Rethinking Acting in Concert: Activist ESG Stewardship is Shareholder Democracy

Activist campaigns by shareholders on environmental, social, and governance (ESG) issues continue to hog the limelight. Even though the results in the 2023 proxy season have been mixed, investors’ razor sharp focus on ESG matters continues unabated, and it remains to be seen whether recent political backlash against ESG is likely to be long-lasting.

The prominence of ESG activism is traceable to an episode in May 2021 when Engine No. 1, an investment fund, received plaudits from the “responsible investment community” for leading a campaign which successfully placed three dissident independent directors on ExxonMobil’s board. The aim of its activist campaign was to promote a more sustainable business model within ExxonMobil, a company with a history of denying climate change. Remarkably, Engine No. 1 was able to achieve this feat despite owning a mere 0.02 percent of ExxonMobil’s shares. The key to Engine No. 1’s success was its ability to inspire major institutional investors – such as BlackRock, Vanguard, and State Street – to follow its lead by voting in support of its activist ESG campaign.

The unprecedented success of Engine No. 1’s campaign has spurred calls for a new engagement approach, led by institutional investors, known as “activist stewardship”. This approach, which goes one step further than the type of activism in the Engine No. 1 case, requires institutional investors to change their corporate governance engagement models to make acting collectively to challenge and replace boards that do not embrace ESG their modus operandi. The activist stewardship movement suggests that major institutional investors should lead – rather than follow – ESG campaigns. To succeed in such campaigns, institutional investors would have to act collectively to harness their combined shareholder power to forcefully promote ESG. The need for institutional investors to become leaders has intensified over the last year as campaigns led by activists like Engine No. 1 have increasingly failed.

The idea of collective activist ESG stewardship should not be hastily dismissed as an academic pipedream. Its current advocates include the United Nations Principles for Responsible Investing (PRI) signatories. The PRI signatories now include over 4,000 institutional investors, from more than 60 countries, representing a staggering US$120 trillion in assets under management. The signatories – which now include BlackRock, Vanguard, and State Street – have committed to follow six principles that prioritize ESG considerations in their investor engagement strategies and to collaborate to promote ESG practices in their investee companies. Following Engine No. 1’s success, a representative of the PRI called for its institutional investors to become activist ESG stewards – which was echoed by a prominent corporate governance professor at Oxford University and representatives of the second largest pension fund in the United States.

While these recent clarion calls for activist ESG stewardship were inspired by the Engine No.1 case, the concept of institutional investors acting collectively to challenge and replace recalcitrant boards aligns with the more established fundamental principles at the core of the global shareholder stewardship movement. ESG is now an integral part of the business models of many institutional investors, for the first time presenting the possibility of aligning their business models with engaging in collective activist ESG stewardship. The latest wave of stewardship codes has seized on this reality by focusing on the promotion of ESG as a core objective of collective engagement among institutional investors – who normally require a plan to escalate their collective pressure on recalcitrant boards to comply with the obligations under their respective stewardship codes. Thus, the possibility for collective activist ESG stewardship to become the modus operandi of major institutional investors globally and, in turn, to result in a step change in sustainable corporate governance is now in clear sight.

However, as we highlight in our recent working paper, there is a significant legal hurdle that has been almost entirely overlooked by those calling for collective activist ESG stewardship: acting in concert rules. Even if the majority of the world’s major institutional investors support collective activist ESG stewardship (which is already the case if the PRI’s call for activist ESG stewardship outlined above is accepted by its signatories) and even if institutional investors collectively hold sufficient voting rights in listed companies to change their corporate governance (which is already the case in most listed companies in the United States and United Kingdom, and in some companies in several other jurisdictions), the legal obstacles created by acting in concert rules in almost every jurisdiction severely limit, and in some cases entirely prevent, institutional investors from acting collectively to replace recalcitrant boards.

Specifically, collective action among institutional investors as shareholders may trigger “acting in concert” rules which, depending on the jurisdiction, could require them to: (i) make disclosures of their shareholding collectively beyond prescribed shareholding thresholds; (ii) make a mandatory takeover offer to the shareholders of the company in certain circumstances; and (iii) deal with the fallout of triggering a “poison pill”. The legal barriers posed by collective action rules in virtually all jurisdictions prevent institutional investors from engaging in collective activism with the aim or threat of replacing the board. These rules were designed in an era when “changes of control” in the context of takeovers were the focus of acting in concert regimes and the concepts of ESG and climate activism had not yet materialized. As such, acting in concert rules were originally designed to prevent some shareholders (such as acquirers of corporate control or sellers of large blocks of shares) from unfairly benefiting themselves at the expense of minority shareholders, or even other stakeholders.

However, these rules now present a significant obstacle to addressing the pressing issue of climate change. Even if the goal of collective activism is to address climate change, investors are not exempt from these rules. Thus, institutional investors in a listed company face the risk of legal action or severe economic consequences if they attempt to replace a board of climate change deniers, even if (or, ironically, precisely because) they collectively represent a majority of shareholders. This effectively prevents major institutional investors from adopting collective activist ESG stewardship as their modus operandi and is antithetical to shareholder democracy. One can only imagine the number of activist ESG proposals that could not be brought due to constraints imposed by the acting in concert rules, which effectively impedes sustainable corporate governance.

We argue that institutional investors who are committed to promoting ESG must be allowed to act collectively to replace boards that resist addressing climate change decisions. Without this threat, institutional investors may collectively possess the shareholder power to change the board, but they will be unable to effectively exercise it – a fact that is not lost on recalcitrant boards that either explicitly or implicitly deny the urgency of climate change. The result is that institutional investors are legally cabined to “soft” engagement if they act collectively but are legally prevented from collectively challenging even the most retrograde climate inactive boards – promoting a type of “faux green activism” where activist ESG stewardship is needed the most.

To remedy this problem, we propose a novel model for acting in concert regimes. This model calls for a refinement of the existing law to enable collective activist ESG stewardship where threats of board change (or their execution) by institutional investors are solely a means to achieve broader sustainability goals rather than a ploy to acquire and maintain control over the company to profit. Specifically, we propose redesigning acting in concert regimes to effectively distinguish between ESG activism battles (in which investors seek to utilize board changes as a means to achieve sustainability in the governance of companies) and takeover contests (in which control is an end in itself).

Our model aims to provide a legal solution that promotes collective activist ESG stewardship (more specifically in relation to climate change) while mitigating the risks posed by rent-seeking shareholders who seek control only for profit without promoting sustainable corporate governance. To achieve this goal, our model suggests that the PRI itself, or other similar organizations, be utilized as a third-party organization to assist in the complex task of distinguishing between control shifts and ESG activism. We believe that this innovative rethinking of the concept of acting in concert has global applicability, unlocking the positive potential of activist ESG stewardship to address the pressing and severe threat of climate change.

Climate change is an existential threat to humanity. Institutional investors holding trillions of dollars of shares around the world have pledged to use their voting power to address this problem in the companies they invest. Outdated acting in concert rules, designed in another age, for another purpose, are perversely preventing this from happening and protecting recalcitrant climate denying boards. Our model seeks to put an end to this, while preserving the reason for which acting in concert rules were created in the first place.  Implementing our model would remove any legal excuse that institutional investors may put forward for their failure to act and be a driver to help save our planet.