The Proxy Advice Industry and Common Owners’ Coordination

Do high levels of common ownership weaken product market competition? The concentration of ownership to large institutional investors means that many competing firms today end up sharing the same owners. In theory, it would be in investors’ financial interests that commonly held firms competed less intensely. Holding minority stakes, however, in practice, institutional investors don’t have the power to significantly influence firms.

The most influential participants in the stewardship ecosystem – proxy advisors – have thus far been overlooked in this debate. Proxy advisors issue recommendations to investors on how to vote at shareholder meetings. The largest proxy advisor, Institutional Shareholder Services (ISS), is used by 70% of institutional investors. Most institutional investors rely heavily on proxy advisors when they cast their votes and passive investors, in particular, often outsource voting completely to proxy advisors. Studies have found that ISS can influence as much as 25% of investors’ votes, which is multiples of any individual institutional investor’s voting power.

In a recent working paper, I study how proxy advisors, by coordinating investors’ interests, can lower competition for commonly held firms. As private, for-profit businesses, proxy advisors get their revenue from fees paid by their clients. They have a fiduciary duty, i.e. a legal obligation to act in the best interest of their clients. Empirical studies have shown that proxy advisors cater to their clients’ interests, by updating their recommendations when clients have disagreed with their advice in the past. In a theoretical framework, I show that a proxy advisor maximizing client value would promote softer competition for firms with higher levels of common ownership. Importantly, this is not a result of collusion but rather what happens if the proxy advisor fulfils its fiduciary duty.

I investigate this using data on ownership structure and shareholder meetings for all publicly listed U.S. firms from 2003 to 2017. I find that common ownership among investors advised by ISS is significant. I measure common ownership based on my theoretical framework, by aggregating the cashflow rights investors hold across competing firms. These high levels of common ownership indicate that the incentives for ISS to promote softer competition are empirically important.

I then analyze whether ISS is more likely to promote corporate governance decisions that soften competition for firms with higher levels of common ownership. I focus on three decisions that are central for how firms compete and examine the voting advice given by ISS. First, I study director elections that result in competing firms sharing a board member. Interlocking directors across competing firms are prohibited by the Clayton Act, but in practice the law is rarely enforced. Firms that share an interlocking director have been found to compete less intensely, by setting higher prices and being more likely to collude. Second, I investigate mergers, which is a major focus area of antitrust authorities. A large empirical literature finds that consolidation generally reduces competition and leads to higher prices. Third, I look at managerial incentives, specifically equity compensation. Managers whose compensation is more tightly linked to firm performance have stronger incentives to compete and equity compensation is commonly used to align managers’ incentives with firm performance. The results suggest that ISS is more likely to promote decisions that soften competition for firms with higher levels of common ownership. For board members, in particular, I find that an increase in common ownership from the 10th to the 90th percentile implies that ISS is 3 percentage points more likely to support an interlocking director, with the effects on mergers and managerial incentives being lower but also statistically significant.

Not only do publicly traded firms share the same owners, these investors generally rely on the same proxy advisor when they vote at shareholder meetings. By bringing attention to the coordinating role of proxy advisors, I show how competition can be softened for commonly held firms. This has important economic implications as ISS’ clients hold USD 22 trillion in assets and control around 20% of the equity traded on U.S. stock markets. 

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By Tove Forsbacka (Norwegian School of Economics)

This article is Part Four of a five-part blog series covering insights from the SHoF-ECGI Corporate Governance Conference. Explore the rest of the posts: read Part One here, read Part Two here, read Part Three here, read Part Four here.

For an in-depth reflection on the working paper “The Proxy Advice Industry and Common Owners’ Coordination”, read the issue # 8 of Debrief, ECGI’s monthly members’ newsletter.

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