A new paper, Shareholder Activism on Sustainability Issues by Harvard University’s George Serafeim and colleagues Jody Grewal and Aaron Yoon, was designed to test whether anecdotal evidence that the adoption of minority-supported shareholder proposals on ESG issues are effective in changing firm practice and valuation was true. The answer is yes… and no.
To differentiate the survey from other academic work, the paper makes a distinction between shareholder resolutions on material ESG issues and immaterial ones. It found that 42 per cent of shareholder proposals relating to sustainability topics are material, while the majority, 58 per cent, is immaterial. “This suggests,” posit the authors, “that a significant number of shareholders are unaware of materiality, or are pursuing objectives other than enhancing firm value.” Though, elsewhere, the paper finds that investors largely engage with firms that have declining material ESG and financial performance.
The paper looks at 2,665 shareholder proposals that addressed ESG matters.
Findings suggest that proposals filed on immaterial issues are accompanied by larger and faster increases in firms’ performance on the ESG issue that the proposal identifies, relative to proposals on material issues. But the paper also finds that immaterial proposals are associated with a decline in firm value, while material proposals are associated with an increase in value. These results apply to both shareholder proposals that were voted on and those that were withdrawn subsequent to a commitment to implement them. Performance is measured five years prior to the proposal and five years afterwards.
With these results in mind, the paper then asks: why would managers implement immaterial ESG proposals if that is associated with a loss of value? Their findings suggest that there is evidence that management does not have the inability to differentiate between material and immaterial sustainability issues, and that the implementation of immaterial sustainability issues is often an attempt to divert attention away from poor performance on material issues.The authors also hypothesise that actions on material ESG issues require “large investments, long-time horizons and fundamental changes in products, processes and business models that will affect multiple corporate functions and are therefore much more likely to affect financial performance”. On the other hand, proposals on immaterial issues might be more effective at: increasing the performance of the company on the issue at hand, they cost less money to implement and would therefore have less effect on financial performance.
The paper defines materiality using Sustainability Accounting Standards Board (SASB) definitions, meaning that the same proposal might be deemed material in one industry but immaterial in another, because SASB differentiates materiality strongly by industry. The paper uses MSCI KLD as its source for sustainability data and an ISS dataset from 1997 to 2012 for shareholder proposals.
The authors admit that the results are a conservative test of improved/deteriorating ESG and financial performance because, for example, they were unable to take account of comparisons in performance that might be affected by, say, a water-related proposal at Pepsico that might have inspired Coca-Cola to implement the proposal avoid shareholder pressure. They also cannot mitigate the effects of engagement, which is likely to make other companies adopt the same measures that are adopted as a result of a shareholder proposal. This would also dilute their findings based on performance comparisons.
“Our results suggest that failing to distinguish between material and immaterial sustainability issues might lead to erroneous conclusions,” they conclude.
New disclosures on material ESG issues now contemplated by the SEC could help focus attention on exactly what is material and what is not, both for shareholders and management. Link