Elimination of Broker Voting: Ineffective Regulation by SEC?

A recent research paper concludes that the elimination in 2010 of uninstructed broker voting in uncontested director elections (an amendment to NYSE Rule 452) is an example of ineffective regulation by the SEC.

In “The Elimination of Broker Voting: Much Ado About Nothing?”, the authors, Ali Akyola, Konrad Raffb and Patrick Verwijmerenb state:

Overall, we do  not find a convincing effect of the rule change on shareholder value, not even for those firms that  seemed to be mostly targeted by the new rule. Moreover, the probability that a particular director would be voted off the board has not increased since the rule change. . .   .

However, given the absence of wealth effects for even those firms in which we expect the strongest impact of the new rule, it appears that shareholders do not view the elimination of broker votes as an important first step,  and are not convinced that other, more value relevant, steps will be taken. .  .

Another potential explanation is that the SEC, the NYSE, shareholder activists, and proxy advisory firms acted in the best interest of investors and simply misjudged the effectiveness of the regulation ex-ante.  . .

We find that excluding broker votes, which in our sample represent 12% of the votes cast in 2009, would decrease the average approval rate by only one percent. .  . .

A more plausible explanation for our findings is that broker votes are not of substantial importance and that outside pressure has been an important factor in the SEC’s decision to change regulation. A desire of proxy advisory firms and shareholder activists to demonstrate vigilance could explain why they strongly supported the change in regulation, even if this change was unlikely to be effective.

This “more plausible explanation” is described in more detail as follows:

Our results raise questions about the role that different actors play in the initiation and adoption of regulation. Many market participants, notably shareholder activists and proxy advisory firms, strongly supported the rule change from its beginning and exerted pressure on the SEC to adopt it. The rule’s apparent futility suggests that it may be of interest to study in more detail the incentives and potential biases in decision making within these organizations regarding regulation. Rather than being unbiased agents for shareholders, these institutions may have incentives to pursue or advocate policies to enhance their own public visibility or perceived disciplinary role. Belinfanti (2009) argues that proxy advisory firms do not have appropriate incentives to act in the best interest of investors because they benefit from high barriers to entry in the proxy advisory market and bear no risk from providing bad recommendations. McCall (2011) stresses the possibility that proxy advisory firms respond to incentives such as the generation of consulting revenue and to demonstrate vigilance to subscribers and politicians. A desire of proxy advisory firms and shareholder activists to demonstrate vigilance could explain why they strongly support changes in regulation, even if these are likely to be ineffective.

Our results also raise the question to what extent the SEC’s actions are distorted by outside pressure, which relates to the political-economy approach to financial regulation that attempts to provide a positive analysis of the evolution of regulations (see Kroszner, 2000). Our findings suggest that it is interesting to open the black box of the SEC and examine more closely its motivations in the design of governance regulation. This topic has not received much attention in the corporate governance literature. A notable exception is Choi et al. (2011), who provide evidence that the SEC may have misallocated enforcement resources to less efficient investigative activities due to news coverage and media frenzy on option backdating. Their results raise the question how the media, in turn, allocates its attention and resources and which distortion may arise in this context. In a time when the SEC and its supporters recurrently complain about the lack of resources devoted by Congress to the SEC’s mission of investor protection, evidence on the effectiveness of SEC regulation is of the highest importance.

Although I have not analyzed this paper thoroughly, I am initially skeptical of the methodology employed by the study and the inferences that can be drawn from it.  But I do not dismiss the questions it raises generally.  The SEC seems to have a lot of economists now (http://www.sec.gov/divisions/riskfin/economistbios.shtml), and it is looking for more (http://www.sec.gov/divisions/riskfin/rfemployment.shtml).  Hopefully some of them are familiar with behavioral economics and that this discipline is also brought to bear in the regulatory process.  See http://ssrn.com/abstract=500203.

The paper is cited as: Akyol, Ali C., Raff, Konrad and Verwijmeren, Patrick, The Elimination of Broker Voting: Much Ado About Nothing? (December 15, 2011). Available at SSRN: http://ssrn.com/abstract=1973558