Outsourcing Corporate Governance: Conflicts of Interest Within the Proxy Advisory Industry

Abstract

Proxy advisory firms wield large influence with voting shareholders. However, conflicts of interest may arise when an advisor sells services to both investors and issuers. Using a unique dataset on voting recommendations, I find that for most types of proposals, competition from a new entrant reduces favoritism towards management by an incumbent advisor that serves both corporations and investors. The results are not driven by factors that influence the entrant's coverage decision, such as the marginal cost of new coverage or previously biased recommendations by the incumbent. Similar to other information intermediaries, biased advice by proxy advisors is shown to have real negative consequences, which allow management to enjoy greater private benefits. These results suggest conflicts of interest are a real concern in the proxy advisory industry, and increasing competition could help alleviate them. * I am very grateful for the guidance and support from

Executive Compensation: A Survey of Theory and Evidence

“…Performance may be measured over one or across multiple years. The proportion of S&P 500 …rms with bonus plans based on multi-year accounting performance rose from 17% in 1996 to 43% in 2008 (Li and Wang, 2016). In addition to prespeci…ed, formula-based plans, many …rms also award discretionary bonuses based on qualitative evaluations of executive performance (Murphy, 1999).…”

“…64 ISS has also been criticized for con ‡icts of interest stemming from selling both proxy voting services to investors and consulting services to corporate issuers (Li, 2017).…”

The real effects of proxy advisors on the firm

“…Another reason to expect time variation in the effect of PAs on the firm is increased competition for voting services by PAs that compete with ISS. According to Li (), Glass Lewis began competing with ISS in 2003, and Glass Lewis’ market share increased through 2011 to 40%. Both Choi et al.…”

“…Glass Lewis differentiates itself from ISS by using different voting recommendation policies (Choi, Fisch, & Kahan, 2009). There is some evidence that competition from Glass Lewis increased the quality of ISS voting recommendations (Li, 2018).…”

“…Another reason to expect time variation in the effect of PAs on the firm is increased competition for voting services by PAs that compete with ISS. According to Li (2018), Glass…”