Earlier, I explained that the business of proxy advisors is rooted in regulations that make proxy voting complex and costly. It’s far better—from the point of an institutional investor—to pay an advisory firm to make recommendations.
UCLA law professor Stephen Bainbridge was good enough to point me to a paper from the Emory Law Review titled “The Power of Proxy Advisors: Myth or Reality.” The authors of the paper—NYU law professor Stephen Choi, Penn law professor Jill Fisch, and Georgetown law professor Marcel Kahan—make a compelling case that some popular descriptions of the power of proxy advisers overstate their influence.
The professors note that while there is a large overlap between proxy advisor vote recommendations and shareholder voting, this doesn’t mean that the proxy advisors are controlling the outcome of the votes. The correlation doesn’t necessarily imply causation.
Proxy advisor recommendations may correlate with the shareholder vote for four conceptually distinct reasons.
- First, the same director nominee and company characteristics may independently influence both the proxy advisors’ recommendation and the shareholder vote.
- Second, proxy advisors may gather information that investors use to make their voting decisions.
- Third, investors may select a proxy advisor based on their ex ante agreement with the bases upon which the advisor formulates its recommendations.
- Finally, investors may view the advisor’s recommendation alone as a basis for deciding how to vote, independent of the underlying factors upon which that recommendation is based. It is only this last reason that can truly be characterized as causality.
The paper concludes that only about 6-10% of shareholder votes are shifted by proxy advisors in a way that fits the final category above.
This supports my argument that the source of demand for proxy advisory services is regulation. If many investors would have come to the same voting decisions if they had analyzed the issues at hand without the aid of proxy advisors, this suggests that customers of proxy advisors are not buying proxy advice so much as protection from regulatory induced liability.
Recall that in my earlier item, I pointed out that a 2003 SEC regulation required mutual fund managers to adopt written policies to ensure that they were casting proxy votes in the best interests of clients.
Rather than subject themselves to post-hoc second-guessing about proxy voting decisions, many mutual funds have apparently found it safer to outsource the decision making to advisory firms. Not surprisingly, they are selecting advisory firms that apparently advise fund managers to vote the way they would have anyway.
Similarly, the paper supports my argument that the increasing complexity regulations have introduced into shareholder proxies is feeding the demand for proxy advisory services. The second and third categories of correlation above—information gathering and agreement on underlying principles—suggest that complexity is at the heart of the matter.
To put it another way, the finding that proxy advisory firms are not as powerful as they may sometimes seem supports the idea that they are creatures of regulation rather than markets. Slightly differently, fees paid to proxy advisors by institutional investors should be considered costs of regulation—akin to taxes—that are borne by the clients of the investors.
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