Do Not fear the Critic: How Proxy Advisors Improve Shareholder Decisions in India

Why in News?

• In the complex world of corporate governance, proxy advisors (PAs) play a crucial yet often contentious role.
• Their influence comes under scrutiny particularly when their recommendations lead to significant shareholder actions, such as the rejection of resolutions or the approval of controversial proposals.
• The dynamics between proxy advisors, corporations, and investors reveal much about the balancing act required to maintain fair and effective governance.

Function and Perception Challenges of Proxy Advisors

• Critical Function of Proxy Advisors
  • The core function of proxy advisors is to scrutinise and evaluate company proposals, governance practices, and overall corporate conduct.
  • They examine a wide range of issues, including executive compensation, board appointments, mergers, and acquisitions, and environmental, social, and governance (ESG) policies.
  • By conducting thorough analyses, proxy advisors offer voting recommendations that aim to align corporate actions with the best interests of shareholders.
• Perception Challenges and Criticism
  • Despite their valuable contributions, proxy advisors often face criticism for their critical nature.
  • Companies and their management teams may perceive PAs as adversarial because their recommendations frequently highlight deficiencies or risks.
  • This perception is akin to a doctor diagnosing an ailment – necessary but not always welcome.
  • One significant point of contention is the interpretation of laws and governance standards.
  • Proxy advisors sometimes develop their own benchmarks and criteria, which can differ from the interpretations held by companies.
  • This divergence can lead to friction, as companies may feel that PAs are setting unrealistic or overly stringent standards.

How Proxy Advisors Improve Shareholders Decision in India: Support System for Investors

• Institutional investors, such as pension funds, mutual funds, and insurance companies, often rely on the expertise of proxy advisors to navigate the complexities of corporate governance.
• While investors have their own research capabilities, proxy advisors offer additional insights and perspectives that complement their analyses.
• This symbiotic relationship enhances the decision-making process, ensuring that investors can cast their votes with a comprehensive understanding of the issues at hand.
• In India, the reliance on proxy advisors is evident, yet it is also clear that institutional investors do not follow these recommendations blindly.
• Of the 1,841 resolutions on which SES recommended an against vote in 2023-24, only 55 were rejected, indicating that investors use these recommendations as one of many tools in their decision-making arsenal.

High-Profile Cases and the Perception of Power Surrounding Proxy Advisors

• Proxy advisors attract attention in cases where their recommendations lead to notable outcomes.
• For instance, the rejection of Nestle’s royalty payout and the diverging views on the demerger of ITC Hotels highlight their potential influence.
• Yet, instances like ICICI Securities delisting and Tata Motors DVR proposal, where PAs were united and investors approved the proposals despite some protests, showcase that proxy advisors do not always hold sway.
• Here, institutional investors often conduct their own analyses,using proxy advisors as a supportive tool rather than a decisive authority.

An Analysis of Expertise and Limitations of Proxy Advisors

• Expertise and Scope
  • Proxy advisors possess a broad understanding of governance principles and regulatory requirements, which allows them to evaluate corporate proposals across diverse industries.
  • However, their expertise is inherently generalised due to the wide range of companies they cover.
  • Proxy advisors, like Stakeholders Empowerment Services (SES), provide recommendations based on general governance principles applicable across various sectors.
  • This general expertise helps ensure a standard approach to governance but may miss the intricacies of specific industries.
• Valuation Limitations
  • Valuation is one area where proxy advisors face significant limitations.
  • While they can raise concerns about potentially unfair valuations, they lack the in-depth expertise of specialised financial analysts.
  • Valuation is often described as an "art" rather than a precise science, and proxy advisors typically rely on independent valuations to mitigate biases.
  • This reliance on external valuations underscores their limited capacity to conduct detailed financial assessments
• Information and Access Constraints
  • Proxy advisors base their recommendations on publicly available information and disclosures provided by companies.
  • This reliance means they might not have access to the full context or strategic considerations that inform board decisions, potentially leading to recommendations that do not fully align with the company’s long-term objectives.
  • The effectiveness of proxy advisors' recommendations often hinges on the quality of communication from companies.
  • Inadequate disclosures or lack of detailed rationales can result in negative recommendations, not necessarily because the proposals are flawed, but due to insufficient information.

Case Studies on Practical Limitations and Expertise of Proxy Advisors

• ICICI Securities Delisting
  • In this case, proxy advisors supported the delisting proposal, which was also backed by most institutional investors.
  • However, some investors raised concerns about the valuation basis and the use of the National Company Law Tribunal (NCLT) scheme.
  • This scenario illustrates the complexity of valuation issues and the need for transparent decision-making processes to address diverse investor expectations.
• Tata Motors DVR Proposal
  • Here, an individual investor opposed the proposal, arguing for an exchange ratio that ignored the market price difference.
  • Proxy advisors and most institutional investors supported the proposal, highlighting the challenge of balancing individual investor concerns with broader market realities.
  • This case underscores the importance of clear, fact-based communication to counteract misconceptions and unfounded expectations.

Future Directions to Enhance Effectiveness of Proxy Advisors

• Enhanced Collaboration: Nurturing better communication and collaboration with companies can help proxy advisors gain deeper insights into strategic rationales, improving the quality and relevance of their recommendations.
• Specialised Expertise: Developing industry-specific expertise within proxy advisory firms can provide more nuanced and informed recommendations, particularly for complex sectors where generalist knowledge may fall short.
• Transparency and Accountability
  • Proxy advisors should continue to enhance their transparency, disclosing their methodologies and criteria clearly.
  • This transparency can build trust with both investors and companies, reinforcing the credibility of their recommendations.
• Stakeholder Engagement: Engaging with a broader range of stakeholders, including minority shareholders and industry experts, can help proxy advisors incorporate diverse perspectives and improve the comprehensiveness of their analyses.

Conclusion

• Proxy advisors serve as a critical component in the corporate governance ecosystem, providing essential oversight and recommendations to investors.
• While their influence and methodologies may sometimes be contentious, their role in promoting higher standards of governance and transparency is indispensable.

The ongoing evolution of this industry will hinge on its ability to maintain independence and effectively balance the interests of all parties involved. 

Q) What are the main limitations faced by proxy advisors in their role within corporate governance?

Proxy advisors face several limitations, including their generalist expertise across various industries, which might miss industry-specific nuances. They also operate with limited access to comprehensive information available to company boards, relying on publicly available data and disclosures. Additionally, their critical nature can lead to perceptions of being overly adversarial, and maintaining independence and objectivity is a constant challenge, especially in avoiding conflicts of interest and ensuring unbiased recommendations.

Q) How can proxy advisors improve their effectiveness and address the challenges they face?

Proxy advisors can enhance their effectiveness by fostering better communication and collaboration with companies to gain deeper insights into strategic decisions. Developing specialised expertise within their firms for more nuanced recommendations, particularly in complex sectors, is also crucial. Improving transparency about their methodologies and engaging with a broader range of stakeholders can build trust and ensure more comprehensive analyses. Finally, providing balanced, constructive feedback can help mitigate perceptions of adversarial criticism and promote a more cooperative approach to governance improvement. 

Source:The Indian Express