Proxy Advisors' Recipe for Compensation Analysis

• In Event: Executive Compensation

Abstract

In this study, I exploit a novel setting where firms may have access to the compensation model of ISS, the most prominent proxy advisor, when engaging a compensation consultant that is an ISS partner (“partner consultant”). I find that for these firms, the ISS report lag is shorter and the incidence of ISS red flags on say-on-pay proposals is lower. Moreover, firms that engage partner consultants reduce by 21% to 30% the likelihood of obtaining an overall negative recommendation from ISS on say-on-pay and equity compensation plan proposals. These results are consistent with private information transfer regarding the ISS compensation model. In terms of consequences, although I find no significant effect on the amount of shares requested in equity compensation plans, I do find that firms with access to the model provide roughly 7% higher executive compensation. This is consistent with firms that engage partner consultants benefiting from the slack in the ISS compensation model without triggering a negative recommendation. If accessing the model merely mitigates uncertainty regarding what optimal governance practices are, shareholders are unlikely to resist. However, I find that shareholders, especially sophisticated ones, underweight the ISS positive recommendations when voting for say-on-pay proposals of firms with access to the model. While firms hiring partner consultants may benefit from knowledge transfer, I do not find that ISS biases its recommendations in favor of these firms. Overall, this study provides the first direct evidence on the tradeoffs that boards, executives, and shareholders face when firms have access to a proxy advisor’s models, and thereby, help shape the debate on the independence of proxy advisory firms.

Author

• Rafael Copat, Rice University