Empowering Shareholders Will Help Reduce Proxy Advisory Firm’s Undue Influence

Titans of Wall Street have become vocal advocates for environmental, social, and governance (ESG) investing – including leaders of the world’s largest asset managers, banks, and other financial institutions.

Less well known proponents, but perhaps even more influential, are the proxy advisory firms ISS and Glass Lewis, who control 97 percent of the proxy advisory market. Proxy advisory firms advise institutional investors (like Vanguard, BlackRock, and State Street) and dozens of state retirement systems on how to vote on the thousands of shareholder resolutions which arise every year.

Despite all this enthusiasm, there are reasons for skepticism. As I have documented here, here, here, and here, ESG investing is far from the panacea its proponents claim.

What is true for investing also applies to the many ESG proxy questions raised at companies’ annual meetings. Institutional investors are required (or believe they are required) to vote on all proxy measures at shareholder meetings and rely on proxy advisory firms to manage this herculean task.

The problem arises because ESG proxy measures often have adverse impacts on companies’ operations. Nevertheless, ISS’ and Glass Lewis’ recommendations support ESG proxy measures most of the time – and much more often than the largest asset managers. This is disconcerting because these advisory firms’ have substantial conflicts of interest with respect to ESG.

Starting with ISS, the company was one of the first creators of ESG metrics such as its Environmental & Social (E&S) Quality scores. In early 2018, ISS described these metrics as a

data-driven approach to measuring the quality of corporate disclosures on environmental and social issues, including sustainability governance, and to identify key disclosure omissions.

The company currently has a program known as ISS ESG. According to their website,

ISS ESG solutions (ISS-ethix, ISS-climate and ISS-oekom) provide ESG screening, ratings and analytics designed to enable investors to develop and integrate responsible investing policies and practices into their investment strategies.

As for Glass Lewis, the company has formed a strategic partnership with Sustainalytics, which Glass Lewis describes as “the leading independent provider of global governance services”. Glass Lewis

features data and ratings from Sustainalytics in the ESG Profile section of our standard Proxy Paper reports. The goal is to provide summary data and insights that can be efficiently used by clients as part of their process to integrate ESG factors across their investment chain, including effectively aligning proxy voting and engagement practices with ESG risk management considerations.

Glass Lewis’ 2021 ESG Initiatives Guidelines made their biases explicit when they claimed climate change is so important that

we will generally recommend in favor of shareholder resolutions requesting that companies provide enhanced disclosure on climate-related issues, such as requesting that the company undertake a scenario analysis or report that aligns with the recommendations of the Task Force on Climate-related Financial Disclosures.

These programs exemplify their clear conflicts of interest with respect to their advice to clients on ESG-related proxy questions. Despite this conflict of interest, the proxy advisory duopoly wields undue influence over the voting behavior of asset managers. According to a 2021 Harvard Law School publication, institutional investors who managed more than $5 trillion in assets automatically voted the ISS or Glass Lewis recommendations without any further scrutiny (a practice referred to as robovoting).

The combination of ESG’s questionable results, the proxy advisory firm’s clear conflict of interest, and their influence over how pension fund managers vote is now garnering warranted scrutiny. Twenty-one Republican Attorneys General are questioning both proxy advisory firms regarding whether each firm’s ESG advocacy violates their fiduciary responsibilities. Explicitly citing the duopoly’s climate change policies, the AGs suggest the firms may be potentially violating their “fiduciary duties,” “contractual obligations,” and “legal duties.”

There is a simple solution to the conflicts created by the proxy advisory duopoly. Since asset managers invest on behalf of the actual investors – the everyday workers, investors, and pensioners that put their money into the funds – the right to vote on all proxy measures should be passed on to these shareholders. As a result, the actual investors would be able to vote their own shares and express their personal beliefs on these important business issues.

Toward this end, BlackRock recently expanded their “shareholder democracy” effort, stating

We believe that voting choice can empower more asset owners to have a deeper and more direct connection to the companies they are invested in and allow company management to better understand the views of these asset owners on critical governance issues.

Empowering the actual shareholders of the company to express their views on ESG issues will help remove the excessive influence of the proxy advisory duopoly over the corporate boardroom, including ESG issues. It will also force ESG issues to pass or fail based on their proponents’ ability to convince shareholders of their value rather than the biases of proxy advisory firms. Ultimately, such a process creates a more effective corporate management environment.