ESG Assignment Part 2

Shareholder Activism
Paresh Shrivastava
11/5/2017
Question 2:

ESG and shareholder activism Shareholder activism as a means for change in the ESG sphere
has increased in momentum across the financial sector & across civil society (the rise of
populous politics), with one news agency quoting a 170 percent increase in campaigns in Britain
since 2011. Discuss (based on secondary research):

a. How is it a means of change in public companies?

b. What are the agendas being pushed by the activist investors across each E, S and G
parameters?

c. What are the pros and cons of such activism?

Ans a.

Shareholder activism "is the way in which shareholders can assert their power as owners of the company to influence its
behaviour" (European Corporate Governance Institute). Activism covers a broad range of actions, most notably the act of
proxy voting and shareholder resolutions. Scientific research into shareholder activism finds that it can be an effective way
to prompt change in company behaviour, concluding that most often these changes occur in company structure, rather than
in share values and earnings.

While shareholder activism gained traction in the late 1990s among institutional investors, it has become increasingly
mainstream with the rise of sustainable investing. Defined as "an investment approach that considers environmental, social,
and governance (ESG) factors in the selection and management of investments" (Weinstein), sustainable investing has an
estimated $8.72 trillion in professionally managed assets worldwide and is expected to continue growing (US SIF, 2016).

In 2013, nearly 40% of all shareholder proposals submitted to Russell 3000 companies related to ESG issues, representing a
60% increase since 2003 (Proxy Voting Analytics, 2014). From 2014 to 2016, 176 institutional investors and 49 investment
management firms with total assets of $2.56 trillion filed or co-filed resolutions (US SIF, 2016). Research completed by
Harvard Business School professors in 2016 finds "anecdotal evidence and industry practitioners suggest that ESG proposals
have been important catalysts of action inside companies and succeed in persuading management to adopt some or all of the
requested changes, regardless of the success of the proxy vote (Shareholder Activism on Sustainability Issues, Yoon, 2016).

Activism in the area of ESG issues has not been driven traditionally by an assessment of materiality. Activism has primarily
been driven by an approach where investors choose one topic, such as climate change or diversity, and then engage with a
wide range of companies across industries (i.e. campaign) based on financial holdings, performance on the focal issue by the
target companies, and/or the size of the target companies (Blackrock and Ceres, 2015). For example, an investor could target
many large companies with poor performance on diversity issues, as part of the diversity campaign. Therefore, because a
given issue can be immaterial for one industry and material for another, one would expect that some of the proposals will be
submitted on material and some on immaterial issues, where the exact percentage falling in either category being ex ante
unclear. However, the financial materiality of different sustainability issues likely varies systematically across firms and
industries (Eccles and Serafeim, 2013). According to Harvard study 58 percent of the shareholder proposals are filed on
immaterial issues and that these proposals are accompanied by larger and faster increases in firms’ performance on the ESG
issue that the proposal identifies, relative to proposals on material issues. The high percentage of proposals on immaterial
issues might not be surprising given the pro-social objectives of a large number of sponsors of such proposals. Overall, we
observe that filing shareholder proposals is effective at improving the performance of the company on the focal ESG issue
across both material and immaterial issues. Thus, even though such proposals have rarely received majority support, they
have still had an effect on corporate management.
Another finding was that subsequent to filing ESG shareholder proposals, targeted firms experience changes in Tobin’s Q.
Proposals on immaterial issues are associated with subsequent declines in Tobin’s Q. In contrast, proposals on material
issues are associated with subsequent increases in Tobin’s Q. This suggests that pressure on companies to address ESG
issues that are not financially material for the firm but are relevant to other stakeholders could lead to decreases in financial
value, while the opposite is true for proposals on material issues. Policy experts, including former Securities and Exchange
Commissioner Troy Paredes and director of the Manhattan Institute's Center for Legal Policy Jim Copland, have argued that
environmental and social issues divert the attention of senior management and directors away from more important work
thereby destroying value.

One question that remain unanswered is why managers would improve performance on immaterial issues if doing so is
associated with decreased financial value. There are various explanations as to why managers seemingly respond to
proposals on immaterial issues. One is evidence of agency problems, the inability to differentiate between material and
immaterial sustainability issues, and an attempt to divert attention away from poor performance on material issues, as
explaining this response.

More recent research provides some evidence that investor activism on ESG issues affects corporate behavior and/or
shareholder value. One study found that shareholder proposals on ESG reporting issues lead to increases in transparency on
ESG issues and the practice of more integrated reporting.(Serafeim, 2015). Another study analyzed 2,152 engagements from
a large asset manager and found that 382 of them were designated as successful (i.e. achieving the objective of the
engagement) by the asset manager (Dimson, Karakas and Li, 2015). For the subset of successful engagements, the authors
found significant increases in stock price and operating performance, consistent with such engagements improving the
financial performance of the company. Another recent study examined a small number of ESG proposals that received
majority support, which represented less than one percent of all proposals, and compared the stock price reactions around the
passage of the proposals with those of proposals that failed by a small margin to receive majority support (Flammer, 2015).
The stock returns were significantly positive for close call passage proposals and the study concluded that these ESG
proposals were value enhancing.

Shareholder stewardship in general and ESG Engagement specifically is therefore an integral part of the investor toolbox for
managing risk, advancing ethical values or international norms, and contributing to more sustainable companies. It is a long-
term process, which requires a structured approach and patience. It can also be resource intensive, which is why few
investors engage with all their companies but rather choose to focus on where the activity can have the most impact. The key
takeaways for public companies with this activism are:

 Investors can best achieve positive results from ESG Engagement through constructive, strategic and targeted
engagement based on sound business analysis;
 Policy makers can use a smart combination of legislation and initiatives to reduce barriers and costs to
engagement, improve transparency by companies and investors and therefore better achieve some of their overall
policy goals;
 Companies can build a constructive relationship with investors by enabling dialogue at board and management
level, and by improving disclosure of material ESG information.
 Standard-setting: The Global Real Estate Sustainability Benchmark (GRESB) has shown how investors can jointly
drive change across an entire industry. Setting a global sustainability standard has created comparability desirable
for other sectors, too.
  Public policy engagement: As discussions over long-term investing, climate change, integrated reporting and the
future of pensions and financial markets at large evolve, investors will need to find increasingly meaningful ways
to engage with public policy.
 Investors will have the opportunity to cash in the opportunities in the ESG aspects like opportunities in cleantech
etc.
 Investors will be more or less directly responsible for the environment and society.

Ans b.

Agendas being pushed by various ESG activist are :

Environmental Issues •

 Impacts on ecosystem/landscapes, such as contamination of groundwater, forests, rivers, or seas, deforestation, or

impacts on wildlife.
 Global pollution and climate change, which includes atmospheric pollution and criticism related to climate change,
carbon, and other greenhouse gas emissions.
 Local pollution, which is pollution into local air, water, and soil.
 Overuse and wasting of resources, which includes inefficient use or waste of renewable or non-renewable
resources, such as water, energy, or commodities.
 Waste issues, such as inappropriate disposal or handling of waste.
 Animal mistreatment, which includes torture, mistreatment or abuse of animals, through experiments, husbandry,
or trophy hunting.

Social Issues •

 Impacts on communities, such as land or water-grabbing, negative impacts on a community’s livelihood or

employment opportunities, relocation of communities, safety impacts, or access to lifesaving drugs.
 Human rights abuses and corporate complicity, such as violence against humans, human trafficking, organ
trafficking, privatization of water sources, supporting oppressive regimes, or supporting terrorist organizations.
 Local participation issue, which arises when local communities or individuals are not consulted about the firm’s
activities or when they do not benefit appropriately, and when critics are silenced by unethical tactics.
 Social discrimination, which refers to treating people differently because of certain characteristics, such as gender,
racial, ethnic, or religious.
 Child labor, which also includes child prostitution, pornography, and trafficking.
 Forced labor, such as bonded labor, prison labor, exploitative practices, restrictions on freedom of movement, or
withholding of wages.
 Occupational health and safety issues, such as lack of safety for employees at work or negligence resulting in
work-related accidents.
 Poor employment conditions, such as “slave-like” working conditions, issues to labor contracts or pay, or spying
on employees.
 Freedom of association and collective bargaining, which refers to violations of workers’ rights to organize and
collectively bargain.
 Discrimination in employment, which is social discrimination against employees.

Governance Issues •

 Corruption, bribery, extortion and money laundering, which includes slush funds, aggressive lobbying, and
overcharging nepotism.
 Fraud, which are intentional deceptions made for personal gain or damage to another individual, including
counterfeiting, false advertising, misleading investors, or stock price manipulations.
 Tax evasion, such as not paying taxes by illegal means, but also the use of tax havens.
 Tax optimization, which are non-illegal practices of minimizing tax liability.
 Anti-competitive practices, which are practices that prevent, reduce, or manipulate competition in markets, such as
bid-rigging, dumping, exclusive dealing, or price fixing.
 Executive compensation issues, such as excessive salaries or bonuses.
 Misleading communication, such as “greenwashing”, false advertising, off-label marketing, or “astroturfing”.

Supplementary Issues •

 Products and services issues resulting in health or environmental damage, such as toxic or dangerous products,
contaminated food, and medical treatments with unintended health consequences.
  Controversial products and services, which refers to the sale of products or services that provoke strong
disagreement or disapproval (e. g. alcohol, weapons, gambling).
 Supply chain issues, which refers to problems at suppliers, vendors, or subcontractors.
 Violation of international standards, set by international governmental organizations or treaties with a global
nature and international customary law.
 Violation of national legislation, which refers to the violation of national and state legislation related to
environmental, social, and governance issues.

ESG activists wants that risk associated with ESG factor should be factored in the stock price of the company because
such risk is a substantial risk which can lead to stranded assets and shareholders wants to price this risk and want to get
rewarded for longing this risk.

MSCI 37 Key ESG Issues

Ans c.

Pros Cons

Shareholders will be able to price ESG risk and will get This can further lead to severe agency problem where
rewarded for longing this risk. managers trying to gain short term gain in performance by
addressing unmaterialistic ESG issues.

ESG activism will remove the reluctant attitude of firms Activists can target firm with good brand reputations on
while carrying out CSR activity. There will be a paradigm ESG issues and can try dissolve the brand image for his
shift from a mere obligation to a responsible behaviour ulterior motive of earning good short term profit by shorting
the firm.

Shareholders will be directly responsible for the any actions Too much focus on ESG activism can divert the company’s
of environmental or societal degradation caused by the focus from core operational issues which can destroy
companies. They can attempt to prevent it beforehand. shareholder value.
 Shareholder activism can lead to increased cost of capital for
the companies since debt holders will not be willing to lend
It will lead to a sustainable future with both the companies at low cost assuming the risk associated with shareholder
and shareholders reaping long term profits. activism.