Jane Jagd, Center for ESG Research: Bank of America— ESG risk is best signal for future risk, July 2017

Jane Jagd

What if we told you how to avoid stocks that go bankrupt?

We think you would listen. Environmental, Social & Governance (ESG) factors are too critical to ignore, in our view. In our earlier report ESG: good companies can make good stocks, we found that ESG-based investing would have offered long-term equity investors substantial benefits in mitigating price risk, earnings risk and even existential risk for US stocks — ESG would have helped investors avoid 90% of bankruptcies in the time frame we examined. Our findings were encouraging enough to warrant a closer look. We here assess how US corporations, regulators and investors are positioned for ESG, and how the market is responding.

ESG is the best signal we have found for future risk

Prior to our work on ESG, we found scant evidence of fundamental measures reliably predicting earnings quality. If anything, high quality stocks based on measures like Return on Equity (ROE) or earnings stability tended to deteriorate in quality, and low quality stocks tended to improve just on the principle of mean reversion. But ESG appears to isolate non-fundamental attributes that have real earnings impact: these attributes have been a better signal of future earnings volatility than any other measure we have found.

US corporates may be behind the curve . . .

Despite empirical evidence of its efficacy, ESG is not drawing much enthusiasm from US corporates. Among companies participating in our survey at our March 2017 BofAML US Investor Relations conference, almost half of the survey respondents indicated they have no resources dedicated to ESG initiatives, and no intentions of implementation. Globally, the theme is burgeoning: ESG-related regulations have doubled since 2015; over 6,000 EU member state companies will be required to publish disclosures; and 12 global stock exchanges require written ESG guidance – but not one is in the US!

. . . but investors are ahead of it & PE multiples are responding

In our May survey of BofAML institutional clients, 20% cited using ESG, well above the estimated 5% of float that corporations believe is held by ESG-oriented investors. In another investor survey, 66% raised issues on sustainability disclosures, and 85% called for improved disclosure in filings. And the investment industry is changing to accommodate governance: for the first time ever, FTSE Russell ruled out the addition of zero voting rights stocks, citing “concerns raised by shareholders.” The market is listening: shareholder-friendly companies have seen significant multiple expansion — and we see strong signs that this re-rating continues.

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James McRitchie, Corpgov.net: Historic Context for Retail Investor Rights, 2018

James McRitchie, Editor, CorpGov.net

While at one time, ownership of a single share of stock came with the right to submit a proposal without restriction as to number or subject, in 1983 the SEC decided it made sense to impose a modest but low submission requirement, setting the threshold at $1,000 held for at least one year. The SEC raised this to $2,000 in 1998, “to adjust for inflation” but did not raise it higher “in light of rule 14a-8’s goal of providing an avenue of communication for small investors.” (File No. S7-25-97)

A study of 286 shareholder proposals submitted between 1944 and 1951 found that 137 or 47% were submitted by the Gilbert brothers. (The SEC Proxy Proposal Rule: The Corporate Gadfly, p. 830 av) The fact that three families submit a disproportionately high number of proposals is not historically unusual.

Without early ‘gadflies’ like the Gilberts and Wilma Soss, shareholders would not have the right to file proposals, vote on auditors, or have executive pay disclosed and there would be even fewer women directors.

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Pax World Fund: Sustainalytics — Understanding ESG Incidents: Key Lessons for Investors, December 2017

Sustainalytics conducted a quantitative analysis of their incident dataset, reviewing 29,000 company activities around the world that generated undesirable social or environmental effects. They found that incidents are increasing, some industries are more exposed than others, and some regions are more exposed as well. These activities can impact company share price, so asset managers and owners can benefit from applying incidents analysis in their portfolios.

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Pax World Fund: ING— From Sustainability to Business Value, February 2018

ING interviewed 210 finance executives in US-based large-cap and mid-cap companies about the importance of sustainability to corporate strategies. They found that over 80% of firms are embedding sustainable thinking into their business growth plans and that nearly half reported that sustainability concerns actively influence their growth strategies. The firms with the most robust sustainability strategies tend to have had better revenue, borrowing and credit-ratings outcomes. 

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New York City Pension Funds Promote Boardroom Accountability

Michael Garland, Assistant Comptroller for Corporate Governance and Responsible Investment in the Office of New York City Comptroller Scott Stringer

With an average retirement benefit of $38,000 per year, it is likely that many of our members only participate in the capital markets through their role as pension fund beneficiaries. Our members are true Main Street investors, as opposed to a group using that name that represents the interests of company managers. We are long-term share owners of approximately 10,000 public companies around the world, including more than 3,000 U.S. companies.

A particularly good example of market change from shareowner proposals relates to “proxy access” — that is, a mechanism to permit shareowners to include their nominees on the company proxy card for a minority of board seats under certain circumstances. In 2014, Comptroller Stringer and the NYC Funds launched the Boardroom Accountability Project, a campaign to implement proxy access on a company-by-company basis in the U.S. market using shareowner proposals.

Today, largely as a result of the Boardroom Accountability Project, approximately 540 U.S. companies, including 70 percent of S&P 500 companies, have enacted proxy access bylaws with terms similar to those in the vacated SEC rule, up from only six companies in 2014 when we launched the project. In July 2015, economic researchers at the SEC released a study that analyzed the public launch of the Boardroom Accountability Project and found a 0.5 percent increase in shareowner value at the first 75 firms that received proxy access shareowner proposals from the NYC Funds. The SEC staff’s findings were consistent with a 2014 CFA Institute study that found that proxy access on a market-wide basis has the potential to raise U.S. market capitalization by as much as 1 percent, or $140 billion.

Investors Persuade Midwest Utilities To Address Climate Change

Seventh Generation Interfaith Coalition for Responsible Investment

Seventh Generation Interfaith (SGI) is a coalition of 40 faith-based and values-driven institutional investors located in the Mid-Western United States. Shareholder proposals have had a major impact on midwestern utility companies. Proposals submitted to the WEC Energy Group and CMS Energy Corporation asked  each to publish an assessment of the long term impacts on the company’s portfolio of public policies and technological advances consistent with limiting global warming to no more than two degrees Celsius over pre-industrial levels.   The proposals were withdrawn upon company commitments and subsequent publishing of scenario analyses, and leading to aggressive GHG reduction goals.  (See CMS Energy Climate Assessment Report;  WEC Pathway to a Cleaner Energy Future).  Engagement with Xcel Energy preceded a groundbreaking announcement of the company’s commitment to zero-carbon electricity by 2050 and  publishing of their Carbon Report (Xcel Energy Building a Carbon-free Future). A proposal at MGE Energy, subsequently withdrawn, also led to their announced commitment to net-zero carbon electricity (Wisconsin State Journal, May 14, 2019). 

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Beverage Container Recycling Boosted By Shareholder Engagement

As You Sow, an investor advocacy organization, began engaging bottled beverage companies 15 years ago to encourage them to improve their bottle/can recycling rates. After dialogue and the filing of proposals for several years, Coca-Cola agreed to recycle 50% of its PET, glass bottles, and aluminum cans by 2015; PepsiCo agreed to an industry recycling goal for 50% of PET, glass bottles and cans by 2018; and Nestle Waters NA agreed to an industry recycling goal of 60% of PET bottles by 2018. If these companies meet their 2018 goals, it will mean about 20 billion bottles and cans avoiding the landfill and instead providing valuable materials to bottling companies for recycled content in new bottles and cans.

Mark Preisinger, Director for Shareowner Affairs, Coca-Cola, told As You Sow: “I do believe [shareholders’ proposals] helped us get to where we are on the recycled content issue. The dialogue that we undertake with shareholders clearly helps advance agendas like this one inside our company.”

Further, what started out as an adversarial dialogue with Nestle Waters developed a couple of years later into a joint effort by As You Sow and Nestle Waters to convince other large brands to take financial responsibility for the collection and recycling of post-consumer bottles. This led to the development of a $100 million Closed Loop Fund by Walmart, along with Coke, Pepsi, Procter & Gamble and several other brands, to help fund improvements to U.S. recycling infrastructure, which will increase materials recycled.

Shareholder Proposals at Monsanto Were Warning of Troubles Ahead for Bayer's Acquisition

In 2016, shareholder John Harrington, the president of Harrington Investments Inc., filed a proposal at Monsanto regarding health risks from the company’s flagship weedkiller Roundup. The proposal noted “an increasing number of independent studies assessing the toxicity of glyphosate, the active ingredient in Roundup, associate it with cancer, birth defects, kidney disease, and hormone disruption, causing world-wide concern about its safety”. The proposal requested a report assessing the effectiveness and risks associated with the company’s policy responses … to the impact of recent reclassification of glyphosate as “probably carcinogenic,” and quantifying potential material, financial risks or operational impacts on the Company in the event that proposed bans and restrictions are enacted.

On its 2016 vote, the proposal received 5.3% voting support. Refiled in 2017, it still only received 5.5% support. Yet, this relatively small group of shareholders proved to be prescient in identifying a material issue.

Only two months after Monsanto was acquired by the German pharmaceutical company Bayer in June 2018, a jury granted a $289 million award in a suit alleging public health threats and cancer of a plaintiff caused by Roundup. This news sliced billions of dollars from Bayer’s valuation. Bayer’s market capitalization has descended steeply in the following months, from $99.1 billion as of August 10, 2018 (the date of the jury verdict), to $64.8 billion as of November 20, 2018 and after losing another jury verdict, $56.2 billion by May 24, 2019.

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Linking Executive Compensation to Diversity and Inclusion

Pat Miguel Tomaino, Director of Socially Responsible Investing, Zevin Asset Management

The structure of executive pay often causes companies to cut corners, take unwarranted risks, and ignore pressing environmental and social challenges. Exorbitant and unfocused pay packages created perverse incentives that reduced oversight at Wells Fargo, leading to the bank’s fake accounts controversy. After the Volkswagen diesel emissions scandal and BP’s Gulf of Mexico explosion, experts and advocates have pressed to “claw back” misbegotten CEO paychecks — without much success.

Responsible investors can help shape incentives toward positive outcomes even as we examine the deeper problem in executive compensation. To this end, Zevin Asset Management has urged dozens of companies to link senior executive payouts to social and environmental risk metrics and performance goals. Late last year, Citrix responded to our proposal, agreeing to spell out how diversity and inclusion factors influence annual CEO performance evaluations.

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Bruce Herbert of Investor Voice Presents Proposal at Starbucks Annual Meeting

The Harrington Investments proposal at Starbucks would embed sustainability in the Company’s corporate governance documents. Bruce Herbert of Investor Voice moved the proposal at the Company’s annual meeting.