“New Rules of Engagement” — Misconceptions around shareholder activism

While this is not something I normally do on my blog, I hope that you will indulge me in a  little shameless self-promotion.  Today’s entry is a duplication from a recently article that I had published in Listed Magazine, which is a magazine who focuses on executives and board members of Canadian listed corporations.  As noted, the title of the article is “New Rules of Engagement”.  I hope you’ll enjoy the read.

Globally, shareholders are asking public issuers to engage with them and provide new levels of disclosure on an array of environmental, social and governance measures. Is it activism? Or should we see it as investors taking responsibility for stewardship on behalf of their beneficiaries?

Of late, there’s been an unmistakable increase in shareholder resolutions, requests for special meetings, proxy contests and prickly questions at AGMs from investors. For senior executives and corporate directors, the questions keep repeating: “Do we pay attention to these stakeholders? Should we give our limited time and energy to deal with their requests?”

Given the global growth in responsible investing, they have little choice. The recognition that one may better assess and mitigate future risk by integrating environmental, social and governance (ESG) factors into one’s investment analysis and decision-making, is taking hold at the highest levels. A recent example: according to the November 2010 SIF Report on Socially Responsible Investing Trends in the U.S., nearly one out of every eight dollars under professional management in the U.S. is now managed according to socially responsible investing criteria. And North America is low compared with much of the world. Another November report, from the Responsible Investment Association Australasia, stated that more than 50% of all funds under management in Australia are now signed to the United Nations- backed Principles for Responsible Investment (PRI).

In fact, the PRI are key building blocks in the responsible investing move- ment. Nothing underlines the increasing level of shareholder engagement better than the growth in the number of institutional investors that have become signatories. From its inception in 2005 to June 2010, the PRI amassed 769 signatories, representing more than US$20 trillion of assets under man- agement, including 32 signatories from Canada.

The PRI are, in fact, a list of six principles that every signatory undertakes. Three of them deal directly with engagement:

  1. Incorporate ESG issues into investment analysis and decision-making processes;
  2. Be active owners and incorporate ESG issues into our ownership policies and practices;
  3. Seek appropriate disclosure on ESG issues by the entities in which we invest.

Another indicator of the increased pressure gathering for institutional investors is the July 2010 UK Financial Report Council’s (FRC) Stewardship Code for Institutional Investors. This code attempts to regulate how institutional investors engage with investee companies. Although new, this “comply or explain” code strongly encourages institutional investors to disclose how they engage with companies based on seven specific principles.

With such growth in responsible investing, it is important to recognize that most “shareholder activism” is being driven by a need for greater transparency. In particular, to meet their obligation of managing risk, investors are seeking increased disclosure around certain ESG issues. The demand for this data is such that it could enable a financial analyst to assess the potential impact of systemic issues on a corporation’s relative valuation. It is estimated that nearly 75% of corporation’s stock valuation is intangible value. Therefore, changes in such intangible value cause fluctuations in pricing. These requests for disclosure and transparency are, therefore, being driven by the investors’ need to better assess whether a holding’s current market value accurately represents its under- lying value over the long term.

As an example, with water becoming an important global issue, Northwest & Ethical Funds publicly disclosed its filing of a shareholder proposal with Potash Corp. asking for increased disclosure on water scarcity, quality and quantity used for operations. After a meeting with the company, an agree- ment was made to disclose more water-related data going forward. The fund company subsequently withdrew its proposal. Many such examples exist.

It is important to note that most activism only comes after efforts of engagement and dialogue have been tried with public issuers. The main mes- sage is that proxy voting is often used as a last-ditch effort to engage manage- ment before divestment of a holding.

With that, here are 10 things a public issuer can do to prepare for this shift:

  1. Learn what responsible or sustainable investing is.
  2. Educate your board members on sustainability issues
  3. Become aware of the key ESG performance indicators for your industry/company
  4. Understand what are the differentiating factors that make you unique versus your competitors
  5. Openly engage and dialogue with your stakeholders to learn more about what they see as your main issues.
  6. If need be, concede on some unfavorable propositions prior to your AGM and then explain how you will co-operate to resolve the issues.
  7. In your sustainability report, speak to our social dividends and financial dividends.  Translate your efforts into financial terms.
  8. Point out your current, voluntary ESG efforts.
  9. When meeting with your shareholders and financial analysts, proactively talk about your ESG efforts.
  10. Be a leader.  Don’t wait for the regulators.  Step up and help share your competitive landscape.

Milla Craig is principal of Montreal-based Millani, which offers sustainable investing industry analysis and consulting services to asset owners, asset managers and publicly listed corporations.

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This entry was posted in Corporate Responsibility, Governance, Sustainability, Sustainable Investing. Bookmark the permalink.

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