Information Bias in the Proxy Advisory Market

Summary of Study

Bottom Line: The proxy advisor, without an actual stake or appropriate oversight, will send unbiased and desirable voting recommendations which help maximize firm value only if the proxy advisor has no conflicts of interest, shareholders have the correct prior belief, and they aim to maximize firm value. 

Proxy advisors provide investors with analysis of and recommendations for voting on matters presented for a shareholder vote. They wield increasing influence over institutional investors over the past three decades. The wide use of proxy advisors in ÿnancial markets has drawn regulators’ attention.

This paper examines the influence of proxy advisors on their clients, and investigates various factors that may affect the quality of voting recommendations (especially unbiasedness) issued by proxy advisors. The findings are particularly relevant for the questions relating to investors’ reliance on proxy advisors’ recommendations; whether there is sufficient transparency about proxy advisor methodologies; and, whether conflicts of interests are adequately disclosed by proxy advisors.

The main findings: 

  • Conflicts of interest at proxy advisory firms will negatively influence the quality of voting recommendations as recommendations are biased and unhelpful to clients.
  • Conversely, when investors are over-optimistic (or over-pessimistic) about the voting item, the voting recommendations issued by proxy advisory firms will be distorted to reflect this investor bias, which may serve to undermine the robustness of proxy advisors’ methodology. Like some mass media outlets, proxy advisory firms will produce reports for their clients containing information they want to hear – not what they need to hear in terms of governance risk – as a means of retaining business.
  • On occasion, delegating voting choices to proxy advisors may be in the best interests of investors but only if the proxy advisory firm has no conflicts of interest and investors have reasonably correct, independent knowledge of the proposed voting item.
  • Funds’ reliance on proxy advisory firms is not necessarily in the best interests of funds’ clients. Specifically, if the interests of funds and fund shareholders are not aligned, proxy advisors will cater to the interest of funds at the expense of funds’ clients (the ultimate beneficial owners).

Based on these findings, the following public policy and regulatory alterations would serve to enhance the proxy voting process:

  • The introduction of a clear requirement for proxy advisory firms to disclose their potential conflicts of interest, particularly relating to consulting services.
  • Provide clarity that taking advice from proxy advisory firms does not necessarily result in funds fulfilling their obligations to vote in the best interests of their clients.
  • Provide guidance for investors on the limitations of proxy advisory firms: The information proxy advisory firms provide is inadequate in protecting them against their own misconceptions and biases.

Read the full comment letter here.