From the House of Commons to the Boardroom: How “Anticipated Reactions” Strengthen Stewardship Efforts
The 2021 Proxy Season highlighted a distinct shift in ESG attitudes among management boards, fuelled by successful stewardship efforts from investors and advocacy groups. Now is the time for investors to revisit their stewardship practices.
Benjamin Stone, Analyst
The 2021 Proxy Season has been recognised for the record levels of support for ESG focused shareholder proposals. Whilst Governance has continued to remain a key issue for shareholders, it has been complimented by a clear increase in shareholder activism around Environmental and Social issues. For example, in 2017 there were just five Environmental and Social focused shareholder resolutions that received majority votes - this increased to 21 in 2020, before jumping to 34 (as of July 2021). In 2019, a shareholder resolution calling for DuPont to regularly report on their plastic pellet spills received 7% support from shareholders, whilst in 2021 the same resolution saw 81% support. There are examples of management boards even recommending that shareholders vote 'for' an Environmental and Social proposal, which, in the realm of corporate governance is considered quite rare. As someone who studied Politics and History, and the anticipated reactions of the British Government specifically, this does not necessarily come as a big surprise. This blog examines why anticipated reactions are being replicated within the boardroom, and how it reinforces the pivotal role that Stewardship has in facilitating investor driven sustainability outcomes. Definitions
Anticipated Reactions: Where the government regularly adjusts its behaviour due to internalising the legislature’s likely reaction to proposed pieces of legislation.Stewardship: An overarching term that describes the proactive activities that an investor can take to preserve and enhance an asset's long term value. Most commonly, these activities include directly engaging with portfolio companies (or governments), voting at Annual General Meetings (AGMs), submitting shareholder proposals, and working with public policy makers and industry initiatives. The stewardship avenues available to investors depend on type of investment made.When it comes to a company’s AGM, losing a vote has been seen as a source of embarrassment for a company’s management. Shareholders traditionally tend to vote in line with management’s recommendations and it is rare for a majority of shareholders to vote against a board's recommendations. This dynamic is similar within the House of Commons – the democratically elected house of the UK’s Parliament – as the government will tend to operate with a parliamentary majority. However, in the House of Commons the stakes are higher, since a government cannot afford to lose votes if they want to implement their legislative agenda. A consequence of this pressure is that governments are determined to win legislative votes, thus anticipated reactions (see definitions) play a key role within the House of Commons. In instances where governments have a slim parliamentary majority and are heavily reliant on their own members of parliament, anticipated reactions become even more important. In fact, an equivalence can be drawn between a government's members of parliament and a company's shareholders. Both are disposed to supporting either the government or the board of directors, but can ultimately withdraw that support when they believe that the other party is acting contrary to their interests. When a majority of shareholders oppose the board, it demonstrates a clear discord between shareholders and management. In extreme circumstances, this discord can result in shareholders deciding not to re-elect board members.Depending on the country, the ease of submitting shareholder resolutions and their effectiveness can greatly differ. For example, shareholder resolutions are non-binding in the United States, whilst the Trump Administration also made it more challenging for smaller activist shareholders to submit their resolutions. Nonetheless, boards remain cognisant of the impact that an activist shareholder can have, with shareholders only needing a minute stake to be able to shake up an entire company. One only has to look at the hedge fund Engine No. 1, who own 0.02% of ExxonMobil, managing to appoint three independent board directors because of the company's continued lag in meeting its sustainability commitments. Therefore, with boards aware that they are accountable to their shareholders, coupled with the heightened sense of urgency surrounding ESG issues and sustainability transitioning, it is likely that company boards are starting to be affected by these anticipated reactions. How do anticipated reactions in Parliament reinforce Stewardship's importance?
Engagement
Anticipated reactions signal the importance for investors to fully use their engagement capabilities. If boards are beginning to internalise that a majority of shareholders are likely to vote for ESG proposals, reprimand or even choose not to re-elect them over poor ESG performance, they will be more incentivised to engage with shareholders. Hanna Orowitz, Senior Managing Director at Georgeson, a corporate governance consultancy, noted that many ESG proposals did not actually reach a vote, thus “demonstrating the extensive engagement that took place between companies and shareholders in the offseason”. Another lesson that investors can learn from parliamentary dynamics is the power of collaboration. Individual parliamentary members are relatively weak but when they join together, especially across party lines, they have the greatest ability to pressure and influence the government. Returning to the Engine No. 1 example, their shareholder resolution was backed by larger shareholders such as Vanguard, Blackrock, the California State Teacher's Retirement System, Church of England Pensions as well as the New York State Common Retirement Fund.Proxy Voting
Management boards that recommend all shareholders vote for ESG focused shareholder proposals are showcasing early signs of the impact that anticipated reactions can have. Boards are now recognising that they can no longer rely on shareholders to vote in line with an antagonistic ESG position. By recommending all shareholders vote for ESG proposals, board members are positioning themselves to be considered the right people for creating long-term shareholder value, which sustainability is an inextricable component of. This has only become clearer through large asset managers, such as BlackRock, updating their Stewardship expectations to emphasise their belief in the importance of material ESG risk factors, enhanced reporting, and right to hold directors who are falling short accountable. The impact that these large asset managers have cannot be understated. Like the government having a good understanding of the majority of Parliament's voting intentions, boards are now developing an understanding of how some of their largest shareholders will vote on ESG proposals, the clarity of which will only increase with more investors publishing their proxy voting guidelines and Stewardship expectations.
Board directors have started to realise that they can no longer insulate themselves from growing ESG demands. This presents investors with an unparalleled opportunity to renew their Stewardship efforts, whether it be through revisiting their proxy voting policies and implementing them at the AGMs, or reviewing their overall engagement strategy to ensure that it is specific, tailored, measurable, and collaborative. Stewardship is an effective tool for investors to create tangible impact by embedding ESG throughout the entire investment lifecycle, the onus is now on them to fully utilise it. Get in touch with our team at info@northpeakadvisory.com to discuss how you can create lasting change.