The current landscape surrounding proxy advisors is marked by an unprecedented surge in regulatory scrutiny and public debate. From high-profile criticisms by influential figures like former President Trump and Elon Musk, to congressional investigations and a patchwork of conflicting SEC regulations and state-level legislative efforts, the role and influence of proxy advisory firms have become a central focus in corporate governance discourse. Amidst this intense scrutiny, a new academic article, "Other People’s Votes," authored by Edwin Hu, Associate Professor of Law at the University of Virginia School of Law; Nadya Malenko, Professor of Finance at Boston College Carroll School of Management; and Jonathon Zytnick, Associate Professor of Law at Georgetown University Law Center, offers a critical economic framework to re-evaluate the function of these firms and proposes targeted reforms. The article, forthcoming in the Georgetown Law Journal, argues that many current proposals to rein in proxy advisors are based on flawed economic assumptions and may prove counterproductive.
The Evolving Regulatory and Public Scrutiny of Proxy Advisors
The intensity of the current debate is underscored by a series of significant actions. In September 2019, President Trump signed an executive order aimed at "Protecting American Investors" by addressing what the administration termed "unfair" practices by proxy advisory firms. This was followed by further directives and proposed rules from the Securities and Exchange Commission (SEC). Elon Musk, CEO of Tesla, famously described proxy advisors as "corporate terrorists" in a 2018 tweet, reflecting a sentiment shared by some corporate executives who argue that these firms wield undue influence and often push for policies detrimental to shareholder value.
The legislative and regulatory responses have been swift and varied. Two House committees, the Committee on Financial Services and the Committee on Oversight and Reform, launched investigations into the practices of proxy advisors, examining their potential conflicts of interest and their impact on corporate decision-making. The SEC, in an attempt to address concerns, adopted two distinct regulatory regimes. The first, in 2019, aimed to increase oversight and transparency, while a subsequent rule adopted in 2020 sought to further refine these requirements. However, these SEC rules have faced legal challenges, leading to conflicting rulings from three federal circuit courts, creating significant uncertainty for the industry.
Beyond federal action, state governments have also entered the fray. Texas, for instance, passed Senate Bill 2337, which could expose proxy advisors to substantial litigation by imposing new disclosure requirements and potential liabilities. At least thirteen other states have proposed or are considering similar legislation, indicating a broad-based concern about the power and influence of these advisory firms.
The Economic Underpinnings of Shareholder Voting and the Rise of Proxy Advisors
The article by Hu, Malenko, and Zytnick posits that understanding the current debate requires acknowledging the inherent economic challenges of shareholder voting. Institutional investors, such as pension funds, mutual funds, and asset managers, are tasked with voting on a vast array of critical corporate matters, including board elections, executive compensation, mergers, and shareholder proposals. These decisions are made across tens of thousands of proposals annually.
However, the economic incentives for individual investors to become deeply informed and actively participate in every voting decision are systematically weak. The costs associated with thorough research and analysis of each proposal are concentrated on the individual investor. In contrast, the benefits derived from casting a single informed vote are diffuse, probabilistic, and shared equally among all shareholders, regardless of their level of engagement. This creates a classic "free-rider problem," where investors have little incentive to bear the costs of becoming informed when they can benefit from the informed voting of others without incurring those costs. The predictable outcome is an underinvestment in monitoring corporate governance and management performance.
Proxy advisory firms, such as Institutional Shareholder Services (ISS) and Glass Lewis, emerged as a direct economic response to this collective action problem. By aggregating the demand for research and analysis across a large base of institutional investors, these firms can achieve economies of scale. This allows them to significantly lower the cost of participating in corporate governance and to produce more informed voting recommendations than most individual investors would be able to generate on their own. The core features of the proxy advisory industry – standardized recommendations, often automated execution processes, and a concentrated market structure dominated by a few large players – are direct consequences of these underlying economic realities of voting at scale.
The Double-Edged Sword: Value and Weakened Oversight
While proxy advisors provide a crucial service by mitigating the free-rider problem, the very economic forces that make their advice valuable also create incentives that can weaken oversight and precision. The need to serve a broad client base with varying levels of engagement and sophistication limits the extent to which investors are willing to pay for highly customized, firm-specific analysis. Consequently, proxy advisors are incentivized to produce standardized reports that can be applied across a wide range of companies.
Furthermore, the reliance on proxy advice reduces investors’ own incentives to rigorously monitor, verify, or supplement the information and recommendations they receive. If a proxy advisor’s report is readily available and seemingly comprehensive, the individual investor’s motivation to conduct independent due diligence diminishes. This can lead to a situation where investors passively accept recommendations without fully scrutinizing the underlying analysis, a phenomenon often criticized as "robo-voting."
Re-framing "Robo-Voting": A Nuanced Perspective
Critics frequently point to "robo-voting" – the mechanical rubber-stamping of proxy advisor recommendations – as a primary concern. However, the article by Hu, Malenko, and Zytnick argues for a more nuanced understanding of investor behavior. Drawing on a growing body of empirical research, they propose a three-stage framework for analyzing investor decision-making:
- Ex Ante Strategy Formation: Investors, particularly institutional ones, often develop overarching voting policies and strategies before the proxy season begins. These strategies are based on their investment mandates, risk appetites, and governance preferences.
- Information Aggregation and Recommendation Generation: Proxy advisors then conduct their research and generate recommendations aligned with these general principles and the specifics of individual proposals.
- Scaled Implementation and Attention Allocation: Investors utilize automated execution systems to implement their pre-determined strategies across a large number of proposals. Crucially, this automation is not necessarily an abdication of judgment. Instead, it serves as a tool to conserve limited investor attention, allowing them to focus their analytical resources on the proposals that are deemed most material or complex.
While acknowledging that some investors may indeed engage in pure robo-voting, the authors contend that the majority of institutional investors use automated execution as an efficient mechanism to implement deliberate, ex ante choices at scale. This approach allows them to conserve their valuable attention for the votes that truly matter, rather than devoting it to every single proposal.
Towards Targeted Reforms: Attention Flags and Fiduciary Floors
Despite this more nuanced view of investor behavior, the article does not dismiss legitimate concerns about the limitations of the proxy voting system. The inherent under-investment in informed voting is a systemic issue that proxy advisors did not create and cannot entirely eliminate. The challenge for policymakers, therefore, is to channel the influence of proxy advisors toward a better aggregation of investor information and preferences, rather than attempting to dismantle the system.
Hu, Malenko, and Zytnick propose two complementary reforms, grounded in the economic reality of investors’ limited attention budgets:
Attention Flags: Guiding Scrutiny Where It Matters Most
The first proposal is a system of "attention flags." Under this model, proxy advisors would be tasked with identifying recommendations that involve material trade-offs, possess significant firm-specific context, or carry high-stakes consequences for the company. These flags would serve to redirect investor attention to the proposals where additional scrutiny has the greatest expected value. This approach aims to enrich the currently often binary nature of proxy recommendations, providing a more granular signal of importance.
While many proxy advisory firms and their sophisticated clients already utilize such flagging mechanisms, these are typically opt-in services, disproportionately utilized by the most engaged investors who arguably need them the least. The proposed reform inverts this default. A baseline rule would automatically flag material ballot items for all clients. This ensures that investors most prone to inattention receive the alert, while more sophisticated investors retain the flexibility to tailor these flags to their specific priorities and portfolios. This default setting would effectively reach investors who might not proactively seek out such guidance, while still allowing experienced investors to customize their experience.
Fiduciary Floor: Ensuring Meaningful Human Judgment
The second proposed reform is a "fiduciary floor." This entails establishing minimum obligations for proxy voting that would prohibit pure robo-voting and mandate some level of meaningful human judgment where it is warranted. This reform is particularly prescient in light of the rapid advancements in artificial intelligence (AI). AI technologies make it increasingly cost-effective to convert raw data into voting recommendations algorithmically. The temptation to bypass human review, which is essential for nuanced decision-making, is therefore growing.
The economic pressure to minimize costs could lead to a "race to the bottom" in human involvement, as firms may prioritize cheaper, purely data-driven systems over more expensive oversight. However, the authors emphasize that firm-specific, "soft-information" signals, which are not easily quantifiable, still necessitate human judgment. Furthermore, the latent biases within large language models, trained on vast and often opaque datasets, remain largely unknowable and could lead to unintended consequences. A fiduciary floor would welcome the increased algorithmic customization that AI offers while ensuring that these tools serve as supplements to, rather than replacements for, human judgment.
These two reforms are designed to work in tandem. Heightened fiduciary duties would incentivize targeted engagement by investors, while attention flags would lower the cost of that engagement. Moreover, attention flags would clearly mark proposals where unsupervised automation is least defensible, creating a more transparent record for assessing compliance with investors’ voting obligations.
Evaluating Current Regulatory Approaches
The article also critically examines the prevailing regulatory approaches to proxy advisors. The authors analyze proposals such as:
- Asymmetric Burdens on Negative Recommendations: Legislation like Texas SB 2337, which imposes specific disclosure and liability burdens on proxy advisors when they issue negative recommendations, is seen as potentially creating an uneven playing field.
- Issuer Standing to Sue: Granting issuers the right to sue proxy advisors could lead to a chilling effect on independent analysis.
- Mandatory Issuer Pre-Publication Review: Requiring companies to review proxy advisor recommendations before they are published could allow management to influence or suppress critical assessments.
- Restrictions on Auto-Submission: Limiting the ability of investors to automate their proxy voting could undermine efficiency without necessarily improving the quality of decisions.
- Antitrust Action Against the Duopoly: While the market concentration of ISS and Glass Lewis is a subject of discussion, broad antitrust action might overlook the economic rationale for consolidation in providing scaled services.
- Shoehorning Proxy Advice into Existing Regimes: Attempts to fit proxy advice into existing rules for solicitations or beneficial ownership could create regulatory mismatches and unintended consequences.
Hu, Malenko, and Zytnick argue that several of these leading regulatory approaches function less as neutral mechanisms for improving governance and more as indirect efforts to drive proxy advisors out of the market or to suppress recommendations that oppose management interests.
Implications for Corporate Governance
The core economic insight of the article is that institutional investors face strong incentives to conserve attention. Weakening the role of proxy advisors is unlikely to be offset by increased independent investor engagement. Instead, such actions would more probably shift voting power toward greater deference to management, thereby exacerbating the very problem of under-investment in oversight that effective reforms are intended to address.
The authors conclude that proxy advisors are not the root cause of the tensions inherent in shareholder voting; rather, they are an institutional response to these deeply embedded economic challenges. Therefore, effective regulation should acknowledge this fundamental premise and focus on enhancing the quality of information aggregation and the responsible exercise of investor judgment, rather than attempting to diminish the role of a crucial market participant. The proposed reforms—attention flags and a fiduciary floor—offer a path forward that respects the economic realities of investor decision-making while promoting more robust and informed corporate governance.
