By Kai Liekefett and Derek Zaba – partners at Sidley Austin LLP and co-chairs of the firm’s Shareholder Activism & Corporate Defence practice
Activist funds known as ‘economic activists’ have claimed noteworthy successes against Big Oil in the US 2021 proxy season. These triumphs reflect the growing and effective pressure that investors are exerting on public companies to improve their environmental, social and governance (ESG) practices and disclosures.
ESG themes are therefore not only becoming important to investors but have transformed into powerful campaign tools for economic activists who seek to make changes to the composition of public company boards. By incorporating criticisms about alleged ESG failures into their campaigns, such funds have gained traction with proxy advisory firms and institutional investors in their efforts to replace directors through proxy contests.
Indeed, the world’s largest institutional investors and pension funds are becoming increasingly supportive of corporate ESG efforts, particularly those relating to environmental and social issues. These key stakeholders view ESG initiatives as worthwhile undertakings that may improve shareholder value. Also, ESG disclosures overlap substantially with systematic risk, a main concern of institutional investors.
“Institutional investors risk criticism and negative feedback from their clients if they decline to support an activism campaign that raises colourable concerns about a company’s ESG practices or disclosures”
As such, institutional investors have ramped up engagement with public companies in order to advocate for ESG-oriented practices and disclosures. They have also updated their proxy voting policies to address ESG issues. Investor support for ESG-related shareholder proposals continues to increase at the ballot box.
While proxy advisory firms remain focussed on a company’s financial performance in their decision-making criteria, ISS and Glass Lewis have also started to take ESG campaign themes into account when making their vote recommendations in proxy contests. This new approach is pronounced in activism campaigns in which ESG themes can be tied to a target company’s financial performance.
Investor expectations and regulatory requirements as they relate to ESG disclosures are meanwhile evolving rapidly. Under the new US presidential administration, the Securities and Exchange Commission (SEC) has renewed its focus on ESG disclosures. New regulations or guidance may be in the works that would expand required disclosures on ESG topics.
Therefore, activist funds are beginning to add ESG topics to their arsenal of shareholder engagement tools. Activists appreciate that ESG themes may appeal to certain institutional investors when those investors are deciding how to vote in a proxy contest. Furthermore, certain clients of institutional investors are pushing those investors to take ESG issues into consideration when making voting decisions. Such institutional investors risk criticism and negative feedback from their clients if they decline to support an activism campaign that raises colourable concerns about a company’s ESG practices or disclosures.
The support of institutional investors is critical to the outcome of a contested director election or other activism campaign because institutional investors hold the bulk of the shares of publicly traded companies. Thus, any serious economic activist will be sure to appeal to the sensitivities and goals of key institutional investors when crafting the campaign strategy. Activist funds may also derive new fodder to use in their campaigns from more fulsome disclosures by companies on ESG-related issues.
The incorporation of ESG themes into activism campaigns by economic activists is still in the early stages of development. Despite the growing prominence of ESG concerns, activists run the risk of handicapping their campaigns if investors perceive the use of ESG themes as a disingenuous campaign tactic to garner shareholder sympathy.
Economic activists also face the challenge of reconciling their typically short-term investment horizons with ESG theses, which tend to focus on changes over a longer period of time. That said, economic activists who integrate ESG issues into their campaigns in their bids to change the company’s leadership or the direction of corporate policy are not charting a new course.
For decades, economic activists have sought to appeal to governance-minded institutional investors by making corporate governance reform – the ‘G’ in ESG – a key part of their campaigns. Common governance topics in activism campaigns include board declassification, the elimination of poison pills, and the separation of CEO and chairperson roles.
Environmental and social themes – the other letters in ESG – have only recently garnered the interest of the activism world. As issues such as climate change and diversity have shifted into focus in corporate boardrooms, both economic activists and institutional investors are reevaluating their understanding of, and expectations for, what constitutes ‘good’ corporate governance. As part of this evolution of thought, activists and other investors are placing greater emphasis on how boards tackle the environmental and social challenges that confront their companies and industries.
While environmental and climate-related topics are currently the most likely contenders for ESG themes in activism campaigns, social justice concepts may eventually move to the forefront of ESG-related activism. The world and the US experienced serious social justice and public health challenges in 2020. At the same time, leading institutional investors began to recognise research which indicates that boardroom and workforce diversity correlate positively with a company’s performance.
ISS and Glass Lewis have already started to pay attention to this topic and even the SEC and stock exchanges have entered the fray. On 6 August 2021, the SEC approved a proposal from Nasdaq that would require its listed companies to have at least two diverse directors (one who identifies as female and another who identifies as an under-represented minority or LGBTQ+) or explain why they have failed to meet such requirement.
In this new environment, public companies should consider the following proactive steps:
- When reviewing your standard shareholder activism preparedness plan, include an assessment of your potential ESG-related vulnerabilities
- Have counsel with experience in proxy contest defence and ESG issues review your ESG disclosures and practices through a shareholder activism lens
- If a previously unknown investor brings up an ESG-related concern, take the time to learn more about the investor’s background, including whether the investor has any history of engaging in shareholder activism
- Stay up to date on your peers’ ESG initiatives, oversight practices and disclosures and ratings with an ESG rating organisation and ensure that your ESG programmes and ratings are at least in line with those of your peers
- Understand what your shareholder base priorities are in terms of ESG issues and regularly communicate relevant ESG efforts to investors to ensure that you receive credit for ESG undertakings
About The Authors:
Kai Liekefett is a partner in New York and co-chairs Sidley’s Shareholder Activism & Corporate Defence practice. He has 20 years of experience in corporate law in New York, London, Germany, Hong Kong and Tokyo. He spends 100 per cent of his time on activism campaigns, proxy fights and hostile takeovers. In the last five years, Kai has been involved in more than 85 proxy contests, more than any other defence attorney in the world. He holds a Ph.D., magna cum laude, from Freiburg Law University; an Executive MBA, summa cum laude, from Münster Business School; and an LL.M., James Kent Scholar, from Columbia Law School.
Derek Zaba is a partner in the Palo Alto and New York offices and co-chairs Sidley’s Shareholder Activism & Corporate Defence practice. Over the past two decades, he has been involved in dozens of activist campaigns and proxy contests in various advisory and principal capacities. Prior to Sidley, Derek was the head of the activism defence practice at a leading shareholder engagement and corporate governance advisory firm. He holds a J.D. from Stanford Law School, where he graduated Order of the Coif; and an MBA and a BS, cum laude, from Washington University in St. Louis.