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What if the influence of ISS on how institutional investors vote has been overstated? That’s the upshot of this groundbreaking new study from Professors Stephen Choi, Jill Fisch and Marcel Kahan, the first to gauge the relationship between ISS and mutual fund voting on director elections. Bear in mind that mutual funds constitute the largest group of institutional investors, holding 27% of US equities and that they are relatively free of conflicts of interests compared to other types of institutions.

I’m not a big fan of academic studies, but this one weighs in at a mere 46 pages (before appendixes) and is easy to read. In fact, it’s a “must read” as it could have profound implications for the SEC’s proxy plumbing project, shareholder engagement and proxy solicitation practices – and perhaps change the views of those that harbor ill will towards ISS these days. And it should be helpful framing some of the discussions that will take place soon enough during the multiple panels during our pair of executive pay conferences that deal with proxy advisors, shareholder engagement, etc.

By examining the voting trends of mutual funds – who have been required to disclose how they vote annually on Form N-PX since ’03 – the trio of Professors were able to confirm their earlier contention that ISS swings only 6-10% of the vote in uncontested director elections. That is far less than what others have concluded – they claim that ISS influences 20-30% in a typical election. That alone is significant, but the study has other interesting findings, including:

– More Lockstep Voting with Management than Blindly Following ISS – 25% of funds (as measured by asset size) blindly vote lockstep with management, compared to less than 10% that blindly follow ISS

– Funds Tend to Consider ISS Recommendations Rather Than Blindly Follow – Overall, ISS’s influence is due more to investors evaluating and considering ISS recommendations rather than blindly following them

– Smaller Funds Tend to Blindly Side with Management – Smaller funds are more likely to blindly vote in lockstep compared to larger funds (with either ISS or management)

– Lack of Conflicts for Affiliated Funds – No evidence exists that funds affiliated with banks, etc. are more likely than independent funds to vote with management in an effort to maintain good business relations

– The Big Three Have Wide Influence – The largest fund families – Vanguard, Fidelity and American Funds, each of whom individually accounts for 11% of total fund assets – vote substantially differently both from each other and from what ISS recommends

High Number of Director “Withhold” Votes? How That Happens

One of the most interesting sections of the study starts on page 40. This section gets into what type of factors are present when a director receives a high level of withhold votes, an issue of great importance to directors concerned about their own reputation. Here is an excerpt from the study’s abstract that highlights the findings here:

Finally, we examine the factors associated with high (in excess of 30%) withhold votes in director elections. An ISS withhold recommendation, in conjunction with at least one of four factors – a withhold vote by Fidelity, the director missing 25% of board meetings, the company having ignored a shareholder resolution that received majority support, and a Vanguard withhold vote on outside directors with business ties to the company – is associated with a 49% probability of receiving a high withhold vote. Directors in these groups account for 48% of all directors who received high withhold votes.

By contrast, an ISS withhold recommendation that is not combined with one of these factors is associated with only a 21% probability of a high withhold vote, and the general probability of a high withhold vote is a mere 2%. These findings suggest steps that companies and directors should take to try to avoid high withhold votes. They are also evidence that not all ISS recommendations have the same impact on voting outcomes.

ISS’s Biggest Shortcoming? Be Careful What You Wish For…

For me, the largest mindblower of the study is on page 24. This is where the professors explain “perhaps the biggest shortcoming of ISS” – which is identified as ISS not providing sufficient details about why it is recommending a vote “for” a particular director. Without that explanation, it is more challenging for an investor to decide whether to not follow ISS’s “for” recommendation – and thus decide to vote “against/withhold” instead.

For those on the “bash ISS at all costs” bandwagon, think about that for a minute. Imagine if ISS fixes this shortcoming and directors stop receiving so many “for” votes just because ISS recommended as such. Read my prior blog entitled “The Debate Over ISS’s Role: Imagine a World Without” – and be careful what you wish for…

– Broc Romanek