Information Intermediary or De Facto Standard Setter? Field Evidence on the Indirect and Direct Influence of Proxy Advisors

• Author: MARSHALL VANCE,CHRISTIE HAYNE
• Published date: 01 September 2019
• Date: 01 September 2019
• DOI: http://doi.org/10.1111/1475-679X.12261

DOI: 10.1111/1475-679X.12261

Journal of Accounting Research

Vol. 57 No. 4 September 2019

Printed in U.S.A.

Information Intermediary or De

Facto Standard Setter? Field

Evidence on the Indirect and Direct

Influence of Proxy Advisors

CHRISTIE HAYNE

∗AND MARSHALL VANCE

†

Received 1 December 2017; accepted 26 January 2019

ABSTRACT

We examine whether proxy advisory firms (PAs) serve primarily an informa-

tion intermediary role by providing research and voting recommendations to

shareholders, or directly influence executive compensation by exerting pres-

sure on firms to adopt preferred pay practices. Through a field study, we find

that PAs are perceived as both information intermediaries and agenda set-

ters and that these roles provide leverage to enable PAs to exercise significant

influence over executive pay practices. Boards feel, and sometimes yield to,

pressure to conform to PA “best” practices despite their own preferred com-

pensation philosophies, even in the absence of overt PA scrutiny or negative

∗Gies College of Business, University of Illinois at Urbana-Champaign †Pamplin College of

Business, Virginia Tech.

Accepted by Douglas Skinner. We would like to sincerely thank the compensation

professionals who agreed to participate in this research. We also appreciate the in-

sightful comments from an anonymous reviewer, Clara Xiaoling Chen, Fabrizio Ferri,

Matt Kaufman, Eldar Maksymov, Ken Merchant, Natalia Mintchik, Abbie Smith, and

Michael Williamson, as well as workshop participants at the 2018 AAA Management

Accounting Midyear Meeting, the 2017 BYU Accounting Research Symposium, and

the University of Illinois at Urbana-Champaign. We thank Ying Gao, Julianna Lyle,

Rachel Lyle, and Sarah Zieve for valuable research assistance. We greatly appreciate

the financial support provided by a grant from the Chartered Institute of Manage-

ment Accountants (CIMA). An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements

969

CUniversity of Chicago on behalf of the Accounting Research Center,2019

970 C.HAYNE AND M.VANCE

shareholder votes. We also find that PAs are susceptible to conflicts of in-

terest and generally use a “one-size-fits-all” approach to voting recommenda-

tions. Overall, however, PAs are viewed as improving compensation practices

by increasing transparency and accountability and fostering dialogue between

firms and their shareholders.

JEL codes: G230; G340; M410; M520

Keywords: executive compensation; corporate governance; proxy advisors;

field study

[P]roxy advisory firms play an important and useful role in enabling effec-

tive and cost-efficient independent research, analysis and informed proxy

voting advice.

Council of Institutional Investors

Letter to the House Committee on Financial Services [2016]

Given the huge percentage of the vote likely controlled by ISS and Glass

Lewis, the failure of an issuer to comply with those firms’ preferred policies

saddles issuers with a large number of negative votes before voting has

even begun. . . . As a result, ISS and Glass Lewis have become the de facto

standard setters for corporate governance policies in the U.S. (emphasis

in original)

Harvey Pitt, former SEC Chairman

Statement of the U.S. Chamber of Commerce [2013]

1. Introduction

Proxy advisory firms (PAs) are considered important and useful by some

and overbearing by others, as highlighted by the foregoing quotes.1On

the one hand, PAs fill an information intermediary role by processing large

amounts of information and providing voting recommendations to institu-

tional investors on matters such as executive compensation and governance

(Ertimur, Ferri, and Oesch [2013], McCahery, Sautner, and Starks [2016],

Ertimur, Ferri, and Oesch [2017]). On the other hand, critics contend that

PAs have outsized influence on proxy voting outcomes, which potentially

allows them to exert pressure on firms to adopt PAs’ preferred practices

(Larcker, McCall, and Ormazabal [2013, 2015]). While these views are not

mutually exclusive, examining PAs’ role(s) is important for understanding

executive compensation design. If PAs primarily serve as information in-

termediaries, their influence on compensation practices likely occurs only

indirectly through their ability to facilitate investors’ monitoring through

shareholder votes. If PAs can apply pressure on firms to adopt favored

1PA firms are hired by institutional investors to provide research and voting recommenda-

tions in advance of shareholder votes. We provide additional background on PAs in section 2

and the appendix and refer readers to a recent report by the Government Accountability

Office (GAO) for a more extensive discussion (GAO [2016]).

THE INDIRECT AND DIRECT INFLUENCE OF PROXY ADVISORS 971

compensation practices, they may be able to directly influence compensa-

tion practices. In this latter case, the effect of PA influence depends on the

quality of PA recommendations.

To date, research on PAs’ role has primarily focused on the perspec-

tive of institutional investors (Iliev and Lowry [2015], Malenko and Shen

[2016], McCahery, Sautner, and Starks [2016]), and PAs’ influence on firm

practices is generally inferred based on responses to shareholder votes

(Ertimur, Ferri, and Oesch [2013], Larcker, McCall, and Ormazabal

[2015]). Ultimately, whether PAs influence executive compensation prac-

tices depends on how internal stakeholders responsible for designing com-

pensation (i.e., board directors with support from human resources [HR]

executives and compensation consultants) perceive the role of PAs, which,

in turn, helps determine how these stakeholders respond to PA recommen-

dations. Thus, key questions include (1) How do internal stakeholders per-

ceive the role(s) of PAs, and, relatedly, how do they respond to their in-

fluence in terms of compensation design? and (2) How do internal stake-

holders perceive the quality of PA recommendations and the resulting in-

fluence on compensation practices? Our purpose is to shed light on these

questions. While our primary focus is on the perspective of internal stake-

holders, it is also important to consider these issues from the perspective of

the PA firms. Therefore, we also consider how representatives at PA firms

perceive their role and respond to the criticisms concerning the quality of

PA recommendations.

Field research methods are well suited to investigating “how” questions

as well as providing understanding of the context and the process through

which individuals evaluate alternatives and make decisions (Myers [2009],

Yin [2014]). We conduct 37 interviews with board directors, HR executives,

and compensation consultants of mainly mid-, large-, and mega-cap pub-

lic companies to understand how they view the role and influence of PAs

with respect to compensation design. We find that PAs are perceived as

having broad indirect influence on compensation practices by supporting

investors’ monitoring efforts through an information intermediary role.

However, we also find evidence that PAs wield direct influence by identi-

fying preferred practices and enforcing their adoption through voting rec-

ommendations. Respondents overwhelmingly view PAs’ recommendations

and general guidelines as “telling them what to do,” and frequently share

examples of PAs’ influence on their compensation design choices.

We provide rich examples of design choices made in direct response

to PAs’ firm-specific vote recommendations in addition to their general

guidelines. For example, the selection of performance measures (especially

total shareholder return [TSR]) as well as the use of equity compensa-

tion (especially stock options), tax gross ups, and single trigger change-in-

control agreements are frequently identified as influenced by PAs. In some

cases, design changes are made to conform to known PA preferences even

when the changes go against what the board believes is optimal given the

company’s unique circumstances. We find broad influence from PAs even