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Note: An author of the comments below, John C. Wilcox, has been a panel member or invited expert in several past Forum programs as Chairman of Morrow Sodali and previously as Senior Vice President and Head of Corporate Governance at TIAA-CREF.

 

Source: The Harvard Law School Forum on Corporate Governance and Financial Regulation, February 27, 2019 posting

2019 Institutional Investor Survey

Posted by Kiran Vasantham, David Shammai, and John C. Wilcox, Morrow Sodali, on Wednesday, February 27, 2019

Editor’s Note: Kiran Vasantham is Director of Investor Engagement; David Shammai is Corporate Governance Director—Cross Border; and John C. Wilcox is Chairman of Morrow Sodali. This post is based on their Morrow Sodali memorandum.

Morrow Sodali’s fourth annual Institutional Investor Survey confirms that 2019 will be another year of transformative change in relations between companies and their shareholders. Survey results reveal that investors continue to dig deeper into the inner workings of portfolio companies. Investors aspire to engage with boards of directors regularly throughout the year, not just during proxy season. At the same time, companies should not, from our experience, take it to mean that any outreach request to any investor will be accepted. Outcomes of such requests would depend on the exact nature of the issue and may of course vary from investor to investor. Investors want more substantive information about board composition and business strategy. They want clearer explanations of the business rationale for governance and compensation decisions. They want an integrated narrative that explains environmental, social and governance practices in terms of business risk and sustainable financial performance.

The good news for companies is that these survey results confirm a continuation of many investors’ move away from reductive box-ticking and compliance checklists. Our more recent experience suggests that some investors have indeed progressed their approach, for example to be willing to nuance their voting decisions based on information gained via engagements. At the same time, a more rigid adherence to stated policies persists with others. Some investors are willing to give companies greater flexibility to explain policies in terms of their specific business conditions and strategic goals. At the same time, however, a deeper dive into companies’ strategic decisions increases demands on the time and attention of directors requires much greater transparency and strains the limitations of regulated disclosure.

Some of the 2019 Institutional Investor Key Survey Findings:

The quality of a company’s governance policies and practices will play a pivotal role when investors take voting decisions say most respondents: Question 1 asked investors to rank the importance of various factors that determine how they make voting decisions, summarizing this year’s message to companies about the content of corporate reporting, disclosure and communication. 93% of respondents selected “governance policies and practices”; 72% selected “long-term business strategy”; 65% selected “the quality and completeness of the company’s communications”; 54% selected “environmental and social policies and practices.” Further, in question 15, 72% of respondents agreed that “companies should adopt recommendations of the Task Force on Climate-related financial Disclosures (TCFD).”

Investors say Quarterly Reporting promotes short-term behavior by companies (78%) and investors (72%), however 89% of respondents said that quarterly reporting leads to reliance on earnings guidance. Only 22% would admit that it affects their own behavior. (For a more detailed analysis of quarterly reporting versus earnings guidance, see the Morrow Sodali client memo—Investor Relations—A communications Clearinghouse.)

Investor focus on board engagement continues to increase. A whopping 87% of respondents indicated that “proactive and regular engagement with the board of directors” helps in their evaluation of a company’s culture, purpose and reputational risk. In addition, 72 % selected “proactive and regular engagement with management.” Thoughtfully planned engagements have become critical, strategic initiatives. They help secure favorable votes and minimize threats of activism. Additional context on proactive engagement can be found in the responses to Question 3: “What are your goals when engaging with listed companies and their directors?” 67% are seeking to understand the company’s business strategy and capital structure and to understand how the board oversees corporate culture and the tone at the top. Only 35% see engagement as a way for investors to proactively inform companies about their voting policies and investment philosophy.

Investors will increase their focus on Board Composition and Accountability In 2019. The spotlight will continue to be on director competence and boardroom transparency. In question 5, respondents made clear that the “skills” (70%) and “independence” (67%) of directors are critical factors in their evaluation of individual board members. These results are reinforced by their response to diversity. Gender and ethnicity scored much lower in importance than “skills and qualifications” (89%) and “professional experience” (72%) as criteria for judging the diversity of a board’s composition. Investors also signaled their support for board evaluation, done either internally or with an external third-party assessment.

Companies can expect more focus on disclosure and increased dialogue around climate change strategy. In question 14, 85% of respondents said that they view climate change as the most important sustainability topic. This result is slightly different than the response to question 11 where, when asked to rank the importance of detailed disclosure on a list of topics, 83% wanted more detailed information about human capital management, while 76% wanted more detail on climate change. This result may indicate that currently more information is available on climate change than on human capital management. The challenge for both companies and institutional investors is to better understand and agree upon which metrics are relevant to a company’s long-term performance and agree on standards that permit comparability with its peers and within a specific industry. In many ways, this is a debate that is taking part largely outside the bilateral connection between companies and their investor, with standard setting bodies, whether regulatory or voluntary taking the lead. The hurdles to progress here should not be understated as standardization and relevance could often conflict.

Many investors indicate that executive pay will frequently be the subject of collective engagement efforts in 2019. This was to us an interesting point to observe. The perennial issue of executive compensation/remuneration continues to be viewed by investors as a window into the boardroom and even more deeply into the values and character of a business enterprise. For investors it is the ultimate issue for evaluating board accountability and independence. In the past however, it was very much the case that investors engaged on this issue separately with companies, expressing views that are based on their own distinct policies. Increasingly however, as some of the pay debate shifts to quantum and reputation (at least in some market, notably the UK but also other European markets), investors find themselves able to work together to put forward certain points. This is clear from the response to question 2, where 67% of investors ranked compensation as the most important issue in their engagement with other investors in connection with an AGM. Question 9 gives companies a useful guide to the elements of executive remuneration that matter most to investors: pay for performance (65%), rigour of performance targets (56%) and the infusion of long-term performance targets (41%). Boards must continue to pay careful attention to explain their pay decisions in terms of performance—financial, operational and increasingly related to sustainability measures—and strategic goals.

Activist credible story focusing on long-term strategy, combined with poorly communicated business strategy by the company are likely to attract investor support of activist campaigns. Activism is on the increase both in the US and internationally. But even so, activists need the support of their fellow shareholders to leverage their influence. In 2017 we identified that 57% of respondents would engage with activists when approached, and 43% would proactively approach activists. This year we sought to find out what are the issues that might trigger such a discussion. Whilst historically activist tended to rest their cases on financial restructuring and operational improvements, these days more strategic issues become common—for example M&A, capital allocation and other aspects of corporate strategy. It is therefore interesting to observe that institutional investors are most likely to support an activist with a credible story focused on long-term strategy (50%) and in cases where the target company has unclear business strategy (46%), misallocated capital (43%) or a lack of board accountability to shareholder concerns (41%). Strategic shareholder activism is now defined as an asset class. Activism is here to stay. The debate over whether activism creates or destroys value is now mainly a topic of interest to academics and regulators, while companies must adapt to the realities of a marketplace that encourages activism.

Looking ahead

The trends of more company investor engagement as well as (separately) deeper integration of ESG to the investment process continue to be both at an important juncture for equity capital markets; our survey highlights this with increasing conviction year on year. Institutional investors now more than ever before play an influential role in setting the agenda on this, and in developing the proper tools. In our view it is only a matter of time before this concept becomes near universally accepted and/or quasi legally binding in some markets.

As asset owners demand greater transparency on how investment managers exercise their stewardship duties, not merely to attract investment returns but also increasingly to integrate ESG considerations into the investment decision making process, it is encouraging to observe that each year more and more respondents indicate that they are progressing on this journey.

As recent as last month, a group of prominent institutional investors re-emphasized their commitments to the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) regarding climate risk and the transition to a low carbon economy. This is reflected in the results of our survey, which indicate that in 2019 investors will priorities engagement around sustainability related topics and especially climate change.

The change of pace around ESG integration, the continued rise of activism and recent corporate scandals all combine to create an ever-growing necessity for issuers and their officers to keep abreast of the agenda and intentions of their Institutional Investors. Those who do this will observe that investors have shifted their focus from issuers’ compliance with corporate governance codes, to sustainability related principles that have impact beyond proxy voting to engagement strategies and investment decisions.

The complete publication, including footnotes, is available here .

 

 

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