delivery is therefore driven by the delivery method itself and not by unobservable characteristics.
We next test whether the delivery method affects the outcome of shareholder voting. We focus on a subset of contested issues where incremental retail voting is most likely to affect the outcome: ballot issues on which management and proxy adviser ISS disagree. We first document that retail shareholders are strong supporters of management. Management-recommended proposals receive significantly more voting support when retail shareholders comprise a larger percentage of the investor base. We then find that these proposals receive even higher levels of support when the full-set delivery option is used. Finally, management receives higher support for recommended proposals when a large retail base is combined with the full-set delivery method. The results are consistent when we focus on management-opposed proposals that are supported by ISS. In these cases, we find a negative effect of retail shareholders on voting outcomes that becomes stronger when the firm opts for full-set delivery of proxy materials.
Based on these findings, managers may have an incentive to alter the delivery method to maximize support for upcoming ballot issues. We find that market reactions to this type of behavior are not favorable. The market reaction to a management-sponsored proposal narrowly passing is significantly negative when the full-set delivery is used in lieu of the notice-only system. This finding not only indicates that the voting outcome is unanticipated by the markets, but also that the voting result is unfavorable for the firm, which may indicate why managers needed the additional support from retail shareholders. The negative surprise by the market is both statistically and economically significant, ranging from 2.47 percent to 5.70 percent across various specifications. In addition, we find a generally similar, although less significant, reaction when the full-set delivery is used to defeat shareholder-sponsored proposals. Overall, the market reacts negatively to the strategic use of delivery methods when management uses them for furthering its agenda and suppressing third party agendas.
The evidence in our study indicates that retail shareholders differ from institutional shareholders by offering much stronger support of management regardless of firm performance, and managers are aware of these tendencies and take advantage of them. We find that managers are more likely to opt for the mailed full-set delivery of materials in times when they need additional support from the traditionally pro-management retail shareholders. First, firm operating performance (ROA) and market performance (abnormal returns) are significant determinants of a firm’s proxy delivery method. Managers opt for full-set delivery following periods of low returns, indicating managers’ incentive to communicate strong overall shareholder support during times of poor performance. Second, we find that managers choose full-set delivery methods following years of abnormally high CEO compensation levels, consistent with the notion that managers aim to report higher levels of approval to justify their higher compensation.
Lastly, we examine managers’ choice of delivery method based on items included on the ballot. We find that managers opt for full-set delivery when the ballot contains executive compensation related issues, including say-on-pay votes. We also find that managers opt for full-set delivery when proposing to reduce shareholder rights, including proposals to add a poison pill, increase supermajority voting requirements, or create other impediments to shareholder action.
Our study makes two primary contributions to the literature. First, the study improves the understanding of the SEC electronic proxy regulation and its unintended uses and consequences while documenting concerns regarding the use of electronic proxy access. These concerns exist regardless of how we choose to view the importance of the retail vote. If we argue that firms should be attempting to maximize voter response rates, then the notice-only method of proxy delivery falls short in accomplishing this. If, on the other hand, we argue that the retail vote is unimportant, thereby relying on institutional investors to more effectively perform the monitoring role, then we raise concerns about management manipulating the manager-friendly retail vote in order to ensure defeat of third-party proposals. Regardless of which stance we take on the role of retail voters in an ideal governance structure, the delivery method remains a relevant concern in the corporate finance literature. Given recent attention to these issues, our findings may be used to improve the regulatory mechanisms in the United States as well as other countries that have introduced an electronic proxy delivery system.
Second, this study contributes to the expanding literature on voting results by focusing on the retail shareholder, an investor class largely ignored by previous academic literature despite accounting for nearly 20 percent of share ownership. Previous studies of shareholder voting focus on the role of institutional shareholders and how observed voting practices relate to proxy advisory recommendations (Iliev and Lowry, 2015), conflicts-of-interest with management (Davis and Kim, 2007; Pound, 1988), and the identity of proposal sponsors and the type of proposals (Gillan and Starks, 2000; Gordon and Pound, 1993). To our knowledge, this is the first study focusing on retail investor voting. We establish that the retail voter tends to be management-friendly, and, more importantly, managers often rely on this vote in order to establish strong support for their objectives.
Iliev, Peter, and Michelle Lowry, 2015, Are Mutual Funds Active Voters? Review of Financial Studies 28, 446-485.
Davis, Gerald F, and E Han Kim, 2007, Business ties and proxy voting by mutual funds, Journal of Financial Economics 85, 552-570.
Pound, John, 1988, Proxy contests and the efficiency of shareholder oversight, Journal of financial economics 20, 237-265.
Gillan, Stuart L, and Laura T Starks, 2000, Corporate governance proposals and shareholder activism: The role of institutional investors, Journal of Financial Economics 57, 275-305.
Gordon, Lilli A, and John Pound, 1993, Information, ownership structure, and shareholder voting: Evidence from shareholder-sponsored corporate governance proposals, The Journal of Finance 48, 697-718.
This post comes to us from Professor Choonsik Lee at Quinnipiac University and Professor Matthew E. Souther at the University of Missouri. It is based on their recent paper, “Managerial reliance on the retail shareholder vote: Evidence from proxy delivery methods,” available here.