Index-Fund Governance: An Empirical Study of the Lending-Voting Tradeoff

Abstract

Institutional investors' role in shareholder voting is among the most hotly debated subjects in corporate governance. Some argue that institutions lack adequate incentives to effectively monitor managers; others contend that the largest institutions have developed analytical resources that produce informed votes. But little attention has been paid to the tradeoff these institutions face between voting their shares and earning profits—both for themselves and for the ultimate beneficiary of institutional funds—by lending those shares. Using a unique dataset and a recent change in SEC rules as an empirical setting, we document a substantial increase in the degree to which large institutions lend shares rather than cast votes in corporate elections. We show that, after the SEC clarified funds’ power to lend shares rather than vote them at shareholder meetings, institutions supplied 58\% more shares for lending immediately prior to those meetings. The change is concentrated in stocks with high index fund ownership; a difference-in-differences approach shows that supply increases from 15.6\% to 22.3\% in those stocks. Even when it comes to proxy fights, we show, stocks with high index ownership see a marked increase in shares available for lending immediately prior to the meeting. Overall, we show that loosening the legal constraints on institutional share lending has had significant implications for how index funds balance the lending-voting tradeoff.