Financial Frenemies: Incestuous Voting

Shareholder voting at financial firms should be required to be confidential, researchers from Cass Business School, City University London, and Toulouse Business School have found.

Members of every industry sector are interconnected through a variety of business relationships, but financial firms are additionally linked through cross-shareholdings. According to the new study, the fact that the finance sector is its own largest investor undermines the sector’s governance, and could ultimately lower director efficacy and firm value.

Frenemies: How do financial firms vote on their own kind by professors Aneel Keswani and Anh Tran of Cass Business School and David Stolin of Toulouse Business School, is set to be published in Management Science journal.

The researchers examined voting by US mutual fund companies on management proposals tabled by companies in their portfolios. They found the rate of acquiescence to be significantly higher when the subject of the vote was another mutual fund company than when it was a firm in a different line of business. The researchers also found that in the financial sector as a whole, investor support for management proposals is higher for firms with more sector peers among their investors.

Professor Keswani said: “Actually, we were initially surprised at our results. Given that financial companies voting on each other are often direct competitors, we thought that, if anything, they’d be more likely to challenge their rivals than to support them.”

Researchers isolated three channels that drive financial firms to support each other through voting:

• professional relationships at the senior management level;
• firm-level competitive interaction; and
• cross-shareholdings.

Professor Keswani said: “Although company management is supposed to be monitored by its shareholders, this mechanism is less effective in the finance sector. For example, if a financial institution voted against Lehman Brothers’ management, Lehman could retaliate in more ways than a non-finance firm could.”

The possibility of retaliation through these channels is enough to dissuade financial firms from opposing their peers’ management, argue the authors. This acquiescence has consequences: the study also showed that greater peer support lowers both director efficacy and firm value.

The study recommends two policy changes in order to improve the governance of the finance sector by mitigating conflicted voting:

1. Voting at financial firms should be required to be confidential – that is, company management must not be allowed to see how each shareholder voted.
2. Institutional investors’ voting policies should address not only conflicts of interest due to client/supplier relationships as they do now, but also conflicts of interest through competitive interaction and reciprocal investments.