- ESG funds have two ways to influence corporate behavior: voice and exit
- Voice uses a fund's rights as a shareholder to push for change
- Funds elect company directors and vote on proposals at annual shareholder meetings
- Funds can directly interact with firm management in engagement sessions
This is Part 2 in a series on how ESG index funds influence corporate behavior. Here's Part 1.
How to be heard
There are several ways that shareholders can influence the policies and priorities of companies they hold.
Shareholders elect a board of directors to manage the company on their behalf. The responsibilities of directors vary from firm to firm, but one of the most important duties is to appoint and evaluate their firm's CEO and other senior management.
To influence a firm's policies, shareholders can nominate and vote for a director who shares their goals. Shareholders can also vote against a specific nominee or against the entire board to signal their unhappiness with the way the company is being run.
In 2015, shareholder activist Fr. Michael Crosby introduced a proposal to nominate a climate change scientist to ExxonMobil's board of directors. The proposal was met by scorn by CEO Rex Tillerson and a vast majority of other shareholders. His activism eventually paid off: in 2017, Susan Avery — a physicist and atomospheric scientist — was elected to Exxon's board of directors. Read more: NYT | NCR
Approve executive compensation
At a firm's annual shareholder meeting, the board of directors submits to a vote an executive compensation plan that details the salaries and bonuses for the firm's senior management. Shareholders can vote for or against the proposal.
Shareholders can use their vote on a compensation plan to express happiness or displeasure with a firm's policies. Shareholders can also demand conditions for executive bonuses by only supporting plans, for example, that make bonuses contingent on a firm's greenhouse gas emissions.
Shareholders for a Minnesota-based utility firm, Xcel Energy, approved an emissions-based long-term bonus for its executive officers. If the firm reduces its emissions by 23% between 2016 and 2019, the CEO will earn about 600,000 USD worth of stock. If emissions decrease by 27.5%, the bonus increases to 4 million USD worth of stock! Full compensation plan details: SEC filing
Introduce and vote on shareholder proposals
In addition to approving compensation and electing directors, at a firm's annual shareholder meeting, shareholders may introduce and vote on proposals that can shape the policies and priorities of the firm.
Shareholder proposals are not legally binding. The board is free to ignore them, even if they pass a majority vote. However, a board that does not fulfill its shareholders' wishes will likely be voted out at the next meeting. Shareholder proposals are taken quite seriously and boards and senior management pay close attention to vote totals when setting annual priorities.
To file a resolution, a shareholder must hold 2,000 USD worth of a firm's stock for at least one year. Firms can challenge a proposal that they wish to omit from the shareholder meeting. The SEC evaluates challenged proposals and rules whether the firm can omit the proposal.
We track shareholder resolutions related to climate change in our Fund Climate Vote Database.
Shareholder proposals are often used by activist investors to open a dialogue with the company's management. If management does not want the publicity associated with a shareholder vote, they may reach out to the shareholder that filed the proposal and make commitments to satisfy the shareholder. If the parties reach an agreement, the shareholder may withdraw their proposal. These conversations are referred to as engagement sessions.
Companies may also proactively start engagement sessions with their shareholders to get a sense for how they will vote on upcoming shareholder proposals. Because institutional investors like Vanguard and BlackRock are the largest shareholders of many companies, they are regularly approached by firms who want to gauge how they will vote at upcoming shareholder meetings.
The details of engagement sessions are typically not made public, so it is impossible for investors in most funds to know what their fund manager is telling managers behind closed-doors.
Climate Action 100+ is an association of institutional investors that share a goal of reducing carbon emissions in the companies they invest in. In April 2019, Climate Action 100+ and Equinor, a Norwegian oil and gas company, disclosed the result of a successful engagement. Equinor made several commitments to its shareholders, including making investments in renewable energy to target a the "well below 2°" scenario specified by the Paris Agreement. See Equinor's Press Release
Voice vs Exit
If a firm chooses to exit a position, it loses the power of voice. Some shareholders, like pension funds, will often try to use their voice to change companies, and use exit as a last resort. Other shareholders, like index funds, cannot use the threat of exit during engagement sessions. They are obligated to invest in a fixed list of companies and cannot change that list based on the result of an engagement session or failed shareholder proposal.
Index funds do not do enough with their increasingly loud voice. Our database shows that the largest index fund providers rarely support shareholder proposals related to climate change.