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25 Feb. 2011 | Comments (0)

One of the biggest targets going into the 2011 proxy season – the year of Say on Pay – is not those in the C-suite, the boardroom or activist investors. It’s the proxy advisory firms, namely Institutional Shareholder Services (ISS) and Glass Lewis. And that’s before the first full wave of annual general meetings has taken place. So, with a target on the back of the proxy advisory firms, what are directors of the companies those firms will recommend votes for supposed to do? One independent compensation consultant has some advice for boards. “There are two things compensation committees should do: talk with ISS,” Russell Miller, managing director and partner with ClearBridge, told me today. “Build a dialogue with them. You could have a third party help, but that’s not necessary. But many directors say that is easier said than done. “ISS has two sides. There’s the advisory side and the voting side. Advisory will talk to companies. While there is a wall between the two sides, advisory can tell you ‘here are the factors the voting side will consider when they vote.’” The other option, Miller said, is to have the board reach out to the company’s institutional investors so the board can find out the investors’ policy on the company’s specific compensation plan and their general policy on executive compensation plans. The environment that is leading directors and management to seek advice about includes competing studies, a letter-writing campaign and possible regulatory involvement (the regulation of proxy advisory firms is being considered by the SEC in its concept release on “proxy plumbing”). The Center on Executive Compensation, a group representing senior human resource officers of more than 300 of the largest U.S. companies, launched a preemptive strike earlier this month. It sent out letters to the CEOs of the top 100 institutional investors asking them to better scrutinize proxy advisory firms for accuracy and conflict of interest issues regarding their recommendations on executive pay programs. “As institutional investors know, they have a fiduciary duty to monitor corporate events and vote their proxies in the best interests of their clients,” Charles G. Tharp, the Center’s executive vice president, said. “Conflicts in proxy advisory firm operations and inaccuracies in their recommendations could lead to erroneous voting decisions that may adversely impact companies and ultimately investors.” Two weeks after the Center on Executive Compensation announcement, the Investor Responsibility Research Center (IRRC) Institute in a report conducted by ISS on corporate and investor engagement found that while there is an increasing trend of engagement, there is a disconnect between investors and issuers in basic areas of engagement. That report, The State of Engagement Between U.S. Corporations and Shareholders, stated that the level of engagement is high, with about 87 percent of issuers, 70 percent of asset managers and 60 percent of asset owners reporting at least one engagement in the last year. But the report also found that asset owners, investors and issuers don’t always agree on what constitutes “successful” engagement. For instance, issuers were materially more likely than investors to think that establishment of a contentious dialogue was a success, while about three-quarters of both asset managers and owners defined either additional corporate disclosures and/or change in policies a success. “The days of the ‘Wall Street Walk’ are largely over,” Marc Goldstein, head of ISS research engagement, said. “Investors often are unwilling or unable to simply sell shares when concerns arise about how a company is managed. Instead, investors will engage with executives or the board to try to bring about change.” Just to be clear, the purpose of the IRRC Institute releasing the report when it did was to establish a benchmark for shareholder-issuer engagement prior to this proxy season. It wasn’t meant to be a retort to the Center on Executive Compensation letter campaign or a way to justify ISS’ role in shareholder dialogue. The Center on Executive Compensation letter was based on a study by the center that found a “growing power of proxy advisory firms over corporate governance and proxy voting” and that “the firms have gained undue and generally unchecked influences over the pay practices of companies as their role as advisors to large institutional investors.” The study’s results were included in a white paper A Call for Change in the Proxy Advisory Industry Status Quo. The letter, which also included a policy brief and the aforementioned white paper, was meant to “initiate a productive dialogue with institutional investors and bring attention to the much needed reform of proxy advisory firms,” Tharp said. Specifically, the letter asks institutional investors to do the following:
  • monitor the analyses and recommendations they receive from proxy advisory firms and the proxy advisory firms’ underlying voting policies to ensure they demonstrate a close link between executive compensation and company performance;
  • require any proxy advisory firm they retain to eliminate the worst conflicts of interest;
  • require proxy advisory firms to disclose any disagreements by companies regarding the characterization of a pay or governance matter; and
  • support greater SEC oversight of proxy advisory firms.
  • About the Author:Gary Larkin

    Gary Larkin

    Gary Larkin is a research associate in the corporate leadership department at The Conference Board in New York. His research focuses on corporate governance, including succession planning, board compo…

    Full Bio | More from Gary Larkin


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