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12 March 2018
Board composition, with a particular focus on enhanced diversity
Board-level expertise that is more aligned with business goals
Increased attention to climate risk and the environment
Enhanced attention to talent and human capital management
Compensation that is more aligned with performance and strategy
The EY Center for Board Matters has identified investors' top priorities for companies in 2018, based on its annual investor outreach involving interviews with over 60 institutional investors with an aggregate of $32 trillion under management.
According to EY, the top five investor priorities are:
According to the report, 82% of investors view board composition as a top priority. Currently, the focus is on diversity, with the goal of providing "fresh and different perspectives in the boardroom." While gender diversity was most commonly cited, other forms of diversity may include race and ethnicity, age, nationality and geography and socio-economic backgrounds. About half of respondents reported that they consider board diversity in voting, while a quarter do so in the context of proxy contests and shareholder proposals. The driver appears to be the "interest in effective board composition, given the wide range of studies demonstrating the benefits of diversity, including how diverse perspectives enhance issue identification and problem-solving ability and impede 'group think.'" Other issues were long tenure (which they define as over 10 to 12 years) and board assessment, refreshment and succession. EY reports that about 25% requested enhanced disclosure about board composition, such as showing how board member selection aligns with the company's strategic goals or providing a meaningful skills matrix.
But why is it important for companies to have women on boards? As Bloomberg has argued, while "[e]quality is a worthy goal on its own terms, of course….for the corporate world, the better rationale for gender diversity is financial…. Companies with at least one female director had better returns for six straight years." See this PubCo post. As cited in California Senate Bill No. 826, which would require a minimum number of women on boards (see this Pubco post), a 2017 study by MSCI found that U.S. companies that began the five-year period from 2011 to 2016 with three or more female directors reported earnings per share that were 45% higher than those companies with no female directors at the beginning of the period. In 2014, Credit Suisse found that companies with at least one woman on the board had an average return on equity of 12.2% compared to 10.1% for companies with no female directors. Additionally, the price-to-book value of these firms was greater for those with women on their boards: 2.4 times the value in comparison to 1.8 times the value for zero-women boards.
Over 90% of respondents identified at least one of these topics as an area that might be appropriate for enhanced board expertise—technology, industry, climate competency, risk oversight and strategy, with cybersecurity cited as the most common concern. About half also advocated strengthening industry expertise, including, a few suggested, by adding a non-independent director. Expertise in climate, environmental and social issues was recommended by 46% of respondents. EY observed that, while boards cannot be expected to master technical areas, they do need to be sufficiently informed to "oversee key company-specific priorities." EY also advocated that it may be advisable to include in proxy statement disclosures a description of how board access to expertise is aligned with company strategy.
Addressing climate risk and environmental sustainability, including topics such as resource use, greenhouse gas emissions reduction, carbon footprint or preparation for a low-carbon economy, was a priority for 64% of respondents. Of respondents, 79% agreed that "climate change is a 'significant risk factor,'" and, EY noted, just since 2016, the percentage of investors citing climate change specifically as a priority has more than tripled. When asked to rank priorities in this regard, most investors identified enhanced reporting first, while others ranked changes to company strategy first. EY identified as potential topics for shareholder engagement company environmental policies and activities, including political spending and lobbying. It may make sense, EY suggests, to determine if key investors are supporters of particular frameworks, such as the SASB framework.
In its Annual Corporate Directors Survey for 2017, PwC surveyed 886 directors of public companies and concluded that there was a "real divide" between directors and institutional investors (which own 70% of U.S. public company stocks) on several issues. And the area where the chasm was deepest between directors and investors was on environmental, social and governance issues. For the first time, in 2017, three environmental-related shareholder proposals actually won majority votes, having received support from several large institutional holders (see this PubCo post). At all public companies, the survey shows, average support for climate change shareholder proposals increased from 24% in 2016 to 32% in 2017. Notwithstanding the focus of many institutional investors on ESG issues, 42% of directors say that these issues won't affect their companies' strategies: 40% say climate change should not play a role in determining strategy, 51% say the same about income inequality, 49% about immigration, and 29% say that resource scarcity should not play a role in shaping strategy. But women directors "are more likely to think that social issues should play a part in company strategy formation. And they are much more likely to think that issues like environmental concerns and social instability will force the company to change its strategy in the next three years." A majority of directors don't think that their boards need expertise in sustainability. (See this PubCo post.)
Human capital management comprises a wide range of topics such as attracting, retaining, training and engaging the entire range of the workforce, the relationship of company culture to hiring and retention, and diversity and inclusiveness. Examples presented by investors included issues such as addressing the changing definition of work for millennials, technology-driven displacement of workers, worker training and broader company efforts to address projected skills shortages. Hiring and retention of the best talent can be key to remaining competitive over the long term, and company culture can play a role. For example, EY reported that some investors indicated that "companies that are strongly identified with a culture of improving the environment or benefiting communities have an advantage in attracting top talent, demonstrating that people want to work in companies that have good corporate citizenship."
In BlackRock CEO Laurence Fink's 2018 annual letter to public companies, Fink advocates that companies recognize their responsibilities to stakeholders beyond just shareholders—to employees, customers and communities. According to Fink, among other things, a company should consider its efforts to create a diverse workforce, its retraining programs for employees in an increasingly automated world and its efforts to help prepare workers for retirement. Companies should not, Fink contended, echoing "succumb to short-term pressures to distribute earnings," and sacrifice investments in employee development, innovation, and capital expenditures that are necessary for long-term growth. (See this PubCo post.)
Slightly over a third of investors cited executive compensation as a priority in 2018. Notwithstanding 90% overall approval for say-on-pay proposals, these investors expressed concern "about the rigor of performance incentive structures and the size of pay, with some investors noting that they vote against a significant proportion of Say-on-Pay proposals." In some contexts, investors were looking at the relationship between pay practices and environmental and social considerations, long-term strategic priorities and the culture of integrity and accountability: these "investors noted that misaligned compensation incentives can affect a company's risk culture and the ethical behavior and compliance culture of its people. Some investors shared that accounting for the impact of litigation costs in pay calculation considerations could be one method to enhance pay for performance alignment." Another issue raised was the possible pay disparities related to gender, race or ethnicity as well as pay gaps among various groups of employees. Interestingly, EY reports that only a few investors raised the topic of CEO-employee pay ratio, with the focus there on managing internal communications with the employee population.
As discussed in this PubCo post, a recent study found that inclusion of corporate social responsibility metrics as performance targets in executive compensation arrangements mitigates "corporate short-termism and improves business performance," including significant increases in firm value that foreshadowed a "large and statistically significant" increase in operating profits that materialized within three years. The study authors contended that inclusion of CSR performance targets "enhances the governance of a company by incentivizing managers to adopt a longer time horizon and shift their attention towards stakeholders that are less salient, but contribute to long-term value creation." These CSR factors can improve long-term value creation "because in the long term, social and environmental issues become financial issues.
For further information on this topic please contact Cydney Posner at Cooley LLP by telephone (+1 415 693 2000) or email (firstname.lastname@example.org). The Cooley LLP website can be accessed at www.cooley.com.
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