Proxy Advisors: From Punching Bags to Boardroom Assets | Farient Briefings IN FULL

Proxy advisor influence remains steadfast. Institutional Shareholder Services (ISS) and Glass Lewis (GL) shape the voting decisions of institutional investors and influence how boards and companies operate. Understanding how to engage and harness the power of proxy advisors can provide insight and certainty for both company management and their boards. In this article, we explore five ways to leverage proxy advisors to enhance governance, shareholder engagement, and long-term business outcomes.

Use Published Resources to Anticipate Vote Recommendations Before Proxy Season

Many companies often only interact with proxy advisors during proxy season in anticipation of or in reaction to vote recommendations made to institutional investors in connection with the annual shareholder meeting. This often leaves little room for companies to respond to adverse vote recommendations from proxy advisors. Companies, and their boards, should not be caught flat-footed with respect to proxy advisor policies on vote recommendation and corporate governance standards.

Both ISS and GL publish policy standards every year. Directors, executives, and those teams responsible for supporting efforts on which shareholders will vote should all be familiar with the guiding principles of how proxy advisors make recommendations for matters like director elections, say on pay, and equity plan proposals. At a minimum, decision-makers should test these actions against proxy advisor policies before finalizing the actions (and certainly well before publishing the proxy).

Go Beyond Filing Requirements to Share What Shareholders Want to Know

Proxy advisors rely on publicly disclosed information for their analyses and proxy vote recommendations. Inaccuracies, omissions, or ambiguities in a company’s disclosures can lead to negative voting outcomes or misunderstandings. Advisors rely on proxy filings (also, in the case of equity plan proposals, particularly the 10-K) to gather necessary information to inform their vote recommendations. Disclosures need to meet standards set by the Securities and Exchange Commission (SEC) and the needs of proxy advisors while also considering other proxy readers such as institutional and individual investors.

Disclosure drafters need to go beyond what is expected and evaluate what they should disclose and what readers (i.e., potential investors and shareholders) want to know. Often, the most important parts of the compensation story (particularly why the compensation committee made the decisions it did) fall squarely into the category of “disclosure not required,” but useful to proxy advisors and investors alike.

Leverage Standards That Set Investor Expectations

Critics seem fixated on all the ways that proxy advisors fall short, particularly in edge cases or special situations, while neglecting to consider that ISS and GL policies go a long way to establish baselines for how investors evaluate items on the proxy ballot like say on pay and equity plan proposals that require a significant amount of data and nuance to evaluate effectively.

While executives and directors might bristle at the fact that third parties like ISS and GL set governance standards, those standards are not law, and they do provide some distinct advantages.

First, proxy advisor policies provide a common way to measure all public companies and enable investors to make easier comparisons.

Second, they enable companies to understand how institutional investors will evaluate executive compensation and corporate governance matters.

Third, proxy advisor policies enable companies and boards to evaluate decisions against established standards in a reliable way that eliminates guesswork about how investors will evaluate those decisions.

Fourth, proxy advisor policies force companies to consider executive compensation and corporate governance decisions in a context outside their business and beyond their state of incorporation to a level meaningful to a global investor base.

Finally, proxy advisor policies encourage institutional investors to apply consistent voting criteria.

Use Benchmarking Data

Despite their status as perennial punching bags of the corporate governance world, proxy advisors possess deep expertise in compensation data and governance practices. While their voting policies may draw criticism for being too restrictive, ISS and GL review and analyze more proxy filings than any other entity in the world, which gives these advisors a perspective not matched by any individual company or a single board.

ISS and GL both offer their proxy voting recommendation reports to corporate issuers. Companies should take advantage of these reports to understand and track the kinds of analyses and findings that their institutional investors receive about them. Reviewing these reports each year can provide insights into situations where advisors may be missing parts of the executive compensation story, for example, allowing the company to consider changes to future disclosure to enable a better understanding of the pay program.

For companies willing to pay for access, ISS offers a trove of benchmarking data on governance practices through its QualityScore methodologies, which cover audit issues, board structure, executive compensation, sustainability, and shareholder rights. Companies can use proxy advisor data to evaluate their own governance structures and policies against practices across industries, countries, and indexes.

Effectively Navigate Controversies and Special Situations

Proxy advisors often serve as a “third-party referee,” guiding investors through the complexities of issues like M&A, shareholder activism, and potential pay-for-performance disconnects. Companies in such situations encounter heightened scrutiny, but they can take advantage of proxy advisor analyses by engaging investors in topics beyond the opinions of the advisors.

Said differently, companies in these circumstances can focus on what makes the situation unique or its decisions appropriate. For example, in cases where a proxy advisor takes issue with executive compensation, a company can discuss with investors why the compensation committee made the decisions it did and why those decisions benefit the company and shareholders while not having to focus on the fundamentals of the situation since proxy advisors have already analyzed the basic facts.

No doubt proxy advisors will likely continue to draw ire, particularly from companies that receive criticism or adverse vote recommendations. Whether that ire is justified depends on the circumstances. What is much clearer, however, is that companies and directors should not let feelings of ill will hinder their use of proxy advisor research, data, and insights to their benefit.

Suggested reading

Check out our article on the coming changes to Glass Lewis’ pay-for-performance model.

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By Trey Poore

Trey Poore is a director with Farient Advisors’ consulting practice.