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CALIFORNIA CORPORATE & SECURITIES LAW

ISS Ignores Contrary Studies In Adopting Overboarding Policy Change

ISS released its 2016 Benchmark Policy Recommendations last Friday.  I had previously criticized ISS for its proposal to change its recommendation on withholding votes with respect to directors who sit on too many boards:

In proposing this policy change, ISS cites surveys that reflect an increase in the time commitment required for board service. ISS also cites the result of its 2015 policy survey. What is entirely missing from ISS’ proposal is any analysis, much less empirical evidence, that service on multiple boards affects firm value either positively or negatively. This illustrates the fundamental and pervasive flaw in most corporate governance “reforms”: they are all prescription and no diagnosis. One would expect that an organization engaged in an advisory business should be able to articulate some basis for its advice. How does ISS know that six is too many and five or four is just right?

Perhaps in reaction to this criticism, ISS now cites three studies to support its recommendation.  However, ISS fails to mention contrary studies that reach the opposite conclusion.  For example, one study examined newly public firms and found that busy boards actually have a positive effect. See Laura Field, Michelle Lowry & Anahit Mkrtchyan, Are Busy Boards Detrimental? J. of Fin. Econ., 2013, 109, 63-82.  Accordingly, these authors warn “Broad-brush recommendations to reduce directorships should not be pursued”.  The authors of another study concluded:

We fail to find the negative relation predicted by the Busyness Hypothesis between the number of board memberships held by a director and subsequent firm performance.  Our other tests of the Busyness Hypothesis are consistent with these results. Market participants do not react negatively to the appointment of a multiple director.  Further, we find no evidence that multiple directors shirk their responsibilities to serve on board committees and no statistically significant evidence of a relation between multiple directorships and the likelihood that the firm will be named in a securities fraud lawsuit.

Pritchard, Adam C., “Too Busy to Mind the Business? Monitoring by Directors with Multiple Board Appointments.” S. P. Ferris and M.
Jagannathan, co-authors. J. Finance 58, no. 3 (2003): 1087-111.

My point isn’t to choose either side in this debate, but rather to point out that there is a serious ongoing disagreement about the impact of busy directors on firm value.  Investment advisers should take note of ISS’ one-sided presentation.  The SEC staff has taken the position that “an investment adviser that receives voting recommendations from a proxy advisory firm should ascertain that the proxy advisory firm has the capacity and competency to adequately analyze proxy issues, which includes the ability to make voting recommendations based on materially accurate information.”  Proxy Voting:  Proxy Voting Responsibilities of Investment Advisers and Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms, Staff Legal Bulletin No. 20 (IM/CF) (June 30, 2014).  When ISS chooses to overlook or ignore academic research that contradicts its recommendations, can it reasonably be said that it has the ability to make recommendations based on “materially accurate information”?

 

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