Scarlet Letters: Remarks Before the American Enterprise Institute

Summary of Study

Bottom Line: Proxy advisors are contributing to the current Environmental, Social & Governance (ESG) mania in investing because companies must address ESG questions that have been included in their proxy statement to be voted at the annual shareholders’ meeting. We ought to be wary of these proxy advisors' ESG recommendations, as they come from a crowd of self-appointed, self-righteous authorities pursuing social goals.

Proxy advisors are now heavily relied on, and they continue to wield great influence. Proxy advisors, who have focused a lot of attention on governance issues over the years, have recently made concerted efforts to expand into environmental and social issues. Some investment advisers make a practice of following all or most of the proxy advisors’ recommendations, giving ESG priorities artificially more weight than they deserve.

Other investment advisers use proxy advisors’ recommendations as a point of reference for their own analysis or defer to proxy advisors’ recommendations on a subset of votes. The proxy advisors’ recommendations therefore can substantially affect a company’s proxy votes.

Sometimes proxy advisors’ recommendations are rooted in inaccuracies. Proxy advisors, which operate with skeletal staffs in comparison to the number of companies with respect to which they are making recommendations, will inevitably get it wrong some of the time. Proxy advisor Glass Lewis, for example, has only 360 employees, only about half of whom perform research, who cover more than 20,000 meetings per year in more than 100 countries.

Proxy advisors often don't give companies an opportunity to correct underlying errors. Companies submitted over 130 supplemental proxy filings between 2016 and 2018 claiming that proxy advisors had made substantive mistakes, including dozens of factual errors. The ramifications for the affected companies can be dramatic, as investment advisers, unaware of the error, vote their proxies in accord with the recommendation.

As a result of shareholder proponents like proxy advisors pushing companies to focus on ESG issues, even favorite issues like executive pay have received an overhaul and now shareholder proposals seek to tie compensation not to performance metrics such as share price, but to ESG metrics. This poses a threat to shareholder value.

Read the full remarks here