Corporate Governance Oversight and Proxy Advisor Firms: Do Proxy Advisors Have Too Much Power?

Bottom Line: The objectives of proxy advisor firms may not align with the institutional investors that defer to them on issues of shareholder governance. The lack of transparency and accountability at proxy firms make it difficult to understand how they are impacting shareholder return. As a result, significant reform of the industry is needed.

The Securities and Exchange Commission requires institutional investors, which control about 80 percent of the stock market, to vote on corporate governance issues. But the SEC allows them to use the recommendations of third-party proxy advisor firms.

Proxy firms have taken on growing importance as activists have increasingly tried to leverage shareholder proposals to pursue fashionable political goals, such as climate change, racial and ethnic diversity, and political spending disclosures. This activism may conflict with investors’ fiduciary responsibilities to maximize shareholder return. 

There are at least three problems with the proxy advisor industry: 

1. There is a lack of transparency about proxy advisors’ methods and accountability. Proxy advisors have become equivalent to regulatory bodies, capable of making demands on public companies without statutory authority. 

2. Proxy advisors are for-profit entities with the same potential for conflict of interest as any other professional service. Yet they are not subject to robust oversight or disclosure.

3. Institutional investors often succumb to “robo-voting” — automatically following the advice of proxy advisors without even a cursory analysis of their recommendations. 

Proxy advisors argue there is no deviation between their recommendations and investors’ desire to maximize return. But at the same time, big proxy advisors are disproportionately owned by union pension funds, which create a conflict of interest to support union political proposals. 

Congress is currently considering legislation to increase proxy firm transparency. The SEC has also declared concern about political activism and may pursue action.

It is worth asking whether institutional investors should be required to vote their proxies at all. It is this requirement that generates over-reliance on proxy advisor firms in the first place. Removing this requirement would give individual investors more power, which would be preferable to the status quo. 

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