ESG, the acronym for environmental, social and governance, includes a broad range of topics such as sustainability, community and political involvement, and diversity and equal opportunity, is gaining greater emphasis from and importance for investors, employees and regulators and is being discussed more frequently by directors, management, corporate governance scorekeepers, proxy advisors and commentators. REITs, many of which have existing policies and practices relating to environmental factors, are placing greater focus on communicating existing ESG policies to investors in proxy statements, publicly-available policies and other communications.
In its 2018 Proxy Season Review, Broadridge reported that "[s]ocial and environmental proposals were again the largest category of shareholder proposals on proxy ballots" and that the average institutional votes in favor of these proposals has increased from 19% to 29% over the last five years. The number of submitted environmental and social proposals have each more than tripled in the past five years. Although many of these proposals did not receive majority shareholder support, the number of proposals and the percentage of shareholder support are increasing. Additionally, many more submitted proposals are being withdrawn because the receiving company chooses to adopt the proposal rather than let it go to a shareholder vote.
Several of the largest and most frequent REIT investors have instituted ESG voting policies or a specific ESG policy or statement. A similar refrain exists in these policies, which is that these investors consider ESG factors in evaluating investment risk and returns. Implicit in such statements is that these investors want companies to disclose business-related ESG risks, opportunities and policies. In fact, some institutional investor policies we surveyed specifically state that companies should provide enhanced and comprehensive disclosure on these matters. Regulators are also addressing ESG topics with increasing frequency, from the SEC's climate change risk factor and conflict mineral disclosure requirements to California's board diversity requirements.
Proxy advisors and corporate governance scorekeepers are closely monitoring ESG. ISS introduced an environmental and social rating product in 2018 that scores these issues independently of more traditional governance issues and Glass Lewis states that ESG factors are considered in its voting report, although currently not dispositive for any voting recommendations. Beyond traditional proxy advisors, however, numerous ESG-related reporting frameworks exist, including products from Bloomberg, MSCI and Dow Jones. Recently, Nareit released the Nareit Guide to ESG Reporting Frameworks, which provides a detailed review of 10 ESG reporting frameworks. Among many other helpful insights, the Nareit Guide sorts the frameworks into three categories: voluntary disclosure (i.e., company provides information to framework); guidance (i.e., frameworks that recommend how to identify, manage and report); and third-party aggregated (i.e., frameworks that access companies' policies from publicly available sources, such as company websites and proxy statements). The Report summarizes the distinctions among the types of frameworks and identifies which ESG performance indicators appear most frequently among the 10 frameworks.
We are reminded of the early 2000s, when corporate governance proposals for board declassification, majority voting and others were gaining prominence. In the early days of those proposals, the number and success of proposals were low; but over a few years, the success rate increased significantly, eventually changing the market standard for board classification and majority voting and ushering in a wave of other governance-related proposals that are now market standard as well. While we are not predicting an imminent sea change, we are mindful of the parallels to ESG.
We recommend that companies consider ESG in four general stages – assessment, implementation, monitoring and disclosure.
Assessment: The assessment stage involves determining what environmental, social and governance factors are most directly relevant to a company's business, including consideration of such issues that may pose a risk to, or an opportunity for, the business. We expect that most boards and management already do this. This stage should also involve determining how the company's major investors, peer companies, regulators and other stakeholders view ESG issues. Engaging with investors on these issues, in conjunction with regular outreach; reviewing their ESG-related policies; and being informed of the ESG factors considered by scorekeepers will also allow a company to determine how its policies align with investor expectations. We expect that many companies will find that significant alignment exists. Assessment should include identifying existing policies, whether written or unwritten components of company culture, that fit into external ESG analysis frameworks and identifying which new policies may be beneficial to the company's business.
Implementation: As with any strategic initiative, decisions need to be made as to the relative importance of the particular initiative, who from management will be responsible for its oversight, how employees will be informed of and participate in implementing the initiative and how the board and management will evaluate the success of the initiative. Unlike our prior comparison to implementation of corporate governance changes (most of which could be fully implemented at a single board meeting and possibly shareholder action), simply documenting a company's existing ESG-related policies and identifying those that are appropriate for public disclosure could take significant time. Developing new policies could take several years to implement and may take several attempts to be successful. Thus, boards and management are well advised to plan early or risk falling behind with a difficult path to catching up to peers.
Monitoring: Again, like any initiative, monitoring of existing ESG strategies is important. Companies will want to confirm that the underlying business reasons for policies are being achieved. Although we have recommended comparing a company's policies to those of its investors, peer companies and other commentators, implementing policies that do not logically align with the business will not likely be desirable. Rather, for each company, continued monitoring of whether an ESG measure is in the best interests of the company is the goal.
Disclosure: As noted above, institutional investors desire disclosure of a company's ESG policies, and many third-party frameworks score based on disclosure. We suspect that many companies already have effective ESG-related policies that they should trumpet. Accordingly, disclosure documents, particularly the proxy statement, should be reviewed with a focus on whether the company is effectively explaining its ESG policies, whether fully implemented or in process, to its shareholders. Doing so will benefit the company by allowing it to receive proper credit from investors for existing policies and to receive feedback from the investment community on such policies, which would add an additional data point in future monitoring of the policies. A company may also want to explain why certain policies that may generally be viewed favorably are not in the best interests of the company. Finally, not all ESG-related policies may be appropriate for public disclosure, particularly policies that relate to tenants, customers or employees. Companies should carefully consider the competitive and other ramifications of disclosure and be careful to ensure that the level of detail is appropriate.
In conclusion, ESG matters should be considered carefully and implemented and disclosed where appropriate. However, as we have noted before in connection with various corporate governance issues, an appropriately informed director's duty under Maryland law is to act in a manner that the director reasonably believes to be in the best interests of the company, which may or may not be the same as or similar to what a particular shareholder (or group of shareholders), a proxy adviser or other external group thinks is a "good" ESG policy. In making ESG choices, directors should consider the company's specific circumstances, including its financial performance, industry, competitors' practices and the directors' individual and collective backgrounds and experiences, as well as any expert advice that directors may seek.
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As always, we and our colleagues are available at any time to discuss these or other matters.