Proxy Advisory Firms and Stock Option Exchanges

Information Intermediary or De Facto Standard Setter? Field Evidence on the Indirect and Direct Influence of Proxy Advisors

“…The other nine respondents gave mixed assessments of PAs’ overall impact on compensation design, with only two of these leaning predominantly negative. This overall positive impact of PAs on executive compensation—as perceived by internal decision‐makers responsible for interpreting and reacting to PA guidelines—is surprising given the overwhelmingly critical public comments by firms and industry groups as noted in prior literature (Larcker, McCall, and Ormazabal [])…”

“…PA representatives we interviewed emphasized that their guidelines come from an aggregation of institutional investor preferences while acknowledging that many governance and compensation issues are not viewed uniformly among investors. Further, informed voting is costly for investors, and Larcker, McCall, and Ormazabal [, ] argue that institutional investors face a free‐riding problem and outsource voting to PAs with limited concern for the process underlying vote recommendations. The exact nature of PA research and how it translates into guidelines is proprietary.…”

“…McCahery, Sautner, and Starks [] survey institutional investors and find that just over half agree or strongly agree with the conflict‐of‐interest criticism, and only a minority agree or strongly agree that PA recommendations are too standardized. Further, some research finds evidence that compensation changes that align with PA guidelines are associated with negative market reactions and lower performance (Larcker, McCall, and Ormazabal [, ], Iliev and Lowry []) while other research does not find any significant market reaction to changes made in response to negative PA recommendations (Ertimur, Ferri, and Oesch []).…”

“…This study makes several contributions. First, our finding that internal stakeholders perceive PAs as information intermediaries, agenda setters, and de facto “standard setters” helps reconcile apparently disparate conclusions about the economic role of PAs (Ertimur, Ferri, and Oesch [], Larcker, McCall, and Ormazabal []). Our interview data reflect the perceptions of internal decision makers who interpret PA guidelines and must choose whether and how to implement compensation changes, and we find these stakeholders perceive indirect and direct influence from PAs, which suggests PAs fulfill a more nuanced role than has been identified in prior studies.…”

“…On the one hand, PAs fill an information intermediary role by processing large amounts of information and providing voting recommendations to institutional investors on matters such as executive compensation and governance (Ertimur, Ferri, and Oesch [], McCahery, Sautner, and Starks [], Ertimur, Ferri, and Oesch []). On the other hand, critics contend that PAs have outsized influence on proxy voting outcomes, which potentially allows them to exert pressure on firms to adopt PAs’ preferred practices (Larcker, McCall, and Ormazabal [, ]). While these views are not mutually exclusive, examining PAs’ role(s) is important for understanding executive compensation design.…”