Shareholders have increasingly taken the lead in pushing for corporate sustainability. In 2021, for example, 20 percent of U.S. environmental and social shareholder proposals won over 50 percent of shareholder support, while in 2016 only 3 percent of such proposals were approved by a majority of shareholders.  Investors have also strengthened their private engagement efforts, with collaborative groups like Climate Action 100+ urging firms to make their operations more environmentally sustainable. Yet an important question persists: How relevant are these stewardship activities to the financial performance of target firms?
In a new working paper, we use an extensive global sample of private environmental, social, and governance (ESG) engagements to answer this question.  The data cover about 25,000 engagement activities (i.e., calls, letters, meetings) by BMO Global Asset Management EMEA (recently acquired by Columbia Threadneedle Investments) for the years 2007 to 2020. We map these activities onto the industry-level materiality frameworks of the Sustainability Accounting Standards Board (SASB) and MSCI to examine their financial relevance. ESG issues are material when they can affect near-term costs and the probability that the effective management of such issues will pay off in the long term.
We find that between 74.8 percent (SASB) and 86.7 percent (MSCI) of the private engagements in our sample are material. In comparison, public shareholder proposals on ESG issues in the U.S. have materiality rates of between 34 percent and 44 percent. We also find that material engagements are between 2.3 (MSCI) and 6.4 (SASB) percentage points more likely to succeed, which is significant given the average success rate of 19.9 percent. Hence, our findings indicate that private ESG engagements are often material and that investors can improve the success of their engagement efforts by focusing on material issues.
The Effect of Engagements on Financial Performance
To examine how target firms perform after an engagement, we study their stock market returns relative to a peer group. This peer group contains firms that are similar in size and in the same industry and country as the target firm. We find that firms targeted by successful material engagements significantly outperform their peers by 2.5 percent over the following 14 months (i.e., the median time it takes to succeed).
In addition to stock market performance, we find that target firms experience changes in accounting measures. For example, governance engagements are associated with lower costs and higher profitability, while social engagements correlate with a decrease in expenditures and an improvement in sales and profitability. Lastly, firms targeted by environmental engagements have increased capital expenditures and R&D expenses relative to their peers after engagement. Importantly, material engagements have stronger effects on accounting performance than immaterial engagements.
The Effect of Engagements on Non-Financial Performance
Investors also aim to improve the non-financial performance of target firms through their engagement efforts. We find that, on average, engagements are associated with a 3.8 percent increase in the target firm’s MSCI ESG score. When separating by topic, we find a significant increase in the MSCI ENV scores following environmental engagements but no change in target firms’ governance or social scores following governance or social engagements. Environmental engagements are also associated with a 12.4 percent decrease in CO2e intensity (emissions/sales) after engagement relative to peers. When the engagement specifically addresses carbon emissions, we find a 24.6 percent decrease in CO2e intensity. However, the total level of CO2e emissions does not change.
Implications for Investors
Our findings have several implications for investors. First, we find that private ESG engagements are associated with financial performance improvements of target firms. Importantly, financially material engagements drive this effect. This finding implies that investors should make materiality salient when engaging with portfolio firms.
Second, we find no effect of environmental engagements on the total CO2e emissions of target firms. Even though emission intensity decreases, an absolute reduction is necessary to reach the goals of the Paris Climate Agreement. Investors aiming for their portfolio firms to support the agreement’s goals should, therefore, ask for short-, medium-, and long-term intensity and absolute emission targets designed to achieve those goals.
Third, we show how investors can use industry-level guidance on the materiality of ESG issues to improve their client reporting. Investors differentiate between financially material and stakeholder material sustainability. However, it is essential to note that an ESG issue can be both financially and stakeholder material to a firm (double materiality). We focus on financial materiality using frameworks by SASB and MSCI. However, investors more interested in double materiality can also use the Global Reporting Initiative (GRI) standards.
However, to use materiality frameworks in their engagement efforts, investors should have sufficient firm-level sustainability information. This information should be standardized and comparable across firms. Currently, the International Financial Reporting Standards Foundation (IFRS) is developing a worldwide sustainability reporting standard in collaboration with, among others, SASB and GRI. Mandatory sustainability disclosure requirements using such a standard can improve engagement’s effectiveness substantially.
We conclude with some cautionary notes. First, because we only observe the private engagement activities of one asset manager, we cannot control for the engagements by other asset managers. Hence, even though we use a strict empirical design and compare target firms with their peers, our results should not be interpreted as causal. Moreover, given data limitations, we primarily study larger firms, while the effect of engagements on smaller firms might be different. Finally, we use ESG scores as a proxy for non-financial performance, but they are an imperfect measure of corporate sustainability. Improved sustainability disclosure and innovative data collection, such as satellites tracking supply chains and deforestation, can foster new research into the effects of ESG engagements on non-financial performance.
 EY (2021). “What boards should know about ESG developments in the 2021 proxy season”. Available at: https://www.ey.com/en_us/board-matters/esg-developments-in-the-2021-proxy-season.
 Bauer, R., J. Derwall, and C. Tissen (2022). “Private shareholder engagements on material ESG issues”. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4171496.
 Grewal, J., G. Serafeim, and A. Yoon (2016). “Shareholder activism on sustainability issues”. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2805512. Schopohl, L. (2017). “The materiality of environmental and social shareholder activism – who cares?!” Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2991544. Bauer, R., J. Derwall, and C. Tissen (2022). “Legal origins and institutional investors’ support for corporate social responsibility”. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4096769.
This post comes to us from professors Rob Bauer and Jeroen Derwall at Maastricht University and Colin Tissen, who is a PhD candidate at the university. It is based on their recent paper, “Private Shareholder Engagements on Material ESG Issues,” available here.