The proxy voting system for pension funds and mutual funds is broken, with unintended consequences of regulations giving preferential treatment to proxy advisory firms, according to a paper from the Mercatus Center at George Mason University.
Institutions like pension funds are currently required to adopt and disclose policies for proxy voting to minimize conflicts of interest. The paper's authors argue that an SEC interpretation that protects institutions from legal liability by hiring an advisory firm has actually proved to be detrimental to shareholder value.
The authors recommend three steps to fix the current system — limit voting requirements of pension and mutual funds so institutions will be the sole decision-makers on what to vote on, end preferential regulatory treatment for proxy advisers and end extraneous proxy requirements such as say-on-pay votes.
“The demand (for proxy advisers) was created because (institutions) have to adopt active voting policies,” said J.W. Verret, co-author and assistant professor of law at George Mason. “It created an artificial demand for services that I think would recede” if regulations were changed.
ISS and Glass Lewis make up 61% and 36%, respectively, of the proxy voting market, and evidence shows that an ISS recommendation carries 20% to 50% of a vote, Mr. Verret said in a telephone interview. Voting should be placed back in the hands of investors, he added.
Mr. Verret said proxy firms often have conflicts of interest, which the Securities and Exchange Commission was trying to avoid in the first place, by advising corporations on how to get proxy questions approved while also advising large pension plans and other institutions on how to vote.
Institutional stock ownership has risen to 76% of assets of the 1,000 largest public corporations from 47% in 1987, according to the paper. Large mutual funds could be required to vote on more than 100,000 proxy questions a year. A Stanford University study found that opposition by a proxy adviser results in a 20% increase in negative votes cast.
“The proprietary models used by proxy advisory firms for say-on-pay recommendations appear to induce boards of directors to make choices that decrease shareholder value,” according to the study cited in the paper.
Another issue the authors take up is proxy firms' one-size-fits-all approach, such as ISS' universal recommendation to appoint an independent chairman.