In Parts I and II of this three-part series on whether and how socially responsible investing (SRI) works, we examined the efficacy of divestment as well as the impact of proxy voting in shareholder resolutions. While it is clear these processes can be impactful in influencing the behavior of corporations and public markets, some investors (and most companies) prefer the backdoor channel of personal dialogue between investors and company leadership, citing it as both more efficient and less adversarial. In this post, we look at these behind-the-scenes processes in order to weigh their impact, as well as the passive investing industry’s role in pushing for change.
What is Shareholder Engagement?
Shareholder engagement encompasses all forms of ‘formal’ interaction between a company’s leadership and its investors, including legally mandated processes such as annual disclosures and shareholder meetings where resolutions are voted. With the rising trend of corporate accountability and shareholder influence over the past few decades, however, shareholder engagement well beyond these yearly events has become a key way for investors to convey their concerns and questions to company management and directors.
On the other end of the spectrum, shareholder engagement also includes distinctly less structured interactions between directors, investor relations, management, and investors. These informal communication channels – often phone calls or meetings – may be the most effective means for investors to promote their agenda, enabled by an environment of confidentiality and trust often lacking in public (and often adversarial) proxy battles.
But Does it Work?
Plenty of accounts anecdotally point to the power of the right conversation at the right time, but the inherently private nature of these kinds of shareholder engagement makes them significantly harder to assess for impact. We broadly observe, however, an increase in the quantity of shareholder engagement over time. In a ten-country survey of large, medium and small public companies last year, 60% of companies reported an increase in engagement relative to 2013.
Although the evidence points to a greater quantity of shareholder engagement, accounts of the impacts of such ‘improved’ engagement remain mixed. One study from 2017 focusing on investor-initiated social and environmental engagements over a decade found that companies with low ESG ratings tend to respond with initiatives that result in an improvement in ESG scores – even when the investor considered the engagement unsuccessful. Surprisingly, companies rated highly on ESG indicators prior to engagement actually underwent a drop in ratings post-engagement – suggesting that investors identified room for improvement in ESG practices that then became ‘priced-in’ to the companies’ ESG rating.
While such studies indicate that investor-investee engagement results in positive outcomes from an ESG perspective, heterogeneity in measurements across issues, methodologies and countries present serious challenges to systematic evaluation of impact. With the emergence of disclosure around informal engagement initiatives over the past five years, however, future studies will benefit from more holistic analysis. Until then, the empirical literature offers cautious optimism that shareholder engagement – when it occurs – yields positive effects on the behavior of companies, in particular ESG efforts and disclosure.
At the same time, the literature also reveals that the impact of shareholder engagement in improving corporate practices may be diminishing.
Structural Changes Ahead
Firstly, it’s important to note that backdoor shareholder engagement is still relatively rare. While companies may prefer one on one calls with their investors, they clearly aren’t taking everyone’s calls, resulting in a concentration of voices and power amongst influential investors. Even amongst this select group, it is unclear how many are leveraging their influence, and if they are, to what ends.
Secondly, the structural incentives for disciplined and sustained engagement are weak. Even amongst index investors, once lauded as “the best hope for corporate governance,” shareholder engagement practices are thin. Analyses of the Big 3 — BlackRock, State Street Global Advisors and Vanguard, collectively representing 81% of index fund assets — reveal they engage with only a very small proportion of their portfolio companies, and an even smaller proportion of these involve more than a single conversation.
This is in some sense unsurprising. Factoring in the Big 3’s underwhelming performance in visible shareholder engagement processes, from proposal submission apathy to their overwhelmingly pro-management voting record, should we expect their back-channel actions to match their stewardship rhetoric?
The Future – and Responsibility – of Index Investing
The stakes are rising. If historical trends hold, the concentration of power in and explosive growth of the index investing industry will result in three firms being responsible for 40% of the votes in S&P 500 companies by 2040. There are strong reasons to believe these are not the champions of shareholder engagement that society needs. Regulators, academics, and even the founder of modern index investing have also expressed concern.
At OpenInvest, we believe there are many ways to affect impact. We don’t have all the answers, but we do believe in working with like-minded actors to fight for the causes our investors believe in. That’s why we’ve recently become a signatory to the UN-supported Principles for Responsible Investing as well as joined the FAIRR Initiative (a global network of investors addressing ESG issues in animal supply chains). More fundamentally, we believe that the way to maximize shareholder engagement’s impact is to put that power back in the hands of individual shareholders, in contrast to those that think “mutual funds are the voice of individual investors.”
Over the past three posts, we have sought to take measured look at some of the ways in which ethical movements try to better our formidable financial system. Progress has been in no way ‘endogenous’ or ‘natural,’ but won through the efforts of intentional investors joining in collective action. Join us in our corner of this struggle: if you’re an investment adviser and your clients are interested in using their assets to change the world, contact us at firstname.lastname@example.org.
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