ESG concerns are increasingly impacting shareholder activism, in turn pressuring boards to engage with investors on these subjects. Farient Advisors’ Marc Hodak shares the way these trends will shape investor relations, corporate governance and compliance.
Corporate Compliance Insights: How has the investor ecosystem changed in recent years? What pressures now exist for companies that haven’t previously?
Marc Hodak: Historically, companies needed only to focus on the largest activist investors — those capable of mounting a credible takeover bid and displacing sitting directors. Today, the largest asset managers are also sophisticated in overseeing and shaping the governance of companies in which they are invested. Index funds cannot walk away from problem companies. Retirement plans cannot ignore the long-term impact of those companies on their retirees’ futures. Investors want to ensure that companies are doing the right thing for the long-term viability of the business and the societies in which they operate.
Recent research from Farient Advisors and our partners in the Global Governance and Executive Compensation Group (GECN Group) — a partnership of independent executive compensation firms serving clients in more than 30 countries — recently completed our 2019 Global Trends in Corporate Governance Series. In this year’s issue, our Farient/GECN Group team interviewed more than 25 investors covering four continents. The results of this survey tell us that if companies fail to listen to their investors or do not provide clear disclosures on the “what” and “how” of what they are doing, investors will exclude them from future funds in their portfolios, potentially impacting the marketability of their stock. In today’s corporate ecosystem, investors are escalating concerns quickly, engaging with management and the board and increasingly voting against directors when they feel their voices are not being heard.
CCI: What high-profile issues recur in conversations with investors about environmental, social and governance (ESG) factors?
MH: Our interviews uncovered several high-profile issues, with climate change emerging as the number one “hot” issue around the world. Most investors are members of the Climate Action 100 and committed to holding companies to high standards with regards to carbon reduction, reduced dependency on fossil fuels, water preservation, reversing the proliferation of plastics in our oceans and related environmental topics that could impact the planet and, in varying degrees, the longer-term financial prospects of their portfolio companies.
The second most important issue globally is human capital management. This covers a variety of topics, from diversity on the board and management to succession planning, workforce of the future and related human resource issues that are likely to have a high impact on corporate success. Talent requirements are rapidly shifting. There is a fierce competition, sometimes considered a “war for talent,” for the skill sets that can meet current and future business needs. To date, disclosures around human capital management have not been as detailed as investors would like and trail behind other aspects of ESG reporting. Investors want a better understanding of who is “minding the store” at their portfolio companies.
CCI: When it comes to executive compensation, which issues and areas do investors most often consider?
MH: The main story remains “pay for performance.” The investors we interviewed see that linkage as critical, and the lack of that linkage as potentially signaling more fundamental governance issues. Investors are holding compensation committees accountable for mismatches between pay and performance with an increasing willingness to vote “against” pay plans. And, if they think a company is not responsive to their concerns, they will also vote against the members of the compensation committee.
Investors want clear, simple and transparent pay disclosures. Through the Council of Institutional Investors and others investor associations around the world, investors are starting to push for less complexity in the compensation programs and more disclosure. Investors continue to highlight the level of pay as a concern. They are especially skeptical about variable pay levels when coupled with weak disclosures about how metrics are chosen, how goals are set and how the program works to keep management focused on the longer term.
CCI: How do investors view the role of the board in ensuring good corporate governance?
MH: Investors continue to view independence as key to good governance, which was a key finding of last year’s Global Trends in Corporate Governance report. In most Western countries, listing standards ensure formal independence of a majority of directors, and most companies have only one company executive on the board. But investors are also looking for evidence of true board independence beyond what listing standards might imply. In Asian countries, formal independence is still a work in progress, and the push to increase board independence is partly driven by regulation.
Investors also see diverse perspectives and experience as improving governance. Some countries (and one U.S. state) have instituted quotas for female representation on boards. Beyond that, investors will continue to pressure firms to diversify their boards. The push for diversity includes looking at the leadership of global companies doing business in their respective countries.
CCI: What questions should boards ask themselves about their performance on shareholder engagement?
MH: After talking to several investors, our Farient GECN Group interviews identified seven questions:
- Is your governance house in order? Investors want to know that the right people with the requisite skills are in board seats providing sound oversight.
- Is your board sufficiently proactive? Approach your largest investors before they approach you, especially if you have issues to surface.
- Does your board know its audiences? Understand each of your investor’s particular concerns.
- Does your board understand investors’ engagement strategy? Some funds have governance divisions to contact, while others expect management to interface directly with their portfolio managers.
- Is your board prepared to act? Investors will expect to interact with someone — either from management or the board — who can answer their questions and take their input under advisement.
- Does your board focus on quality (versus quantity)? Voluminous disclosures devoid of substance will create more suspicion than comfort.
- Is your board ready to put it all together in a compelling narrative? Investors seek a clear, well-founded strategy for long-term success, taking into account material issues related to ESG and other areas that impact your company, your industry and the communities in which they are active.
Marc Hodak is a Partner with Farient Advisors, an independent executive compensation and corporate governance consultancy, and an Adjunct Professor of Business Ethics at New York University’s Stern School of Business. Marc is a recognized thought leader in managerial incentives; he has been published in numerous magazines and academic journals and extensively quoted in the national press. Marc is a frequent speaker at conferences throughout the U.S. and Europe on executive compensation, corporate governance and managing for value. He holds an MBA in Finance from the University of Pennsylvania’s Wharton School and a BS in aerospace engineering from the University of Maryland.