Environmental and Social Issues Gain Investor Interest, According to ISS Report

Posted on May 5, 2011 in Financial Communications, IR Therefore I Am | 0 comments

“Engagement is expanding beyond financial and strategic issues and ‘traditional’ governance topics to include more environmental and social issues,” according to a recent report issued by Institutional Shareholders Services (ISS) on the engagement between investors and public corporations in the US.  Entitled, The State of Engagement between US Corporations and Shareholders, the report was based on a survey of 355 issuers of stock and 161 investors.

It noted that the past several years have witnessed a significant increase in the frequency and scope of engagement between investors and issuers. Previously, “routine” communication generally referred to quarterly discussions about earnings and corporate strategy which occurred in company‐designed forums such as conference calls and analyst meetings. Today, for many investors and issuers, it has become a year‐round exercise involving dialogue on topics such as executive compensation, board‐ room independence, and sustainability which take place in a variety of media, from conference calls and meetings to e-mails, public announcements, telephone calls and regulatory filings.

According to the ISS study, the growing tendency of issuers and investors to engage has been fueled by a number of developments. Investors, burned by scandals at companies such as Enron and WorldCom and more recently by the collapse of major financial services firms, are more sensitive to risks at their portfolio companies and less willing simply to trust boards to oversee management and leave it at that. Investors are demanding higher levels of independence and accountability in the boardroom, and remuneration programs that better align the interests of executives with those of shareholders. Shareholder proposals calling for greater accountability, such as those seeking annually‐elected boards and majority voting standards in director elections, typically receive strong levels of support from institutional investors, and now receive majority support on average, even counting the votes of retail investors. Directors who are perceived to act in a manner contrary to shareholders’ best interests can expect to receive higher levels of opposition at the ballot box. Issuers, keenly aware of these trends, have greater incentives to engage proactively with investors.

A more investor‐friendly regulatory environment has also fueled increasing levels of engagement, the ISS report notes. Enhanced disclosure requirements have provided shareholders with greater visibility into company financials, potential conflicts of interest involving officers and directors, and compensation practices. This has facilitated peer comparisons and prompted shareholders to pursue additional information where they have questions or to push for change when they view the status quo to be unacceptable. Additionally, the Wall Street Reform and Consumer Protection Act, more commonly known as Dodd‐Frank, has directed the Securities and Exchange Commission to require public companies to allow shareholders a non‐binding vote on executive compensation (extending a mandate already applicable to companies participating in the U.S. Treasury’s Troubled Asset Relief Program ). Out of more than 700 “say on pay” votes through mid‐February 2011, five U.S. issuers failed to receive majority support for such resolutions, resulting at the very least in unwanted publicity. Experience in other markets that have “say on pay” votes, such as the U.K. and Australia, suggests that issuers likely will reach out to shareholders to discuss their compensation practices prior to such votes rather than face the embarrassment of significant shareholder opposition. Lastly, the New York Stock Exchange’s amendment of Rule 452 to prohibit discretionary broker voting in uncontested director elections ended a practice that likely helped to inflate support for management nominees.  This change has had the effect of making shareholder votes more consequential.

The ISS study notes that issuers, too, are realizing the benefits of engaging with shareholders. Those who keep a finger on the pulse of shareholders can identify potential concerns early and address them before they reach a boiling point, thereby minimizing the prospect of contentious activity. When confronted with a contentious situation, an informed issuer can frame the debate and reach its investor base more effectively. Further, issuers that work constructively with investors can build trust and goodwill and gain advocates in the investor community. Finally, investors have different points of view about issues facing companies; some focus on capital structure, others on sustainability, etc. Some com‐ panies have found that listening to those points of view occasionally serves as an early warning system for corporate managements.

Highlights of the study include:

  • The level of engagement between issuers and investors is high. Approximately 87% of issuers, 70% of asset managers and 62% of asset owners reported at least one engagement in the past year.
  • The level of engagement is increasing. 53 percent of asset owners, 64 percent of asset man‐ agers, and 50 percent of issuers said they are engaging more. Virtually none of the investors and only 6 percent of issuers responded that engagement is decreasing.
  • Amongst investors, engagement is either a priority or a non‐event. A biomodal (or“barbell”) distribution was evident, with 28% of asset owners and 34% of asset managers reporting engagements with more than 10 companies. On the other hand, about 45% of asset owners and 43% of asset managers indicated they did not initiate any engagement activity whatsoever.
  • Despite the headlines that result from high‐profile conflicts between issuers and investors, the vast majority of engagements between issuers and investors are never made public.  About 80% of issuers said most engagements remain private, as did 72% of asset owners and 62% of asset managers.
  • Asset owners, asset investors, and issuers do not always agree on what constitutes “successful” engagement.  While all three groups believed constructive dialogue on a specific issue was a success, issuers were materially more likely than investors to think that establishment of a contentious dialogue was a success.  An even more dramatic difference was that about three quarters of both asset managers and asset owners defined either additional corporate disclosures and / or changes in policies as a “success” while only about a third of issuers agreed.
  • Engagement is most likely to lead to concrete change by issuers in areas where shareholders are broadly in agreement, such as declassification of the board of directors or the elimination of poor pay practices, than in areas where shareholders’ views diverge, such as the need for an independent board chair.