What is a Proxy Advisory Firm?
A Proxy Advisory Firm is a business primarily involved in providing shareholder services to institutional clients. According to The Activist Investor they “have become a critical stop on the road show when management and activists contest matters, such as over electing directors“. They may engage in, but not be restricted to
- agenda translation
- provision of vote management software
- voting policy development
- company research
- vote administration
- voting recommendations
- vote execution
The two most well-known firms in the U.S. are Glass, Lewis & Co and Institutional Shareholder Services. A 2018 study at the Rock Center for Corporate Governance noted that when combined, these two firms have a 97% market share of the industry in the U.S. and continues with
“the industry exhibits signs of market failure, in that despite their demonstrated poor track record and questionable practices, the market has not been able to gradually eliminate them and they have in fact thrived.”
To avoid confusion we shall consistently refer to these firms as Proxy Advisory Firms, although they may also be known by the following terms, proxy firm, proxy advisor, proxy voting agency, vote service provider or shareholder voting research provider. Working in conjunction with these firms, and therefore not to be confused with, a “Proxy Solicitation Firm” helps an issuer “know what to expect from shareholder voting intentions” in advance of the meeting by consulting with Proxy Advisory Firms.
What is a Proxy Vote in a Meeting?
The common thread amongst the alternative monikers given above is the term “proxy”. Individual shareholders do not usually attend shareholder meetings. Instead, they send instructions – known as a proxy appointment – for a third party to vote their shares in accordance with their predefined instructions. The votes are generally cast by the chairman of the meeting and subsequently known as “Proxy Votes”.
Proxy voting can take place at any time and is most commonly practiced at the shareholders annual meeting. However, it is during the special meeting that is of most interest to an arbitrageur. During this meeting, shareholders are asked to vote their shares on whether or not they agree to the proposed merger. If it is a hostile takeover or hostile action from an activist investor that shareholders are voting on, the actions and influence of the proxy advisory firm will be most observable. Hostile takeovers are discussed in more detail in our article “Hostile Takeovers and Merger Arbitrage – What All Traders Should Know“
What is a Proxy Takeover?
A proxy takeover is a corporate strategy that may arise during a hostile takeover and often used when a tender offer is not optimal. An acquiring company attempts to convince shareholders to use their proxy votes to install new directors that are open to the takeover. Sometimes the acquiring company is an activist investor, who, rather than takeover the entire target, wishes to force some sort of change in company strategy or organizational structure. This action may also be referred to as a proxy fight. Individual investors have the choice of siding with the firm and maintaining the status quo, or choosing corporate change that will usually have some immediate financial benefit attached. Obtaining and reviewing the necessary unbiased information with which to make this decision is not necessarily a simple task.
In the case of a proxy contest or takeover, the target company may already have a certain number of defenses in place to restrict the hostile actions of a bidder. Actions such as staggered boards will restrict the number of directors up for re-election at any one time and management will be busy giving presentations and Q&A sessions to major shareholders in order to secure their support. At this time, the services and actions of the Proxy advisory firm can play a crucial role.
What is an Example Involvement of a Proxy Advisory Service in a Takeover?
On December 4, 2019, Thoma Bravo and Instructure (INST) made an official announcement stating INST had agreed to be acquired for $47.60 per share in cash. The closing price before the announcement was made was $52.96. Following the announcement, the stock crashed $4.21 to close at $48.75. Many speculators who had bought the stock as rumors spread of an imminent takeover were left with a losing position. Some exited immediately whilst other have held on (at time of writing) in hope of a higher bid.
On December 5, 2019, Rivulet Capital, LLC filed a SC 13D with the SEC stating they planned to vote against the deal. Shortly after, Oberndorf Enterprises issued a similar statement. Then followed the expiry of the go-shop period without and additional bidding interest and a set of results slightly below analysts forecasts. After 4 different institutional shareholders came out opposing the deal, on January 27, Institutional Shareholder Services (ISS) issued a statement advising “shareholders vote against the Thoma Bravo merger” citing “vehement” shareholder opposition. The company immediately responded by saying it “strongly disagrees” with the advisor and that “its exhaustive, conflict-free and well-publicized strategic review process” attracted no other offers.
Analysis
It has been researched that ISS and Glass Lewis rarely recommend against a deal in the absence of any public dissent by acquirer shareholders. ISS have simply repeated what they have observed in the market. There is no analysis of deal value provided other than what they have gleaned from shareholders. ISS claimed “Instructure did not treat all potential buyers alike, allowing Thoma Bravo to sign a confidentiality agreement within six days while it waited five months to let another party sign one“. As the story unfolds, what investors do not seem to be reminded of is the price of INST on September 24 when the stock hit a low of $37.04. Before the buyout offer was announced there were 4 days showing significantly high volume and price movements. Thus demonstrateing the continued rumors of the stock as an acquisition target. ISS is subsequently playing with fire but risking other people’s money. If traders follow their advice and vote against the deal, it may force a higher offer from the Private Equity firm. On the other hand if Thoma Bravo walk away, the stock, without support from additional bids will surely crash. Subsequently, it remains to be seen what influence ISS will have on the ongoing deal.
Proxy Advisory Service and Activists
According to the Harvard Law School Forum on Corporate Governance, “Proxy advisory firms have arisen due to market failures underlying voting and the broader system of corporate governance.” The importance therefore of advisory firms and their interactions with activist investors cannot be understated. As TheActivistInvestor.com goes on to say
“An activist investor that seeks to elect directors to a company board, or to approve a resolution at the annual meeting, inevitably will need to persuade one or more proxy advisor to recommend the activist’s position over management’s.”
The endorsement or lack thereof can have a significant effect on the outcome of the upcoming vote. Large institutional investors comprised of pension funds, endowments, and mutual funds, tend to play a pacifist role in these circumstances and follow proxy advisor recommendations when voting. Activists are only too aware of the fact that it is not practical for these institutional investors to research and analyse the information necessary to make an informed voting decision in each and every stock they own. Therefore, in exchange for a fee, a third party vendor, the proxy advisory service, is employed to do it on their behalf.
How Else Does a Proxy Advisory Service Effect Mergers?
Advisory firms can be involved in any aspect of shareholders services. They can have a huge effect on mergers and not only by simply recommending how investors should vote their shares. In addition to the activist investor using this service in the above section, the Harvard Law School Forum on Corporate Governance also goes on to cite additional services required by activists which may effect merger outcomes
- public criticism of the transaction through letters addressed to the acquirer’s board and/or shareholders, usually accompanied by press releases or attachments to Schedule 13D filings
- proxy solicitation intended to veto the deal
- proposing alternative acquisitions
- lobbying proxy advisory firms like ISS and Glass Lewis in order to influence their institutional shareholder clients
It is important the arbitrageur is aware of these machinations behind the scenes. What may appear to be a good deal, especially one that is profitable for the trader, may be scuppered by clever marketing and lobbying by those who have significant influence.
Investment Advice from a Proxy Advisory Service
As the services offered by advisory firms grow wider and expand in depth, one very important topic becomes unavoidably obvious. The role of the firm as an investment advisor. The Institute for Governance of Public and Private Organisation (IGOPP) in a 2013 paper entitled “The Troubling Case of Proxy Advisors” noted,
Proxy advisors now stand in a bully pulpit from which to harangue corporate management and boards of directors on all matters of governance and compensation; neither investors, nor investment advisers, they enjoy a franchise to “make recommendations” to investors on how to discharge their fiduciary responsibility as shareholders…Their influence has grown in spite of repeated criticism of their performance, because investors seemed to find these “advisors” useful in discharging what could be an onerous responsibility.
The most recent SEC guidance on the issue now recommends “Investment advisors will also need to implement policies ensuring clients that their use of proxy advisory firms are justified, and every vote is being cast in the clients’ best interest“. How much this will effect trading merger arbitrage remains to be seen. However, judging by the influence these firms currently wield, it would be a brave call to trade against their recommendation.
The Proxy Advisory Firm and Merger Arbitrage - Key Points
So there we have it. 7 questions and 7 answers on the most popular aspects of Proxy Advisory Firms and their effect on merger arbitrage. We summarize below some of the key points in the article.
- A Proxy Advisory Firm is a business primarily involved in providing shareholder services to institutional client
- These firms rarely recommend against a deal in the absence of any public dissent by acquirer shareholders
- The endorsement, or lack thereof can have a significant effect on the outcome of the upcoming vote
- Proxy advisors now stand in a bully pulpit, neither investors, nor investment advisers
Further Reading
- Hostile Takeovers – The use of Attack and Defence Strategies by Panagiotis Papadopoulos gives an academic and theoretical analysis of hostile takeovers and defences
- Proxy Advisory Firms, Governance, Failure, and Regulation – Harvard Law School Forum on Corporate Governance
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