Proxy Advisor Influence

Andrew F. Tuch is Professor of Law at Washington University School of Law. This post is based on his recent article, forthcoming in the Boston University Law Review.

Commentators point to a fairly standard set of factors to explain why proxy advisors exert the influence they do over institutional investors and corporate managers. They say that proxy advisors can mitigate institutional investors’ collective action problems, that legal rules and high levels of institutional investor ownership have created demand for proxy advisors’ services, and that the increased economic significance of investors’ voting decisions has magnified their incentives to use proxy advisors. But there’s a puzzle that casts doubt on the completeness of these explanations. If we compare the United States with a system exhibiting similar laws, institutions, market actors (including proxy advisors), and other relevant characteristics—the United Kingdom—we observe the presence of the oft-cited explanatory factors in both. To be sure, there are differences between the systems as the comparison becomes more granular. But, at the level of abstraction at which the factors are often described, they exist in the United Kingdom as well, suggesting that institutional investors have broadly similar incentives to engage and rely on proxy advisors, giving proxy advisors somewhat similar influence. Yet, to the best of our knowledge, proxy advisors enjoy significantly stronger influence over institutional investors and corporate managers in the United States.

Why this difference in the influence proxy advisors wield, when we would expect a similar role for them in the United States and United Kingdom based on the presence of the conventional set of explanatory factors? Answering this question points to other factors that contribute to the outsized influence of U.S. proxy advisors. Without considering these factors, one cannot convincingly explain why proxy advisors wield as much influence as they do in the United States. These factors must be understood if regulation intended to rein in proxy advisors’ influence is to be effective. In my article Why Do Proxy Advisors Wield So Much Influence? Insights From U.S.-U.K. Comparative Analysis, I examine this puzzle and identify four such factors.

First, the United States has relatively weak institutional investor trade groups. The Council of Institutional Investors does coordinate institutional investors’ activities, but it enjoys nothing like the sway of its U.K. counterparts, investor groups that arose decades earlier than the CII and grew strong. U.K. institutional investors enjoyed close geographic proximity to one another (being based primarily in London and Edinburgh) and faced no real regulatory obstacles to concerted action. U.K. institutional investor trade groups crowded out proxy advisors to some extent; for example, they provided proxy voting guidelines that proxy advisors—when they later emerged—borrowed from and still broadly follow. U.K. institutional investor trade groups also drive and shape debates on governance and the merits of major corporate transactions. These trade groups have helped collectivize institutional investors’ voting power, diminishing the need and space available for proxy advisors. In the United States, by contrast, proxy advisors have not faced competition from strong investor trade groups; rather, they have performed roles that institutional investor trade groups undertake in the United Kingdom. They act as functional substitutes for institutional investor trade groups in important respects, coordinating the actions of big investors and wielding greater influence than they otherwise would as a result.

Second, corporate governance issues that are settled in the United Kingdom remain open—and are often vigorously contested—in the United States, which requires U.S. investors to make decisions that call for expertise and amplifies investors’ incentives to turn to third parties for information and voting guidance. Essentially, what market participants in the United Kingdom regard as uncontroversial or settled in their best practice governance codes is often still a source of dispute for their U.S. counterparts.

Third, U.S. shareholders have relatively weak governance rights. The U.K. regime not only settles governance questions that remain contested in the United States, but grants shareholders stronger rights, giving them greater ability to hold managers accountable. For example, U.K. shareholders may propose resolutions at AGMs and call special meetings. They also have broader access than U.S. shareholders to the corporate proxy machinery. US-style staggered boards and poison pills are not a feature of the U.K. governance landscape. Strong shareholder rights created incentives for institutional investors to coordinate and form trade groups. In the United States, however, institutional investors lacked strong shareholder rights that would have made them more likely than otherwise to act collectively and to form and act through trade groups. Today much of their concerted action occurs instead through proxy advisors.

Finally, the State has played different roles in each system. In the United Kingdom, it has pushed for institutional investors to collectively influence corporate managers and has sometimes unambiguously threatened regulatory intervention unless they do, whereas in the United States it has exhibited suspicion of powerful institutional investors by imposing regulatory barriers to concerted action. In the United States, the State has also been receptive to popular distrust of accumulations of economic power. [1] Aware of these political forces, and lawmakers’ responses to them, U.S. institutional investors would seem more likely than their U.K. counterparts to act collectively through third parties that provide them with cover from the threat of political reprisal. Unaffiliated actors like proxy advisors give more cover than member organizations formed to act for their members.

Implications

The article explores the implications of this analysis for proxy advisor reform in the United States. Briefly stated, the analysis raises questions about the likely effect of proposed reforms, reforms that would subject proxy advisors to greater regulation in order to curtail their influence. For instance, reforms targeting legal requirements to vote, such as the withdrawal of the ISS and Egan-Jones no-action letters in September 2018, [2] may have limited influence—a plausible expectation if, as the analysis suggests, the outsized influence of proxy advisors in the United States is largely explained by other factors.

Second, if proxy advisors’ influence in the United States needs reining in, the article’s analysis suggests possibilities for reform. The U.K. experience shows that best practice codes or statements of agreed principles promulgated by independent bodies, or even by investor trade groups, prevent proxy advisors from dictating widely adopted governance measures. Such codes or statements might diminish the influence proxy advisors have over discourse on corporate governance issues and mitigate the related concern that they deprive managers of “essential latitude” in running their companies.” [3] There is of course resistance to one-size-fits-all approaches, but important benefits would flow if corporate managers and institutional investors were able to find more common ground on governance issues. Other measures, including the removal of regulatory barriers to concerted action, could encourage stronger trade groups, which could function as alternatives to proxy advisors, a change that should attract less opposition given that trade groups are formal representatives of their members, more accountable to them than proxy advisors, and less susceptible to the conflicts of interest that afflict some proxy advisors.

Third, if proxy advisors in the United States are functional substitutes for trade groups in some respects, as the analysis suggests, one might expect proxy advisors’ influence to naturally wane in response to conflicts of interest. Reforms designed to ensure that proxy advisors better represent institutional investors’ interests may assure that proxy advisors continue to have influence over institutional investors and corporate managers. Falling within this category of reforms are measures that limit the conflicts of interest afflicting proxy advisors or that require them to provide more accurate information to investors. By requiring proxy advisors to better serve investors, reforms may be assuring proxy advisors a central, ongoing role in governance, countering the loss of influence that their conflicts or other deficiencies in their services would otherwise bring.

Finally, for those concerned about the influence of proxy advisors in the United States, the irony is that corporate managers’ longstanding opposition to shareholder rights may have created conditions that hampered the emergence of strong institutional investor trade groups. On a wide range of issues, boards have refused to give shareholders rights that are taken for granted in other jurisdictions. In the name of tailoring individual arrangements for companies, boards generally have resisted broad-based rights for shareholders along the lines of those existing in the United Kingdom, leaving U.S. shareholders, by and large, with significantly less influence over the management and affairs of the corporation, even on important corporate matters such as director elections. Had strong institutional investor trade groups been encouraged or even allowed to form in the United States, proxy advisors would almost certainly not have gained the influence that they now wield.

By suggesting new factors to explain proxy advisors’ influence, the article invites greater scholarly attention to the explanatory power of features unique to the U.S. corporate governance landscape. The article casts doubt on the merits of existing ideas for reform and generates fresh options. It illuminates in the United States how proxy advisors perform a coordinating function that institutional investor trade groups perform elsewhere, what legal and other factors impede concerted action by institutional investors, how corporate managers may have unwittingly helped strengthen proxy advisors by opposing stronger shareholder rights, and how reforms intended to weaken proxy advisors may strengthen their ability to coordinate institutions’ activities and ultimately assure their continued influence.

The complete article is available here.

Endnotes

1See Mark J. Roe, A Political Theory of American Corporate Finance, 91 Colum. L. Rev. 10, 11, 31-53 (1991).(go back)

2See Public Statement, Sec. Exch. Comm’n, Statement Regarding Staff Proxy Advisory Letters (Sept. 13, 2018), https://www.sec.gov/news/public-statement/statement-regarding-staff-proxy-advisory-letters [https://perma.cc/JM3U-GJEQ] (announcing withdrawal of previous SEC no-action letters regarding proxy advisory). The two no-action letters are: Institutional S’holder Servs., SEC No-Action Letter, 2004 SEC No-Act. LEXIS 736 (Sept. 15, 2004); and Egan-Jones Proxy Servs., SEC No-Action Letter, 2004 SEC No-Act. LEXIS 636 (May 27, 2004).(go back)

3See Paul Rose, The Corporate Governance Industry, 32 J. Corp. L. 887, 918 (2007).(go back)

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