Shareholder Activism: The Missing Piece in Fighting Climate Change?
Tags: Activism, Retail Investors, Shareholder Activism, Sustainable Investment, Esg

Over the past years, the outcry for climate action and sustainability has only gotten louder and louder. It’s been great to observe the initiatives and companies in my network that have been started since, as well as more and more sustainable brands and products gaining traction, fueled by more sustainable consumer demands.

At the same time, ESG-investment products (rated well for their Environmental, Social and Governance criteria), most famously ETFs, are receiving higher than ever capital inflow.

The simple idea that formed in my head was that sustainable capitalism is an interaction of three factors:

(1) Behavior — riding bicycle, eating local vegetables, recycling plastic,…

(2) Consumption — buying sustainably produced goods and services, consuming less, saving water, saving electricity, … and

(3) Investing — which companies we invest in and how we monitor them as shareholders.

As a finance enthusiast, I decided to shift my personal portfolio into 100% “sustainable” products, green bonds, ESG-rated ETFs and companies. However, the deeper I got into the topic of sustainable investing (check this free course recommendation from my Alma mater), the more I realized that ESG-investing was not all that sustainable (a discussion of the arguments will follow below). And then, wallstreetbets, Gamestop and other “stonks” happened.

In addition to all the hype around short-selling and hedge funds it created, the simple insight was that small investors can have a real impact if they collectively allocate their money to pool their power.

What occurred to me is that there exists a more structured mechanism for collective investor actions, just that it seems to be extremely unpopular among retail investors: a set of investor rights and mechanisms that can be grouped under the term “Shareholder Activism”.

In the following, I will therefore shed some light on what shareholder activism is and why it can and should play a huge role in solving some of our largest problems today.

Before diving deeper into the idea behind shareholder activism, I want to provide some background on sustainable investing and why investing matters as much as behavior and consumption, if we intend to fight climate change and other ESG-issues.

Why sustainable investing matters

In total, according to the SEC, retail investors own about 58% of the stock market. In aggregation then, the money of small investors — you and me, everyone owning shares, ETFs, mutual funds or a pension scheme, has serious power and serious impact on our societies, our real economy and our planet.

Why is sustainable investing powerful? Oftentimes, consumers blame corporations for their misconduct, but at the same time, they keep buying and using their products, while also demanding low prices on them, which makes it hard for businesses to act more sustainably.

Note that I do not want to lecture anyone, or to generalize individual behavior. I merely want to point to the fact that sustainable investing provides a tool to solve the chicken and egg problem of demand and supply: with sustainable investing, you have some say as to which corporations get financial resources and how they operate. That is, we can influence what is standing on the supermarket shelf, to avoid the dilemma of facing only “bad” consumption options.

In the following, let’s explore what sustainable investing means in practice and how you can have an impact, even as a small investor. For the purpose of this article, I differentiate two approaches to sustainable investing: ESG-investing and Shareholder Activism.

Mechanics of ESG-investing

Let’s start with a definition of what ESG-investing is: an investment approach that does not purely aim to maximize the financial return for shareholders, i.e. the profit of the company, but also takes into account and aims to minimize “negative externalities” that a business may produce for the environment, its workers, or other stakeholders that are somehow affected by its operations.

Given the urgent attention that climate change is rightfully receiving, a sustainable finance industry has emerged that uses different methods to identify and rank companies according to their sustainability standards like CO2-emissions, workers rights, gender equality on boards of directors and much more.

These methods include ESG-rating and ranking methodologies that allow investors and asset managers to divest from unsustainable firms and to invest into well-rated companies. Before exploring why this approach is limited, let’s look at shareholder activism.

Mechanics of Shareholder Activism

What is Shareholder Activism? When you own common stock in a company, you are eligible to propose and vote on shareholder resolutions at the Annual General Meeting (AGM), you are able to ask questions to the management and you can request information from the company. Typical matters to vote on include which directors are appointed to the board, dividend payouts, as well as the strategic direction of a company. These rights enable shareholders to monitor corporations, ensuring that management boards act in line with shareholder interests — your interests.

For those who want to have a truly sustainable impact with their money then, shareholder activism poses an opportunity to ensure that firms create ESG-strategies and targets, implement them and report on them transparently the same way they report on financial information.

Today, for large, institutional investors and asset managers, there are service providers, so-called proxy advisors, who take over the task of joining AGMs and voting, as well as engaging in discussions, if necessary. Similarly, hedge funds become activist investors, usually to push for specific strategic matters.

For retail investors, however, voting is somewhat unpopular with only 12% of retail accounts participating in votes and merely 32% of eligible shareholder votes being cast, on average. Regardless, research suggests that active retail investors do have an impact, if they vote and engage with corporations.

Why only ESG-investing isn’t enough?

While ESG-investing can certainly help to create a more sustainable economy, it is also flawed and can mislead investors regarding the impact their money has.

The following is only a brief and debatable list of shortcomings (more here):

Divestment from bad companies in the stock market has no effect, or a limited, indirect impact on a firm’s available capital and therefore, the real economy. That is, because (1) the secondary stock market does not directly affect the cash that a company has available for investments and (2) if the firm’s financial performance remains unchanged, other investors will likely step in and buy the shares, pushing the price up again

ESG-ranking and rating methodologies suffer from a lack of transparency and a lack of standardization. This leads to limited comparability across sectors and companies

As shareholder value maximization, i.e. profit maximization is not always aligned with good ESG-performance, many “ESG” activities are rather a marketing gimmick aka. Greenwashing

The data available for ESG-ratings is often insufficient or unreliable, given that they are either self-reported or collected by auditors who are paid by the audited firm

There is simply a lack of many relevant data points, e.g. data concerning the full value chain of companies, suppliers of suppliers and other sub-contractors (“Scope 3 data)

Many ESG-rated mutual funds, ETFs and other investment products vote against ESG resolutions or do not take their monitoring functions seriously, delegating voting to proxy advisors without reviewing their default suggestions in order to save costs

ESG-certification creates a bias towards large firms, able to pay the costs of expensive ESG-ratings services

Some ESG certificates are obtained by buying carbon credits or other CO2-emissions offsetting products. While this is a fair start, it does not create any CO2-emission reductions or a change in operations

Therefore, let’s get to the essence:

Why is shareholder activism a solution to truly sustainable investing?

A good, recent example of the impact of shareholder activism is oil giant Exxon Mobil. In May 2021, hedge fund Engine №1 bought Exxon shares and convinced other shareholders of Exxon Mobil, including Blackrock, the largest asset manager in the world, to initiate Exxon’s shift away from fossil fuels, towards more sustainable energy sources. Ultimately, three new board members were appointed to push for the energy transition and a more sustainable agenda.

What is noteworthy about this is that an ESG-investing approach would have sold Exxon shares thus losing all power to influence the company. However, by investing in Exxon and using the voting power that comes with it, these investors have directly changed corporate behaviour for the better.

This recent case is one of a few popular examples. Now, imagine the potential that is currently lost, because 88% of retail investors do not make use of their voting rights, pushing for similar strategies at more corporations!

The conclusion is simple. Truly sustainable investing is active investing. Let’s turn to the status quo of shareholder activism and what we can do in practice.

Shareholder activism in practice

When you own shares with voting rights, in most cases your broker will inform you about upcoming Annual General Meetings and necessary information to participate in the votes via the corporation’s investor relations website or by joining the AGM. As you may imagine, the list of matters to vote on is long for every AGM and for many of the voting options, you will not have heard of the matter in question, or the board directors that are up for selection unless you are an industry insider or finance professional. Hence, the process is somewhat complex, both bureaucratically as well as informationally.

Enter Proxy Voting

Fortunately, there is a solution that allows you to make use of your votes without all the hassle. Just like institutional investors, retail investors can delegate their votes to a representative, who votes on their behalf. The options range from finding a personal representative like a lawyer or anyone else you trust to joining retail investor associations. We can see with the low retail voting participation that few retail investors are currently making use of these options.

In addition to the fact that all these solutions are somewhat cumbersome and expensive, another reason for the unpopularity of shareholder activism is probably that corporations do not have a particular incentive to advertise or make the topic accessible. After all, most management boards consider it a distraction from their own agendas to deal with small shareholder demands. In view of the urgency of the climate crisis and the rather slow response of many corporations then, this is another argument for the importance of increasing shareholder activism.

Conclusion

Our investment decisions contribute to the health of our planet and our society as much as behavior and consumption decisions.

While ESG-investing/divesting faces severe limitations, shareholder activism appears to be an underutilised tool in the fight for a more sustainable capitalism.

While institutional investors have long been using activist strategies to achieve their goals and now do so to push for ESG-outcomes as the Exxon case shows, retail investors face a bigger challenge in coordinating and realizing their influence.

However, pooled retail investor voting and other forms of small shareholder activism can have a huge impact, given the direct effect of pushing for ESG strategies. This effect has spill-over potential to the industry, suppliers, competitors, customers, and smaller, privately held firms, who follow the standards that the largest players set in the market.

One implication is that investors must carefully rethink their investments into ESG-rated funds and firms, as divesting or excluding firms may not be the most effective strategy.

Moreover, mutual funds, ETFs, and other financial products offered by asset managers are problematic, given that asset managers do not always vote in line with ESG-criteria.

We are currently working on providing an easier and better solution for shareholder activism — if you want to get notified about our progress, drop your email here.

Keep a lookout for the next read, where we will explore the concept of Beta Activism and why there is also a financial benefit to fighting climate change and other risks by means of shareholder activism!

Finally, please share and discuss with your friends, colleagues and fellow investors — I am looking forward to your comments, critique, and feedback!

Kudos: Thank you Conor Digan for your review, comments and ideas!