My wife, Myra Young, submitted a proxy proposal to Costco aimed at establishing a new and innovative way for shareowners to obtain proxy voting advice. The proposal would set up a contest, pay for proxy advice out of entry fees and corporate funds, and would then share the advice of four winners with all Costco shareowners.
Under the current framework, investors generally subscribe to proxy advisory services such as those provided by Institutional Shareholder Services (ISS) and Glass Lewis. These services then provide advice on how to vote at thousands of companies. For example, the Investment Company Institute (ICI) estimated there were 20,000 proxy proposals at Russell 3000 companies in 2009. ISS claims to cover 40,000 meetings in over 100 different markets.
Large institutional investors might subscribe to both of these services, as well as others such as UK-based Manifest or PIRC, or India’s InGovern. There is much debate concerning just how influential such services are but there is a widely-held perception their influence is substantial. Researchers report anywhere from 3.5% to over 50%. Choi, Fisch and Kahan, who found ISS accounted for a 6%-10% vote shift, identified four reasons why proxy advisor recommendations correlate with shareowner voting in their paper, The Power of Proxy Advisors: Myth or Reality?:
First, the same director nominee and company characteristics may independently influence both the proxy advisors’ recommendation and the shareholder vote. Second, proxy advisors may gather information that investors use to make their voting decisions. Third, investors may select a proxy advisor based on their ex ante agreement with the bases upon which the advisor formulates its recommendations. Finally, investors may view the advisor’s recommendation alone as a basis for deciding how to vote, independent of the underlying factors upon which that recommendation is based. It is only this last reason that can truly be characterized as causality.
Those wishing to delve deeper into issues surrounding the use of proxy advisers should read Voting Decisions at US Mutual Funds: How Investors Really Use Proxy Advisers by Robyn Bew and Richard Fields. Regardless of how influential such services are, many institutional investors and most retail investors don’t benefit from their services because they don’t subscribe. According to Mark Latham (Proxy Voting Brand Competition),
The biggest obstacle to paying advisors is the shareowners’ free-rider problem. Whether you are an individual or an institution, if you pay for advice to improve the quality of your voting, that helps all other shareowners even if they do not pay for or receive the advice. For example, if you own 1% of a company’s shares then only 1% of the beneﬁt from your voting comes back to you. So most shareowners have almost no incentive to pay for voting advice.
Before federal rules defined proxy votes as assets, which must be voted in the best interest of plan beneficiaries or mutual fund participants, many funds simply voted with management. Federal rules and the rise of proxy voting services provoked many funds to develop proxy voting policies and to pay for advice but they are incentivized to spend only a minimal amount. Latham estimated that in 2004 ISS spent about “four hours of analysis per proxy, costing perhaps $2000 including ISS infrastructure costs.” Even if they spend twice that amount, it still seems low.
Evolution of Proxy Advisor Contest Proposal
The solution Latham proposed eliminates the free-rider problem:
By paying as a group, we shareowners would beneﬁt from better voting advice than any we have now. All shareowners of a company would get the advice instead of just the minority that currently subscribe to such research. Competition for advisor reputation would maintain pressure for high quality and moderate pricing.
Holding a contest for the best advice could bring in new proxy advisors specializing in specific countries, industries or companies. In-depth analysis might comment not only on items on current proxies but might provide investors with key comparisons with competitors and could delve into issues on the horizon.
Our current proxy advisor competition proposal builds on proposals Latham drafted beginning in 1999. I had the pleasure of submitting two of those proposals, which obtained from about 9% and 18% of shares voted in favor. During the intervening decade, Latham experimented, primarily at the University of British Columbia (see “Experiments in Voter Funded Media” at votermedia.org/publications). Those experiments led to significant improvements. Compared to our earlier proposals, this new version would support four advisors instead of just one; it would take two years to implement instead of three years; and shareowners would vote after seeing the proxy advice instead of before. See also Proxy Advisor Competition on the VoterMedia Finance Blog.
The new design, submitted to Costco, reads as follows:
PROXY ADVISOR COMPETITION
WHEREAS many shareowners lack the time and expertise to make the best voting decisions, yet prefer not to always follow directors’ recommendations;
WHEREAS shareowners could benefit from greater competition in the market for professional proxy voting advice;
THEREFORE BE IT RESOLVED that Costco (Wholesale Corporation) shareowners request the Board of Directors, consistent with their fiduciary duties and state law, to hold a competition for giving public advice on the voting items in the proxy filing for the Costco 2014 annual general meeting, with the following features:
- The competition will be announced and open for entries no later than six months after the Costco 2013 annual general meeting. To insulate advisor selection from influence by Costco’s management, any person or organization can enter by paying an entry fee of $2,000, and providing their name and website address. Each entry will be announced publicly, promptly after it is received. Entries’ names and website addresses (linked) will be shown promptly on a publicly accessible Costco website page, in chronological order of entry. Entry deadline will be a reasonably brief time before Costco begins to print and send its 2014 proxy materials.
- The competition will offer a first prize of $20,000, a second prize of $15,000, a third prize of $10,000, and a fourth prize of $5,000.
- Winners will be determined by shareowner vote on the Costco 2014 proxy. The proxy will show this question: “Which of the following proxy advisors do you think deserve cash awards for how they have been informing Costco shareowners? (You may vote for as many advisors as you like. See each advisor’s website for their information for Costco shareowners.)” Then the name and website address of each advisor entered will be listed in chronological order of entry, with a check-box next to each. The advisor receiving the most votes will get first prize, and so on.
- It is expected that each proxy advisor will publish advice on its website regarding the Costco 2014 proxy, but there will be no formal requirement to do so. The incentive to win shareowner voting support and to maintain the advisor’s reputation will be considered sufficient motivation for giving quality advice.
- The Costco filing that reports the final 2014 proxy voting results will show the total number of shares voted for each proxy advisor.
- The competition will continue annually with the same terms, except that competitors who renew their entries for a subsequent year, by paying the entry fee within 30 days after the Costco filing of voting results, will have their names listed on the website page and on the subsequent proxy in the order of their voted ranking in the most recent year. New competitors can enter at any time before the entry deadline, and will be listed after renewed entries, in chronological order of entry.
(Further information on proxy advisor competitions: “Proxy Voting Brand Competition,” Journal of Investment Management, First Quarter 2007; free download at http://votermedia.org/publications.)
Information & Analysis Vital to Democratic Framework
Shareowners can use our voting power to hold boards accountable more effectively if we have high quality professional voting advice. ISS and Glass Lewis do a good job for the amount of compensation they receive. However, we believe they and/or others could do substantially more if they were incentivized with more funds and more competition.
“… one of the primary complaints from corporate issuers is that proxy advisory firms rely heavily on a ‘cookie cutter’ or ‘one-size-fits-all’ approach, and may base recommendations on inaccurate and unreliable information in particular cases.” [page 9]
Recently I’ve gotten complaints from directors at the Silicon Valley chapter of the National Association of Corporate Directors who tell me they will no longer serve on a corporate board unless there is a dual class structure that essentially negates input by most shareowners. (see SVNACD: Red Flags of an Ethical Collapse & Alternative Proxy Voting Advice to Stem Dual Class IPOs). My biggest takeaway from that meeting was the growing opinion in Silicon Valley that rating agencies, such as ISS and Glass Lewis are considered so powerful and use tools seen as so badly designed and executed that directors increasingly feel the need for dual class structures.
From a different perspective, Marjorie Kelly also advocates in favor of dual-class structures in her book Owning Our Future: The Emerging Ownership Revolution. Her reasoning is that such structures insulate companies from the pressures of shareowners who pay too much attention to quarterly earnings reports, rather than to the company’s mission.
Yet, dual class structures are antithetical to democracy and the wishes of institutional investors. See, for example, the discussion at Weathering a Crisis: Weil in Silicon Valley. GMI Ratings has already identified over 200 dual class publicly traded companies in the Russell 3000. Read Kimberly Gladman‘s insights concerning where dual class shares have led radio broadcaster Emmis Communications at the HLS Forum on Corporate Governance and Financial Regulation, The Dangers of Dual Share Classes.
If ISS and Glass Lewis do use something of a check-box approach, who can blame them, considering the amount they are paid for their research? The answer is not to exclude shareowners from influencing corporate governance. The answer is giving shareowners easy access to better analysis, tailored to the needs of each specific company. We might even attract hedge funds like ValueAct Capital and Relational Investors with years of experience serving on boards to perform the analysis. Of course, ISS, Glass Lewis and other proxy analysts would also be able to join the competition but would have to provide their analysis to all shareowners, not just their subscribers.
Costco has many characteristics, such as an entrenched board, that we expect to be criticized by proxy advisors. Perhaps a more thorough analysis will show the value of what appear to be negatives. Perhaps such analysis will not only confirm them to be negatives but will encourage shareowners to submit proposals in the future to bring Costco more in line with “best practices.”
- Classified board with staggered terms, whereas 82% of S&P 500 have annual elections of all directors.
- Plurality vote standard to elect directors with resignation policy, whereas 80% of S&P 500 have a majority vote standard.
- Board is authorized to increase or decrease the size of the board without shareholder approval.
- Directors may only be removed for cause, a limitation followed only by less than 35% of the S&P 500.
- 6 directors over 70 years old.
- 7 directors with over 15 years of tenure.
- Total realized compensation for CEO James D. Sinegal appears excessive at $16.75M
We expect our proposal to continue to evolve and welcome your comments. How can we improve it? If the proposal is implemented, what results would you expect? I would love to hear from readers, especially any who might consider entering such contests.