Given the multi-year growth in investor focus on ESG — accelerated further by the confluence of a global pandemic, social unrest and political change — it is no surprise that the 2021 proxy season was unlike any other. For many companies, this year’s annual meetings marked full shareholder revolts, as environmental and social shareholder proposals received record support levels, votes against directors became a ’normal’ practice, and a number of high-profile companies failed Say-on-Pay.
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An unprecedented 35 E&S proposals passed with more than half of the vote, and average support level across all environmental proposals was above 50%.[1]
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Perhaps more notable for the future, many large shareholders began to channel their displeasure with companies’ ESG practices into votes against individual directors. Policy updates from large institutional investors indicate an increased willingness to withhold director votes when ESG practices are seen as lacking, such as in instances of limited board diversity or perceived failure to oversee climate risk.
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Investors’ ESG focus also factored into the most-followed proxy contest of the season – perhaps the most-followed in the history of proxy contests — when at ExxonMobil, a newly-formed activist hedge fund holding 0.02% of its outstanding shares secured three seats on the $270B company’s board. Notably, the activist’s criticisms were focused not only on the company’s underperforming stock but equally on perceived weaknesses in climate strategy, board composition, and corporate culture. Leveling these ESG critiques, the activists gained the advance support of influential investors such as CalSTRS, CalPERS, and New York State Common, and ultimately the votes of the world’s largest asset managers. Perhaps the safest prediction for 2022 is that other activists will increasingly use E&S issues as the ‘tip of the spear’ for their campaigns.
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While the average Say-on-Pay support level remained generally flat compared to 2020, there was a 31% increase in the number of Say-on-Pay proposals that failed to receive majority support – and more of these proposals were at “blue chip” companies versus years prior. Investors increasingly questioned the magnitude of payouts and rigor of targets – particularly against the backdrop of the pandemic.
In our view, 2021 was not an anomaly, and we expect that investor pressure on companies – and expectations for Board oversight of ESG practices – will continue to grow in future years. To that end, we offer some thoughts to help public companies navigate this new Age of ESG.
WHY DID THIS HAPPEN?
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Changes at the Big 3 … and the Big 2 in particular. The world’s largest asset managers, BlackRock, Vanguard and State Street Global Advisors continue to accumulate market share, and now control over 40% of the fund industry’s U.S. equity assets. They are now among the top shareholders of nearly every U.S. public company. In years past, BlackRock and Vanguard have also been among the least likely institutional investors to support E&S shareholder proposals (6% and 9%, respectively, in 2020) and withhold support from directors (5% and 4%, respectively, in 2020).
Over the past twelve months, we have seen a more aggressive shift in the voting patterns at Vanguard and BlackRock. This follows new leadership for each firm’s Stewardship team, which — along with growing pressure from clients, advocacy groups, public protests, and shifting political winds in Washington – have driven significant revisions to each firm’s proxy voting approach. In BlackRock’s words, their Stewardship team would be “more likely to support a shareholder proposal without waiting” to see the results of engagement. While the Big 2’s full voting record will not be available until August, their public disclosures and market intelligence indicates that BlackRock and Vanguard supported a wide range of E&S proposals in 2021 – often for the first time (see sidebar). These voting trends are unlikely to abate.
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Mainstreaming of shareholder proposals, and proponents. In the not-so-distant past, many proposal proponents were widely viewed as fringe groups implementing political or faith-based agendas through corporate advocacy. Now, many E&S proposals are linked, directly or indirectly, to large investor coalitions with the backing of many ‘mainstream’ asset managers, such as Climate Action 100+[2]. These asset managers increasingly recognize the economic link between certain E&S issues and long-term stock performance, and are engaging with ESG ‘activists’ and even adopting these groups’ views as their own. Moreover, the language of many E&S proposals has been refined to focus on disclosure – not prescriptive action – and long-term financial value – not political or moral values, thereby avoiding hurdles that prevented many institutional shareholders from supporting those proposals in the past.
This ‘mainstreaming’ is reflected not only in the increase in passing proposals, but also in actual support levels reaching new heights: among the 31 passing proposals that lacked management support, three received support levels in the 70s, eight in the 80s, and two in the 90s.
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Rising expectations for directors. A key theme in investor engagements – as well as in the ExxonMobil proxy fight – is that directors are expected to possess or build the skills and knowledge required to oversee relevant E&S issues. Rather than advocate narrowly for a single ‘ESG expert’ on the board, most investors expect that the full board builds its ESG fluency through exposure to these issues, engagements with experts and outside stakeholders, and integration of ESG issues into the board’s strategic oversight.
Investors are increasingly willing to act against directors where they do not see these practices. As a prime example, BlackRock has been actively voting against directors at companies that lack sufficient climate disclosure or a “credible plan” to transition their business model to a low-carbon economy. The firm has also developed a “focus universe” of companies under evaluation for their climate risk oversight. This list contained 440 companies in 2020, and more than 1,000 companies in 2021. These heightened expectations for directors – and the understanding that they require more time and focus from directors – are also driving many investors’ increasingly stringent ‘overboarding’ policies.
WHAT DO I DO NOW?
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Solidify your foundation on key issues. Well-prepared companies will take the coming weeks to closely analyze the results of the 2021 season, identify potential vulnerabilities, and develop action plans – focused around robust governance, strategy, investor engagement and disclosure – for those proposal topics that received the greatest levels of shareholder support.
This analysis should cover not only proposals that went to a vote, but also those that were ‘settled’ in advance of the meeting by companies anticipating significant shareholder backing.[3]
In addition, this post-season analysis should identify which proposal topics have the most momentum; for example, ‘repeat’ proposals seeking disclosure of corporate political activity saw significant jumps in shareholder support from 2020 to 2021.
Finally, this analysis should also look around the corner for future focus areas for investors. For example, with the UN Principles for Responsible Investment (PRI) issuing recommendations to accelerate the implementation of ESG metrics in executive compensation, expect more investor focus on this issue from PRI’s 3,000+ investors with $100 trillion+ in AUM.
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Embrace the importance of ‘off-season’ engagement … and the diminishing effectiveness of last-second outreach. The importance of having direct ESG conversations with a company’s largest shareholders has become well-established in recent years, as has the value in engaging outside of proxy season to address a broad range of issues and build longer-term relationships with shareholders. As investors’ proxy voting functions and ESG policies become more refined, calls to investors right before the annual meeting have been less successful in securing support than in prior years. Accordingly, knowing that companies are unlikely to have more than 1-2 conversations with the Big 3 each year, we encourage clients to re-double their focus on these off-season engagements, and ensure that they:
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Choose the right people, including directors, to join the conversation;
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Be knowledgeable about each investor’s individual priorities;
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Focus the agenda, while also building on prior conversations;
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Ask questions, listen, and engage in a true dialogue; and
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Be responsive on issues of investor concern.
Finally, as advocacy groups and other stakeholders continue to gain influence with the largest institutional investors, companies should ensure that their engagement program also includes the most influential among these groups. We have found that, in these engagements, there are often important areas of alignment between an advocacy group and the company. Where misalignment exists, companies are better positioned, after such an engagement, to provide disclosure on their preferred strategy.
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Continue to support directors’ ESG fluency as part of building a ‘fit for purpose’ board. Investors expect the board to be ESG competent, and to have the requisite industry expertise to both challenge and support management decisions around risk and strategy – in other words, to serve as the company’s ‘internal activist’. In addition, some investors increasingly expect that certain key E&S topics are owned by board committees that can go deeper than the full board, while many investors also believe that certain topics are better overseen by the full board. Companies lacking a methodical, transparent oversight process to oversee ESG should expect, at best, disappointing investor engagements and, at worst, activists using this as a key component of their proxy battle campaign.
The ESG zeitgeist has indeed shifted; as SEC Commissioner Lee recently remarked, “[t]his proxy season is just the latest affirmation of a sea change on climate and ESG.” While the specter of increasing shareholder pressure is hardly welcome for most companies, in our view the Age of ESG provides well-placed companies with the opportunity to differentiate themselves as responsive to shareholders, committed to enhancing their ESG practices, and focused on building long-term value.
[1] All data reflects votes at companies included within the Russell 3000 index during the period from July 1, 2020 through June 30, 2021. E&S proposals included in the data sample exclude so-called ‘counter-proposals’ seeking companies to discontinue corporate ESG efforts.
[2] Climate Action 100+ is made up of 545 global investors who are responsible for more than $52 trillion in assets under management.
[3] Interestingly, while 2021 saw a sizable increase in the number of negotiated withdrawals compared to prior years, many of these settlements related to just a small number of proponent campaigns – such as the New York City Controller’s campaign to drive disclosure of companies’ annual EEO-1 workforce demographic data. Our market intelligence suggests that most proponents were actually less willing to make concessions and negotiate as compared to prior years, and we anticipate many will be similarly emboldened by 2021’s spike in support levels.
