Detractors be damned: For the next generation of proxy advisors, being socially conscious is trendy.
“We’re sitting on a wealth of data and research,” says Marija Kramer, managing director and head of ISS-Corporate Business. It’s a point of pride for the Rockville, Maryland-based firm.
A unit of Institutional Shareholder Services, Kramer’s team specializes in helping companies design and manage their governance. While chiming in on a merger or acquisition vote is still very much a part of ISS’s bread and butter, the proxy advisory firm’s newer suite of services is something that wasn’t available to your grandfather’s boardroom, she says.
A topic like ESG, or environmental, social, and governance policy, is still unfamiliar territory for many corporates, despite the visibility and sometimes controversy it has attracted in the investment community. As a result, ISS’s role in the business world has expanded to include collecting massive amounts of data that it says could help companies craft their ESG strategy.
At least that’s the intention. Against the backdrop of frightening geopolitical tensions and economic uncsertainty, it sometimes feels like “the Wild West,” Kramer says.
Morrow Sodali, a proxy solicitor, can relate. Like ISS, its offerings have grown more diverse and ESG-heavy. “Our evolution as a business has been significant over the last 12 months,” says Christian Sealey, CEO-International at Morrow Sodali, citing the “ever-increasing demands” placed on clients by their stakeholders.
The New York- and London-based firm traditionally offers “tailored solutions” to clients in areas including communications, investor relations, crisis and reputation management, public affairs, and branding. But over the past year, it has conducted three bolt-on acquisitions to solidify its ESG bona fides, purchasing FrameworkESG in March, HXE Partners in August, and Powerscourt in October. “There’s more pipeline in the works from an M&A standpoint that will hit the tape soon enough,” Morrow Sodali managing director Tommaso Breschi says.
Another player is Glass Lewis & Co., the “number two” behind ISS when it comes to corporate governance research. Last year, the San Francisco-based firm launched “ESG scores” as part of an effort to provide what it called “a snapshot view” of companies’ emissions reduction initiatives.
ISS and Glass Lewis’ proxy recommendations typically grab headlines due to the caliber of big-name companies involved—Starbucks, McDonald’s, Alphabet, and Toyota were among the recent few—and the choices they make.
The stakes are certainly high. If a client’s board is wrangling over how to justify generous pay packages for its top executives, a proxy adviser might present a case that helps determine the proper incentives. The outcome could make the difference between a lofty bonus or a steep pay cut for a CEO.
Last year, more than 80% of the companies in the STOXX Europe 600 index and 55% in the Standard & Poor’s 500 explicitly disclosed ESG metrics as a part of executive pay. That’s up from 59.4% and 22%, respectively, in 2021. Numbers were not yet available for 2023.
Right now, “the heavy ESG focus is among the bigger trends that companies and investors are grappling with,” Kramer says. That’s especially the case with European companies, which tend to utilize more environmental metrics than their US peers. The latest round of EU rules around ESG reporting will likely influence decision-making in the US, since investors are showing a growing interest in sustainable criteria, she predicts.
“My sense is that we often have a trend start in one market and it continues across the pond into another,” Kramer says, calling ESG “an area of growth.”
Sealey agrees. While there are nuances in the issues Morrow Sodali’s clients face in European markets compared to, say, the Asia-Pacific region, and vice versa, “the more interesting observation is that the challenges corporates encounter wherever they operate are becoming increasingly common and global in nature,” he argues. “This trend is evident in the continued rise of shareholder activism and the integration of ESG directly into business strategy: trends that show no sign of losing momentum anytime soon.”
Backlash Against ESG
Advising companies on what they ought to do is big business, and proxy advisory firms continue to grow their influence.
In the case of ISS, Glass Lewis and Morrow Sodali, each firm is well-funded by large private equity firms. In 2017, Genstar Capital teamed up with Deutsche Börse Group to buy ISS in a deal valued at about $2.3 billion. A few years later, Toronto-based Peloton Capital Management scooped up Glass Lewis for a price that reportedly hovered below that range. And last year, Morrow Sodali sold a majority stake to TPG Growth.
Critics say this strong cash position has allowed the triumvirate to exercise too much sway. Earlier this year, Tesla CEO Elon Musk broadcast his dislike for ISS and Glass Lewis on social media. “Far too much power is concentrated in the hands of ‘shareholder services’ companies like ISS and Glass Lewis,” he complained over Twitter, now X, “because so much of the market is passive/index funds, which outsource shareholder voting decisions to them.”
Musk’s comments were echoed in July when a scathing op-ed in The Wall Street Journal slammed ISS and Glass Lewis for their pro-ESG stance. ISS insists it’s apolitical. Glass Lewis didn’t respond to requests for comment. The firms’ newfound focus on ESG has also been a sticking point among right-leaning US lawmakers, many of whom sought to reverse a Department of Labor rule that allows for the consideration of ESG factors in investment decisions in retirement plans. They were unsuccessful.
Even BlackRock CEO Larry Fink, formerly a strong supporter, has gone sour on ESG, disavowing the term entirely and claiming he is “embarrassed” to have been associated with it.
But Barri Rafferty, who joined Morrow Sodali as CEO, Americas in September, believes ESG has only gained steam, despite detractors. “While the nomenclature for ESG may be under dispute, the commitment to responsible business practices does not seem to be waning,” she says.
Stakeholders clapping back against proxy advisers is nothing new, but the firms’ opinions still count. When cinema giant IMAX Corp. had to cajole dissenting investors to accept a $124 million bid as part of a takeover of IMAX China earlier this year, company brass hyped the fact that ISS and Glass Lewis both agreed the Hong Kong-listed subsidiary should accept the deal.
“Glass Lewis joining ISS in recommending in favor of our offer to take IMAX China private is further validation of the benefits of this transaction,” IMAX chief executive Rich Gelfond said in October.
But ISS and Glass Lewis’s advice fell on deaf ears. More than 10% of the votes were cast against the “scheme” that the two firms favored. IMAX China remains a publicly traded company—banking that, in a post-pandemic market where movie-goers are returning to theaters, there’s value to be gained as a separate entity.
“The IMAX case strikingly illustrates a discord between proxy advisers’ recommendations and the actual investor sentiment, spotlighting a critical flaw in the advisory system,” argues Thomas Smale, CEO of FE International, a tech-focused M&A adviser. He calls it a “potent reminder” that advisory guidance without critical analysis can lead to decisions misaligned with stakeholders’ real interests.
For all the backlash that ISS, Glass Lewis and Morrow Sodali receive, they continue to expand their reach. Since 2015, Glass Lewis has opened four locations, most recently in Tokyo as a means of expanding across the broader Asia-Pacific region. ISS is currently implementing “methodology enhancements” to its ESG scoring solution for institutional investors; the new criteria are set to take effect in December. And Morrow Sodali’s “glocal” approach is paying off, according to Rafferty.
“As we expand our business, we want to connect the dots for our clients globally, yet offer deep vertical expertise locally,” she says. “As the number of non-US holders in US companies’ shareholder profiles and institutions evolve, we are seeing the need to work across the globe with less firm boundaries, leverage our global reach to help clients track who has voting authority to get those shares voted, and answer questions that require expertise in multiple markets and jurisdictions.”