Investors are increasingly using the shareholder proposal process to push companies to integrate corporate sustainability-generally defined as environmental, social, and governance (ESG) considerations-into their business plans. Sustainability proposals typically promote climate change reporting, greenhouse gas emissions and energy efficiency goals, employee and management diversity, human and animal rights, fair labor practices, and worker and consumer health and safety. This article focuses on shareholder proposals asking companies to link executive pay to sustainability metrics, companies that already link pay to ESG goals, the role of the board in ESG issues, and proxy advisors' views.
Sustainability Proposals Gain Traction
Of all the shareholder proposals filed, 40 percent seek ESG action, according to an Ernst & Young report. A 2013 Investor Responsibility Research Center (IRRQ report looking at proposals from 2005 through 2011 identified the following trends:
* Average support for all types of ESG proposals increased from 10 percent to 21 percent, with those seeking disclosure or reporting on ESG matters receiving greater support than those seeking changes in company policies and practices.
* The number of proposals voted on that sought ESG measures in pay programs increased 35 percent.
* The number of proposals voted on that asked companies to consider ESG expertise in director qualifications increased 73 percent.
Proponents and Targets
Faith-based organizations, public pension funds, and socially responsible investment (SRI) funds typically take the lead in sponsoring ESG proposals, and these shareholders have generally focused on the same group of high-profile companies, according to the IRRC report:
* Of the roughly 350 companies targeted with ESG proposals, 30 large-cap companies received more than 500 proposals (or more than 40% of all proposals) during the 2005 to 2011 period.
* Nearly half of the proposals voted on were at large-cap companies and more than one-third at mid-cap companies; smalland micro-cap companies made up 16 percent and 1 percent of the total, respectively.
Some Success
Although ESG proposals do not typically receive significant shareholder support, a 2013 proposal at CF Industries Holdings Inc. asking the company to provide a sustainability report on ESG issues received majority (67%) support, as did proposals on board diversity and political spending disclosure. An Institutional Shareholder Services (ISS) blog called this a "high-water mark" for environmental and social policy resolutions.
The Ernst & Young report shows growing attention from institutional investors, with average support for ESG proposals in 2012 reaching 19 percent, nearly double the 2005 level.
Linking Pay to Sustainability Goals
Companies that link executive pay to ESG goals often focus on worker health and safety, such as the number of OSHA incidents. But shareholders are pressuring companies to consider a broader range of ESG factors, such as board and management diversity, human rights, and environmental leadership (e.g, reducing greenhouse gas emissions and energy efficiency).
The growing interest in linking executive pay to ESG goals is in part a recognition that ignoring sustainability risks-such as costs of environmental disasters and cost savings from energy efficiencies-can have a significant negative effect on a company's bottom line, and failing to consider sustainability issues-such as sourcing materials from suppliers that are not socially or environmentally responsible-can harm a company's reputation.
2013 Proposals
This year, proposals at two S&P 500 companies, Caterpillar and Dominion Resources, asked the companies' boards to adopt policies tying senior executives' incentive pay to nonfinancial measures, such as reducing environmental damage from company operations.
The proponent of the Caterpillar proposal, the Nathan Cummings Foundation, offered the following arguments in support of its position:
* Compensation incentives should include metrics that promote sustainable value creation and reduce negative environmental impacts so they are aligned with business strategies for creating sustainable, long-term shareholder value and mitigating risks.
* Deliberations on executive compensation should consider social and environmental factors as well as financial and strategic goals.
* Many companies have added sustainability criteria to the mix of metrics used to determine executive compensation.
* Greater emphasis should be placed on sustainability factors in incentive pay in light of recent environmental incidents that caused significant losses to shareholders.
* Caterpillar countered with the following arguments:
* Adopting the proposal is unnecessary because Caterpillar has been committed to responsible business practices for more than 85 years and is continuously looking to improve sustainability efforts.
* Caterpillar was named to the 2012 Dow Jones Sustainability Indexes for the 12th straight year as one of the sustainability leaders in the industrial engineering sector. Such longstanding recognition has helped build Caterpillar's image as a responsible corporate citizen.
* The company's executive pay program already motivates executive officers to operate the business in a sustainable manner and create long-term value for stockholders.
Similarly, Dominion Resources defended its current executive compensation program, saying it creates a strong incentive for executives to operate the business in a sustainable manner by establishing performance goals designed to create long-term shareholder value. The company also cited its leadership in the areas of stewardship and sustainability and its commitment to being a responsible corporate citizen and providing safe, clean, and reliable energy.
Although the proposals received only about 7 percent of shareholder support (see Caterpillar and Dominion Resources), they and others like them are sending a message to companies that sustainability may be a factor to consider in setting pay plan goals.
Companies Using Sustainability Goals
A number of companies already include sustainability goals in their executive pay plans. A 2012 Glass Lewis & Co. report notes that 42 percent of several hundred companies comprising 11 global market indices provided a link between executive pay and sustainability, up from 29 percent in 2010.
Among S&P 500 companies, 43 percent link executive pay to ESG goals, according to an April 2013 IRRC/Sustainable Investments Institute report. The most common goals-in descending order-were social criteria (e.g., safety, employee retention, and diversity), environmental factors (including toxic spills, greenhouse gas emissions, and energy efficiency), and ethical factors {e.g, misstatements of financials and ethical breaches). Utilities and energy and materials companies were the businesses most likely to consider environmental and social factors, and utilities and energy companies were most likely to consider ethics.
A 2012 report by the United Nations-backed PRI Association, a global network of investors that recommends companies link executive rewards to ESG metrics, noted the following companies included sustainability goals in their pay plans:
The Board's Role
Sustainability issues have traditionally been the purview of management. Shareholders, however, are pushing corporate boards to oversee policies and decisions that affect corporate sustainability and to consider ESG experience in evaluating director qualifications.
Board Oversight
Ceres, a network of investors that addresses environmental issues, reviewed committee charters and governance documents and found that 28 percent of 600 large US companies mention board oversight of sustainability. In The Road to 2020: Corporate Progress on the Ceres Roadmap for Sustainability, Ceres recommends boards establish a committee that has clear accountability for sustainability. The organization also encourages companies to include sustainability performance measures as a core component of compensation packages and incentive plans for executives.
A 2011 Glass Lewis report found that 44 percent of S&P 100 companies had a boardlevel committee with explicit oversight responsibilities for issues related to sustainability. The proxy advisor views board-level oversight as a key indicator that companies place appropriate attention on sustainability and as a mechanism investors can use to hold boards accountable for environmental and social performance.
Considering ESG in Director Qualifications
Partly in response to pressure from shareholders, companies are increasingly including ESG qualifications in their director recruitment process. The number of shareholder proposals voted on that asked companies to consider ESG expertise in director qualifications increased 73 percent from 2005 to 2011, according to the IRRC report.
Some companies, like Prudential Financial, have shown a commitment to recruiting directors with skills in sustainability and environmental responsibility. Others have established ESG committees. For example, Alcoa's Public Issues Committee provides guidance on matters relating to social responsibility, environmental sustainability, and health and safety. At Chevron, 22 percent of shareholders voted in favor of a proposal to nominate a director with environmental expertise, and at Freeport-McMoRan Copper and Gold, 30 percent of shareholders supported a similar proposal.
Proxy Advisor Views
The two major proxy advisory firms, ISS and Glass Lewis, usually support shareholder proposals that address ESG issues generally. But when considering proposals linking executive pay to environmental and social criteria, ISS typically makes voting recommendations on a case-by-case basis under its policy guidelines, considering the following factors:
* Whether the company has significant or persistent controversies or regulatory violations regarding social and environmental issues;
* Whether the company has management systems and oversight mechanisms in place regarding its social and environmental performance;
* The degree to which industry peers have incorporated similar nonfinancial performance criteria in their executive compensation practices; and
* The company's current level of disclosure regarding its environmental and social performance.
If a shareholder proposal receives majority support and the company does not implement the proposal, ISS may recommend shareholders vote against director nominees.
If at least 25 percent of shareholders vote for a shareholder proposal, Glass Lewis believes the board should demonstrate some level of engagement and responsiveness to the concerns.
Interest in Sustainability Likely to Broaden
In most cases, ESG proposals do not receive significant shareholder support. This may change, however, as more attention is placed on the way sustainability risks affect the bottom line and company reputations. According to the IRRC report, shareholder support for ESG proposals generally tends to be highest at companies in which investors question board performance and to rise after adverse events, such as a financial crisis or environmental disaster. The report concludes that, although the proposals are not yet garnering significant levels of support, they raise issues of importance to some shareholders and may be early indicators of matters that may concern all investors in the future.
Sustainability issues are also increasingly part of the ongoing dialogue between companies and investors, with support for incorporating ESG goals into corporate policy development expanding beyond social welfare and environmental advocacy organizations. For example, in response to shareholder concerns, a group of global stock exchanges is considering a proposal to require listed companies to disclose sustainability information to shareholders as part of the Sustainable Stock Exchanges (SSE) initiative. The proposal was drafted by a coalition of investors led by Ceres this fall.