Proxy Advisors Research Articles

Disciplinary power in corporate governance: A Foucauldian analysis of the emergence and development of proxy advisors

Prior research in corporate governance has extensively investigated the mechanisms through which a variety of actors (financial analysts, investment managers, shareholder activists) monitor and discipline corporate executives. However, one recently emerged actor has received little attention so far: the proxy advisory firm. Mobilising Foucault’s concept of disciplinary power, this study uses historical analysis to examine the role of proxy advisors in corporate governance. This article shows that proxy advisors actively contributed to developing and implementing disciplinary mechanisms. This involves (1) hierarchical observations of corporations and their executives on a global scale. These observations are made available to institutional investors on proxy advisors’ voting platforms which have Panopticon-like features; (2) normalisation of judgements through the provision of generic voting policies, generic voting recommendations and corporate governance ratings prepared by proxy advisors and delivered to many institutional investors; (3) ritualised examination of the performance of corporations and of their executives during the annual general meeting, including record-keeping of all past voting results.

Proxy Advisory Firms, Governance, Market Failure, and Regulation

AbstractProxy advisory firms developed due to market failures underlying voting and corporate governance more broadly. However, these firms, which have not been subject to mandatory regulation, reflect their own market failures, emphasizing challenges underlying corporate governance. We highlight underlying frictions, such as economies of scale and public goods aspects to information production, the import of incentive conflicts faced by the advisory firms, their power, and the implications of their recommendations and votes by different types of investors. Asset managers emphasizing stewardship are more supportive of management than are proxy advisors. We highlight the evolving regulatory environment and limitations of one-size-fits-all recommendations. (JEL G34, G38, G24, H4)Received October 31, 2019; editorial decision October 17, 2020 by Editor Andrew Ellul.

Determinants of commitment and opportunism of institutional investors’ behaviour: an empirical investigation on Robo-voting Phenomenon

Purpose of the paper: Recent research identifies a troubling number of institutional investors that automatically follow the advice of their proxy advisors so that they can prove to have complied with their fiduciary duties in a practice known as robo-voting. Therefore, our central research questions are: How could the characteristics of institutional investors affect robo-voting phenomenon? How could robo-voting phenomenon favour the creation of new opportunistic behaviour, changing the scope of shareholder engagement? Methodology: Our paper directly addresses these questions by using ANCOVA (Analysis of Covariance) to test the effect of characteristics of institutional investors on the dependent variable under study. We use a manually constructed sample of coverage information from 123 Annual General Meetings held by large Italian companies in the 4-year period 2015 to 2018 and the voting reports of three proxy advisors. Findings: We show that such voting based on robo-voting phenomenon is restricted to specific types of institutional investors and it may be highlighted as a negative aspect of a duty to ‘demonstrate’ engagement on the part of institutional investors. Specifically, this duty could depend on location, strategy and category of institutional investors. Research limits: We refer only to the Italian market and it may be considered as a peripheral market by investors. Practical implications: We argue that legal enforcement of the conceptual and operational spectrum of engagement duties currently sits uncomfortably upon institutional investors and proxy advisors. Originality of the paper: We think it is important to consider how to promote shareholder engagement in general in a European context and at the same time curb negative activism by some shareholders.

Creating Controversy in Proxy Voting Advice

The quality of proxy advisors' voting recommendations is important for policymakers and industry participants. We analyze the design of recommendations (available to all market participants) and research reports (available only to subscribers) by a proxy advisor, whose objective is to maximize its profits from selling information to shareholders. We show that even if all shareholders’ interests are aligned and aim at maximizing firm value, the proxy advisor benefits from biasing its recommendations against the a priori more likely alternative. Such recommendations “create controversy” about the vote, increasing the probability that the outcome is close and raising each shareholder's willingness to pay for advice. In contrast, it serves the interest of the proxy advisor to make private research reports unbiased and precise. Our results help reinterpret empirical patterns of shareholders’ voting behavior.

Contradictory Voting by ESG Funds

This paper studies the conflict between ESG funds and their investors. Funds trade-off greater short-term financial performance against long-term sustainability. This conflict results in ESG funds voting against their stated pro-social mandate, even when supported by proxy advisors. Lower returns to sustainable proposals result in funds actively managing returns, while flow tests suggest that investors do not respond to contradictory voting. Simulating a correction to this voting pattern suggests an increase in passage of proposals, and greater sustainability disclosures. While investors delegate their pro-social preferences onto socially responsible funds, financial returns ultimately determine a funds' stance towards such issues.

Does Proxy Advice Allow Funds to Cast Informed Votes?

This paper estimates to what extent proxy advice allows funds to vote as if they were informed. A fund’s vote is classified as “informed“ if the fund accessed the company’s proxy statement from the SEC’s Edgar website prior to voting. A fund’s proxy advisor, if any, is identified from the format of its Form N-PX filing. Our main finding, for the period 2004-2017, is that proxy advice did not result in funds voting as if they were informed – more often than not it pushed them in the opposite direction – and this distorting effect was particularly noticeable for ISS. The finding is robust to several strategies designed to control for endogeneity of acquiring information and seeking proxy advice, including fixed effects and instrumental variables. We also show that advice distorted votes toward policies favored by socially responsible investment (SRI) funds, and provide suggestive evidence that proxy advisors slanted their recommendations toward the preferences of SRI funds because of pressure from activists.

Busy Season and Proxy Recommendations

The short period of time, from the fourth week of April to the end of May, referred to as the proxy season, has about 333 proposals voted a day relative to 27 proposals voted per day outside the proxy season. The compressed workload results in 17.6% fewer negative recommendations from ISS during this busy period. The proxy season also entails busy voting schedules for institutional investors who in the aggregate, respond by increasing their reliance on ISS recommendations. Aggregate support for proposals with a negative recommendation from ISS is 10% lower during the busy period. Stock price reaction to outcomes in close votes show that successful negative recommendations during the busy period, that is when negative proposals fail, are not value enhancing. In sum, ISS recommendations during busy voting periods are less likely to be negative, have greater influence on voting, and are not value enhancing. The results inform the policy debate on the role and influence of proxy advisors.

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.

REVERSING THE DECLINE OF CANADIAN PUBLIC MARKETS

It is the best of times for Canada’s public markets, it is the worst of times for Canada’s public markets. It is an age when markets have been rewarding public companies with the highest valuations seen in generations. It is an age of a rapid decline in Canadian companies opting to go public. Given that Canada’s reliance on public markets is far higher than that of any other country — double that of the next-highest country — we should be alarmed that fewer and fewer companies are choosing to go public. Companies that stay private are, on average, less successful, less productive, less likely to grow into national champions, and more likely to be sold to foreign buyers. The current decline of public markets may go to the heart of what is arguably the biggest long-term policy issue in the country: our innovation gap and declining relative productivity growth. There is no shortage of advantages for a company to go public. Public companies grow faster, grow larger, become both more productive and efficient, and have cheaper access to capital. An IPO permits early investors to exit while allowing managers to continue to build the company. What is evidently causing more and more Canadian executives to avoid going public, despite all these advantages, is a regulatory and governance ecosystem that has grown increasingly hostile to and distrustful of corporate leadership. Executives who consider going public face an environment in which their compensation levels will be high; indeed, pay for senior executives at public companies has grown remarkably in recent years. However, because of increasingly onerous regulatory disclosure requirements, earning those rewards comes at the cost of having their pay disclosed to the public, debated by shareholders and scrutinized by the media. Companies that go public also face a growing loss of control over their own governance due to pressure to adhere to an ever-evolving list of so-called universal best practices that can run dozens of pages long. These practices exact costs but don’t generally improve results. The result is a dominant one-size-fits-all governance model that does not in fact fit many, or even most companies. The key factor creating this hostile environment is a massive intrusion by outside forces on the powers traditionally exercised by boards and executives. Corporate governance used to arise from the bargaining and experimentation of the private parties that coalesce around corporations. Now governance is frequently imposed ex post on public companies by third parties with their own agendas. Particularly problematic are third-party commercial proxy advisors, ostensibly representing the interests of institutional shareholders. Their short-term, faddish, complex, and value-harming governance practices diverge dangerously from the interests of long-term flesh-and-blood investors. The innovations over the past three decades in governance rules were designed to reduce agency costs and improve corporate performance. Those that have proven failures at doing so, and there are several, should be scrapped. Rather than helping Canada’s markets become stronger, public markets have grown substantially weaker, and rather than making Canadian companies better, we now face an environment where companies would rather sell to a foreign buyer and leave the country, than go public here. The repercussions can only be adverse for Canada.

Voluntary Performance Disclosures in the CD&A

This paper examines how firms use voluntary disclosures in response to information asymmetries between firms and shareholders surrounding the design and approval of executive compensation. Prior research finds that firm performance is a primary determinant of pay and negative shareholder response to pay is largely influenced by recent performance. We find evidence that firms voluntarily increase discussion of their performance in the Compensation Discussion and Analysis (CD&A) section of the annual proxy statement when shareholder scrutiny is high, i.e., when compensation levels are high relative to peers and performance. This relation strengthens after Say-on-Pay, when shareholder scrutiny arguably increased for all firms. These voluntary performance disclosures are associated with higher shareholder approval and more positive proxy advisor recommendations, as well as higher relative compensation in the subsequent year. Altogether, our findings suggest CD&A performance disclosures allow firms to communicate the context of their compensation choices in order to mitigate negative shareholder scrutiny.

Mind the gap: CEO–employee pay ratios and shareholder say‐on‐pay votes

AbstractWe examine the Securities and Exchange Commission's assertion in the pay ratio disclosure rule that the ratio of Chief Executive Officer to employee pay is useful to shareholders for say‐on‐pay (SOP) voting decisions. Using an estimated pay ratio for a broad panel of commercial banks from 2010 to 2017, we find that voting dissent on SOP proposals is significantly higher in the top pay ratio decile, particularly when institutional ownership is high. Results are robust to controlling for a number of other determinants of voting dissent, including proxy advisor recommendations and executive compensation. Additionally, inferences using the first year of disclosed pay ratios in 2017 for S&P 1500 firms are consistent. However, we do not find similar results in the other deciles of the pay ratio in either sample, calling into question whether a cost‐benefit analysis would support the disclosure requirement imposed by Dodd‐Frank and implemented by the SEC.

Bonds Lie in the Portfolio of the Beholder: Do Bonds Affect Equity Monitoring?

We analyze whether institutional investors’ increasingly extensive corporate bond holdings are associated with how actively institutions vote and monitor their equity investments. We find that institutions conduct more governance research and are less likely to follow proxy advisor vote recommendations for companies whose bonds represent a larger proportion of their overall portfolio. Corporate bonds held in equity-focused funds and shareholder proposals that are more likely to require investors’ attention drive these findings. There is no evidence that creditor-shareholder conflicts explain these findings. Our results suggest that institutions’ bond holdings contribute to their overall incentive to be engaged monitors.

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.

Introduction to a Special Issue of the Financial Planning Review on financial technology

Introduction to a <i>Special Issue</i> of the <i>Financial Planning Review</i> on financial technology

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).

Proxy Advice Industry and Its Growing Influence

Mutual funds rely on recommendations from proxy advisors when voting in corporate elections. Proxy advisors’ influence has been a source of controversy, but it is difficult to study because information linking funds to their advisors is not publicly available. A key innovation of this paper is to show how fund-advisor links can be inferred from previously unnoticed features of a fund’s SEC filings. Using this method to infer links, I establish several novel facts about the proxy advisory industry. During 2007-2017, the market share of the two largest proxy advisory firms has declined slightly from 96.5 percent to 91 percent, with Institutional Shareholder Services (ISS) controlling 63 percent of the market and Glass Lewis 28 percent in the most recent year. A large fraction of ISS customers appear to have robo-voted, rising from 5 percent in 2007 to 23 percent in 2017, at which time over 50 percent of small index funds robo-voted. Negative recommendations from ISS or Glass Lewis reduce their customers’ votes by over 20 percent in director elections and say-on-pay proposals. Finally, proxy advisors cater to investors’ preferences, adjusting their recommendations to align with fund preferences independent of whether those adjustments lead to recommendations that maximize firm value.

The Agency Problems of Institutional Investors: Presentation Slides

The presentation slides in this document provide an overview of our study The Agency Problems of Institutional Investors, which was published in the Journal of Economic Perspectives in its summer 2007 issue. The slides build on our presentations at the 2017 ALEA annual meeting. Our study focuses on how the rise of institutional investors has transformed the governance landscape. The study analyzes the agency problems that the investment managers of institutional investors have vis-a-vis their own investors. We develop an analytical framework for examining these agency problems and apply it to study several key types of investment managers. We analyze how the investment managers of mutual funds - both index funds and actively managed funds - have incentives to under-spend on stewardship and to side excessively with managers of corporations. We show that these incentives are especially acute for managers of index funds, and that the rise of such funds has system-wide adverse consequences for corporate governance. Activist hedge funds have substantially better incentives than managers of index funds or active mutual funds, but their activities do not provide a complete solution for the agency problems of institutional investors. Our analysis provides a framework for future work on institutional investors and their agency problems, and generates insights on a wide range of policy questions. We discuss implications for disclosure by institutional investors; regulation of their fees; stewardship codes; the rise of index investing; proxy advisors; hedge funds; wolf pack activism; and the allocation of power between corporate managers and shareholders. Our study is part of a larger project on the incentives of investment managers that also includes Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy and The Specter of the Giant Three.

Information Bias in the Proxy Advisory Market

Abstract We study an information sale problem in which a monopolist proxy advisor sells recommendations to a firm’s shareholders for corporate voting. We find that even an unconflicted proxy advisor skews its recommendations based on its clients’ beliefs or preferences. A novel bias-quantity relationship affects firm value. Under some parameters, shareholders’ biased beliefs or preferences can lead shareholders to make more information purchases, which enhances their collective decision-making. Thus, firm value may increase despite the negative effects of biased proxy voting recommendations. JEL D82, G34, L15 Received: April 16, 2019; editorial decision March 25, 2020 by Editor Uday Rajan.

Investor ideology

We estimate institutional investor preferences from proxy voting records. The W-NOMINATE method maps investors onto a left-right dimension based on votes for fiscal year 2012. Public pension funds and other investors on the left support a more social and environment-friendly orientation of the firm and fewer executive compensation proposals. “Money-conscious” investors appear on the right. The proxy advisor ISS makes voting recommendations that place it center, to the left of most large mutual funds. A second dimension reflects a more traditional governance view, with management-disciplinarian investors, the proxy advisor Glass Lewis among them, pitted against more management-friendly ones.

Stock Buybacks as an Executive Compensation Problem

This Article is the first academic study to systematically analyze the overall sensitivity of executive compensation to stock buybacks. Specifically, my analysis of executive compensation arrangements of CEOs included in the S&P 500 Index reveals that buybacks can enhance a record high portion of incentive compensation, corresponding, on average, to one-third of total CEO pay. I further show that, despite the focus of financial economists on the ability of buybacks to mechanically improve per share performance measures that determine executives’ annual bonuses, repurchases can, in addition and to a much greater extent, boost performance measures that decide executives’ long-term incentive awards. I argue, first, that because a buyback can increase pay even when it would destroy firm value, executives are motivated to conduct buybacks excessively. Second, I explain that this potential motivates executives to game their incentive compensation arrangements and turn them from pay for performance into pay for manipulation. Third, I find that the impacts of buybacks on executive pay are camouflaged in firms’ public filings. These distorted incentives and the lack of transparency are likely to lead firms to underinvest in productive capabilities, disguise poor financial performance, and contribute to the creation of a market bubble that increases the likelihood of another financial crisis. Borrowing from dividend protection, which safeguards executive stock and option awards from the automatic decline in the stock price that dividends trigger, I suggest applying buyback protection, which would shield executive pay from the mechanical performance improvement that stock buybacks stimulate. Because I do not expect a mandatory rule requiring firms to adopt buyback protection to be effective I propose a novel regulatory reform to make the impact of stock buybacks on executive pay transparent. Transparency can be expected to push boards, shareholders, and proxy advisors to pressure firms to adopt buyback protection.