Affirmative Impact - Spring 2016
Posted on Tuesday, April 19, 2016
Roadblock to Shareowner Empowerment Removed
By Holly A Testa, Director Shareowner Engagement
Investment advisors who file shareholder proposals on behalf of clients can no longer be compelled by companies to provide documentation that proves their authority to do so. This is thanks to the work of Bruce Herbert, Chief Executive of Newground Social Investment, a Seattle-based investment advisor and long-standing partner of First Affirmative Financial Network.
Newground filed a shareholder resolution on behalf of a client focused on a company's vote-counting practices. Baker Hughes Incorporated, a major oil field service company, subsequently informed the Securities and Exchange Commission (SEC) that it planned to omit that proposal from the proxy ballot.
The company argued 1) that Newground did not provide proof it was authorized to file the proposal on behalf of the shareowner, and 2) that the shareowner failed to provide its own written Statement of Intent that it would to continue to hold shares through the date of the company's next annual meeting. Newground had issued the Statement of Intent on behalf of its foundation client, which the company asserted could only be authorized by the client.
Companies often contend that each shareholder proposal requires case-by-case documentation of a client's authorization. Such tactics have successfully blocked meaningful discussion and shareholder votes on a variety of important topics over the years.
Ironically, these demands for proof of authorization often come from law firms that act in an "agency" capacity but are never required to submit evidence of their being authorized to do so.
Herbert refused to jump through the hoops that Baker Hughes placed in his path. Instead, he chose to fight the company's demand for proof of authorization. His rebuttal to the SEC was deliberately presented as a test case of the Principles of Agency as they apply to investment advisors vis-a-vis shareholder authorization and representation.
The SEC fully concurred with Newground's interpretation of Agency law in a precedent-setting ruling that clarifies and establishes that investment advisors who represent their clients operate on the same Agency footing as attorneys that represent corporations. As a result:
- Companies can no longer stall or dodge accountability by demanding proof of representation when a Registered Investment Advisor files a shareholder proposal on a client's behalf.
- An Advisor can issue a Statement of Intent (and other communications) on behalf of a client without being subject to spurious claims of misrepresentation.
On the surface, this ruling may seem technical or obscure, but the SEC's decision has great potential to expand shareholder advocacy-both by allowing current advocates to extend their activities, and by encouraging new firms to join the effort.
"This decision should make participation in this arena significantly more possible for advisors who have not yet gotten their feet wet," said Herbert. "It's been a long-standing goal of Newground's to democratize the process of shareholder advocacy, and to have the ease and possibility of engagement walk arm-in-arm with the responsibility investors have to shepherd the impact of their assets in the world."
First Affirmative could not agree more. We celebrate the SEC's determination and hope to see an expansion of investor engagement around equity, justice, and sustainability issues.
What Should Shareowners Say on Pay?
By Holly Testa, Director, Shareowner Engagement
As income inequality continues to rise, outsized executive pay packages linked to short-term performance are being called into question. This was discussed at length during the recent Investing for Impact event First Affirmative hosted in San Francisco.
In 2011, the SEC (Securities and Exchange Commission) mandated that shareowners have a "say on pay"-the right to vote on executive compensation pay packages. What have we collectively done with this vote? Overwhelmingly shareholders have voted in favor of ever-increasing pay packages for the Chief Executive Officers of public companies, while average worker pay and market returns languish in comparison.
According to First Affirmative's Chief Economist, Mel Miller, disclosure of executive compensation has caused unintended consequences: "Nobody wants to be considered below average, and disclosure of peer pay has led to the "Lake Woebegon effect"-a human tendency of overestimating our own abilities, achievements, and performance."
The Lake Wobegon effect is not limited to executives. The boards of directors responsible for crafting and approving CEO pay packages tend to think they have chosen well-that their CEO is above average! But, statistics clearly show that only a handful of companies have this coveted above average leadership in any given year. And higher pay at the top does not mean better returns for shareowners. In fact, research indicates that the CEO pay at high-paying companies may be negatively related to the company's future stock returns.
Shareowners and boards have a responsibility to determine the real value received by the company in exchange for the pay, as well as the unacceptable trade-offs that may result from getting this value proposition wrong. Excess pay at the top may mean inadequate compensation for other key employees, or it may mean underfunding of capital improvements and research.
Carol Bowie from Institutional Shareholder Services noted that while "Say on Pay" has not reigned in executive compensation, it would probably have been worse without the mandated disclosures, as the growth in the rate of pay increases in the last five years has slowed. She also noted a promising trend: "We have seen a tremendous rise in engagement between directors and investors, and this has spilled over to other issues of concern to investors."
Danielle Fugere from As You Sow shared the results of the organization's second 100 Top Overpaid CEO publication which highlights the worst offenders and pay practices. Her response to the question of what should shareowners say on pay is very straightforward: "Shareholders should say NO, often and vigorously! We don't believe it's good for the economy or for economic growth to keep putting more and more money into the pockets of a very few people. It raises the cost of capital and reduces competitiveness."
Many asset managers working with responsible investors have stringent policies in place and vote against bloated pay packages. First Affirmative, for example, voted against 45% of pay packages at portfolio companies in 2015. But this is in stark contrast to the voting records of many institutional investors. In fact, as Fugere points out, "Some mutual funds have never met a compensation plan they did not like."
It is clear that how we value our "human capital" is broken across the whole spectrum, from the top paid executive to the lowest paid worker. While we collectively work on a solution, we will take Danielle's advice. We will say no, often and vigorously!
How Long Does a Company Need to Stay in SRI Jail?
By Laura Isanuk
The modern world of Sustainable, Responsible, Impact (SRI) investing was initially based on avoiding undesirable companies.
Twenty-five years ago, responsible investment strategies were primarily based on "negative screening" which initially focused on avoiding "sin stocks" such as tobacco and alcohol. Over time, other avoidance criteria were included in the portfolio construction process to side-step companies and industries viewed as creating more negative than positive impacts. Companies causing serious environmental degradation, for example, were added to the avoidance lists beginning in the early 1990s.
More recently, portfolio managers have expanded their horizons to include evaluation of a broader set of corporate behaviors through the analysis of ESG (environmental, social, governance) factors. Some investment managers call this "positive screening;" others simply consider it part of their overall portfolio design and construction process.
Even managers who do not directly identify themselves as being in the responsible investing space are beginning to integrate ESG into portfolio construction. As the volume of available data grows, the evidence mounts that understanding such "non-financial" issues as a company's impact on its employees, customers, and communities, its impact on the natural environment which sustains us all, and its governance practices are critically important. In-depth analysis of ESG factors can shed a bright light on the financial risks and opportunities for public companies.
Some years ago, First Affirmative moved away from exclusively basing investment decisions on negative screens to focus more on the positive attributes of the companies we want to own. Our efforts are now aimed at seeking to own companies of the future.
We also redefined "SRI" as Sustainable, Responsible, Impact
investing. We felt that the original acronym, which stood for
"socially responsible investing," was more negative and too
restrictive. Our approach now reflects both the broadening scope of
what responsible investors care about, as well as the positive
impacts we can have on
public companies through shareowner advocacy.
With discussions around terminology and process intensifying as the industry grows and evolves, we decided that the topic would make a great educational session at our recent regional Investing for Impact event in San Francisco. Specifically, we teed up a discussion focused on how long a company that has been shunned in the past should be considered untouchable and what might influence a manager's decision to let such a company out of "SRI Jail" and add it to a portfolio designed for responsible investors?
So Many Ways to Do SRI, So Little Consensus
What drives the future risk and impact of your portfolio? Many factors like human, social, and environmental capital.
Yelena Danzinger from HIP Investor highlighted the challenges of analyzing company investment potential when 84% of market value is considered "intangible" (value not captured in the financial statements). "Generally Accepted Accounting Principles (GAAP) do not properly account for intangible assets. In economics, land, labor, and capital are factors of production. While land is an asset on the balance sheet, labor is an expense. This can vastly miscalculate and understate the drivers of value creation for all organizations especially when many CEOs claim that people are the most important asset, but people are not classified that way financially."
The breadth and depth of ESG data now available to managers running investment strategies for responsible investors is significantly better than ever before. At the same time, the challenges managers face in deciding how to be truly responsible and positively impactful, while delivering the returns clients expect, are growing and becoming more complex.
Lincoln Pain put it this way: "If [portfolio managers] are looking at these new technologies that are avoiding the past, will they provide the upside for our clients with shorter time horizons, [or] will our clients face more risk?"
It is imperative to monitor macro data as well as actual on-the-ground behaviors and impacts. But there is no easy way to determine what tips the balance from "bad" to "good"-not yet, anyway. However, for those managers who participate in shareowner advocacy, there is always the upside of shareowner engagement creating positive change within targeted companies.
Ways to Get In and Out of SRI Jail
Companies can indeed change their behavior, and new information may present new opportunities. John Streur, CEO of Calvert Investments, stressed that Calvert works hard to gather metrics on how companies are managing risks to measure how well they are doing in meeting their responsibilities to control negative impacts and create positive ones. Streur shared a few success stories from Calvert's files.
- Ball Corporation, a worldwide leader in packaging, recently implemented a sustainability program throughout their manufacturing operations in the U.S. and eight other countries. After monitoring their progress, last year Calvert included the company in a fund portfolio.
- Similarly, Ford Motor Company had for many years been viewed as week on product safety and environmental sustainability. But, under new management, Ford has turned this around with new manufacturing techniques that have led to greater safety and sustainability. Streur says, "I think today one can look at the auto industry and see real leadership from Ford."
- Information on a company's supply chain is hard to come by, and the audit system is prone to misleading investors. Streur noted how Calvert works with small NGOs on the ground. He spotlighted Hanes for being an industry leader in supply chain best practices.
- Another Calvert holding once had a bad reputation for how it treated its workforce. However, over time, this company moved to hire and train a different type of employee and realized that a better connection with employees would result in better profits. It took about eight years to transition, but this company is now on Calvert's okay-to-buy-list.
The plethora of new information and the competitive advantages enjoyed by companies that generally receive high ESG scores has created more challenges as well as more opportunities for investment managers. The good news is that realizing positive impact in public market investments is becoming more and more of a reality every day!
Did You Hear What BP's CEO Said About Climate Change?
Climate change is a big issue of concern for many Americans and for many more citizens of Europe and other countries around the world. Interestingly, corporate America is mostly silent on this issue, which First Affirmative and most of our clients consider perhaps the most important issue of our time.
Why? Because Big Oil, the most profitable and arguably the most powerful corporate sector on the planet, has a vested interest in keeping the world addicted to fossil fuels.
But that could be changing. In an amazing and rare public display in advance of the UN Climate Change Conference in Paris late last year, Bob Dudley, CEO of BP plc publicly acknowledged climate change and urged global governments to pursue policy changes that incentivize shifts to lower-carbon fuel sources, such as renewables.
Dudley's comments were considered shocking, considering they came from the top executive of one of the world's biggest oil companies.
Did he wake up one morning with the realization that burning fossil fuels is putting the entire planet in peril? More likely, he was trying to shift attention to the cleaner energy investments BP has made that could help lead the way toward a new energy future.