Friday October 31, 2014

Shareholders Press on CSR Risks

Corporate responsibility issues made up approximately 40 percent of shareholder proposals through June of 2011, with social and environmental policies strongly correlating with risk management strategy.

As proxy season comes to a close, an analysis of shareholder proposals continues to indicate a growing belief on the part of institutional investors that a company’s social and environmental policies correlate strongly with its risk management strategy—and ultimately its financial performance.

Steve Starbuck

Steve Starbuck

In the 2011 proxy season, resolutions on corporate responsibility issues made up about 40 percent of all of shareholder proposals up for a vote during meetings that took place through June, according to the Ernst & Young corporate governance database. As in 2010, these proposals represented the largest category of shareholder proposals. The 40 percent figure also represents a significant increase over the 2010 full year figure of about 30 percent.

Initial projections by Ernst & Young analysts predicted the proportion of social/environmental proposals would reach 50 percent of all shareholder proposals. However, the actual proportion that came to a vote was 40 percent, partly due to a higher-than-expected number of submitted proposals that were later withdrawn by proponents.

A significant number of corporate responsibility resolutions were withdrawn by proponents, as a result of substantive dialogue with and/or action taken by companies, which is an indication of how company shareholder engagement can lead to mutual agreement on complicated issues. This is a level of success that is not captured in vote outcomes.

The increase in voting support for CSR-related proposals may be a significant factor influencing why companies are increasingly open to reaching an agreement with shareholders on these matters, rather than putting them up for vote on the proxy. For example, of the nine proposals on hydraulic fracturing (a controversial natural gas extraction technique) submitted this proxy season, half were withdrawn due to company action. The remaining proposals, which were included in proxy ballots, received very high levels of support, averaging more than 40 percent of votes cast; one won support from 49.5 percent of votes cast.

Ann Brockett

Ann Brockett

Investor and Regulator Focus
While the number of CSR resolutions is increasing, so to is the level of support, especially among mutual funds and other important institutional investors. Partly, this is because investors and regulators such as the Securities and Exchange Commission (SEC) are becoming more aware of the reputational and financial risks associated with social and environmental issues. Shareholder proposals have become increasingly prescriptive in asking boards to mitigate potential risks tied to evolving regulations, shifting global weather patterns and heightened public awareness of climate change issues—any of which can affect a company’s business.

These developments have placed more pressure on companies to show they appreciate such risks and are taking appropriate steps to manage them. Board members and senior management need to understand requests for information related to environmental subjects. Just as important, they must work actively to mitigate shareholders’ concerns about environmental issues whether the board considers them legitimate or not. Increasing support on shareholder proposals will put pressure on boards to respond. Although non-binding, failure to respond to a shareholder proposal that receives 50 percent or more of votes cast may result in votes against directors in the following year. First steps toward addressing shareholder concerns related to environmental risks include understanding their investment philosophies and voting policies; knowing who is responsible for key voting decisions; and becoming familiar with shareholders’ history of activism with other target companies.

Greater Support for CSR-Related Proposals
Shareholder proposals are important because they shape the corporate landscape and often frame conversations that take place in corporate boardrooms. Resolutions linked to corporate social responsibility (CSR) historically have been skewed toward social issues. But now, environmental sustainability has become the fastest-growing and most prominent issue, as more institutional investors begin questioning the potential financial impact of CSR issues on their investee companies.

A 2010 survey conducted by ISS, a proxy advisory firm, shows that 83 percent of investors now believe environmental and social factors can have a significant impact on shareholder value over the long term. This belief is clearly visible in the rising level of support for shareholder proposals requesting action related to social and environmental issues.

Additionally, according to our research, the average voting support for CSR-related shareholder proposals rose from 7.5 percent in 2000 to 18.4 percent in 2010, and data for 2011 shows that to date, average voting support on these issues has further increased to 21.4 percent.

Broader support means that proponents gain more traction with investee companies and put greater pressure on their boards. This is especially true if the proposals reach critical thresholds. For example, many boards take note once support levels reach the 30 percent mark. In 2005, only 2.6 percent of all shareholder resolutions related to social/environmental issues received average support of more than 30 percent of votes cast, according to our research. Last year, more than one-quarter of proposals reached the critical 30 percent support threshold, and so far in 2011, the figure has grown to nearly a third.

Regulatory changes are also driving broader support for resolutions linked to environmental risks. In late 2009, the SEC began to allow shareholder proposals to include the phrase “financial risk” in discussing environmental and other issues. In February 2010, the agency issued guidance reminding companies of their responsibility to disclose their material risks related to climate change.

Support From Mutual Funds Grows
A clear example of the growing support for environmentally related proposals comes from the mutual fund industry. According to an analysis by Ceres, a coalition of environmentally oriented investors, average support by mutual funds for climate change-related resolutions grew from 14 percent in 2004 to 27 percent in the 2009 proxy season, and the percentage of abstentions increased as well. In the same period, opposition to those resolutions fell from 76 percent to 55 percent, reflecting a sharp departure from traditional voting policies. The Ceres analysis evaluates proxy votes on climate change-related proposals by 46 mutual fund companies with more than $5 trillion in total assets under management.

Director Expertise, Compensation Targeted
A growing number of shareholder proposals are linking social and environmental matters to traditional governance issues such as compensation and the qualifications of board members. For example, some resolutions advocate tying performance metrics used for determining executive compensation to environmental goals. Others seek to ensure that board members have the environmental expertise needed to deal with sustainability and other environmental issues.

For example, at a 2010 annual meeting for a large oil and gas company shareholders filed a proposal requesting that the company have at least one board member with expertise in environmental matters relevant to hydrocarbon exploration, and that the business and environmental communities recognize the board member as an authority on environmental matters. This proposal received support from 27 percent of the votes cast. A similar initiative last year at a large mining and metals company was supported by 34 percent of votes cast. This year, shareholders of a major energy company asked the company to spell out how it planned to strengthen its risk management function to better prepare for environmentally related incidents, and how it would move to a low-carbon economy.

Corporate responsibility resolutions receiving highest levels of voting support to date include those requesting:

  • A sustainability report disclosing the company’s environmental, social and governance performance, including a discussion on water risk and greenhouse gas reduction targets and goals (92.8 percent of votes cast)
  • A report on the company’s risk management efforts related to coal combustion waste (52.7 percent)
  • A report on the board’s oversight of process safety management and related operational safety efforts (54.3 percent)
  • Disclosure of the company’s policies and procedures for making political contributions and expenditures, directly and indirectly, with corporate funds (53.3 percent)
  • An amendment of the company’s EEO policy to explicitly prohibit discrimination based on sexual orientation and gender identity (61.7 percent)

The specific proposal requesting a corporate sustainability report received a dramatic and historically unprecedented level of support in part because a similar proposal at that company’s 2010 meeting had received 60.3 percent of votes cast and shareholders appeared to be dissatisfied with the company’s response. Another factor in raising the 2011 support is that, in an unusual step, management recommended that shareholders vote in support of the shareholder proposal.

Actions to Take
Risks related to sustainability, including climate change risk and other environmental issues, matter a great deal to shareholders. Yet many corporate directors lack a deeper understanding of these issues. Board members, as a result, would greatly benefit from formulating a strategy for anticipating shareholders’ future concerns. At a minimum, companies and their boards must be prepared to do the following:

  • Enhance dialogue with shareholders and improve disclosure in key areas, particularly those related to social and environmental issues. Robust sustainability reporting can help with this.
  • Ensure that directors’ skills are relevant to the chief areas of stakeholder concern, including risk management tied to social and environmental matters. In particular, companies must communicate with shareholders. They could, for example, take advantage of the SEC disclosure rules around director qualifications to explain how the qualifications, backgrounds and skill sets of their directors—both individually and as a group—contribute to overall corporate strategy, including risk mitigation.
  • Consider whether using non-traditional performance metrics—including those related to environmental/sustainability issues—could help align compensation with risk. In addition to financial metrics, performance goals could align with overall environmental strategy, including clearly defined metrics relating to energy efficiency, water usage and the reduction of carbon emissions.
  • Shareholders are paying closer attention to environmental and social matters, believing them to bear closely upon the risk to which investee companies are exposed and, ultimately, upon the financial performance of those companies. The 2011 proxy season reflects this deepening trend. Driven by concerns about the financial and reputational risks associated with climate change, institutional investors will likely push harder for action on these matters. Forward-thinking companies will be prepared to address their concerns.

Takeaway: Leading Practices in CSR Governance

Shareholder pressure and increasing legislative and regulatory requirements are driving boards to take a more active role in managing corporate strategy and engaging stakeholders. Here are some steps your organization may want to consider taking to improve its CSR-related governance:

  • Board. Make sure your board has a standing agenda item to review emerging environmental and social issues, opportunities and risks.
  • Board committee. Install a dedicated board sub-committee to oversee the company’s management of environmental and social issues, opportunities and risks.
  • Committee composition. Ensure that relevant committees are composed of executive and non-executive directors with the expertise to assess the organization’s progress in environmental matters.
  • Materiality. Apply a systematic process to determine which environmental and social issues are most relevant to the organization.
  • Accountability. Hold individual leaders accountable for environmental performance, and schedule regular presentations to the appropriate committees to document progress.
  • Reporting. Establish clear frameworks for reporting on the issues most material to the organization. Regularly publishing a sustainability report is one of the best ways to do this. Relevant board committees should sign off on all sustainability reports.
  • Assurance. Obtain both internal and external assurance of all reports to gain independent insights on emerging risks and progress, and to be confident that disclosures are accurate.

Steve Starbuck is Americas Leader and Ann Brockett is Americas Assurance Leader for Climate Change and Sustainability Services at Ernst & Young LLP.

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