Shareholder Activism on Sustainability Issues

George Serafeim is the Jakurski Family Associate Professor of Business Administration at Harvard Business School. This post is based on a recent paper by Professor Serafeim, Jody Grewal and Aaron Yoon.

A growing number of investors are now engaging companies on environmental, social and governance (ESG) issues, in addition to traditional executive compensation, shareholder rights, and board of directors’ topics. In 2013, nearly 40 percent of all shareholder proposals submitted to Russell 3000 companies related to ESG issues, representing a 60 percent increase since 2003 (Proxy Voting Analytics, 2014). The topics of ESG proposals are diverse, ranging from disclosure of political contributions and compliance with human rights policies, to the adoption of a climate change policy. The purpose of this paper is to test the effect that ESG proposals have on firms’ subsequent ESG performance and market valuation. Critically, we use recent innovations in accounting standard setting to classify shareholder proposals that address ESG issues as financially material or immaterial, and we analyze how proposals on material versus immaterial issues affect firms’ subsequent performance on the focal ESG issue and market valuation.

There is little that is known about the efficacy of ESG shareholder proposals. Almost all of those proposals have failed to receive majority support and in most of the cases, votes in support of the proposal are below 20 percent. However, anecdotal evidence and industry practitioners suggest that ESG proposals have been important catalysts of action inside companies (Blackrock and Ceres, 2015). For example, the US Sustainable Investment Forum claims that, “often, a shareholder resolution will fail to win a majority of the shares voted, but still succeeds in persuading management to adopt some or all of the requested changes because the resolution was favored by a significant number of shareholders.” Moreover, while there seems to be consensus on the shareholder desirability of adopting corporate governance practices, such as increasing shareholder rights, decreasing takeover provisions, and appointing more independent directors, no such consensus within the investment community exists around ESG practices.

However, the financial materiality of different sustainability issues likely varies systematically across firms and industries (Eccles and Serafeim, 2013). A new organization, the Sustainability Accounting Standards Board (SASB), adopts a shareholder viewpoint in defining materiality and develops standards for reporting ESG issues that distinguishes between material and immaterial issues. We develop a novel data set to measure the materiality of ESG proposals in ISS, by hand-mapping recently-available industry-specific guidance on materiality from SASB to ISS, and then to MSCI KLD that has firm-level ratings on an array of sustainability issues. SASB considers evidence of investor interest and financial impact when determining the materiality of ESG issues, which are the same criteria used by the SEC in determining the materiality of financial information.

We track the industry-adjusted market valuation (i.e. Tobin’s Q) over time for firms that are the subject of a shareholder proposal. We assess for the validity of a parallel trend assumption between engaged firms and the industry median and complement this research design with a propensity score matched sample of non-engaged firms that exhibit identical pre-engagement performance level and trend on the focal ESG issue and identical level and trend on Tobin’s Q to that of engaged firms. We find that 58 percent of the shareholder proposals in our sample 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 prosocial 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.

We also find that subsequent to filing ESG shareholder proposals, targeted firms experience changes in Tobin’s Q. However, proposals have a substantially different effect depending on whether they relate to immaterial versus material issues. 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. We find that the positive effect of proposals on material issues is present for both companies that start from low or high levels of performance on the focal sustainability issue.

One question that our results generate is why managers would improve performance on immaterial issues if doing so is associated with decreased financial value. We test different explanations as to why managers seemingly respond to proposals on immaterial issues. We find 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.

Our paper provides the first evidence, to our knowledge, of systematic increases in firms’ ESG performance after shareholder activism. In contrast to proposals on compensation and board composition issues that were ineffective in the absence of majority vote, we find management to be responsive in our sample of non-majority vote ESG proposals. Importantly, this study sheds light on why managers appear to respond to shareholder proposals on immaterial issues and suggests that agency problems, the inability to identify material issues and “goodwashing” incentives contribute to this phenomenon. In addition, our study provides evidence on how investor induced changes in corporate ESG performance are associated with future market valuation. Our results suggest that failing to distinguish between material and immaterial sustainability issues might lead to erroneous conclusions. It is critical to make this distinction, because arguments made by influential policy experts that corporate engagement with environmental and social issues is value-destroying, are supported only for a subset of the shareholder proposals in our sample; we find that a considerable portion (42 percent) of ESG proposals are financially material, and associated with subsequent increases in firm value.

The full paper is available for download here.

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