Does Compliance with Proxy Advisors' Recommendations Decrease Shareholder Value?

By Cydney Posner

You might be interested in this recent white paper, Outsourcing Shareholder Voting to Proxy Advisory Firms (forwarded by Ann Costelloe of Towers Watson), that discusses the economic and other implications of voting by institutional and other investors in accordance with the recommendations of proxy advisory firms, such as ISS and Glass Lewis. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2101453

The study concludes that proxy advisory firm recommendations do have a substantive impact on say-on-pay voting outcomes and lead a number of firms to revise their compensation programs before the vote in an effort to reverse a negative recommendation. The study notes that, "in a recent survey conducted by The Conference Board, NASDAQ, and the Stanford Rock Center for Corporate Governance (2012), over 70% of the director and executive officer respondents indicated that their compensation programs were influenced by the policies of and/or guidance received from proxy advisory firms during their evaluation of SOP. " One analysis conducted for the study showed that "firms that received a negative recommendation by ISS (GL) obtained an average 68.68% (76.18%) voting support in SOP proposals. In contrast, firms that did not receive a negative recommendation from ISS (GL) obtained an average of 93.4% (93.7%) support in those proposals." An earlier study cited in the report showed that a negative ISS recommendation on a management proposal can sway 19% of votes. The Outsourcing study was originally posted in 2012 and appears to have been updated in 2013, but much of the data derives from 2011. In light of recent media reports suggesting a decline in the importance of proxy advisory firms as well as the growing company efforts at direct shareholder engagement (see, e.g., my article dated May 23, 2013, regarding the WSJ article, For Proxy Advisers, Influence Wanes), it would be interesting to see how the empirical data would shake out for 2013.

The most interesting conclusion, however, was that "the stock market reaction to these compensation program changes is statistically negative. These results suggest that the outsourcing of voting to proxy advisory firms appears to have the unintended economic consequence that boards of directors are induced to make choices that decrease shareholder value." The authors examined the stock market results for companies, in the time period preceding the SOP vote, when they filed 8-Ks showing changes to their compensation plans and programs that better aligned the compensation program with known proxy advisor policies. The authors found that "the average risk-adjusted return on the 8-K filing date is a statistically significant -0.44% lower among compensation changes aligned with proxy advisor policies than among compensation changes unrelated to proxy advisor policies. Moreover, this effect is unique to 8-K changes in the time period before SOP and similar results are not observed for earlier time periods." The study concludes that "the proprietary SOP policies of proxy advisory firms induce the boards of directors to make compensation decisions that decrease shareholder value."

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