Is Shareholder Voting an Effective Corporate Governance Tool?

Proponents of shareholder voting argue that restricting it would reduce the ability of shareholders to hold management accountable. The implication of this argument is that mandating equal voting rights for all shares will benefit shareholders. However, the evidence as to the effectiveness of shareholder proxy voting is inconclusive (see, e.g., Ertimur et al. (2011), Armstrong et al. (2013), and Larcker et al. (2015), among others). One of the limitations of prior studies that examine the efficacy of shareholder voting is that the optimal voting decision for a given proxy item is often unclear. For example, one major proxy voting issue that has garnered much attention is the vote on executive compensation – often referred to as the “say on pay” vote. In this vote, shareholders are given the opportunity to express their opinion as to the reasonableness of the compensation of a company’s top executives. However, evaluating the reasonableness of executive compensation is a difficult task, especially for less sophisticated shareholders who may not have the resources or the desire to evaluate the issue.

In our study (available here), “Should Uninformed Shareholders Vote? Evidence from Auditor Ratification,” we examine whether shareholder voting is an effective governance mechanism by using a setting where the optimal voting decision is relatively easy to identify. As the title suggests, we study the auditor ratification vote, where companies allow shareholders to ratify the audit committee’s selection of an external auditor. While the vote is not legally required, a vast majority (between 80 and 95 percent) of public companies submit their choice of auditor for shareholder ratification. Many companies state in the proxy materials that they give shareholders a voice on auditor selection to promote “good corporate governance.”

A unique feature of our setting is that we can observe public signals of audit failures (i.e., financial statement restatements) that, presumably, should drive shareholder dissent in auditor selection. If the auditor ratification vote is effective at identifying and holding low-quality auditors accountable for poor performance, we expect that votes against auditor ratification will be associated with the disclosure of a restatement.[1] On the other hand, it is possible that shareholder voting on the auditor is driven by factors unrelated to auditor performance, and we propose that the primary one is company stock market performance. That is, shareholders may vote with their pocketbooks by voting in favor of (against) the audit committee’s selection when their investment is performing well (poorly).

Our initial results suggest that, on average, shareholder votes on auditor ratification are not associated with audit failures, but are strongly associated with company stock returns. Thus, on average, shareholder votes on auditor ratification are uninformed. However, we expect that some shareholders may be more informed than others. Prior work suggests that institutional investors are better collectors and processors of information than are other investors (e.g., Bushee and Goodman 2007; Solomon and Soltes 2015) and are better corporate monitors (e.g., Gillan and Starks 2000; Bushee 2004). Consistent with this, we expect that the auditor ratification vote will be more informed when institutional ownership within a company is higher. Our results confirm this expectation—we find that votes against an auditor are driven by audit failures and not by stock returns among companies with higher proportions of institutional shareholders.

Our finding that the vote is only informed under certain conditions has implications for the usefulness of the vote as a governance mechanism. Presumably, the audit committee considers the results of the auditor ratification vote in deciding whether to retain the incumbent auditor. However, given the findings described above, an audit committee would ideally consider the vote only when it is driven by factors that reflect the quality of the auditor (i.e., when it is informed). However, we find that votes against auditor ratification are associated with an increased likelihood of auditor dismissal regardless of the level of institutional ownership. This finding suggests that audit committees hold some auditors responsible for factors beyond their control (i.e., company stock market performance), which is inconsistent with the premise that the auditor ratification vote improves governance of the auditor selection process.

In summary, our results contrast with the arguments of auditor ratification vote proponents—that the auditor ratification vote serves as an important corporate governance mechanism. More generally, our study is relevant to the current debate described above about the benefits of the shareholder voting process for corporate governance and company value. Our study is especially timely, given that the effectiveness of the U.S. proxy system appears to be at the forefront of the Securities and Exchange Commission’s (SEC’s) agenda.[2]

The title of our paper asks whether uninformed shareholders should vote, and our results suggest that they should not so long as they remain uninformed. Several recent papers from the law literature discuss potential adverse implications of and remedies for proxy voting by uninformed investors (Lund 2018; Lund 2019). For example, Lund (2019) advocates issuing nonvoting shares to encourage uninformed voters to self-select out of the voting process. To the extent that informed (uninformed) investors would self-select into voting (nonvoting) shares, the issuance of nonvoting shares could improve the effectiveness of the shareholder voting process.[3] Alternatively, uninformed shareholders could elect to become informed by searching for information relevant to a particular vote topic. This process could be facilitated by improving disclosure in the proxy materials to make relevant information more readily available to interested shareholders. This, in turn, would likely facilitate more informed shareholder voting while still permitting all shareholders to retain their voting rights.

REFERENCES

Armstrong, C. S., I. D. Gow, and D. F. Larcker. 2013. The efficacy of shareholder voting: Evidence from equity compensation plans. Journal of Accounting Research 51 (5): 909-950.

Bushee, B. J. 2004. Identifying and attracting the “right” investors: Evidence on the behavior of institutional investors. Journal of Applied Corporate Finance 16 (4): 28-35.

Bushee, B. J., and T. H. Goodman. 2007. Which institutional investors trade based on private information about earnings and returns? Journal of Accounting Research 45 (2): 289-321.

Ertimur, Y., F. Ferri, and V. Muslu. 2011. Shareholder activism and CEO pay. The Review of Financial Studies 24 (2): 535-592.

Gillan, S. L., and L. T. Starks. 2000. Corporate governance proposals and shareholder activism: The role of institutional investors. Journal of Financial Economics 57 (2): 275-305.

Hennes, K. M., A. J. Leone, and B. P. Miller. 2014. Determinants and market consequences of auditor dismissals after accounting restatements. The Accounting Review 89 (3): 1051-1082.

Larcker, D. F., A. L. McCall, and G. Ormazabal. 2015. Outsourcing shareholder voting to proxy advisory firms. The Journal of Law and Economics 58 (1): 173-204.

Lund, D. S. 2018. The case against passive shareholder voting. Journal of Corporation Law 43: 493-536.

Lund, D. S. 2019. Nonvoting shares and efficient corporate governance. Stanford Law Review 71 (Forthcoming).

Solomon, D., and E. Soltes. 2015. What are we meeting for? The consequences of private meetings with investors. The Journal of Law and Economics 58 (2): 325-355.

Swanquist, Q. T., and R. L. Whited. 2015. Do clients avoid “contaminated” offices? The economic consequences of low-quality audits. The Accounting Review 90 (6): 2537-2570.

ENDNOTES

[1] Prior work supports the view that restatements are indicative of audit failures and poor auditor performance (e.g., Hennes et al. 2014; Swanquist and Whited 2015).

[2] In a recent statement, SEC Chairman Jay Clayton announced an upcoming SEC staff “roundtable” to discuss the effectiveness of the current proxy system. Available at: https://www.sec.gov/news/public-statement/statement-announcing-sec-staff-roundtable-proxy-process.

[3] The issuance of nonvoting or restricted voting stock has been the subject of recent controversy. Notably, in their $3.4 billion IPO in March 2017, Snap Inc. made headlines by issuing common stock with no voting rights. Following this decision, both the S&P Dow Jones Indices and FTSE Russell announced that they would exclude Snap Inc. and other companies that issue classes of stock with limited or no voting rights. Despite this controversy, not all interested parties are against the use of nonvoting stock. For example, in a recent post on the Harvard Law School Forum on Corporate Governance, David J. Berger states, “we believe that the current effort to mandate some form of one-share one-vote for all public companies in the U.S. is premature … the evidence that is available indicates that the most recent group of dual-class companies may have performed as well, if not better, than those with a single class of stock.” Available at: https://corpgov.law.harvard.edu/2018/04/15/are-dual-class-companies-harmful-to-stockholders-a-preliminary-review-of-the-evidence/.

This post comes to us from Cory A. Cassell, an associate professor of accounting at the University of Arkansas; Tyler J. Kleppe, a doctoral candidate in accounting at the university; and Jonathan E. Shipman, an assistant professor of accounting at the university. It is based on their recent article, “Should Uninformed Shareholders Vote? Evidence from Auditor Ratification,” available here.

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