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Too big to listen

27 June 2017 by Lauren Compere

US: Too big to listen - read more

Limiting US shareholder voting rights puts onus on governance and compliance professionals to voice shareholders’ concerns

A lesser known component of the Financial Choice Act, introduced to replace the Dodd-Frank Act in the US, is set to have a significant impact on corporate governance. For decades, shareholder proposals have allowed investors to engage with companies on important matters. Although the UK has long restricted this right to investors holding at least 5% of company stock, in the US anyone with a minimum of $2,000 in shares held for a year can file a resolution for the corporate ballot.

The suggested reform would limit this to investors with 1% of shares that they must have held for three years. For many large listed companies, this threshold is out of reach for all but the very biggest investors. This has implications for governance and compliance standards.

Communication channel

Despite the UK limit to file a shareholder resolution being significantly higher at 5%, it provides a more powerful governance device – as unlike in the US the results are binding and shareholders also have the right to call special meetings and elect directors. In contrast, US proxy rules emphasise shareholder participation and protection, but have still proved to be an important tool for promoting good corporate governance.

Shareholder proposals provide a channel of communication between investors and corporate management. They act as a risk management tool because they allow shareholders to engage with management on emerging threats, such as environmental impact and executive compensation, which have a demonstrated correlation with financial performance.

To date, resolutions have proved to be very effective in providing important checks and balances and improving management systems. Removing them would ultimately put business and capital markets at risk as a result of lower standards of corporate governance.

Shareholder action

Sustainability reporting, now recognised as an important sign of good corporate governance, is often introduced as a result of shareholder activity.

According to a report prepared by US sustainability non-profit organisation Ceres and others, 85 companies have agreed to publish sustainability reports as a result of shareholder resolutions since 2009. Similarly, in 2015, more than 5,600 companies disclosed environmental data through CDP at the request of a $100 trillion group of investors. For companies hoping to remain sustainable and profitable in the long term, climate data is an important risk-management tool.

Shareholder engagement has also been helpful in preparing companies for the financial effects of emerging climate change policies. In May, a proposal at oil and gas giant Occidental Petroleum Corporation asking the company to assess the long-term impact of climate change on its business was approved by shareholders. In a first for a major US oil and gas company, the proposal calls for an annual report to include environmental scenario analyses, which will help equip the company to develop a strategic response to climate change.

At the AGM of electric utility PPL Corporation this year, more than 50% of shareholders voted in favour of a proposal asking company management to publish an assessment of the likely impact on its portfolio of the regulatory changes and technological advances following the Paris Agreement. Such an assessment will put PPL in a far better position to minimise and manage climate-related risks. A similar proposal was backed by more than 62% of shareholders at ExxonMobil’s recent AGM.

HR-related benefits also accrue as a result of shareholder action. Most major companies now have sexual orientation non-discrimination policies, chiefly as a result of hundreds of shareholder proposals on the topic. In 2016, Credit Suisse found that 270 companies which offered inclusive LGBTQ work environments outperformed global stock markets in the preceding six years by 3%.

Smaller shareholders – retail and institutional investors – often join larger institutions in filing and supporting resolutions about sustainability issues and diversity. Yet these would be excluded from this process entirely by the proposed Financial Choice Act.

Legal and reputational risks

Shareholders often file resolutions to protect the reputation of companies from environmental or labour scandals. For example, the first proposal requesting a company to source deforestation-free palm oil was put to a vote in 2011, and five years later more than 20 companies had committed to source deforestation-free palm oil, in response to similar resolutions.

Shareholder resolutions have also led to broad integration of international human rights frameworks into corporate codes of conduct and supply chain policies, helping protect companies from legal and reputational risks.

Recent attacks on shareholder resolutions stem in part from their increasing popularity. Since 2000 the number of proposals receiving at least 25% support almost doubled to 61%. The argument made by President Trump’s administration officials in favour of the reform, including business figures such as JP Morgan Chief Executive Jamie Dimon, is that shareholder resolutions have been taken over by a handful of activist investors who own small stakes and are pursuing ‘special interests’ not related to shareholder value.

On the contrary, counter Ceres, the vast majority of resolutions are filed by institutional investors with large and long-term holdings or individuals with similarly long-term interests in the company’s performance. Recently, the likes of BlackRock, Goldman Sachs and Deutsche Bank threw their weight behind proposals for environmental impact management.

Investors large and small recognise that natural resource strain has significant material impact, while promoting equality and diversity clearly makes for better decision-making and is simply good business sense. Well-managed, successful companies recognise the importance of talking to shareholders and appreciate their concerns and ideas. In the long term, this leads to high-quality corporate management, and superior long-term financial performance.

Able to ignore

The original Dodd-Frank Act, which the Financial Choice Act aims to repeal, was created to stop companies becoming ‘too big to fail’, yet the proposed reforms would enable them to ignore shareholders and act as if they are ‘too big to listen’.

This creates novel risks for corporates and investors. Governance and compliance professionals must fill the gap and ensure that investors’ concerns are heard, to help protect their companies from regulatory risks and lawsuits.

The transition towards a green economy is already under way and the financial uncertainties caused by deforestation, pollution and carbon emissions are more pressing than ever. Investors – whether they hold a handful of shares or 5% – are alive to the risks and expect companies to manage them.

Lauren Compere is a Managing Director at Boston Common Asset Management

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