How small businesses suffer when investors vote alongside proxy advisors

Small companies have a steep hill to climb when it comes to recruiting more women and minorities to their boards, but the nation’s two largest proxy advisers may make it even harder.

The problem arises when institutional investors delegate their voting rights to Institutional Shareholder Services and Glass Lewis, which is common practice. ISS and Glass Lewis review proxy proposals and issue voting recommendations on thousands of companies.

Although the two advisers have developed a set of standards for providing voting proposals on a wide range of corporate governance issues, such as board composition and capital structures, they hamper – even if unintentionally — much-needed progress on diversity at smaller public companies, according to Dallas-based investment manager Ranger Investments. The asset manager is urging shareholders of smaller companies to think twice about blindly following the recommendations of proxy advisors.

Here’s how it works: During the proxy voting process, shareholders can vote “for”, “against” or “abstain” on their ballots, with the latter two signaling their passive, but negative, views on certain board decisions. ‘business. ISS and Glass Lewis often recommend that investors vote “Withhold” or “Against” all board members who serve on nominating and governance committees because of broader issues. For example, directors could be rejected for their company’s adoption of the classified board structure, which is often seen as a less progressive approach to governance because it allows more experienced members to serve longer. In such cases, the proxy advisors would recommend voting “Withhold” or “Against” directors standing for re-election, regardless of their qualifications. As more companies bring women and people of color onto nominating and governance committees to promote overall board diversity, removing them for such technicalities can significantly slow board progress. company, said Andrew Hill, president and portfolio manager at Ranger Investments.

And the challenge is particularly acute for smaller companies, as proxy advisors “tend to compare small- and micro-cap companies based on their large-cap counterparts,” Hill said. A consumer small-cap company might be held to the same standards as Procter & Gamble because advisors cannot customize their proxy decision framework for the thousands of companies they oversee. But unlike their larger corporate counterparts, which have established diversity programs and inclusion events, smaller companies have fewer resources to recruit female and minority directors. As a result, they suffer more when their choices for board members are rejected. In fact, the removal of a diverse board member can sometimes hurt the company more than the broader corporate governance issue that led to the ‘no’ or ‘abstain’ vote in the first place, according to Hill.

Given the duopoly of ISS and Glass Lewis in the market, it is nearly impossible for them to customize proxy proposals for companies of different sizes. Controlling at least 90% of the market, the two “assumed outsized influence on corporate voting matters,” Paul Rose, a professor at Ohio State University’s Moritz College of Law, wrote in a statement. Manhattan Institute paper released last year. Rose found that 114 institutional investors with $5 trillion in collective assets under management have opted for “robovoting,” meaning they vote mechanically based on recommendations from their proxy advisors.

ISS argues that its power is overrated. Marc Goldstein, head of US research at the ISS, said Institutional investor that proxy advisors have limited power over shareholder decisions, particularly when it comes to dismissing various board members. “Regardless of the recommendations of the ISS, some shareholders will be reluctant to vote against the only woman” or person of color, he said. And even if a diverse board member doesn’t get the majority vote, they’re not directly fired from the board in every US state except California. Instead, the board reviews the principal’s letter of resignation before making the final decision. “Spoiler: board generally doesn’t work [accept the resignation]“, said Goldstein.

Fionna Ross, senior ESG analyst at UK-based asset manager abrdn, said that while the company relies on ISS for some voting decisions, it does not mechanically follow the proxy advisor on every vote. Abrn has an internal proxy team that prioritizes board diversity in the investment process, Ross said, adding that its decision-making framework varies by company size. “For the large-cap companies we invest in, we push to see at least 25% female representation on the board,” she said. “For small companies, we want at least one female representative on the board.” Abrdn will not follow ISS proposals if they conflict with its own framework, according to Ross.

Courteney Keatinge, senior director of environmental, social and governance research at Glass Lewis, is confident that companies will redouble their efforts to replace all diverse applicants who have been rejected by another person of color or a woman. “Over the past two years, every company we’ve spoken to, regardless of profile, wants to talk about how they encourage diversity on the board,” Keatinge said. “I haven’t heard many excuses from companies when it comes to diversity.”

A bigger problem may be an industry-wide reluctance to broaden the scope of possible frameworks for boards of directors. Goldstein said many companies will only “go one level” below the C-suite when they need to replace the current generation of directors.

“A lot of great candidates haven’t been promoted to the C-Suite yet,” Goldstein said. To promote a diverse and inclusive work environment, companies must stop neglecting mid-level talent, he concluded.

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