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By Christine Benz | 10-15-2010 06:14 PM

Bogle: Index Funds the Great Hope for Corporate Governance

Index funds will be called to task to play a larger role in corporate governance as they gather more assets, says the Vanguard founder.

Christine Benz: Jack, I know you are a big believer in holders of stock exercising their right to weigh in on governance matters vote against outlandish pay packages and so forth. A question that I have, actually my colleague Gregg Wolper raised it to me, is that, if indexing continues to gain traction as it has, does that sort of run at odds with the idea of governance and if the corporation knows that the passive investor doesn't have that ultimate weapon of walking away, can it just really ignore the index fund's wishes?

Jack Bogle: Well, I come to the exact opposite conclusion. This is what we call the Wall Street Rule, if you don't like the management sell the stock. We can't in index fund, cannot sell a stock. So, the only weapon we have, if we don't like the management, is to get a new management or to force the management to reform. To me, it's pretty simple, and its right out of Benjamin Graham's first book. What governance should do. What stockholders should do if the company is ill-governed? Take an active role. Nobody paid any attention to that advice, and they haven't yet. So, I'd say index funds are the great hope for governance.

Index funds are now about, in round numbers 22% of all equity fund assets and when you get to state and local governments and even corporate pension plans, indexing is probably every bit of 25% of all stock, and that's the only recourse we have. I suggested years ago, post-Enron, the formation of a group of long-term investors to get together and agree to some governance principles, not telling people how to vote, but to get involved in governance. It was very hard to get people even to talk about it.

Benz: Why is that, do you think?

Bogle: I think, it's -- first of all, there is no money in governance. You don't make more money by paying in a lot of attention to governance. Second, we run the money for corporate America, we institutional investors, and so, if we take on a corporation, somebody is going to lose that client, and so one doesn't want to take on one's biggest clients. Everybody says, 'Oh, we would never do that.' It's a pretty subtle thing, and it's hard to measure. But the fact of the matter is that there is no evidence by the way that this happens. That mutual funds or other institutional investors have a different stance on voting with clients as compared to with non-clients. But that's because we have no interest in active voting at all.

And it's not that if there is an active and inactive share, it's all inactive and bringing to mind the aphorism that I have used for a long time. And that is, from the fund managers perspective, pension fund manager, mutual fund managers perspective, there are only two kinds of clients we don't want to offend, actual and potential. That's a lot of clients.

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