Power relationships and influence matter a lot when it comes to corporate behaviour. However one of the less well covered power relationships is between investors and the companies they own. A recent paper by Fabrizio Ferraro (IESE) and Daniel Beunza (LSE) offers some interesting insights on how the Interfaith Center on Corporate Responsibility (ICCR) has used its position as an investor in major multinationals to catalyse changes in corporate behaviour through dialogue. The findings are revealing and also relevant for non-investors, such as activists and certification bodies, for engaging with corporates on environmental, social and governance (ESG) issues. The constructive and collaborative nature of dialogue enables corporates to be more willing to engage.
In Part 1 of this blog post, the key findings of this paper are discussed together with implications for the pensions and investment industry, particularly the way in which fund managers can play a stronger role. Part 2 will analyse broader implications for other stakeholders, including activists, and the way in which non-investors can influence corporates by collaborating with the investment channel.
In their award-winning paper entitled Why talk? A process of model of dialogue in shareholder engagement, Ferraro and Beunza (2014) observe and analyse the ICCR’s successful and unsuccessful engagement with a range of well-known companies including retailer Walmart (who recently raised their minimum wage paid to employees), drug company Merck (who opened access in developing countries to an HIV children’s drug patent) and oil major Exxon Mobil. ICCR is a coalition of “faith and value-driven” investors who aim to use their investments to push for social change.
When companies talk about their obligations, they traditionally refer to acting in the best interests of their shareholders from a financial perspective. However as investors have begun to become more concerned with ESG issues, shareholders have been more willing to engage with companies they own to instigate change. As owners of the firm, shareholders are able to exert influence over management through formal channels (eg shareholder resolutions, attending annual general meetings) and informal channels such as meeting with management to discuss ESG issues.
Ferraro and Beunza focus on the way in which dialogue between shareholders and corporate management is able to shape corporate behaviour on ESG matters (emphasis mine):
Specifically, we argue that stakeholders can wield influence by shaping corporate debate… stakeholders perform three sets of activities: they raise awareness about the issues of concern, build coalitions with potential supporters within the corporation, and reframe the issue in business terms. When shareholders are committed to the dialogue and these encounters are repeated, trust develops among the parties.
Looking at each of the three activities in turn:
1) Raising awareness:
All forms of engagement with corporates are aimed at highlighting an issue which stakeholders would like to be addressed. What is different in this instance is the use of constructive dialogue rather than other more aggressive forms of engagement.
ESG-aware investors have a vested interest in this matter: they want good financial performance, but crucially they also want this to be achieved in a responsible way. This vested interest explains why private dialogue may be the preferred route for engagement. If the investor applied a confrontational public show of disapproval, the investor’s shares in the company may lose value and damage their financial interests.
Previous academic research has tended to focus on the more contentious public engagement between shareholders and corporates, including the use of shareholder proposals and proxy votes to highlight poor ESG practices or by issuing public statements. Public displays of dissatisfaction by investors usually act as a threat which can damage the company’s reputation. By contrast, engaging in a constructive dialogue with a firm can result in more pervasive cultural change within the organisation.
Regardless, Ferraro and Beunza argue that a fine balance is required when engaging on an issue: being forceful but respecting internal limits (emphasis mine):
ICCR pushed for change at Wal-Mart by raising awareness, namely, sensitizing company managers about equal employment opportunities. In the context of stakeholder dialogue, raising awareness has a significant emotional component, as it is grounded in the stakeholders’ ability to elicit the empathy of company managers about how activists feel. This helps managers recognize that an issue exists. Yet the practice requires skill, as senior managers might not be used to direct questioning by outsiders and might feel undermined. For that reason, bringing issues to the boardroom requires the rare ability on the part of the activists to create an emotionally charged, but not explosive, situation.
2) Coalition building:
By using dialogue to break down barriers and build empathy between investors and company management, ICCR is shown as being able to develop internal allies who understand the issues being raised. These internal allies are then able bring the issues into the corporate’s specific context and then identify ways of progressing the matter in a way that is still compatible with the firm’s financial goals.
Ultimately, by using a collaborative non-threatening approach, ICCR is able to get on the “inside” of the firm which means that their ideas become embedded within the corporate. This contrasts with situations where external activists face difficulty in getting the attention of management, where public campaigns may be more effective. A good recent example of this is Greenpeace’s “one-way conversation” with Lego regarding their partnership with Shell.
Ferraro and Beunza argue that the contentious approach to raising awareness can result in the firm deciding to fight the “external” enemy instead of looking to evolve thinking inside the organisation. Meanwhile, forming coalitions with internal influencers can ensure that the message gets to those inside the corporate with the “decision-making authority” (as highlighted in the paper’s analysis of ICCR’s concerns with Merck on their enforcement of HIV drug patents in developing countries), ultimately enabling the issue to be “more likely to resonate with the target audience”.
3) Reframing the issue:
Building mutual trust on ESG matters requires all parties involved to understand the issue on each other’s terms. In the Merck example, ICCR are described as “setting basic premises rather than dictating concrete policies”, which enables firms to understand or contextualise the matter at hand within their own business constraints.
Further, when the problem can be shaped to specifically demonstrate a particular impact on the company’s core business model, corporate management is more likely to pay attention. This is also exemplified in the Merck example from Ferraro and Beunza:
The report wrote of Merck: “the company’s HIV/AIDS response appears to be overly driven by philanthropy. Merck should be bringing the full force of its core business strengths to overcome registration lags, pediatric formulations challenges, and a still-tentative licensing approach” (ICCR, 2006). The report added that access to medicine was not only important in its own right, but also for its business impact. ICCR thus translated a moral frame that activists cared about (“access to medicine”) into a business frame that companies could relate to (“emerging markets.”)
By emphasising their role as the investor, ICCR are able to reposition themselves as an aligned interest group looking to act in a consultative way to create what will hopefully be a win-win situation.
Rules of engagement
Importantly, Ferraro and Beunza do not argue that dialogue is better than confrontation. Rather, the two approaches are both relevant:
… we suggest that dialogue and contentiousness are complementary in achieving a movement’s objectives. We complete our analysis by identifying the conditions under which one is more appropriate than the other
When is dialogue likely to be more successful in comparison to contentious approaches? Ferraro and Beunza highlight the following key determinants:
- “Emerging” versus “mature” issues: Dialogue can encourage thinking on newer ideas, whereas confrontation may be required when trying to fight the status quo.
- Degree of internal corporate debate: Where corporates are already considering their stance on an issue, investor dialogue can add to the conviction of one perspective over another. However, for companies which are more hierarchical in their structure (such as family-controlled firms) or where views are more entrenched, confrontation may be more effective.
- Success of the firm: Weaker firms can be easier targets for confrontation as they are more likely to “cave in” to external pressures. Successful businesses with “higher organizational capacity” are more likely to engage in dialogue to strengthen their industry leadership position.
Ultimately, successful dialogue takes long-term commitments from all parties involved (ICCR engaged Walmart over 10 years, Merck lasted 7 years) with the ultimate aim of achieving “synthesis” where both parties converge towards behaviours that are acceptable to each.
It is also important to recognise that the degree of influence and power varies significantly between stakeholders in each type of interaction. For example, non-shareholder activists may find it more difficult to gain access in order to engage with corporate management through dialogue and may have to subsequently resort to confrontation. This will be further discussed in Part 2 of the blog post.
Principles, responsibility and access to management
The responsible investment movement has gained momentum over recent years, initially through bottom-up initiatives, including the ICCR’s work, to the current commitments under the United Nations Principles for Responsible Investment (UNPRI) initiative. UNPRI is aspirational with signatories working to incorporate ESG considerations into their investment processes through more active engagement.
As indicated earlier, investors are in a privileged position when it comes to engagement as their direct part ownership of firms means that they have the possibility of gaining greater access to management. Principle 2 of UNPRI states that signatories will be “active owners and incorporate ESG issues into our ownership policies and practices.” This principle means that investors cannot shy away from their responsibilities and are required to engage with companies they invest in.
Meanwhile, there is a growing movement for investors to divest from companies which are not engaging on ESG matters. This approach has its merits and can be appealing for getting a company’s attention, especially if they are not willing to enter the debate on the issue of concern (as highlighted above). A potential danger is that by no longer owning companies, investors become outsiders and are likely to have a more limited scope for changing the company’s behaviour.
UNPRI have put together a useful guide to help investors to collaborate on engaging firms on ESG matters. Dialogue is highlighted as an important step in this process, although divestment is also considered as an important signalling approach. An example is Norway’s sovereign wealth fund who took the divestment route for part of its coal related investments in 2014.
Activating fund managers
Where can further dialogue on ESG issues be encouraged? An important group of players in the investment community are fund managers. This group typically has the most day-to-day interaction with corporates: meeting with management is a key part of the job for most investment analysts. It is arguable that this group has the most access to corporate management and potentially has the greatest sway with companies due to the significant amounts of capital invested by these firms on behalf of their end clients.
In my experience, larger fund managers tend to separate the roles of investment analysts from those focused on ESG matters. This means that investment analysts, who have the greatest access to corporate managers, tend to focus purely in financial considerations and only bring up ESG issues when they are expected to specifically impact on the bottom line. Meanwhile, most investors usually deal with ESG considerations through the shareholder proxy mechanism, as outlined by Clark and Viehs (2014), in addition to screening stocks for inclusion or exclusion depending on performance on ESG criteria. These approaches are relatively passive in nature – having a proxy voting policy or excluding a stock is very different from engaging a firm in constructive dialogue on ESG matters.
Is there a missed opportunity in these interactions? How can fund managers and investment analysts influence company practices with respect to ESG issues through dialogue? Would corporate managers view the issues more seriously if investment analysts raised these issues during their regular conference calls and investor meetings? Further, what is the role for fixed income investors and passive investors in engaging on ESG issues? A greater focus on these relationships and dynamics has the potential to enable ESG considerations to become more mainstream.
As Ferraro and Beunza suggest, dialogue and commitment from investors can have profound effects on corporate ESG considerations. Mobilising more of the investment community to take part in this process can build on the momentum from groups such as ICCR. Understanding how players such as fund managers and investment analysts use dialogue to further ESG-related engagement with corporates could be valuable further research.
In Part 2 of this blog post, the focus will shift towards how non-investor activists can engage with corporates through dialogue. The role of the investment community as part of this dialogue will also be considered. It seems natural for non-investor activists to work with investors and fund managers to amplify their message both from the outside the company and by promoting internal dialogue.