Shareholder proposals give investors of all sizes a direct line into boardrooms and executive suites. As sustainable investors, we file them when we see opportunities for companies in our portfolios to improve in ways that might make them even better investments. Over the years we’ve witnessed many companies make value-enhancing changes to their business as a result of our engagements and those of other investors. But recently some industry groups have urged the Securities and Exchange Commission to consider measures that would make the shareholder proposal process less available to investors. Julie Gorte explains why that would be detrimental.
Lately it seems to have been open season on shareholder engagement, with a handful of groups, often funded by big business, ridiculing the activity as something that’s driven by frustrated political activists with no financial acumen or by “special interest groups” riding hobby horses.
Dog bites man: We’re all probably guilty of using dismissive or deprecatory adjectives or nouns to describe tribes whose views don’t comport with our own. But caricaturing the opposition is no substitute for facts and evidence, especially in the investment world. Acting on sentiment, alone, is something that has proven countless times to be a recipe for financial failure over the long term. Those who criticize shareholder engagements and proxy proposals about environmental and social issues often dismiss them as non-financial and even self-righteous, but they almost never present any evidence that proves these instruments have no financial relevance or impact. The few commissioned “studies” that have been conducted have used dubious methods1 and cherry-picked sample sets to “demonstrate” that social and environmental shareholder proposals do not improve company performance, but people who understand statistics even a little bit already know that if you carefully pick the sample, the variables and the time period, you can “prove” pretty much anything.
So, what does the literature that doesn’t start with the conclusion that environmental and social engagement is frivolous, costly and non-financial say? Goldman Sachs’ equity research report “Shareholder Engagement in the Age of Transparency”2 says: “We believe shareholder resolutions can offer additional insight into emerging material risks and externalities for issues, as well as management responsiveness.” The report also notes that support for environmental and social shareholder proposals has been rising for several years, with nearly 30 percent of votes going in favor of shareholder proposals. Considering that insider ownership for U.S. companies averages about 13.6 percent,3 it is quite possible that the support for these proposals among outside shareholders is significantly higher.
Some observers tend to see vote totals on shareholder proposals as binary — either they pass or they don’t. But it is useful to understand the nuances, too. In accounting, a shareholder holding at least 20 percent of a company’s shares has a significant or active interest, and that is something that can influence management decisions. That provides a different lens through which to see the 30 percent average support for shareholder proposals than a simple pass/no pass view. It’s also an indicator that it’s not just a bunch of frustrated political activists interested in these proposals; it’s an indication that a significant proportion of a company’s investors see them as relevant to the company’s financial performance.
Results such as these help to explain why the votes in support of these proposals have gone up: They are about things that can and do affect financial performance. For example, of the proposals that did receive majority votes of support in 2018,6 the engagements included topics that absolutely had financial relevance: the opioid crisis, coal ash risks, climate change and greenhouse gas emissions. Consider that one drugmaker’s stock price lost 80 percent of its value7 after it was indicted for misleading doctors and public health officials about the effects of its opioid addiction treatment, and one of the major manufacturers of opioids, Purdue Pharmaceuticals, is reportedly looking into declaring bankruptcy in the face of expanding litigation.8 On the climate change front, 2019 witnessed what The Wall Street Journal described as the world’s first climate change bankruptcy,9 after PG&E declared Chapter 11 as its liabilities and penalties for destructive wildfires skyrocketed.
All About Engagement
Find out what we’ve asked of companies and how they’ve responded.
Bankruptcies and stock price collapses happen all the time, of course; is there any evidence that proactive work to be more sustainable might lessen them? Yes, plenty. Several recent papers have focused on what we often call tail risk — highly impactful events that can have major implications for value but that are relatively rare historically. One recent paper10 provides quantitative evidence that investors see strong ESG practices as a hedge against what we call a left-tail risk, or large drop in value. This could be because better sustainability practice reduces firms’ vulnerability to litigation and environmental disasters, both of which can make noticeable dents in companies’ reputational value. Another recent article noted that ESG, while not a traditional style factor, was known to reduce risk in portfolios.11 A 2018 report from MSCI12 sheds additional light on that idea, noting that investors are interested in how ESG integration changes both systematic and stock-specific risks in portfolios over multiple time periods. Portfolios with higher ESG ratings had better risk-adjusted returns than their parent indexes.
Climate change, which is one of the main topics in shareholder proposals, is another good example of the connection with financial value. If not addressed, climate change could cost us perhaps five percent of gross domestic product annually in perpetuity,13 and investors see it as a material source of several kinds of risk and opportunity. One recent paper14 constructed a portfolio that had long positions in more carbon-efficient firms and short ones in carbon-inefficient firms, and that portfolio generated abnormal returns of 3.5-5.4 percent per year. Another study showed that low-carbon indexes have generally outperformed mainstream benchmarks.15
These are only a few examples of a large and robust body of literature linking better sustainability performance with better financial performance. The growing support for shareholder proposals, along with the fact that giant financial companies such as Goldman Sachs, BlackRock, State Street, Morgan Stanley and Bank of America Merrill Lynch are turning out a stream of reports showing the connections between sustainability and financial performance, is evidence that investors increasingly see sustainability as financially material to company and portfolio performance. The act of investors filing shareholder proposals on sustainability-related topics should be seen as what it is — investors interested in long-term performance engaging with companies to make them even better investments. We have a lot of evidence to support that, and we didn’t have to fund anybody to create it especially for us. It was created by analysts and academics interested in finding true things.
1 Gorte, Julie, “Candidate for the Journal of Irreproducible Results,” Impax Asset Management, June 19, 2018.
2 Derek R. Bingham, Tristyn Martin, Sharmini Chetwode, Christopher Vilburn, Evan Tylenda and SoYoung Lee, “Shareholder Engagement in the Age of Transparency,” Goldman Sachs Equity Research, June 12, 2019.
3 “Insider and Institutional Holdings by Sector (US),” Damodoran Online, Stern Business School, New York University, Jan. 2019.
4 Tamas Barko, Martijn Cremers, Luc Renneboog, “Shareholder Engagement on Environmental, Social, and Governance Performance,” European Corporate Governance Institute, May 31, 2017.
5 Elroy Dimson, Oguzhan Karakas, Xi Li, “Active Ownership,” The Review of Financial Studies, Aug. 12, 2015.
6 Heidi Welsh, “Proxy Season Review: Social, Environmental & Sustainable Governance Shareholder Proposals in 2018,” Sustainable Investments Institute, Nov. 9, 2018.
7 Theron Mohamed, “A UK Drugmaker’s Stock Crashed 80% After It Was Indicted for a ‘Truly Shameful’ Opioid-Addiction Scheme, Markets Insider, April 10, 2019.
8 Berkeley Lovelace Jr., “OxyContin-maker Purdue Pharma Reportedly Exploring Bankruptcy Amid Litigation Over Opioids,” CNBC, March 4, 2019.
9 Russell Gold, “PG&E: The First Climate-Change Bankruptcy, Probably Not the Last,” The Wall Street Journal, Jan. 18, 2019.
10 Michael Shafer and Edward Szado, “Environmental, Social, and Governance Practices and Perceived Tail Risk,” July 26, 2018.
11 Carlo Svaluto Moreolo, “ESG: The Sustainability Factor,” Investments & Pensions Europe, April 2018.
12 Guido Giese, Linda-Eling Lee, Dimitris Melas, Zoltan Nagy, Laura Nishikawa, “Foundations of ESG Investing,” MSCI, May 2018.
13 Nicolas Stern, “The Stern Review: The Economics of Climate Change,” Cambridge University Press, March 2014.
14 Soh Young In, Ki Young Park, Ashby H.B. Monk, “Is ‘Being Green’ Rewarded in the Market?: An Empirical Investigation of Decarbonization and Stock Returns,” Stanford Global Projects Center, April 19, 2019.
15 Oliver Oehri, Christoph Dreher, Christoph Jochum, “Climate-friendly Investment Strategies and Performance,” Center for Social and Sustainable Products and South Pole Carbon Asset Management Ltd., Nov. 7, 2016