Promoting Long-Term Economic Value Creation

Smart reforms to improve the proxy advisory process

September 1, 2016

To create value for shareholders, workers and consumers over the long haul, U.S. companies need a regulatory environment that is conducive to promoting job creation and economic growth. This particularly means enacting policies that will improve the efficiency of U.S. capital markets and enhance good corporate governance, including the quality of information available to shareholders and investors.

Unfortunately, such an environment has not yet been fully realized, largely due to the current proxy voting process and the role proxy advisory firms play in this process. Today, two proxy advisory firms, Institutional Shareholder Services and Glass Lewis, account for 97 percent of the market share of the proxy advisory business and wield enormous influence. How is that possible?

ISS clients directly influence an estimated 20 percent to 30 percent of the votes of a typical mid- to large-cap public company, while Glass Lewis clients typically influence 5 percent to 10 percent of the votes. Mind you, these are the firms from which many institutional investors, which hold 76 percent of outstanding U.S. publicly traded shares, receive advice for managing their fiduciary duty to vote proxies in the best interests of the beneficial owners they represent.

The CEO members of Business Roundtable — who lead major U.S. companies with $7 trillion in annual revenues and nearly 16 million employees — see the outsized influence of ISS and Glass Lewis up close and feel the negative effects of their often inaccurate reporting, conflicting interests and lack of transparency and accountability.

In a survey conducted in 2013, nearly all Business Roundtable CEOs reported finding significant factual errors in reports prepared by proxy advisory firms. According to a 2010 survey of HR Policy Association members and Center On Executive Compensation subscribers, 53 percent of the chief human resource officers of large companies say that a proxy advisory firm had made one or more mistakes in a final published report on the company’s compensation programs in 2009 or 2010. Public companies have little opportunity under the current regulatory regime to help correct these errors and inaccuracies.

Meanwhile, ISS offers proxy voting recommendations while also offering paid consulting services to the companies whose proxies they evaluate. Glass Lewis is owned by the Ontario Teachers’ Pension Plan, which invests in companies on whose proxies Glass Lewis makes recommendations. The owners, executives and staff of proxy advisory firms are free to invest in, or even serve on the boards of, public companies whose proxies they assess.

Furthermore, neither ISS nor Glass Lewis fully discloses the methodologies used to develop their voting recommendations. They also do not disclose the academic research, if any, that is used in formulating their decisions and whether or not such decisions were based on the creation and preservation of shareholder value.

The good news: There is positive, bipartisan momentum to strengthen the transparency and accountability of the proxy advisory process.

The Corporate Governance Reform and Transparency Act of 2016, which was introduced by Representatives Sean Duffy (R-WI) and John Carney (D-DE) and is currently pending before the U.S. House of Representatives, would require proxy advisory firms to register with the U.S. Securities and Exchange Commission and annually provide the agency with material disclosures. These disclosures would include information regarding the procedures and methodologies used in advising the firm’s clients; the firm’s organizational structure; whether or not it has a code of ethics; and any potential or actual conflict of interest related to its ownership structure.

The legislation would also help resolve problems related to the reliability and accuracy of proxy advisory firm reports. For example, the bill would require that registered proxy advisory firms hire sufficient staff and allow issuers receiving proxy advisory firm recommendations to comment on the recommendations. Additionally, the bill would prohibit registered proxy advisory services from engaging in unfair, coercive or abusive practices. Registered firms would be prohibited from conditioning or threatening to condition a voting recommendation on the purchase by an issuer of services or products of the registered proxy advisory firm or affiliate.

As a long-standing champion for increased oversight of proxy advisory firms, America’s business leaders strongly support these smart reforms — changes that will better enable our companies to do what they do best for the greater U.S. economy.

This column originally appeared in the Q3 2016 edition of Corporate Board Member magazine. See it here.