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E-MailErica Lukoski is a Managing Director and Chief Operating Officer, Allie Rutherford is a Managing Director, and Eric Sumberg is a Director at PJT Camberview. This post is based on a PJT Camberview memorandum by Ms. Lukoski, Ms. Rutherford, Mr. Sumberg, Christopher Wightman, and Rob Zivnuska. Related research from the Program on Corporate Governance includes Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).
Proxy season has come to a close and companies are beginning to prepare for a new cycle of engagement in the off-season. Here are the topics that drove vote outcomes this spring that will infuse investor conversations this fall.
New Overboarding Policies and Lower Support Levels for Directors
In a sign of growing investor assertiveness, significant opposition to directors of Russell 3000 companies this year increased to its highest level since 2011 despite a year-over-year decrease in negative proxy advisor recommendations, according to a June ISS Analytics report. A contributor to this decline was new or stricter overboarding policies put in place by leading institutional investors such as Vanguard, BlackRock and Boston Partners. Active public company executives sitting on more than two boards were particularly hard hit, and a number of directors saw their support drop 25 or more percentage points on a year-over-year basis.
Investors’ stated concern with “overboarded” directors is that they may not have sufficient time to dedicate to their roles, particularly when an activism, M&A or crisis event hits one or more of the companies on which they serve. Tighter overboarding policies may become more prevalent in the coming years, with direct implications for board diversity, succession planning and the way that directors and companies manage and track their board commitments.
Evolution of Environmental and Social Topics
Investor conversations around board oversight and company management of environmental and social (E&S) risks and opportunities have become a year-round dialogue. During proxy season, discussions around E&S topics are usually driven by negotiations of shareholder proposals and vote outcomes. This spring, top-line statistics through May from ISS show that for the third year in a row, the number of E&S shareholder proposals filed surpassed governance-focused proposals. Nearly half of E&S shareholder proposals that went into a vote, which encompass several distinct topics including sustainability reports, political spending and gender pay gap disclosure, received above 30 percent support, representing a close to ten percentage point increase over last year.
A broader shift that has emerged in the first half of this year is the growth in the number of investors creating sustainability data screens for investment and stewardship purposes. These systems are built upon proprietary analysis as well as various reporting frameworks and sustainability ratings providers and are intended to evaluate and incorporate environmental and social factors throughout the investment cycle. For example, State Street Global Advisors’ new R-Factor system leverages ESG materiality frameworks to create a unique company score that is used to help its clients make investment decisions and is integrated into the firm’s stewardship program. A recently released analysis of climate risk in oil, gas, mining and utility companies by State Street demonstrates how this new system may be used in practice. Active managers such as T. Rowe Price and Columbia Threadneedle have also announced their own rating and screening frameworks that leverage ESG data to help aid investment decision-making.
In addition, this proxy season saw the continued prominence of investor coalitions such as the $33 trillion Climate Action 100+, whose members played leading roles in negotiating settlements with oil and gas companies targeted by climate risk shareholder proposals. Collective action by investors to amplify targeted campaigns is likely to continue in the coming years as consensus forms in the investor community on both the need to address climate risk as well as the preferred disclosure frameworks along which companies will be encouraged to report.
Executive Compensation Complexity
Average Say-on-Pay results tend to be confined to a narrow band on a year-over-year basis, and as a result, small changes in aggregate vote totals may be indicative of broader shifts. According to data from Semler Brossy through June 6, average vote support among Russell 3000 companies ticked up slightly to 91%. However, Say-on-Pay failures at those same companies increased to slightly more than 2.2% of all votes. ISS data released in June indicates that 13.5% of Say-on-Pay proposals voted through May received less than 80% support, the second year in a row that figure has increased from a post-2011 low of 9.4% in 2017.
Feedback from engagement meetings this spring indicated a heightened focus on one-time or supplemental awards and a desire for plan design that is tightly linked to challenging strategic and financial measures. As investors continue to become more sophisticated in their compensation analysis, they have also become more willing to support plans that have moved away from traditional metrics such as TSR and toward those specific to company circumstances and strategy. As a result, compensation plans have generally become more aligned with key performance metrics, with the caveat that unique plan design requires clear disclosure and more in-depth engagements to provide investors with context.
Underlying both voting and engagement trends is the continued search for perceived or actual gaps in pay and performance. Many investors have created proprietary quantitative pay screens to flag potential disconnects that can prompt an engagement request to understand the underlying causes. Companies that faced investor challenges this spring on compensation can expect further discussion this fall into the rationale behind the compensation committee’s decision-making and how investor feedback has informed potential changes to plan design. 2020 should bring further complexity as investors continue to dig deeper into compensation plans and ISS potentially expands its analysis to include Economic Value Added (EVA) in addition to TSR and other financial metrics.
Activist Investors, Active Investors and Activated Employees
Even as the total number of public activist demands in the U.S. in the first half of the year declined on an aggregate level as compared to last year, activists have continued to target high-profile friendly and hostile M&A deals in the U.S. and abroad, introducing complex dynamics into already complicated dealmaking. According to Activist Insight, just six activism contests went the distance in the first six months of 2019, a substantial drop off from prior years as settlements reached before proxy votes remain a common tactic to defuse activist pressure. The broader impact of activism today, however, can be measured by how other market constituents are taking pages from the activist playbook.
An emerging trend that took on more prominence in 2019 has been the increasing assertiveness of active managers who are adopting activist stances and overlaying a governance focus to help differentiate themselves in a market that continues to see outflows to passive funds. In recent months, traditional active investors such as Neuberger Berman, Wellington Management and T. Rowe Price have initiated high-profile activist campaigns or taken public stances on M&A situations that have affected board and deal dynamics.
Perhaps the most prominent new trend in “activism”, broadly defined, has been the growth in employee activism outside of the traditional framework of organized labor. Several companies this spring faced employee walkouts or shareholder proposals co-sponsored by employee groups intended to prompt company action on topics ranging from climate risk to government contracting and non-disclosure agreements relating to discrimination or harassment. While employee views have long figured in the governance decision-making processes, the ability of employees to find common cause with certain investors, and effectuate sophisticated campaigns via traditional and social media, presents both a substantial departure from years past and new challenges for management teams and boards.
Expectations for Voting and Engagement Trends
Companies should be tapped in to how these trends are shaping the evolving investor landscape. As competition to demonstrate superior investment stewardship continues to grow, investors have become more proactive and assertive than ever. One way this has manifested itself is through greater accountability for directors across their board service. New overboarding policies are just one example of how policies can “follow” directors – proxy advisors and investor groups are also tracking board members based on additional issues of concern.
Investors are taking a more nuanced approach to traditional engagement. While many engagement discussions are still initiated by companies, some major asset managers have begun identifying and reaching out to engagement targets with clear expectations for agenda topics and key focus areas already identified. Even as investment stewardship teams expand, the growth in demand for engagement has made securing meetings both more difficult and also more important to get right. Management teams and boards should take an investor-by-investor approach, including identifying the correct opportunities to deploy a director, building off of prior conversations and understanding their investors’ key focus areas and preferences. Those companies that can pull together all of these distinct threads are well positioned to get the most out of their engagement conversations and build strong investor relationships going forward.
