July 19, 2018
On July 16, the UK Financial Reporting Council (FRC) published a revised Corporate Governance Code (the Code), explicitly referring to the role of proxy advisors – and a ‘box ticking’ approach to corporate governance and reporting.
The Code sets standards of good practice for corporate governance, for all premium listed UK companies. In revising the Code, the FRC has aimed to make it less prescriptive – acknowledging that a ‘one-size-fits-all’ approach does a disservice to companies, their shareholders and the wider economy. The FRC recognizes that companies come in all shapes and sizes – and what is might appropriate approach to governance for one firm may not apply to another. This is bad news for proxy advisors, making the UK’s FRC the latest to refer to the ‘box-ticking’ approach that many other groups have flagged, and its potential to harm corporate governance and capital markets.
Specifically, the regulator expects proxy advisors to pay due regard to a company’s individual circumstances; avoid evaluating company reporting in a mechanistic way; and, give companies sufficient time to respond to inquiries about corporate governance reporting. While proxy advisors might argue they are already doing this, ISS and Glass Lewis (who, together, control approximately 97% of the proxy advisory market) are simply unable keep up. ISS boasts that it covers over 42,000 meetings a year, while Glass Lewis produces analysis on over 20,000 companies. To survive, and provide recommendations to their clients, their understaffed research teams are forced to conduct the type of ‘box-ticking’ exercises that are harming companies and retail investor returns. Evaluating companies on a case-by-case basis would require a significant expansion in capacity at these proxy advisory firms.
Even if they had the required resources, analysts at proxy advisory firms are rarely experts in corporate governance, have little or no experience of major companies, and do not receive any meaningful training. This results in strict adherence to internal models and guidelines. Unfortunately, their ‘one-size-fits all’ approaches can influence upwards of 30% of shareholder votes.
Much has been written about proxy advisory firms and the negative impacts their poor methodologies are having on capital markets, including: driving short-termism; the lack of evidence that they improve shareholder value; and, a decline in IPOs – all of which negatively impact returns for retail investors. Across the world, it appears regulators have started to notice: In the U.S., a bill designed to increase transparency around proxy advisory practices has passed the House of Representatives; while in the UK, the FRC has effectively stated their evaluations of companies are overly reliant on ‘box-ticking’ exercises. Whether proxy advisors – and their defenders – will begin to accept these facts and evolve their practices to align with shareholder returns remains to be seen.