Proxy Advisors and Institutional Investor Engagement
How Do Proxy Advisors and Institutional Investors Shape ESG Governance?
Institutional investors hold the majority of equity in large publicly listed companies — and they exercise governance influence primarily through proxy voting and engagement. Proxy advisory firms ISS and Glass Lewis serve as analytical intermediaries, providing vote recommendations that influence how hundreds of institutions vote at thousands of annual general meetings. Understanding how proxy advisors operate, what they assess, and how large asset managers use engagement and voting as governance tools is essential for understanding how ESG governance norms are set and enforced in practice.
Proxy advisors are firms that provide institutional investors with research and vote recommendations on AGM agenda items — including director elections, compensation plans, shareholder resolutions, and corporate governance charter amendments — enabling investors to discharge their proxy voting fiduciary obligations at scale.
Key Takeaways
- ISS (Institutional Shareholder Services) and Glass Lewis are the two dominant proxy advisors; ISS has approximately 60% market share.
- Both firms publish policy updates annually; for ESG, their policies on climate resolutions, board diversity, compensation, and dual-class structures are most consequential.
- Institutional investor engagement — direct dialogue with company boards and management — is the governance influence tool that complements voting.
- Collaborative engagement platforms (Climate Action 100+, IIGCC, UNPRI engagements) amplify individual investor influence through coordinated asks.
- The "Big Three" (BlackRock, Vanguard, State Street) together own approximately 20% of most S&P 500 companies; their voting behavior effectively determines outcomes on many contested resolutions.
How Proxy Advisors Work
Research and Recommendations
ISS and Glass Lewis analyze governance documents (proxy statement, annual report, bylaws, governance guidelines) against their published policy guidelines and produce vote recommendations for each AGM agenda item. Recommendations are distributed to subscribing institutional investors before each AGM, enabling scaled portfolio voting.
For ESG, the most consequential ISS/Glass Lewis policies include:
Director elections: Recommendations to vote against individual directors based on: independence concerns, over-boarding, committee-specific failures (audit financial expert absence, compensation misalignment), diversity deficiencies (no women on board), attendance failures (<75% in most years).
Executive compensation (say-on-pay): ISS quantitative pay-for-performance test compares CEO pay to an estimated peer group expected pay based on performance; significant misalignment generates "against" recommendation. Glass Lewis applies similar methodology.
Board diversity: ISS recommends voting against nominating committee chair at companies without at least one female director. From 2023, ISS extended this to include ethnic diversity expectations for Russell 3000 companies.
Climate governance: ISS and Glass Lewis publish climate policies that can recommend against directors at companies where climate governance is deemed materially inadequate.
Shareholder resolutions: On shareholder climate, social, and governance resolutions filed by investors, ISS and Glass Lewis provide recommendations based on whether the resolution's request is reasonable, specific, and supplemental to existing company practice or excessive.
ISS vs. Glass Lewis: Key Differences
ISS and Glass Lewis agree on most votes but diverge meaningfully on:
- Compensation quantum: ISS uses a more mechanical pay-for-performance formula; Glass Lewis applies more holistic assessment
- Climate resolutions: Glass Lewis has historically been more supportive of company management against shareholder climate resolutions; both firms have evolved toward more nuanced positions
- Say-on-pay failure threshold: ISS flags votes for engagement below 70% support; Glass Lewis uses similar thresholds
- Poison pill term: ISS recommends against shorter poison pill terms with quicker sunset provisions; the threshold details differ
Institutional investors do not always follow proxy advisor recommendations. Large asset managers with developed internal governance teams often override recommendations on specific cases, particularly where they have conducted company-specific engagement.
Institutional Investor Engagement Models
Bilateral Engagement
Large institutional investors engage directly with companies on governance and ESG topics through:
- Annual governance meetings with board chair or independent director
- CEO/CFO meetings on ESG strategy
- Written correspondence on specific proxy season concerns
- Escalation meetings with full board on significant governance failures
Bilateral engagement is most effective when the investor has a significant ownership position (>0.5%), a specific ask with a defined timeline, and a credible escalation path (voting against directors or supporting shareholder resolutions).
Collaborative Engagement
Collaborative engagement platforms aggregate investor voice to increase influence on companies where bilateral engagement is less effective:
Climate Action 100+: Over 700 investors with >$68 trillion AUM engaging 166 "systemically important emitters" on net-zero transition planning, TCFD disclosure, and ESG governance. CA100+ has produced significant corporate commitments to net-zero targets and TCFD-aligned reporting.
IIGCC Corporate Programme: EU investor engagement on ESRS compliance, Paris Alignment, and just transition planning.
UNPRI Investor Engagements: Thematic engagement coordinated by the Principles for Responsible Investment on topics including human rights, biodiversity, and plastics.
Workforce Disclosure Initiative: CDP and ShareAction-coordinated engagement requesting standardized workforce disclosure from companies.
Stewardship Codes and Fiduciary Context
Institutional investors in the UK, Japan, EU, and other jurisdictions operate under stewardship codes that define responsible ownership expectations:
UK Stewardship Code (2020): 12 principles requiring UK asset owners and managers to have purpose and governance; investment approach; stewardship, engagement, and voting activities across the investment chain.
Japan Stewardship Code (2014, revised 2020): Seven principles including engagement with investee companies.
EU Shareholder Rights Directive II (2017): Requires institutional investors and asset managers to develop and publicly disclose shareholder engagement policies.
These codes create a framework within which ESG engagement is not just a preference but a defined institutional responsibility — strengthening the case for treating engagement as a core investment function rather than an optional ESG add-on.
Common Mistakes
Assuming proxy advisor recommendations determine AGM outcomes. ISS and Glass Lewis recommendations are influential but not determinative. The Big Three make independent voting decisions; major pension funds and sovereign wealth funds frequently deviate from recommendations based on bilateral engagement outcomes.
Conflating engagement with impact. Corporate engagement meetings happen; commitments are made. Whether commitments are implemented requires follow-up engagement and outcome monitoring. Many engagement programs have weak accountability for whether stated commitments translate into actual behavior change.
Treating engagement as a substitute for divestment analysis. Engagement is most effective where the investor has leverage (significant ownership, credible escalation path) and where the company has a path to improvement. For companies with fundamental business model conflicts with ESG objectives and no credible transition, engagement as an indefinite holding strategy may not be appropriate.
Frequently Asked Questions
Are proxy advisors regulated? US proxy advisors became subject to SEC oversight following SEC guidance in 2019 and 2020. The SEC's proxy voting rules require proxy advisors to disclose conflicts of interest and give companies the opportunity to review and respond to research before distribution to investors. EU proxy advisors are regulated under the Shareholder Rights Directive II, which requires disclosure of methodologies, conflicts of interest, and dialogue with companies.
What is the "Say on Climate" movement? "Say on Climate" refers to the practice of companies voluntarily putting their climate transition plans to a shareholder advisory vote at annual meetings. Launched as a campaign by investor Chris Hohn (TCI), it has been adopted by over 100 companies. ISS and Glass Lewis provide vote recommendations on these resolutions based on the quality and credibility of the climate plan presented. Some investors support Say on Climate as engagement; others view annual votes as distracting from the fundamental accountability of board elections.
Related Concepts
Summary
Proxy advisors and institutional investors form the primary governance accountability infrastructure for publicly listed companies. ISS and Glass Lewis shape voting outcomes through recommendations on directors, compensation, and shareholder resolutions; their ESG policies increasingly incorporate climate governance, diversity, and anti-corruption considerations. Institutional investor engagement — bilateral and collaborative through platforms including Climate Action 100+ — translates ownership scale into governance influence. Stewardship codes in the UK, Japan, and EU formalize engagement as an institutional investor responsibility. The proxy governance ecosystem is the practical mechanism through which ESG norms are set and enforced across global markets.