ISS, the largest proxy advisory service company, has just released their annual proposed voting guidelines. ISS guidelines are highly influential. Nearly every large institutional shareholder subscribes to ISS, and many of these institutions follow ISS’s recommendations closely when making their votes. There is an open comment period, which ends on October 26, 2020, before the guidelines become final.
The most important changes in ISS’s Guidelines
The first noteworthy change to ISS’s guidelines this year relates to Board Diversity. Under the proposed guidelines, ISS would recommend voting against the Chair of the Board Nominating Committee if a company had no racial or ethnically diverse board members.
The second noteworthy change relates to companies’ attention to environmental and social risks: significant risk oversight failures may cause ISS to recommend against certain board members.
Do these changes to ISS guidelines matter?
This increased attention to environmental and social issues will attract attention among management of publicly traded companies. Many shareholders pay close attention to ISS’s recommendation. Iliev and Lowry (2015) find that 25% of mutual funds follow ISS’s recommendations in nearly ALL cases – specifically in over 99% of all agenda items up for vote, across all their portfolio firms, over a five-year period. In sum, changes in ISS guidelines can have real effects among the underlying companies.
How many firms would be affected by these new ISS guidelines?
According to a 2019 ISS study, among Russell 3000 firms just over 10% of directorships were held by ethnic minorities: 4.1% by Blacks and African Americans, 2.9% by Asians, 1.8% by Hispanics and Latin Americans, and 1.6% by other. The many firms with no racially or ethnically diverse directors may be forced to search beyond their immediate network to identify qualified candidates. This can provide many benefits, to firms and communities alike.
If these proposed guidelines pass, ISS would join the state of California in working to affect real change on publicly traded companies’ approaches toward social and environmental issues. In addition to bringing attention to these matters, ISS and California are implementing real consequences for companies that do not move forward on these issues. For ISS, the consequence is an Against recommendation for key directors, which in turn will almost certainly lead to lower vote support. The state of California is outright requiring such change: recently passed legislation requires that publicly traded companies headquartered in the state have at least one ‘diverse’ director by 2021.
Effects on shareholder value
There is an ongoing debate within the literature regarding the effects on shareholder value, when companies devote resources to social and environmental issues. A growing body of work suggests that shareholders benefit. Increased attention to social issues can improve company culture, which Edmans (2011) shows leads to higher shareholder value. Also, increased investment in social and environmental issues can mitigate risks, which similarly provides benefits to shareholders (see, e.g., He, Kahraman, and Lowry (2020)).