If Proxy Advisors
Don't Really Matter, Why Do They Exist?
Tuesday, 26 Oct 2010 | 5:21 PM ET
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.
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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
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.
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
- Third, investors
may select a proxy advisor based on their ex ante agreement with the
bases upon which the advisor formulates its recommendations.
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
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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