How effective is the relationship between a firm's performance and the recommendations provided by ISS?
A recent study released by The Rock Center for Corporate Governance at Stanford University shows that firms that adopt stock option exchange programs consistent with ISS policies tend to exhibit lower market reaction and operating performance and higher executive turnover.
The paper, titled ‘Proxy Advisory Firms and Stock Option Exchanges: The Case of Institutional Shareholder Services,’ concludes that proxy adviser recommendations can decrease shareholder value.
‘Our hypothesis is that the incremental cost of determining proxy votes internally exceeds the loss they suffer from bad voting recommendations,’ says Allan McCall, one of the co-authors of the study, who is a member of the accounting department at Stanford Graduate School of Business. ‘At a general level, the question of whether the policies of proxy advisers help or hurt shareholders is a concern of many public companies.’
While he was working as a consultant to firms on stock option exchange programs, McCall noticed that proxy advisers held significant influence in designing programs.
‘Companies that changed their plan designs from what they thought was best in order to win the votes are effectively controlled by proxy advisers,’ he says, on the basis of the results of the study. ‘I was hopeful that we would be able to measure that influence without the assistance of the proxy advisory firms who have generally been reluctant to disclose the details of their policies,’ says McCall.
According to the analysis, ‘Since proxy advisory firms can sway substantial numbers of shareholder votes, they have the ability to influence corporate governance choices.’ And this can be harmful to shareholders.
‘The industry appears to be a classic oligopoly, with two primary players and little or no new competition and this likely does not provide the proxy advisers with incentives to invest in costly research,’ McCall states.
The analysis was based on a comprehensive sample of 264 stock option exchanges announced between 2004 and 2009, says Stanford, in which each was measured by the degree of conformity to ISS guidelines. The observed design was then compared with ISS guidelines and was later assessed to reveal the result of the firm’s subsequent performance and executive turnover.
‘For firms developing any program that will be submitted to shareholders for approval, it is important to realize that the policies implemented by these proxy advisers may reduce the value of the program,’ McCall asserts. ‘However, under the current policy regime, firms may still have to adjust their plans to win the votes controlled by proxy advisers.’
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