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AT ARM’S LENGTH, FOR CORPORATE HEALTH

SYLLABUS:

GS 3:

• Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Focus:

• Proxy advisors attract attention when their recommendations lead to rejection of resolutions like in the case of Nestle’s royalty payout

Source: Reddit

Proxy advisory firms position themselves as independent entities that offer guidance to individual shareholders, minority shareholders, or institutional investors concerning the proper utilisation of their rights within a company.

Objectivity in Recommendations:

• Proxy advisors attract attention when their recommendations lead to significant decisions, such as the rejection of Nestle’s royalty payout.
• Divergence in views among proxy advisors is common, exemplified by the ITC Hotels demerger.
• Rarely do proxy advisors unanimously agree, with exceptions like the ICICI Securities delisting and Tata Motors DVR proposals.
• The influence of proxy advisors varies globally, with limited power in India compared to other countries.
• Stakeholders Empowerment Services (SES) recommended against 1,841 resolutions in 2023-24, but only 55 were rejected.

Support System for Investors:

• Institutional investors in India conduct their own analysis, using proxy advisors as supplementary support.
• Proxy advisors serve as a support system for informed decision-making rather than being decision-makers.
• They often criticize and find faults, akin to a doctor diagnosing issues.
• PAs should be treated as doctors for good governance, offering corrective insights.
• The right approach is for investors to make their own informed decisions with the help of proxy advisors.

Interpretation of Laws and Governance

Interpretation Differences:

• Problems arise when proxy advisors and companies interpret laws differently.
• Proxy advisors create their own benchmarks, leading to conflicts between regulatory compliance and governance.
• Governance is seen as a higher form of compliance, encompassing spirit and letter of the law.
• Proxy advisors should not second-guess management decisions if they adhere to governance parameters.
• They lack the expertise and information that boards have to determine the best course for a company.

Drafting of Meeting Notices:

• The drafting of meeting notices is crucial to ensure proposals are well-supported with specific rationale.
• Proper disclosures and rationale are necessary for informed decision-making.
• Most negative recommendations arise from inadequate disclosures.
• Controversial issues often relate to valuation concerns.
• Proxy advisors have a fiduciary responsibility to raise concerns about unfair valuations.

Valuation Issues

Valuation Controversies:

• Proxy advisors are not experts in valuation but must address unfair valuations.
• Valuation is often considered an art rather than an exact science.
• Discrepancies in valuations raise questions about the accuracy of the “valuation is an art” claim.
• SES relies on independent valuations, especially for deals between listed entities.
• The market price is viewed as the fairest estimation of value.

Recent Case Studies:

• Tata Motors and ICICI Securities faced noteworthy issues with proxy advisors.
• In both cases, a minority of investors raised opposition despite majority institutional support.
• The ICICI Securities case involved concerns about valuation based on current vs. listing price and the chosen regulatory route.
• The NCLT scheme route was chosen transparently, involving greater scrutiny.
• Tata Motors faced unique opposition from an individual investor advocating for an exchange ratio that ignored market price differences.

Challenges and Expectations

Managing Expectations:

• It is impossible to satisfy all stakeholders’ expectations.
• The ICICI proposal satisfied most proxy advisors and institutional investors, despite some opposition.
• Proxy advisors’ recommendations are not binding, and they cannot cry foul if their advice is not followed.
• Legal and logical arguments must support reasonable expectations.
• Any legally available route, if fair and not benefiting select individuals, can be chosen.

Unique Case of Tata Motors:

• An individual investor’s campaign claimed Tata Motors DVR shareholders were treated unfairly.
• The exchange ratio demand ignored a decade-long market price difference.
• An economic valuation concept was used to argue Tata Sons were unfairly benefiting.
• Proxy advisors must remain grounded in factual and legal realities.
• The law must stay practical and cannot support imaginative flights of fancy.

Evolution and Independence of Proxy Advisors

Maturity of the Industry:

• The proxy advisory industry has matured over more than a decade.
• Initial struggles have given way to established practices and recognition.
• The current challenge is to maintain independence and freedom from conflicts of interest.
• Proxy advisors must continue their work without worrying about outcomes.
• They are not beneficiaries of the outcomes but serve the investors’ best interests.

Maintaining Integrity:

• Proxy advisors should focus on maintaining their objectivity and independence.
• They must avoid conflicts of interest to preserve their credibility.
• Continuous improvement and adherence to best practices are essential.
• Their role is to provide informed recommendations based on thorough analysis.
• The industry’s success lies in supporting good governance and investor decisions.

Source:The Hindu

Mains Practice Question:

Discuss the role of proxy advisors in corporate governance. How do they influence decision-making in shareholder meetings, and what challenges do they face in maintaining objectivity and independence?