Proxy favors: Confidential proxy voting with institutional dual holders

• Published date: 01 May 2024
• Author: William J. Becker,Sattar Mansi,Maryam Nazari,John K. Wald
• Date: 01 May 2024
• DOI: http://doi.org/10.1111/corg.12557

ORIGINAL ARTICLE

Proxy favors: Confidential proxy voting with institutional dual

holders

William J. Becker

1

| Sattar Mansi

2

| Maryam Nazari

3

| John K. Wald

4

1

Department of Management, Pamplin College

of Business, Virginia Tech, Blacksburg, Virginia,

USA

2

Department of Finance, Insurance, and

Business Law, Pamplin College of Business,

Virginia Tech, Blacksburg, Virginia, USA

3

Meta Corporation, Austin, Texas, USA

4

Department of Finance, Alvarez College of

Business, University of Texas at San Antonio,

San Antonio, Texas, USA

Correspondence

John K. Wald, Department of Finance, Alvarez

College of Business, University of Texas at San

Antonio, San Antonio, TX 78249, USA.

Email: john.wald@utsa.edu

Abstract

Research Question/Issue: For firms with institutional dual holders, is proxy voting

affected by whether the vote is confidential? Does confidential voting affect firms'

cost of debt?

Research Findings/Insights: Consistent with social exchange theory and reciprocity

norms, we find that, in the absence of confidential voting, firms with institutional dual

holders gain more favorable votes for proposals and, in particular, for management-

sponsored compensation proposals. Further, these firms pay a higher cost of borrow-

ing. This reciprocity relation does not exist if the firm has confidential voting in place.

Theoretical/Academic Implications: The results are consistent with reciprocity norms

creating a psychological obligation to repay valuable favors between firm managers

and institutional dual holders when proxy votes are not confidential.

Practitioner/Policy Implications: The findings support the popular position that con-

fidential voting is in the best interests of shareholders and rigorous external corpo-

rate governance.

KEYWORDS

confidential proxy voting, corporate governance, cost of debt, institutional holdings, voting

outcomes

1|INTRODUCTION

Corporate governance involves the structures and processes that pro-

vide oversight and control over corporate managers (Westphal &

Zajac, 2013). While governance has been extensively studied, we do

not know much about the role social processes in external forms of

governance play in “prevent[ing] managers from engaging in activities

detrimental to the welfare of shareholders”(Aguilera et al., 2015,

p. 483). Among these relatively understudied external governance

devices, proxy voting is a fundamental mechanism through which

shareholders exercise control over the corporation (Krause

et al., 2014). Proxy voting is a process by which each shareholder is

entitled to one vote per share on corporate governance issues, but

voting is conducted by proxy, often through agents who represent

many investors and have a fiduciary responsibility to vote in the best

interests of their clients. During the 2018 US proxy season, over

400 billion shares were voted to elect directors, adopt compensation

plans, ratify external auditors, set or alter corporate charters, and

approve the disposition of mergers, sales, liquidations, or breakups.

These rights provide shareholders, as owners of the ultimate stream

of residual profits, the power to ensure that management acts in their

best interest. While proxy voting in the United States has become

more contentious, there is an ongoing debate as to whether the form

of proxy voting (either openly or in confidence using a secret ballot)

affects vote outcomes and firm performance (Romano, 2003).

1

A number of controversies erupted in 2013 over firm access to

interim vote tallies, suggesting that confidential proxy voting is an

important issue for shareholders and the Securities and Exchange

Commission (SEC). As a result, new “enhanced confidential voting”

proposals were submitted in multiple high-profile firms such as Ama-

zon, Verizon, and Whole Foods Market during subsequent proxy sea-

sons. The new proposals restrict management's access to a running

tally of votes and prohibit its use of such information to solicit votes.

Corporate governance reformers and institutional activists have

Received: 3 August 2022 Revised: 31 July 2023 Accepted: 7 August 2023

DOI: 10.1111/corg.12557

Corp Govern Int Rev. 2024;32:549–566. wileyonlinelibrary.com/journal/corg © 2023 John Wiley & Sons Ltd. 549

argued that confidential voting reduces conflicts of interest that arise

when institutional equity holders have other business dealings with

the firm (e.g., Black, 1992; Pound, 1988; Romano, 2003; Securities

Regulation & Law Report, 1989). Although the belief that anonymous

voting is beneficial has popular appeal, there are also downsides to

anonymity in group voting (Jessup et al., 1990).

Existing empirical research, while limited, has not found that the

form of proxy voting has measurable real effects. In particular,

Romano (2003) examined the effects of confidential voting on voting

outcomes and stock valuations and found that confidential voting has

little effect on either. The existing literature has been largely empirical

and silent on the relation between confidential voting and institutional

investors, who have shown a drastic increase in share ownership (over

70% according to 13F filings). Anecdotal evidence, though limited,

suggests that shareholders, including companies that conduct busi-

ness with the firm, are pressured to vote with management when vot-

ing is not confidential. For instance, at a 1989 SEC hearing, Dale

Hanson, executive officer of CalPERS, stated that without confidential

voting, managers regularly encourage institutional shareholders to

change their votes. The outcome of such pressure would be manage-

ment adopting policies that are more self-serving than value-enhanc-

ing.

2

However, in 2004, the SEC established a rule requiring

registered management investment companies to report how they

voted their proxy shares. This rule further complicates confidential

proxy voting adoption. Despite anecdotal evidence, there is a lack of

theory-driven predictions and large-scale data analyses to test

whether confidential proxy voting leads to better corporate

governance.

Westphal and Zajac (2013) initiated the movement to consider

the socially situated nature of corporate governance, which argues

that behavioral theories are useful in understanding the actions of

governance actors (Hambrick et al., 2008). In this paper, we draw on

social exchange theory (Blau, 1964) and reciprocity norms (Bosse

et al., 2009) to examine how non-confidential versus confidential vot-

ing affects proxy vote outcomes. We argue that non-confidential

voting creates social considerations by both parties that are not pre-

sent in confidential voting. In particular, we believe that it creates

incentives to make concessions to institutional investors, who control

large blocks of shares, to solicit support for proxy proposals. While

these concessions may often not be readily observable, we believe

that institutional dual holders—institutional shareholders who are also

creditors of the same firm—provide a unique case. Because dual

holders are part of the institutional equity ownership base, they are

likely to observe voting outcomes on their overall portfolio and

are therefore uniquely positioned, as debtholders, to potentially price

in the actions of other institutional equity holders in a firm (non-dual

holders). Firm managers may make concessions in debt financing

terms, which are public record and observable, in order to garner

proxy support of dual holders. We expect the effects of this quid pro

quo to hold because both parties are aware that management can ver-

ify the voting of these lending institutions. However, confidential vot-

ing removes dual holders' social pressure to vote more favorably and

managers' reciprocity motive to agree to a higher cost of debt for the

firm. Thus, firms that have adopted confidential voting arrangements

should receive less proxy support from dual holders but have a lower

cost of debt than those with non-confidential voting. Our results

show that firms with institutional dual holders are more likely to vote

positively on a variety of proposals, but only if the firm has not

adopted confidential voting. This result is particularly strong for

management-sponsored compensation proposals, which offer little

benefit to lenders. Therefore, this study contributes to research on

governance policies by providing initial evidence that confidential

proxy voting has real effects on voting outcomes that favor share-

holder interests and thus effective corporate governance.

2|THEORY AND HYPOTHESES

2.1 |Corporate governance and institutional

investors

The past decades have seen interest in corporate governance shift

from board of directors to corporate ownership structures and their

ability to influence firm strategic actions (Connelly, Hoskisson,

et al., 2010). Thus far, the extant research into how managers and

shareholders interact in governance has been dominated by agency

theory and the associated agent–principal motives and issues (Dalton

et al., 2007). While this work has been informative, one shortcoming

has been that it treats all external agents as being homogenous

(Connelly, Hoskisson, et al., 2010). The growing diversity of ownership

and types of investors—dual holder institutional investors being a

prime example—exacerbates this issue and limits the ability of agency

theory alone to account for how these new types of shareholders

interact in corporate governance, while also increasing the importance

of trust, reciprocity, and mutual interdependence (Larson, 1992).

Institutional investors have risen to the forefront of academic and

regulatory interest due to their economic and political power

and unique and varied interests (Connelly, Tihanyi, et al., 2010). The

prevalence and influence of institutional investors in corporate gover-

nance have also risen dramatically in recent decades (Gillan &

Starks, 2007). Subsequently, institutional investors are able to exert

greater influence on firm managers (David et al., 2007; Filatotchev &

Toms, 2006). The literature has long indicated that institutional inves-

tors have two options when they are unhappy with a firm. They can

sell their shares or they can engage directly with management (voice

vs. exit). One recent study showed that firms increasingly choose to

engage rather than exit (McCahery et al., 2016).

With the rise of investor activism, one of the most prominent

ways that institutional investors exert their influence on firm man-

agers is through their proxy voting rights as shareholders

(Benton, 2017; Mallin & Melis, 2012). An important distinction

between institutional investors involves their time horizon

(Porter, 1992). Transient, short-term investors tend to value near-term

profits and undervalue strategic initiatives (Schnatterly et al., 2007).

Many institutional investors are inclined to value longer term pros-

pects and tolerate short-term disappointments (Harford et al., 2018;

550 BECKER ET AL.