Proxy Advisory Firms: Empirical Evidence and the Case for Reform

Summary of Study

Bottom Line: Proxy advisory companies, which control the shareholder voting of institutional investors, have come under increasing scrutiny and criticism for conflicts of interest, too much influence, and lack of transparency and accuracy. Reforms that address these criticisms or eliminate the SEC requirement that institutional investors vote on all items on corporate proxy statements may be required.

Typically, Shareholders exercise their corporate voting rights by proxy. Some proxy voting is routine, while some has important implications on the direction of the company. Shareholder voting is dominated by institutional investors, which are required by the SEC to vote on all matters put forth in the proxy statement, but they are allowed to rely on the voting guidelines of third-party proxy advisory firms to satisfy this obligation. The proxy advisor market is essentially a duopoly between Institutional Shareholder Services (ISS) and Glass, Lewis & Co.

Problems with proxy advisors include:

1) A lack of transparency: Proxy advisors do not publicly disclose 1) how they develop their proprietary guidelines, 2) the results of any testing to demonstrate that their recommendations are accurate and lead to positive future outcomes for shareholders, and 3) the method by which feedback from corporate issuers and market participants is evaluated and incorporated into their final guidelines. 

2) Influence over institutional investors: Proxy advisors' influence is most significant in proxy contests, the approval of company-wide equity compensation plans, and executive compensation advisory (“say on pay”) voting. 

3) Influence over corporations: Corporations make governance decisions to increase the likelihood that they will receive a positive recommendation from these firms, particularly in the case of company-wide equity compensation plans and say-on-pay voting. Research generally shows that this influence is harmful to shareholders. 

4) Recommendations may not be in the best interest of shareholders: Some proxy advisory firms are not bound by fiduciary duties and might be subject to conflicts of interest or other governance issues that limit proper incentives to align their recommendations with maximizing shareholder value.

These problems with proxy advisor firms suggest that regulation is needed. This could include 1) increasing regulatory standards to improve advisory firms’ accuracy, transparency, and accountability; and 2) reducing the regulatory demand for proxy advisory services by eliminating the requirement that institutional investors vote all items on the proxy.

H.R. 4015, “The Corporate Governance Reform and Transparency Act of 2017," would address many of these concerns.

Read the full report here.

Feature Charticle

Institutional Investor Voting Record: Aggregate Percent of Votes in Favor of Proposal, by Proposal Type (2017)


Proxy Advisory Firms: Empirical Evidence and the Case for Reform

By James R. Copland, David F. Larcker & Brian Tayan for the Manhattan Institute

Page 12

  • Institutional voting data suggest that proxy advisors have a significant influence on voting behavior, with institutional investors significantly more likely to vote in accordance with proxy advisor recommendations across a broad spectrum of governance issues.
  • For example, 95% of institutional investors vote in favor of a company’s say-on-pay proposal when ISS recommends a favorable vote, while only 68% vote in favor when ISS is opposed.
  • Voting data also shows that several large institutional investors often vote in near-total alignment with proxy advisory firm recommendations.