Are Voting Guidelines Ruling Your Business? By GAIZKA ORMAZABAL & ALLAN L. McCALL PROXY ADVISORS O ver the past two decades, U.S. mar- kets have seen corporate gover- nance failures blamed for a series of crises, including the dot-com boom/bust, the accounting scandals at the be- ginning of the 21st century and the global finan- cial crisis. In response, legislators drafted new laws such as Sarbanes-Oxley and Dodd-Frank, which aimed to improve internal controls and corporate governance. Less well known, at least outside the world of institutional invest- ment, are the regulatory changes made in 2003 by the U.S. Securities and Exchange Commis- sion (SEC) to require mutual funds to develop “unconflicted” policies and procedures in rela- tion to their proxy votes, as well as disclosing their voting on all shareholder proposals. The reasoning was simple: If conflicts of in- terest on boards were as widespread a problem as the corporate governance crises suggested, then investors – particularly institutional in- vestors – needed to pay much closer attention to governance in the companies in which they invested. The intentions behind this new legislation were laudable. After all, what investor would not want better disclosure, transparency and accountability? C r i t i c s p u s h b a c k t h a t t h e s e p o t e n t i a l benefits need to be weighed against other DEEP insight IESEinsight 31 ISSUE 21 SECOND QUARTER 2014 IIR119 For the exclusive use of A. Sivakumar, 2015. This document is authorized for use only by Abirami Devi Sivakumar in 2015. Are Voting Guidelines Ruling Your Business? Recent legislative and regulatory decisions giving shareholders more influence over the governance of U.S. listed companies has motivated corporate boards and management to engage with shareholders – with unintended consequences. There has been a dramatic rise in the number of proxy issues that have to be voted on by shareholders. Under SEC rules, many institutional investors have a fi duciary obligation to cast a vote on every item that comes before them, leading many to outsource their voting decisions to proxy advisors. The two largest proxy advisory fi rms – Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis) – control most of the proxy advisory market and have thousands of institutional clients, meaning that the corporate governance policies of these two companies affect a signifi cant proportion of shareholder votes. The authors studied proxy voting on 264 stock option repricings for 251 individual firms and found that those repricings that were more aligned with proxy advisory firm guidelines experienced lower stock returns, weaker operational performance and a higher likelihood of executive and employee turnover. This negative impact on shareholder value suggests that there is a need to better understand the role of proxy advisor.

1. Are Voting Guidelines
Ruling Your Business?
By GAIZKA ORMAZABAL & ALLAN L. McCALL
PROXY ADVISORS
O
ver the past two decades, U.S. mar-
kets have seen corporate gover-
nance failures blamed for a series
of crises, including the dot-com
boom/bust, the accounting scandals at the be-
ginning of the 21st century and the global finan-
cial crisis. In response, legislators drafted new
laws such as Sarbanes-Oxley and Dodd-Frank,
which aimed to improve internal controls and
corporate governance. Less well known, at
least outside the world of institutional invest-
ment, are the regulatory changes made in 2003
by the U.S. Securities and Exchange Commis-
sion (SEC) to require mutual funds to develop
“unconflicted” policies and procedures in rela-
tion to their proxy votes, as well as disclosing
their voting on all shareholder proposals.
The reasoning was simple: If conflicts of in-
terest on boards were as widespread a problem
as the corporate governance crises suggested,
then investors – particularly institutional in-

2. vestors – needed to pay much closer attention
to governance in the companies in which they
invested.
The intentions behind this new legislation
were laudable. After all, what investor would
not want better disclosure, transparency and
accountability?
C r i t i c s p u s h b a c k t h a t t h e s e p o t e n t i a l
benefits need to be weighed against other
DEEP
insight
IESEinsight 31 ISSUE 21 SECOND QUARTER 2014
IIR119
For the exclusive use of A. Sivakumar, 2015.
This document is authorized for use only by Abirami Devi
Sivakumar in 2015.
Are Voting Guidelines Ruling Your Business?
Recent legislative and regulatory decisions
giving shareholders more influence over
the governance of U.S. listed companies
has motivated corporate boards and
management to engage with shareholders

3. – with unintended consequences. There
has been a dramatic rise in the number
of proxy issues that have to be voted on
by shareholders. Under SEC rules, many
institutional investors have a fi duciary
obligation to cast a vote on every item
that comes before them, leading many to
outsource their voting decisions to proxy
advisors. The two largest proxy advisory
fi rms – Institutional Shareholder Services
(ISS) and Glass, Lewis & Co. (Glass Lewis)
– control most of the proxy advisory market
and have thousands of institutional clients,
meaning that the corporate governance
policies of these two companies affect a
signifi cant proportion of shareholder votes.
The authors studied proxy voting on 264
stock option repricings for 251 individual

4. firms and found that those repricings that
were more aligned with proxy advisory
firm guidelines experienced lower stock
returns, weaker operational performance
and a higher likelihood of executive and
employee turnover. This negative impact
on shareholder value suggests that there
is a need to better understand the role
of proxy advisors’ recommendations on
other more important voting issues such
as executive compensation, director
elections or equity compensation plans. The
regulatory debate on the U.S. proxy advisory
industry is important worldwide, as the
SEC’s regulatory choices are a benchmark
for other national and regional regulatory
bodies.
EXECUTIVE SUMMARY

5. possible drawbacks of the regulation. In a
2013 speech on the dangers of reactive legis-
lation, Daniel M. Gallagher, a commissioner
at the SEC, argued that “the resulting regu-
latory mandates are often based upon false
narratives and in the end lead to the expan-
sion of a universal law: the law of unintended
consequences.”
In the case of the SEC’s proxy voting legisla-
tion, the unintended consequences have been
subtle but impactful for corporate boards and
investors. One of the controversies is the in-
crease in the influence of proxy advisors – firms
specializing in corporate governance research
to whom institutional investors frequently
outsource part or all of the analysis of corpo-
rate governance matters that are put to a share-
holder vote.
This article draws upon research that we
have conducted with David F. Larcker from
Stanford University. We highlight one unin-
tended consequence of this new regulatory
framework and discuss the main controver-
sies around the proxy advisory industry. We
also call for a more thorough investigation of
the impact of proxy advisory firms on company
performance.
This issue concerns firms and investors not
just in the United States but worldwide, as oth-
er national and regional regulatory bodies use
the SEC’s regulatory choices as a benchmark.

6. The Rise of Proxy Advisory Firms
The traditional view of corporate governance
involves three main actors – shareholders,
managers and boards of directors – whose in-
terests are not always aligned.
Shareholders provide corporations with
capital, managers make use of that capital and
boards supervise the managers to make sure
This article discusses the main controversies around
the proxy advisory industry. We also call for a more
thorough investigation of the impact of proxy
advisory firms on company performance.
IESEinsight32 SECOND QUARTER 2014 ISSUE 21
For the exclusive use of A. Sivakumar, 2015.
This document is authorized for use only by Abirami Devi
Sivakumar in 2015.
Are Voting Guidelines Ruling Your Business?
they allocate the capital appropriately. Share-
holders are also meant to oversee the board’s
actions through periodic shareholder votes.
In the wake of the last decade’s corporate
governance failures, the U.S. government, fi-
nancial regulators and major stock exchanges
sought to rectify the balance of power between
these three actors. Shareholders, they decided,
needed greater input on corporate governance

7. matters.
In 2003, the New York Stock Exchange and
the Nasdaq altered their listing conditions
to require that any new equity compensation
plan or material modification to an equity
compensation plan had to receive shareholder
approval. This was followed by the SEC’s re-
quirements that many institutional investors
disclose both their voting polices and actual
votes in proxy voting matters, ostensibly to
expose potential conflicts of interest between
mutual fund management and the funds’ ulti-
mate shareholders.
The result has been a dramatic increase in
the number of proxy issues that have to be vot-
ed on by shareholders, putting strain on insti-
tutional investors’ limited time and resources
available to research these issues.
To deal with this burden, the SEC allowed
investment firms to use independent third par-
ties to guide their proxy voting and thereby ful-
fill their proxy voting obligations. Specifically,
the SEC issued guidance providing that if an in-
vestor’s votes followed the recommendations
of an independent third party (i.e., a proxy
advisor) then its voting would be considered
“unconflicted.”
Consequently, many institutional inves-
tors began relying more heavily – some even
exclusively – on the recommendations of third-
party proxy advisory firms in determining their
proxy votes. This, in turn, led to a rise in influ-

8. ence of a small number of proxy advisors on
the outcomes of corporate elections. A decade
later, two firms – Institutional Shareholder
Services (ISS) and Glass, Lewis & Co. (Glass
Lewis) – control most of the entire sector.
For institutional investors, hiring proxy
advisors provides a mechanism for sharing the
cost of research on proxy issues. What’s more,
having a proxy advisor’s seal of approval on
your proxy votes could help shield you against
accusations of conflicted voting.
Although it seems like a win-win arrange-
ment, doubts are starting to be raised with re-
gard to the depth and quality of the research
offered by proxy firms, and whether enough is
being done to understand the economic con-
sequences of their voting recommendations.
Does One Size Fit All?
One concern is that public companies may fol-
low the corporate governance policies of proxy
advisors in order to gain a majority of favorable
votes for management proposals, even though
the policies may not be appropriate for the
firm’s specific circumstances. Such actions
have the potential to impose real costs on firms
and their shareholders.
As anyone with managerial or executive
experience will know, few rules of corporate
governance can be accurately assessed without
deep knowledge of a company and its manage-
ment. And herein lies the problem: The recom-

9. mendations of proxy advisors tend to be based
on best practices applied to all companies. Yet
these general rules could be irrelevant and
even detrimental to some companies in certain
business situations.
To help shed light on this issue, we exam-
ined the economic consequences of proxy ad-
visor guidance on “underwater” stock option
repricings, whereby fi rms seek to replace stock
options whose exercise price is higher than the
current share price (i.e., “underwater”) with
new awards of options (with lower strike pric-
es), restricted stock and/or cash.
Critics of repricings – including proxy ad-
visors – have argued that such moves are used
Doubts are being raised regarding the depth and quality
of the research offered by proxy firms, and whether
enough is being done to understand the economic
consequences of their voting recommendations.
IESEinsight 33 ISSUE 21 SECOND QUARTER 2014
For the exclusive use of A. Sivakumar, 2015.
This document is authorized for use only by Abirami Devi
Sivakumar in 2015.
Are Voting Guidelines Ruling Your Business?
Gaizka Ormazabal is an as-
sistant professor of Account-

10. ing and Control at IESE. He
received a PhD in business
from Stanford University and
a PhD in construction engi-
neering from the Polytechnic
University of Catalonia, where
he also earned a degree in civil
engineering. His research fo-
cuses on executive compensa-
tion and corporate governance
mechanisms, including mana-
gerial risk-taking incentives and
corporate risk oversight.
Allan L. McCall is a re-
searcher in the Center for
Leadership and Development
at Stanford’s Graduate School
of Business in the areas of

11. corporate governance and
compensation. He holds a
PhD from Stanford University.
Prior to that, he was a co-
founder and principal at Com-
pensia, and vice president of
compensation and benefits
for Providian Financial. He
earned a degree in economics
from Yale University.
ABOUT THE AUTHORS
by entrenched managers to extract rents from
shareholders by reducing the downside risk of
their compensation contracts. In other words,
repricings end up insulating managers from
the financial repercussions of their own bad
performance.
However, research has shown that allowing
some exchange of underwater stock options
could be preferable to refusing to adjust initial
contracts after they have gone underwater,
which risks leaving a company’s employees
with little or no financial incentive to stay the
course in their current role, or with incentives

12. to take excessive risks.
In our study, we analyzed a sample of 264
stock option repricings announced between
2004 and 2009. For each repricing, we mea-
sured the degree of conformity to proxy advi-
sor guidelines.
We then compared the conformity with
subsequent firm performance and executive
turnover and found that repricing programs
that did not conform to proxy advisor policies
were generally more benefi cial for shareholders.
Specifi cally we found that fi rms with repricing
Compliance with proxy advisor guidelines on stock
option repricing limited the recontracting benefits
of these transactions and had a detrimental effect on
shareholder value.
programs more aligned with proxy advisors’
policies had a smaller increase in stock price,
weaker operational performance and a higher
likelihood of executive and employee turnover.
Put another way, compliance with proxy
advisor guidelines on stock option repricing
limited the recontracting benefits of these
transactions and had a detrimental effect on
shareholder value.
Proceed With Caution
This is not to say that everything proxy advi-
sors do is flawed or damaging to shareholder
value. Admittedly, our study examined only
one management proposal that affected 251

13. individual firms in our sample.
For example, in the context of mergers
and acquisitions, there is evidence suggest-
ing that proxy advisory firms’ recommenda-
tions may be better tailored to each situa-
tion. In these settings, proxy advisors must
typically conduct firm-specific research into
e a c h M & A t r a n s a c t i o n t o d e t e r m i n e t h e i r
recommendation.
Moreover, some large investment firms
seem to make up their own minds regardless
of the proxy advisor’s views. Michelle Edkins,
head of governance for the New York-based
asset manager BlackRock, told Reuters that
proxy advisors provide a valuable service by
helping them cast votes in relation to thou-
sands of company stocks, but added that re-
search from proxy advisory firms was just one
of many inputs in their voting decisions.
Advocates of the proxy advisory industry
also argue that critics overstate the influence
of proxy advisors because many shareholder
votes are non-binding and thus can be disre-
garded by corporate executives and boards of
directors.
That being said, negative non-binding vot-
ing outcomes could also introduce significant
costs for the affected companies in the form of
reputational damage and litigation.
IESEinsight34 SECOND QUARTER 2014 ISSUE 21

14. For the exclusive use of A. Sivakumar, 2015.
This document is authorized for use only by Abirami Devi
Sivakumar in 2015.
Are Voting Guidelines Ruling Your Business?
However, critics’ main concern rather re-
lates to the fact that proxy advisors’ incentives
to produce high-quality voting recommenda-
tions are unclear.
First, proxy advisors owe no fiduciary du-
ties to the shareholders of the companies on
which they are advising, nor have they any di-
rect stake in corporate performance.
Second, proxy advisors are deemed inde-
pendent and thus protected by the current
regulatory framework.
Third, because the proxy advisory industry
is highly concentrated (being controlled as
it is by only two main players), it is not clear
whether proxy advisors are subject to substan-
tial competitive pressure.
Fourth, to the extent that proxy advisors
provide services to both investors and corpo-
rate issuers on the same governance issues,
proxy advisors could be subject to conflicts of
interest. For example, the largest proxy advi-
sor, ISS, not only sells proxy voting services to
institutional investors but also offers consult-

15. ing services to corporations that are the sub-
ject of ISS recommendations to institutional
investors.
For these reasons, it seems vital that both
policy makers and regulators scrutinize the
effects of proxy advisory firms’ recommenda-
tions on issues that could potentially have a
very large impact on investor returns, such as
equity compensation plans, executive bonus
plans, director elections and say-on-pay.
Time is of the essence given that countries
and regions far and wide are contemplating
adopting regulatory frameworks for proxy
voting similar to the SEC’s, including propos-
als for self-regulation.
Before such measures are exported beyond
U.S. borders, we need to establish a much
broader and deeper understanding of how the
recommendations of proxy advisors impact
shareholder value and the economy at large.
This improved understanding will help answer
the questions about the proxy advisory indus-
try that are currently on the desk of regulators.
Should the SEC regulate the proxy advisory
industry? Would this regulation stifle a source
of independent research and increase manage-
rial entrenchment? Is competition rather than
regulation the solution to the potential prob-
lems of the proxy advisory industry?
Moreover, the debate on the role of proxy
advisors cannot be decoupled from the regu-

16. latory debate on shareholder voting. We agree
that investors should vote their shares if doing
so is expected to increase shareholder value.
However, should institutional investors be re-
quired to vote in every election?
While there is a clear case to be made for a
certain amount of shareholder supervision of
boards and management, especially in light of
recent scandals, we believe it should be done
with both caution and moderation.
Otherwise, we risk solving one problem
only to create a potentially bigger one – name-
ly the loss of independence of company boards
and management and, by extension, their abil-
ity to create value for both their institutional
and retail investors.
While there is a clear case to be made for a certain
amount of shareholder supervision of boards and
management, we believe it should be done with both
caution and moderation.
� Larcker, D.F., A.L. McCall and G. Ormazabal.
“Proxy Advisory Firms and Stock Option
Repricing.” Journal of Accounting and Economics
56 (2013): 149-69.
TO KNOW MORE
IESEinsight 35 ISSUE 21 SECOND QUARTER 2014
For the exclusive use of A. Sivakumar, 2015.

17. This document is authorized for use only by Abirami Devi
Sivakumar in 2015.
JUBAIL UNIVERSITY COLLEGE
DEPARTMENT OF BUSINESS ADMINISTRATION
Assignment I
BUS 325 Investment
Semester 382
Team Name
Student ID
Student Name
Teacher: Dr. Abirami Devi

18. Instructions:
· This is a group assignment with only 4 members. As discussed
and explained in the class, this assignment is a Case study.
· The students should read and analyze the Case study and
submit their report.
· The report should contain the following:
The Assignment should cover the following points:
1. Brief Overview (Describe the Company and issues discussed)
1. Situation Analysis (SWOT)
1. Key Issues (Symptoms/Problems)
1. Alternatives (A set of strategic alternatives that have a
potential to solve the problem)
1. Evaluation of Alternatives (How well does the alternative
address the issue stated? / List the pros and cons of each
alternative)
1. Recommendation
1. Implementation Plan (Steps to follow constrained by budget
and timeline/Short term and long term plan/Always look for
appendices)
1. Risk and Mitigation (List all the challenges that would
prevent the company from successfully implementing the
proposed solution/List risk mitigation strategies for every
challenge)

19. Rubric for Report: 20 marks
Category
Failed
0-1
Partially
2
Mostly
3
Absolutely
4
Key Issue(s)
Did not identify Key Issues
Partially identified Key Issues
Mostly identified Key Issues
Absolutely identified Key Issues
Relevant Factors
Did not analyze Relevant Factors
Partially analyzed Relevant Factors
Mostly analyzed Relevant Factors
Absolutely analyzed Relevant Factors
Alternatives (Identify)
Did not develop realistic Alternatives

20. Partially developed realistic Alternatives
Mostly developed realistic Alternatives
Absolutely developed realistic Alternatives
Alternatives (Evaluate)
Did not evaluate Alternatives
Partially evaluated Alternatives
Mostly evaluated Alternatives
Absolutely evaluated Alternatives
Recommendation
Did not select a Recommendation to address key issues
Partially selected a Recommendation to address key issues
Mostly selected a Recommendation to address key issues
Absolutely selected a Recommendation to address key issues
Date of Submission: WEEK 6
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