Role of Proxy Advisory Firms

Nicholas J Price
5 min read
Proxy advisory firms provide a valuable service in helping investors make wise choices about their shareholder votes. In addition, by nature of their industry, proxy advisors are experts in governance, and their recommendations often set the stage for best practices for good governance. Investors rely on proxy firms all year round, not just during proxy season.

Because proxy firms act as consultants for companies and also represent shareholders, strong potential exists for a conflict of interest. For this reason, concern is brewing over whether there should be more regulation over proxy advisory firms.

The Rise of Proxy Advisory Firms

For most companies, proxy season runs from late April through early June, with a peak week in May. This is the time that most companies file their proxy statements that contain shareholder votes with the Securities and Exchange Commission (SEC) and hold their annual general meetings. Institutional investors need to disseminate and evaluate a lot of information to make wise decisions about voting and engagement.

Lack of time prevents them from engaging at the highest level. In addition, institutional investors don't always have the resources at their disposal to respond appropriately to each proposal. Proxy firms fill the gap by providing information and recommendations to investors.

Shareholder proposals can now surface at any time during the year. In many cases, it makes practical sense for investors to rely on the recommendations of their proxy advisors, who are better informed on the finer distinctions of current and emerging issues.

Role of Proxy Advisory Firms

Every year, shareholders have the opportunity to vote their shares at the annual general meeting. It's not always possible for them to appear in person because many institutional investors have a wide variety of holdings, which makes it difficult to assess the specific issues and risks.

Many shareholders take the opportunity to vote by proxy. The company provides them with a proxy card, and they can send their voting instructions on it. Investors don't always have the time and resources to do the proper research or understand the agendas for numerous shareholder proposals in order to make informed decisions on voting.

Proxy advisory firms, such as Glass Lewis and Institutional Shareholder Services (ISS), emerged to fill the gap in providing the knowledge that shareholders need around voting times.

The purpose of proxy advisors is to uncover the risks and inform institutional investors about issues so they can make the best decisions with respect to the shareholder votes at publicly traded companies. The role of proxy advisory firms has grown as engagement around shareholder proposals has grown.

Role of Proxy Advisors Can Be Conflicting

ISS and Glass Lewis manage thousands of clients and trillions of assets every year. Of course, they claim to put the best interests of their investors first. In reality, in addition to providing recommendations to investors and setting standards for best practices for governance, proxy advisory firms also offer consulting services to publicly traded companies.

While proxy advisory firms state that they put the best interests of the shareholders first, representing both sides of the same issues holds strong potential for a conflict of interest. Proxy companies are largely unregulated, and they have no requirements for reporting and transparency. Non-clients are not able to access any reports and recommendations that the proxy advisors make on the same matters. As a result, there's no way for shareholders or portfolio managers to know how advisory firms made their recommendations or how they get compensated. Proxy firms maintain that they have internal firewalls between the two sides of the business, but some question whether that is enough to mitigate the conflict. Some would like to see proxy advisory firms have more regulations on them.

To make matters even more concerning, some are questioning whether the advice that proxy advisors give is even helpful to shareholders.

The Role of Proxy Advisors in Governance

Proxy advisors are considered the utmost in governance expertise, which has quite naturally landed them a broader role in regulation. They're often the first to establish metrics for evaluating corporate governance practices. They were the first to make recommendations for board composition and highlighted the importance of having more women on boards.

There's a new trend for shareholders who are interested in companies that focus on environment, social and governance (ESG) and proxy advisors took note and made companies aware of these principles. As the economic climate ebbs and flows, proxy advisors are the first on alert and are the prime advisors to inform companies and shareholders.

Proxy advisors also influence the decisions that boards make on certain issues. As part of board development, board directors listen to what proxy advisors have to say on many matters. Over 70% of board directors and executive officers stated that they examined the guidelines on executive remuneration by ISS and Glass Lewis before making decisions about their executive remuneration packages.

Proxy advisors have at times taken strong action toward board directors who fail to go along with the guidelines and recommendations that proxy advisors make. ISS has openly remarked that board directors who make decisions that aren't in keeping with their recommendations could face serious consequences, such as making recommendations to shareholders to withhold certain votes in director elections.

Board Management Software Systems Provide a Valuable Board Tool

Boards have to be at the top of their game in dealing with shareholders and proxy advisors. A board management software program is a valuable tool that board directors can use to communicate and collaborate on shareholder engagement issues using a highly secure platform. Diligent's board portal system has the capability for unlimited cloud-based storage so that companies can secure and store all the documents that proxy advisors put out and house them in an online library for easy retrieval. This way, board directors can retrieve documents at any time of day or night using any electronic device they choose. As the proxy advisors come out with new research and recommendations, boards will be able to file the information so that it's easily accessible for board directors and boards can get to work immediately making the recommended changes.