April 6, 2016
As stewards of millions of families’ savings, we at American Funds and our adviser, Capital Research and Management Company, take our contribution to the successful governance of modern business enterprises very seriously. Sound corporate governance means that the companies we invest in on behalf of our investors have the appropriate policies and checks and balances in place to ensure the entity is run in the best interest of its shareholders, employees and other relevant stakeholders.
The money that investors have entrusted with us makes the American Funds a significant shareholder in many public companies across the world. The success of these companies is critical to helping our investors send their children to college, retire securely or meet their other financial goals. We use rigorous analysis, diligence and care when considering governance issues. To us, corporate governance involves more than just proxy voting; it must be an integral part of the investment process. We engage with company directors and management to encourage good governance as we have found it to be a key element in achieving investment success. This is also why we devote significant energy and resources in our effort to positively influence governance standards globally.
Over eight decades, American Funds has developed a thoughtful and robust process for managing our role in corporate governance. What makes our approach different? In an era when investment decisions, as well as markets themselves, are increasingly dictated by algorithms, formulas, split-second computerized trades and index investing (where one buys a basket of stocks without regard to the valuation of each underlying security), American Funds approaches both investment decisions and corporate governance decisions with great care and deliberation, evaluating issues on a case-by-case basis and with a long-term orientation. Our analysts and portfolio managers devote significant time and energy to these matters, which differentiates us from many of our peers. We debate critical questions with our colleagues and then exercise experienced, nuanced judgment.
At American Funds, the cornerstone of our investment process is fundamental research. Within this process, known as The Capital System℠, we study companies and industries intensively, interviewing management teams and seeking all available, relevant information. This information forms the foundation for our investment decisions. Our process combines individual accountability with teamwork. Each fund is divided into portions that are managed independently by investment professionals with diverse backgrounds, experience levels and investment approaches. An extensive global research effort supports The Capital System.
Our investment process underpins our approach to corporate governance. Unlike some fund managers who hand off such matters to a separate department — or others who effectively outsource this function to advisory firms who favor “bright line” rules that can miss key details of a company’s specific situation — our analysts and portfolio managers drive our corporate governance practices directly. We believe our detailed, hands-on, case-by-case approach to governance serves an especially important role today, when a growing portion of ownership in global equity markets takes place via investment vehicles designed to take human judgment out of the equation entirely.
Our investment professionals encourage long-term thinking and value creation for shareholders through (1) direct engagement with management and directors, (2) proxy voting and (3) participation in policy and governance organizations. We’ll consider these roles in turn.
Our portfolio managers currently average 27 years of investment experience, including 22 years at our company. Over their careers, our portfolio managers and analysts develop deep knowledge of companies and industries, including best practices that can help generate positive shareholder returns over time. In evaluating such practices, we seek to strike a balance between delivering current returns to shareholders (via dividends and share buybacks) and assuring long-term growth for the business, its employees and other stakeholders (via capital investments). We conduct thousands of in-person meetings and conversations each year with senior management and directors of portfolio companies. This allows us to assess not just the operations and strategies of the companies we follow, but also to make informed assessments of the individuals who guide and manage them. The relationships we build through this process can also result in companies seeking our input on a variety of corporate governance matters.
Proxy voting is an integral part of corporate governance. Investment analysts are responsible for developing proxy voting recommendations for each company held by one of the American Funds. These recommendations are reviewed by senior analysts serving as proxy coordinators. Our internal governance and proxy team coordinates and informs this process, drawing on their deep knowledge and institutional expertise. Portfolio managers on the investment committees within Capital Research and Management Company debate and ultimately vote on the proposals. We also benefit from the perspective and experience of the independent board members of the American Funds, who work with us to develop and vet guidelines that shape our deliberations.
Because each proxy vote is analyzed on a case-by-case basis, and because multiple decision-makers may weigh in, certain American Funds may vote differently than others. However, all votes are informed by the same basic principles. Following are examples of those principles, applied to specific topics of interest:
Compensation should create incentives for superior investment returns and align management’s long-term interests with those of the shareholders. For this reason, consistent with our approach to investing, we generally prefer a significant portion of management’s compensation to come in the form of equity stakes tied to long-term value creation for all shareholders. It is important, however, that such compensation be designed not merely to reward a “rising tide” in either the market or a specific industry that cannot be fairly attributed to management skill or contribution. We look for multiyear arrangements that are appropriately tailored to both the industry and the company’s size and growth rate. We also believe that absolute levels of compensation (as well as pensions and severance, when they apply) should be monitored with an eye toward preventing excess. In addition, we are vigilant about assuring fairness for public shareholders; we frown on plans that unjustly dilute their stakes and stand ready to vote these convictions. We believe the goal should be to balance incentives for high performance with a commitment to superior shareholder returns.
Election of Directors and Separation of Chairperson/CEO
Board independence is essential to good corporate governance. Typically, we find this requires that a significant majority of the board remains fully independent of management. We also generally prefer a separation of the chairperson and CEO roles, with the chair being an independent director (i.e., not a current or former executive or other affiliated director). Additionally, we recognize that, in some cases, a sufficient level of board independence and leadership can be accomplished via other means, such as through an empowered lead independent director.
Shareholder Access to the Proxy
Giving shareholders the ability to nominate directors is a potentially constructive tool in cases in which there are questions regarding a company’s dedication to creating shareholder value. This input, however, must be balanced against the risk of abuse by groups whose short-term agenda can distract or destabilize a company in ways that undermine long-term value creation. When assessing such proposals, we believe it’s important to consider a company’s existing governance structure and responsiveness to shareholders. In some cases, the presence of strong independent directors and a strong chair of the nominating committee may better meet our clients’ goal of long-term value creation than new forms of proxy access.
Action by Written Consent/Right to Call a Special Meeting
The right to act by written consent (without calling a formal meeting of shareholders), as well as the right to call a special meeting, can be powerful tools for shareholders. As a practical matter, these tools are needed only rarely, but it’s essential that proper options be “on the shelf” should such occasions arise. We therefore typically seek to ensure appropriate access to these tools while avoiding abuses by small groups that may not be in the long-term interest of most shareholders.
An intelligent capital structure is an integral part of any business strategy. As proposals arise, we seek to balance the need for flexibility in managing the financing needs of the business with an overriding commitment to fairness for existing shareholders. In this context, we generally support reasonable increases in authorized shares when the company has articulated a need (for example, a stock split or recapitalization).
Environmental, Social and Governance (ESG) Issues
A company’s ability to align its business strategy with evolving societal expectations is essential to long-term value creation. Management’s understanding of emerging issues and their efforts to minimize risks forms an important part of our assessment of management quality, a key factor in our stock-selection decisions. ESG issues are an important and natural part of this ongoing dialogue. They can affect a firm’s reputation and license to operate, its ability to attract and retain talent and its ability to work effectively with stakeholders and regulators.
When evaluating proxy proposals relating to ESG issues, we assess the impact to the company’s shareholders, the specific circumstances at each individual company and the company’s current policies and practices. Our guiding principle is always to act in the best long-term interests of our investors and clients.
We believe that we serve our clients’ long-term interests by helping improve governance practices globally. In addition to our direct engagement with companies, we know from experience that detailed technical matters can often play a vital role in sound stewardship. We frequently share ideas with such bodies as the Financial Accounting Standards Board and the Public Company Accounting Oversight Board, and with stock exchanges and their regulators around the world, from Hong Kong to London to New York. We work to improve standards more broadly via key industry initiatives in the United States as well as overseas, including the Japan Stewardship Code (on which we were a charter signatory), or by participating in such venues as the Asian Corporate Governance Association.
The direct involvement of analysts and portfolio managers in governance issues, together with our case-by-case analysis of critical proxy issues, is an important part of our investment process.
By helping ensure that investment capital flows to ideas that often become products and services that improve people’s lives (and thus create long-term value), effective corporate governance contributes to shared prosperity. The stakes are high; after all, when taking the long view, the extraordinary rise in human well-being in the last 200 years is due in significant measure to the investment, innovation and talent mobilized within publicly owned corporations.
We take pride in helping many of the world’s leading firms work for the benefit of the millions of investors we serve, and look forward to continuing this tradition of diligence and stewardship on their behalf.