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Stewardship of corporate governance by Proxy Firms

  1. According to Regulation 2(1)(p) of the SEBI (Research Analysts) Regulations, 2014, ‘proxy advisor’ refers to any individual or any organization that prepares recommendations and gives advice for the institutional investors or shareholders so as to aid them in the casting of their vote in respect of any policy issues or a public offer.

  2. Proxy firms are products of shareholders’ activism that have boomed because of unscrupulous corporate governance in the organizations. Their main aim is to provide counseling to the shareholders but they can also be given the right to vote if they are expressly authorized by the shareholders.

  3. Post Satyam scam SEBI incorporated several steps to prevent these scandals and one such measure was the passing of the Securities and Exchange Board Of India (Mutual Funds) (Amendment) Regulations, 2010 in July 2010. It brought in more transparency in the disclosure of the norms and voting followed, as already there was a rise in shareholder’s activism and indulgence which led to the beginning of the proxy advisory firms in India.

  4. The ‘InGovern Research Services’ was the first proxy advisory firm of India started by Mr. Shriram Subramanian in June 2010. Thereafter several firms like the Institutional Investors Advisory Services (IIAS), Stakeholders Empowerment Services (SES), etc have been incorporated.

  5. Investment decision are influenced by the reports put up by the Proxy firms. These reports help the companies to build their reputation and trust among the shareholders. A report showcasing positive aspects of corporate governance standards adopted by the company would attract investor confidence in the company. This helps company in raising funds at lesser cost. Thus, it is believed that companies tend to follow good governance policies so that the recommendations drafted by the proxy advisors favour them.

  6. One of the latest advisory given by Proxy firms was to shareholders of One97 Communications, the parent company Paytm to vote against the resolutions , of reappointment of Vijay Shekhar Sharma as MD. Stakeholders Empowerment Services (SES), which, among others, has red-flagged the company’s resolution to approve his appointment and remuneration. SES cited “dual position of CMD and excessive remuneration” as reasons to disagree with the two resolutions. In its AGM notice, One 97 Communications had sought shareholders’ approvals to reappoint Sharma as managing director (designated as managing director and CEO) for five years from December 19, 2022 and salary payment as “minimum remuneration” for three years from FY23.

  7. The outside shareholders have little control over the operational issues of the company, but are affected by decisions taken by the controlling shareholders/managers. Such arrangement might result in conflict situations where the managers take decisions which are not in the interests of the outside shareholders, which is known as Agency Problem (Jensen and Meckling, 1976).

  8. There exist a contract between managers and shareholders about how the former should manage the company. However, it is not a complete contract covering every aspect of business decisions because of significant uncertainty, information asymmetries and contracting costs (Hart 1995). In such an environment, some mechanisms are needed to control these conflicts. The precise manner in which these mechanisms are set up and fulfill their role in a particular firm defines the nature and characteristics of that firm’s corporate governance system.

  9. The board of directors is the most important internal corporate governance mechanism, in which the board members, elected by shareholders, monitor the functioning of top management.

  10. Though they are outside shareholders, institutional investors, due to their significant holding, are one of the most important external corporate governance mechanisms. This phenomenon of active monitoring of the governance of the investee firms is known as shareholder activism. Researchers had observed that institutional investors by virtue of their large stockholdings would have greater incentives to monitor corporate performance since they have greater benefits of monitoring (Shleifer and Vishny (1997)).

  11. But there was a problem in showing activism in voting on resolutions. Most of these institutional investors hold a large number of securities, making the cost of engaging in research necessary to determine the correct vote on every proxy item very high. Determining how to vote on complex issues of corporate governance typically involves evaluating a wide range of idiosyncratic firm issues.

  12. This type of research was not the primary business of most institutional investors. Also there would be lot of duplication of research as companies would have many institutional investors invested in them. Hence institutional investors started to outsource the corporate governance and voting recommendation research to third parties. This resulted in the birth of proxy advisory firms.

  13. It is essentially the responsibility of institutional investors to carefully invest the funds of their clients in order to generate returns. However, institutional investors also have a duty of care to maintain the corporate governance of the companies in which they have invested. This is a part of their stewardship obligations. Data from the annual general meetings ("AGMs") of the top 10 Nifty-50 businesses over a four-year period is analyzed to analyze the strength of institutional investors' activism motivated by these obligations

  14. In India, listed companies are significantly financed by MFs, a major institutional investor. By December 31, 2021, investments made by MFs have increased exponentially to a total of over 38 lakh crore, or almost 14% of market capitalization. The sum of 10 folios represented significant retail investment in listed businesses through MFs.3 As a result, MFs have come to be seen by millions of investors as "pillars of trust" for both their investments and for preserving the value of those investments through involvement in corporate governance processes. While it may be acceptable for household shareholders to concentrate on short-term objectives (financial performance), controlling shareholders and institutional shareholders are expected to concentrate on maintaining performance and value by investee companies by actively participating in their governance.

  15. The Stewardship Code is attached to a SEBI's cover letter to Institutional Investors that makes clear that it only applies to listed equities. Consequently, it does not apply to institutional investor's investments in listed debt. The Stewardship Code consists of six principles ("Principles"), each of which includes certain guidance. The following are the Principles:


Institutional investors should create a detailed policy for handling their stewardship obligations, make it public, and frequently evaluate and improve it.


Institutional investors should have a transparent policy in place that outlines how they will handle conflicts of interest when carrying out their stewardship duties.


Institutional investors need to monitor the companies they have invested in.


Institutional investors need to be very explicit about when they will intervene in the companies they invest in. To protect the interests of the final investors, institutional investors should also have a transparent policy for working with other institutional investors when necessary. This policy should be made public.


Institutional investors ought to have a transparent voting and disclosure policy.


Institutional investors should report their stewardship activities periodically.

Even though the number of resolutions where institutional shareholders have made a difference is increasing gradually, it still represents a miniscule proportion of all resolutions put to vote by Indian publicly listed companies. Moreover, despite the overall growth of institutional shareholding in Indian companies and the decline in controller shareholding, critics have argued that the role of institutional shareholders is useful only in theory, and that efforts towards shareholder activism are unlikely to have any significant impact on corporate governance in India, primarily due to continued concentration in shareholdings. Hence, the effect of shareholder activism in Indian companies is likely to be minimal at best.

As Professor Geis notes: Ultimately, however, Indian corporate insiders simply own too many shares to worry about activist institutional investors. Any near-term regulatory reliance on outside shareholder power as a strategy for sound governance is likely to disappoint. This does not necessarily mean that efforts to give independent shareholders a greater role in firm governance should be abandoned. But near-term priorities for regulatory reform should likely focus on protecting minority shareholders from the threat of controller opportunism – and not on strategies that rely on the flexed muscles of the outside owners.

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