Prominent activist investors such as hedge funds, pension funds, and influential individual shareholders and families increasingly aim to reshape corporate policies and strategy. In our paper “Shareholder Engagement on Environmental, Social, and Governance Performance”, we use a proprietary dataset covering 660 companies globally over 2005-2014 to study investor activism promoting environmental, social, and governance (ESG).
In the past two decades, socially responsible investing (SRI) has grown from niche to mainstream. The 2015 report of the UN Principles for Responsible Investing indicates that a large number of institutions (managing about $59 trillion) have endorsed these investing principles, thereby declaring that corporate social responsibility is an essential part of their due diligence process and matters for investment decisions. Further, the Global Sustainable Investment Alliance estimates that over $21 trillion of professionally managed assets are explicitly allocated in accordance with ESG standards, driven by pension funds, but increasingly also by mutual funds, hedge funds, venture capital, and real estate funds. A subset of these investors actively engages with the companies in their portfolios, requesting that companies improve their ESG practices.
In our paper, we study investor activism on corporate social responsibility using a large, detailed, and proprietary dataset on corporate social responsibility (CSR) activist engagements by a leading European investment management company. The firm is managing SRI funds both for its own account and for its clients. To the best of our knowledge, ours is the first paper to investigate such ESG engagements in an international context. In particular, we address the following questions: (i) how does the activist investor choose target companies aiming at improving their ESG practices; (ii) how are such engagements carried out; (iii) are such engagements successful in improving the targets’ ESG performance; (iv) what drives success or failure in ESG activism; and (v) is the activism visible in the targets’ operations (e.g., accounting returns, profit margin, sales growth, etc.) and in the value of investments (i.e., stock returns)?
Our panel covers a decade (2005-2014) of 847 separate engagements by 660 companies from around the globe. The engagements in our sample primarily concern social matters (43.3 percent) and environmental issues (42.3 percent), while only relatively few concern governance issues (14.4 percent). As a result, these CSR engagements are quite different from the activities of other activist investors such as hedge funds that generally focus on financial value by advocating for asset restructuring and governance improvement.
We find that engaged companies typically have a higher market share and are followed by more analysts than their peers. Accordingly, in order to avoid selection bias and to account for unobserved heterogeneity, in subsequent analyses we match the engaged firms to control firms from the same industry that are similar ex ante in size, market-to-book ratio, ESG rating, and profitability. In the case of environmental and social activism, the most common method of engagement is a letter or email addressed to top management or the board of directors. In cases that relate to governance, the activist typically participates in shareholder meetings or meets in person with firm representatives (managers or non-executive directors).
In our sample, firms with lower ex ante ESG ratings are more likely to be engaged by the activist. Our evidence suggests that these engagements reveal information about the ESG practices at the engaged companies, which information is subsequently reflected in commercially available, independent ESG ratings. On the one hand, targets with ex ante low ESG ratings see their ratings improve during the activism period. On the other hand, for targets with high ex ante ESG ratings, the engagement process seems to induce a negative correction during the activism period, suggesting that some of the concerns of the activist investor were not incorporated in these ratings and are publicly disclosed due to the activism.
The activist considers an engagement successful if the target sufficiently adjusted its policy on one or more ex ante ESG factors. Most of the engagement files in our sample (59 percent) are considered successfully closed by the activist, which is more likely for targets with a larger market share, a good ESG track record, and prior successful engagements. The presence of a large controlling shareholder, high short-term growth, and a larger cash reserve are associated with a lower likelihood of success. The activist’s request for a material change in the engaged company (which we call a reorganization) reduces the likelihood of a successful outcome, relative to an engagement that, e.g., stimulates the target to be more transparent in its ESG policies.
Examining the changes in operating performance following engagement, we find no relation with accounting performance or any of its components. However, sales growth increases substantially on average following a successful engagement, which could indicate that the implemented changes appeal more broadly customers. Finally, we find positive buy-and-hold stock returns in the month of the completion of the engagement and over subsequent periods of six and 12 months. After the completion of an engagement, excess stock returns (with four-factor adjustment and relative to a matched sample) are higher after successful outcomes, where the difference between successful and unsuccessful engagements is mainly significant within a period of six to 12 months, and disappears subsequently. For example, the excess returns of targeted firms are higher than those of non-targeted peer firms by 2.7 percent over the six-month period following the engagement. Results are especially strong for firms with low ex ante ESG scores. Specifically, targeted firms in the lowest ex ante ESG quartile outperform their matched peers by 7.5 percent in the year after the end of the engagement. Our results thus suggest that the activism regarding corporate social responsibility generally improves ESG practices and corporate sales and is profitable to the activist.
This post comes to use from Professor Martijn Cremers at the University of Notre Dame’s Mendoza College of Business, Professor Luc Renneboog at Tilburg University, and Professor Tamas Barko at the University of Mannheim. It is based on their recent paper, “Shareholder Engagement on Environmental, Social, and Governance Performance,” available here.