Paid Proxy Firm Consulting with Issuers is Very Bad
Friday, August 21, 2020
You have heard it for years, certain proxy firms, except for Egan-Jones, have an unforgivable conflict of interest: they get paid to consult with the very firms they rate and recommend votes on. Sometimes called “pay for pay” instead of “pay to play,” many have assumed that this issue is well controlled—why else would it be allowed to persist if it were really a problem? Let us explain, in our expert opinion why we believe it to be a very big problem.
First, of course it is not a problem for the large corporations willing to spend tens if not hundreds of thousands of dollars to try to get a better vote outcome. Nor is it a problem for the proxy firms collecting those fees. To find out who gets hurt takes a little bit of looking under the hood at a rather complex engine.
The first victims are the small or principled firms that either cannot afford or will not pay to better ensure their compensation plan gets the vote it needs to pass. Especially if you target a certain percentage of firms for “failure” as seems to be the case for some of our competitors, it’s obvious that for every company that gets moved into the pass bucket presumably as a result of purchasing consulting services there must be another that moves in the opposite direction.
The next victim of course are the shareholders, many of whom engaged the other proxy firms with the expectation that they would recommend appropriate action in their proxy reports to control excess executive compensation. Instead, it is our belief that they end up with a bucket of companies that may have under-compensated CEOs and executives and another bucket with over-compensated employees as outlined above.
So how exactly does this work, what are issuers paying for when they buy compensation consulting? Issuers usually have two options when maximizing compensation allowed by most proxy firm compensation methodologies. The first of course is that they go right up to the limit of the methodology for maximum compensation allowed instead of picking a lower but “safe” level for their compensation proposal. For example, ask for the maximum number of shares or pick a stock option that is less valuable when granted according to whatever option valuation model or methodology is used.
The second, much more problematic option is to adjust certain qualitative measures that matter as little as possible to the company’s executives but have as big an impact as possible on the methodology used. For example, if Egan-Jones wanted to successfully engage in compensation consulting we would probably need to add five to ten times the number of qualitative factors to our compensation methodology than we currently have.
Hence it would appear to us that compensation consulting is one of the key reasons that executive compensation at large companies, who can afford to pay for such consulting, is so high today even with the level of concern and review it has brought.
What can you do? While not using a proxy advisor with this conflict would of course be the best choice, at a minimum asking for a second opinion should be standard policy. Either way, Egan-Jones Proxy is here to help.
How we can help
Prospective clients have often asked how we can help them and what areas we consider are particularly
strong. In response, below are the areas worth reviewing:
Private Placement Ratings – assisting investors access private markets via ratings on private placements.
Subscription Ratings – we have had a strong track record in providing early, accurate independent credit
Climate Change / ESG Scores – an assessment of entities’ current and prospective scores.
Independent Proxy Research and Recommendation/Voting – assisting fiduciaries in fulfilling their voting and record-keeping obligations.