Amidst ever-present chatter about shareholder activism and its influence on short-term thinking, a groundswell of support has been bubbling up among investors with rising concerns about their portfolio companies’ commitment to long-term shareholder value.
At the heart of this focus on long-term impact of corporate activity is climate change and environmental impact—the “E” in “ESG,” or Environmental, Social and Governance issues. From 2012 to 2016, according to Equilar data, the number of shareholder proposals at S&P 500 companies on environmental and social issues increased from 148 to 192, and the percentage of total proposals that represented increased from 39% to 45% in that time frame (Graphs 1 & 2).
The number of proposals does not reflect overall support from the investment community, and in fact, most first-time proposals receive very little support from broader shareholder bases, especially if they come from investors with smaller stakes.
“The notion of pressuring institutional investors to vote a certain way, not because it’s good for the company but because it’s good for the issue, is really widespread now,” said Donna Anderson, Vice President and Global Corporate Governance Analyst, T. Rowe Price, in a recent webinar hosted by Equilar. “This can make it difficult for asset managers to maintain our focus on what really matters, which is what’s the right vote for each company.”
At the same time, shareholder votes take the temperature of the larger shareholder base as they continue to show up year after year on proxy ballots, and there are some indications that support on environmental issues may be reaching a tipping point. For example, 2017 votes to support greater disclosure of climate impact at Exxon Mobil, Occidental Petroleum and PPL Corp. received majority support, a signal to some that a tide is turning, and a deeper level of scrutiny on climate change and environmental impact from large shareholders is becoming more mainstream.
Those are just three examples at companies with clearly high environmental impact, so to see calls for greater disclosure of how organizations are approaching climate risk may not be surprising. However, at the 250 largest U.S. companies by revenue, 27% of shareholders voted to approve climate and environmental proposals on average in 2017, up from 21% in 2016, according to Proxymonitor.org (Graph 5). That’s up from just over 10% in 2006 and about 17% as recently as 2015, as cited in a recent Bloomberg article.
“More and more investors believe this is important, and they realize it is up to us to engage on these issues,” said Brian Rice, Portfolio Manager in Corporate Governance for CalSTRS. “ESG can impact value, and companies are being exposed to and managing that risk.”
“We have to move beyond this false idea that sustainability is a choice between ‘doing well’ and ‘doing good.’”
- Veena Ramani, Program Director, Capital Market Systems, Ceres
Donald Trump won the presidency partially due to the promise of lowered regulations on balance, particularly with respect to environmental protections. With proposed funding cuts to the EPA and a declaration that the U.S. will pull out of the Paris climate accord, some of that campaign rhetoric is being fulfilled. As a result, the burden for action on climate change has shifted to the private sector, and publicly traded companies in particular are seeing their shareholders intensify the call for action on climate change in the absence of legal mandates.
“We may not see environmental regulations move forward over the next four years, and they may even be rolled back, but that doesn’t mean the risks have gone away,” said Veena Ramani, Program Director, Capital Market Systems at Ceres, a sustainability nonprofit organization. “In fact, companies are more exposed to risk from environmental and social issues than ever, and the mitigating effect of regulations has gone away. This has made investors feel that boards need to step up and provide more active oversight of environmental and social issues.”
Ironically, the loosening of regulations—or the promise thereof—is resulting in more activity from investors and companies recognizing this shift in responsibility. In a highly regulated scenario, companies may be more apt to comply with the letter of the law and nothing more. With broad-sweeping regulations on climate and environmental risk pushed to the back burner, investors are demanding that each individual company identify specific, material risks and disclose that information.
“We’re seeing a trend in real-time moving from gestures to action, which is unprecedented,” said Jean Rogers, Founder and Chair of the Sustainability Accounting Standards Board (SASB). “Shareholders are leveraging their rights as investors to material information on environmental impact and are voting their proxies to see this disclosed.”
As the door opens to relax efforts on practices that may reduce climate impact—which may be disruptive and expensive in the short-term—companies have the choice whether to walk through that door. Danielle Fugere, President and Chief Counsel of As You Sow, a shareholder advocacy group, cautions against the temptation to take advantage of what may help companies’ short-term bottom line.
“If you see weakened regulations as a reprieve, you’ll be behind the curve,” Fugere said. “Shareholders see risk in companies that back off previous commitments and focus on the short-term—we want to know who is being strategic.”
In other words, businesses that would see short-term cost-cutting and profits by running higher carbon emissions may set themselves up for failure later by falling behind competitors that are heeding the sentiment of their shareholders and customers. “The market values low carbon emissions—more and more consumers want to know that the companies they buy from are sourcing renewable energy,” said Fugere.
“If you see weakened regulations as a reprieve, you’ll be behind the curve.”
- Danielle Fugere, President and Chief Counsel,
As You Sow
Rogers at SASB cited a 2015 CFA Institute survey that showed 73% of institutional investors indicating that they take ESG issues into account to help manage investment risks. Furthermore, 89 of the world’s top 100 asset managers are signatories to the Principles for Responsible Investment (PRI), including Blackrock, Vanguard, SSGA, Fidelity Investments, JP Morgan and PIMCO, committing to incorporating ESG issues into investment analysis and decision-making processes, she noted. (Graphs 3 & 4)
With this backdrop, corporate boards are recognizing that they are responsible for the solution, and that there are a variety of steps that can be taken to increase awareness and action around climate change from the top down in their organizations. Shareholders are now coming directly to the boardroom, submitting proposals to have their voices heard. For directors, that means balancing the short-term focus of many activist investors and hedge funds with this increasing tenor around environmental and social issues and impact on the long-term from traditionally “passive” investors.
However, Rice cautioned that the idea of a dichotomous “short-term/long-term” strategy for corporations with respect to environmental concerns is not a zero-sum game.
“I definitely think there’s a perception that ESG is ‘long-term,’ but I see it as multidimensional,” he said. “Environmental issues can affect you today—oil spills, mine collapses, etc.—and corporate managers are appreciative of our position to think more broadly, and approach the concept of sustainability as balancing what the company needs to be successful in the present and the future.”
The question remains how boards create a comprehensive strategy to strike this balance.
Tanuja Dehne, former EVP, Chief Administrative Officer and Chief of Staff at NRG Energy, who currently serves on two public company boards, is also a Senior Advisor for The B Team, a not-for-profit initiative led by global business leaders including Sir Richard Branson, Marc Benioff and Andrew Liveris. She said that it’s critical that boards consider all stakeholders, beyond investors, including the community, customers and employees.
“Boards and management teams have to be vigilant on creating long-term value and to avoid getting sucked into a short-term focused vortex,” said Dehne. “One of the ways boards can motivate and empower management teams to focus on the long-term is by instituting longer-term incentive programs.”
For many boards, oversight of risk starts by identifying to what degree climate impact is material to corporate performance. All corporations will have to consider this at some level, but there are very clear lines drawn for some companies.
Rogers at SASB noted that sustainability issues manifest themselves differently from one industry to the next. In terms of climate change, just seven out of 79 industries account for 85% of the Scope 1 carbon emissions from public equities, she said.
However, the remaining 72 industries still have to consider climate risk, even if it’s indirect and not a specific threat based on carbon emissions. For example, apparel companies must consider their ability to source cotton, which is highly affected by shifting weather patterns. Commercial banks have to vet loans to oil and gas companies, industrials, utilities and other industries whose own risk exposures could threaten their ability to repay or refinance. Automakers are focused on developing alternative-fuel vehicles in response to shifting consumer demand patterns.
Board composition also plays a role. For example, Exxon Mobil added a climate expert to its board of directors earlier in 2017 in response to shareholder pressure, and the assessment of materiality to the business goes hand in hand with who is making those decisions.
“Irrespective of the committee where environmental risk assessment is housed, it should be linked to board discussions on strategy, risk and compensation, and not in a silo,” said Ramani. “You don’t necessarily need a technical expert or Ph.D. on the board, but your directors do need to be able to ask the right questions and make those linkages to strategy.”
Dehne, who has first-hand experience with the subject, agrees. “Boards are bombarded with so many emerging issues and risks that they have to stay ahead of,” she said. “However, there needs to be a greater sense of urgency on the issue of climate change because there is a deadline that must be met to stave off the worst impacts.”
“I definitely think there’s a perception that ESG is ‘long-term,’ but I see it as multidimensional. Environmental issues can affect you today.”
- Brian Rice, Portfolio Manager in Corporate Governance, CalSTRS
The shareholder proposal process may not be the most comfortable way for companies to address issues that are simultaneously sensitive and quite complicated, admits As You Sow’s Fugere, but it is the principal mechanism shareholders have for dialogue with the company.
“Shareholder resolutions are important for identifying change, and while companies may not look forward to this process, many that we work with every year look to us for what’s new on the horizon,” she said.
She also noted that the democratic basis for shareholder proposals is important. As the numbers show, climate proposals are still generally in the minority, so companies still have a lot of control over these outcomes through engagement with investors and other means. It’s all part and parcel of keeping companies accountable and ensuring that they’re paying attention to what may be coming to the forefront.
Indeed, a critical portion of this dialogue is disclosure. While not required, and not likely to become so—especially not in the U.S. in the near-term—the more companies can engage in clear communication with their stakeholders about their environmental impact, the better opportunity they will have to push strategy forward. And in that respect, disclosure and engagement has the potential to mitigate some of the friction around the proposal process.
According to Rogers at SASB, 100% of corporations are confident in the quality of ESG information they report, but just 29% of investors are confident in the quality of the ESG information they receive. Research by her organization shows that 69% of companies are already addressing at least three-quarters of SASB disclosure topics for their industry in SEC filings, and 38% are already providing disclosure on all SASB disclosure topics. However, more than half of sustainability-related disclosures in SEC filings use boilerplate language, which is inadequate for investment decision-making, she said.
“What we have is a failure to communicate, and this is an opportunity where boards can lead,” Rogers added. “There’s a disconnect between investor demand for improved ESG disclosure and corporate response to this demand. Companies are meeting the letter of the law with boilerplate info, and while it’s not intended, different information is being shared at different times to different investors in separate meetings.”
Rice at CalSTRS agreed that access to information is critical in their investments.
“Disclosure is central to whether or not a company is paying attention to this,” he said. “We search all the sources of public information and find out if these companies are and aren’t paying attention to the risk, and that allows us to make more informed investment decisions.”
Beyond the relationship between the board and the company’s shareholders, there is the simple matter that consumer sentiment is shifting toward wanting to see a clearer link to social responsibility from companies in general. If those voices become loud enough, regulation may be immaterial to faster movement toward broader sustainability practices.
“I’m optimistic that market forces, corporate leadership and consumer demand will speed the transition to a clean energy future,” said Dehne. “Companies may not be as vocal on this issue right now, but many are taking advantage of the value creation opportunities and listening to what their consumers want when it comes to sustainably sourced goods and services. The pace of change, however, has to pick up.”
“We have to move beyond this false idea that sustainability is a choice between ‘doing well’ and ‘doing good,’” Ramani added.
Dan Marcec is the editor-in-chief of C-Suite magazine. He can be reached at dmarcec@equilar.com.