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March 02, 2011
Companies and Shareowners Differ on what Engagement Means
    by Robert Kropp

Benchmarking of views on engagement by investors and issuers finds that changes in corporate behavior is most likely when shareowners are in agreement on an issue.

In a report described as "the first attempt to benchmark engagement, or the dialogue between public companies and their investors," the Investor Responsibility Research Center Institute (IRRCi) and Institutional Shareholder Services (ISS) found "broad consensus that engagement between issuers and investors is common and increasing," but marked differences between respondents as to what engagement means.

The study, entitled The State of Engagement Between US Corporations and Shareholders, surveyed a wide range of asset owners, asset managers, and issuers. Perhaps as a result of efforts to include voices from such a diversity of respondents, the study reveals a wide range of opinions on the subject of engagement.

Marc Goldstein, head of research engagement for ISS and author of the report, told, "We tried to get a representative sample of issuers and investors." Respondents to an online survey included 161 institutional investors and 335 issuers
based in the US, and ISS followed up with in-depth telephone interviews with 21 investors and 22 issuers.

As an example of the complexity of approaches to engagement, Goldstein pointed out that "Small investors just don't have the resources available to engage as CalPERS or TIAA-CREF do. Large institutions that own a significant percentage of companies have a powerful incentive to engage, not just talking to the IR departments but with the boards."

Nevertheless, the report did find that a power shift in engagement has occurred in recent years. As Goldstein pointed out, "The financial crisis damaged the credibility of corporations. Boards could no longer say, trust us, we know what we're doing. There's powerful evidence that boards did an inadequate job of risk management. The credibility issues as a result of the financial crisis have led to legislation giving even more power to shareholders."

Legislative initiatives such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, as well as subsequent regulatory actions by the Securities and Exchange Commission (SEC) such as enhanced disclosure requirements and mandating corporations to permit advisory votes on executive compensation, have created an environment in which "issuers now appear to be more willing to engage, while investors have more to gain from engagement," according to the report.

"Another reason for the power shift is that shareholders have been fighting for a long time to get companies to adopt majority voting for directors," Goldstein added.

However, the report also found that the question of what constitutes engagement received markedly different answers from companies and investors. "A lot of issuers still think of engagement as picking up the phone and calling their top ten investors every time a quarterly financial report comes out," Goldstein said. "They prefer to have conversations with portfolio managers about strategy and performance, and are not happy to talk with corporate governance or proxy voting specialists about board leadership or compensation."

He continued, "Investors say a typical engagement lasts a month or more, and issuers say a week or less."

According to the report, "Engagement is most likely to lead to concrete change by issuers in areas where shareholders are broadly in agreement, such as declassification of the board of directors or the elimination of poor pay practices, than in areas where shareholders' views diverge, such as the need for an independent board chair."

"Majority voting is one example of an issue about which shareholders are in broad agreement," Goldstein said. "Separating the CEO and Chair positions, on the other hand, is not in this category, although a lot of investors say they're in favor of it. But votes in favor of shareholder proposals on the issue tend not to be so high."

When spoke last year with Julie Tanner, Assistant Director of socially responsible investing (SRI) at Christian Brothers Investment Services (CBIS), she expressed disappointment in the recommendation to institutional investors by ISS to vote against a shareowner resolution calling for the separation of CEO and chair at Goldman Sachs, observing that the proposal could have received as much as 15% more support if ISS had recommended a vote in favor.

Asked about the position of ISS on the issue, Goldstein said, "We like the concept of separating the positions, but we are willing to make exceptions in cases when companies can demonstrate that there is a robust independent lead director. When you combine the Chair and CEO, you need a strong counterweight to that."

Investors and issuers alike reported that the number of issues addressed through engagement is increasing, and to a degree the greater specificity of engagements relating to environmental and social issues have contributed to the trend. As the study reported, "The director of CSR for an asset owner noted that the issues of concern to her constituents had become more specific for example, moving from sustainability generally, to issues such as hydraulic fracturing requiring her to have more engagement with issuers on specific topics."

Goldstein said, "Nearly half of asset owners said that when they request engagement with an issuer, they talk about environmental or social issues. For asset managers, the results weren't nearly as high."

"We know that sustainability issues aren't going to become less important, and engagement around compensation is only going to increase," he continued. "We're seeing attempts to tie compensation to the achievement of environmental and social goals."

The report pointed out that a lack of resources was most often cited by asset owners and asset managers as an impediment to effective engagement. Goldstein said, "The need for engagement isn't diminishing, and until the market improves enough that mutual funds can hire more staff, we're likely to see more attempts to share the burden."

"The fact that investors consider engagement to be important but find resource restraints suggests that we may see more attempts to share the burden by engaging collectively," he continued.


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