ESG and Activism: The Year of Convergence
By Richard Howitt, Skytop Contributor / July 4th, 2022
Richard’s background celebrates three decades as a strategic thinker who integrates innovation into organisational practice. A 22-year member of the European Parliament Rapporteur on Corporate Social Responsibility, he led the EU’s Non-Financial Reporting Directive. This initiative, recognized as the world’s foremost legislation on Corporate Transparency, brought him to new challenges.
This includes his work as CEO of the International Integrated Reporting Council, the Task Force on Climate-Related Financial Disclosure, Advisor to the UN Global Compact, Member of the European Commission SDG Platform, and the UN Guiding Principles for Business and Human Rights Reporting Framework Eminent Persons’ Group.
Richard is recognized as a Sage Top 100 Global Business Influencer, Thomson Reuters ‘Top 30’ Influencer in Risk, Compliance and Regtech. He is a Member of the B20 International Business Leaders’ Group and its Climate and Resource Efficiency Task Force. He currently serves as Strategic Advisor on Corporate Responsibility and Sustainability, and Senior Associate at the law firm Frank Bold LLC.
Two Types of Shareholder Activism
There are two types of shareholder activism.
There are the traditional shareholder activists, a mainstream part of the financial community, targeting under-performing companies and seeking to change company practices and Board composition in order to improve financial return.
Then there is the new generation of shareholder activists, sometimes coming from the broader environmental movement, seeking to galvanize shareholding to influence companies and boards towards environmental, social, governance (ESG) disclosure and in pursuit of sustainability goals.
These two may have different visions of activism, changing business from the inside or from the outside and each would express some degree of skepticism towards the other.
One wants to come to the AGM with a proxy card, the other with a placard.
However, the irony of today is that they are increasingly coming to a common view that ESG matters and are beginning to mount collaborative campaigns for business change.
Businesses take note.
U.S. Attitudes
This change is perhaps most notable in the United States, where the first of these types of activists has traditionally been more prevalent. Companies and activists are part of an established landscape, led by corporate lawyers on both sides. Activism is accepted as a market process to address vulnerable companies and boards or sub-optimal company returns in comparison to competitors. A big focus is on mergers and acquisitions.
I had the privilege of being involved in a project based in the United States, the Coalition for Inclusive Capitalism, in which businesses and investors tackle issues about social equity.
What struck me in those conversations, was a deep caution, even antipathy from at least some in U.S. business towards shareholder activism itself. The prevailing attitude seemed to be one of averting investor attention and preparing to resist and defeat activist shareholder proposals.
A Different Attitude
Meanwhile, my own background in Europe meant I had witnessed a different prevailing attitude towards shareholder activism.
European companies experience their fair share of hostile shareholder actions, but shareholder relations is very much an established part of the business investor relations function, based on an underlying assumption that better dialogue is in the mutual interest of the business and the shareholder alike.
In Europe and across many regions of the world, growing shareholder activism has been associated for some years with calls for increasing ESG disclosure by firms and better management of climate risk. The first response of companies has often been to work with these interests, not simply to oppose them.
Mounting evidence on the sheer scale of the risk has propelled this forward.
Perhaps differences of emphasis between the United States and Europe are explained by the fact that this year, 55% of all global activism has been in the United States itself compared to the rest of the world, according to Lazard. This has increased from 45% two years ago, with this proxy season seeing a rebound from the temporary dip in activism experienced during the period of COVID lockdowns.
The litigation culture in the United States has long been known as a key obstacle for U.S. business to fully join global efforts for better ESG disclosure.
Genuine Concern
How might this clash of cultures inhibiting ESG transition be tackled?
Perhaps part of the answer lies in arguing that risks arising from the activist shareholder have been overstated?
Even when campaigns get as far as AGM votes, shareholder support for sitting Directors still remains typically above 90%.
Activists generally also want to save time and money themselves, by reaching agreement rather than in forcing a vote.
Meanwhile, concerns about managing ESG risk, about competence amongst Board members on ESG, about board diversity, about good corporate governance in totality, are legitimate concerns, which are of just as much interest to the company as to its shareholders.
They should also be of concern to every Non-Executive Director in every Board.
Meanwhile the demand for ESG information in capital markets may rapidly transform attitudes in the U.S. market too.
Standardisation of ESG metrics and further growth in ESG ratings will increasingly mean that these issues matter not just for the active investor, but for passive funds too.
The exponential growth in ESG investment – predicted to be one-third of all global investment by as soon as 2025 – will further amplify these trends.
Ultimately, the quest for good ESG performance is in pursuing the long-term health of the company, not in seeking to avoid unwanted shareholder pressure or attention.
If all of this is true, instead of preparing a defense against the activist shareholder, even more emphasis should be placed on engagement.
After all, in the ESG space at least, many of the activist shareholder campaigns are motivated by the very same civil society and non-governmental organisations, who are the ‘stakeholders’ which business now seeks to embrace.
Retail Shareholders
Which should lead us to reflect on who shareholders really are?
Asset managers are increasingly criticised for assuming that shareholders are only interested in financial returns, when evidence including research conducted for Morgan Stanley finds that 95% of millennials give equal weight to ESG outcomes.
The new generation of shareholders are moral beings too.
The skyrocketing demand for ESG investment demonstrates the desire for companies to combine their pursuit of good financial performance with environmental and social goals too.
The concept of ‘stewardship’ which has received increasing attention in the debates on long-term value creation, should not simply be applied to the public institutional investor, but to the retail investor, her or himself.
Current trends are for retail investors to be better organised and more motivated by ESG issues, including the big and influential family offices within the U.S. investment community.
It is clear that many institutional investors have already altered their voting practices, representing a willingness to give unprecedented support to ESG issues in proxy votes.
The next big trend may be the devolution of voting rights to ultimate investors, in which the world’s biggest investor, BlackRock, has already led the way and intimated that it may seek to act further in concert with other investors in this area.
Whether this is about deflecting criticism of investors themselves, without securing meaningful change in company practice, or whether it is part of a genuine move towards democratisation in investment to savers, to pension fund holders and to other beneficiaries, remains to be seen.
New Trends
Next, regulatory changes may also support these trends.
In the United States, the Security and Exchange Commission’s adoption of a universal proxy rule, due to take effect later this year, will put activist Board nominations on the same footing as incumbent Directors.
In Germany, there is pending legislation around holding and participation rules for virtual AGMs, which are predicted to encourage shareholder activism too.
Therefore, the new trend will perhaps not be about business preparedness for campaigns against the company, but of continuous shareholder outreach by companies to understand shareholder concerns and to engage them in sustainability efforts.
What hard evidence does the 2022 Proxy Season across the States tell us about these trends?
Eye-Catching Changes in 2022
High profile cases in the last year include the successful activist campaign to elect alternative Board members to ExxonMobil to introduce greater emphasis on the transition to renewable energy and on the ultimately unsuccessful campaign to replace Board members at McDonald’s, based on animal welfare concerns.
These cases are eye-catching because in the first case, it was initiated by a small and only recently-launched hedge fund, which has only a 0.02% stake in Exxon; whilst the second proposal came from a billionaire investor – but one who held just 200 shares in the fast-food giant.
It shows that a small voice can still affect a mighty corporation.
However, it is important not to generalise from such high profile cases alone, but instead understand that there appears to be a trend towards an unstoppable growth in activist proposals based on ESG issues, but also an increasing selectivity about how far institutional investors will support them and potentially a sea-change in how companies respond.
First, the numbers.
Unstoppable Rise of ESG
Last year represented an historic proxy season, in which 18 climate-related shareholder resolutions won majority votes.
Latest figures for this year suggest that 924 shareholder proposals have been submitted, with 286 proposals specifically on ESG having been voted, another record.
However, analysis suggests that big investors have slightly reduced their support for such resolutions this year compared to last, although as BlackRock has indicated, this is about a higher level of prescription in proposals (for example in favour of Scope 3 emissions reporting), rather than in a drop of support for the underlying issues.
It was always the case that activist proposals to be successful are aided by bringing together ESG activism and traditional shareholder concern about financial performance and returns from the company.
One example which illustrates this, as companies increasingly link executive pay to sustainability as well as to financial performance, is that this necessarily sees financial analysts pushing for more ESG disclosure from the company, to be able to fully scrutinise the link.
The current figures are that 35 Russell 3000 companies have failed to receive majority support for their ‘say-on-pay’ proposals this year, again a record number. These include big company names, including at JP Morgan and at Intel.
A further clear trend this season has been in challenges to Chairs of Nominating Committees, where there are concerns about racial or ethnic diversity on the company’s Board.
So the trend remains resolutely upward and the range of issues being addressed is broadening.
The U.S. National Investor Relations Institute suggests that the slight dip in the number of proposals which actually succeeded this year, should not disguise the big increase in the number of proposals and the likelihood that success for more prescriptive ESG proposals will increase again next year and into the future.
Interestingly, business attitudes are changing too.
How Business is Responding
What also needs to be understood from viewing the numbers is that increasingly U.S. companies are indeed choosing not to fight proposals, but to engage with shareholders instead to find consensus on ESG goals.
The non-profit Ceres suggests that nearly half of climate-related shareholder resolutions this year have been resolved through negotiated agreement, securing the improved ESG performance which shareholders demanded.
Even where proposals have been put to a vote, company acquiescence has seen four shareholder proposals gaining over 80 per cent support.
In a mirror-image, it is smaller and non-specialist ESG investors who have been seen to increasingly engage on ESG issues, even if this does not lead to open proxy battles.
Put together – engagement by the company and engagement from the mainstream investor – have combined to put an irresistible emphasis in ESG, which has been labelled ‘stealth activism’.
Perhaps 2022 will be seen as the year where a fundamental shift has taken place, in which trends towards ESG activism in the United States and the rest of the world have begun to converge.
Coalition
If so, we should not be surprised.
So much of the discourse in ESG is about successfully building coalitions.
So much of the narrative for business success in modern markets is in building networks.
Shareholder activists may not come to the company, seeing themselves as a partner.
But perhaps the company’s aim is that they should leave, feeling just that.