This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Steve Waygood, Aviva Investors’ chief responsible investment officer, argues it’s better to talk than walk to address poor corporate behaviour.
The economist Albert Hirschman once argued people have two different ways of responding to disappointment: they either stay put and complain or vote with their feet. Hirschman called these options ‘voice’ and ‘exit’. An oppressed citizen may start a protest or emigrate to another country. Unhappy customers may return their goods for a refund or simply start shopping elsewhere.
This dilemma also applies to ethically-minded investors. If shareholders in a company discover it is polluting the environment or mistreating its staff, should they voice their concerns or simply exit the investment?
Divesting from companies that break ethical rules is often the more convenient option and may even bring a useful reputational boost. But once investors sell out they are no longer able to apply pressure to company boards. They may be replaced by less conscientious shareholders, who are more than happy to look the other way as long as the profits keep rolling in. As Hirschman observed, while exiting may sooth the conscience, it tends to entrench the status quo.
Using Your Shareholder Rights
Investors should use their voices before heading for the door. They have the power to fire a company’s leadership at AGMs, and can use this to vote against strategies they oppose. They can also vote against auditors if they are concerned the company’s report and accounts are not being properly scrutinised or do not truthfully represent the financial and reputational risks it faces due to unethical practices.
Shareholders can work in tandem to bolster their influence. Collaborative engagement can be particularly important, when addressing the behaviour of powerful fossil fuel companies that are used to resisting pressure from environmental campaigns. Left unchecked, the activity of these companies could threaten the future of the planet. With the stakes so high, engagement is more important than ever.
If carbon emissions are not curtailed, global temperatures could rise by six degrees by the year 2100. Humanitarian and social disaster could ensue and $43 trillion could be wiped off the value of global financial markets. Without engagement from large and powerful investors, policymakers may not come under enough pressure to correct the market failure. If shareholders stay silent, energy utilities could simply continue burning fossil fuels, using their own lobbying activities to ensure policymakers let them do so.
What Can Shareholders Do?
By collaborating to put pressure on executives, investors can push these companies towards more-sustainable energy sources. Such a transition is in the interests of everyone, including the companies themselves, as at a certain point the remaining hydrocarbon reserves will become uneconomic to extract.
Consider Exxon Mobil’s (XOM) recent steps to improve its approach to climate reporting. The company was traditionally among the most resistant of the oil majors to climate-related initiatives. Yet, after pressure from investors led by the Church of England, Exxon’s reporting now includes assessments of the impact of a global rise in temperatures on its operations, as well as the sensitivity of its portfolio to various supply and demand scenarios, such as the proliferation of electric cars.
Engagement is about reducing the underlying emissions too. Italian multinational electricity firm Enel (ENEL) has pledged never to build another coal station after investors helped to convince it that renewables were winning the battle for competitiveness against fossil fuels and nuclear power. Half of Enel’s £18 billion growth investment over the next five years is going into solar and wind energy, which currently provide just seven per cent of its electricity.
Investors can also influence wider issues such as corporate governance. After years of controversy centring on the exercise of undue political influence and the misappropriation of shareholder funds, South Korea’s Samsung Electronics (005930) announced important reforms, including the appointment of independent international directors and the splitting of the roles of chairman and chief executive. Samsung also revealed it would significantly increase its dividend pay-out ratio, which had long been a point of contention between the controlling family and minority shareholders. The concessions came after investors exerted their influence with the company.
To make their influence felt, investors themselves need a clear process for identifying the companies that are of greatest concern in their portfolios, and ensure their fund managers are proactive in addressing the issues. Institutions can ensure their managers are taking appropriate action by embedding engagement into their incentive structure.
Is there a sanction in place if the engagement plan fails to deliver? And is there a reward if the plan is delivered and change is implemented?
Not every investor will have such a process in place and some do not have the clout to make a company alter its behaviour. Sometimes firms will refuse to improve their business practices no matter how powerfully investors protest. Engagement doesn’t always pay dividends and there will always be a time when the only option is to stop the talk, and walk the walk.
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