How CEOs and Boards Should Handle Proxy Firms

(Editor's Note: This is the last in a four-part series on proxy service firms. Read parts one, two, and three.)

Given the questions about the influence and performance of proxy service firms, how should top executives and boards handle them?

On one level, the idea of assessing how public firms are fairing regarding corporate governance seems wholly transparent and positive. Shareholders and their institutional managers in pension funds and other collectives deserve to know how different firms regard them and whether they are truly valued as the technical owners of the corporation. Proxy service firms can play a big role in providing the analysis and recommendations that shareholders may be too busy or distracted to do.

Yet somehow, this valuable, public service concept seems to have morphed into something else, critics say. Instead of providing real service, the proxy firms may have provided only self-service as they have grown into intimidating, self-sustaining monsters without many checks or balances.

Too often, boards seem satisfied to pander to ratings or recommendations just to avoid conflict. The C-Suites and boards of smaller companies may find they just haven't the resources to come up with competing data or perspectives. So, they give in to the "check the box" style of review by far-away analysts who may or not know them well.

"Directors are the one sweet spot in all of this," says Robert Daines, Pritzker Professor of Law at Stanford University who co-authored a critical study of the data in the ratings of proxy service firms. "But the board should be cautious about changing corporate governance practices just to get a better rating. So, don't just do it for the rankings. But this does not mean that governance doesn't matter and sometimes the "ratings' are right."

And don't give in to fear. Boards can be moved to go along with a proxy service firms recommendations against someone as director or in favor of this policy because they want to avoid hassle and attention. "Companies just don't want to end up on somebody's focus list," says Shirley Wescott, managing director of policy at ProxyGovernance.
RiskMetrics, which bought much-criticized Institutional Shareholders Services two years ago and says it is in the midst of a transition, argues that furthering a dialogue between boards, the C-Suite and investors is the way to go. They have created a constant, online Website and chat room to facilitate discussion and make their research resources more available.

Calls for codes of ethics seem a good idea, but have their limits, as do creating outside advisory councils. It isn't certain if the Securities & Exchange Commission will undertake a panel-led review of proxy service firms. It probably won't be known until after the election when there is a new SEC Chairman. By then calls for regulation following today's financial chaos so some kind of eventual review seems likely.

Proxy service firms can offer benefits, but it appears that a review of their power and purpose is long overdue.