Week 9 - ESG & Capital markets Flashcards
- Do shareholders care about ESG?
Yes
- Academic theory says that shareholders have diff. “taste” (financial vs social) & stock price is determined by investors’ taste
{eg. pension funds care more about long run; sovereign wealth funds} - Academic EVIDENCE shows that institutional ownership is +vely associated with firms’ E&S scores, esp. among investors from countries w/ strong social norms about E&S issues, eg. Scandinavian countries, Switzerland, Canada, Netherlands
- How much do shareholders care about ESG?
(by geography, investor type, impact category)
Measured by Willingness-To-Pay
- WTP tells how much ppl are willing to sacrifice to generate +ve {environmental} impact
Academic EVIDENCE
1. investors knowingly accept LOWER FINANCIAL RETURNS in exchange for nonpecuniary benefits (by investing in assets with social objective)
- IRR 4.7 percentage points lower
2. index investors are willing to pay 20 basis points (bps) more per annum to invest in an ESG fund
Highest WTP by
1. geography - Africa, Latin America, Eastern Europe
2. investor type - development org.s eg. World Bank, IMF
3. impact category - environment {since most pressing, universal, affects everyone}
- Why do shareholders care about ESG?
CSR and shareholder value
Academic theory - impact of ^^
1. win-win; “doing well by doing good”
2. delegated philanthropy - firm as an efficient channel for expressing citizens’ values, eg. Starbucks Fairtrade coffee
3. Milton Friedman (1970) - “the social responsibility of business is to increase its profits”
- managerial agency problem: CSR destroys shareholder value
Academic EVIDENCE
1. survey evidence shows that institutional investors believe that CLIMATE RISKS have FINANCIAL IMPLICATIONS for portfolio firms
- Why do shareholders care about ESG?
- 3 ways CSR improves shareholder value
- 3 ways climate change affects shareholder value
How does CSR improve shareholder value?
1. CSR increases firm value, attracts consumers and increases CUSTOMER LOYALTY
2. firms with HIGHER EMPLOYEE SATISFACTIONS increase employee loyalty & efficiency -> generate higher abnormal returns
3. attract socially conscious INVESTORS
- also lower stock return volatility {b/c these investors care about long run}
How does climate change affect shareholder value?
1. cash flow from operations
2. discount rate
» rmb that firm value = DCF
3. cost of debt
- How do shareholders care about ESG?
- pros & cons for each
Exit
= vote with feet, sell your shares (divestment)
+ EASY to implement
- COSTLY to sell large blocks of shares
- portfolio becomes LESS DIVERSIFIED {ie. where to invest your freed-up cash once sold?}
- cannot make +ve impact once actually sold; the THREAT of selling is MORE POWERFUL to make mgmt change than actually selling
- not an option for index funds
Voice
= communicate with mgmt, voting rights & shareholder proposals
= voting OR engagement
+ making a POSITIVE CHANGE
- COSTLY to implement
- LOW VOTING RIGHTS in large firms with DISPERSED OWNERSHIP
- shareholder proposals are often not binding {ie. not legally necessary to be followed}
-> active engagement is more effective than divesting in affecting firms’ ESG performance
-> The greater the availability of EXIT, the less likely VOICE will be used.
-> however, when exit is limited / forced to have LOYALTY, ppl are more inclined to use VOICE to make an impact
Investor STEWARDSHIP
- Investors need to CONTROL & TAKE CARE of the firm they invest in,
- take charge of their money,
- the RESPONSIBLE allocation, management and OVERSIGHT of CAPITAL (eg. prevent money laundering)
- Stewardship Codes are generally VOLUNTARY and operate on a “comply or explain” basis
- UK Stewardship Code applies to asset owners (eg. pension schemes, insurers), asset managers, service providers (eg. proxy advisors)
4 major ways to exercise Shareholder stewardship
- shareholder proposals
- proxy voting
- private meetings
- public activism
Value vs Values
Value
- ESG decision driven by FINANCIAL value, or risk and return opportunities
eg. traditional investing, classic ESG investing (some values but more towards value-driven)
Values
- ESG decision driven by NON-FINANCIAL preferences
eg. impact investing, socially responsible investing
Shareholder voting
- Proxy advisory firms
- Who wins? shareholders vs management
- Shareholders typically seek advice from PROXY ADVISORY FIRMS eg. ISS, Glass Lewis
eg. Blackrock has thousands of funds & require intensive resources to understand proposals before voting, thus typically outsource to ^
» many criticisms by public on voting b/c
- sometimes there is conflict of interest
- sometimes fund managers blindly follow PFA’s advice although not in best interest of shareholders; not questioning mgmt and violating fiduciary duty
Academic EVIDENCE
2. typical US board candidate runs unopposed and receives 94% support {usually if below 90%, the board candidate will leave firm after 3 years}
3. management more likely wins shareholder proposals rather than shareholder activists
» since board of directors is nominated by mgmt
» therefore although shareholders can use their votes to propose changes, normally mgmt still wins
*also very costly, average $10.71 million to submit shareholder proposals, so only submitted by large institutional investors
- US ESG funds more likely to support ESG shareholder proposals
- more pronounced for index funds than active funds since cannot exit; so the only way for firm to improve is for index funds supporting proposals
Europe vs US support for shareholder proposals {from 2022}
Increased for Europe
- the EU Shareholder Rights Directive, in force in Sep 2020, requires managers to report on their shareholder engagement policy & how it has been implemented on a “comply or explain” basis
Decreased in the US
- due to ESG backlash
- state officials withdrew billions of $$ from BlackRock funds on anti-ESG grounds; concerned about greenwashing and wasting ppl’s money; mainly political issues
Academic evidence on voting by retail shareholders vs institutional investors
Retail shareholders with large stakes support E&S proposals LESS OFTEN than institutional investors.
Why? your own money vs clients’ money
3 benefits & 3 cons of SHAREHOLDER collaboration in engagement
Pros
1. pooling of resources, eg. MORE VOTING POWER, “voice” for mid-size firms
2. risk-sharing
3. information and cost sharing
eg. collaborating with local investors, can remove language barriers, speak with Chinese fund managers
-> shareholder collaboration mitigates the costs of active engagement
Cons
1. free-riding and competition
2. COORDINATION is DIFFICULT and time-consuming {the more collaborators, the more costly}
3. legal concerns/REGULATORY BARRIERS: “concert party”
> PRI, as a third-party coordinator, can help substantially exploit the advantages and overcome the challenges
2 main channels of shareholder ENGAGEMENTS on ESG
- Direct dialogue with target firms
eg. conferences, letters, face-to-face meetings, phone calls - Shareholder proposals and voting
Firms’ ENGAGEMENT is more likely to be successful alone, with shareholders, or with stakeholders?
More likely to be successful by COLLABORATING, esp. with SHAREHOLDERS…
eg. pension funds, asset managers, financial institutions
…since SHs have higher VOTING RIGHTS
- for stakeholders, eg. collaboration with governments often takes a long time
PRI two-tier engagement strategy -> higher success rate
What are the 3 “conditions”?
- Higher success rate when there is a LEADER + FOLLOWER when engaging
- when have a LOCAL LEADER, ie. in same country, as TARGET FIRM
- the leader should have MORE SHARES in target firm than follower, to avoid FREE-RIDER PROBLEM
