Shareholder Activism On Sustainability Issues

Jyothika Grewal
Harvard University, Harvard Business School, Students

George Serafeim
Harvard University – Harvard Business School

Aaron S. Yoon
Harvard University, Harvard Business School, Students

July 6, 2016

Abstract:

Shareholder activism on sustainability issues has become increasingly prevalent over the years, with the number of proposals filed doubling from 1999 to 2013. We use recent innovations in accounting standard setting to classify 2,665 shareholder proposals that address environmental, social and governance (ESG) issues as financially material or immaterial, and we analyze how proposals on material versus immaterial issues affect firms’ subsequent ESG performance and market valuation. We find that 58 percent of the shareholder proposals in our sample are filed on immaterial issues. We document that filing shareholder proposals is effective at improving the performance of the company on the focal ESG issue, even though such proposals nearly never received majority support. Improvements occur across both material and immaterial issues. Proposals on immaterial issues are associated with subsequent declines in firm valuation while proposals on material issues are associated with subsequent increases in firm value. We show that companies increase performance on immaterial issues because of agency problems, low awareness of the materiality of ESG issues, and attempts to divert attention from poor performance on material issues.

Shareholder Activism On Sustainability Issues – Introduction

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.1 In line with increasing engagement, shareholder proposals on ESG topics have more than doubled in the last two decades. 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.

Past research has shown that shareholder proposals on traditional corporate governance issues, such as executive compensation, takeover provisions and board of directors’ composition, have in recent years been effective at changing corporate governance, although their impact on firm valuation is unclear (Ertimur, Ferri and Muslu 2011). These proposals, although not binding, increasingly receive majority support by voting investors and as a result proxy access is being considered an important corporate governance mechanism. In contrast, 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.”2 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. Past research has found mixed results on the financial implications of these practices and many investors still do not take into account ESG issues in investment decisions (Kotsantonis, Pinney and Serafeim 2016).

However, the financial materiality of different sustainability issues likely varies systematically across firms and industries (Eccles and Serafeim, 2013).3 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.4 We develop a novel data set to measure the materiality of ESG proposals in ISS (formerly RiskMetrics), 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 is the same criteria used by the SEC in determining the materiality of financial information (the SASB classification process is described in more detail in Appendix I and Appendix II).

Shareholder Activism, Sustainability Issues

Consistent with prior literature on shareholder activism (Bebchuk, Brav and Chiang 2015), we use the standard methodology and 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. Our finding that most of the ESG proposals focus on issues that are immaterial from a financial standpoint is in line with the U.S. Chamber of Commerce’s claim that companies spend resources on issues that are financially immaterial.

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. Policy experts, including former Securities and Exchange Commissioner Troy Paredes and director of the Manhattan Institute’s Center for Legal Policy Jim Copland, have argued that environmental and social issues divert the attention of senior management and directors away from more important work thereby destroying value.6 We show that this position is supported when analyzing financially immaterial ESG proposals. However, our results suggest that one should be careful about overgeneralizing since a significant number of ESG proposals are financially material and associated with subsequent increases in market valuation. 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.