Talk isn’t cheap: Engaging corporates on ESG issues (Part 2)

ShareAction In Part 1 of this blog post, the focus was on the use of dialogue between investors and corporates to engage on environmental, social and governance (ESG) issues. A framework for this engagement proposed by Fabrizio Ferraro (IESE) and Daniel Beunza (LSE) was discussed, in addition to the way in which it might possibly be extended to other actors in the investment community, including fund managers.

How can this framework be harnessed and utilised by non-investors? Part 2 of this blog post takes a closer look at aligning the actions of investors and non-investor activists in interacting with corporates. Further, the use of dialogue by groups such as ShareAction, Fairtrade and Oxfam as part of ESG engagement is analysed. Ultimately, further collaboration between end investors, fund managers, civil society organisations (CSOs) and individuals will enable greater awareness and integration of ESG considerations by investors and corporates.

Most of us will be aware of the well-known saying that “money talks”. Capital flows are a crucial element in modern finance and the size of one’s capital base often dictates one’s ability to participate in a conversation. At a corporate level, an example of this is the way in which activist hedge funds, such as Bill Ackman’s Pershing Square, use their sizeable investment balances to buy large stakes in companies they want to influence. Often the aim of these groups is to own a large enough stake in a company to make appointments to the board of directors, hence enabling direct influence on the target firm’s governance.

While this formula has been repeated many times with a for profit motive, the approach is yet to be used, to the best of my (admittedly limited) knowledge, with regard to ESG issues. One could argue that Ackman’s campaign against Herbalife is based on governance factors, but it’s as easy to view the activism purely on financial terms. So the question remains, how can non-investor activists use the investment channel to amplify their voice and have a stronger role in influencing corporates on ESG matters?

Direct engagement and dialogue is already used by these groups and examples will be further discussed below. However, a potentially more powerful approach is for non-investors, end investors and fund managers to collaborate and subsequently engage with corporates in dialogue together.

Untangling the web – alignment of interest groups

As discussed in Part 1 of this blog post, Ferraro and Beunza (2014) shed light on the use of dialogue by ICCR, a coalition of “faith and value-driven” investors, in their attempts to influence corporates to promote social change. One of the case studies discussed in this paper was the ICCR’s dialogue with the Ford Motor Company on environmental issues. In this case, the ICCR was able to use their “convening power” to bring together investors, non-investor activists and the company itself. As stated in the paper:

… one key role ICCR played was to help create a bridge between the company and environmental groups who might not otherwise have sat at the same table with the corporate managers

A logical next step for engaged investors such as ICCR is to further leverage their network in investment circles to include fund managers who invest on their behalf. ICCR’s current asset base is sizeable at over $100 billion. However, ICCR invests with fund managers who have a much larger collective asset base in the trillions of dollars. Imagine the volume if all of these groups spoke together in unison!

Figure 1 depicts two models for engagement. In the “web engagement” approach the three groups (end investors, non-investor activists and fund managers) independently seek a strong engagement relationship with the corporate using techniques such as dialogue, shareholder resolutions and public activism. However the relationship between the three categories of actors is relatively loose. The benefit of this approach is that each group can clearly articulate their individual concerns using a range of engagement techniques. For example, the end investor may use dialogue, while the non-investor activist uses public media campaigns to raise awareness in the community. However, under this model, there is a higher potential for conflicting messages and differing priorities between organisations, leading to confusion for the corporate.

Meanwhile, under the “aligned engagement” model, the three groups come together in collaboration to prioritise and distill their concerns before engaging with the corporate in one voice. This approach benefits from a clearer message, combined resources between the groups and a larger total asset base or combined shareholding in the company. By contrast, the drawbacks include the difficulty of reaching consensus among the collaborators and a lack of clarity around who is actually “in charge” of the engagement.

Figure 1: Two models of ESG engagement Talk Part 2Source: CURRENTLY UNDER DEVELOPMENT.

Regardless, using the aligned engagement model would have multiple benefits for those involved:

  • Weight of capital: For the end investor, their already large investment in the corporate can be multiplied by many times to include the assets of the fund managers with whom they collaborate. By working together prior to any direct engagement, the collaborators can bring a clear unified message to the corporate. Fund managers can also benefit by developing a stronger relationship with their end investor clients.
  • Broadening the context: Bringing informed activists into the dialogue already demonstrates that the matter at hand is of concern to the wider community. Rather than being a single “nagging” voice, the investor’s concerns are echoed in the wider community and may reflect a growing consensus among the corporate’s customer base. Fund managers can integrate these concerns into their views of the corporate’s future revenue prospects, especially when compared to the corporate’s competitors.
  • Deepening investor understanding: Further, end investors and fund managers able to benefit from the depth of knowledge on the particular issue that a dedicated CSO is more likely to have. For example, Amnesty International is likely to have more firsthand experience on human rights conditions in workplaces than any end investor or fund manager could amass.
  • Seat at the table: Non-investor activists benefit from having direct engagement with corporate management, enabled by the collaboration with end investors and fund managers, which might not have been possible otherwise. Non-investors and corporates can better understand each other’s concerns and constraints, in order to build empathy rather than antagonism.
  • Conversations behind closed doors: Corporates benefit from this collaborative form of dialogue as the concerns are discussed in private, at least initially. The alternative would be for non-investor activists to use more threatening public approaches which would likely be more damaging for the corporate’s image.

By working together, investors and non-investors can use their aligned interests to better articulate and magnify each other’s message. Corporates can better understand the issue which can help determine changes to their strategy, especially if brand damage or loss of revenue is likely.

Taking (share) action

One CSO successfully using a hybrid approach for engaging with corporates is ShareAction, based in the UK. ShareAction engages with firms on a number of ESG related issues, using the investment channel to access corporates and aligning the various actors:

We believe the best way for investors to improve the behaviour of big business (while maximising their own earnings) is through dialogue and persuasion, rather than picking and choosing investments (“screening”). That’s why at ShareAction our focus is on engaging with pension funds, asset managers and pension fund trustees on the issue of Responsible Investment.

A key part of ShareAction’s work relates to research including analysing and ranking the ESG activities of a range of UK pension funds and fund managers. By doing so, ShareAction is able to have regular interaction with these investors, potentially providing a platform for raising awareness of concerning practices used by corporates who receive capital from these investment groups.

An additional, more public, method used by ShareAction is their “AGM Army” program where interested individuals are able to represent the organisation and ask direct questions of corporate management. This is a very clever technique and is based on the fact that any shareholder in a public company is entitled to attend the firm’s Annual General Meeting (AGM).

A live example of ShareAction’s work relates to energy giants BP and Shell where the group has used both public and private engagement techniques in collaboration with a range of investors and non-investors over a number of years. Large pension funds and fund managers have also backed ShareAction’s proposal, highlighting the effectiveness of a coordinated approach.

While ShareAction do not have the same weight of capital as groups like the ICCR, a combination of mobilising consumers, lobbying sympathetic end investors, working with fund managers and engaging directly with corporates enables the CSO to have a greater impact than it would on its own.

Fair trade-offs

Staying on the ground-up theme, as consumers become more aware and concerned about supply chain practices, investors need to become more aware too. Major food companies including Nestle, Mondelez and Coca Cola are public companies, mainly owned through fund managers. There is an opportunity for certification bodies such as Fairtrade to work with fund managers and end investors to highlight the longer term benefits of certification. Constant engagement and the use of dialogue is a key part of Fairtrade’s engagement with corporates:

The Fairtrade mark currently appears on more than 5,000 products, and the organisation is “engaged in very constructive conversations with companies every day of the week”.

However, an important lesson from Ferraro and Beunza’s paper is that corporates operate within their own specific business constraints and often need time and encouragement to change their practice. A clear example of this was in the ICCR’s engagement with Ford where board member Bill Ford noted:

When I began speaking out on environmental and social issues more than 30 years ago, the Interfaith Center on Corporate Responsibility was a welcome voice of encouragement among many that were doubtful. They cheered us on when we made progress, and challenged us to move faster and do better when we didn’t.

This recognition is especially relevant where corporates are being challenged on their core operating model, as is the case for food companies engaging with Fairtrade. For some activists, there may be a danger of demanding too much, too soon. In such a case, corporates may choose to disengage rather than face overly onerous demands. Regardless, this doesn’t seem to be the case with Fairtrade’s engagements.

As I’ve previously made obvious in my previous blog posts, I’m a massive fan of Fairtrade. I would be ecstatic if every product sold by the world’s largest food companies was Fairtrade certified right now. But it’s simply not realistic and smaller steps are required to enable long term change, even if the initial steps seem underwhelming. It’s easy to be critical, as I have been recently of Nestle, but similar to the Ford example, Fairtrade needs to challenge food companies, but also encourage and congratulate them when they move in the right direction.

For example, Fairtrade recently announced that Mars was to begin using the Fairtrade Sourcing Program (FSP) for cocoa used in its products in the UK. The FSP enables corporates to take a step in the right direction by sourcing all of one input (cocoa in the case of Mars) under Fairtrade terms rather than all relevant inputs, including Sugar. Fairtrade decided on this pragmatic approach after recognising the constraints large chocolate manufacturers face, as highlighted by Fairtrade CEO Harriet Lamb:

We’d been unable to convince the big chocolate manufacturers on the continent. They were insistent they were going to use locally-sourced beet sugar… The local sugar beet lobby is very strong and very powerful indeed

While some may view this as giving in to the corporates, the pragmatists will recognise that Fairtrade is encouraging these large brands to act in the right way, but also recognising the real world business limitations of wide scale changes to their business models. It’s not perfect, as noted by Divine Chocolate, and there’s still more to do but it’s important to recognise and encourage initial efforts.

However, as business models evolve, clued-up investors would surely want to have a greater understanding of the role that certifications such as Fairtrade can have on consumer views on corporates. As consumer preferences change and awareness of the benefits of certification increases, the impact on corporate revenues will grow. Even investors who do not explicitly integrate ESG considerations into their investment processes would want to have better knowledge of factors impacting corporate profitability.

“Critical friend”

A similarly pragmatic approach has been used by Oxfam as part of their “Behind the Brands” campaign which ranks the performance of the world’s largest food companies on a range of CSR metrics including women’s right, labour conditions and environment impact. Oxfam’s Erinch Sahan commented that the aim of the campaign is:

… to encourage people to put pressure on the companies without it being a threatening or boycotting exercise… We want to foster competition between them to get to the top

This sort of information could prove to be very useful to end investors and fund managers alike (in my experience, the investment community loves to use rankings and scorecards!) Oxfam are providing an informed opinion on a topic on which investors are likely to have less expertise. Further, Oxfam’s influence with consumers is growing so the relevance of this information for corporate revenues should be of interest to investors when analysing companies they invest in.

More information isn’t always better when it comes to investing. However, collaborating with knowledgeable non-investor activists should provide a valuable and different perspective for investors on the corporates that they own. There is a strong potential to create win-win situations where the interests of consumers, corporates, non-investor activists, end investors and fund managers become aligned.

It would certainly be a good news story if all of these groups can work together to promote a sense of shared responsibility.

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Talk isn’t cheap: Engaging corporates on ESG issues (Part 2)

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