Proxy advisors attract attention when their recommendations lead to rejection of resolutions like in the case of Nestle’s royalty payout, or when there is a divergence of views such as in the demerger of the ITC Hotels. However, it is rare when proxy advisors (PAs) are not divided and when investors have approved the proposal, but there are still a few who are protesting, as in the case of ICICI Securities delisting and the Tata Motors DVR proposal.
A recent article on Jamie Dimon, the CEO of JP Morgan Chase, flagging concerns over the “undue influence of proxy advisors” gave the impression that PAs are all powerful. While that may be true in other countries, it does not seem to be the case in India.
Of the 1,841 resolutions on which Stakeholders Empowerment Services (SES) recommended an “against” vote in 2023-24, only 55 resolutions were actually rejected. Institutional investors in India tend to do their own analysis, supplemented of course by PAs. Proxy advisors’ only function as a support system for investors to make their own informed decisions. This, in fact, is the right approach.
Most of the time, PAs tend to criticise and find faults. Who likes a critic? When one goes to a doctor who finds something wrong, what does one do? Take corrective action. So why not treat PAs as doctors for good governance?
The problem starts with the interpretation of laws by proxy advisors which many-a-time differ from the company’s interpretation. PAs create their own benchmarks, leading to, what could be termed as “regulatory compliance” vs “governance” situation. They believe that governance is the higher form of compliance, in spirit and beyond letter.
The role of PAs is not to second guess the decisions/actions of the management so long as they are fair and the governance parameters are adhered to. PAs neither have the expertise, vision nor the information that the board has to determine what’s best for the company. Nor are they expected to possess the skills to out-think the boards of the thousands of companies that they track. Therefore, the drafting of notices for meetings becomes important. The board should ensure that the proposals are supported with specific and detailed rationale, and provide requisite disclosures for informed decision making. Most negative recommendations are the result of lack of proper disclosures and rationale. But, the most controversial issues are related to valuation.
A proxy advisor is not an expert in valuation. However, they have a fiduciary responsibility to raise concerns in case the valuation is unfair. While valuers claim that valuation is an art, not an exact science, when two valuers working independently arrive at almost the same value/ratio, one wonders whether to believe the phrase, “valuation is an art”. How can two pieces of art be the same? Unless one is a fake or a copy.
Therefore, SES hardly puts any reliance on the valuer’s report, and works on independent valuation if possible. In case a deal is between two listed entities, the undisturbed share price of the entity for a reasonable period preceding the transaction announcement date is considered. The market price is the fairest estimation of value.
Mostly, companies have problems with PAs. However, two recent cases, that of Tata Motors and ICICI Securities, are noteworthy. In these cases, the issues were raised by a few investors although a majority of institutions backed the proposals. In both cases, their opposition emanated from their expectations which were not backed by sound arguments.
In the case of ICICI Securities, the argument was that the valuation was based on the current price which was lower than the listing price and why the National Company Law Tribunal scheme route was adopted, although the market Regulator SEBI had permitted this. The NCLT scheme route was chosen in a transparent manner, but questions were raised. Is it possible to satisfy everyone? No. The ICICI proposal satisfied all PAs and most institutional investors. In fact the management chose the NCLT scheme route, which is a two-step process involving greater scrutiny, first from shareholders and then from the NCLT. There is no law which says that if someone’s expectations are not met, the proposal is unfair. Even PAs, after giving their opinion, cannot say that if their recommendations are not followed, they will cry foul. Law and logic both cannot support unreasonable arguments and expectations. Any legally available route, as long as it does not intend to benefit any select individual, can be chosen. In the case of ICICI, no individual has unfairly benefitted.
The case of Tata Motors was unique, where an individual approached all and sundry to convince them that Tata Motors DVR’s shareholders were treated unfairly. The exchange ratio should have been one equity share for one DVR share, notwithstanding the market price difference, which has been prevailing for a decade. A new concept of economic valuation was invented to claim Tata Sons was increasing their value at the cost of other shareholders. Although, factually, Tata Sons’ equity was coming down. The law cannot control a flight of imagination; it also cannot take the same flight. It has to remain grounded. So is the case with companies and investors. PAs are no exception.
In its existence, which spans more than a decade, the PA industry, after struggling in the initial few years, has come of age. The challenge now is not to boast about its success but rather maintain its independence, be free from conflict and continue without worrying about the outcomes. After all, proxy advisors are not beneficiaries of the outcome.
The writer is managing director, Stakeholders Empowerment Services. SES has released reports on Nestle, ITC, Tata Motors and ICICI securities
