How the Changing Landscape of Corporate Governance Disclosure Affects Shareholder Voting

The board of directors serves as the liaison between shareholders and management; directors monitor and advise management, with the objective of maximizing shareholder value. Shareholders have significant input into the composition of the board via voting. Shareholder votes on directors have arguably become more influential over the past decade: The percentage of firms with majority voting provisions has increased, the SEC recently adopted the universal proxy, and firms whose boards do not include requisite skills are at risk of being targeted by an activist. However, despite these factors, many institutional investors effectively outsource voting decisions to third parties. The costs of evaluating all directors up for vote across all portfolio firms are prohibitively high for mutual funds and other institutional investors. As a result, these investors simply follow the recommendations of proxy advisers, for example ISS or Glass Lewis.

The outsourcing of votes to proxy advisers comes at a cost. For example, research shows that advisers lack critical information: They do not fully understand firms’ governance demands, and they often only partially grasp directors’ skills. Moreover, firms complain that it can be difficult to effectively communicate their governance choices to investors.

Over the past 10 years, an increasing percentage of firms have voluntarily changed their disclosure practices, arguably in response to these dynamics. Firms increasingly present the qualifications and expertise of their directors in image-based formats, commonly referred to as director skills matrices. In a new paper we examine these skills matrices, and we provide evidence on the ways in which they benefit both investors and firms.

Our empirical analyses are based on detailed data collected from the proxy statements of S&P 1500 firms over the 2011 to 2021 period. The percentage of firms presenting director skills matrices grew from less than 5 percent in 2011 to nearly 65 percent in 2021. The change is striking because, unlike most disclosure changes, it was not precipitated by any regulatory requirement. The voluntary nature of these disclosures suggests that firms find it beneficial to present director skills in an image-based matrix format.

Our empirical analyses focus on the benefits firms obtain from director skills matrices. We begin by examining the influence that director skills matrices have on investors’ reliance on proxy advisers. We predict that an image-based representation of director expertise decreases investors’ costs of evaluating directors up for vote and thus will reduce investors’ reliance on ISS’ recommendations. Our results are consistent with this prediction. Following the introduction of a director skills matrix, investors are more likely to come to a different conclusion than ISS, which is what one would expect if investors independently evaluated directors up for vote. Our findings are strongest among those shareholders who show some inclination to assess the directors rather than outsourcing the entire process to ISS.

We further document that the effects of director skills matrices on investors’ propensity to vote independently is greatest when ISS’ recommendation is least informative. For example, the effects of a skills matrix are larger for director types that ISS tends to recommend voting against, such as affiliated directors and directors serving on too many different boards.  In addition, we find that the effects are greater among firms that are characterized by greater uncertainty, as evidence by higher stock-return volatility and higher bid-ask spreads. Such firms are more likely to have unique governance demands that are not recognized by proxy advisers. Overall, our results suggest that skills matrices lower investors’ reliance on ISS’ recommendations. Given proxy advisers’ tendencies to ignore firm specific governance demands, these findings suggest that the skills matrices contribute to more informed voting.

In our second set of analyses, we examine whether the introduction of a director skills matrix changes the level of support for directors. If firms (on average) strive to appoint high-quality directors, and if skills matrices enable investors to assess the contribution of each director more accurately, then this disclosure format will contribute to greater voting support.  Consistent with this joint hypothesis, our results indicate that adoption of a skills matrix significantly increases average voting support for directors. The effects are concentrated among directors whose contribution to the firm is least clear and among firms whose governance demands are least transparent. In sum, by highlighting the contribution of each director to the board’s collective expertise, skills matrices contribute to higher average support.

In our third set of analyses, we focus on firms’ decisions to adopt this image-based disclosure of director skills. If firms recognize that skills matrices have benefits such as helping investors become better informed voters, then firms should voluntarily adopt matrices even without explicit external pressure. Alternatively, if agency issues lead some firms to maintain suboptimal boards, then managers of these firms have incentives to be less transparent about board composition. In such cases, we would expect external forces to pressure firms to increase transparency. Our findings suggest that both propositions are true.., We show that more independent boards and non-dual class boards are significantly more likely to adopt matrices. However, we also find that activist pressures regarding board composition have a significant effect: A one standard deviation increase in this measure is associated with a 10 percent increase in subsequent matrix adoption.

We also present evidence of a learning effect that contributes to matrix adoption. When at least one of a firm’s directors sits on the board of another firm that has a matrix, the focal firm is significantly more likely to adopt a matrix.

In our fourth set of analyses, we independently evaluate the information content of firms’ directors’ skills matrices. If matrices provide investors with relevant information, then the skills reported for directors should correspond to firms’ governance demands. On the other hand, if matrices are window dressing, then a reported skill is more likely exaggerated and  not informative about directors’ skills. We distinguish between these two motives by exploring whether the presence of certain skills conforms to a firms’ governance demand and whether it predicts future firm outcomes.

Our results indicate that skills reported by firms reasonably match a firm’s governance demands. For example, firms with international operations are significantly more likely to have a director who reports international expertise, and firms with more patents are significantly more likely to have a director who reports technology expertise. We also find that the presence (or absence) of directors with certain skills is informative regarding the risk of future firm events. Here, our analysis focuses on the subset of firms that report skills matrices. We show that firms with at least one director with risk management expertise are significantly less likely to face a class action lawsuit in the next one to three years. More specifically, we document that cybersecurity expertise is significantly negatively related to future cybersecurity lawsuits. We also find that firms who have at least one director with strategy or M&A expertise are significantly less likely to make a value-decreasing acquisition.

Overall, our findings highlight the informativeness of director skills matrices for outside investors. As stated by the Council of Institutional Investors, “To vote thoughtfully, shareholders need relevant information about director nominees and an understanding of the board’s perspective on how each individual serves the company’s needs.” Matrices facilitate investors’ ability to evaluate whether directors have the necessary skills.

This post comes to us from professors David Becher and Michelle Lowry at Drexel University and Jared I. Wilson at Indiana University’s Kelley School of Business. It is based on their recent paper, “The Changing Landscape of Corporate Governance Disclosure: Impact on Shareholder Voting,” available here.