How Blockchain Proxy-Voting Improves Shareholder Engagement

We live in an increasingly globalised world. Although some world leaders believe that the future belongs to patriots rather than globalists, technology is making the world an ever more integrated and smaller place.

In fact, we can say that globalisation has gone digital. In the 21st century, globalisation is all about exchanging data. Thanks to the interconnected digital world that we live in, borders are disappearing, and national legislation is increasingly difficult to maintain. In today’s world, even a 1-person company can be a multi-national and thanks to blockchain and Security Token Offerings (STOs) organisations can raise funds from anywhere in the world.

Not only startups can benefit from these new distributed ledger technologies, but also existing public multi-national enterprises (MNEs) can use it to improve, for example, corporate governance. MNEs span multiple jurisdictions and territories, where variables such as technologies, infrastructure, markets, legislation and customer demands are different. In addition, shareholders can be located anywhere in the world, thereby directly affecting corporate governance.

Corporate Governance and Proxy Voting

Corporate governance controls how public MNEs behave. The objective of corporate governance is to ensure that the agent (the management of an organisation) behaves as intended by the principal (the shareholders). To achieve that, there are multiple systems in place. One is the Annual General Meeting (AGM) where shareholders vote on proposals put forward by the management (or other shareholders). However, shareholders are often widely distributed across the globe and, hence, shareholder engagement systems such as the AGM face many inefficiencies, while especially during AGMs, the stakes are very high.

After all, it can cost an organisation millions of dollars to create a proposal, communicate with shareholders and persuade them to vote in favour of it. The more shareholders, the higher the costs. AGMs are democratic processes, and since all shareholders have the right to vote at an AGM, but might not be able to attend an AGM, organisations use proxy voting. Proxy voting means that shareholders delegate their voting power to a representative who votes in their absence.

Proxy voting relies on multiple layers of intermediaries, including financial institutions and information service providers, which makes it inefficient, costly and complex due to a lack of transparency. Fortunately, blockchain technology can help here, but to understand how we first need to understand how voting works within organisations. To do so, let’s first untangle the different democratic processes.

Direct versus Represented Democracy

Democracy has been around for some time now, but it has not really changed over the years. Despite different tests with new forms of democracy, give or take, there are two main forms of democracy: direct (or pure) democracy and represented (or indirect) democracy. Each has its advantages and disadvantages.

Direct Democracy

In a direct democracy, every citizen decides on initiatives or proposals directly. Each vote counts and the outcome is determined by the majority of the votes. It originated in the 5th century BC when the Athenian democracy allowed its male citizens to control the entire political process. Currently, the only known direct democracy exists in two Swiss Cantons. That is because direct democracies pose multiple problems for today’s society. First of all, there are so many topics that require a decision, that it is impossible for all citizens to be informed about all topics. It would simply require too much time. In addition, we do not have the technological capabilities, nor the funds, to vote on every topic. Especially because in today’s world, voting is a slow and manual process. These two problems make a direct democracy impractical on a daily basis.

Represented Democracy

Represented democracy is the other form and it is the most accepted form of democracy. Within a represented democracy, citizens will vote for a delegate who represents their constituents. The system of elected officials is adopted by nearly all Western-style democracies. It has become so popular because it is seen as the most efficient form of democracy. However, a represented democracy presents its own problems. First of all, in many countries, there is a disconnect between citizens and politicians and citizens no longer trust the traditional parties of elected officials representing the citizens. Representatives are only loosely held accountable for their actions, and promises are not necessarily kept. In addition, the problem with having elected delegates is that corruption becomes possible. Power corrupts and, in some countries, delegates rather listen to money than to the people who elected them. Finally, countries having a two-party system, such as the United States, significantly limit the choices that citizens have, while in multi-party systems, such as in The Netherlands, coalitions need to be formed, often taking months. In both systems, progress is slow.

As mentioned, democratic systems not only exist in countries. Of course, also, organisations have democratic systems. Direct democracies are common in smaller organisations, where shareholders can still vote on all decisions. As such all can join to determine the company’s strategy (complex proxy voting mechanisms is not really required in a startup of 10 or 50 people with a few shareholders). However, as soon as an organisation becomes bigger with multiple shareholders, or even goes public with thousands of shareholders, direct democracy no longer works. Such organisations opt for a represented democracy, where the shareholders appoint a board to make decisions for them, and the annual shareholders’ meeting can hold the board accountable for their actions.

Three Characteristics of Democratic Voting Process

When shareholders – or citizens during an election – vote, there are three important characteristics that the voting should adhere to. First, if you vote, you need to know that you will be able to submit your vote for it to be counted. This is called censorship resistance. It refers to the electoral fraud of disenfranchisement. The second characteristic is that after casting, you need to know, and be certain, that your vote was included in the result. This is called a consensus protocol. Finally, you need to know, and be certain, that your vote, and others, will not be changed after they have been cast. This is called immutability of votes. Without these three key aspects of voting, the democratic process, whether in organisations or elections, is deemed to fail.

Until today we have trusted electoral committees – or complex proxy voting mechanisms using trusted intermediaries – to ensure that these key voting characteristics are in place. However, it is impossible for individuals to check to be 100% sure that their vote was included, counted and not changed afterwards. In addition, when it comes to proxy voting or electronic voting in AGMs, voting information becomes available to some before the AGM. Research showed that up to 80% of votes are now done using electronic or proxy voting. The recipient of the votes is already familiar with how shareholders are expressing their votes, which can cause information asymmetries and impediments.

However, the biggest problem with proxy voting is that it is opaque and often difficult to tabulate accurately. Thanks to middlemen (proxy communications firms and tabulators) there is lack of an auditable data trail which makes it hard to comply with verifying who cast their votes if these votes have been counted and have not been changed afterwards. These information problems, the lack of transparency and the costly complex voting mechanisms of an AGM indicate the need for a new solution. Blockchain, being an immutable, verifiable and traceable record of data, could be such a solution.

Proxy Voting and Blockchain Technology

Annual general meetings tend to be high-cost events, with low shareholder participation. With the increasingly global world, where investments are made across the globe, shareholder engagement becomes important, but participating in person becomes more difficult.

Blockchain-enabled shareholder voting will offer corporations a secure and immutable digital copy of voting instructions cast by shareholders during an AGM. It will ensure that shareholders can exercise their rights in a secure and transparent way, which at the same time could foster cross-border investments (thanks to security tokens, also resulting in increased liquidity of global assets). In addition, if a regulator needs to get access to these instructions, it can simply do so by joining the private blockchain network. All records are distributed among participating members, making the voting instructions immutable, verifiable and traceable.

Blockchain-enabled voting during AGMs will remove the complexity of proxy voting during traditional AGMs while increasing the quality and efficiency of proxy voting. Auditors will be able to check, in real-time, if all votes have been placed, if all votes have been counted and whether no vote has been changed afterwards. A proxy-voting organised on a distributed ledger will reduce the voting errors and possible voting fraud. A simplified, transparent and auditable voting process could also increase participation of shareholders, for the betterment of corporate governance.

5 Examples of Blockchain-Enabled Proxy Voting

Already in 2016, Russia’s central securities depository, the National Settlements Depository (NSD), a member of the Moscow exchange, developed and tested a blockchain prototype for proxy voting. They developed the open-source e-proxy voting system prototype to securely process electronic interaction between security holders and issuers when exchanging information during the annual securities holders’ meetings. The solution was developed using Hyperledger Fabric and the privacy technology called zk-snarks (unsurprisingly, not all stakeholders want increased transparency and using zk-snarks could overcome this).

Blockchain-enabled e-proxy voting also improves corporate governance. In 2017, Broadridge Financial Solutions, JPMorgan, Northern Trust, and Banco Santander successfully accomplished a blockchain pilot developed to improve transparency in the proxy voting process during an annual general meeting (AGM). The pilot acted as a ‘shadow’ digital copy of votes cast by the shareholders. The objective of the pilot was to increase transparency during proxy voting as part of the AGM and as such, to improve corporate governance.

In 2016, Nasdaq experimented with using blockchain to record the ownership of securities and offer voting-right assets based on those assets to shareholders. The company worked with the Tallinn Stock Exchange, and it benefited from the already developed digital identification solutions. Consequently, shareholders with the right voting right asset can view relevant information, transfer voting rights to a proxy, monitor the proxy and recall if necessary and review previous meetings and votes.

Next, in April 2018, Dutch bank KAS BANK, launched a pilot on Ethereum to bring shareholder voting to the blockchain. The solution will expedite collation of ballots and significantly improve reporting transparency. According to Pat Sharman – UK Managing Director – the solution, called Voteroom, will uphold “shareholder’s democratic voting rights and […] improve efficiency and transparency when communicating shareholders’ decisions on investment policies.”

Finally, in 2017 ConsenSys, a developer of products based on Ethereum, started developing BoardRoom. The blockchain governance platform is a decision-making platform for organisations to simplify board member elections, budget allocation, shareholder voting and more. Subsequently, larger organisations can start experimenting with Blockchain voting.

Conclusion

Blockchain-based proxy voting offers a lot of benefits for large multi-national enterprises with shareholders distributed across the globe. It will improve corporate governance mechanisms by creating an efficient, trustworthy, immutable and verifiable voting system that minimises fraud, improves transparency and increases shareholder engagement. Security tokens are programmable, which means that rules related to dividend release, voting rights or other privileges, can automatically apply to the owner of the token. These rules can then incentive shareholder engagement, resulting in improved corporate governance mechanisms.

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