Planning For and Responding To ESG-Fuelled Activist Campaigns, featuring Innisfree’s Gabrielle Wolf

September 17th, 2021 03:08 PM Eastern Standard Time



Risk & Compliance Magazine: Could you provide an overview of how investor scrutiny of environmental, social and governance (ESG) issues has evolved in recent years? How would you describe the current state of ESG activism?


Gabrielle Wolf: Over the past decade, institutional investors have become increasingly focused on – and critical of – issuers’ management of environmental, social and governance (ESG) risks and opportunities, particularly as index investors focused on the potential negative impact of climate change on long-term value creation. There has been no single watershed moment of change. Instead, the prominence of ESG issues has steadily increased over time. While ESG-related shareholder proposals have been popular for at least a decade, proxy contests focused on ESG issues are a relatively new development. Previously, to the extent ESG concerns were featured in activism campaigns, they were typically woven into the activist’s messaging as window dressing to draw support from index funds and were not central to the activist’s platform. More recently, ESG concerns are becoming a major driver of activism in and of themselves. This is in large part due to the substantial influence of index and pension funds. As permanent capital, index and pension funds already subscribe to the long-term focus underlying ESG principles and represent on average about 20 percent of all large- and mega-cap public companies. Campaigns that focus on an issuer’s poor ESG performance or lack of a coherent ESG strategy have the advantage of receiving a sympathetic ear from index and pension funds, whose votes are ever more crucial to winning proxy contests.


R&C: In what ways do investors expect companies to quantify and disclose their ESG performance? Are any common metrics and methods gaining acceptance?


Wolf: Institutional investors are increasingly demanding issuers disclose their ESG performance using certain widely accepted disclosure frameworks and guidelines – particularly the Sustainability Accounting Standards Board (SASB) and Task Force on Climate-Related Financial Disclosures (TCFD) – and punishing issuers that fail to make such disclosures. Indeed, in the 2021 proxy season, some index funds withheld votes from directors of certain mid-, large- and mega-cap companies that did not publish or commit to publish SASB-compliant disclosures by the end of 2021. Index and pension funds use SASB’s and TCFD’s prescribed metrics to benchmark companies against peers in their relevant industries and sectors, ensure that the targets chosen are sufficiently ambitious, and track improvements in an issuer’s ESG performance over time. Though the narratives in sustainability reports are helpful context for investors to understand the reasoning behind specific ESG targets – and perhaps why an issuer failed to meet certain performance measures – institutional investors expect that quantifiable metrics and targets accompany any such qualitative descriptions.


R&C: What are the key drivers behind activist campaigns related to ESG accountability? What specific issues are particularly prevalent?


Wolf: Financial materiality is the key driver behind activist campaigns focused on ESG concerns. Activists need to demonstrate that their ESG arguments have strategic and economic merit. Recent ESG activism campaigns have focused on an issuer’s management of environmental and sustainability risks, as they are the most easily quantifiable and have the most obvious and direct connection to an issuer’s fiscal bottom line. Engine No. 1’s successful proxy contest at ExxonMobil is a perfect example of an activist investor effectively utilising ESG issues to drive institutional shareholder support by demonstrating that Exxon’s poor management of climate risk was directly impacting short- and long-term shareholder value. Though we have not yet seen a successful activist campaign focused on a social concern, an activist who can show that a company’s fundamental value drivers are integrally tied to a social or human capital management issue could make a persuasive and credible case for change. Poor management of risks and opportunities related to an issuer’s supply chain, or the cost of the issuer’s workforce and rate of employee turnover, could be ripe for an ESG activist campaign in the coming years.


R&C: What tactics are typically deployed by investors to push an ESG agenda? In what ways have investors modified their voting practices on ESG proposals, for example?


Wolf: Proxy contests centered around ESG arguments are a relatively new development, but shareholders have been submitting non-binding Rule 14a-8 proposals covering a wide range of ESG-related topics for many years. Historically, corporate gadflies such as John Chevedden, William Steiner and James McRitchie submitted various governance-related Rule 14a-8 proposals, including, among others, calls to reduce the ownership threshold to call a special meeting or act by written consent, implement proxy access, separate chair and chief executive positions, eliminate a supermajority voting standard to amend organisational documents and declassify the board. More recently, environmental and social (E&S)-focused shareholders began to submit similar advisory proposals on environmental, social and human capital topics, including, among others, workforce diversity, equal employment opportunity (EEO)-1 reporting, emissions reduction targets, Paris Agreement compliance, ‘Say on Climate’ proposals whereby shareholders are given the opportunity to vote on an issuer’s emissions reduction plans, and political spending and lobbying disclosures. In the past, companies were able to persuade institutional investors not to support shareholder proposals that requested improvement in ESG disclosures or performance metrics by pointing to fulsome sustainability reports or demonstrating that the company was making progress toward a related ESG target. However, in the past proxy season, institutional investors supported ESG-related shareholder proposals, even when the issuer was already producing relevant disclosures or striving to meet pertinent targets. Institutional investors are now analysing ESG-related shareholder proposals by asking whether there is additional room for improvement, and not by looking to reward what an issuer has already accomplished.


R&C: Could you highlight any recent examples of activist campaigns with ESG goals? What lessons can we draw from their outcome and how they were handled?


Wolf: Engine No. 1’s proxy contest at ExxonMobil, in which three of the dissident’s four nominees were elected to Exxon’s board, is an obvious example of a recent successful ESG activist campaign. The most important lesson from that contest is that sustainability concerns are most effective and persuasive when directly tied to a company’s profits. Engine No. 1 demonstrated that its ESG grievances drove share price declines. Its arguments focused on Exxon’s ability to survive the climate transition and continue to create shareholder value in light of shifting consumer demands for cleaner energy. By contrast, activists in other proxy contests this year attempted to use human capital management concerns – in the case of Tegna – and environmental concerns – in the case of Genesco – but without linking those concerns to profitability. No dissident directors were elected at either company. Exxon’s history of discounting frustration among its long-term shareholders, particularly passive funds, and its underestimating Engine No. 1’s deep governance contacts teach us a second lesson. Engine No. 1 emerged as a new fund in December 2020 – the same time that it launched its campaign against Exxon – and held a mere 2 basis points of Exxon’s stock, so it is understandable that Exxon viewed Engine No. 1’s nominations as mere annoyances instead of a real threat. In fact, Exxon did not offer to interview any of Engine No. 1’s highly qualified director nominees and instead, consulted with investor D.E. Shaw in appointing three new directors to deflect the proxy fight. Engine No. 1’s efforts were backed by CalSTRS, the nation’s largest teacher retirement fund, and the Church of England, both of which facilitated introductions between Engine No. 1 and ESG-focused shareholders whose disappointment with Exxon’s ‘head in the sand’ attitude toward managing climate risk and addressing governance flaws had been mounting for years. Indeed, in the decade prior to the 2021 proxy contest, Exxon did little to address the 26 non-binding ESG-related proposals that received over 30 percent of votes cast at its annual meetings. Likewise, it was rumoured that for years Exxon refused index funds’ stewardship teams requests to meet with its independent directors. After some time, Exxon allowed such engagements but only under the oversight of management attendees. Exxon’s imprudence in failing to manage nascent shareholder discontent primed its shareholder base to support a dissident and underscores the importance of proactive engagement with passive investors on a clear day – and well in advance of an activist’s emergence.


R&C: What advice would you offer to companies on preparing for and responding to an ESG-related activist campaign? What steps can they take to improve their chances of a favourable outcome?


Wolf: Best practices for preparing for an ESG-related activist campaign are similar to responding to a traditional activist campaign. Engagement with a company’s largest shareholders acts as an early warning system for identifying budding shareholder discontent with corporate performance, which can then be addressed by a company in advance of an activist surfacing. Waiting to take action until after an activist publicises its critique of a company leaves the company in a defensive position, allowing the activist to claim credit for seeking to increase shareholder value and makes the company’s response seem reactionary. Moreover, a company with strong relationships and a history of credibility with its shareholders will be in a better position to persuade those shareholders to support the board in a potential proxy contest.


R&C: What are your expectations for ESG activist campaigns in the months and years ahead, particularly as the world continues its recovery from the COVID-19 pandemic? What overarching trends would you anticipate?


Wolf: Just as sustainability arguments have been central to ESG activism thus far, arguments focused on human capital issues are likely to gain prominence in ESG activism going forward. The COVID-19 pandemic brought additional attention specifically to employee health and safety. Institutional investors continue to demand more fulsome E&S disclosures from their portfolio companies, and such enhanced disclosures will provide fodder for ESG-focused activists who will be able to better identify those companies that lag their peers in mitigating human capital risk. In particular, disclosures of key human capital metrics, such as the cost of a company’s workforce, rate of employee turnover, number of part-time, full-time and interim workers, types of investments made in a company’s workforce, including those related to employees’ health and safety, and the gender, ethnic and racial diversity of a company’s employees, will bring additional transparency that ESG activists may exploit in future campaigns. Further in the future, after companies with the most obvious ESG vulnerabilities have been targeted, activists may turn from ESG risk arguments, such as challenging companies to reduce their exposure to ESG risks, and instead demand that companies take better advantage of profitable ESG opportunities. Once the ‘low hanging’ ESG fruit has been picked, even some well-performing companies might be vulnerable to ESG activism if their mediocre ESG performance leaves them at a competitive disadvantage.

About Innisfree

Founded in 1997, Innisfree M&A Incorporated (New York), along with its wholly-owned subsidiary Lake Isle M&A Incorporated (London), is a high-stakes shareholder engagement firm, delivering shareholder intelligence, strategic advice and proxy solicitation services to the world’s leading corporations and investors when it matters most. Its integrated approach and unsurpassed analytics–ActiveIQ™–set Innisfree apart as the firm of choice. Innisfree provides expert advice on a wide range of matters, including shareholder activism, executive compensation proposals, corporate governance issues and investor relations.

With an experienced professional staff in New York, London, Pittsburgh and Richmond, VA, Innisfree has represented hundreds of clients in over 20 countries.


Innisfree M&A Incorporated
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