Last month, the US Chamber of Commerce’s Center for Capital Markets Competiveness (CCMC) released a set of principles for the development, dispensation, and receipt of proxy advice.
Before I go into a detailed analysis of what the principles mean and how effective they might be, let me tell you a story. I was recently speaking to a group of US chairmen and lead directors, and such was the influence of Glass Lewis and ISS, the two largest US proxy advisory firms, that they cast a pall over the proceedings. Many new remuneration solutions that I offered were met with scepticism not because my audience was unsympathetic to the idea but because they were concerned that they wouldn’t be able to get them past ISS. One audience member contributed the fact that his remuneration committee had dropped stock options in favour of restricted stock not because they felt they were more effective but solely because of ISS’s dislike of stock options.
Frankly, I can think of few worse reasons for making a remuneration decision than that; not that I’m a fan of stock options. So my sympathy with the Chamber’s assertion that one-size of governance does not fit all companies is substantial. I came to the principles with an open mind. Unfortunately, the principles did not deliver.
The principles were developed following a conference on proxy advisory firms in December 2012 hosted by the Chamber, and after consulting with a large number of stakeholders. The Chamber’s press release adds that the conference included a presentation from Stanford University Professor David Larcker of his paper that demonstrates a disconnection between proxy advice and shareholder return. I don’t have the space to look at Professor Larcker’s paper here, but one paper does not a disconnect make.The Chamber’s principles are available here, and include principles for proxy firms, portfolio managers and public companies. For the proxy advisory firms (abbreviated by the Chamber as PA Firms) themselves, the principles are organized according to three topics:
• Potential conflicts of interest
For example, under conflicts of interest, the principles recommend that the PA Firms are “free of conflicts of interest that could influence vote recommendations.” While this would seem to be pretty obvious, indeed many of them are, an interesting point is made. What are the PA Firms’ recommendations on shareholder proposals from shareholders who are clients? Clearly these potential conflicts of interest should be disclosed. It is not realistic for the firms to recuse themselves from offering a vote recommendation on client-sponsored proposals simply because it is unlikely that more than a handful of such proposals would come from a non-client. But the conflict disclosure would allow other clients to assess the relationship and its impact on the objectivity of the recommendation.
Other principles seem so fundamental as to be pointless. Take this one: “PA Firms should adopt and disclose clear policies and procedures to ensure the accuracy of data contained in their reports and on which their recommendations are based.” Any data firm without such a policy in place would have gone out of business years ago. Other principles would require the PA Firms to disclose their proprietary methodologies: “PA Firms should, consistent with protecting their proprietary data, provide interested persons—including PCs [public companies], IPMOs [investment portfolio manager organizations], investors, regulators, and the public—with analytical methodologies and modeling utilized in their research.”
To do so without compromising their proprietary methodologies would be impossible. Both ISS and Glass Lewis regularly produce voting guidelines indicating where they stand on certain issues. Both are open about their remuneration analysis. But, reasonably, that’s about as far as they can go without giving so much away that it would be possible for any stakeholder to replicate their voting recommendations.
Some principles simply don’t make any sense. This one, for example: “Discloses the extent to which the same advice on the same subject has been (or will be) rendered to other clients, and the reasons why this advice is consistent with differing or multiple client interests and objectives.” The Chamber is well aware that both ISS and Glass Lewis make the same voting recommendations to all clients, regardless of what those clients’ voting policies might be. To expect them to tailor recommendations to individual clients would render their respective businesses inoperable without increasing their analyst base by about a thousandfold. If clients have different interests and objectives, they will make the decision to follow or not follow the advice of the PA Firm.
Other nonsensical principles include: A PA Firm’s acceptance of an assignment certifies, among other things, that the PA Firm’s advice “Relates to a subject on which the PA Firm is (or will be) competent to opine” – a statement of such obviousness that it beggars comment.
Other principles would be impossible to put into practice. One requires PA Firms to review the effects of their recommendations after six months or so. These should allow for clients to assess whether proxy voting policies “have a positive—or at a minimum no negative—effect on shareholder value.”
Firstly, revisiting a recommendation six months after the event does not allow sufficient time to show any kind of significant effect on company performance. As with bad corporate governance, good corporate governance is slow to mature, often taking up to 10 years to show negative or positive outcomes respectively. Even more importantly, exactly how can you tell whether the voting recommendation – if it went through – had a negative or positive effect on shareholder value when there is – as far as I know – no control firm to check against?Say the Disney vote to split the chairman and CEO had succeeded and the positions had been split; how would anyone be able to test whether this had a positive or negative effect on shareholder value unless there was a shadow Disney, identical in every way except that this one still had a combined CEO and chairman? Such analysis could be done in the aggregate, comparing the performance of peer firms who had and had not taken such a step, but not individually.
Other principles have nothing whatsoever to do with the PA Firms. One recommends that they “should affirmatively advise that the recommendations (and their underlying research) are intended solely as guidance to assist IPMOs in exercising their own judgment on each significant voting issue, and that the ultimate voting decision cannot be delegated to or exercised by the PA Firm.” Such advice is irrelevant to the PA Firm. Following or not following voting recommendations is clearly the portfolio manager’s decision. He or she does not need the PA Firm to tell him or her that it is because it is a recognised element of the contractual arrangement.
The principles also contain recommendations for IPMOs. As far as these are concerned, in the main, one is tempted to ask why the Chamber is attempting to teach its grandmother how to suck eggs. The following is a typical example of the recommendations to IPMOs: “IPMOs should vest ultimate decision-making authority on whether and how to exercise proxy-related decisions solely in a person (or persons) possessing the ultimate authority to exercise judgment on how to vote the IPMO’s shares. This does not preclude IPMOs from delegating vote execution or clerical tasks to one or more third parties (which may include a PA Firm).”
In contrast, the recommendations to public companies are sensible, discrete, and well-aimed.
Given this, one is tempted to conclude that, whatever its expertise in the area of public companies, the Chamber fundamentally misunderstands the nature and workings of proxy advisory firms, and is therefore not qualified to offer advice. Most of these principles somehow miss the point. If the PA Firms followed them all, they would find themselves so hamstrung as to be incapable of offering the services for which their clients have engaged them. Perhaps, given its complaints about the demands on public companies of Sarbanes-Oxley and Dodd-Frank, this is precisely the Chamber’s intent.
Still, I must agree that one-size-fits-all governance recommendations are unsatisfactory, especially when it comes to remuneration analysis. I agree that it would be more appropriate and more accurate to have individual analysts look at individual companies’ remuneration policies and make individual recommendations on each company, but it would be impossible to run such a business profitably. So it is necessary to develop an aggregated proxy for such analysis. Sometimes this will produce appropriate recommendations, sometimes not. And portfolio managers and other clients are well aware of this, and often subscribe to multiple advisers for this very reason.
One principle, however, would seem to me to be wholly appropriate.Produce vote recommendations and policy standards that are supported by data driven procedures and methodologies that tie recommendations to shareholder value….
All too often, corporate governance best practices, as with environmental and social best practices, are recommended for their own sake rather than because they are good for shareholders and other stakeholders. More research to confirm the value of such best practices would be an important contribution to the debate. If the Chamber were to encourage its members to join with their owners in funding such objective research, that would be a better use of its time and influence than developing principles like these.
Paul Hodgson is an independent governance analyst