Director elections and the role of proxy advisors

Southern California Law Review

Volumn 82, Issue 4, 2009, Pages 649-701

  Choi, Stephen J ^a   Fish, Jill E ^b   Kahan, Marcel ^a  

^a NEW YORK UNIVERSITY   (United States)

^b UNIVERSITY OF PENNSYLVANIA   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 70349459291     PISSN: 00383910     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (102)

1. Rachel McTague, Chamber Approaches RiskMetrics with Proposed Changes to Policy-Setting, 40 Sec. Reg. & L. Rep. (BNA) 569, 589 (2008).
2. RiskMetrics Group, Company History, http://www.riskmetrics.com/history (last visited Apr. 20, 2009).
3. RiskMetrics Group, Proxy Research Services for Institutional Investors WORLDWIDE 1-3 (2009), available at http://www.riskmetrics.com/sites/default/ files/GS1-Proxy% 20Research%20Services.pdf. ISS recommendations are frequently reported in the media.
4. See. e.g., John D. Stoll & Stephen Wisnefski, ISS Recommends Lear Holders Reject Icahn Bid, Wall St. J., June 21, 2007, at A12 (reporting ISS's recommendation against Carl Icahn's proposed takeover of Lear).
5. RiskMetrics Group, supra note 3, at 1-3.
6. Id. at 2. Some companies have made notable use of these proxy voting services.
7. See, e.g., Luisa Beltran, ISS Could Kill HP-Compaq, CNNMONEY, Mar. 4, 2002, http://money.cnn. com/2002/03 /04/deals/iss-hp/index.htm (describing how Barclays Global Investors delegated to ISS the authority to vote its nearly sixty million Hewlett-Packard shares in the vote on the merger with Compaq Computer Corporation and how one Barclays spokesman stated "[w]e provided ISS the authority to vote the shares" and "[w]e have no influence on how they are going to vote").
8. Robert Daines, Ian Gow & David Larcker, Rating the Ratings: How Good Are Commercial Governance Ratings? 8-10 (Stanford Univ. Rock Ctr. for Corp. Governance Working Paper Series, Paper No. 1, 2008), available at http://ssm.com/absrract=1152093. Firms are given a score based on their standing within their own industry and a score based on their standing within their index (for example, Microsoft standing within the S&P 500).
9. Id. at 9.
10. See Investor Group Acquires Stake in Proxy Monitor, Wall St. J., June 10, 1998, at A8.
11. Mark Thomsen, Proxy Monitor Buys ISS, SOCIALFUNDS, Aug. 13, 2001, http://www.social funds.com/news/article.cgi/648.html.
12. Martha McNeil Hamilton, Player in the Proxy Wars: HP-Compaq Merger Has Brought a Shareholder-Services Firm out of Obscurity, Wash. POST, Apr. 1, 2002, at E01 (describing ISS as "something close to a monopoly").
13. Daines et al., supra note 6, at 2.
14. Joann S. Lublin, ISS Accepts Bid of $553 Million from RiskMetrics, WALL ST. J., Nov. 1, 2006, at A10.
15. RiskMetrics Group, Corporations, http://www.riskmetrics.com/corporations (last visited Apr. 20, 2009).
16. See U. S. Gov't Accountability Office, Rep. No. GAO-07-765, Corporate Shareholder Meetings: Issues Relating to Firms That Advise Institutional Investors on PROXY Voting 6-7 (2007) (describing various regulatory and market developments as leading to growth in the proxy advisory industry).
17. See also PROXY Governance History, http://www.proxygovernance.com/ content/pgi/content/history.shtml (last visited Apr. 20, 2009) (describing the development of proxy advisory services as "encouraged by a developing regulatory environment that would expand the market for proxy advisory and voting services").
18. 17 C. F. R. § 275.206 (4) -6 (2003).
19. Id. § 270.30bl-4.
20. The Department of Labor had previously taken several steps to encourage mutual funds to vote shares in their portfolio companies responsibly. In 1988, the Department advised fund managers that "the decisions] as to how proxies should be voted⋯ are fiduciary acts of plan asset management." Letter from Alan D. Lebowitz, Deputy Assistant Sec'y, Dep't of Labor, to Helmuth Fandl, Chairman of the Ret. Bd., Avon Prods., Inc. (Feb. 23, 1988), in 15 Pens. Rep. (BNA) 371, 391 (Feb. 29, 1988). The Department reinforced this position in 1990.
21. See Letter from Alan D. Lebowitz, Deputy Assistant Sec'y for Program Operations, Dep't of Labor, to Robert A. G. Monks, Institutional Shareholder Services, Inc. (Jan. 23, 1990), in 17 Pens. Rep. (BNA) 205, 244 (Jan. 29, 1990). It then formalized its policies in an interpretive bulletin in 1994.
22. See Interpretive Bulletins Relating to the Employee Retirement Income Security Act of 1974, 29 C. F. R. § 2509.94-2 (1994)
23. amended by 29 C. F. R. § 2509.08-2 (2008). Prior to the SEC's rule change in 2004, however, these efforts did not receive extensive attention.
24. See Clifton D. Petty, Pension Consultants, Inc., Gathering Strength: The Reinforcement of Fiduciary Responsibility for Proxy Voting 1 (2004), available at http://pension-consultants.com/cimages/file-85.pdf (calling the 1994 Interpretive Bulletin "far ahead of its time").
25. The analysis in this Article focuses on the four major proxy advisory firms-ISS, PG, GL, and EJ-which issue publicly reported voting recommendations on a regular basis. Several firms provide related services. For example, CtW Investment Group was organized in February 2006 and provides a limited number of recommendations to union pension funds. CtW's primary efforts are devoted to developing initiatives to support the activism of member pension funds.
26. See CtW Investment Group, Who We Are, http://www.ctwinvestmentgroup. com/index.php?id=1 (last visited Apr. 20, 2009). Also, Marco Consulting Group, which is included in the GAO Report as one of the major proxy advisory firms
27. see U. S. Gov'T ACCOUNTABILITY OFFICE, supra note 13, at 8, provides investment consulting services to Taft-Hartley funds and a number of public employee benefit plans. These services include voting its clients' proxies.
28. See Marco Consulting Group, Company History, http://www.marcoconsulting. com/1.2.html (last visited Apr. 20, 2009). Marco does not, however, publicly issue voting recommendations. Id.
29. About Glass Lewis, http://www.glasslewis.com/company/index.php (last visited Apr. 20, 2009).
30. Id.
31. Id.
32. See About Egan-Jones Proxy, http://www.ejproxy.com/about.aspx (last visited Apr. 20, 2009) ;
33. U. S. GOV'T ACCOUNTABILITY Office, supra note 13, at 8. In 2007, EJ was recognized by the SEC as the fourth "nationally recognized statistical rating organization, " a status equivalent to that enjoyed by Moody's, S&P, and Fitch. Order Granting Registration of Egan-Jones Rating Company as a Nationally Recognized Statistical Rating Organization, Exchange Act Release No. 57031, 72 Fed. Reg. 73, 909 (Dec. 21, 2007).
34. See also Aaron Lucchetti, Tiny Firm Gives Ratings Giants Another Worry: Mr. Egan's Ranks Gain Favor as S&P. Fitch, Moody's Draw Scrutiny, WALL St. J., Feb. 9, 2008, at B1.
35. About Egan-Jones Proxy, http://www.ejproxy.com/about.aspx (last visited Apr. 20, 2009).
36. Id.
37. PROXY Governance History, https://wwwproxy.governance.com/content/pgi/ content /history.shtml (last visited Apr. 20, 2009).
38. Id.
39. John Authers & Francesco Guerrera, Institutions Increase Equity Stakes, FIN. TIMES (London), Jan. 22, 2007, at 27.
40. See 17 C. F. R. § 275.206 (4) -6 (a) (2003) (requiring that mutual funds "[a]dopt and implement written policies and procedures that are reasonably designed to ensure that [they] vote client securities in the best interest of clients").
41. Bd. of Governors of the Fed. Res. Sys., Flow of Funds Accounts of the United States, Flows and Outstandings, Second Quarter 1996, at 88 tbl. L.213 (1996), available at http://www.federalreserve.gov/releases/z1/19960912/21.pdf.
42. Bd. of Governors of the Fed. Res. Sys., Flow of Funds Accounts of the United States, Flows and Outstandings, Fourth Quarter 2006, at 90 tbl. L.213 (2007), available at http://www.federalreserve.gov/releases/z1/20070308/z1.pdf. Mutual funds include open-end and closed-end funds as well as exchange-traded funds.
43. Jill E. Fisch, The Transamerica Case, in THE ICONIC CASES IN CORPORATE Law 46, 72 (2008) (stating that "as a result" of increased hedge fund activism, "proxy contests are on the rise") ;
44. Alon Brav et al., Hedge Fund Activism, Corporate Governance, and Firm Performance 16 (Eur. Corp. Governance Inst, Fin. Working Paper No. 139/2006, 2007), available at http://ssm.com/abstract= 948907 (recognizing the launching of a proxy election as a hedge fund tactic). For a helpful description of hedge fund activism
45. see William W. Bratton, Hedge Funds and Governance Targets, 95 GEO. L. J. 1375, 1401-09 (2007).
46. See Fisch, supra note 30, at 67-70 (describing the adoption and effect of majority voting policies).
47. See Claudia H. Allen, Neal, Gerber & Eisenberg LLP, Study of Majority Voting in DIRECTOR ELECTIONS, at ii (2007), available at http://www.ngelaw.com/ files/upload/majoritystudy 111207.pdf.
48. See id. at i.
49. See id.
50. Fisch, supra note 30, at 71. In her study of majority voting practices, Claudia H. Allen posits that the increased shareholder power that results from majority voting is augmented by developments such as the rise of proxy advisory firms, the fiduciary requirements placed on mutual funds, and the proposed New York Stock Exchange rule discussed below.
51. Allen, supra note 32, at ii, vi.
52. In 2006, the NYSE submitted a proposed rule change to the SEC that would have eliminated such "discretionary voting" for director elections.
53. See Press Release, N. Y. Stock Exch., NYSE Adopts Proxy Working Group Recommendation to Eliminate Broker Voting in 2008 (Oct. 24, 2006), available at http://www.nyse.com/press/1161166307645.html. Although the proposed rule was scheduled to become effective on January 1, 2008, to date, the SEC has not taken action on it. The NYSE recently refiled its proposed rule change, and recent changes in SEC leadership may increase the likelihood that the rule will be approved. Notice of Filing of Proposed Rule Change to Amend NYSE Rule 452 and Listed Company Manual Section 402.08 to Eliminate Broker Discretionary Voting, Exchange Act Release No. 34-59464, 74 Fed. Reg. 9864 (proposed Feb. 26, 2009), available at http://www.sec.gov /rules/sro/nyse/2009/34-59464.pdf.
54. See CtW Investment Group Urges SEC to Promptly Eliminate Broker Votes, REUTERS, Apr. 17, 2008, http://www.reuters.com/article/pressRelease/ idUS177265+17-Apr-2008+PRN20080417 (explaining that discretionary voting has enabled directors to be reelected solely on the basis of broker votes and has been criticized as "legalized ballot stuffing" by which shareholders are "disenfranchised").
55. See Fisch, supra note 30, at 63-67 (describing the SEC's consideration of proposals to allow shareholder nomination of directors).
56. See Yonca Ertimur, Fabrizio Ferri & Stephen R. Stubben, Board of Directors' Responsiveness to Shareholders: Evidence from Shareholder Proposals 20 (Harvard Bus. Sch., Working Paper No. 08-048, 2008), available at http://www.hbs.edu/research/pdf/08-048.pdf.
57. See id. at 30-31.
58. See Fisch, supra note 30, at 71 (describing "say on pay" initiatives).
59. Dennis K. Berman & Joann S. Lublin, Advisor ISS Puts Itself on Sale. Could Fetch Up to $500 Million, Wall St. J., Sept. 6, 2006, at C4.
60. Robert D. Hershey, Jr., A Little Industry with a Lot of Sway on Proxy Votes, N. Y. TIMES, June 18, 2006, §3, at 6.
61. William J. Holstein, Is ISS Too Powerful? And Whose Interests Does It Serve?, BNET: THE CORNER OFFICE, Feb. 7, 2008, http://blogs.bnet.com/ceo/?p= 1100&tag=content;coll.
62. Id.
63. See, e.g., Tom Johnson, HP, Compaq Merger Now in Hands of Shareholder Adviser, REUTERS, Dec. 11, 2001, http://www.rediff.com/money/2001/dec/11hp. htm (detailing efforts by both sides to obtain ISS support in the HP-Compaq merger vote and observing that "[m]erging companies typically place a great deal of weight" on meetings with ISS analysts).
64. Tiffany Kary, ISS Pressed on Conflict by Governance Expert Millstein, Wall St. J., Nov. 16, 2005, http://www.shareholderforum.com/PVN/Library/ 20051116-WSJ.htm.
65. Robert M. Krasne, Proxy-Voting Concern: ISS Wields Extraordinary Clout in Recommendations to Investors, Yet Also Provides Services to Corporations, PENSIONS & Invs., May 31, 2004, at 12, available at http://www.pionline.com/ article/20040531/PRINTSUB/405310706/1026 /TOC.
66. Arden Dale & Kaja Whitehouse, Legg Mason CEO's Pay Questioned, Wall St. J., July 18, 2006, at C11;
67. Bill Baue, Conflict of Interests Policies and Practices Vary Widely at Proxy Advisory Firms, SocialFunds, Apr. 19, 2006, http://www.socialfunds.com/ news/article.cgi/1985.html.
68. Baue, supra note 49.
69. See Glass, Lewis & Co., Leading Independent Analysis and Voting Recommendations on Global Proxies 2 (2008), available at http://www.glasslewis. com /downloads/overviews/proxypaper.pdf ("Glass Lewis does not provide consulting services to corporations, CEOs or directors; as such, Glass Lewis' research is without bias.") ;
70. Egan-Jones Proxy Services, http://www.ejproxy.com (last visited Apr. 20, 2009) ("[T]he integrity of our recommendations is not clouded with the complication of also selling corporate directors and managers consulting services pertaining to these same shareholder proposals.").
71. See Kary, supra note 47 (quoting OPERS governance officer Cynthia Richson as stating that ISS had been dismissed "as a result of the 'actual or perceived conflicts'").
72. PROXY Governance, Inc., Policy and Analysis Methodology 1 (unpublished manuscript, available at http://www.integrityfunds.com/PortalIntegrityFunds/ DesktopModules/ViewDocument.aspx-?DocumentID=170) (refusing to take a "one-size-fits-all approach" that does not consider proxy issues in context) ;
73. PROXY Governance Recommendations on an Issue-by-Company Basis, https://www.proxygovernance.com/content/pgi/content/issue-by-issue.shtml (last visited Apr. 20, 2009) (same).
74. PROXY Governance, Inc., supra note 53, at 3-5. PROXY Governance does not explain how these factors will be weighted or combined.
75. See id.
76. Institutional S'holder Servs., ISS U. S. Corporate Governance Policy 2006 UPDATES 16 (2005), available at http://media.gibsondunn.com/fstore/documents/ pubs/2006-US-Policy-Update-1117051.pdf.
77. Id. ISS stated that poor compensation practices "include, but are not limited to, the following:" (1) "[e]gregious employment contracts including excessive severance provisions"; (2) "[e]xcessive perks that dominate compensation"; (3) "[h]uge bonus payouts without justifiable performance linkage"; (4) "[p]erformance metrics that are changed during the performance period"; (5) "[e]gregious SERP (Supplemental Executive Retirement Plans) payouts"; (6) "[n]ew CEO with overly generous new hire package"; (7) "[i]nternal pay disparity"; and (8) "[o]ther excessive compensation payouts or poor pay practices at the company." Id.
78. Even where the criteria appear to be objective, the proxy advisors emphasize that they are examined and applied on a case-by-case basis.
79. See, e.g., Egan-Jones Proxy Services, Proxy Voting Principles and Guidelines 3-5 (unpublished manuscript, on file with authors) (describing policies used in formulating recommendations for directors in uncontested elections).
80. Jay Sherman, Eisner Still in Charge, Disney Shareholders Re-Elect Board, Book Stirs Iger Doubts, Television Wk., Feb. 14, 2005, at 3.
81. See id. (reporting Disney's September 2004 announcement that Eisner intended to retire when his contract expired in September 2006).
82. Concededly, shareholder votes on mergers, spin-offs, and similar transactions are very important. By the same token, shareholder votes in contested elections are important, because election contests typically occur in situations involving a control or structural change.
83. See generally Cindy R. Alexander et al., The Role of Advisory Services in Proxy Voting (Jan. 2008) (unpublished manuscript, available at http://www.law.yale.edu/images/CBL-Workshop/ACSS-proxy-advice-1-2008b-.pdf) (studying the role of proxy advisors in election contests). In transaction-driven votes, however, the shareholder vote is driven largely, if not exclusively, by the perceived economics of the proposed transaction- economics that are company specific. It is impossible to compare a recommendation for a merger at one company with one involving a different transaction at another company.
84. See Jeffrey N. Gordon, The Rise of Independent Directors in the United States, 1950-2005: Of Shareholder Value and Stock Market Prices, 59 STAN. L. Rev. 1465, 1477-1500 (2007) (describing the developments that led to increased board independence beginning in the 1970s).
85. See, e.g., Paul E. Fischer et al., Investor Perceptions of Board Performance and Board Response to Those Perceptions: Evidence from Uncontested Director Elections 18-28 (Oct. 2008) (unpublished manuscript, available at http://ssrn. com/abtract=928843) (finding that boards who perform poorly in elections are more likely to dismiss CEOs, rein in compensation, and scrutinize acquisitions and divestitures).
86. See generally Jie Cai, Jacqueline L. Garner & Ralph A. Walkling, Electing Directors, 64 J. Fin. (forthcoming Oct. 2009), available at http://ssrn. com/abstract=1101924 (finding evidence that boards with low shareholder approval tend to reduce management compensation, dismiss CEOs, and remove takeover defenses) ;
87. Diane Del Guercio, Laura Seery & Tracie Woidtke, Do Boards Pay Attention When Institutional Investor Activists "Just Vote No"? (Jan. 2008) (unpublished manuscript, available at htrp://ssrn. com/abstract=575242) (finding a correlation between "vote no" campaigns and subsequent improvements in operating performance).
88. See infra app.
89. See, e.g., John K. Wells, Multiple Directorships: The Fiduciary Duties and Conflicts of Interest That Arise When One Individual Serves More Than One Corporation, 33 J. MARSHALL L. REV. 561, 581 (2000) ("More and more corporate watchdogs call for directors to limit the number of boards on which they serve.") ;
90. CPP Investment Board Releases Proxy Voting Guidelines, CANADIAN CORP. NEWSWIRE, Feb. 24, 2003 (identifying poor meeting attendance as an indicator of potential director ineffectiveness).
91. See, e.g., Useless at 70? Trends in Mandatory Director Retirement, AllBusiness, Oct. 1, 2001, http://www.allbusiness.com/business-planning- structures/business-structures/958172-1.html (reporting age limits and mandatory retirement policies among publicly traded companies).
92. Since it is generally accepted that CEOs should be on the board of their companies, their presence does not raise similar issues.
93. See Ertimur et al., supra note 39, at 30 (finding outside directors who failed to adopt a shareholder proposal were more likely to be removed).
94. For an examination of the relationship between antitakeover and other entrenchment devices and equity prices
95. see Paul Gompers, Joy Ishii & Andrew Metrick, Corporate Governance and Equity Prices, 118 Q. J. ECON. 107 (2003).
96. Shareholders may, in particular, impose greater accountability on directors with specialized expertise.
97. See Jill E. Fisch & Caroline M. Gentile, The Qualified Legal Compliance Committee: Using the Attorney Conduct Rules to Restructure the Board of Directors, 53 Duke L. J. 517, 561-63 (2003) (assessing the effectiveness of using "expert" directors on specialized board committees).
98. We define a factor as affecting relatively few directors if it affects less than 1% of the sample.
99. Both Interlock = 1 and Chairman Only = 1 were perfectly correlated with a for recommendation by PG and, as a result, were dropped from the sample.
100. ISS, GL, and EJ had some individuals who received more than three recommendations, but those numbers of individuals were too small for statistical analysis.
101. In particular, the spillover hypothesis would predict that, for advisors who issued two recommendations, there would be fewer withhold/for recommendations (in that chronological order) than for/withhold recommendations. For all advisors, these numbers were virtually identical.
102. In effect, ISS may be holding the CEO responsible for allowing the issuer to maintain an ineffective board or lobbying for the CEO's replacement in circumstances in which the board is unresponsive.