The Big Thumb on the Scale: An Overview of the Proxy Advisory Industry

Summary of Study

Bottom Line: Proxy advisory firms have a large influence over the voting decisions of institutional investors and the governance choices of publicly traded companies. Yet, it is not clear that the recommendations of these firms are correct and generally lead to better outcomes for companies and their shareholders.

Proxy advisory firms are not transparent about the process they use to develop their guidelines for shareholder voting, the models they use to determine recommendations, the accuracy of their recommendations, or potential conflicts of interest. They do not disclose their historical recommendation data, arguing that this data is proprietary.

Proxy advisory firms are also not held to a fiduciary standard, which would require them to demonstrate that their recommendations are in the best interest of shareholders and the corporation. Furthermore, proxy advisory firms do not have financial incentive to issue accurate or correct recommendations because they do not have an economic interest in the outcome of votes.

Some proxy advisory firms, such as ISS, receive consulting fees from the same companies whose governance practices they evaluate. The terms of these arrangements are not disclosed, including whether paid clients are given special access to information about the models underlying the firm’s recommendations.

Proxy advisory firms might also have insufficient staff to accurately evaluate the full scale of proxy items on which they provide recommendations each year. ISS, which is the largest firm, employs 1,000 individuals company-wide including non-research (administrative) personnel. 

In a properly functioning market, companies with a poor service record are driven from the market. Proxy advisory firms, however, are insulated from these forces, primarily because many institutional investors rely on their services as a cost-effective method to satisfy the obligation imposed by the Securities and Exchange Commission to develop guidelines that are free from conflict and to vote all items on the proxy. 

Proxy advisory firms are not subject to material oversight by the Securities and Exchange Commission or other regulatory bodies in the U.S. Nevertheless, regulation of the proxy advisory industry might improve their contribution to the voting process. Regulators could follow two paths: 

1. Take steps to compel proxy advisory firms to improve the quality of their product.

2. Eliminate the requirement that institutional investors vote all items on the proxy. This action would free investors to decide whether to pay for the voting recommendations of proxy advisory firms based on an evaluation of their price and value.

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