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The Role of Proxy Advisors in Shareholder Voting and Corporate Governance
In the world of corporate governance, the influence of proxy advisors has increased significantly. As institutional investors increasingly depend on these specialised firms to guide their voting decisions at shareholder meetings, the role of proxy advisors has expanded, making them pivotal players in shaping corporate policies and governance outcomes.
Proxy advisors offer recommendations on critical issues such as board elections, executive compensation, mergers, and emerging environmental, social, and governance (ESG) concerns. Their guidance is indispensable for institutional investors managing vast portfolios, as these investors often lack the resources to conduct in-depth analysis on each agenda item across numerous companies. As a result, proxy advisory firms have emerged as gatekeepers, ensuring investors are well-informed before casting their votes.
The growing influence of these firms has not been without controversy. Concerns about their market power, potential conflicts of interest, and the “one-size-fits-all” nature of their recommendations have sparked debates about the transparency and accountability of the industry. With a small number of firms dominating the proxy advisory space, their recommendations can sway a major portion of the votes on key corporate decisions, making their role critical to the outcome of shareholder meetings.
This article delves into the functions of proxy advisors, their impact on shareholder voting, and the challenges they present in the modern corporate landscape. Understanding the influence of these firms is vital for companies and investors alike, as they navigate the complexities of corporate governance in an era of increasing shareholder activism and regulatory scrutiny.
What Are Proxy Advisors?
Proxy advisors are specialised firms that offer voting recommendations and corporate governance analysis to institutional investors, such as pension funds, mutual funds, and asset managers.
Their primary role is to analyse the voting matters presented in annual and special shareholder meetings and then provide recommendations on how investors should vote on these issues. The voting issues can range from the election of directors, executive compensation packages, and mergers and acquisitions to shareholder proposals concerning environmental, social, and governance (ESG) matters.
Proxy advisory firms emerged to mitigate information acquisition costs and enhance voting efficiency for institutional investors. However, their concentrated market presence raises concerns about accountability and influence, as many asset managers rely heavily on their recommendations.
A 2020 study by the Harvard Law School Forum on Corporate Governance revealed that 69% of institutional investors rely on proxy advisor recommendations when making voting decisions during annual meetings.
Two of the most prominent proxy advisory firms in the industry are Institutional Shareholder Services (ISS) and Glass Lewis, with a combined control of 97% of the proxy advisory market in the U.S. The four main UK proxy advisory firms are ISS, Glass Lewis, IVIS, and PIRC.
These firms have vast databases of corporate governance practices, making them influential voices on governance standards.
Key Functions of Proxy Advisors:
Proxy advisors act as a bridge between institutional investors and the companies in which they invest. Investors pay for these services, and the advisors help plug the information gap between shareholders and companies, ensuring informed voting decisions.
Their analysis helps investors fulfil the fiduciary duty to act in the best interest of beneficiaries, ensuring investors make informed decisions in alignment with governance best practices. Proxy advisors can:
• Provide detailed research reports on corporate governance practices.
• Issue voting recommendations on resolutions for shareholder meetings (Proxy advisor recommendations can sway up to 25-30% of the total votes cast in a shareholder meeting, particularly for contentious issues such as director elections and executive compensation).
• Analyse executive pay structures, board independence, and ESG issues.
• Offer consulting services to companies seeking to align with governance best practices.
However, the industry faces criticism for potential conflicts of interest, lack of regulation, and excessive power. Despite concerns, proxy advisors remain valuable to boards by offering governance expertise, advising on emerging issues like ESG, and helping prepare for the proxy season.
Therefore, it is recommended that boards should maintain strong relationships with proxy advisory firms and prepare for proxy season proactively to avoid surprises.
How Do Proxy Advisors Affect Shareholder Voting?
For many institutional investors managing large portfolios, it is logistically impossible to conduct in-depth research on every company in their portfolio. This is where proxy advisors step in, providing voting recommendations based on their independent analysis.
Given that institutional investors control significant voting power, proxy advisors’ recommendations can have a significant effect on vote outcomes. A favourable or unfavourable recommendation from a proxy advisor can often tip the scales on issues such as executive compensation or board elections.
One of the most visible impacts of proxy advisors on shareholder voting occurs during proxy contests, where shareholders or activist investors challenge a company’s management on specific issues. Proxy advisors’ recommendations are often critical in shaping the outcome of these contests.
Investors who follow their recommendations may vote against the management or in favour of an activist’s proposal. In 2019, a study found proxy advisors’ recommendations aligned with activist shareholders 67% of the time, especially in proxy contests where the activist was pushing for board changes.
Moreover, the introduction of the universal proxy rules has heightened the role of proxy advisors in contested board elections. These rules, which mandate shareholders can vote for any combination of director nominees, require an even more nuanced analysis of candidate qualifications and governance principles. As a result, institutional investors increasingly rely on proxy advisors to help them navigate these complex decisions.
Additionally, in 2020 the U.S. Securities and Exchange Commission (SEC) introduced new rules aimed at increasing the transparency and accountability of proxy advisory firms, requiring them to disclose conflicts of interest and give companies the opportunity to review and respond to voting recommendations.
The Process Behind Proxy Voting Recommendations
Globally, proxy voting participation has surged. As per Glass Lewis’ Policy Guidelines, over $40 trillion worth of assets are being managed by them, participating in proxy voting processes across various markets. Proxy advisors follow a rigorous process to develop their voting recommendations.
Here are the typical steps involved:
• Research: Proxy advisors gather and analyse public filings, including annual reports, proxy statements, and other corporate disclosures.
• Engagement with Companies: Some proxy advisors engage with corporate management to discuss governance issues, obtain clarifications, or understand the context behind specific resolutions.
• Development of Voting Policies: Based on their analysis and established governance guidelines, proxy advisors develop standardized voting policies that drive their recommendations.
• Voting Recommendations: For each shareholder meeting, proxy advisors release reports containing their analysis and voting recommendations for institutional investors.
• Investor Decision: While institutional investors may follow the recommendations of proxy advisors, they can also deviate based on their own policies or further engagement with the companies.
Why is This Important for Corporate Governance?
Proxy advisors play a crucial role in maintaining the integrity and effectiveness of corporate governance. By providing independent assessments and recommendations on key governance practices, proxy advisors help institutional investors hold companies accountable for their decisions, ensuring that management acts in the best interests of shareholders.
Effective corporate governance promotes long-term shareholder value, mitigates risks, and strengthens the overall stability of a company. Proxy advisors, through their voting recommendations, help shape key governance decisions, such as:
Board Composition
Proxy advisors evaluate the qualifications and independence of board members, ensuring that boards remain balanced and effective in overseeing company management.
Executive Compensation
Proxy advisors provide recommendations on say-on-pay proposals, ensuring executive compensation aligns with company performance and shareholder interests (in the U.S. market 12% of say-on-pay proposals faced significant shareholder opposition in 2022, with negative recommendations from proxy advisors playing a major role).
Risk Management
Proxy advisors focus on governance policies that promote sound risk management practices, from environmental sustainability to corporate ethics.
ESG Issues
Environmental, social, and governance issues have become a major focal point in corporate governance. While anti-ESG movements have grown this year, calling for fewer ESG related agendas, it remains a key aspect of a company’s performance. Proxy advisors analyse and provide voting recommendations on shareholder proposals related to ESG concerns, helping investors shape corporate responsibility initiatives. As per a study on ESG shareholder engagement, there has been a 60% increase in the number of proposals since 2015, with proxy advisors increasingly influencing how institutional investors vote on these issues.
Proxy advisors assist institutional investors as stewards of responsible investing, promoting transparency and good governance practices that drive long-term sustainability.
How Do Proxy Advisors Help the Board?
Proxy advisors, while mainly serving shareholders, offer significant support to corporate boards by providing independent evaluations of governance practices. Their assessments give boards an impartial view of how they are perceived by shareholders, helping to improve decision-making and governance frameworks.
This feedback often covers key areas like board independence, executive compensation, and environmental, social, and governance (ESG) issues, helping boards align with best practices and investor expectations.
Additionally, proxy advisors promote transparency, helping boards refine communications with shareholders and align governance practices with investor priorities. This engagement not only improves governance but also strengthens the board’s credibility and long-term value creation.
In short, proxy advisors act as a valuable resource for boards, offering external insights that enhance governance, communication, and overall performance.
Key Benefits for Corporate Boards
• Independent Feedback: Proxy advisors offer an impartial evaluation of governance practices, highlighting areas where companies may fall short of best practices.
• Enhanced Credibility: Companies receiving positive proxy advisor recommendations often enjoy greater credibility with shareholders, signaling strong governance.
• Investor Relations: Engaging with proxy advisors can help boards understand investor concerns and align governance practices with shareholder expectations, fostering better relationships.
• Improved Decision-Making: Proxy advisors’ recommendations can prompt boards to rethink certain decisions, particularly around executive compensation, director nominations, and ESG initiatives.
For corporate boards seeking to improve governance practices, engagement with proxy advisors can be a strategic tool. By addressing the concerns raised in proxy reports and aligning with governance best practices, companies can enhance their reputation and foster stronger relationships with institutional investors.
What Are the Challenges and Controversies of Working with Proxy Advisors?
Proxy advisors play a crucial role in corporate governance, helping investors navigate complex decision-making processes. However, their growing influence has sparked concerns among companies, investors, and regulators.
Critics argue that the dominance of a few firms, particularly ISS and Glass Lewis, raises questions about their accountability, transparency, and potential conflicts of interest. Below are some of the most common criticisms levelled against proxy advisors.
Common Criticisms of Proxy Advisors
• Over-Reliance by Investors: Some critics argue institutional investors rely too heavily on proxy advisors’ recommendations without conducting their own research, which could lead to decisions that may not fully reflect the investor’s specific interests. Additionally, investors have reported factual and analytical errors in their proxy reports in previous proxy seasons.
• Conflicts of Interest: Proxy advisors often provide consulting services to the same companies they analyse. This dual role has raised concerns about conflicts of interest and whether the objectivity of their recommendations may be compromised.
• Lack of Accountability: There is limited oversight of proxy advisors. Their methodologies and decision-making processes can sometimes lack transparency. Critics have called for greater regulatory scrutiny of their operations. For instance, a survey conducted on the 2016 and 2017 proxy seasons reported that over 30% of the companies reported adverse recommendations and a large portion of the respondents highlighted a lack of proper prior-notice.
• “One-Size-Fits-All” Approach: Proxy advisors use standardized voting policies across a broad range of companies. The top advisory firms in the market have a headcount of 1000-1500 but need to advise on millions of ballots, questioning the research backing their recommendations. For instance, companies like ISS have reportedly indicated that their clients vote on ballots representing nearly 40,000 shareholder meetings. Not all companies are alike, and the nuances of each company’s unique circumstances may not be adequately considered in these proxy reports.
These challenges have led to debates about the appropriate role of proxy advisors in corporate governance. Some corporate leaders have called for reforms to increase transparency, while others advocate for more direct engagement between investors and company management.
How to Respond to Proxy Advisors’ Influence?
Given the growing influence of proxy advisors, both investors and boards must develop strategies to effectively respond to recommendations. Engaging with proxy advisors and proactively addressing concerns can help mitigate potential negative outcomes and ensure shareholder votes align with long-term interests.
One key approach is for investors to have direct digital engagements with issuers and other parties in the custody chain, providing more oversight of the agendas and allowing more time to scrutinize proxy advisor recommendations.
Direct digital engagement enhances communication, enabling a better understanding of priorities and concerns—particularly valuable during proxy contests. This collaborative dialogue fosters improved governance practices and aligns corporate actions with shareholder expectations.
Boards that are proactive in communicating with investors can clarify their position on key issues, helping to build trust and ensuring investor voting reflects a well-informed perspective. Such engagement strengthens corporate governance by addressing shareholder concerns before they escalate into voting challenges.
Platforms like Proxymity Vote Connect and Vote Insights facilitate this direct connection between issuers, investors, and all participants in the custody chain. Proxymity’s fully digital capabilities enhance transparency, accuracy, and efficiency in the proxy voting process, ensuring voting outcomes reflect genuine investor preferences.
By streamlining communication and creating real-time transmission of golden source agendas, Proxymity offers an innovative solution to the complexities of proxy voting.
Several policy changes have been proposed to address proxy advisor influence, including:
• Enhancing transparency around proxy advisors’ business models
• Requiring disclosure of additional business interests
• Ensuring regulations do not hinder market entry
• Increasing oversight to better reflect diverse investor preferences in proxy voting
Overall, there is a need for a balanced approach that encourages competition and diverse governance perspectives while maintaining effective voting practices. While proxy advisors help fill information gaps in voting, their market power raises concerns around influence and accountability.
How Can Companies Maximise the Value of Proxy Advisors?
• Engage Early and Often: Companies should actively engage with proxy advisors well before annual meetings. By providing transparent information about governance practices, companies can help shape proxy advisors’ recommendations in a positive way.
• Tailor Governance Practices to Investor Expectations: Proxy advisors often highlight governance practices that fall short of investor expectations. By understanding the top corporate governance issues, companies can take steps to address these concerns and align with best practices.
• Provide Clear and Transparent Disclosure: Proxy advisors base their recommendations on publicly available information. Ensuring corporate filings are clear, transparent, and comprehensive can help improve proxy advisor evaluations.
• Engage with Shareholders: Companies should maintain open lines of communication with their institutional investors. By understanding investor concerns and addressing them directly, companies can reduce their reliance on proxy advisor recommendations.
• Consider Third-Party Advice: In cases where proxy advisors issue negative recommendations, companies may consider engaging third-party governance experts to provide independent analyses and counterarguments.
By taking these steps, companies can ensure proxy advisors’ influence is constructive and aligned with long-term shareholder value creation.
Learn More About the Influence of Proxy Advisors
Proxy advisors continue to play a central role in shaping corporate governance and shareholder voting outcomes.
As their influence grows, it is essential for companies, institutional investors, and other stakeholders to understand how to effectively engage with these firms and respond to their recommendations.
By staying informed and proactive, companies can align with governance best practices, foster better relationships with shareholders, and drive long-term value.
If you would like to learn more about how your company can effectively navigate the influence of proxy advisors or have questions regarding shareholder engagement, feel free to contact us for expert guidance and support.