Proxy voting advisors are not new. ISS, the proxy voting market leader, was established in 1985 (Belinfanti, 2009), PIRC in 1986 (PIRC, ND) Manifest and 1995 (Manifest, ND), however, their increased popularity has been mostly since the early 2000s after the failures of Enron and WorldCom. In the US, the growth has been mainly attributed to the SEC requiring mutual funds to disclose their voting annually in 2003. This lead to a swell in demand for proxy agencies in the US (Belinfanti, 2009).
It is commonplace for institutions to employ a proxy voting advisor to review its
investments’ corporate governance and offer advice on how to vote at the AGM. Large proxy voting advisors include Manifest, PIRC, ISS, Glass, and Lewis. With the increasing international diversity of investments by institutions, the greater the use of proxy advisors and corporate governance ratings (European Commission, 2011, Verdam, 2007). ISS is a US proxy voting advisor and has the largest global presence and in 2003 ISS joined forces with NAPF in the UK which resulted in the RREF (Research Recommendations and Electronic Voting), where RREF recommendations are based upon NAPF’ governance policies (Verdam, 2007). The UK market leader is PIRC that specialises in proxy advice (Verdam, 2007).
There can be a conflict of interest between the proxy voting advisors and their clients, as they may “provide services to both to the investor and to the issuer or the proxy advisor is owned by an institutional investor or by a listed company to whom, or about whom, the proxy advisor may be providing advice.” (EMSA, 201, p9). However, it is only whom ISS provides both governance consultancy and proxy advice services (Belinfanti, 2009; Weterings (2010), whereas Glass Lewis, Proxy Governance, Egan-Jones and
GovernanceMetrics International only provide proxy advice services (Weterings (2010). The proxy agents bare none of the risk associated with their recommendations, the risk is borne by the institution that employed them. Belinfanti (2009) argues that “Under classic agency theory, this separation of decision and risk should not be tolerated without effective control procedures” p406. This viewpoint demonstrates why there have been modifications of the Stewardship Code (2012) to encompass proxy agents. The proxy advisory services have no fiduciary duties towards their corporate clients (Belinfanti, 2009).
43
There could be some competition issues within Proxy Agencies, as at the present state the industry shows signs of an oligopoly (EMSA, 2013). The role of proxy agencies is questioned in the Green paper on corporate governance in 2011 (EMSA, 2013), this demonstrates the importance of the role in stewardship the proxy advisors have.
Verdam (2007) cites research from SEC Business Roundtable December 2003 that “40 per cent of votes cast by institutional shareholder for US-listed companies for shares in US-listed companies are in conformity with ISS’ recommendations” p5. In addition, 15-20% of ISS’ clients automatically vote with ISS recommendations. Verdam (2007) highlights the practicalities of voting against the ISS recommendations, firstly the institution has paid for their advice, so why would they vote against ISS recommendations and in addition there is the cost of extra research involved in voting against and secondly there is the possibility of having to explain to the beneficiaries why they went against ISS recommendations. In essence, the view is that if an institution employs an agent, they are likely to use the advice they pay for. Choi, Fisch and Kahan (2010) provide a different view; from their tests, it is found that ISS do have an influence over the voting for reappointment of directors.
However, not as much as much as commonly believed, were from various tests on 2005 and 2006 data on directors’ nominations for S&P 1500 companies the ISS influenced 6%-10% of shareholder votes. Where the other proxy agencies examined: Glass Lewis, Egan Jones and Proxy Governance had less of an influence. Larker, McCall and Ormazabal (2012) found similar results with ISS influencing 8.84% (8.40%) mean (median) for say on pay when controlling for other variables. However, both Choi et al (2010) and Larker et al (2012) examined the means of voting for a proposal after the voting agency issued a negative vote, as can be seen in Table 2:
44
TABLE 2VOTING PROPOSALS
Choi et al(2010) – Withhold of recommendation for Reappointment -
Larker et al (2012) – Oppose to Compensation package
ISS 76.14% (ISS For 96.44%) 68.68% (Positive vote from ISS 93.4%)
Glass Lewis (GL) 76.18% (Positive vote from GL
93.7%)
The proxy advisory service industry indeed has signs of an oligopoly with a limited choice of advisors, and most research demonstrates this by studying only ISS, however, from Choi et al’s (2010) research, it is found that there were differences in the recommendations given. For example, when recommending for voting against director nominations, Glass Lewis was the most prolific with 18.8% of their recommendations for withholding vote compared to, ISS 6.8%, Proxy Governance and Egan Jones 11%. Although Larker et al (2012) state that the say on pay recommendations ISS and Glass Lewis in 79% of cases for 2011 their
recommendations coincided.
There has been some concern about the transparency and the general quality of proxy advisors’ advice and the EC raised the question of whether there should be regulation over proxy advisors (European Commission, 2011). However, the final proposals by EMSA (2013) stated there is no need to overburden proxy advisors with regulation, but suggest that there should be a uniform practice. The EMSA suggest that there should be a soft law where there should be a ‘comply or explain’ standard for proxy advisors. The redrafted Stewardship Code (2012) has placed proxy agencies as a part of the Stewardship Code’s remit and institutions need to state how the proxy agents’ advice is used, however, this move has been criticised by ISS founder Bob Monks (Sullivan, 2012).
It could, however, be argued that the market should be able to effectively monitor the proxy agents so that only the best survive. Currently, ISS is the market leader in the US and PIRC for the UK, it could just be a case of the emperor’s new clothes where the institutions are just using them as a mark of quality because they are the market leader, and not really examining their recommendations. In the US there is very little competition against ISS,
45
except for Glass Lewis, although unlikely to pose a threat to ISS (Belinfanti, 2009). Both PIRC and ISS were the first proxy agents in their country of origin, both benefit from the
consumer switching costs, thus also limiting the possibility of market forces checking the agents (Belinfanti, 2009). Certainly, for ISS there is very limited disclosure on the governance scores, which makes it very difficult to effectively monitor.
Overall, the role of the proxy advisor makes the traditional view of agency theory from Berle and Means (1932) more outdated. In the current environment of corporate governance and corporate responsibility it is difficult to assess the effectiveness of institutions engagement, thus highlighting the need for further research into institutions and their appetite for good governance of the investee companies, especially in the wake of the recent financial crisis, where the lack of governance and monitoring of internal controls is present (Walker, 2009). It is clear that financial institutions use proxy agencies for corporate governance, as it makes their choices easier. This argument supports the theory that shareholders have limited attention (Hirshleifer and Teoh, 2013) and use simple easier measures of corporate governance to feed into their decision making on corporate governance.