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Director Elections and the Influence of Proxy Advisors

In some quarters, there has been growing concern about the power of proxy advisors such as Institutional Shareholder Services (ISS), Governance Metrics International (GMI), and others (e.g., Green Street for REITs). The groups publish corporate governance ratings of public companies and make recommendations as to how institutiional investor clients should vote thjeir shares.

Stephen Choi, Jill Fisch and Marcel Kahan have just published an important paper, Director Elections and the Influence of Proxy Advisors, in which they argue that:

Using a dataset of proxy recommendations and voting results for uncontested director elections from 2005 and 2006 at S&P 1500 companies, we examine how advisors make their recommendations and how these recommendations and other factors affect the shareholder vote. Of the four firms we study, Institutional Shareholder Services (ISS), Proxy Governance, Glass Lewis, and Egan Jones, ISS is widely regarded as the most influential and its recommendation is claimed to sway 20-30% of the vote. We find that the four proxy advisory firms differ systematically from each other both in their willingness to issue a withhold recommendation and in the factors that affect their recommendation.

We further find that all the proxy advisors, but particularly ISS, base their recommendations largely on factors that shareholders take into account (independent of the recommendation) in casting their vote. Once these factors are controlled for, overall voting outcomes are substantially similar whether or not a proxy advisor has issued a recommendation. Our analysis demonstrates that the reported influence of ISS is substantially overstated. Our evidence is consistent with the view that proxy advisors act primarily as agents or intermediaries which aggregate information that investors find important in determining how to vote in director elections rather than as independent power centers.

I view ISS and its ilk as providing mainly an insurance policy. If its clients get sued by DOL (in the case of pension funds) or shareholders (in the case of mutual funds) over voting, they can point to their use of ISS to justify their voting decisions. This understanding of ISS’ role is broadly consistent with their findings. Clients use ISS as CYA insurance to justify what they already want to do.