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.
SEBI’s Proposed Code of Conduct for Proxy Advisory Firms

  • Introduction of ‘Comply or Explain’ Approach:
    • Listed companies can approach SEBI for redressal if aggrieved by proxy advisors’ views.
    • Companies must either comply with proxy advisors’ recommendations or publicly explain their non-compliance.
  • Role of Proxy Advisors:
    • Proxy advisors provide advice to institutional investors and shareholders on exercising their rights in companies.
    • They offer recommendations on public offers and voting on agenda items.
  • Disclosure of Conflicts of Interest:
    • Proxy advisors must disclose any potential conflicts of interest from ancillary business activities.
    • Their boards should be independent of shareholders to avoid conflicts of interest.
  • Ensuring Capacity and Capability:
    • Institutional investors, including foreign portfolio investors and alternative investment funds, must ensure proxy advisory firms they employ have the appropriate capacity and capability.
    • This ensures the reliability and quality of proxy advice provided.

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?