When institutional investors hire proxy advisors to prepare reports on matters up for vote at the public companies in which they invest, are they interested in acquiring a bottom-line recommendation on how to vote (on which they can then blindly rely), or in acquiring information that will help them make their own voting decisions?
Supporters of heightened proxy advisor regulation gravitate toward the former position. They argue reforms like those introduced by the Securities and Exchange Commission (SEC) in 2019 and 2020 are needed to discourage institutional investors from blindly relying on proxy advisor recommendations. Opponents gravitate toward the latter position, arguing such reforms generally are unnecessary because institutional investors tend to use proxy advisors merely as research providers—aggregators of relevant information—and as such already review their proxy advisors’ work product and make their own voting decisions as a matter of course.
My forthcoming article argues that neither of these accounts presents a full picture of proxy advisors’ role in shareholder voting, and proposes a more nuanced account that better reflects existing evidence. It also explores this account’s potential implications for reform.
Empirical research measuring the potential influence of the leading proxy advisor, Institutional Shareholder Services (ISS), on voting outcomes at US public companies is inconsistent with the notion that all, or even most, institutional investors blindly rely on proxy advisor recommendations. The difference between the average levels of shareholder support received by proposals endorsed by ISS and those opposed by ISS is too small—and varies too greatly depending on the type of proposal up for vote—to suggest that lockstep conformance to ISS recommendations is the norm. (Though a minority of investors do seem to vote in near-total alignment with ISS recommendations, their US public equity holdings appear too small for them to be likely to have a material influence on voting outcomes.) At the same time, though, surveys of institutional investors suggest these investors lack the time and staff resources to scrutinize and make independent decisions on every matter up for vote, undercutting the notion that institutional investors tend to use proxy advisors merely as research providers.
The empirical evidence does tend to support a more nuanced account: institutional investors tend to use proxy advisors first and foremost as issue spotters, helping them distinguish controversial matters from non-controversial ones:
- When a proxy advisor’s recommendation aligns with that of management, this signals that the vote is non-controversial and that the investor can rely on the advisor’s bottom-line recommendation without reviewing the underlying research or undertaking further analysis.
- When a proxy advisor’s recommendation opposes management’s recommendation, this signals that the vote is controversial and that the investor should examine the research presented in the proxy advisor’s report, as well as other relevant information, to reach its own voting decision.
On this account, proxy advisors do influence shareholder voting, but this influence derives primarily from their ability to direct institutional investors’ attention away from some proposals and toward others, not from institutional investors’ following their recommendations in lockstep.
This account has at least three implications for proxy advisor reform.
First, it casts in a new light one common criticism of proxy advisors’ standards—that their ‘one-size-fits-all’ approach to corporate governance fails to account for individual companies’ circumstances and thus results in too many negative recommendations against management proposals. If investors view negative recommendations only as a signal that a vote is controversial and that investigation into a company’s individual circumstances may be warranted, this criticism does not provide a basis for reform. Proxy advisors’ voting standards run into trouble only if they result in too few negative recommendations (eg, as a result of efforts by management to game these standards), as this means controversial votes would escape institutional investors’ notice. This potential problem should be a focus of future regulatory work.
Second, it points toward a more focused approach to the presentation and delivery of proxy advisor recommendations and related communications. Reforms should focus on helping institutional investors access new signals about the quality of proxy advisors’ recommendations of which they would not otherwise have been aware, instead of merely reminding them of obvious risks—such as potential inaccuracies and conflicts of interest—that most investors already address by, among other things, scrutinizing recommendations on controversial matters.
Third, instead of outlining new steps all institutional investors should take before casting votes, regulatory guidance should focus on the small minority of institutional investors that appear to vote in lockstep with proxy advisor recommendations. This guidance could state that institutional investors need not exercise voting rights on their clients’ behalf when the costs of doing so appear likely to exceed the benefits, and that in assessing these costs institutional investors should consider the cost of independently reviewing proxy advisor recommendations on controversial matters.
The impending appointment of a new SEC Chair could provide an opening to revisit this issue, and perhaps arrive at a revised regulatory approach that better reflects proxy advisors’ role in shareholder voting.
Douglas Sarro is a Bombardier Scholar and Graduate Fellow in Capital Markets Research at the University of Toronto Faculty of Law. He previously was an associate at Sullivan & Cromwell LLP in New York.