Revealed: the influence of proxy advisers and ESG rating agencies on investor voting behaviour

What is the influence of proxy voting advisers and the impact of ESG ratings agencies on investor voting decisions? 

And do they steer actions and reporting by some of the biggest UK companies?

Yes, they do so quite significantly, it has emerged.

For a starter, many asset owners use proxy voting research and advisers to make their voting decisions and at voting outcomes where proxy advisers recommend a vote against.

Interestingly, they primarily focus on board appointments and remuneration, according to new research that was studied by Net Zero Investor.

The aim of the researchers was to test the validity of the assumption that many investors will automatically follow the voting recommendations of their chosen manager or proxy adviser.

While almost all investors use the services of proxy advisers, an increasing number of them ask for voting research to be based on the investor’s own in-house voting policies - known as customised policies - rather than the adviser’s standard policies - known as benchmark policies.

In fact, 75% of all investors that spoke to the researchers stated that they do so.

Due to limited resources, most investors will issue voting instructions based on recommendations from proxy advisers without manual intervention where the resolution is uncontroversial, according to the research by Durham University and Morrow Sodali, which was published and signed off by industry watchdog the Financial Reporting Council.

All investors the researchers spoke to said that they always review recommendations to vote against management and other resolutions that met certain criteria.

For example, they stressed this is the case for all companies above a certain size or in which they own more than a certain percentage of the shares, or with which they have previously engaged about governance concerns.

While there is some evidence of a correlation between negative voting recommendations and voting outcomes in FTSE 350 companies, it appears to be less extensive than is often asserted.

A vote of 20% or more against a resolution relating to director elections or remuneration occurred in only half of the cases where one or both of ISS or Glass Lewis - the two most prominent proxy advisery services - had made such a recommendation last year, although this increased to 77% of cases when both did so.

There do not appear to be many notable differences in voting behaviour based on the size of the investor or the choice of proxy adviser. 

However, comparing investors with UK-based teams to those without UK-based units or divisions, a much higher proportion of the latter voted in line with their proxy adviser, namely on more than 50% of resolutions. 

There is a similar pattern when comparing asset owners and asset managers.

With the notable exception of remuneration, recommendations by the largest proxy advisers to vote against resolutions are relatively rare on most topics. 

For example, only 1.2% of all board appointment resolutions in FTSE 350 companies in 2022 attracted a vote against recommendation from one or both of ISS or Glass Lewis. 

By contrast, 14.6% of remuneration resolutions attracted a vote against recommendation.

There can be considerable variation in the position taken by ISS and Glass Lewis on remuneration and director appointments. In two-thirds of cases where one recommended a vote against last year, the other took the opposite position.

“There’s an ongoing debate on the role of proxy advisers, and it’s clear that the topic is a more complex and nuanced one that some have led us to believe," said Mark Babington, Executive Director of Regulatory Standards at FRC.

He told Net Zero Investor that “proxy advisers, voting agencies, and ESG ratings agencies are an important resource for fund managers."

Corporate Governance Code

Many company interviewees considered that proxy adviser methodologies should be aligned to the UK Corporate Governance Code to increase consistency.

All proxy adviser interviewees stated that the Code is one of the main sources for their UK benchmark policy.

However, there are a few topics on which benchmark policies are more specific than the Code and other UK regulatory requirements and standards.

For example, the researchers looked at how companies’ perceptions of the extent of proxy advisers’ influence on the likely voting outcomes affects their own behaviour.

Some company interviewees stated that they had changed proposals purely in order to avoid receiving a recommendation to vote against from proxy advisers on at least one occasion, but only in relation to what they considered to be non-strategic issues.

Engagement during the AGM season

Obviously during the AGM season, companies, investors and proxy advisers are all working under pressure, with time and resources at a premium.

There can be as few as 14 calendar days between AGM papers being sent by companies to shareholders and the shareholders having to submit their voting instructions; and a large number of AGMs take place in a short period of time, increasing the pressure on investors and proxy advisers.

Perhaps inevitably, these conditions contribute to frustrations on all sides about the effectiveness of the process, the behaviour of the other parties and, on companies’ part, to concerns that their AGM resolutions may not get the level of attention from proxy advisers and investors that they deserve.

Companies stressed they value the opportunity to comment on draft research reports produced by proxy advisers for their investor clients to ensure they are balanced and factually accurate.

Proxy advisers have adopted different policies – some provide an opportunity to comment in all cases, others only in certain circumstances, and others not all.

All companies considered that they should have a mandatory right to comment on draft research reports. Only 56% of investor respondents thought that companies should have this right.

The majority of proxy advisers will not usually engage face-to-face with companies during the AGM season, with most citing time and resource constraints as the main reason.

Many investors take the same position for the same reasons. In addition, the majority of investors do not notify companies of their intention to vote against a resolution in advance of doing so.

There was no consensus between companies and investors on the quality of the research reports prepared by proxy advisers. Nearly half of companies that responded to the survey said that they were dissatisfied, compared to only 6% of investors.

Engagement outside the AGM season

Many companies will seek to engage with proxy advisers and major shareholders when considering changes to their governance policies and structures. Because of the constraints described above, this engagement typically takes place in advance of the AGM season.

The influence of proxy advisers and ESG rating agencies on the actions and reporting of FTSE 350 companies and investor voting,

Just over 60% of companies said they had attempted to engage with one or more proxy adviser in advance of the AGM season in the previous two years.

Of these companies, 96% had engaged on remuneration, compared to 23% on both board composition and ESG issues, the researchers found.

There was a notable difference in the percentage of FTSE 100 companies that had attempted to engage with proxy advisers (68%) compared to FTSE 250 companies (50%). The reason for this difference is not clear.

Also read
Drastic misalignment in master trust shareholder climate votes at AGMs

Companies and proxy advisers hold different views on the purpose of engagement in advance of the AGM season.

Many companies sought to obtain an indication of whether or not the proxy adviser would recommend voting in favour of the company’s proposals, whereas proxy advisers viewed it purely as an opportunity to exchange information.

Interviews with company and investor representatives suggest that there can often be a mismatch between a company’s desire to engage with its major shareholders and those shareholders' willingness or ability to do so.

Some company interviewees suggested that when investors were unwilling or unable to engage, this contributed to the perception on the part of companies, that those investors were not active stewards and may have delegated their voting decisions to proxy advisers.

Evidence suggests that the ability of companies to engage with their major shareholders may be related to the size of the company and the composition of its share register.

Investor interviewees stated that their decision on which companies to engage with were primarily driven by their own priorities rather than in response to requests from companies.

Influence of rating agencies

The fear of receiving an adverse ESG rating was not a significant consideration for most companies when setting the strategy and developing action plans to address ESG-related issues.

However, they were concerned that investors may place reliance on the headline ratings when making voting decisions, and that the potential existed for the company to be penalised on the basis of a rating that, in their opinion, did not fairly reflect the company’s actions or performance.

For this reason, the majority of company interviewees concluded that they needed to ‘play the game’ by providing the information used by ESG rating agencies in their methodologies, in the hope that they would receive a positive rating.

Also read
EU revamps ESG ratings industry in fresh investment push

Most investors stated that they primarily used ESG rating agencies as a source of data rather than relying on the rating itself to inform voting decisions; and some have developed their own proprietary rating systems.

However, some investors acknowledged that their clients may place more weight on the headline ratings from the rating agencies than they do themselves.

There are many ESG data providers and rating agencies operating in the UK market. This means there are considerable differences in terms of the reliability of the research and the approach taken to collecting and interpreting data, as well as the particular data points that are used.

This can have a significant impact on the volume of data that companies measure and publish and the associated resources.

Transparency

The researchers stressed that across the board, both companies and investors would welcome greater transparency on the methodologies used by ESG rating agencies.

For example, this includes more information on the specific ESG factors covered and how they are weighted, the extent to which the model takes account of national and sectoral differences, and the quality assurance process. 

The new code of conduct being developed by the FCA and an industry working group will aim to address some of these issues.

Companies identified a number of concerns about the data-gathering techniques used by some ESG rating agencies and data providers, in particular the use of ‘data scraping’ and controversy reports, such as ones on ESG-related incidents involving the company.

Finally, both companies and some investors raised concerns about the timeliness and timing of ESG rating agencies’ updates to their ratings and research reports.

These do not always align with reporting and voting cycles, meaning that the information on which investors draw when making decisions may be out-of-date, the researchers concluded.

Also read
‘Asset owners face an intimidating to-do list’, says WTW’s green investment chief