12 Nov 2018
The economist Albert Hirschman once argued people have two different ways of responding to disappointment: they either stay put and complain or vote with their feet.
Hirschman called these options ‘voice’ and ‘exit’. An oppressed citizen may start a protest or emigrate to another country. Unhappy customers may return their goods for a refund or simply start shopping elsewhere.
This dilemma also applies to ethically-minded investors. If shareholders in a company discover it is polluting the environment or mistreating its staff, should they voice their concerns or simply exit the investment?
Divesting from companies that break ethical rules is often the more convenient option and may even bring a useful reputational boost. But once investors sell out they are no longer able to apply pressure to company boards. They may be replaced by less conscientious shareholders who are more than happy to look the other way so long as the profits keep rolling in. As Hirschman observed, while exiting may be convenient and conscience-soothing, it tends to entrench the status quo.
Steve Waygood, chief responsible investment officer at Aviva Investors, argues investors should use their voices before heading to the exit door. In this Q&A, he explains how shareholders can engage with companies to improve their practices; sets out what investors can do to ensure their asset managers are applying the necessary pressure; and highlights examples of engagements that have delivered positive change.
Engagement is more than a buzzword; it can be traced back to the origins of company law, which positioned shareholders as the primary regulators of corporate behaviour. Modern investors should approach their responsibilities in this spirit. They have a moral duty to act where they have the power to enforce generally-accepted standards. Often this means staying put to establish a dialogue and exerting pressure where necessary. It can also help to protect long-term shareholder value.
Divestment may be a simpler solution in many cases. Selling out can ease an investor’s conscience and earn praise from divestment campaigners. But the real question is what is more likely to bring about change? Imagine you are an executive at a mining company where lax safety standards are leading to fatalities among staff. You are coming under heavy criticism from the company’s investors and could be voted off the board at the next annual general meeting. Would your life become easier or harder if those concerned investors walked away? I would say it becomes considerably easier.
Equity investors have a variety of tools at their disposal. They have the power to fire a company’s leadership at AGMs, and can use this to vote against strategies they disagree with. They can also vote against auditors if they are concerned the company’s report and accounts are not being properly scrutinised or do not truthfully represent the financial and reputational risks it faces due to unethical practices.
Shareholders can work in tandem to bolster their influence. Collaborative engagement can be particularly important when it comes to addressing the behaviour of powerful fossil fuel companies that are used to resisting pressure from environmental campaigns.
It is true that the activity of fossil fuel companies threatens the future of the whole planet. But we would argue this makes engagement even more important, because the stakes are so high.
If carbon emissions are not curtailed, it is possible global temperatures could rise by six degrees by 2100. In current prices, the associated damage could wipe US$43 trillion off the value of financial markets.1 Such a catastrophe is difficult to contemplate. But without government engagement from large and powerful investors, policymakers may not come under enough pressure to correct the market failure. And without company engagement, energy utilities could simply continue burning fossil fuels, using their own lobbying activities to ensure policymakers let them do so.
By collaborating to put pressure on executives, investors can push these companies towards more-sustainable energy sources. Such a transition is in the interests of everyone, including the companies themselves, as at a certain point the remaining hydrocarbon reserves will become uneconomic to extract.
Consider Exxon Mobil’s recent steps to improve its approach to climate reporting. We’ve been engaging with Exxon for over a decade on this issue, voting against board members due to their position on climate change. Traditionally Exxon was among the most resistant of the oil majors to climate-related initiatives, but a significant milestone was reached at the company’s AGM in 2017.
At the meeting, the Church Commissioners, the organisation that manages the assets owned by the Church of England, led a shareholder proposal requiring Exxon to publish an annual assessment of the long-term effects of global climate agreements on its portfolio. Aviva Investors and other shareholders supported the proposal, and this investor pressure has begun to bear fruit. The company’s reporting now includes assessments of the impact of a global rise in temperatures on its operations, as well as the sensitivity of its portfolio to various supply and demand scenarios, such as the proliferation of electric cars.
This shows just how long engagement can take, which is why it is also important for investors to engage with governments to make sure market incentives are properly structured and encourage good corporate behaviour.
Engagement is about reducing the underlying emissions, too. For example, Italian multinational electricity firm Enel pledged never to build another coal station following our engagement. At its renewables programme launch event, the chief executive Francesco Starace said it was “obvious that renewables are winning the battle for competitiveness against fossil fuels and nuclear power. It is a matter of fact, there is no discussion any more.” A coal-fired power station opened in Chile in 2016 will be Enel’s last. Nor will the company spend any more money on nuclear. Half of Enel’s £18 billion growth investment over the next five years is going into solar and wind energy, which currently provide just seven per cent of its electricity.
Similarly, we asked Glow Energy in Thailand for a public ‘no new coal’ commitment. A few months later it announced it will not add any new coal-fired power plants to its generation fleet. In total, five of the 40 fossil fuel firms we have engaged with have committed to science-based targets (i.e. consistent with the Paris agreement on climate change) on emission reductions. For example, Origin Energy became the first Australian company to have science-based emissions targets recognised by the global We Mean Business initiative, which helps drive collaborative engagement on this issue.
Engagement can help investors tackle wider issues such as corporate governance. Take Samsung Electronics in South Korea. The company has been involved in a series of controversies over the years, centring on the exercise of undue political influence and the misappropriation of shareholder funds.
But Samsung recently announced important reforms, including the appointment of independent international directors and the splitting of the roles of chairman and chief executive. Samsung also revealed it would significantly increase the dividend pay-out ratio, which had long been a point of contention between the controlling family and minority shareholders. Much more remains to be done, but these changes reflect the efforts of Aviva Investors and other long-term shareholders over many years to engage with the company.
It is important that institutions have a clear process for identifying the companies that are of greatest concern in their portfolios, and ensure their fund managers are proactive in addressing the issues. One way for institutions to ensure their managers are taking responsibility on engagement is to incorporate it into their incentive structure. Is there a sanction in place if the engagement plan fails to deliver? And is there a reward if the plan is delivered and change is implemented?
Not every investor has the clout to make a company alter its behaviour, and sometimes firms will refuse to improve their business practices no matter how powerfully investors protest. Engagement can fail, and there will come a time when the only option is to walk away.
Where persistent and concerted engagement has failed, then it’s time to use the exit. For example, in 2017 Aviva divested its own money from a Japanese coal company called J Power because, despite our best efforts, we saw no progress on a series of key issues. But we strongly believe investors should use their voices to bring about change before they head for the exit. It helps to accelerate corporate action.
Steve Waygood
This document is for professional clients and advisers only. Not to be viewed by or used with retail clients.
Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). As at 25 September 2018. Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. This material is not a recommendation to sell or purchase any investment.
In the UK & Europe this material has been prepared and issued by AIGSL, registered in England No.1151805. Registered Office: St. Helen’s, 1 Undershaft, London, EC3P 3DQ. Authorised and regulated in the UK by the Financial Conduct Authority. In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1Raffles Quay, #27- 13 South Tower, Singapore 048583. In Australia, this material is being circulated by way of an arrangement with for distribution to wholesale investors only. Please note that Aviva Investors Pacific Pty Ltd (AIPPL) does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 30, Collins Place, 35 Collins Street, Melbourne, Vic 3000, Australia.
The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom. Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is registered with the Ontario Securities Commission (“OSC”) as a Portfolio Manager, an Exempt Market Dealer, and a Commodity Trading Manager. Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) and commodity pool operator (“CPO”) registered with the Commodity Futures Trading Commission (“CFTC”), and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.
RA18/0954/23092019