Corporate Governance

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Twenty-two Vanguard employees share arguably one of the most important roles on Wall Street. When any publicly traded company puts a matter up for shareholder consideration, it's their job to determine how Vanguard should vote.

This is no small matter. Vanguard is almost always the largest owner of any company in the S&P 500. Investors in its funds collectively own about 6% of Apple, 6.5% of ExxonMobil, and 5.5% of Wells Fargo, just to give a few examples.

Of course not all shareholder votes are groundbreaking, but some certainly are. When Tesla and SolarCity investors ultimately cast a vote on their controversial plan to merge, Vanguard will play an important role. Its funds own 4.3% and 3.2% of SolarCity and Tesla, respectively, but this understates the asset manager's importance. Elon Musk is expected to withhold his voting privileges, thus giving every other shareholder proportionally more influence.

These must be the busiest 22 people on earth, assuming they're actually doing their diligence on every single proxy. After all, Vanguard's Total World Stock Index Fund holds 7,498 stocks. Most of these companies will send out proxy materials to their shareholders at least once a year. Given a 40-hour workweek, they'll have less than a full workday to decide how to vote for each company.

It's only logical that these twenty-two people prioritize. Vanguard doesn't have much reason to spend time on its smaller holdings. Take, for example, a small California bank holding company named Bank of Marin Bancorp. Vanguard owns 2.5% of the bank, but what happens to the company is of little consequence to its fund investors.

Suppose aliens descended on the San Francisco Bay to destroy its branches and abduct its employees, leaving the bank to the bankruptcy courts. The stock would invariably fall to zero, and Vanguard's Total Stock Market Index Fund would lose 0.001% of its value as a result.

Labeling it a rounding error would overstate just how little this investment matters to Vanguard's investors. But for other Bank of Marin shareholders, how it votes is very consequential. Vanguard is the seventh-largest institutional owner of the company's stock. This is just one of many companies of which I could make an example.

The index fund is probably one of the most important innovations in the financial industry over the past century. But what they save investors in fees and expenses cannot be championed in a vacuum. The concentration of power in so few hands could create ugly externalities in corporate governance that can't be measured as easily as one can measure the difference in fund fees and expenses.

It's becoming increasingly important for passive investors to take an active interest in how their fund managers act on their behalf.

Jordan Wathen has no position in any stocks mentioned. Check out a recent Industry Focus: Financials podcast for more on how to do your mutual fund due diligence. The Motley Fool owns shares of and recommends Apple, SolarCity, Tesla Motors, and Wells Fargo. The Motley Fool owns shares of ExxonMobil and has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.