A Long/Short Incentive Scheme for Proxy Advisory Firms

Abstract

Proxy advisory firms such as ISS or Glass Lewis play an important role in our capital markets. They advise institutional investors how to vote in shareholders’ meetings and often have a dramatic influence on the outcome. Such immense power, however, has sparked concern and calls for regulation, given that proxy advisors have no “skin in the game". In this Article we propose a novel framework for an incentive pay scheme for proxy advisors within the highly important context of Mergers and Acquisitions, that would align their incentives properly. In short, instead of their current flat fee arrangements, part of the advisors’ fees would be used to create the following incentive framework: if proxy advisors recommend their clients to vote against an acquisition, and shareholders accept their recommendation, proxy advisors should be placed in a "long" position on the stock of the target. The advisor would gain if share prices eventually pass the acquisition price and lose if they do not. However, if proxy advisors recommend shareholders to accept an acquisition and shareholders nevertheless reject the takeover bid and advice, the proxy advisor should be placed in a ״short" position on the stock. They will lose if share prices eventually pass the acquisition price and gain if they do not. In the Article we discuss how to implement and promote this proposal.

Keywords: Proxy advisory firms; incentive-based scheme