Feature Too much sway

  • Date:01 May 2010
  • Type:CompanyDirectorMagazine

Proxy advisers have come under attack recently, accused of being poorly resourced, not having the expertise to handle complex issues and using a tick-the-box approach. Tony Featherstone weighs into the debate and discovers there are two sides to the story.

Too much sway?

Two sides to the story


  • Proxy advisory firms:
  • Are poorly resourced
  • Lack expertise in complex areas such as remuneration
  • Use a formulaic approach to governance matters
  • Don’t give boards enough opportunity to state their case


  • Boards are “shooting the messenger”
  • Australia’s small size limits the need for large research teams
  • Super funds and fund managers value the research
  • Advisers’ doors are always open to directors, although the lines are long just before AGM season

It was a debate waiting to explode. Lend Lease and Foster’s Group chairman, David Crawford AO FAICD, lit the fuse when he complained about proxy advisers’ growing influence in Corporate Australia and accused institutional investors of abdicating their governance responsibilities by outsourcing their votes to proxy advisers. Crawford’s view struck a chord with other influential business figures and sparked a heated response from board consultants and proxy advisers in newspaper letter pages.

Crawford said publicly what some boards believe privately: that proxy advisory firms are poorly resourced, lack expertise in complex areas such as remuneration, take a formulaic approach to governance matters and do not give boards enough opportunity to state their case on governance initiatives before making voting recommendations. There is also a view that fund managers and superannuation funds sometimes blindly follow ill-considered proxy adviser recommendations.

“They [proxy advisers] have a very limited time to assess those (remuneration) reports, we don’t know the quality of the people they use to assess them, we don’t get an opportunity to talk to them,” Crawford reportedly said at an Australian Institute of Company Directors event in Melbourne earlier this year. “They don’t talk to us about why we are doing what we are doing and yet they are the ones who are making a recommendation on a ‘tick-the-box’ method. This is a really important issue that boards face. Are they really having to satisfy the investors, or do they satisfy the proxy advisers who are inaccessible, and what qualifications do they have? That in itself raises the question: are the institutional shareholders who are relying on these reports abdicating their responsibility?”

Stockland chairman Graham Bradley AM FAICD also has concerns about aspects of proxy advice, the biggest being that some institutional investors and super trustees have rules requiring them to subscribe to proxy adviser research and follow their voting recommendations.

“This mechanistic approach is not in investors’ best interests and can be dangerous,” he says.

Bradley also believes proxy advisers can be too quick to reject non-traditional performance hurdles used to set both short-term and long-term executive pay and that they do not always give boards the right to comment before recommending votes against board recommendations. He believes proxy advisory firms should have a more transparent code of practice, so boards can have confidence dealing with them.

In addition, Bradley reckons more institutional investors need to form their own views on corporate governance matters, rather than just follow the advice of proxy advisory firms. “If I have a criticism, it is that institutional investors should take greater personal interest in corporate governance issues and should make their own judgements based on their own inquiries, supplemented by research from advisers,” he says.

Further, the Government recently supported the “two strikes” proposal in its response to the Productivity Commission’s executive remuneration inquiry. This proposal would require that where there are two successive 25 per cent “no” votes on the remuneration report, a board-spill resolution would be triggered. Some pundits, however, caution that this change could give proxy advisers to super funds and other institutional investors even more power in an indirect sense – their recommendations could end up triggering a board spill.

Martin Lawrence, head of Australian and New Zealand research at proxy adviser RiskMetrics Group, responded to board criticisms of the proxy advisory industry in an interview. “Shareholders in Australia have lost a lot more money following the advice of directors than they ever have following that of proxy advisers,” he says.

There is no doubt proxy advisers wield a disproportionate amount of influence for firms their size. Australia’s two key proxy advisers, RiskMetrics and CGI Glass Lewis, have fewer than 15 full-time local staff between them. Their detractors say it is impossible for so few staff to assess complex governance matters across the top 200 or 300 ASX-listed companies, especially during the busy lead-up to the annual general meeting (AGM) season where scores of voting recommendations are made. Critics also argue that proxy advisers have inflamed the remuneration debate by focusing too much on pay and not enough on other key issues such as board composition or corporate strategy.

Even proxy advisers say resourcing is an issue. “It is a challenge, particularly during AGM season,” says Lawrence. “We have a core team of three researchers and a data team of five people based in Manila who tap into the global resources of our parent company when needed.”

Sandy Easterbrook, a prominent governance expert who founded and is now a consultant with CGI Glass Lewis, says the economics of proxy research in Australia make it hard to employ large research teams. “Like all proxy firms in small markets, we have to run a tight ship,” he says. “The local market is not big enough to support more proxy advisory firms. Having said that, we pride ourselves on the depth and quality of our research and we assess each situation on its merits. We are able to use Glass Lewis & Co’s global research capacity, including bringing in the firm’s overseas experts as needed, especially in areas such as mergers and acquisitions and dual-listed companies. We get a lot done with the resources available to us.”

Consider the economics of Australia’s proxy advisory industry. A funds management firm typically pays about $50,000 a year for proxy adviser research on the top 200 companies, more if the research covers the top 300 firms or includes tailored governance information. Less than 100 Australian fund managers and super funds are thought to subscribe to this research, which suggests proxy advisory firms have annual turnover in the low millions. Their business models simply cannot support large research teams.

This means a small number of researchers, some of them university students during busy periods, are providing crucial information that underpins voting recommendations on hundreds of large companies and increasingly affects board decisions. Their research is also informing giant superannuation funds. The Australian Council of Superannuation Investors (ACSI) provides its own proxy advice, based on its own corporate governance guidelines. ACSI’s 39 industry, corporate and public sector superannuation funds manage almost $300 billion on behalf of nearly six million beneficiaries. ACSI uses RiskMetrics’ company research in forming its voting recommendations.

It is a little wonder some boards are unhappy with proxy advisers. But these boards have a simple choice: complain about the low resourcing and rising influence of proxy advisers, or get on with the job of improving relations with these firms by better understanding their constraints in what is an emerging industry. The reality is that proxy advisers are here to stay and are likely to become better resourced and more influential over time as institutional investors pay even greater attention to governance as a driver of investment performance. Even more telling is that the ultimate owners of large companies – superannuation funds – seem to value proxy adviser research. Fund managers, which invest superannuation monies, are also paying more attention to proxy adviser research to ensure they receive the same information as their clients.

“We think proxy voting is very important”, says ACSI president Michael O’Sullivan. “Institutional investors seek recommendations from proxy advisers because the research is considerable. The voting decisions, however, always rest with the investor, not the proxy adviser. We have found proxy adviser research to be evidence-based and well researched. If anything, proxy advisers probably err on the side of conservatism when it comes to voting recommendations. They seem willing to engage with companies and listen to what they have to say before making recommendations to investors. I believe these firms are playing a useful role in improving governance standards in Australia.”

O’Sullivan’s comments are not meant to promote the work of proxy advisers. Rather, they show that investors who should matter most to boards – industry, public sector and commercial super funds – find proxy adviser research useful. Fund managers Company Director spoke to have a similar view. “We think proxy advisers do a pretty good job,” says George Clapham MAICD, managing director of one of Australia’s better performing funds, Fortis Investment Partners.

This trend will only strengthen over time as superannuation funds manage more money and pressure their suppliers – fund managers – to pay greater attention to governance and become more active and vocal in voting matters. Fund managers, meanwhile, face more long-term fee pressure and need to amortise the cost of detailed governance research across 200 or 300 companies by subscribing to proxy advisory services rather than doing it all themselves. Taken together, these trends suggest demand for governance research could grow substantially in the next decade.

The upshot is that boards are fighting a losing battle complaining about proxy advisers. More debate on this issue is overdue, but there is danger that the public comments of boards such as Lend Lease, which received a 41.8 per cent “no” vote on its last remuneration report, suggest that most boards have a frosty relationship with proxy advisers. That is not true. Many boards have made stronger efforts to meet superannuation funds and proxy advisers on governance matters that require clarification well before the AGM season.

“From my perspective, we usually have very useful and civilised meetings with companies on governance issues,” says Easterbrook. “Boards especially have stepped up their effort to engage with proxy advisers in the last few years. They are also getting better at coming to us earlier. In the past, boards would ask to talk to us just before their AGMs when everything was set in stone. We don’t agree on everything – for example, director independence can be a key sticking point – but I would argue our relationship with directors and senior executives is generally productive and appreciated on both sides.”

Proxy advisers clearly have limitations but there is some truth in their main defence: that some boards and fund managers are “shooting the messenger” when complaining about their voting recommendations. Certainly, it is easier for a fund manager to claim it was just following its proxy adviser when a board objects to its vote. The fund manager may not want to challenge the company directly and damage its relationship. The company may not want to attack a fund manager for fear it could sell its shares or destabilise the share register. To some extent, proxy advisers are convenient scapegoats.

Also, the evidence does not suggest fund managers blindly follow proxy adviser recommendations and abdicate their governance responsibilities to these firms. “We use proxy adviser research to benchmark companies across industries and markets on governance matters,” says Clapham, whose fund manages $5 billion. “We also devote considerable internal resources to governance issues and form our own views on voting decisions. We do not always follow proxy adviser recommendations. In some ways, it is a bit like stockbroking research. You look at the actual recommendation as only one of several information sources to help form your own view. Sometimes you agree with it, sometimes you don’t.”

AGM voting trends also support proxy adviser claims that institutional investors make their own voting decisions. CGI Glass Lewis recommended shareholders vote against 51 per cent of remuneration reports it analysed for top 300 companies in 2009. PricewaterhouseCoopers’ 2010 executive remuneration report found 68 per cent of top 100 companies had more than 90 per cent shareholder approval for their remuneration reports. This suggests institutional shareholders often have a different view to proxy adviser research.

“It is nonsense to suggest top fund managers simply outsource the voting decision to proxy advisers and are not forming their own views on governance issues,” says Easterbrook. “Voting statistics that have to be publicly disclosed simply do not back up that claim. Many institutional investors have their own internal resources assessing governance issues and making decisions. Our research is part of their information set, not the sole basis of how most large funds choose to vote.”

Another criticism of proxy advisers is of their expertise in detailed remuneration matters. In a letter to The Australian Financial Review in March, Egon Zehnder International partner Chris Thomas FAICD, wrote: “Opportunistically, such (proxy) advisers offered to provide remuneration reports despite the fact that then, and arguably now, their level of expertise to do so was highly questionable… Their expertise is quite narrow and, I argue, should remain focused on the implementation of pure governance maxims as was their original intent… Proxy advisers attempt to fit their ‘one-size-suits-all’ template to the remuneration report and, surprise, surprise, find out it often does not fit.”

John Egan FAICD, principal of remuneration consultancy Egan Associates, says proxy advisers have highlighted some important executive pay anomalies in recent years. “I believe these firms play a useful role in bringing pay ‘outliers’ to the attention of major shareholders,” says Egan. “They don’t get them all right, though my judgement is they provide a valuable service in identifying pay issues that require further research and consideration from institutional investors. However, remuneration is not the core expertise of proxy advisers, so I would be concerned if, say, a top 10 shareholder was following their voting recommendations on remuneration reports without doing further research or meeting with the company.

“Executive pay is complex and proxy advisers have to form a view on large numbers of companies in a very short period. Fund managers, too, have to make voting decisions in a short period, so we are seeing proxy advisers move closer to a ‘one-size-fits-all’ approach to voting recommendations. This does not work for companies that may have a genuine case when implementing an arrangement that is different. Such companies need an opportunity to state their case before proxy advisers decide on a voting recommendation.”

Another complaint – that proxy advisers are inaccessible and make recommendations without talking first to boards – also requires scrutiny. “I have a simple response to this,” says Lawrence. “Come and talk to us. Our door is always open and always has been. Don’t leave it to the week before your AGM when everybody is trying to see us and the pressure is on. We want to build long-term dialogue with boards to understand not just what they are doing on governance matters, but why. Suggestions that we are inaccessible are unfair.”

Perhaps the biggest potential problem is the growing influence of proxy advisers and the potential to glean price-sensitive information that has not been disclosed to the market. There is a fear that as proxy advisers become more powerful, their recommendations on issues such as executive pay could greatly affect share prices and provide ammunition for hedge funds or other short-sellers. “Our parent company has a very rigid policy that it will only consider information that is publicly available when making voting recommendations,” says Easterbrook. “And, we insist companies disclose information that may emerge through our discussions with them if it could be deemed to be price sensitive. Boards of large companies generally are very good in this regard and mindful they are not providing material information to proxy advisers that other investors do not have.”

O’Sullivan says the benchmark for ACSI members in any voting matter is good governance. “We provide our guidelines to companies, so there can be no surprises when we recommend voting in accordance with our guidelines. Our motive is simple – we believe well-governed companies will outperform over time, building sustainable wealth creation for our members whose living standards in retirement are 50 per cent dependent on Australian and global equity markets. Significant ‘no’ votes against some remuneration policies and a small number of board members have prompted a few complaints about the role of proxy advisors. Investors, not advisers, are responsible for their voting decisions. In ACSI’s case, our members are long-term owners who take their responsibility seriously. That is not going to change.”

Clearly both sides of the recent proxy adviser debate have merit. Arguably the biggest challenge for boards is ensuring the debate does not become an “us versus them” scenario where companies and proxy advisers are constantly at loggerheads. All that will do is create more negative headlines and shareholder angst, as the media sides with the views of proxy advisers over boards. It will also make it harder for boards to gain shareholder approval and get on with the job of governing their enterprise.

The sticking points

The main sticking points between boards and proxy advisers are:

1. Director independence

CGI Glass Lewis, for example, has a strict definition on director independence. Boards need to argue why they consider a director independent when the proxy adviser does not.

2. The audit committee

After the collapse of HIH Insurance and more recently, ABC Learning Centres, proxy advisers take a strong line on the audit committee’s independence – an issue that has improved in the past five years.

3. Executive pay

A continual sticking point. Boards need to explain to proxy advisers why their proposed remuneration policy differs from accepted benchmarks. Excessive pay, not enough “at risk” pay and long-term incentives that are too easy to achieve, are usually the main problems.

4. Director reputations

Increasingly, proxy advisers and superannuation funds are looking at the past “form” of a new director. Those who come from boards of failed companies are meeting resistance. Proxy advisers want to know why a director is being elected if his or her recent record is poor.

5. Board composition

This could become the next big target of proxy advisers and superannuation funds. Industry and public sector super funds, in particular, are questioning why boards have so few women on them.

Tips for boards

Tips for boards to deal with proxy advisers:

1. Treat them like other stakeholders

Good boards include proxy advisers in their ‘communication set’ and meet them on a structured basis, or as required. They ensure proxy advisers are abreast of key governance issues in the company.

2. Be proactive

Do not wait until there is a contentious issue before making contact with proxy advisers. Ensure the proxy adviser can assess the issue in the context of overall corporate strategy and goals.

3. Be early

The mistake too many boards make is approaching proxy advisers a week or two before their AGM, when they are usually swamped with work. A better approach is making use of “downturn” after reporting periods and AGM seasons for companies with 30 December and 30 June balance dates.

4. Understand the limitations

Know that proxy advisers have limited internal resources and can rarely devote days to understanding a particular company’s governance initiatives at short notice. Plan communication around this limitation.

5. Do not disclose material information

There is a risk that companies disclose price-sensitive information when explaining their governance or remuneration initiatives to a proxy adviser. Ensure proxy advisers base their decisions on publicly available information.

6. Agree to disagree

There may be times when a board must stand its ground when a proxy adviser says it will vote against a matter. The board may believe the proxy adviser’s view is incorrect, or that its decision is in the best long-term interests of shareholders. The challenge is understanding each party’s point of view and accepting there is an irreconcilable difference on this occasion.

7. Keep disputes indoors as much as possible

Attacking a proxy adviser publicly over a “no” vote recommendation just provides more ammunition for headline writers in business news pages, and shareholder activists. Right or wrong, it can suggest a board is “attacking anybody who dares challenge it”. The best response is often no response.

Q&A with Graham Bradley

Company Director asked one of Australia’s most prominent chairmen, Graham Bradley AM FAICD, for his views on proxy advisers. Here is the Stockland chairman’s response:

Company Director (CD): Do proxy advisers have too much power in your opinion?

Graham Bradley (GB): Any power they have is granted by the institutional investors who subscribe to their research. If I have a criticism, it is that institutional investors should take greater personal interest in corporate governance issues and make their own judgements based on their own inquiries, supplemented by research from advisers. I am concerned that some institutions and super trustees have mandates or rules that require them to engage proxy firms and are forced to follow their advice. This mechanistic approach is not in investors’ best interests and is dangerous.

CD: Is there a better model for institutional investors to use proxy advice?

GB: I do know of alternative models that work much better. For example, one very large institution I know requires its chairman to be notified if a portfolio manager proposes to vote against any resolution supported by a board of directors. The chairman can then take a personal view on whether the proxy adviser is right. This approach has worked successfully in cases I know and has avoided a very mechanistic voting approach.

CD:Do proxy advisers give boards a fair hearing?

GB: The practice varies between firms, but boards generally do not always have enough opportunity to state their case to proxy firms. Having said that, it is incumbent on chairmen to contact proxy firms and discuss with them any contentious resolutions well before the notice of meeting is issued. In my experience, proxy advisers sometimes misinterpret statements in annual reports that could be easily cleared up if the chairman had more opportunity to discuss their concerns before they issued their voting recommendation.

CD: How else could proxy advisers better engage boards?

GB: It is important that proxy advisers have a clear code of conduct in how they interact with boards. They should have a written policy of always discussing contentious matters with companies before they issue their recommendations. They must be clear about whether these conversations are on or off the record. If they quote people, they should do so by name and they should check their comments first before publishing them. I have had some poor experiences with proxy advisory firms in this regard. A more transparent code of ethics in this industry would certainly help.

CD: A frequent criticism of proxy advisers is they lack detailed expertise on remuneration matters. What is your view?

GB: It is not surprising that proxy advisers focus so much on executive pay. Few other proposals are voted on by shareholders. I have sometimes found proxy advisers to be overly formulaic in how they approach pay. They typically favour a narrow range of approaches for setting performance hurdles for long-term and short-term incentives and are less willing to consider non-standard approaches. This has constrained the willingness of boards to devise remuneration structures best suited to particular company circumstances. It has led to boards being pressured to use inflexible, hardwired formulas on remuneration simply because that is what proxy advisers see as being auditable. In my experience, proxy advisers can be flexible on remuneration arrangements if you argue your case early, clearly and forcibly. I have done this on several occasions and averted negative votes.

CD: Proxy advisers are being quoted more frequently in the media? Should they stay out of the headlines and deal with company matters privately.

GB: It is understandable the media turns to them for comments. In my view, these firms should comment on general trends, rather than specific company situations.

CD: How can boards better engage proxy advisers?

GB: I view proxy firms as an inevitable part of the corporate eco-system. They have a role to play and need to be treated seriously. We should be mindful that proxy firms don’t have a lot of resources, especially around AGM season. You will get a better hearing if you meet them early and are known to them. But do not focus only on proxy advisory firms. Boards should also state their case directly to institutional investors as well, so they can form their own judgements on contentious issues. This should lead them to view issues differently from their proxy advisers.