What You Don’t Say on E&S Can and Will Be Used Against You: How Economic Activists Are Gaining a Boost from ESG

Written By Elizabeth Saunders, Partner & Victoria Sivrais, Partner

December 8, 2022

You only need to be half listening to catch the chatter about environmental and social proposals playing a more important role during the coming proxy season. But the reality is, less than 50 of these proposals saw the light of day in 2022. Very few companies will ever have to battle a real environmental or social proposal during the annual meeting season, even companies with E&S policies that are not as robust as they could or should be.

But before you gain a false sense of confidence, consider this: economic activists are learning how to play the E&S card. They can and will leverage it to generate attention and support from passive institutions and other ESG-oriented institutions when their primary campaign arguments don’t do the trick. E&S “add-ons” may very well give them the edge they need to win over the electorate for a successful proxy contest.

Beware of governance battles cloaked in environmental terms.

The Engine #1 proxy fight is a text-book example. While the investment startup was successful in ousting three of ExxonMobil’s Board members and replacing them with more climate-savvy candidates, the campaign was in large part motivated by the activist investor’s frustration with an entrenched Board, poor shareholder returns, and a lack of portfolio pruning leaving the company exposed to volatile energy prices. Fast forward less than two years, and the biggest headlines from the company are increased discipline in planning and strategy, a reduction in capex, a strengthened balance sheet, and a portfolio in the middle of pruning. Sounds a lot like traditional activism campaign results to us.

Smart activists have learned the lesson. They are well aware that the largest passive institutions (think BlackRock, State Street and Vanguard) do not historically rubber stamp activist campaigns that are, in the end, always about unlocking corporate value for shareholders through the means the activists see fit. Indeed, more times than not, the passive firms do not support these campaigns and instead advocate for a less public, and less disruptive, outcome.

However, these very same institutions have made strong public commitments to certain ESG issues and, accordingly, are increasingly focused on corporate hygiene. As a result, every single proxy season, activists find even more ways than in previous years to promote ESG themes and make demands for ESG reforms in their proxy fights and other campaigns for corporate control. It’s much more difficult for the passives to ignore these arguments. The most accomplished activists are getting much better at using them to punctuate their cases to unlock value and ultimately win over shareholders.

The deck is increasingly stacked in activists’ favor.

Before considering a full-blown campaign, the most successful activists are fairly confident that they can gain the support of a company’s shareholder base to further their agendas. In several ways, this is becoming increasingly easier for them to do.

First, activists know exactly where the Achilles’ heel is. They have figured out that passive intuitions are much more amenable to supporting activist causes if they are frustrated with a company’s lack of engagement on ESG issues. And they know which ESG issues are the most sensitive and most likely to be points of contention.

According to our data on top shareholder engagement topics and ESG stewardship statements, key weak spots where activists can gain leverage include:  

  • No oversight of E and S in Board Committee charters.
  • Failure to address climate change. Specifically, failure to meet BlacRrock’s request for disclosure of how long-term strategy will be impacted by the decarbonization of the economy, assuming regulation of the Paris Agreement.
  • Lack of Diversity, Equity, and Inclusion (DEI) statements and commitments including at the board level.
  • Lack of discussion of employee engagement and disclosure of employees’ diversity profile.
  • No statement of natural resources management approach, including biodiversity, waste, water usage statistics, and commitments to protect or reduce resources.

Second, the new universal proxy rule allows activist investors to nominate individual directors to the board and allows voters to vote for individual directors as opposed to being constrained by a set of directors on one of two slates. This significantly increases the chance of an activist’s nominee winning an election.

4 ways to increase your shareholder activism defenses.

Companies that want to avoid giving activists more fuel for their fights (and, ultimately, more board seats) need to stay on top of the E&S policies that matter to their shareholders, even if they do not anticipate an environmental or social proposal. As is typically the case, a good offense is always the best defense. As a starting point, companies can:

  1. Eliminate the “red meat.” None of the issues noted above are an open-and-shut case for activists. But they do provide an easy in. Activists will also quickly sniff out companies that are holding on to the most heavily litigated governance policies such as classified boards, the right to call special meetings, or a majority vote for direction election. Start with eliminating your obvious vulnerabilities so as not to give activists an easy foothold. 
  2. Increase shareholder engagement in the offseason. Make this a priority every year, paying special attention to the most sensitive issues as well as any shareholders who didn’t support you in the past as these voters may be the most receptive to activists’ messages. If shareholders will not take a meeting, you can still be proactive by sharing a deck of ESG accomplishments and commitments on the most sensitive topics.
  3. Show responsiveness to proposals. Failure on non-binding or advisory votes (or narrow wins for issues or directors) are a sure sign of mounting shareholder dissatisfaction and frustration. A failed say on pay proposal, for example, should not be ignored, nor should a high level of opposition to a specific board member. Any proposal or director that squeaked through with a thin margin should be proactively addressed with an appropriate response, including commitment to make future changes, to demonstrate you are hearing shareholders’ concerns and taking them into consideration.
  4. Disclose an ESG roadmap now. One of the most damaging messages you can send to your shareholders is that you are waiting for regulations to pass before starting your ESG journey. Even if your organization has not published sustainability information in the past, it is time to share your plans to do so moving forward, especially on any E and S issues with financial relevance. Communicating your intentions and your timeframe now, before an activist points out any gaps or shortcoming in your policies, is a great way to take charge of the dialogue and keep your shareholders listening to you as opposed to the activists.

Make sure you own the conversation on E&S.

If you go by the numbers, chances are you won’t get an E or S proposal this proxy season. But that doesn’t mean an activist won’t use your lax environmental and social policies to bolster their arguments in other areas and gain the ear of your major passive shareholders. Don’t give them that chance. Start building your narrative now and get in front of the issues your shareholders care about most. Reach out to our team to help with planning engagements or disclosures. We can activist-proof your stock from every angle.

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