A growing number of investors are undertaking corporate engagement and exercising their rights as shareholders to influence corporate behaviour.
Between 2014 and 2016, the volume of assets managed with explicit commitments to engage or vote on ESG issues grew 41% (GSIA, 2016). In Europe alone, engagement (and exercising voting rights) is the third most popular responsible investment strategy. It is carried out by managers of more than €4.27 trillion assets under management, a figure that grew by 30% in the two years to 2016 (Eurosif, 2016: 22).
This growth will continue to be sustained through the support of regulatory changes such as the EU Shareholders’ Rights Directive, the progression of global corporate governance and stewardship code requirements, and mounting social pressures on companies and investors to adopt of more sustainable business practices (Çelik & Isaksson, 2013).
This shift in institutional investor practices towards ‘active’ forms of ownership indicates that institutional investors recognise that their fiduciary duty to clients and beneficiaries should involve purposeful consideration, monitoring and intervention regarding ESG factors affecting investee companies.
However, despite the increasing amount of resources devoted by institutional investors to engagement practices, the manner in which ESG engagement creates value remains understudied. Moreover, studies that focus on the role of companies in the engagement process are especially scarce. This report addresses these gaps, and acts as the first product of an on-going research project commissioned by the Principles for Responsible Investment (PRI) to develop a better knowledge of how and why ESG engagement can create value for both companies and investors.
Moving from whether to how: Value-creation dynamics
Studies have shown that engagement can help protect long-term investment value (Blackrock & Ceres, 2015: 2; see also: OECD, 2017; Smith, 1996). Dimson, Karakaş and Li’s (2015) analysis of 2,152 engagement exercises with 613 public firms between 1999 and 2009 offers, thus far, the most convincing empirical results that successful ESG engagement leads to cumulative size-adjusted abnormal returns over the years following the initial engagement. Dimson et al. (2017), confirm these results with regard to collective rather than individual engagement.
This report extends and complements these insights by investigating ‘how’, rather than ‘whether’, ESG engagement creates different types of value for companies and investors alike. In line with O’Sullivan and Gond (2016), we regard engagement as being worth more than its pure financial returns, and we adopt a broad definition of value that recognises a variety of benefits of engagement beyond financial performance alone.
These include: enhanced exchange of information (‘communication value’); the production and diffusion of new ESG-related knowledge (‘learning value’); and the political benefits that can be derived from engagement, for instance, through enhanced executive support for ESG issues (‘political value’)1. These facets of value help us to understand how and why corporations can integrate and manage ESG issues so as to: reduce their exposure to various risks; ensure long-term financial value creation; and contribute to more sustainable societies. This report unpacks the value-creation dynamics by which these benefits are captured by investors and corporations through ESG engagement.
Bringing the corporate perspective to the fore
A distinctive feature of this study is its adoption of the corporate perspective on engagement. Engagement is a relational process between investors and companies (McNulty & Nordberg, 2016). The intra-organisational dynamics that take place within companies are therefore as central to the investigation of whether and how ESG engagement can create long-term financial value as are those taking place within institutional investor organisations.
For instance, recent practitioner reports suggest that engagement is often merely a box-ticking exercise for compliance experts, rather than a genuine catalyst for ESG policy implementation by corporate board members (VBDO, 2014). Further, they also shed light on the differences arising between corporate investor relations and sustainability specialists – with regard to language, timeframes, knowledge, and resources – which can lead to a ‘sustainability-investment’ gap within companies (SustainAbility, 2016).
Our research examines the interactions between the actors in charge of ESG engagement within corporations (e.g. investor relations or sustainability department executives), and/or institutional investors (e.g. ESG or financial analysts in asset management firms). We focus on increased communication, learning opportunities and executive support for ESG issues during, and as a result of, engagement.
We do not assume that the dynamics we identify in this report are present in all their dimensions in every ESG engagement process. Rather, we regard them as a range of plausible explanations for how and why engagement practices may contribute to the long-term value of investments and delivery of abnormal returns. As a result, these dynamics offer a useful tool to evaluate and analyse how a given process of ESG engagement can produce benefits for companies and investors alike.
Research process and method
In order to provide corporations with a voice, and to understand their perspectives on ESG engagement, we adopted a qualitative approach, conducting interviews with 52 executives responsible for the management of investor ESG requests at 36 companies, between January and August 2017. These global corporations operate across a broad range of industries and are listed in Asia, Australia, Europe and North America. We deliberately sampled corporations known for having been engaged through PRI-led collective investor engagements in prior years.
This primary data obtained from the interviews was complemented with numerous secondary data about each specific corporate case. Appendix A provides a more detailed presentation of our sample of interviewed companies.
Although the key results presented in the report are mainly derived from the analysis of corporate interviews, our analysis was also informed by broader knowledge of the ESG engagement context. That is, our comparison of corporate and investor perspectives was also enabled by our access to approximately 30 interviews with investors conducted by the PRI about their ESG engagement practices, as well as insights gained through a prior study incorporating 36 interviews with institutional investors based in Europe (see: O’Sullivan & Gond, 2016).2 Our results are thus based on in-depth, qualitative insights gained from more than 102 interviews with ESG engagement professionals.