Who’s Monitoring the Monitors? The Rise of Intermediaries and the Threat to Capital Markets

Summary of Study

Bottom Line: Abetted by SEC rules and procedures, idiosyncratic “corporate gadflies” and institutional investors with labor affiliations and social investing orientations have gained power in the boardroom. By co-opting proxy advisory firms—and, to some degree, institutional investors facing their own significant agency costs—these activists have pursued their agendas at other shareholders’ expense. At least some of this social activism appears to be depressing share value.

The aggressive sweep of shareholder influence over corporate handling of far-flung social and environmental causes can hurt shareholder value. Entrepreneurs and investors tend to opt for equity ownership notwithstanding high agency costs. 

In general, shareholder voting rights have been thought of as a tool—complementary to legal fiduciary duties and market exit rights—to mitigate agency costs between corporate managers and equity owners. But such voting rights today are dominated by institutional investors. And most of these institutional investors themselves have substantial agency costs, between fund managers and individual investors. Institutional investors—either directly or through other intermediaries, such as proxy advisory funds—are monitoring corporate boards and managers.

Individual investors delegate their investment decisions to intermediaries precisely to avoid complexities like the minutiae of proxy voting. Individuals may shift their assets from one fund manager to another; but such moves will be prompted by relative portfolio performance, or fee structure, or public controversy—not by shareholder voting.

Special interests can take advantage of shareholder voting by introducing the same proposal year after year, even when 90% of all voting shareholders consistently oppose it. These rules have enabled special-interest shareholders to capture the attention of corporate boards and managers, at all other shareholders’ expense. 

For example, when McDonald’s stockholders gathered for the company’s annual meeting in 2017, they had to vote on seven shareholder proposals. Among these were a proposal against the company’s use of antibiotics in its meat supply, brought by the Benedictine Sisters of Boerne, Texas; and one by the nonprofit Holy Land Principles, which wanted the company to modify its employment practices in Israel. The Boerne Sisters owned 52 McDonald’s shares. The Holy Land group owned 47. No shareholder sponsoring a proposal at the company’s annual meeting that year owned more than 0.0001% of the company’s stock.

Proxy advisory firms can serve to amplify such special-interest advocacy. To manage their proxy voting, institutional investors rely heavily on a pair of proxy advisory firms, Institutional Shareholder Services, or ISS, which is today owned by private-equity firm Genstar Capital; and Glass, Lewis & Co., a subsidiary of the Ontario Teachers’ Pension Plan Board

And ISS’s voting guidelines have generally shown a propensity to support various social and environmental proposals, much moreso than the median shareholder. Historically, ISS has backed some 70% of shareholder proposals related to political spending, 45% of those related to employment rights, and 35% of those related to human rights or the environment—a sharp contrast to the dearth of average shareholder support for these proposal classes. In general, ISS support for these social issues has been increasing. 

Read the full statement here.