One of the lessons of the financial crisis is that investors should beware of subcontracting key financial decisions to third parties.
History might have been different had they been less willing to trust the word of credit rating agencies in the run up to the 2007 crash. However wise intermediaries may seem, they are as prone to conflicts of interest as anyone else.
Now Jamie Dimon thinks he has perceived a new threat: that of proxy advisers. These are entities that advise institutional investors how to vote their shares on governance issues such as pay and board composition.
JPMorgan’s boss thinks that “lazy” and “irresponsible” shareholders have given too much power to two leading US advisers — International Shareholder Services and Glass Lewis. Many fund managers have farmed out decision making to these organisations — an effective duopoly in the US — leaving them to deploy large block votes at annual meetings as they see fit.
Some have dismissed Mr Dimon’s intervention as sour grapes — it came just days after those same proxy agencies induced JPMorgan Chase’s shareholders to revolt in large numbers over his own outsize pay package. But Mr Dimon has touched on a point that should not be dismissed.
There is nothing wrong with employing proxy agencies. Indeed, used intelligently, they can genuinely help investors to hold companies to account. They get around a collective action problem that springs from the dispersed ownership of public companies. Because each institution only holds a comparatively small stake in every company it owns, none has much incentive to engage in activism.
It is a problem pithily summed up a decade ago by Tom Jones, then head of Citigroup’s fund management arm. “If we spend money to do shareholder activism, Citigroup asset management shareholders bear the expense but don’t get a benefit that is distinct from other shareholders,” Mr Jones said. He likened activism to “do-gooding” and said he preferred to engage in activities for which he was actually paid.
Getting investors to club together to analyse companies’ governance helps to get around the free rider problem. The snag is that in fixing this glitch, proxy agencies can create fresh ones. These stem in part from the Cinderella status of governance within fund management businesses. While trumpeted as important, it is not an area on which institutions have historically lavished pay and investment.
Many fund managers have leapt at the chance to delegate this task to external advisers, paying them a certain (often quite low) price per company vote. This is especially the case in the US, where regulations permit the whole process to be delegated. At many company meetings, ISS alone disposes of more than a fifth of the vote.
A second issue is that the proxy advisory industry is itself concentrated. While the US regulators have not given advisers the sort of protected status they accorded credit rating agencies, ISS and Glass Lewis, have come to dominate the market — not only in the US but in Europe too.
The risks this poses are two fold. The first is that companies will recognise the outsize influence wielded by these firms and simply lobby them instead of engaging more broadly with shareholders.
A second connected concern is that proxy advisers may face conflicts of interest. ISS is under private equity ownership, while Glass Lewis is owned by Ontario Teachers, a Canadian pension scheme. Both are under pressure to increase their financial returns. One way they can do this is to sell services not only to investors but to companies too. ISS already offers advice to corporate bosses on how to improve governance, while Glass Lewis peddles them investor-relations services. Both firms claim these activities are sequestered from the advice they give shareholders, and they disclose the names of companies that they advise. But vigilance will be needed to ensure that the revenues they generate don’t come to cloud the judgments agencies make on the other side of the house.
Of course, there’s an easy way for investors to sidestep any of these problems. That is not to delegate to a single external source, but to consult before taking governance decisions themselves. Indeed, to do otherwise is simply lazy. However conflicted he may be about his pay, Mr Dimon is entitled to point this out.