Institutional Shareholder Services Research Articles

Proxy Advisory Firms and Corporate Shareholder Engagement

Abstract We study how Institutional Shareholder Services (ISS) affect firms’ engagement with shareholders. Our analyses exploit a quasi-natural experiment using say-on-pay voting outcomes near a threshold that triggers ISS to review engagement activities. Firms receiving ISS treatment exhibit swift and substantive increases in extensive and intensive margins of engagement, especially when their boards have higher agency conflicts and directors are more likely to lose voting support from ISS. Increases in engagement persist over time, and shareholders appear to value the increased engagement. Collectively, we shed light on an unexplored channel through which ISS positively influences firms’ governance and information environments.

Financial analysts’ coverage, forecast accuracy, and climate change vulnerability

The effects of climate change are real. The understanding of how these effects manifest in business operations is still nascent, but even more so, how they affect users of company information. This study sought to determine whether and how climate change vulnerability relates to an important business stakeholder, the financial analyst. We hypothesize that climate change vulnerabilities reduce both analysts’ following and analysts’ forecast accuracy. Using data from the Center for Research in Security Prices (CRSP), Compustat, Audit Analytics, Institutional Shareholder Services (ISS), and London Stock Exchange Group (LSEG), we construct a sample of 3,754 firm-year observations comprising 1,269 unique firms for the years 2019–2022. Our proxy for climate change vulnerability is the environmental, social, and governance (ESG) controversies score. We estimate cross-sectional regression models to test our hypotheses. We find support for our hypotheses. Also, we find that firms with high climate change vulnerability have significantly lower analyst coverage than those with low vulnerability. We also find that financial analyst forecasts are significantly less accurate for firms with higher vulnerability. However, this effect is only observable in industries classified as more exposed to the effects of climate change. We recognize the noisy nature of our proxy for vulnerability to climate change. Cognizant of this, we conduct further analysis to allay concerns of bias in our findings. We make important contributions to the existing literature by not only showing that ESG controversies score is an appropriate proxy for climate change vulnerability but also by adducing empirical evidence that climate change vulnerability affects how analysts react to and use company financial information. We discuss the significance and limitations of our results and make recommendations for further research.

The Controversy over Proxy Voting: The Role of Fund Managers and Proxy Advisors

In this statement, we assess the role and power of proxy advisors and asset managers in corporate governance in a market that is characterized by a limited number of voting advisory firms (Institutional Shareholder Services and Glass Lewis) and a growing dominance of index investing concentrated in a few large asset managers, such as BlackRock, Vanguard, and State Street. We discuss the business model of proxy advisory firms and contrast its objectives with those of asset managers in the context of the informational screening/filtering role and voting analysis and conclude with a set of policy recommendations addressing transparency and regulatory oversight.

The audit committee and dividend policy: an empirical study of the post-SOX era

PurposePost-Sarbanes Oxley Act (SOX), the audit committee has been empowered greatly to play a central role in the corporate governance of firms. Embedded in agency theory, this study aims to examine the effect of the audit committee on the likelihood by firms to pay dividends.Design/methodology/approachThe study population is US firms in the Institutional Shareholder Services (ISS) database from 2007 to 2018. The authors apply the multivariate logit fixed-effect regression for the analyses after conducting the appropriate statistical tests.FindingsFrom the results of the research model, the authors find that there is a positive relationship between the size and gender diversity of the audit committee and the propensity to pay dividends suggesting that a larger audit committee with substantial women representation improve the information environment in firms leading to higher dividend distribution. The extent of busyness of the audit committee impacts negatively on the propensity to pay dividends. The results are driven by high-performing firms and not driven by specific levels of firm size.Research limitations/implicationsThe findings of the study give impetus to the audit committee as an important component of the corporate governance mechanism that advances the interest of stakeholders. Thus, efforts that seeks to promote the audit committee’s resourcefulness must be embraced by all stakeholders.Originality/valueTo the best of the authors’ knowledge, this study is the first to focus on audit committee and dividend payout policy of US firms post-SOX. The study demonstrates how the audit committee characteristics including its size, gender diversity and busyness affect dividend policy by mitigating information asymmetry problems.

Institutional shareholder services' proxy voting guidelines and ROE management

AbstractWe examine the impact of the Institutional Shareholder Services (ISS) proxy voting guidelines on managers' opportunistic reporting behaviours. In February 2015, the ISS introduced a new advisory policy based on firms' return on equity (ROE) and started to issue negative recommendations for top executive election in firms whose past average and most recent ROE are lower than 5%. We find that managers are more likely to achieve the 5% ROE after implementing the policy, and they do so by discretionary activities. Our findings imply that accounting‐based guidelines issued by a proxy voting advisor can generate managers' incentives for opportunistic reporting.

Share pledging and earnings informativeness

PurposeThe purpose of this paper is to investigate the effect of share pledging by controlling shareholders on earnings informativeness.Design/methodology/approachUsing a sample of 23,120 firm-year observations from 2003 to 2019 in China, this paper examines how share pledging by controlling shareholders affects earnings informativeness, measured by earnings persistence and earnings response coefficients.FindingsThis paper finds that share pledging by controlling shareholders makes earnings less informative. The adverse impacts are more pronounced when share pledging distorts incentives of controlling shareholders to a greater extent and when the signaling of share pledging about a firm’s weak future performance is stronger. Finally, this paper further shows that the 2018 new regulation on share pledging effectively alleviates the negative impacts of share pledging on earnings informativeness.Originality/valueFirst, this paper adds to the growing literature on the economic consequence of share pledging by documenting the adverse impacts of share pledging on earnings informativeness. The literature on the economic consequence of share pledging is often mixed, which justifies further research on the impacts of share pledging on earnings informativeness. Second, this paper documents a new signaling channel through which share pledging affects earnings informativeness. Third, the finding of this paper on the 2018 new regulation on share pledging may be interesting to research agencies, such as the Chartered Financial analyst institute and Institutional Shareholder Services institute that recommend tightening regulations on share pledging.

Causality Between Firm-Level Governance and Firm Value

This paper investigates empirically whether there is a causal relation between firm-level governance and firm value. The firm-level governance quality is quantified by using anti-takeover provisions, which are classified boards, fair price, and poison pill. The firm value is measured by Tobin’s Q and return on assets in the part of Robustness Check. The data was found in platform WRDS, with database vendors of Compustat and Institutional shareholder services (ISS), ranged from 1998 to 2006, after data matching and data cleaning, with 1645 left. The regression results indicate that there is causality between firm-level governance and firm value, specifically that poor governance significantly contributes to the reduction of firm value. The robustness check has certified that the results in the regression analysis are credible. Further research will be desirable for firm data from countries such as China. In addition, the range of observation years of the data is expected to expand as data vendors have increased authority to access to the data.

Shoot the Arrow, Then Paint the Target: CEO Compensation and Institutional Shareholder Services Benchmarking

AbstractWe document that firms that expect their CEOs’ compensation to exceed the median CEO compensation of their Institutional Shareholder Services (ISS) peers influence ISS to revise these peer sets. Controlling for changes in firm characteristics that ISS uses to select peers, we find that ISS applies an abnormally high turnover rate in the members of these peer sets and increases the representation of focal firms’ chosen peers. This turnover results in increases in the medians of the ISS peers’ CEO compensation and size. We find that these firms underperform and conclude that they attempt to camouflage high CEO pay to mitigate outrage costs.

Director reputational penalties when shareholders disapprove of executive compensation

AbstractWe investigate the reputational consequences for directors of firms that receive a low‐support Say‐on‐Pay (SOP) vote. These affected directors face a significantly greater likelihood of losing board seats, both at the voting firm and in the external labor market. However, penalties are not equal for all directors. Directors who serve on compensation committees and at firms with high chief executive officer pay suffer internal penalties. Both internal and external penalties affect directors of low‐support firms with high executive entrenchment. Compensation committee members serving low‐support firms are more likely to receive a negative reelection recommendation from Institutional Shareholder Services and fewer votes for reelection, at both voting and external firms. We provide the first evidence of external labor market penalties when directors fail to align executive compensation contracting with shareholder preferences. Our findings suggest that nonbinding SOP votes provide shareholders with a mechanism to influence director incentives and, therefore, executive compensation.

Vetting of Bloomberg’s ESG Governance ISS: QualityScore [GQS™]: Discriminant Testing

Recently, vetting investigations were conducted of the Institutional Shareholder Services [ISS] taxonomy whereby firms are assigned to Corporate Governance-Risk[CGR] decile-groups:[GQS[1] the lowest CGR-group and GQS[10] the highest CGR-group] based upon ISS:GovernanceQualityScores: (GQS™). These results are available in the Environment, Social, and Governance [ESG™]-platform offered by Bloomberg™ Professional Services. These vetting investigations indicated: (i) there was no evidence that the ISS-taxonomy used, as a driver, the reported magnitude of the accounts of the Balance Sheet or Income Statement, (ii) for the GQS[1]-group the ISS-taxonomy assignment seemed to align with Managing of the Revenue at the margin while that of the GQS(10) aligned with Net Asset management. In the second study, a group of experts were given two groups of GQS firms, 10 from each of the two-polar groups. They used the Bloomberg ANR©-platform and any other information that they desired to assign these 20-firms into two groups. There was no evidence that their assignment aligned with the ISS-CGR-assignment. These studies affirmed that the ISS-CGR assignment is not likely driven by the firm’s periodic reported performance profile. Current Study We offer an extension of the vetting of the ISS-assignment to determine if there is discriminant evidence that a set of 21-financial variables from the Balance Sheet, Income Statement, Cash Flow Statement, and the Market Reported Annual Market Price are aligned with the reported ISS-triage of the firm into one of the ISS:CGR-polar groups. This will address a question begged by the study where there was alignment with the Revenue or the Net Asset Management basis for the Firms in the ISS;polar-groups. Results We elected to use a single BBT-Account Panel matched with the ISS-Polar Assignments to form the Discriminant 2×2 Classification-profile. This allows the computation of: (i) the percentage of the Misclassifications, (ii) inferential measures, and (iii) the R2 Entropy measure. We used these inferential measures to profile the discrimination of the BBT-Panel vis-à-vis that of the ISS-Assignment. Interestingly, among the 21 Discriminant Classification Matrices there were NO cases where the Nulls of no effect of these inferential measures could be rejected in favor of alignment of the Panels with the ISS-taxonomic assignment. Summary There was no Individual Panel over the 21 Accounts that indicated that the Accounts of these BBT-Panels could have been the likely driver of the ISS-assignment.

ISS and Other Proxy Advisory Firms' Conflicts of Interest

This Note discusses the impact of conflicts of interest on the proxy advisory firm industry, with a particular focus on conflicts plaguing Institutional Shareholder Services, the dominant proxy advisory firm. The increased proportion of shares held by institutional investors, strong reliance on voting recommendations by certain investment advisors and continuing dominance of Institutional Shareholder Services have culminated in Institutional Shareholder Services’ substantial influence in proxy voting. The lack of sufficient regulatory oversight has precipitated considerable risk of proxy voting that serves the best interest of proxy advisory firms rather than that of shareholders. Recent rules and guidance issued by the Securities and Exchange Commission have not adequately addressed these concerns. Several possible reforms may help this situation, including eliminating robo-voting, separating voting advice and corporate governance consulting services and mandating engagement in voting research beyond that provided by proxy advisory firms. Pursuing these avenues of reform could help restore the integrity of voting recommendations and ensure that proxy advisory firms are used in the way they were initially intended: to reduce information costs and help investment advisors vote shares in their clients’ best interests.

Meta-frontier and measures of efficiency emphasising optimal corporate governance risk across countries

PurposeThis paper aims to investigate the internal and external determinants of firms’ efficiency and develop optimal corporate governance risk benchmarks for the manufacturing sector across different countries.Design/methodology/approachCorporate governance risk data were acquired from Institutional Shareholder Services Europe SA. Data on firms’ efficiency and for explanatory and control variables were taken from the DataStream database. The generalised directional distance function data envelopment analysis (GDDF-DEA) model and its stochastic extension provided corporate efficiency measures and optimal corporate governance benchmarks. The authors used ordinary least squares multiple regression analysis with wild bootstrapping to test the study hypotheses.FindingsThe authors found significant differences between firms’ optimal and actual efficiency input/output variables and corporate governance risks in the manufacturing sector across countries. Internal firm characteristics such as group affiliations, product market competition and insider ownership and external institutional factors such as the legal system, the rule of law, control of corruption, law enforcement and cultural values are vital determinants of firms’ efficiency.Practical implicationsThis paper provides valuable guidance to enable corporate managers, regulators and policymakers to enhance firms’ efficiency and corporate governance practices.Originality/valueThis paper develops optimal corporate governance risk benchmarks and identifies the most critical internal and external factors affecting firms’ efficiency in the manufacturing sector in various countries. It also used a novel GDDF-DEA model, with the multi-parametric model for bias correction of efficiency estimator.

Do local proxy advisors matter? – Evidence from Germany

Prior research documents that the large US-based proxy advisors, Institutional Shareholder Services (ISS) and Glass Lewis (GL), play an important role as information intermediaries in corporate governance worldwide. We provide initial evidence on the role of local proxy advisors, using the German setting. We analyse voting recommendations by local (IVOX) and foreign (ISS, GL) proxy advisors. First, we find that IVOX's voting recommendations differ substantially from those of ISS and GL. Second, we observe that IVOX's against-recommendations are significantly negatively associated with voting support. Third, we find that this association is particularly negative for voting outcomes at companies where local institutional investors hold larger stakes. Taken together, our findings suggest that the local proxy advisor IVOX considers relevant factors appreciated by local institutional investors that are distinct from factors incorporated in foreign proxy advisors’ voting recommendations.

Exporting Corporate Governance: Do Foreign and Local Proxy Advisors Differ?

Prior research documents that the large US-based proxy advisors, Institutional Shareholder Services (ISS) and Glass Lewis (GL), play an important role as information intermediaries in corporate governance worldwide. We provide initial evidence on the role of local proxy advisors, using the German setting. We analyse voting recommendations by local (IVOX) and foreign (ISS, GL) proxy advisors. First, we find that IVOX’s voting recommendations differ substantially from those of ISS and GL. Second, we observe that IVOX’s against-recommendations are significantly negatively associated with voting support. Third, we find that this association is particularly negative for voting outcomes at companies where local institutional investors hold larger stakes. Taken together, our findings suggest that the local proxy advisor IVOX considers relevant factors appreciated by local institutional investors that are distinct from factors incorporated in foreign proxy advisors’ voting recommendations.

Vetting of Bloomberg’s ESG Governance ISS:QualityScore [GQS

Context Of the plethora of market navigation platforms, the Environment, Social, and Governance [ESGÓ]-platform offered by BloombergÔ Professional Services* is one of the most richly endowed, including nearly 2,000 data-fields that provide an invaluable context for better understanding the “Stakeholder-impact” of the firm’s activities. A recent amelioration of the ESG-platform is the link with Institutional Shareholder Services [ISS] that offers a taxonomy where firms are assigned to Governance-risk decile-groups based upon ISS:GovernanceQualityScores: (GQSÔ). The GQS-platform offers a data-driven approach to scoring & screening designed to help investors monitor company governance activities so as to better inform their decision-making. Study Design Clear is: Market Intel-Platforms only have one simple raison d’être: To provide a relative advantage in teasing out market winners relative to the “Squawk-On-The Street”. If this is the case, information professionals, in a best practices context, are tacitly obligated to offer vetting tests of platforms such as the GQS to service investors in need an independent and reliable evaluation to Ferret-out useful market guidance platforms. In this endeavor, we offer a vetting evaluation of a random sample of firms included in the two polar-ISS:GQS:Classifications: GQS[1] & GQS[10]]. Point of information The intent of the GQS-Vetting is not to “reverse-engineer” the results of the GQS-assignment protocol so as to arrive an “inferentially” de-coded approximation of the actual ISS:GQS-protocol. Our vetting addresses the question: Is there a logical reason to reject the belief that the set of GQS-assignment protocols are not well formed thus creating Governance-risk-groupings that have no intra-group coherence and so exhibit no inter-group differentiability. Results Initially, we used a Strawman-Vetting test followed by FPE-inferential tests using specific and sensitive Income Statement and Balance Sheet Panel-profiles from a random sample of the firms in: GQS[1] & GQS[10]. We find that the triage-focus of GQS[1] is “Revenue at the Margin” while that of GQS[10] is “Asset[Net] Management”. Also, both groups have exhibited impressive attention to managing Working Capital. Summary: The ISS:GQS-assignment protocols seem to be well-formed and capable of offering useful differentiation.

Proxy Advisory Firms and Corporate Shareholder Engagement

We examine the influence of proxy advisors on firms’ shareholder engagement behavior. Our analyses exploit a quasi-natural experiment using Say-On-Pay voting outcomes near a threshold that triggers a review of engagement activities by Institutional Shareholder Services (ISS). Firms receiving ISS treatment exhibit a swift and substantive increase in engagement, especially those with weaker ex-ante governance. The elevated engagement persists beyond the period of ISS scrutiny. Treated firms alter elements of compensation and pay transparency that align with shareholder feedback, and enjoy ex-post economic benefits. Our findings indicate a disciplinary spillover effect of ISS through enhanced and enduring firm-shareholder interactions.

Required CEO stock ownership: Consequences for risk-taking and compensation

In response to corporate governance concerns, SEC disclosure rules, and pressure from Institutional Shareholder Services, most large U.S. public firms have adopted executive stock ownership requirements (‘SORs’) in recent years. Compared to CEOs already in compliance, CEOs who have not yet fulfilled the requirement at adoption subsequently increase stockholdings, exposing themselves to more company-specific risk, potentially providing risk-reduction incentives and diminishing their subjective valuation of firm equity. We find that these CEOs on average subsequently reduce firm risk through diversifying M&A, less financial leverage, and smaller R&D investment. They experience a deterioration in firm performance and valuation, each associated with firms that do reduce risk, but receive significantly increased stock grants. Our evidence suggests that boards should exercise judgment when adopting this popular governance initiative.

Comment Letter to the DOL: Fiduciary Duties Regarding Proxy Voting and Shareholder Rights (RIN 1210-AB91)

This comment letter provides support for the Department of Labor's proposed rule, Fiduciary Duties Regarding Proxy Voting and Shareholder Rights (RIN 1210-AB91). Part I of this comment letter provides a theoretical framework for shareholder voting and the creation of voting recommendations. This Part focuses on the collective action problem found in shareholder voting and its ramifications for both voting and the creation of voting recommendations by proxy advisors. I discuss this framework in more detail in my law review article The Risks and Rewards of Shareholder Voting (forthcoming, SMU Law Review). Part II recommends, as a means to help mitigate the collective action problem found in shareholder voting, that proxy advisors, such as Institutional Shareholder Services (ISS) and Glass Lewis, be designated investment advice fiduciaries under Section 3(21)(A)(ii) of ERISA. This is something I discuss in detail in my law review article Now Is the Time to Designate Proxy Advisors as Fiduciaries under ERISA (Stanford Journal of Law, Business and Finance). Part III supports the proposed rule’s approach of increasing the role of board voting recommendations in the voting policies of ERISA plans. My support is based mainly on another recent law review article I wrote, Enhancing the Value of Shareholder Voting Recommendations (Tennessee Law Review). Part IV provides support for the proposed rule’s approach to shareholder voting proposals. Part V discusses an issue that is not currently in the proposed rule but that should be considered for inclusion, i.e., how an ERISA plan manager is to incorporate into its decision-making the shareholder activism of investment advisers of mutual funds and exchange-traded funds (ETFs) with large amounts of delegated voting authority. This activism is reflected in an investment advisor’s rhetoric disclosing the objectives of its activism, shareholder voting, and engagement with portfolio companies. The incorporation of this new consideration would occur when deciding to invest in such funds or considering them as options for self-directed accounts. This Part argues that a plan manager’s duty of prudence requires it to investigate how this shareholder activism will be used prior to making these decisions. The fiduciary objective in this investigation is to ensure that the investment adviser is utilizing shareholder activism consistent with a plan manager’s duty of loyalty, i.e., “solely in the interest of the participants and beneficiaries” and for the exclusive purpose of providing financial benefits to them. If that is not happening, these funds should be excluded from an ERISA plan. This Part has at its foundation a recent white paper that I wrote, The Conflict between BlackRock’s Shareholder Activism and ERISA’s Fiduciary Duties.

Institutional Debtholder Governance

AbstractUsing data on the universe of U.S. based mutual funds, we find that two out of five fund families hold corporate bonds of firms in which they also own an equity stake. We show that the greater the fraction of debt a fund family holds in a given firm, the greater its propensity to vote in line with the interests of firm debtholders at shareholder meetings, even when against Institutional Shareholder Services (ISS) recommendation. Voting has direct policy consequences as firms that receive more votes in favor of creditors make corporate decisions more in line with the interests of debtholders.

Are ISS Recommendations Informative? Evidence from Assessments of Compensation Practices

Using detailed information from the largest proxy advisor in the U.S., Institutional Shareholder Services (ISS), we examine whether proxy advisors’ assessments of firms’ compensation practices are able to identify poor compensation practices as measured by subsequent performance. While prior research provides consistent evidence of an association between shareholder voting outcomes and proxy advisors’ Say-on-Pay recommendations, the evidence is mixed over whether their recommendations are informative about the quality of firms’ compensation practices. We find that ISS “Against” recommendations and negative assessments are associated with worse future accounting performance, consistent with ISS being able to detect low quality compensation packages. However, workload compression has an effect, as we find that the relation between assessments and future performance only occurs during the off season (i.e. for firms with non-December fiscal year ends).