A Contemporary Analysis
There has been considerable discussion about the impact proxy advisors have on the voting patterns of shareholders who now have a more powerful voice on executive remuneration. While much of the legislation that has given greater strength to the voice of shareholders is relatively new, some studies in the US and now Australia are providing insight on the impact that proxy advisers are having.
Interestingly, the conclusion appears to be that engaging with shareholders is not a distinct or unique “reporting season” activity, rather companies are engaging with shareholder and proxy advisors regularly throughout the year to ensure a full understanding of their policies and decisions with respect to executive remuneration. It could be in fact that what goes on behind the scenes, in the investor briefings and discussions, well before Annual General Meetings, is having the greatest impact on the design and delivery of executive reward.
Companies are making changes to remuneration plans based on ongoing discussions with proxy advisors which may not be reflected in voting patterns at annual general meetings. Having plans reviewed (and in some cases modified and then reviewed again) in advance by proxy advisers, companies are better positioned at their AGMs to gain the majority support of shareholders with plans that neither surprise nor concern larger shareholders.
In the US
In a 2010 US survey, the Center on Executive Compensation found that 54% of companies had changed or adopted a compensation plan or policy in the previous three years primarily to meet the standards of a proxy advisory firm. Negative say-on-pay recommendations, for example, did cause companies to change their approach even if they did not completely reject their original say-on-pay proposal. Before the vote, many companies modified pay practices “in response to preliminary ‘against’ recommendations of proxy advisers.”
Similarly, a recent Conference Board-NASDAQ-Stanford survey of 110 companies found that 72% of respondents reviewed proxy adviser policies or engaged with a proxy adviser to receive feedback on their executive remuneration plan, while 70.4% said that their programs were influenced by the proxy advisers or the advisers’ policies.
In response to proxy firm policies, companies in the sample reported making changes to their executive remuneration plans, including:
- Enhancing proxy disclosure (32% of respondents)
- Reducing or eliminating certain severance practices (24%) and perks (16%)
- Adopting stock ownership guidelines (13%) and
- Introducing performance-based equity awards (9%).
The study concluded “The majority of companies determine in advance whether their executive compensation programs are likely to receive a favourable recommendation from ISS or Glass Lewis; and companies are likely to make changes to a program in anticipation of a negative recommendation from these firms.”
Also consistent with the 2011 trend and gaining impetus in 2012, the single biggest say-on-pay issue continues to be pay for performance, with Institutional Shareholder Services (ISS) and Glass-Lewis, two leading U.S. proxy advisers, issuing negative recommendations on at least 14 percent of the votes, on the grounds that the companies’ executive pay is not aligned with their performance. In this year’s votes, ISS’ negative say-on-pay vote recommendations, on average, have resulted in 30 percent less support.
In June 2012 a report, “Voting Decision at US Mutual Funds: How Investors Really Use Proxy Advisers” that investigates the influence proxy advisors have over institutional proxy decisions was published in the US. The research project was commissioned by the IRRC Institute (The Investor Responsibility Research Center Institute) and undertaken by Tapestry Networks, Inc.
Key findings from the study include:
- While there is a high correlation between proxy adviser recommendations and shareholder voting, it is difficult to measure the degree to which proxy advisers shift investor votes. What is widely held as good corporate governance has been internalised by shareholders. As one asset manager noted, “so many people overestimate the importance of ISS. Just because we reached the same conclusion, it doesn’t mean we didn’t do our own thinking.”
- Because of the enormous number of proxies that must be voted, proxy advisers have become increasingly valuable to institutional investors as aggregators and packagers of information. And they are influential in shaping voting guidelines in advance of the proxy season.
- Most asset managers find proxy adviser data especially useful for say-on-pay and international voting.
- Institutions are mixed as to whether portfolio managers or the corporate governance team vote proxies, and which party has the final authority. At over half the asset managers that participated in the survey, portfolio managers were moderately to actively involved in discussions about proxy voting decisions.
- Participants in the study indicated that direct discussions with companies are more influential than the proxy advisers.
The research reinforces the long-standing view that the proxy season is not a discreet season but rather a continuum that encompasses annual meetings and the periods in-between. Because corporate governance is evolving over time and being seized upon by parties having particular agendas, a company’s ongoing engagement with its shareholders is critical to understanding their thinking, corporate governance views and resulting voting behaviour. This helps to ensure that the dialogue regarding remuneration, board structure and responsibilities, political activities and company policies is being proactively managed by the company rather than heavily influenced by others.
The full research report can be accessed here
The above research findings have been mirrored here in Australia by recent research conducted for the Institute of Company Directors. The key findings from that research were:
- That 80% of voting by institutions takes place over an eight week period known as the peak proxy period. Given that superannuation funds and large managed funds invest in both small and large cap companies, they could have up to 300 votes to make during that period. As such there is a strong incentive to outsource their voting or at least to outsource the research required to inform their voting;
- Proxy firms are an important influence on institutional share voting in Australia because the high volume, time-pressured environment in which votes are made means that proxy advisers undertake what shareholders cannot afford to do, either in terms of direct investment or in terms of time;
- Access to institutional shareholders and proxy firms is limited in this peak proxy period (and, as shown in the US research above) communication needs to be ongoing throughout the year for it to be truly effective;
- Institutional investors have become increasingly active in voting and are willing to vote against company resolutions if it is in their interests to do so; and
- A significant number of company directors think that proxy advisers are improperly influential.
For full details of the research click here
In Perspective – Recognising the “Advisor” in Proxy Advisor
A recent paper from the Stanford Graduate School of Business examining 10 myths on the Say-On-Pay legislation has found that proxy advisory firm recommendations are not always correct. According to their research:
“Proxy advisory firms rely on proprietary methodologies to develop their guidelines for say on pay. For example, ISS takes into account factors such as total CEO pay, one- and three-year total shareholder return, the performance metrics used in incentive plans, the presence of “problematic” pay practices, communication and responsiveness to shareholders, the use of peer groups in benchmarking pay, and the mix of performance and non-performance-based pay elements.” read more
Glass Lewis considers similar factors.
Research evidence demonstrates that these proxy adviser recommendations are highly influential, both on voting outcomes and on pay structure. Ertimur, Ferri, and Oesch (2012) found that an unfavourable recommendation from ISS reduced shareholder support for an executive compensation program by 24.7 percent in 2011. The results of say-on-pay votes suggest that several institutional investors vote in lock-step with the recommendations of ISS and Glass Lewis.
Survey data finds that over 70 percent of companies were influenced by the policies, recommendations, or guidance received from proxy advisory firms regarding their executive compensation programs. Unfortunately, the research evidence also suggests that these recommendations are not only influential but also that they might not be correct.
Using a sample of 2,008 firms, Larcker, Ormazabal, and McCall (2012) found that companies that amend their executive compensation plans to avoid a negative recommendation from proxy advisory firms exhibit statistically significant negative stock price returns on the date these changes are disclosed. This suggests that proxy advisory recommendations for say-on-pay actually decrease shareholder value. The results of this study are consistent with previous studies that find that the voting recommendations of proxy advisory firms regarding stock option exchange programs are similarly value decreasing.”
In light of the above, it will be imperative for Boards to proactively assess any advice made available to investors from proxy advisers. Whilst there is no denying the increasing influence of proxy advisers both here in Australia and globally, this development does not obviate the fiduciary obligations imposed on Boards to independently assess all sources of advice to ensure their decisions are in the shareholders’ best interests.