Before Academics Complain About Conflicts of Interest, They Should Disclose Their Own

Academics who study business love to talk about the power of incentives and the importance of full information to enable the most effective and efficient decisions. Unless it applies to them.

As David Kocieniewski reported in the New York Times on December 27, 2013, "academic experts" who testify and make filings in favor of business-friendly regulations and rulings often fail to disclose the corporate sources of funding for their research. While they appear to represent the ivory tower virtues of scholarly integrity, with fidelity to nothing but the truth, they are in fact advocates who are paid to take the positions they promote.

[M]ajor players on Wall Street and elsewhere have been aggressive in underwriting and promoting academic work... part of a sweeping campaign to beat back regulation and shape policies that affect the prices that people around the world pay for essentials like food, fuel and cotton.

Inside Job, the superb documentary about the financial meltdown, has a devastating scene with Glenn Hubbard, the Dean of Columbia's Graduate School of Business, refusing to discuss the payments he receives from the financial services industry. As one commenter on the Times article noted, "Nothing is funnier than watching people who study economics declare that money can't possibly have any influence on their work."

In a recent Wall Street Journal op-ed, two academics from Stanford University, David F. Larcker and Allan L. McCall, repeat the same talking points big business has been using to attack ISS and Glass-Lewis, the two proxy analysis firms that advise shareholders how to vote on CEO compensation and other issues of vital interest to shareholders. But the authors do not say whether they receive any funding for research or programs from corporate sources.

It is difficult to imagine any other reason they could be calling for government regulation of proxy advisory firms, which exemplify and support an efficient free market. Those firms sell their reports to pension funds and mutual funds who are sophisticated purchasers of financial analysis. These customers are not obligated to buy the reports, as explicitly made clear in an SEC ruling.

Some investors choose one firm, some use both, and some use neither. Some read the reports and disregard or overrule the advice, especially in particularly complex or controversial matters. The proxy advisors provide analyses and information that investors find valuable, just like other independent, outside research firms helping shareholders make investment decisions.

Larcker and McCall raise concerns over conflicts of interest in the proxy advisors but overlook the far deeper conflicts of interest faced by institutional investors and corporate executives that led to the demand for independent assessment from outside firms and the success of their products.

If Larcker and McCall think the reports from these firms can be improved, the solution is not regulation, but competition. They should encourage others to produce a better product, or perhaps produce their own. A warning, though -- when a corporate-funded proxy advisory service tried to compete with ISS and Glass-Lewis, it failed, probably because sophisticated institutional investors can recognize and assess conflicts of interest.

Those who accuse the proxy advisory firms of being too powerful never mention that most of their recommendations are to vote for management. What this is really about is big business trying to silence its critics who point out that some executives are overpaid and some boards of directors are ineffective. If corporate executives do not want shareholders to vote against their proposals, they should stop asking them to approve actions that do not make sense, not ask the SEC to stifle the only source of independent research and analysis with regulation.

The absurdity of the accusation that proxy advisors have too much power is clear from one key fact: virtually all shareholder votes are non-binding. Even a 99 percent "no" vote from shareholders can be disregarded by corporate executives and directors. Larcker and McCall claim that the "say on pay" proposals that allow shareholders to have an advisory "vote" on CEO compensation have "increased the power of proxy advisory firms." Yet only 71 companies failed to get shareholder approval out of the thousands voted on in 2013, and even they are still not obligated to make any changes because "say on pay" votes are only symbolic.

If the biggest, best-informed, and most powerful investors in the world were somehow wrongly persuaded by proxy advisors to vote against some worthy corporate proposal or CEO pay plan, it is still impossible to say they are too influential because companies have no obligation to pay attention to the vote.

On the other hand, academics are influential, because they are perceived as uniquely able to evaluate all sides with equal rigor, free from bias or obligation. If that is to continue, they must be completely transparent about their sources of funding. Before they raise the issue of conflicts of interest faced by others, they should disclose their own.

Note: Having called on others for disclosure, here is mine. I was a co-founder of the largest of the proxy advisory firms, ISS, in 1986, serving as its first general counsel and its second CEO. I left the company in 1990 and have had no professional or ownership connection to it for more than 18 years. Like ISS, my current firm also provides independent research about corporate governance but we do not sell proxy analysis or recommendations and would not be affected by the proposed "reforms."