Voting is important in the modern public corporation. Shareholders often vote on corporate referendums, they vote to elect directors, and the directors vote on major corporate policies. Yet, despite the significance of voting, there has been little research exploring whether it’s effective in different situations, such as when a company is considering environmental and social objectives.
In a recent paper, my coauthors and I examine voting on corporate policies when investors care about both maximizing firm value and achieving one or more social objectives. We find that the push towards socially responsible corporate policies may lead to worse corporate governance. In particular, the outcome of corporate votes may not accurately reflect the preferences of the investors, and firm policies may change regularly, depending on who sets the voting agenda. As a consequence, our findings suggest some caution is warranted about the push for firms to focus on multiple environmental or social issues.
Public Choice Theory
There are, of course, different voting systems and different conditions under which voting is effective. Arrow’s Impossibility Theorem (1951) famously shows that no voting system can aggregate voter preferences in a way that satisfies a small set of fairness axioms. However, subsequent research has shown that voting can effectively aggregate preferences in certain cases. For example, under some technical conditions, corporate voting is effective when all investors share the same general goal (like maximizing firm value). Importantly, it is unclear whether this remains true when investors also have environmental and social goals.
In our study, we show that socially responsible corporate policies can be viewed as adding new dimensions to voters’ objective function for the firm. Put differently, investors in a firm face a trade-off when pushing for many environmental and social goals. For example, minimizing pollution will cost money at the expense of maximizing shareholder value. We then examine the effectiveness of voting when voters have these multi-dimensional goals.
Implications of Socially Responsible Investing
We make several key findings. If voters care about maximizing firm value and one other objective (like minimizing pollution), then voting can successfully aggregate voter preferences. However, we show that several challenges arise if voters care about maximizing firm value and two or more social objectives (like minimizing pollution and maximizing employee satisfaction). In particular, in such situations:
- Corporate voting will not typically identify stable policy choices,
- The outcome of the vote will depend on the process by which policies are proposed instead of merely the quality of the proposed options, and
- The volatility of firm choices will tend to be higher
As a result, our findings suggest that the rise of socially responsible investing may lead to worse corporate governance. The mechanism behind these findings is relatively simple. When investors or managers care about more than two dimensions (say, maximize firm value, minimize pollution, and maximize employee satisfaction), the outcome of voting will depend on seemingly mundane details, like the rules for the vote and who has the power to set the voting agenda. As a result, the outcome of the vote may not accurately reflect the preferences of the voters. Moreover, firm policies may change regularly, depending on who sets the voting agenda.
Overall, our findings suggest caution is warranted in the push towards socially responsible investing. If corporate voters face a trade-off between maximizing firm value and one social policy (like minimizing pollution), then it is possible for majority rule voting to lead to stable policy choices that reflect investor preferences. But if corporate voters care about too many dimensions, then majority rule voting may no longer be effective. As a result, corporate governance may suffer.
This post comes to us from Matthew C. Ringgenberg, an associate professor of finance at the University of Utah. It is based on a recent article, “Voting for Socially Responsible Corporate Policies,” available here, which he co-wrote with Professor Adam Meirowitz at the University of Utah, and Shaoting Pi, a research associate at the Cambridge Centre for Finance and Cambridge Endowment for Research in Finance.