With the 2019 proxy season fast approaching, public companies must contend with an investment community that is as focused as ever on Environmental, Social and Governance (ESG) matters. The rapid ascent of passive investors, and their desire to invest in responsible corporate citizens, has created an environment that now requires issuers to proactively address this growing area of interest.
Shareholder Dynamics Are Changing
For decades now, institutional ownership has been on the rise. However, that dynamic has undergone its own recent transformation, with fund flows shifting from higher-priced, actively-managed funds into passively-managed ETFs, indexes and other lower-fee vehicles. Notably, 42 percent of all U.S. stock fund assets were held by index funds as of June 30, 2017, and Ernst & Young projects that passive assets under management could exceed actively-managed investments in fewer than 10 years.
Yet, while actively-managed funds have long been able to express displeasure with a company’s strategy through activist campaigns or by selling their ownership position, index funds must continue to hold the securities that apply to the corresponding index criteria.
As a result, passive investment managers have begun to flex their muscles through increased engagement with issuers, principally on corporate governance matters. In his annual letter to CEOs, Larry Fink, Chairman and Chief Executive Officer of BlackRock, made the case for increased shareholder engagement: “Our responsibility to engage and vote is more important than ever. .… We must be active, engaged agents on behalf of the clients invested with BlackRock. …. This responsibility goes beyond casting proxy votes at annual meetings – it means investing the time and resources necessary to foster long-term value.”
Fink, as well as leaders from other major passive funds like Vanguard, are seen as key contributors to the rise in “passive shareholder activism.” These passive funds have specific priorities for issues, which increasingly focus on how issuers can deliver long-term returns and societal good at the same time. And so, as proxy season gears up, we believe it is critical for boards of directors and executives to educate themselves on how the landscape has changed and what they can do to lead from the front.
A Transforming Landscape
Shareholder activism is not new. What is new, however, is that ESG-specific activism is becoming mainstream and rapidly gaining support. According to the 2018 Edelman Trust Barometer Special Report: Institutional Investors, 66 percent of U.S. investors mentioned that their firm altered its voting or engagement policy to be more attentive to ESG risks in the last year alone.
This evolution has resulted in growing support for, and increased success in, passing proposals related to topics such as the environment, workforce diversity, and shareholder rights. In fact, Sullivan & Cromwell reports that environmental, social and political proposals saw votes cast in favor climb four percentage points to 26 percent in 2018, and the percentage of passed proposals more than tripled from the prior year.
With increasing engagement and ownership from passive investors, there is a strong likelihood that this type of support will continue to grow.
How Issuers Can Prepare
In the current economic and social environment, nobody is exempt from ESG matters and companies must evolve much like investor interests. Edelman’s investor survey reflects that having a point of view and a strategy for engaging on ESG topics is critical to building trust; 93 percent of U.S.-based investors believe that active engagement on corporate governance issues impacts trust in the firm. And 94 percent of U.S.-based investors believe that long-term value hinges on both financial performance and ESG features.
Companies must recognize these trends and actively engage with proxy advisors and passive investors from a position of strength. Companies should recognize that building a relationship now and establishing a foundation of understanding can ultimately influence future shareholder voting outcomes. As issuers prepare for the 2019 proxy season and beyond, here are five practices to ensure that you are pursuing a best-in-class shareholder engagement strategy:
- Prepare content aimed at governance analysts, passive investors and proxy advisors
Clearly articulate how your environmental, social and corporate governance practices supports your firm’s corporate strategy to create long-term shareholder value. Many issuers will prepare presentations that discuss the two and how they are supportive of each other. Be honest about where your firm is and where it is going by sharing measurable targets. How diverse is your board and your employee base? Is executive pay aligned with shareholder interests and how does it compare to peers? And what are your environmental and sustainability initiatives? Each of these topics is top of mind to investors.
- Engage your Board
Investors are routinely asking for more time with experts beyond the usual suspects. Access to board members is critical. In the U.S., 94 percent of investors say they need to trust the board before making an investment. Luckily, according to the Edelman survey, board members are viewed as the most credible internal spokespeople globally, so make sure to include them in your shareholder engagement process and set aside time to ensure directors are well-trained to participate in the conversations.
- Engage in the off-season
Investor focus on ESG doesn’t begin and end with proxy season. Engage with key stakeholders year-round to understand and respond to topics of interest. Proxy advisors are busiest in the spring, right after proxies have been filed, so it is best to start your conversations and proactively solicit feedback in late summer or autumn.
- Give your proxy a facelift
The annual proxy is in the early innings of being transformed into a document that can serve as a key part of your investment narrative. Consider adding more compelling content to the document through engaging graphs, matrices for the board’s varying expertise, improved storytelling around the firm’s ESG efforts, and how your firm is engaging with investors.
- Ingrain your findings across the organization’s collateral
There are multiple ways a company can communicate its ESG practices, and this information needs to live and breathe outside of the proxy statement. According to the Edelman study, a company’s corporate website is ranked No. 1 in the U.S. as an ESG source. ESG should span platforms, including the proxy statement, annual report, corporate website, earnings calls and investor presentations.
Jeremy Cohen is vice president, Investor Relations, Chicago.
Hunter Stenback is senior account supervisor, Investor Relations, Chicago.