It’s fair to say that Engine No. 1’s victory over Exxon Mobil this week is completely unprecedented. It’s also much more than that.
Q1 2021 hedge fund letters, conferences and more
The Poor State Of The Proxy Plumbing
At the time of writing, at least two of the activist’s four nominees were forecast to win election to the board, while the fate of one other and four management nominees were too close to call. Investors also voted for two shareholder proposals on lobbying. That haul, plus Exxon’s scramble for extra votes by calling a recess during the annual meeting and the still-uncertain final tallies that show lessons over the poor state of the “proxy plumbing” have not been learned, is already extraordinary.
America has become accustomed to financiers taking board seats at large and well-known companies but no activist hedge fund has ever won a proxy contest vote with a less than 0.1% stake, at least since 2013 according to Activist Insight Online (the smallest on record is a 0.6% stake – a beverage for the first correct guess). Engine No. 1's 0.02% stake, the almost equal amount it spent on its shares and the campaign, Exxon’s $250 billion market cap, and the enormous retail component of Exxon’s shareholder register are further reasons to consider this the biggest activist win of all time.
But the reaction to Exxon’s defeat, including its description by Nell Minnow as “a monumental step forward in the history of corporate governance and the history of climate change,” highlights that this is not just a talking point for gatherings of Insightia readers but a potential turning point for the entire asset management industry.
First the familiar, if not prosaic reasons for the outcome. Bolstered by poor financial returns and a historic lack of engagement, investors felt Exxon’s all-star board wasn’t doing a good enough job holding management to account. Three new directors, endorsements by two other activist funds, and a promise to add two new board members in the next year failed to stave off doubts. Lest Exxon’s last-minute concession be forgotten in defeat, its largest shareholder, Vanguard, indicated it believes the two new board members can still be accommodated.
Exxon Chairman And CEO May Keep Both Roles
As I wrote last week, one botched board appointment was a signal that directors couldn’t be trusted to pick their own colleagues. By next year, half the board will have turned over, although as consolation, Exxon Chairman and CEO Darren Woods may yet keep both roles.
But Engine No. 1 also needed a positive reason for change, and it so happened that institutional investors were ready to accept that without their pressure, energy companies – and Exxon in particular – could not address the implications of climate change on their own businesses.
"Industry analysts have raised questions about Exxon’s overall strategy, including its approach to capital allocation amid increasing levels of debt, which has not preserved value nor driven operational efficiencies within the enterprise," Vanguard said, in supporting two dissident nominees. “We have further observed that an increasingly pressing need exists for Exxon to better align its climate strategy with (1) target setting in line with global peers and (2) its public policy efforts related to climate risks.”
BlackRock went even further. “In our view, Exxon and its board need to further assess the company’s strategy and board expertise against the possibility that demand for fossil fuels may decline rapidly in the coming decades, as was recently discussed in the International Energy Agency’s (IEA) Net Zero 2050 scenario,” it said in a vote bulletin explaining its vote. “The company’s current reluctance to do so presents a corporate governance issue that has the potential to undermine the company’s long-term financial sustainability.”
"A lot of times we make more of something than we should,” King & Spalding partner Richard Fields told me this week. “This is something where I don't think we’ve acknowledged how big this really is."
ESG Activism
"Candidly, the arguments wouldn't have been taken seriously by most mainstream asset managers in the past,” he added. “For the last however many years, holes have sprung in the dyke on ESG issues that have demonstrated there is a huge amount of water waiting to break."
While ESG activism has been gathering pace for several years, it has never until now been the foundation for a proxy contest, let alone the reason for victory. And although it is unlikely to be repeated too frequently, it will send shockwaves through the increasingly overlapping stewardship and activism communities.
"[V]igilance will also be required in an investment community that still too often treats acceptance of the idea that humanity will inevitably drive itself off a cliff as hard-headed realism," Engine No. 1 co-founder Charlie Penner argued at Exxon’s meeting. “Again, changing that mindset and showing it can be done in a profitable manner over the long-term will take years, but bending the trajectory has to start now.”
Josh Black, Editor-in-Chief, Insightia
SEC's Rule Changes
The Securities and Exchange Commission (SEC) has adopted a variety of changes under its new leadership this year, but one of the most noteworthy changes is the U.S. regulator’s understanding of which issues are considered material to investors.
An increasing number of shareholder proposals, especially environmental and social resolutions, are being considered as material by the new SEC leadership, and therefore ineligible for exclusion. In 2020, 49.6% of 14a-8 no-action requests were approved by the regulator, compared to just 44.7% so far this year, according to Proxy Insight Online data.
More importantly, many proposals denied exclusion are consequently receiving impressive support from investors, highlighting that the regulator is prioritizing shareholders in its considerations.
On May 18, a shareholder proposal asking Wendy’s to report on human rights risks in its operations and supply chain won an overwhelming 95.2% of votes cast.
Exclusion of this proposal was rejected in March, the regulator being “unable to concur” with Wendy’s assertion that it already “sets forth comprehensive guidelines with respect to human rights.”
Similar situations have also presented themselves at IBM and ConocoPhillips, where proposals seeking corporate diversity program reporting and the establishment of emissions reduction targets, won 94.3% and 59.3% support respectively, following the denial of no-exclusion requests earlier in the year.
Twenty-two proposals seeking climate change reporting were filed for exclusion with the SEC in the whole of 2020, 10 of which were accepted, compared to three of the 13 filed in the first five months of 2021.
Rejection Of ConocoPhillips’ Exclusion Request
Similarly, eight proposals seeking political lobbying and contributions reporting were filed at the SEC for exclusion in 2020, four of which were accepted, two denied, and two withdrawn by proponents. In the first five months of 2021, nine no-action requests have been filed for proposals of this kind, zero of which have been approved, according to Proxy Insight Online data.
Follow This, the proponent of ConocoPhillips’ emissions reduction proposal, told Proxy Insight Online that the SEC’s rejection of ConocoPhillips’ exclusion request “indicates a shift at the SEC, allowing other investors to build on this decision and submit climate resolutions, which the SEC had largely categorically rejected.”
The new SEC is clearly listening to investors and revising its stance on ESG materiality, as evident not just in its revised approach towards the no-action process, but also in its establishment of a Climate and ESG Task Force and its request for public comment on current ESG disclosure frameworks.
With institutional investors stepping up their support for shareholder proposals, issuers will have no choice but to engage with issues they would historically seek to avoid. If so much can change in one proxy season, the next three could advance ESG activism considerably.
Rebecca Sherratt, Corporate Governance Editor, Insightia
