Regarding Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice

Summary of Study

Bottom Line: There is a collective action problem at the heart of shareholder voting causing problems for proxy advisors. The SEC should pursue regulatory action to mitigate this market failure and resulting harm by directing proxy advisors to move away from their low-cost, low-value approach. This will result in voting recommendations that are more precise, less biased, and more informed.  

There is a collective action problem inherent in shareholder voting because the many entities entitled to vote on shareholder proposals don't expect their votes to make any difference, so none of the voters has the appropriate incentive at the margin to study the firm's affairs and vote intelligently.

The collective action problem of shareholder voting has major implications for proxy advisors. It means that they must exist in an environment where their institutional investor clients, including investment advisers, are only willing to pay a minimal fee for voting recommendations. It also explains why institutional investors are not demanding greater precision in the voting recommendations provided by their proxy advisors and “leading the charge for reform.” They simply don’t want them if it means having to spend more money.

As a result of these agency costs, proxy advisors are resource-constrained, with a relatively small number of analysts covering tens of thousands of companies. Proxy advisors exist in an industry where there is a clear mandate to produce low cost, low-value voting recommendations within a resource-constrained business environment. As a result, an excessive amount of conformity in voting recommendations is the result.

Because of the collective action problem embedded in shareholder voting and the market failure that occurs in voting recommendations, shareholder voting is not a very efficient way to make decisions at a public company. It may lead to significant uninformed decision making. As a result, shareholder voting is rarely used when it comes to decision making at a public company. However, there is significant value in shareholder voting if it is used sparingly and wisely.

If there is no incentive for institutional investors to seek adequately informed and precise recommendations, then the SEC must act or else great harm may be done to the governance of public companies. The proposed amendments direct proxy advisors to move away from their low-cost, low-value approach in a few key areas of the voting recommendation process.

When providing voting recommendations, proxy advisors will be required to provide additional disclosures on conflicts of interest. They will also be subject to potential disclosures of methodologies used and sources of information in order to meet anti-fraud prohibitions. These new disclosure requirements should discourage bad practices and result in voting recommendations that are more precise, less biased, and more informed.  

Read the full comment letter here