The article by Susan Baker and Jonas Kron provides a fascinating example of how Trillium Asset Management has used its influence as an investor to impact corporate policies on an important social issue. But is Trillium’s story an outlier or part of a trend? Do companies change their governance practices in response to input from shareholders? If so, why? And more importantly, does it benefit the bottom line?
Corporate governance engagement is a distinctive form of dialogue between shareholder and company. In contrast to analyst calls or shareholder activism, corporate governance engagement is not based on the specifics of business strategy. Instead, shareholders ask whether corporate governance policies and practices are likely to lead to decisions made in the best long term interests of shareholders. As a part of this, shareholders may raise questions about board accountability to shareholders, executive compensation, or corporate social responsibility practices.
Until recently, anecdotes were the only evidence of the effectiveness of these practices. Because shareholder dialogues are confidential, little data was made available to researchers to study trends. However, new partnerships between academics and investor advocates have begun to unlock the “black box” of shareholder engagement on corporate governance.
A 2014 study by Carleton Center for Community Innovation1 studied 6,000 corporate dialogues conducted over twenty years by members of the Interfaith Center on Corporate Responsibility, an association of primarily religious investors dedicated to promoting corporate social responsibility. The study focused in particular on engagements which included the filing of a shareholder proposal, in which shareholder places a question on a company annual meeting proxy ballot related to a governance issue. The filing of a shareholder proposal implies resistance from the company to adopting the requested changes, yet the study found that in half of the cases studied, the company did make at least some of the requested changes. The study concludes that shareholder proposals help to open the door to engagement between shareholders and companies, and that this engagement can lead to tangible governance changes, and that engagement has become more effective over time.
One limitation of the Carleton Center study was that it did not examine the factors that led to successful dialogue once initiated by a shareholder proposal. A qualitative study by Fabrizio Ferraro and Daniel Beunza2 sheds light on the mechanisms by which shareholders wield influence. Although in some cases they may raise the same issues as outside activist groups, religious investors gain legitimacy and trust through their long-term investment in the company: shareholders are seen as insiders having a credible voice within corporate decision-making processes.
The particular capability of these investors is to reframe moral issues as business issues, helping companies to identify concerns that may become business risks. These dialogues often help lower level managers who agree with the investors gain the attention of senior managers. Finally, investors can use tactics such as shareholder proposals to force companies to confront issues that they would rather ignore. The authors conclude that corporate governance engagement functions as a tool of corporate learning, rather than as a pressure tactic used by outside groups to force unwanted change.
Because both these papers used data supplied by religious investors, they did not include the experience of larger institutional investors whose experiences may be distinct from those of smaller investors. For example, because of their larger holdings, larger investors do not usually need to file shareholder proposals in order to gain access to corporate management. Although comprehensive data on the engagements of larger investors are not available, research does suggest that their experience is similar.
A 2014 survey of investors and issuers by the Investor Responsibility Research Center Institute3 examined the frequency and perceptions of effectiveness of shareholder dialogue among companies and shareholders, including both large and small investors. The study found engagement between companies and shareholders is “firmly rooted in the corporate governance landscape” that the number of engagements between companies and shareholders has risen, and that the subject matter included financial, governance, social and environmental concerns. Approximately half of investors agreed that engagement was always or usually successful.
Finally, there is emerging research that associates successful engagement with improved financial performance. Previously in these pages, we noted two studies that demonstrate economic value related to successful engagement. The first4 demonstrated that successful engagements are followed on average by a one-year abnormal return of 4.4%, which persists over time and which was supported by improved operating performance. (Unsuccessful engagements yielded no abnormal returns.) Successful engagements were documented across environmental, social and governance issues and yielded similar performance benefits. A second study5 examined shareholder proposals on environmental and social issues which narrowly passed or failed. The study finds that companies where proposals are fully adopted experience a .7-.8% increase in return on assets, a 1.1-1.2% increase of profit margins and a positive market reaction of 1.9% as compared to proposals that fail. This study also notes that this effect is reduced for firms with higher social and environmental performance, indicating a diminishing marginal returns to engagement.
Though more research is needed to confirm and expand upon these results, these studies suggest that the market is increasingly recognizing and responding to the contribution of shareholder engagement to firm performance. In evaluating companies, investors may wish to consider how shareholder engagement by issuers may be a sign of quality of management. Investors may also consider the specific issues being raised in these engagements as a signal of areas of corporate risk and opportunity.
John Wilson is Head of Corporate Governance, Engagement & Research at Cornerstone Capital Inc.
1 “Power and Shareholder Saliency,” Tessa Hebb, Andreas Hoepner, Tatiana Rodionova and Imelda Sanchez, 2014
2 “Understanding Voice: Mechamisms of Influence in Shareholder Engagements,” Fabrizio Ferraro and Daniel Beunza, 2013
3 “Defining Engagement: An Update on the Evolving Relationship Between Shareholders, Directors, and Executives,” IRRC Institute, April 2014
4 “Active Ownership,” Elroy Dimson, Oguzhan Karakas, and Xi Li, December 17, 2012
5 “Does Corporate Social Responsibility Lead to Superior Financial Performance? A Regression Discontinuity Approach,” Carol Flammer, January 2013