“Corporate Social Responsibility” and the Institutional Investor

ATTORNEY: JESSICA N. DELL | POMERANTZ MONITOR JANUARY/FEBRUARY 2020

In the last issue of the Monitor, Tamar Weinrib reported on the recent, surprising statement issued by the Business Roundtable (“BRT”), stating a new objective for corporations is to “ensure more inclusive prosperity” by encouraging companies to “build long term value by investing in their employees and communities.” Continuing a decades-long debate about “corporate social responsibility” (CSR), this statement was met with concern about accountability – not only because it would undermine the premise that corporations have responsibilities to shareholders above all, but because even for proponents of CSR there is a plethora of different codes and benchmarks and it is no small undertaking to achieve consensus about how to implement and measure such performance. It also puts an “ask” on investors, requiring closer oversight, including on index funds that may be less equipped or inclined to act as stewards.

Long before the BRT statement, “socially responsible investments” (SRI) and Environmental, Social and Governance (“ESG”) factors have been addressed by institutional investors aiming to factor these practices into their investment processes without compromising their risk– return objectives. Many, if not most, pension funds and asset managers take their stewardship responsibility seriously, fighting vigorously for shareholder rights and corporate governance reform. They often engage with companies before they invest, asking the tough questions.

Institutional investors may have less agency when investing in mutual funds. Morningstar recently published sobering news on the voting trends of the largest three index funds: Vanguard, Black Rock, and State Street Global Advisors (SSGA). In 2017, it had been much publicized that BlackRock and Vanguard voted to require Exxon Mobil to produce a report on climate change, so it was startling when Morningstar revealed that those two funds currently hold the worst voting records on social issues supported by other shareholders. In 2019, 84 resolutions addressing social factors received the support of more than 30% of shareholders, but BlackRock and Vanguard supported only 10% of these resolutions.

As Lucian Bebchuk of the Harvard Corporate Governance Project explains, the “agency-costs analysis shows that index fund managers have strong incentives to (i) underinvest in stewardship and (ii) defer excessively to the preferences and positions of corporate managers.” And he predicts that if the trend continues, the disparities will become more glaring as these big funds become more dominant.

Although recent reports show that too often investors as a whole, in exercising their proxy rights, vote blindly with management, there are also signs that investors are evolving to play a more meaningful stewardship role. Investors have made, and can continue to make, significant impacts through ESG investing. In follow-up research on its 2017 report, Professor Bebchuck’s Project revealed that ESG investing has grown to $30+ trillion, over a quarter of the world’s professionally managed assets.

The debate over CSR is a global one. Responsibility for the 2008 financial collapse has been placed, in large part, on failures in corporate governance. Over sixty codes around the world are focused on the issues inherent to CSR goals. But there has been far less focus on a uniform approach for the investment side. Only two such codes exist. The U.K. first issued governance guidance specifically for institutional investors with the Stewardship Code in 2010, and Japan followed in 2014 with Principles for Responsible Institutional Investors.

The Stewardship Code is set by the Financial Reporting counsel (FRC) an independent regulator in the UK and Ireland overseeing auditors, accountants and actuaries, and setting the U.K.’s Corporate Governance and Stewardship Codes which apply to “fi rms who manage assets on behalf of institutional shareholders such as pension funds, insurance companies, investment trusts and other collective investment vehicles.” The code, entirely voluntary, espouses seven principles:

• Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities.

• They should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed.

• They should monitor their investee companies.

• They should establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value.

• They should be willing to act collectively with other investors where appropriate.

• They should have a clear policy on voting and disclosure of voting activity.

• They should report periodically on their stewardship and voting activities

In response to criticism that the Code did not go far enough, additional provisions took effect on January 1, 2020, setting a higher standard. A statement from Sir Jon Thompson CEO of the FRC said “Asset owners and beneficiaries will be able to see if those investing on their behalf are doing so in accordance with their needs and views … they will also be able to see the impact of their managers’ decisions, particularly in relation to environmental, social and governance issues, including climate change.”

From the outset, the Stewardship Code came with a “Comply or Explain” approach: if institutional investors do not comply with any of the principles set out, they may explain any meaningful difference and provide justification on their websites.

This is all food for thought. Vague pledges for corporate responsibility from BRT CEOs do little to lead the way for either corporations or institutional investors. Pomerantz, aware of the complexities of decision-making faced by institutional investors—such as when and how “responsible” investing makes economic sense—regularly organizes conferences and educational events to address these very issues. At such events, institutional investors from around the globe share their expertise and compare notes on developments in their countries. Our next Corporate Governance Roundtable, to take place in June, will focus on the latest developments in ESG investing and corporate governance.