ISS: Friend or foe to stewardship?

20 June 2018

The influence of ISS on voting outcomes in the UK is overstated, but still material 

The role of shareholder advisory agencies such as Institutional Shareholder Services (ISS) is coming under increasing focus around the world. Accused of wielding power without responsibility, they are frequently blamed by issuers of having undue influence on voting outcomes. This brings into scrutiny their processes and methodologies, and has given rise to calls for tougher regulation. 

This could be seen as a strange reaction. After all, it is shareholders themselves that are responsible for voting proxies - advisory firms advise, shareholders decide. If shareholders rely on adviser recommendations in an unthinking manner, whose fault is that? Surely not the adviser. 

In the UK it is ISS, as the dominant advisory firm, that finds itself the subject of most attention from boards who may blame it for “causing” high votes against shareholder resolutions - particularly on pay. Data shows an average vote against of c. 35% when ISS makes a negative recommendation. This leads to some people equating the influence of ISS to that of a 35% shareholder. But correlation does not imply causation. Is ISS causing the high level of vote against, or is it simply the case that many shareholders would in any case agree with the ISS assessment? ISS would not be doing a very good job of anticipating shareholder concerns if there was no correlation between its recommendations and voting outcomes.

There is academic evidence from the US that ISS recommendations do indeed have a causal impact on voting outcomes, with an AGAINST recommendation costing 25% points on the vote on average. We decided to look at the issue for the UK to see if there was a similar strength of impact. Using data from Proxy Insight we looked at how shareholder voting behaviour differs in response to ISS recommendations, depending on whether the investor is towards the top of a company’s register or not. We also looked at how, on a given resolution, the voting in the top of a company’s register differed from that of the tail. Using this device we were able to obtain strong indicative (although not completely conclusive) evidence about the causal impact of ISS recommendations. You can read the full report here.

We found that ISS does indeed appear to have a causal impact on voting outcomes in the UK, of the order of 10% to 15% points. This is much less than the c. 35% impact commonly attributed to ISS, but is still material. Particularly in the context of a 20% vote against triggering requirements under the UK Corporate Governance Code, and resulting in a company being logged on the Investment Association’s Public Register. 

What do we conclude from all this? Companies can’t just use an ISS recommendation as excuse for a low vote. A negative ISS recommendation can increase opposition, but isn’t the sole cause. A company getting a large vote against will have done something to displease at least some of its largest shareholders. However, although not as being as great as commonly inferred, ISS does have a material casual impact on voting outcomes, of c. 10% to 15% points in the case of an AGAINST recommendation. This impact is particularly strong in the tail of a company’s shareholder register. 

This is really a problem for shareholders to address. Does unthinkingly following a proxy adviser recommendation just because an investor has a low stake in a company constitute good stewardship? Given the implications, investors should be more thoughtful about how they use these recommendations. But although this is fundamentally a problem for investors, ISS also has a role to play. There are aspects of how ISS engages with companies, issues recommendations, and uses quantitative methodologies that could be improved, in acknowledgement of the influence they have. Without voluntary change, the calls for enforcing regulation will grow. 

This would be unfortunate. Shareholder advisory agencies play an important role in helping investors conduct stewardship. By lowering costs of standard information gathering and analysis, they enable engaged shareholders to monitor companies more efficiently. This is good for stewardship and for the functioning of capital markets. Regulation is frequently heavy-handed, has unintended consequences, and would likely end up stifling competition if onerous requirements were placed on shareholder advisory firms. That would be counterproductive.

The advisory firms themselves are currently reviewing their voluntary Best Practice Principles. This is an opportunity for the firms to reinforce the important role they play in stewardship. It is always better to embrace change than to have it forced upon you.

I wrote this article while a Partner at PwC so references to ‘we’ or ‘our’ should be taken to refer to PwC

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