On the Role and Regulation of Proxy Advisors

In anticipation of proxy season-the springtime ritual where companies prepare and deliver proxy statements in preparation for annual shareholder meetings-U.S. public companies typically reexamine their corporate governance structures and policies. Many corporate governance structures that were acceptable ten years ago are now considered outmoded or even evidence of managerial entrenchment. For example, consider the classified board of directors. In recent years, many companies have shifted from a classified board of directors to an annually elected board.

A company might adopt an annually-elected board structure for a number of reasons. A classified board can serve as an entrenchment device, for instance, and so the company may hope to increase the accountability to shareholders that such a structure entails. Likewise, there may be legitimate reasons to retain a classified board of directors, such as the negotiating leverage a classified structure provides the board in the context of a hostile takeover. As a company considers such a change, however, high-minded considerations of the optimal governance structure do not always, and probably do not regularly, drive the discussion.

Instead, the primary consideration is often that Institutional Shareholder Services ("ISS") or another proxy advisor is opposed to classified boards, and the firm feels compelled to make the change in order to improve its corporate governance rating even though the change may have no beneficial effect on the firm's corporate governance or performance.