Paper Spotlight: Information Bias in the Proxy Advisory Market

Yan Xiong

Shichao Ma

Investors increasingly rely on proxy advisors such as ISS in deciding how to vote in corporate elections. In the paper “Information Bias in the Proxy Advisory Market,” Shichao Ma and Yan Xiong construct a theoretical model to examine the biases that can arise when the proxy advisor is a profit-maximizer. An intuitive finding is that a conflicted proxy advisor provides biased recommendations. More interestingly, if shareholders have either distorted preferences or distorted beliefs, even an unconflicted advisor finds it profit-maximizing to cater to shareholders, rather than provide the recommendation most consistent with maximizing firm value. The key is that shareholders’ willingness to pay for the recommendation depends on their own perception of the value of the recommendation, and the proxy advisor can raise the price of its services when shareholders find the recommendation to be more valuable. The equilibrium is sophisticated, as shareholders have an incentive to free-ride off each other to avoid paying for the service. Surprisingly, firm value can sometimes be greater when shareholders have intrinsic biases, compared to when shareholders want to maximize firm value. By skewing its recommendations to cater to shareholders’ beliefs and preferences, the proxy advisor can increase its price, which sometimes leads to more shareholders acquiring their own information. For example, if shareholders are a priori overly optimistic but also loss-averse, in equilibrium the information acquisition effect leads to a better electoral outcome for the firm and an enhancement of firm value.

Spotlight by Uday Rajan
Photos courtesy of Shichao Ma and Yan Xiong

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