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Jan 31, 2009

Policy watch

  • Advisers’ institutional clients control record amount of equity
  • Understanding your institutional investor mix is vital
  • Solicitors discuss tackling negative recommendations

The 2009 proxy season is shaping up to be a bloody one, with institutions keen to rein in management after a year of bankruptcies and bailouts. Key players in the coming season will be the proxy advisers, which continue to grow in size and apparent influence. The biggest of the bunch, RiskMetrics Group, says it now advises on votes at 38,000 global AGMs.

percentage of total US equity held by institutionsWhat’s more, institutional clients of advisory firms hold a record amount of company stock. Using the latest available data, a study by the Conference Board finds professional money managers held 66 percent of all US stocks in 2006, a new high (see Percentage of total US equity held by institutions, right).

Proxy solicitors say it would be foolish to ignore the policies and recommendations of advisory firms. But they also caution against viewing advisers’ pronouncements as the deciding factor in a shareholder vote. The influence of advisers is different for each company, depending on its institutional mix. As a result, a thorough knowledge of your shareholder base – especially the voting policies of your institutional investors – is vital to working out the potential impact of proxy advisers at the AGM.

Some institutional investors follow a sole adviser’s recommendations automatically, while others take into account different advisers’ views before deciding how to vote. One big US money manager uses Glass Lewis for its US holdings and RiskMetrics for its non-US investments, explains Cas Sydorowitz, managing director of corporate advisory at Georgeson.

Proxy solicitation firms can help issuers by providing updated profiles on institutions and advisers. They can then alert companies in good time when a shareholder proposal is likely to pass, and offer advice on the different options available.

‘We can create a vote projection of the likely outcome,’ says John Siemann, a partner at Laurel Hill. ‘If the projection shows the shareholder proposal is likely to pass, you need to think about whether you want to keep on fighting, how bad the loss might be, whether to negotiate, and so on.’ He warns that if an issuer fails to act on a shareholder proposal that passes with a lot of support, the advisory agencies might recommend a withhold vote against it in a year or two years’ time.

Further complicating matters, the biggest institutional holders often formulate their own corporate governance guidelines. Estimates suggest this is the case at around three quarters of the top investment managers. They still take into account the advisers’ policies and recommendations, however.

‘Large institutions ultimately reach their decision in-house but many come to that decision while also reaching out to the proxy advisory firms,’ says Richard Grubaugh, a senior vice president at DF King. ‘In the event of a negative recommendation you should never give up. You have to make sure you have addressed the issues directly with the institutional investors.’

This view is backed up by research from the New York University School of Law. A paper released in May last year – titled ‘Director elections and the influence of proxy advisers’ – finds evidence that proxy advisers act primarily as aggregators of information shareholders find useful, but do not on their own determine voting outcomes via recommendations. US proxy solicitor Innisfree highlights to its clients the importance of identifying and contacting the ‘key voting decision makers at each institution.’ 

Talking to the advisers
As well as talking with shareholders, companies can also reach out to the advisory firms directly, though this is not as easy as dealing with institutions. Proxy advisers usually have guidelines in place stipulating how much contact they can have with listed companies, and in what form, to protect the independence of their analysis.

RiskMetrics’ rules of engagement state that, ideally, meetings between issuers and advisers should take place outside of the proxy season. But the firm will make allowances for ‘contentious issues, particularly if there are new circumstances or unique issues that would materially affect the analysis.’ Engagement can take place through face-to-face meetings, telephone calls or simply an exchange of emails if it suits the situation.

Similarly, Glass Lewis does not usually speak to issuers once the proxy has been filed. After this point, any contact that takes place is through ‘proxy talk’, a conference call Glass Lewis’ clients can listen in on, explains Robert McCormick, chief policy officer at the proxy adviser. If it is a particularly contentious or controversial issue, dissident shareholders may also participate in the process, as happened last year during the scrap between CSX and activists 3G Capital and the Children’s Investment Fund, when both sides were given a call to outline their respective positions. 

Essentially, then, advisers remain open to contact once the proxy season has begun, as long as issuers play by their rules. Even if direct contact is kept to a minimum, there is nothing stopping companies pushing information to the advisers to influence their thinking, points out Grubaugh.

‘All the proxy advisers have a different approach to developing their analysis,’ he explains. ‘Some engage directly with the issuer and others do not. But issuers can always make sure they are providing the proxy advisory firms with the necessary information or added insight to reach a positive recommendation.’

Policy switch
The earlier an issuer begins communication with institutions and advisers the better, as most shareholder proposals are resolved without a vote. Things get more difficult once a negative recommendation is released. The media are increasingly covering the decisions of proxy advisers, and an issuer may need to respond with a PR campaign to supplement additional solicitation material being sent out.

If a negative recommendation does appear, companies that react quickly may be able to get the adviser to reconsider and change its opinion.

‘You can take a look at why it flunked,’ says Mark Harnett, president at MacKenzie Partners. ‘Sometimes, extra language can be added to a proposal to change the recommendation. In rare circumstances, there may simply be a mistake or some incorrect data that can be corrected. But if you can’t change the recommendation – and you usually can’t – you need to go to your institutional investors and present your reasons why they should support the proposal despite the adviser’s decision.’

Regardless of what the advisers say, however, it is the big institutions that have final control over voting outcomes at most companies’ annual meetings. Successfully handling the proxy advisory firms, therefore, involves understanding their influence as much as their policies.

Pay for performance

Ever since RiskMetrics Group set up its corporate advisory service, market commentators have cried foul. For some, an adviser cannot independently judge a company’s corporate governance if it is also advising that company on the same topic. Academics have accused RiskMetrics of ‘creating a governance test and then selling the answers’, according to the Washington Post. In response, RiskMetrics says Chinese walls separate its institutional and corporate services.

Placing business ethics to one side, the question companies might ask is: should I pay up to ensure a positive recommendation? Proxy solicitors say the answer depends on RiskMetrics’ influence over your share register. ‘If conditions are right, we recommend companies use RiskMetrics’ corporate services to access its equity compensation model,’ comments Reid Pearson, a managing director at the Altman Group.