Over the past generation, we have seen broad positive changes to corporate governance that have benefited businesses and their investors. Shareholders have taken a more active role in businesses that they invest in, and companies are communicating more with shareholders. Companies are more conscious of the need for strong and transparent governance policies, and progress has been made in advancing these goals. In short, today’s board of directors and investor base isn’t your father’s board and investor base.
The U.S. Chamber’s Center for Capital Markets Competitiveness (“CCMC”) has long advocated policies that promote effective shareholder participation in the corporate governance process. Strong corporate governance is a critical cornerstone for the healthy, long-term performance of public companies and their positive promotion of long-term shareholder value.
The canary in the coal mine of governance, warning us that the system is not working, is the continued flight of businesses from the public company ownership structure. Public companies are the greatest wealth creators our economy has known; however, we are seeing that businesses are deciding to go private or stay private instead.
What has also changed, and some would argue retarded this progress of good corporate governance and contributed to the declining number of public companies, is the role of proxy advisory firms.
Proxy advisory firms; public companies, including boards of directors; and investment portfolio manager organizations each play an important role in ensuring that corporate governance furthers the interests of shareholders through a process that relies heavily on fair shareholder communications and informed participation.
Over the past decade, important positive strides have been made to improve corporate governance, transparency and accountability. Sarbanes-Oxley helped foster more active and independent public company boards; there has been a welcome and necessary increase in communications among boards, management and investors; and asset managers have increasingly established programs to enhance their due diligence in executing shareholder votes, including robust internal capabilities focused on proxy voting as well as the use of proxy advisory firms’ recommendations as one of a number of data points to inform their independent proxy voting decisions.
However, there have also been some negative trends. In particular, annual proxy solicitations increasingly have become a referendum on a growing and sometimes conflicting array of issues. As the range of issues proposed in the name of corporate governance has grown, the need for clear, objective and empirically based corporate governance standards has also grown to help management and investors evaluate and improve corporate governance as a means of increasing shareholder value.
Proxy advisory firms play a growing role in this process. They are called upon to evaluate every issue for which corporate proxies are solicited and, in doing so, have become de facto corporate governance standard setters for public companies. And yet, as the involvement of proxy advisory firms in corporate governance-related shareholder voting issues has increased, their transparency in developing and recommending voting policies has not.
Two firms, Institutional Shareholder Services Inc. (“ISS”) and Glass Lewis & Co., LLC (“Glass Lewis”), constitute 97 percent of the proxy advisory industry, and one of them employs a total of 180 analysts to evaluate 250,000 issues, spread over thousands of public companies, within a short six-month period. Because of (1) conflicts of interest (such as ISS offering consulting services to the same companies about which it renders proxy voting advice, or Glass Lewis’s ownership by activist investors with defined agendas), (2) one-size-fits-all voting advice, industry concentration, and (3) policymaking conducted largely outside the public eye, proxy advisory firms’ influence in corporate governance parallels (and pragmatically may exceed) that of formal standard setters, such as government regulators, but without the corresponding benefit of strong transparency and accountability.
This has caused obstacles to good corporate governance that, if unaddressed, may reverse the positive advances in corporate governance of the past 20 years.
In order to advance this collaboration constructively, the Chamber has set forth core principles and a series of specific improvements to serve as a basis for proxy advisory firms, public companies and investment portfolio manager organizations to engage in a dialogue to create a system that brings transparency and accountability to proxy advisory firms and fosters strong corporate governance.
Proxy advisory firms and their affiliates should provide clients with proxy voting advice that furthers the interests and objectives of their clients. To do so, proxy advisory firms must disclose their research methodologies and conflicts of interest, and must regularly review and update their policies (based on their actual experience) to ensure that their recommendations advance shareholder value. To that end, best practices and core principles include:
At their core, the best practices and core principles for proxy advisory firms do the following:
Public companies should engage in a dialogue with shareholders to understand their interests. As part of their broader shareholder communications strategy, public companies should endeavor to communicate with proxy advisory firms (“PA firms”) on corporate governance matters so that shareholders may evaluate what is at stake for them with respect to any matter presented for shareholder approval. With the passage of Sarbanes-Oxley and various corporate initiatives, shareholder communications, board independence and accountability have increased. To ensure the continuation of these positive trends, the following best practices and core principles should be followed.
At their core, the best practices and core principles for public companies do the following:
There is a broad variety of investment portfolio manager organizations – that is, persons or entities exercising or influencing investment and proxy voting decisions on behalf of the following, among others: individual investors; hedge funds; mutual funds; corporate, state, municipal and labor union pension funds; endowment funds; trust funds; bank collective investment funds; investment banking firms; venture capital funds; insurance companies; and commercial banks. Because investment portfolio manager organizations manage or influence the disposition of the assets of others, they are obligated to ensure that their proxy voting decisions reflect their independent judgment and are intended to further the best interests of their shareholders, investors and clients.
Recently, some investment portfolio manager organizations have utilized proxy advisory firms as one of several sources in formulating independent voting decisions on highly significant issues, consistent with the interests and objectives of their shareholders, investors and clients. This positive trend, in conjunction with the increased dialogue between public companies and shareholders, has improved the proxy voting process. Where investment portfolio manager organizations are already structured to facilitate the exercise of their independent judgment, the best practices discussed below are merely suggestions of alternative ways operative core principles might be achieved. Where investment portfolio manager organizations are not already structured in a manner that ensures their exercise of independent judgment in satisfying proxy voting responsibilities, the following best practices and core principles are intended to guide investment portfolio manager organizations’ receipt of necessary data from proxy advisory firms.
At their core, the best practices and core principles for investment portfolio manager organizations do the following:
Is this a perfect solution to a complex set of problems? Of course not, but it is a chance to kick-start a dialogue amongst all parties to get to those solutions. The CCMC believes that public companies, investors and proxy advisory firms should engage in a dialogue to create a system that brings transparency and accountability to proxy advisory firms and fosters strong corporate governance.
With the ever-shrinking number of public companies in the United States, it is a conversation that needs to be had, before it is too late.
Tom Quaadman is Vice President, U.S. Chamber Center for Capital Markets Competitiveness.