Governance and shareholder engagement firm Morrow Sodali has released its fourth annual Global Institutional Investor Survey which includes feedback from a third of the world's assets under management representing $33 trillion gathered from 46 respondents, including several domestic funds.
The results confirm that 2019 will be another year of transformative change as investors step up engagement to better understand the alignment between board composition and business strategy, especially in the way the board oversees corporate culture and the 'tone from the top'.
Increasing role of non-financial factors
In light of the report from the Hayne Royal Commission, these findings reinforce the increasing importance of non-financial factors in assessing a company's performance and corporate behaviour.
Investors want to engage with boards regularly throughout the year and they also want more substantive information about board composition and business strategy. They want clearer explanations on governance and executive remuneration. They also want an integrated narrative that explains environmental, social and governance practices in terms of business risk and sustainable financial performance.
Many investors are moving away from box-ticking and compliance checklists which is good news for companies. It gives companies greater flexibility to explain policies in terms of their specific business conditions and strategic goals. But a deeper dive by investors into companies’ strategic decisions increases demands on the time and attention of directors, requires much greater transparency and needs to consider the continuous disclosure obligations.
Key survey findings
Five important issues raised by the results are:
1. The quality of a company’s governance policies and practices will play a pivotal role when investors make voting decisions
Asked to rank the importance of various factors that determine how they make voting decisions, 93% of respondents selected “governance policies and practices”, 72% selected “long-term business strategy”, 65% selected “the quality and completeness of the company’s communications” and 54% selected “environmental and social policies and practices.”
2. Investor focus on board engagement continues to increase
A whopping 87% of respondents indicated that “proactive and regular engagement with the board of directors” helps in their evaluation of a company’s culture, purpose and reputational risk. In addition, 72% selected “proactive and regular engagement with management.” Thoughtfully planned engagements have become critical, strategic initiatives. They help secure favourable votes and minimise threats of activism. Additional context on proactive engagement can be found in the responses to “What are your goals when engaging with listed companies and their directors?” with 67% seeking to understand the company’s business strategy and capital structure and to understand how the board oversees corporate culture and the tone at the top. Only 35% see engagement as a way for investors to proactively inform companies about their voting policies and investment philosophy.
3. Investors will increase their focus on board composition and accountability in 2019
The spotlight will continue to be on director competence and boardroom transparency. Respondents made clear that the “skills” (70%) and “independence” (67%) of directors are critical factors in their evaluation of individual board members. These results are reinforced by their response to diversity. Gender and ethnicity scored much lower in importance than “skills and qualifications” (89%) and “professional experience” (72%) as criteria for judging the diversity of a board’s composition. Investors also signalled their support for board evaluation, done either internally or with an external third-party assessment.
4. Companies can expect more focus on disclosure and increased dialogue around climate change
85% of respondents said that they view climate change as the most important sustainability topic. This result is slightly different than responses to a previous question where, when asked to rank the importance of detailed disclosure on a list of topics, 83% wanted more detailed information about human capital management, while 76% wanted more detail on climate change. This result may indicate that currently more information is available on climate change than on human capital management. The challenge for both companies and institutional investors is to better understand and agree upon which metrics are relevant to a company’s long-term performance and agree on standards that permit comparability with its peers and within a specific industry.
5. An activist’s credible story focusing on long-term strategy is likely to attract investor support
Activism is on the increase both in Australia and internationally. But even so, activists need the support of their fellow shareholders to leverage their influence. In 2017 we identified that 57% of respondents would engage with activists when approached, and 43% would proactively approach activists. This year we sought to find out what are the issues that might trigger such a discussion. Whilst historically activists tended to rest their cases on financial restructuring and operational improvements, these days more strategic issues become common – for example M&A, capital allocation and other aspects of corporate strategy. It is therefore interesting to observe that institutional investors are most likely to support an activist with a credible story focused on long-term strategy (50%) and in cases where the target company has unclear business strategy (46%), misallocated capital (43%) or a lack of board accountability to shareholder concerns (41%). Strategic shareholder activism is now defined as an asset class. Activism is here to stay. The debate over whether activism creates or destroys value is now mainly a topic of interest to academics and regulators, while companies must adapt to the realities of a marketplace that encourages activism.
Looking ahead
The trends of increased investor engagement as well as deeper integration of ESG into the investment process are at an important juncture for equity capital markets; our survey highlights this with increasing conviction each year.
As asset owners demand greater transparency on how investment managers exercise their stewardship duties, not merely to attract investment returns but also increasingly to integrate ESG considerations into the investment decision making process, we observe the encouraging progress on this journey.
The change of pace around ESG integration, the continued rise of activism and recent corporate scandals all combine to create an ever-growing necessity for companies to keep abreast of the expectations and thinking of their Institutional Investors. Those who do this will observe that investors have shifted their focus from a company's compliance with corporate governance codes, to sustainability related principles that have impact beyond proxy voting to engagement strategies and investment decisions.
Maria Leftakis is CEO Australia at Morrow Sodali. To read the Morrow Sodali’s Global Institutional Investor Survey in full, click here.