Guest Blog | The Financial CHOICE Act: The Wrong Choice for Investors and Companies, Part II


In Part I of this series, we focused on how section 844 would eliminate the right for all but the very largest shareholders to file shareholder proposals. Part two explores how the existing shareholder proposal process has been instrumental in enhancing corporate transparency on critical ESG issues and what its dismantling would mean.

How Do Shareholder Proposals Benefit Investors?

What Is Non-financial Information?

Non-financial information is disclosure on issues and metrics that impact company performance that are not generally referenced on a company’s financial statements. The Global Reporting Initiative (GRI) defines this as extra-financial information. Some examples include information related to corporate governance, intellectual capital, human capital practices, customer satisfaction, climate change, human rights and reputation risk.

Contrary to the term’s implication, non-financial aspects of a company’s operations can have a profound financial impact that may not be immediately apparent and have not been accounted for in a company’s short-term returns. In other words, while traditional financial reporting concentrates on accounting for what has already happened, extra-financial reporting can provide insight into factors that may strongly influence future financial performance.

Shareholder proposals can lead to substantive improvement in corporate policies and practices that create impact far beyond the companies that were the original target of the proposal. If a proposal is adopted by one company, and doing so provides competitive advantage, other companies may follow, thus raising the bar across the broader market and potentially enhancing the performance of multiple corporations in the long run.

Investors who file shareholder proposals often serve as proverbial canaries in the coal mine, driving awareness of issues before they hit the bottom line and often before the wider investment community takes notice. Until reporting on long-term, so-called “non-financial” issues becomes standard practice, shareholder proposals serve as a way to get such issues onto a company’s agenda.

An April, 2017 EY survey of 320 global institutional investors’ attitudes to non-financial reporting found that over 80% of respondents believe ESG risks have been ignored for far too long and that non-financial risks are not adequately disclosed by companies. 68% believe that non-financial performance plays a pivotal role in investment decisions.

Shareholder proposal proponents often file to obtain information not currently publicly available that will allow for a more complete evaluation of an investment. Broad-based efforts are now underway to standardize reporting frameworks to guide the disclosure of the types of non-financial information regularly requested via the shareholder proposal process. The Sustainable Accounting Standards Board (SASB) and Task Force on Climate Related Disclosures (TFCD) are both strong examples. If broadly adopted these standards could eliminate the need for many such proposals.

Sustainability Reporting

Direct Impact: 85 U. S. companies have issued substantive sustainability reports prompted by shareholder resolutions since 2009.

Systemic Change: 81% of S&P 500 companies were publishing sustainability reports by the end of 2015.

Business Case: It is now widely recognized that companies focused on sustainability significantly outperform their counterparts over the long term, both in terms of stock market and accounting performance. (The Impact of Corporate Sustainability on Organizational Processes and Performance)

Board Diversity

Direct Impact: Over 150 shareholder proposals focused on diversity have been filed since 2008, with an average 80% withdrawal rate] as companies came to the table and agreed to take action.

Systemic Change: Board diversity amongst S&P 500 companies achieved an all-time high of 31% in 2016, representing a painfully slow but steady increase from 25.5% in 2010. The number of S&P 500 boards with no women dropped to six, a record low.

Business Case: Companies with “at least three women on their board in 2011 saw a median change in Return on Equity (ROE) of 10 percentage points and in Earnings Per Share (EPS) of +37% by 2016, while companies with zero women on the board in 2011 saw median changes of -1 percentage point and -8% respectively over the same period.” Companies lacking board diversity also suffered more governance-related controversies than average. (MSCI)

Climate Change

Direct Impact: Few investors supported climate risk proposals when they first emerged and they received relatively low support for many years. In 2005, Proxy Preview reported the average support level for climate-related proposals at 14%, but this increased to 26% by 2016. Fast-forward to 2017 and the shifting attitudes towards climate risk are clearly reflected in landmark majority votes at Exxon Mobil, Occidental and PPL owing to support from major institutional investors such as BlackRock and Fidelity.

Systemic Change: The TFCD disclosure recommendations have been widely endorsed by major investors and companies, and were included in the G20’s climate and energy action plan. These developments reflect a general consensus among the leaders of the world’s largest economies that risks and opportunities arising from climate change must be addressed and disclosed.

Business Case: Carbon reduction can enhance financial performance and reduce risk.  Nearly 80,000 emission-reducing projects by 190 Fortune 500 companies resulted in almost $3.7 billion in savings in 2016 alone. As of December, 2016, 48% of all Fortune 500 companies have at least one climate or clean energy target. Increasingly companies are setting 100% renewable energy goals and science-based greenhouse gas reduction targets that align with the global goal of limiting temperature rise to below two degrees Celsius. (Power Forward 3.0).

Human Rights

Direct Impact: The first shareholder proposal addressing LBGT rights in the workplace was filed at Cracker Barrel in 1992. Although the SEC allowed this resolution to be excluded from the ballot, many more similar proposals were filed in subsequent years at major U. S. companies.

Systemic Change: The protracted efforts of investors led to a majority of S&P 500 companies adopting sexual orientation nondiscrimination policies.

Business Case: Research by Credit Suisse indicates that the adoption of such policies may boost returns, finding that 270 global companies with inclusive policies outperformed global stock markets by 3% over a period of six years.

What Is at Stake for Companies in Section 844?

Section 844 would be a severe blow to shareholder democracy as it would dismantle a well-functioning mechanism that creates value and reduces risk. The examples above demonstrate how shareholders have been at the forefront of encouraging focus on non-financial factors that influence the long-term financial performance and reputational standing of public companies. As recent research by Bank of America states, “Companies exhibiting strong performance on ESG metrics are less volatile, demonstrate lower earnings risk, and are less susceptible to price declines in bankruptcy”.

Drastic policy changes can lead to unintended consequences. Stu Dalheim, Vice President, Shareholder Advocacy at Calvert Research and Management, believes that “the shareholder resolution process is not only an important tool in our advocacy toolkit; it also serves as a stress release valve.” In the absence of the current system, it is unlikely that shareholders will just sit on the sidelines.

So, what happens if this “stress relief valve” is removed from the system? 

Rob Berridge, Director of Shareholder Engagement at Ceres, indicates that “The proposal process is efficient compared to the alternatives – such as voting against directors, lawsuits, books and records requests, and requests for additional regulations. Each of these is more onerous and adversarial than including a 500-word proposal in the proxy statement for the consideration of shareholders.” 

Companies that choose to have a conversation in response to a proposal may find that the benefits to dialogue far outweigh any costs. Each year, approximately one third of proposals addressing ESG issues are withdrawn subsequent to productive dialogue. This can result in improved investor relations and a better understanding of the expectations of their shareholders.

Dialogue sparked by shareholder proposals can foster strong long-term relationships that provide insight beyond the focus of a specific proposal into a spectrum of shareholder concerns. Over time, engagement may reduce the overall number of shareholder proposals. As stated in Part I, most resolutions seek greater transparency into a corporation’s assessment and action plan on a specific issue. Therefore, as companies become more transparent, and as investors gain a better understanding of how the company manages ESG issues, investors may not need to rely as heavily on the proposal process to access this information.

Proponents of dismantling the existing shareholder proposal process may find that the unintended consequences are not worth the additional costs as measured in both shareholder dollars and the accompanying deterioration of shareholder relations. We urge companies to focus on the benefits rather than the inconveniences, and encourage them to develop effective communications strategies that leverage the process for the benefit of all stakeholders.

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Holly Testa is the Director of Shareowner Engagement at First Affirmative Financial Network. Connect with her on LinkedIn.

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