State laws generally require all publicly traded companies to hold annual meetings to conduct the most important business of the year. The investment field generally refers to the months between March and June as the annual meeting season. Mid-cap and small-cap companies often employ proxy advisors at this time of year.
The annual meeting is usually the time of presenting ballots for the appointment of new board directors and important issues like management and shareholder proposals. The Dodd-Frank Act requires that shareholders vote on the executive director’s compensation every 1-3 years. Shareholders also have the opportunity to vote on key issues like mergers and acquisitions at annual or special meetings.
Proxy Voting Basics
Corporations send out advance notice of annual or special meetings through a written proxy statement because It’s impractical for all shareholders to attend meetings in person. The proxy statement often includes a proxy ballot, or proxy card, that lets the shareholder appoint someone to vote on their behalf.
Shareholders have the right to instruct the proxy on how to cast their vote. For example, shareholders can decide to vote their own wishes or they can vote with the institutional investors or managers. Shareholders can allow the proxy to vote on what the proxy believes is in the best interests of the shareholders, and they can instruct the proxy not to vote at all.
Investment advisors, insurance companies, mutual funds, and pensions plans are collectively called institutional investors. They get the lion’s share of the proxy votes, so their influence can greatly outweigh individual votes.
The impact of institutional investors has risen substantially in recent decades. Institutional investors held about 20% of shares in the 1960’s. By 2011, institutional investors shares grew to an astounding 60%.
Two Duties of Proxy Advisory Firms
Regulatory requirements have generated a demand for an independent third party that helps corporations of all sizes to adhere to the guidelines for corporate governance compliance. The two largest proxy advisory firms are Institutional Shareholder Services (ISS) and Glass Lewis, which advise about 97% of the market. Proxy advisory firms provide consultation services and recommend votes for institutional investors.
Corporations that seek counsel from proxy advisory firms are taking the first step towards protecting themselves from unexpected litigation over corporate governance matters. Think of contracting with a proxy advisory group as a layer of liability insurance.
Proxy advisory firms analyze the shareholder base and provide reports to educate and inform investors. Proxy advisors use the reports to counsel shareholders regarding the decisions on upcoming ballots.
The reports from the proxy advisory firm have strong influence and may make direct recommendations on the institutional investors’ votes, which are the larger percentage of shareholders.
Firms that use proxy advisory firms tend to get a higher participation on voting. This can be a strategic move for mid-cap or small-cap companies. Activist groups sometimes target companies that tend to get a lower voter turnout. Having a higher voter turnout can neutralize the voting.
Proxy solicitors are different than proxy advisors. Some publicly traded corporations hire proxy solicitors to find shareholders whose votes can be swayed and educate them on the company’s views on particular issues to influence their votes.
How Much Influence Do Institutional Investors Have?
Institutional investors cast thousands of ballots every year where they vote on shares in the billions. The 2016 report by the Government Accountability Office (GAO) called “Corporate Shareholder Meetings: Proxy Advisory Firms’ Role in Voting and Corporate Governance Practices” sheds some light on the size of companies and the influence of institutional investors. The report states that the influence of institutional investors varies based upon the size of the companies. Large institutional investors often perform their own research internally, and they have their own voting policies, so they have less influence on voting.
Larger companies are more likely to contract with proxy advisory firms for consulting services in addition to using them as proxy advisors. In exchange for giving them more business, proxy advisory firms allow larger companies more latitude to review drafts and offer input on the reports prior to voting, Mid-cap and small-cap companies aren’t offered the same opportunity because they don’t pay as much for the proxy services. Thus, their size places them at a bit of a disadvantage.
The Role of Proxy Advisory Firms for Mid Cap and Small Cap Companies
Unlike larger corporations, mid-cap and small-cap companies don’t usually have the financial resources to employ an internal department that performs the research they need to vote in the best interests of their clients.
Hiring a proxy advisory firm provides mid-cap and small-cap companies with research and analysis at a much lower cost. Many mid-cap and small-cap corporations call in the proxy advisory firms only for consultation and voting at their annual meetings. Many of them find that proxy firms can help them even when they aren’t having any issues.
Regardless of the size of the firm, corporations have flexibility in making decisions about how the advisor should vote on the client’s behalf. The parties can create an arrangement where the proxy casts votes always, sometimes, or never, or only votes in the companies with larger shares of their holdings.
Are New Regulations Creating a Conflict of Interest for Proxy Advisory Firms?
The fact that mid-cap and small-cap companies don’t use proxy advisory firms on the same scale and frequency as their larger counterparts isn’t always a bad thing. Some people are starting to feel that the pressure from regulatory bodies to use proxy firms as an independent source of information are creating new problems and new conflicts of interest.
Proxy companies are now taking on so many clients that, like the larger corporations that have internal research departments, they don’t have time to prepare accurate and thorough reports. The result is that they apply the information in a “one-size-fits-all” manner, which defeats the purpose of contracting for the information.
There is a growing concern that the information that the proxy firms start out with is bad or inaccurate which skews the reports from the onset.
There is also a growing concern within the industry that advisory firms own the same shares as their clients which creates a conflict of interest. Proxy advisors need to be transparent and disclose their relationships with companies.
In addition, investors tend to focus less on the low cost, low maintenance funds, favoring to leave their votes at the discretion of the proxy advisor. This practice calls to question whether the proxy advisor is truly voting those shares in the best interest of the client.
Wrapping Up How Mid Cap and Small Cap Companies Leverage Proxy Advisory Firms
Because of regulatory concerns, proxy advisory groups have a role in mid-cap and small-cap companies, even if they only use them occasionally, or at the annual meeting. Mid-cap and small-cap companies should be aware of the evolving industry concerns surrounding proxy advisory firms that conflicts of interest or that develop their reports using inaccurate information. Proxy advisory firms have become a necessary part of the investment industry, but currently, there are no checks and balances for proxy advisory firms.