A Call for Change in the Proxy Advisory Industry Status Quo: The Case for Greater Accountability and Oversight

Summary of Study

Bottom Line: Proxy advisory firms have enormous influence over corporate governance with little oversight and significant conflicts of interests. The following proxy advisor reforms should be pursued to rein in the industry: 1) Ban the worst conflicts of interest, 2) disclose other conflicts of interest, 3) disclose methodologies behind voting recommendations, 4) clarify investors' fiduciary duty, 5) monitor proxy firm recommendations for accuracy, and 6) encourage additional competition in the proxy advisor industry.

Institutional investors cast billions of votes that determine corporate directors, executive compensation and corporate governance policies at more than 8,000 publicly traded U.S. companies. By law, the institutions have a fiduciary duty to vote in the best interests of their clients. However, with the high number of votes they are required to make, many institutions essentially outsource the analysis and process of developing voting recommendations to a handful of third parties called proxy advisory firms and some firms delegate the actual proxy voting to such firms.

With the exponential increase in institutional assets over the past 20 years, the proxy advisory industry has quietly grown extremely powerful. It exercises a considerable degree of influence and control over corporate governance and executive compensation standards and its power is concentrated with one firm dominating the industry. Despite its considerable clout, the proxy advisory industry is scarcely regulated. As a result, the characteristics of the industry bear an uncanny resemblance to the credit ratings industry before the financial crisis.

Based on proxy advisory firm reports, corporate issuers are increasingly concerned that proxy advisors are transmitting inaccurate information to institutional investors that could adversely impact investors’ decisions on pay and governance matters.

Because the potential impact on the companies is substantial, the following proxy advisor reforms should be pursued:

1) Ban on Worst Form of Conflicts: The largest proxy advisory firm, ISS, provides consulting services to corporate issuers while simultaneously providing “independent” analyses to institutional investors on those same companies. This approach creates a vicious cycle in which companies may feel an obligation to patronize ISS for its consulting services in order to obtain favorable proxy voting recommendations on their proposals.

2) Full Disclosure of Other Conflicts: The SEC should mandate disclosures designed to make the financial relationships that underpin the most controversial aspects of the proxy advisory industry transparent to investors. This includes any report containing voting recommendations about a specific issuer, whether the firm has received consulting fees from either the issuer, or the proponent of a shareholder resolution on the ballot at that issuer, in the previous year and the amount of those fees.

3) Disclosure of Methodologies Behind Voting Recommendations: The SEC should mandate that proxy advisory firms disclose the analytic processes, methodologies and models utilized to derive their voting recommendations. For instance, proxy advisory firms that utilize pay-for performance compensation models to determine recommendations on compensation plans or advisory say on pay votes should be required to publicly disclose all inputs, formulas, weightings and methodologies used in these models.

4) Clarification of Fiduciary Duties of Institutional Investors and Plan Sponsors: The SEC should provide additional guidance to investment advisers and plan sponsors making it clear that their fiduciary obligations to vote proxies in the interests of investors require diligent monitoring of the conflicts, practices and competence of third-party proxy advisors. The mere act of hiring a proxy advisor should not be sufficient to allow institutions to meet their fiduciary obligations. 

5) Implement SEC Monitoring of Proxy Firm Recommendations: The SEC should implement periodic reviews of proxy firm research reports to check for accurately and completeness, much the way the SEC currently does for company filings.

6) Support More Competition: Private sector corporations and institutions should support measures designed to bring additional competition into the proxy advisory industry and to promote greater voting participation by retail investors.

Read the full report here.

Feature Charticle

Types of Potential Conflicts of Interest at Major Proxy Advisory Firms

By Center On Executive Compensation

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Concerns about conflicts of interest in the industry fall into four general categories: 

  1. Potential conflicts that arise when proxy advisors provide services to both institutional investors and corporate issuers on the same subjects.
  2. Potential conflicts related to proxy advisors providing recommendations on shareholder initiatives backed by their owners or institutional investor who are clients.
  3. Potential conflicts when the owners, executives or staff of proxy advisory firms have ownership interests in, or serve on the boards of, public companies that have proposals on which the proxy advisors are making voting recommendations.
  4. Potential conflicts when proxy advisory firms are owned by firms that provide other financial services to various types of clients.