Facing activists on ESG
Climate change, diversity and the #MeToo movement are just some of the challenging topics investor relations teams are addressing as the corporate ESG movement gains momentum. With large shareholders pressuring businesses to be more responsible on such issues, IR professionals know they must be prepared to engage on a wider range of sensitive topics.
Now there’s a new wrinkle. Activist investors are starting to adopt tools from the ESG movement to attempt to gain influence on corporate boards. In January, for example, activist fund Jana Partners sent an open letter to Apple’s board asking that the company change its products to be more socially responsible. Joined by CalSTRS, Jana didn’t follow the usual activist strategy of focusing on financial engineering. Instead, Jana and CalSTRS called on Apple to alter its iPhone technology to protect children from device over-exposure. Their unusual request implored Apple to continue its pioneering ways by doing what no other company has done.
Jana isn’t alone. Last year activist fund Trian Partners emphasized the importance of ESG issues for a company’s long-term performance. In February, ISS launched its Environmental & Social QualityScore, which grades the quality of corporate disclosures on these issues. This makes robust disclosure even more important because ISS, which often controls more than 20 percent of shareholder voting, tends to side with activists.
According to Sullivan & Cromwell’s survey of activist campaigns, last year ISS recommended in favor of the activist 45 percent of the time, and in support of issuers only 33 percent of the time. (It split its recommendation for the remaining vote.)
Outside the activist arena, BlackRock CEO Laurence Fink in January announced a ‘new model for corporate governance’ in which companies must show how they’re making a positive contribution to society.
In this new landscape, no company – no matter how admired and profitable – is safe from the attention of large activist investors. By using an ESG platform, activists not only gain additional avenues to launch attacks, but can also distinguish their fund-raising efforts with a message that appeals to many pension funds and other asset managers. It’s no coincidence that Jana recently announced that it’s raising a new sustainability fund.
A company that ignores the ESG movement, or hopes it goes away, will appear out of touch to investors and be vulnerable to an activist campaign. Many IR teams have already developed strategies for discussing ESG issues with shareholders. But planning for a potential activist campaign centered on these topics requires some additional considerations.
Start a healthy discussion
First, don’t view a meaningful discussion of ESG issues with shareholders as an unwelcome chore. In the current environment, it will be a valuable exercise even if an activist doesn’t land at your door. In the worst case, it builds goodwill with passive investors that represent about 30 percent of every large public company’s shareholder base. In the best case, looking at the company from a new perspective prompts changes that ultimately improve long-term value. A review of best practices is an easy, almost costless, first step in this area.
Review and update public disclosures
Some companies created their disclosures on sustainability 10 years ago and haven’t revised them since. Make sure all your public disclosures, including SEC filings and website content, reflect the company’s efforts on ESG issues.
Under its new Environmental & Social QualityScore, ISS is examining not only a company’s understanding of its environmental and social risks, but also its stated plans to mitigate them. ISS has noted that European companies generally score far better on their disclosure of environmental factors than US companies. In light of this, you should review disclosures by comparable European companies.
Strengthen relationships with institutional shareholders
The support of these investors will be crucial in any activist campaign. As the BlackRock letter shows, institutional shareholders are increasingly focused on ESG issues. With $1.7 tn in assets under management, BlackRock sets the tone for the investing sector.
Fink is now demanding ‘a new model of shareholder engagement – one that strengthens and deepens communication between shareholders and the companies they own.’ He expects companies to articulate their strategic framework for long-term value creation and to discuss the societal impact of their business.
Both Vanguard and State Street have also announced that they’re placing increased emphasis on ESG initiatives.
Unfortunately, most companies overestimate their relationships with institutional shareholders and many take their support for granted. Prominent activists have frequent conversations with the large institutional investors, even if just as part of their other campaigns throughout the year.
Make sure to continue discussions and outreach year-round, not just during proxy season or in the midst of an activist campaign. Be thoroughly prepared and make sure your message is consistent with the company’s other public statements. And be a good listener: These institutional investors may be the canary in the coal mine, alerting you to issues you and your board may not have considered.
If your company does make changes as a result of engaging with these investors, give them some credit. This creates goodwill that can benefit your company later.
Know the data
Be prepared to discuss the metrics relevant to ESG concerns, including diversity data, labor and supply practices and environmental practices. In his January letter, Fink says his firm intends to ask more than 300 companies about the diversity in their boardrooms and workforces.
Make sure your board is aware that these issues are increasingly vital to large investors and that a diverse company and board can bring valuable insight to ESG issues. Although activist investors haven’t been known for promoting diverse boards in their own nominations, this won’t keep them from alleging that a non-diverse incumbent board is evidence of poor governance practices.
Engaging with activists
None of these steps guarantees that a company will stay off the radar of an activist investor, as these investors may take aim at companies with good governance and strong shareholder outreach. Remember that a scorched-earth defense can backfire, particularly if an activist proposal resonates with institutional shareholders and the market.
Increasingly, companies are quietly engaging with these investors and are able to avoid a messy public fight. Collaborative engagement will not always help an issuer to avoid having to put an activist on its board, but it may reduce the number of board seats the activist obtains. More importantly, collaborative engagement may also help the activist, the incumbent directors and the management team to work together more constructively going forward.
Melissa Sawyer and Marc Treviño are partners with Sullivan & Cromwell