Modern finance has provided investors with an understanding of risk and return that essentially mandates ownership of stock in hundreds or even thousands of companies, allowing them to earn the high returns of risky equity while limiting the risks that come with placing too many eggs in a single basket.
But with ownership spread across so many companies, industries, and geographies, investors must decide how to vote on thousands of proxy questions; this means they often rely on proxy advisory business for help. This is the time of year the two biggest advisors, ISS and Glass Lewis, survey their clients and other stakeholders to determine how their standards will evolve for the coming proxy season.
While some criticize the use of proxy advisors as a dereliction of duty by institutional investors, the annual surveys provide shareholders with a mode of collective action by helping these services create policies that reflect the combined views of dispersed shareholders. This turns what could be the noise of unaided individual voting by disparate investors into a signal approximating a consensus viewpoint.
In this month’s newsletter, we explain why investors should use the surveys to protect the systems upon which their entire portfolios rely. Such a systemic perspective departs from current practice of both advisory firms, who focus almost entirely on using votes to maximize the financial return at the individual company where the vote is cast, regardless of the overall impact such companies might have on the economy and financial market.
Following that explanation, we summarize some of the model answers to the ISS and Glass Lewis surveys that we recommend for implementing systemic stewardship.
System Stewardship
The greatest threat to investors’ long-term doesn’t come from individual companies’ failure to optimize their own returns, but rather from the trillions of dollars in social and environmental costs businesses externalize every year. These costs weigh down the entire economy, and directly reduce the long-term value of a diversified portfolio.
Climate change is a quintessential example of this phenomenon. When shareholders fight climate change with proposals or other voting strategies to decrease a company’s carbon footprint, the proxy advisors evaluate whether decreasing its emissions will increase the value of the company itself by avoiding or anticipating regulations or by preserving the company’s reputation. But the advisory firms don’t account for the impact of the company’s emissions on the climate system itself, and the corresponding impact on diversified portfolios.
This is a missed opportunity, because the biggest threat shareholders face from climate change will occur at the economy-wide level: one recent report suggested our collective failure to change the economy’s carbon trajectory will cause the global equity markets to lose 30-40% in value. This means if ISS and Glass Lewis are only giving advice on whether a climate proposal is in the financial interest of the company where the proposal has been made, they’re missing the most important value proposition from the perspective of a diversified investor. As a result of this gap in advice, the proxy advisors inadvertently prioritize companies’ interests over those of most investors, while also exacerbating risk to the entire economy.
What’s true for climate is true for almost every proxy question that addresses the social, economic, or environmental sustainability of a company’s practices. As another example, decisions that contribute to inequality undermine the global economy, no matter how profitable those practices might be at an individual company. In the 2024 proxy season, The Shareholder Commons collected more than 70 shareholder initiatives that were backed by systemic arguments addressing diversified shareholders’ interests. To date, however, neither ISS nor Glass Lewis appears to consider these arguments.
Despite this advisory gap, investors can use their unique combination of power and incentive to rein in the types of behavior that threaten critical systems. We’ve addressed these issues at length in Congressional testimony. Indeed, one global law firm explained that fiduciaries who manage assets on others’ behalf are obliged to address systemic risk. (Of course, this newsletter and the other publications of The Shareholder Commons don’t constitute legal advice.)
Proxy Advice with a Systemic Lens
ISS is seeking input for its proxy advice in its annual survey, which closes on September 5. Glass Lewis’ survey closes on August 30. We encourage you to fill out the surveys and clarify that you’re interested in proxy advice that accounts for the systemic impact of proxy votes that affect value across diversified portfolios. To be clear, such accounting is in addition to—not in lieu of—accounting for the impact such votes have on the individual company where the vote takes place.
We have prepared model answers for certain questions in the surveys here (ISS) and here (Glass Lewis). These are of course suggestions only, and you may wish to modify the language, or expand on it. For the most part (but not entirely), we avoid taking substantive positions on individual issues—our goal is to highlight the need for investors and their advisors to address systemic issues. We encourage you to use the type of argument illustrated in the model answers to support any request for a sustainability policy that addresses system-wide threats.
The question numbers in the model responses correspond to the question numbers in the surveys themselves. We have reprinted the relevant portion of the original question in roman type and provided the model answer in italics. In a number of places, we didn’t answer questions regarding specific standards, but used the option of providing additional information to explain why the advisor should account for portfolio effects when making its decision as to what standard to apply.
Here are some examples:
Answer to ISS executive compensation question: incentive compensation should be contingent on protecting systems.
Although we believe time-based only vesting is problematic, we believe ISS’ qualitative review should include performance criteria designed to ensure companies are not profiting from practices that create systemic risk. For example, at companies that have significant carbon emissions, equity should not vest if a company is not meeting reasonable targets to conform to consensus goals, such as the Paris Accords. As another example, equity should not vest unless companies ensure employees and supply chain workers are being treated in a manner that addresses the systemic risks that arise from increasing inequality. Without such measures, executives will be incentivized to prioritize enterprise value over the interests of most clients (or client beneficiaries) in protecting the systems that undergird their entire portfolios.
Answer to ISS climate change question: standards must account for alignment with Paris Accords.
The economy’s current greenhouse gas emissions trajectory may lead to a rerating of the entire equities market of 30-40% in comparison to a Paris aligned economy. See Rebonato, R., D. Kainth, and L. Melin. (2024) How Does Climate Risk Affect Global Equity Valuations? A Novel Approach. EDHEC-Risk Climate Impact Institute, EDHEC Business School (July); see also, Rachel Teo and Willemijn Verdegaal, Integrating Climate Scenario Analysis into Investment Management: A 2023 Update, 23.
ISS’ standard for climate accountability recognizes the importance of addressing this overhang by recommending votes against responsible directors “where ISS determines that the company is not taking the minimum steps needed to understand, assess, and mitigate risks related to climate change to the company and the larger economy.” This requirement that climate damage to the economy—as well as to the company itself—be mitigated recognizes that climate change is a critical factor for ISS clients due to the diversified nature of modern investing. Accordingly, shareholder proposal analysis should be focused on whether they are reasonably calculated to bring a company closer to Paris alignment.
Answer to ISS human capital management question: standards must address inequality.
Inequality, including racial and gender inequality, threatens the intrinsic value of the global economy. See Living Wage and the Engagement Gap: Using a Systems Lens to Build Portfolio Value Through Improved Wages.
ISS’ analysis of human capital management disclosure metrics should ensure that the metrics are designed to capture the risk a company’s practices pose to the global economy through contribution to inequality and other systemic risks.
Answer to Glass Lewis question on AI: development must not outstrip alignment.
The misuse of AI is a critical systemic risk for most Glass Lewis clients, who are generally diversified at the beneficial owner level. AI that is misaligned with society’s needs has the potential to exacerbate existing inequality, to create vectors of social strife, and to provide bad actors with opportunities to pose existential threats. These potentials threaten the social, economic, and environmental systems that undergird the economy, and thus diversified portfolios. Glass Lewis policies on AI should be designed to protect their typically diversified clients (or the diversified beneficial owners those clients may represent) from value extraction practiced by individual companies seeking to profit from rapid, risky development of AI ahead of clearly effective alignment technologies.
Answer to Glass Lewis question on adoption of benefit corporation (PBC) status: in the right circumstances, it can be a tool to protect diversified shareholders.
Adoption of a properly formulated benefit corporation status can enhance the ability of a company’s board to limit the costs it externalizes in pursuit of profit. See McRitchie v. Meta Platforms, Inc (Del. Ch. 2024). However, such a status should only be adopted at a corporation with adequate governance protection, such as single-class voting and a clear, enforceable mandate that the expanded ability to consider social and environmental impacts will be used to protect the portfolios of diversified investors.
Answer to Glass Lewis question on reincorporation to a different jurisdiction: to preserve the rule of law that protects shareholders, companies should not be able to choose out of jurisdictional law following unfavorable decisions.
There is no single critical factor. While both shareholders and management often criticize Delaware, keeping companies in Delaware promotes the rule of law and stability, even if there is disagreement with individual decisions made by the courts or legislature. GL should recommend AGAINST reincorporation out of Delaware where companies are trying to avoid long-accepted, balanced principles and protections, as is happening with some companies. If companies begin to choose jurisdictions based on individual predilections, we will see a race to the bottom that will be harmful to investors and the global economy.
Global answer that can be provided as answer to Glass Lewis general comment question or used where otherwise appropriate:
As we understand your benchmark and other voting guidelines, voting recommendations are designed to optimize returns solely at the individual company at which shares are being voted, without regard to their impact on clients’ broad portfolios. We would like access to a voting product that also addresses a vote’s impact on the value of a diversified portfolio.
As a diversified investor, the intrinsic value of the economy is by far the greatest determinant of our overall financial returns. To optimize our [clients’] returns, we need proxy voting advice that will incorporate the impact of our votes on our [their] entire portfolio, not just on the individual companies where the votes take place. This is a critical distinction, because it is not in our [their] interest as a diversified investor for a portfolio company to engage in practices that threaten social and environmental systems, even if those practices maximize the returns of the individual company: those systems underpin the broad economy upon which our [their] portfolio[s] depend[s].
We believe we share this value proposition with many if not most investors who follow the diversification principles dictated by Modern Portfolio Theory, and such advice could be rendered broadly for the benefit of all diversified clients, regardless of individual differences in portfolio composition.
