Creating a foundation for a substantive debate on proxy-access proposals
If shareholder proposals on proxy access—that is, the ability of certain large shareholders to have their own slates of nominees to corporate boards included in the proxy materials companies must distribute ahead of their annual meetings—were candidates running for election, they could be thought of as running unopposed. That is, ever since the Office of the Comptroller of New York City (comptroller) launched its proxy-access initiative in the fall of 2014, there has been little public response from the community of public companies and others who do not believe proxy access is good for corporate governance.
As a result, the advocates for proxy access are winning the public debate hands down. Not surprisingly, the comptroller and other shareholder activists have been quite successful in gaining significant shareholder support for these proposals and many corporate boards have felt compelled to implement proxy access without even requiring a shareholder vote.
One very important reason for this lack of response has been the inability to provide substantive arguments that explain why the documents provided as evidence supporting proxy access are lacking or inappropriate to make the argument that proxy access enhances shareholder value. This inability to respond is strikingly clear when dealing with proxy-access proposals that cite as support the CFA Institute report on proxy access, Proxy Access in the United States: Revisiting the Proposed SEC Rule, and/or the draft empirical study on proxy-access proposals done by Tara Bhandari, Peter Iliev and Jonathan Kalodimos, Public versus Private Provision of Governance: The Case of Proxy Access.
For the 2017 proxy season and beyond, those who oppose proxy access must do a better job to provide substantive responses to these documents. To help in that effort, I have written two papers, Critiquing; and What Shareholder Proposals on Proxy Access tell us about its Value, which vet the two documents noted above and, in the process, provide substantive arguments that respond to their use as support for proxy-access proposals.
Critiquing the CFA Institute’s Report on Proxy Access (R Street Institute policy brief)
The CFA Institute report on proxy access was originally written to encourage the Securities and Exchange Commission (SEC) to put mandatory proxy access back on its agenda. The report takes a marketwide approach in trying to estimate the value of proxy access; it does not pretend to estimate the value of proxy access at any specific company. Nevertheless, shareholder proposals on proxy access invariably reference the CFA Institute report and its finding that mandatory proxy access could raise overall U.S. market capitalization by up to $140.3 billion.
While it does not appear appropriate to use the generalized findings of the CFA Institute report as support for any one shareholder proposal on proxy access, it’s even more important to note that the report should not be used in any circumstance as support for proxy access. As explained in my R Street Institute policy brief, the report is full of errors, including a major error in the $140.3 billion calculation. It’s also rife with contradictions and practices of questionable methodology. As stated in my policy brief, “A closer look reveals shortcomings that should disqualify the CFA (Institute) report from being used as support for mandatory proxy access; for shareholder proposals on proxy access; for board discussions about whether a proxy-access bylaw should be implemented; and, perhaps most importantly, for board discussions about whether a proxy-access bylaw needs to be rescinded.”
It is perhaps most disturbing to note that the report was heavily used by shareholder activists for 18 months before its first formal vetting in my R Street policy brief. No doubt, the use of this report helped garner shareholder support for proxy-access proposals during the time when the report’s findings went unchallenged.
In sum, the lesson to learn is that all statistical work, no matter how impressive-looking or how prestigious the source, needs to be vetted properly before it is used as authority in any debate, including the debate on proxy access. Vetting is no fun but it needs to be done.
What Shareholder Proposals on Proxy Access tell us about the Value of Proxy Access (forthcoming, Yale Journal on Regulation Online)
Not all vetting leads to debunking someone else’s work. Sometimes, it leads to an interpretation of the results of a well-done study that differ from what the authors believe them to demonstrate. This is how I interpret my vetting of the Bhandari, Iliev and Kalodimos (Bhandari) event study on proxy access, which originated in the SEC’s Division of Economic and Risk Analysis and is the only empirical work to date that tries to estimate how much the stock market values shareholder proposals on proxy access.
Bhandari focused their study on the day the comptroller unexpectedly announced its proxy-access initiative to the public, Nov. 6, 2014. Bhandari found the announcement led to a positive, statistically significant 0.53 percent abnormal return for the 70 firms that they used in their sample. Moreover, as discussed in my paper, they interestingly found a strong correlation between the returns generated on this event date and the returns of the sample on the date, approximately four years earlier, when the SEC announced it was going to stay the implementation of its universal proxy-access rule.
The main problem with the study is that it lacks external validity. That is, the results cannot be generalized to the market as a whole. The sample clearly suffers from selection bias, resulting in a lack of randomness. Of the 75 companies targeted by the comptroller, 20 were from the petroleum and natural gas industry, nine from the utilities industry and another six from the coal industry. This sample is significantly overweighed with firms that are either producing or consuming huge quantities of carbon-based fuels. Moreover, the sample size is small, so it’s not possible to support the overall result with cross-sectional analysis.
Even if the results lack external validity, one result that deserves review is the large impact the comptroller’s announcement had on the target sample, a 0.53 percent average abnormal return. It is hard to understand why was the return so large, given that the proposals were nonbinding; uncertainty existed over whether they would win approval by shareholders or be implemented by the board even after shareholder approval; whether shareholders had the wherewithal or desire to ever use their right to nominate, even if it were implemented; and if they did use their right to nominate, if any of their nominees would actually win election. Moreover, the proposals effectively excluded activist hedge funds from participating in proxy access because of the required three-year holding period.
Other factors include the study’s finding that the comptroller was not specifically targeting poor-performing firms that could benefit the most from proxy access and the study controlled for abnormal returns generated by the industries where the target firms belonged. Most importantly, proxy access does not exist in isolation from the markets for corporate control (friendly and hostile takeovers through mergers and acquisitions) and influence (shareholder activism including hedge-fund activism), the primary means by which board members are replaced outside of board-nominating committees.
A possible explanation for this counterintuitive result is that one or more independent variables, not specified in the event study’s regression equation, may have caused the abnormal return. That is, there may be omitted variables that are correlated with both a company receiving a proxy-access proposal from the comptroller and the abnormal returns generated by the shares of the target firms on the event date.
One possible variable could be the level of dissatisfaction a company’s shareholder investor base currently has with the board. If correct, then we should interpret the appearance of a proxy-access proposal as a confirming signal to the market that there is a high level of shareholder dissatisfaction with the board, making the company vulnerable to a takeover (friendly or hostile) and hedge fund activism. Such a proposal is a clear signal to the market that the board may be vulnerable to these market forces, especially when the stock price has been under pressure. Therefore, the increased potential for hedge-fund activism or acquisition activity may be what is really being reflected in the abnormal returns found in the Bhandari study and not the market’s estimation of the value of proxy access as a stand-alone tool for enhancing corporate governance.
Finally, the value of the Bhandari study is limited because it focuses on the abnormal returns generated at one point in time—the date the comptroller announced its proxy-access initiative. As a result, it is possible that, as the market becomes more informed about the real impact of the event on corporate decision-making, it may change its opinion on how such an event affects shareholder value.
In sum, while the Bhandari study is an important first step to understand the value of proxy-access proposals, to become truly informed about its value, much more data and analysis is required; something that will most likely take a number of years to produce.
