This week, a new report by the American Council for Capital Formation on the proxy advisory firm industry analyzed both the inherent conflicts of the business model as well as the impact proxy advisory firms have on corporate governance policy. The report reinforces the points the Center has been making about proxy advisory firms since the release of its widely circulated 2011 white paper on the proxy advisory firm industry. Among the key points addressed in the new report include:
- Proxy Advisory Firms Wield Outsized Influence as Unregulated Entities: Noting “[a]cademic studies using regression models find that a negative ISS recommendation can lead to a 25 percent decrease in voting support”, the report details how, despite this influence there is essentially no oversight of proxy advisory firms. Thus, as the report notes, the firms “have emerged as quasi-regulators” due to their influence on votes and their policies which have pushed for great disclosures, particularly in the environmental and social areas. At the same time, the problem is even more complex because the client – the investors – “mistakenly perceive proxy advisors as neutral arbiters” when in fact both ISS and Glass Lewis are “for-profit enterprises” who “work for their customers who can influence their policy through anonymous comment periods and back-channels.”
- Conflicts of Interest are Inherent in Proxy Advisory Firm Business Structure: The report covers the well-known conflicts of interest in the proxy advisory firm industry including ISS’s consulting services offerings and Glass Lewis’s ownership by the Ontario Teachers Pension Fund.
- Major Institutional Investors Vote With ISS, but “Robo Voting” by Different Funds is Likely a Bigger Problem: The report details the voting correlation between ISS recommendations and the proxy votes of major institutional investors, including Vanguard, State Street, and Blackrock which demonstrates that on average the three firms have voted in alignment with ISS an average of 86% of the time with “For” recommendations and 72% of the time for “Against” recommendations. Further, other types of funds, like quant funds and hedge funds may vote in alignment with ISS at a significantly higher rate. The report details how quant fund AQR Global Alignment voted with ISS 99% of the time between 2014 and 2017 and surmises that other firms have similar patterns.
- Proxy Advisory Firms Have an Activist Agenda: The report details how the increase in shareholder support of environmental and social issue shareholder proposals reflects the evolution of Glass Lewis’s and ISS’s policies on those issues. The report questions the basis for the policy shifts, quoting the Manhattan Institute which stated in the Wall Street Journal in 2012 that “ISS receives a substantial amount of income from labor-union pension funds and socially responsible investing funds, which gives the company an incentive to favor proposals that are backed by these clients.” However, as the report notes “because the comments and influence on ISS’s policy guidelines are not public, it is unclear what is driving the change, but it is clear that the change is occurring.”