THE ROLE OF PROXY ADVISORY FIRMS IN CORPORATE GOVERNANCE

Abstract

The aim of this paper is to study the role of proxy firms in corporate governance and understand their legalities. The corporate world has grown tremendously over the years with many new additions to the field. Through technological advancement and market infrastructural expansion the business world is blooming. With the emerging world many new challenges have also grown, and firms need to be very careful of what they choose for themselves. In this paper we discuss one of the emerging tools of corporate governance which helps them with consultancies and provide in-depth research to investors to invest better. This paper investigates what proxy firms are, their role, impact on corporate governance and the challenges surrounding them which is crucial to understand the work of proxy advisory firms better. Proxy advisory firms recently have got recognition, they help in bridging the gap between the corporate and the shareholder by providing detailed analysis. The recommendation of proxy advisory firms has made fabulous impact on the decision of corporation giving them shape and design. Additionally, this paper studies the legal provisions related to proxy advisory firms and how they are regulated. By understanding the importance of proxy advisory firms in corporate governance not only shareholders but policymakers, investors and executives can enhance and reform their decision. Transparency in corporate is very important, and proxy advisory firms can bring theses transparency and advice on where the governance is lacking, providing shareholders with better voting decision. The findings of this paper will make it easier for the readers to understand what proxy advisor firms are and their association with corporate governance.

Keywords

Proxy advisory firms, voting, corporate, governance, shareholder.

Introduction

Proxy means ‘authority given to a person to act for someone else, such as by voting for them in an election, or the person who is this authority is given to’[1]. Proxy advisory firms are those firms which provide investors with detailed analysis, research data and recommendations on management and voting. They help with taking better and informed decisions during an organization’s annual or special meetings. These firms are independent and work for the best interest of their clients by evaluating complex corporate policies and recommending their clients to vote for or against the decision laying with the board. Not all shareholders are well versed with the working of corporate and thus need additional analyst who can evaluate these complex policies for them and help them in casting their vote over the issues like compensation, corporate governance, appointment of CEO etc. The concept of proxy advisory firm came into picture as the shares of a company are owned by a diverse group of people and it is practically impossible for everybody to be present to cast their vote for a policy or a decision at the same time. Moreover, foreign investment also pours in making the voting system even more difficult, this led to the coming of proxy advisory firms in scene, as we already knew the meaning of proxy, which is mentioned above these firms play a very significant role in bridging the gap between corporate governance and shareholders. This concept first came in United States in 1980s and globalized in the 21^st century although the evolution of proxy advisory firms was not easy as they faced many oppositions and credibility challenges but today there are many large firms operating in the world. There are two biggest proxy advisory firm in U.S.A, Institutional Shareholder Services (ISS) and Glass Lewis & Co. The biggest U.K based proxy advisory firms are Institutional Voting Information Service (IVIS) and Pension & Investment Research Consultants (PIRC). In India Institutional Investor Advisory services (IiAS) and Stakeholders Empowerment Services (SES) are the biggest proxy advisory firms but they are not limited there are many other firms as well who are providing great services to their clients. There are diverse areas in which proxy advisory firms provide support like environment, social and governance (ESG), proxy voting, research, executive compensation models and board diversity and by providing recommendation in these areas proxy advisory firms strength the corporate governance[2].

Further in the sections of this paper we will discuss the role of proxy advisory firms, their impact on corporate governance and provisions related to them in India, last but not the least this paper reflects over the challenges that proxy firms face majorly, followed by the conclusion of overall findings.

Role of Proxy Advisory Firms

The proxy firms gave their service in exchange for payment from the investor. By providing insight into the related matter, they help investors cast vote. The role of proxy advisory firms has become very crucial in maintaining the transparency of the corporate governance. Some important roles played by them are helping in corporate governance by providing advice to the firms regarding important deals, mergers, acquisitions, transaction deals and many more issues. This nature of proxy firms makes them proxy advisory firms. The second important role of proxy firms is to provide investors with detailed and structured data of the company so they can better decide for themselves and know the pros and cons of the deals, this also promotes transparency in the governance. Creating reports on the observations of the company’s performance, these firms observe the firms and prepare a scorecard on their performance which provides shareholders with a better understanding of the company. Proxy proposals and voting, proxy firms also participate in this by giving a brief insight of the company’s issues. This guides the shareholders on how to vote on such matters.

Maintaining transparency for good governance, they criticize the structure and functions of corporations if they do not follow the law and norms of corporate governance which promotes the customs of good governance and maintain the lucidity of corporations which in the end help the shareholders to form their decisions. This monitoring aspect of proxy advisory firms helps others to learn from others mistakes and comply with corporate governance norms. Due to the involvement of proxy firms’ shareholders are not passive members anymore. The firms also help the board by providing them with a view of how they are perceived by their shareholders. Proxy proposals related to voting guide shareholders about their interests, they analyze the strengths and weakness of the companies and put out reports analyzing the environmental and social factors that will hinder or promote the future of the company. The goal of these firms is to protect and promote the interest of their clients and provide them with the best results of effective investment[3].

However, it is not necessary that the recommendations of these firms will surely provide with good results only many times they tend to fail as well because in the end proxy firms are also the result of failed market apparatus, but these firms have influenced the corporate governance at several level though faced with many criticism they continue to grow. In the upcoming section we are going to see the major impact of proxy advisory firms on corporate governance.

Impact of Proxy Firms on Corporate Governance

The proxy advisory plays a crucial role in maintaining the uprightness and ethics of corporate governance. The recommendations of proxy firms help hold the companies accountable if they do not work in the best interest of their investors and do not adhere to the norms of corporate governance. It is important to protect the probity of corporate governance as it promotes the company’s name, robustness, long-term shareholders value and deaden risk. Since the introduction of proxy advisory firms in the 1980s they have been in constant extension.

With the increasing credibility of proxy advisory firms in the corporate world investors are heavily relay over their impartial evaluations and recommendations for voting that is giving these firms a sense of authority and they act as the watch dogs for corporate governance. Compelling them to confirm to the international procedure of openness, responsibility and shareholder’s interest. They promote the best practices of executive compensation, board diversity and ESC[4]. It’s been established that recommendations made by proxy advisors have an impact on voting decisions. The level of influence is not determined. In the study of Brav, Cain and Zytnick (2022) it reveals that institutional investors move 51% more in voting support when there is no opposition from ISS compared to 2% of retail investors. Malenko and Shen (2016) find that the voting support for say-on-pay proposals stands to be 25% points lower when ISS gives a negative recommendation. Similarly, Copland, Larcker and Tayan (2018) note that advisory negative recommendation is likely to decrease shareholder votes to equity-plan proposals by 17%, the votes for uncontested directors by 18% and say-on-pay by 27%. In the paper of Rose (2021), the author considers the Phenomenon of ‘robo-voting’, understood as the fund managers’ voting with the ISS recommendations more than 99.5% of the time[5]. The above-mentioned reports by various researchers show the growing dependency of corporate on proxy firms and how much their recommendation matters to them before taking any decision. The studies show that the recommendations by proxy firms are followed by the majority. Proxy promotes transparency and responsibility by pointing out the loopholes of governance and providing assessment of the governance of the company to the shareholders. For instance, IiAS and Stakeholders Empowerment Services recommended shareholders to not vote for the resolution of One97, the parent company of Paytm, on the reappointment of Vijay Shekhar Sharma as MD. SES gave the reason of dual position of CMD and excessive renumeration[6].

For the smooth running of corporate governance agencies are required to keep in check that companies are compiling to the international norms of corporate governance. Proxy firms have improved the working of corporate governance in many crucial ways like providing transparency, criticizing corporations for non-compliance of laws and norms, giving recommendation to which majority adhere to. But there are many challenges that these firms face in the next section we will investigate these challenges but before that we will investigate the different laws and regulations related to proxy advisory firms in India.

Laws for Proxy Advisory Firms

Proxy advisory firms have become crucial in today’s corporate governance landscape. In India the first proxy advisory firm was established in 2010 and since then they have impacted the voting of investors in a very significant way by analyzing the governance practices of the companies. The Security and Exchange Board of India regulates the proxy advisory firms in India by its SEBI (Research Analysts) Regulation,2014, Procedural Guidelines for Proxy Advisors August 3,2020 and Grievance Resolution dated August 4, 2020. Registration is binding over the proxy firms who wants to operate in India through SEBI by submitting Form A along with non- refundable application fees. Some specific qualifications have been outlined like the individual or partnership firms must have a minimum net asset of not less than 1 lakh, there is no standardized model for proxy firms in India. For foreign proxy firms they are required to enter into an agreement with registered proxy firms of India with SEBI. Regulation 15 mandates the firms to have written internal policies and procedures to curd any potential conflict. In regulation 19 disclosure of conflict matters is made mandatory. Code of conduct listed in the third schedule under Regulation 24(2) with Regulation 23(1). The third schedule mandates the ethical practices of proxy advisory firms like good faith, due diligence, compliance to rule and laws. This is made to adhere to good governance practices by firms, in addition they are required to be abide by the guidelines given in the Circular August 3, 2020, which mandates the firms to establish polices for voting recommendation, which are annually reviewed. The disclosure of process involved in their research as it will make the communication with clients much easier and sharing policy publicly disclosed along with client and companies on their website. As mentioned earlier, disclosing any conflict of interest is mandatory by firms along with the measures taken to curb them. Grievance redressal is one of the regulations of SEBI Working Group in which they say that before approaching the court for any grievances related to power abuse, violating code of conduct or any egregious acts, the parties need to visit the SEBI first. On August 4, 2020, the SEBI gave circular that companies may visit the SEBI in case of grievances, but it does not use the word shall which makes it suspectable whether the entities can still take legal ways without involving SEBI first[7].

The growing importance of proxy advisory firms in India is evident as many big entities take recommendation of proxy firms in their big decisions. Proxy advisory firms help maintaining the corporate governance transparency and it helps the shareholders to make well informed decision regarding voting. The proxy firms build confidence and credibility among their investors when they gave positive results but not everything is easy as they have many challenges which we will investigate in the next section.

Challenges and Recommendations

There are several challenges that proxy advisory firms must face as they are opposed by many since their growing power and authority. Some major challenges face by proxy advisory firms are like lack of transparency and potential conflict of interest as there is no disclosure over the methodologies use by them on how they make their recommendations and the risk of conflict between their shareholders, clients and investors is also there. Since there is no disclosure of their methodology it became a mystery how they came to such conclusions and proxy advisory firms have zero obligation towards any conflicts that arise between entities involved[8] they necessarily do not act in the best interest of the investors and companies, to avoid such issues proxy firms need to maintain transparency in their works and obliged to the rules and regulations to serve the positive result as more and more companies are relaying on proxy advisories which will eventually became a big burden to these firms so to be relevant they need to maintain their transparency. Another issue faced by proxy firms are lack of clarity of guidelines, proxy advisory lack in giving detailed instructions which bridge the gap among the potential goal of good corporate governance. There are no standardized criteria to evaluate the transparency and adequacy of these firms which will eventually harm their credibility. Although there are other minor shortcomings of proxy advisory firms, lack transparency, conflict of interest and standardized criterion for recommendation are the major. These loopholes need adequate attention to maintain the proxy market otherwise they will lose their credibility, reforms need to be made the mechanism of proxy firms regarding their transparency, specification of guidelines, monitoring mechanisms. The regulations and laws related to proxy firms are well versed but there is no clear guidance over the penalties for non-compliance and no enforcement mechanism makes it even more complicated to understand the working of these firms[9]. These issues need to be addressed properly.

Conclusion

Proxy advisory firms have gained reputation and credibility over the years yet there are many areas they need to work on like transparency, guidelines, conflict of interest which will make their position in the corporate world more firms and inclusive. They act as the bridge between shareholders and the corporation by providing analysis of corporate governance of the entities involved. They work as an independent organization providing voting recommendations to the investors but still it is in their growing stage so to comment on the effectiveness of these firms is still too early. Not every shareholder abides by the recommendations made by proxy firms, the awareness of these firms has not reached the minor shareholders and corporations. Proxy advisory firms’ role in corporate governance has been crucial with the ever-changing nature of the corporation it is adapting and getting the best results. The budding role of these firms cannot be discarded, with the introduction of proxy firms the corporate world has gained many advantages making it easier for every shareholder to participate in the voting if they cannot make it there physically. With the expert teams and expert knowledge, they make an impactful position in the corporate and many big corporations relay over their recommendations. There is way more to go for proxy advisory firms as they have not reached the ground level but through all the analysis done in this paper it can be concluded that proxy advisory firms have played a crucial role in promoting good corporate governance.

References

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[1] Cambridge dictionary, https://dictionary.cambridge.org/dictionary/english/proxy#google_vignette

(last visited Oct. 15, 2024).

[2] Cassidy Alexander, The role of proxy advisory firms, Glass Lewis (Oct. 15, 2024, 10:11 PM), https://www.glasslewis.com/the-role-of-proxy-advisory-firms/.

[3] Jyotsna Suthar, Proxy Advisory Firms, WALL STREET MOJO (Oct. 15, 2024, 1:08 PM), https://www.wallstreetmojo.com/proxy-advisory-firms/.

[4] Arjun Kapur, Akshat Joon, Behind the Vote: A Critical Analysis of Proxy Advisors in the Indian Market, CENTRE OF BUSINESS AND FINACIAL LAWS (Oct. 17, 2024, 10:11 PM) https://www.cbflnludelhi.in/post/behind-the-vote-a-critical-analysis-of-proxy-advisors-in-the-indian-market.

[5] David F. Larcker, Brian Tayan, Seven question about Proxy Advisory, Harvard Law School Forum on Corporate Governance (Oct. 16, 2024, 2:39 PM),

https://corpgov.law.harvard.edu/2024/05/13/seven-questions-about proxyadvisors/#:~:text=Proxy%20advisor%20recommendations%20influence%20voting,ISS%20(see%20Exhibit%203) .

[6] Shashank Shekhar, Namisha Ojha, Proxy Advisory Firms: Shaping Corporate Governance Practices in India, IRCCL (Oct. 16, 2024, 4:55 PM), https://www.irccl.in/post/proxy-advisory-firms-shaping-corporate-governance-practices-in-india.

[7] Rashi Mittal, Nishant Sharma, Proxy Advisory Framework and the Role of Company Secretaries, 14 ICSI 82, 83-84 (2024).

[8] Thomas Kingsley, Proxy Advisory Firms: A Primer, THE AMERICAN ACTION FORUM (Oct. 18, 2024, 8:01 PM),

https://www.americanactionforum.org/insight/proxy-advisory-firms-a-primer-2/ .

[9] IRCCL, https://www.irccl.in/post/proxy-advisory-firms-shaping-corporate-governance-practices-in-india (last visited Oct. 18, 2024).

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