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30 Oct. 2018 | Comments (0)

On Governance is a series of guest blog posts from corporate governance thought leaders. The series, which is curated by the Governance Center research team, is meant to serve as a way to spark discussion on some of the most important corporate governance issues.

Proxy advisors have certainly been the focus of much discussion in the last couple of years, culminating in the House of Representatives passing the “Corporate Governance Reform and Transparency Act of 2017" (H.R. 4015). (The Senate has yet to vote on the legislation.) It is also one of topics to be discussed at the Securities and Exchange Commission’s (SEC) November 15, 2018, Staff Roundtable on the Proxy Process.

The following is a short summary of the comment letter (dated October 12, 2018) I sent to the Staff Roundtable on the topic of proxy advisors and the expected quality of their voting recommendations as fiduciaries under the Investment Advisers Act of 1940. 

The impact of proxy advisors

The essence of a proxy advisor’s existence is to help an institutional investor decide how to cast its votes at a shareholder meeting of a public company.  Its existence is essential for many institutional investors who may hold hundreds or thousands of stocks in their portfolios. For these investors, it is not feasible or desirable to internally perform independent research on the tens or even hundreds of thousands of votes they may face each year. Instead, the institutional investor leans heavily on one or more proxy advisors to provide them with voting recommendations. 

As a result, it should not be surprising that a proxy advisor’s voting recommendations can have a significant impact on the results of a shareholder vote.  For example, Malenko and Shen report that a negative Institutional Shareholder Services (ISS) recommendation on say-on-pay proposals led, on average, to a 25 percentage point reduction in voting support by shareholders during the sample period of 2010-11.[1] In a general review of the empirical research on proxy advisor recommendations, Copland, Larcker, and Tayan conclude that, “the evidence suggests that proxy advisors have a material, if unspecified, influence over institutional voting behavior and therefore also voting outcomes.”[2] Moreover, they also conclude that an “against” recommendation from a proxy advisor “is associated with a reduction in the favorable vote count by 15–30 percent.”[3]

Being informed and the lack thereof

Given the potential for a proxy advisor’s voting recommendations to have a significant positive impact on voting outcomes, it is critical that these recommendations be targeted toward enhancing long-term shareholder value. Moreover, for a proxy advisor to generate a recommendation that enhances long-term value, the proxy advisor must be truly informed. 

For a proxy advisor to be truly informed it needs to be held to the standard of an informed investor or what Goshen and Parchomovsky would call an “information trader.”[4] According to Goshen and Parchomovsky, an information trader, even though she lacks access to the information possessed by the board of directors, is identified by her willingness and ability “to devote resources to gathering and analyzing information as a basis for its [her] investment decisions,”[5] including the gathering of private information. Moreover, “information traders have the ability and knowledge to collect, evaluate and price firm-specific and general market information.”[6] Furthermore, “[s]earching for, verifying, analyzing, and pricing general market and firm-specific information are costly tasks.”[7] 

Unfortunately, it is doubtful that most voting recommendations provided by a proxy advisor are made based on the standard of an information trader. Many critics of proxy advisors argue that a significant number of their voting recommendations are not truly informed and incorporate various types of data, analytic, and methodological errors.[8] This should not be surprising as a proxy advisor has limited resources to provide informed recommendations on the tens of thousands of votes it must deal with during each proxy season.  For example, in 2014 the ISS had a global staff of 250 research analysts to provide recommendations on 250,000 shareholder votes.[9] Based on this information, the U.S. Chamber of Commerce stated that “it is clear that, on average, each ISS analyst is responsible for researching and preparing reports on 1,000 issues in the truncated period of the usual ‘proxy season.’ [primarily between March and June]”[10]

It does not appear that much has changed since 2014. As of June 2017, the ISS Global Research team covered 40,000 shareholder meetings with approximately 270 research analysts and 190 data analysts.[11] 

According to Nathan and Barrall, “As a result of the large number of voting recommendations that must be made in a short time period, it is inconceivable that proxy advisors’ recommendations can or will be based on a thorough analysis of the facts and circumstances of each company in the context of each voting decision.”[12] Therefore, if implemented, such voting recommendations will lead to sub-optimal corporate decision-making and a reduction in shareholder value. Such imprecision cannot be tolerated in a proxy advisor’s recommendations.    

The voting recommendations of the board

Fortunately, the board of a public company already provides a foundational level of information in their own recommendations on how shareholders should vote. The board of directors is not only the default locus of authority in a public company; it is also the most informed. Directors, as well as executive management, are often referred to as “insiders.” According to Goshen and Parchomovsky, “insiders have access to inside information due to their proximity to the firm; they also have the knowledge and ability to price and evaluate this information.”[13]

As observed by Malenko and Malenko, “The presence of the proxy advisor increases firm value (the probability of a correct decision being made) only if the precision of its recommendations is sufficiently high.”[14] Combing this statement with the premise that the board is the most informed locus of authority in the corporation, this implies, at least to me, that the precision of a proxy advisor’s recommendation must exceed that of the board’s.[15] This is possible, given that the board, being so close in proximity to the firm, may have, at times, difficulty in being objective in its voting recommendations.[16]


To enhance the voting recommendations provided to institutional investors by proxy advisors, my comment letter requests the SEC to modify its rules, policies and guidelines to the extent that:

Recommendation No. 1: When making a voting recommendation, the proxy advisor should be held to the standard of an information trader. If a proxy advisor cannot attest to the use of that standard when generating a voting recommendation, then the proxy advisor must abstain from making that recommendation to its clients. Making a recommendation that does not meet this standard would be a breach of a proxy advisor’s fiduciary duty under Section 206 of the Investment Advisers Act of 1940.[17] 

Unfortunately, for the vast majority of voting recommendations made by a proxy advisor, it is doubtful that it could attest to the use of that standard. However, there still is a low cost, high value alternative available.   

Recommendation No. 2: The SEC, as well as the Department of Labor, should clarify that an institutional investor, as an alternative to using the voting recommendations of a proxy advisor, can meet its fiduciary voting duties by utilizing the voting recommendations provided by the board of directors.  

Despite some statements by the ISS to the contrary,[18] an institutional investor does not violate its fiduciary duties when it votes according to management’s voting recommendations. This is consistent with the understanding that the voting recommendations provided by the board of directors are informed as they are based on inside information and enhanced by the expertise of executive management. 

Recommendation No. 3: Consistent with the prior recommendation and assuming that technical issues can be overcome, retail investors who invest in voting stock indirectly through the use of investment advisers and beneficiaries of public pension funds should have the option of transmitting voting instructions to their institutional investor informing it that their pro rata investment in voting stock must be voted in conformity with the voting recommendations of the board of directors of each company held in portfolio.

This third and final recommendation allows the retail investor or public pension fund beneficiary the opportunity to make sure that the vote of their respective institutional investor will always be an informed one. However, this option may be hard to implement because of the technical issues involved, issues that are beyond the scope of this writing.   



Institutional investors have a fiduciary duty to vote. However, the use of uninformed and imprecise voting recommendations as provided by proxy advisors should not be their only option. They should always be in a position of making an informed vote, whether or not a proxy advisor can help in making them informed. This issue is what the recommendations provided above is meant to address. 

My comment letter is available for download here

The opinions expressed here are the author’s and do not represent the official position of any organization that he is affiliated with.

The views presented on the Governance Center Blog are not the official views of The Conference Board or the Governance Center and are not necessarily endorsed by all members, sponsors, advisors, contributors, staff members, or others associated with The Conference Board or the Governance Center.

[1] Nadya Malenko and Yao Shen, The Role of Proxy Advisory Firms: Evidence from a Regression-Discontinuity Design, 29 Rev. of Fin. Stud. 3394, 3395 (2016). 

[2] James R. Copland, David F. Larcker, and Brian Tayan, Proxy Advisory Firms, Empirical Evidence and the Case for Reform, The Manhattan Institute at 13 (May 2018),

[3] Id.

[4] Zohar Goshen & Gideon Parchomovsky, The Essential Role of Securities Regulation, 55 Duke L.J. 711, 721-23 (2006).  

[5] Id. at 723.

[6] Id. 

[7] Id.

[8] Charles M. Nathan and James D.C. Barrall, Latham & Watkins LLP, Proxy Advisory Business: Apotheosis or Apogee?, Corporate Governance Commentary at 5 (March 2011).

[9] Harvey Pitt, U.S. Chamber of Commerce Corporate Governance Update: Public Company Initiatives in Response to the SEC Staff’s Guidance on Proxy Advisory Firms, The U.S. Chamber Center for Capital Markets Competitiveness at 5, (January 2015),

[10] Id. 

[11] Institutional Shareholder Services Inc., Due Diligence Compliance Package (November 2017),

[12] Nathan and Barrall, supra note 8, at 4.

[13] Goshen & Parchomovsky, supra note 4, at 722.  

[14] Andrey Malenko and Nadya Malenko, The Economics of Selling Information to Voters, J. Fin. (forthcoming) (June 2018),;

[15] To clear up any confusion found in the text of my comment letter, the argument that the level of precision must be greater than the board’s is Mr. Sharfman’s, not Malenko and Malenko’s.  See email from Nadya Malenko to Bernard Sharfman (October 14, 2018) (“While our paper indeed shows that the proxy advisor's recommendations have to be sufficiently precise to increase value, our work unfortunately cannot speak to the comparison of this precision with the precision of the board's information.”).

[16] Goshen & Parchomovsky, supra note 4, at 721–23.  

[17] 15 U.S.C. § 80b-6. 

[18] In the recent past, the ISS has mistakenly asserted that the Department of Labor’s Proxy Project Report of 1989 provided the guidance that “blindly voting all proxies with management are inconsistent with the fiduciary responsibility provisions of ERISA.” See Gary Retelny, President, Institutional Shareholder Services to Ms. Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, Re: Proxy Advisory Firms Roundtable, File No. 4-670 at 2 (March 5, 2014),; Statement of Gary Retelny, President and CEO Institutional Shareholder Services Inc. to the Subcommittee on Capital Markets and Government Sponsored Enterprises Committee on Financial Services United States House of Representatives, Legislative Proposals to Enhance Capital Formation, Transparency and Regulatory Accountability at A-14 (May 17, 2016),  The ISS cites the Proxy Project Report as its source for this assertion, but I could find no such guidance in the report.  See Pension and Welfare Benefits Administration, U.S. Department of Labor, Proxy Project Report (March 2, 1989).  

  • About the Author:Bernard Sharfman

    Bernard  Sharfman

    Bernard Sharfman is an associate fellow of the R Street Institute, chair of the Advisory Council of the Main Street Investors Coalition, a member of the Journal of Corporation Law’s editorial ad…

    Full Bio | More from Bernard Sharfman


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