Forbes – When Passive Investors Become Active And Other Tales From The Street

May 17, 2019

By Robin Ferracone

Almost three years ago to the day, I interviewed Moira Conlon, CEO and president of Financial Profiles Inc., on the topic of “How to Best Communicate with Shareholders.” Conlon has been involved with investor relations and financial public relations for more than 25 years. She started Financial Profiles in 2007 to help public and pre-IPO companies address issues affecting valuation and corporate reputation and to effectively communicate with Wall Street and the financial press. In addition, Financial Profiles serves as the public relations (PR) agency for the Pacific Southwest and Chicago Chapters of the National Association of Corporate Directors. With a staff of about 20 executives, Moira and her team have deep and broad experience gained at Wall Street firms, global Investor Relations (IR) and PR organizations and corporations across several market segments. Moira, thanks again for participating in our Executive PayWatch blog.

Robin Ferracone: I know you are in the thick of proxy season 2019. What are the biggest changes you see this season as it relates to investor relations?

Moira Conlon: Best practices continue to evolve as companies focus on leveraging the proxy to win the vote of passive investors, a category that has grown exponentially in recent years. Today’s proxy disclosure goes well beyond SEC requirements. It includes investor relations messaging, addresses a growing number of investor concerns, and provides context for evaluating all of the information presented. Key areas of focus in the 2019 proxy season include board diversity, executive compensation, and environmental, social and governance (ESG) issues, among others.

While adding women to boards remains a hot topic, proxy disclosures on board diversity extend far beyond that, and encompass the board’s collective skills and perspectives as well as how directors support the company’s strategy and ability to oversee an ever-expanding list of risk factors. In an age of technology disruption, globalization, and ESG, investors want to know how companies are embracing change to effectively manage risk and capitalize on opportunities. Gone are the days of boards comprised solely of ex-CEOs with relevant industry expertise. Investors want to know that the board has the right mix of experience and diversity, in all aspects, and if those essentials are lacking, what the plans are to attract the right directors.

As you know, Robin, compensation is, of course, a key issue in proxy season. While investors want to understand how the executive compensation program works and what the metrics are, they are also interested in how pay is aligned with the business strategy and execution. The proxy should address the company’s value drivers, as articulated in the standard investor presentation, and how the compensation plan supports those drivers. The compensation discussion and analysis (CD&A) should provide insightful narrative and context around executive pay.

ESG may be relatively new, but it hardly lacks prominence. It went mainstream in 2018, with the largest institutional investors asking companies of all sizes and across all sectors to address ESG risks and opportunities. Leading asset managers with trillions of dollars under management are global in their operations and, by extension, must increasingly consider opportunities and threats at a global level. Mainstream investors, including long-term actively managed institutional investors, are following their lead. And that is reflected in 2019 proxy disclosures.

Investors are pressing executives and directors to focus foremost on ESG issues that are material to their businesses – carbon emissions, water shortages, supply chain labor, business ethics, privacy and data, etc. And, meeting investors’ growing expectations requires extensive communications work and close collaboration among boards, management, legal teams, corporate secretaries, investor relations officers and others, each of whom represents different points of view.

Ferracone: Let’s continue on that topic. How is the growing importance of ESG impacting your clients?

Conlon: ESG investing reached the $20 trillion mark in 2018, representing one of every four dollars invested in global equities. And for good reason: According to State Street, 68% of funds that employ ESG standards saw improved performance. In 2018, the world’s largest asset manager, BlackRock, announced plans to require all of its fund managers to consider ESG factors when making investment decisions. As a result, ESG is factored into investment decisions more than ever before and companies are increasingly focused on it.

It’s important for companies to understand that this shift is occurring because investors see a genuine need for improved ESG initiatives and disclosures. As BlackRock Chief Executive Larry Fink wrote in his 2019 letter to CEOs, ESG is not about feel-good projects. It is about an enduring focus on the impacts of social and environmental factors that maximize performance – as well as those that hamper it – and earning the recognition of increasingly attentive customers and employees. To transition from a high-carbon world to a genuinely digital economy, Fink argues that companies must get to the forefront of environmentally responsible practices. To bolster brands and attract talent, they need to prove themselves in tune with a socially evolving culture.

ESG disclosure is not a regulatory requirement, and as usual, the large-cap corporate leaders were the first to implement ESG communications programs. While many larger companies have well-evolved ESG programs, many small- and mid-cap companies are just beginning to think about it. It’s complicated; while there are frameworks available, there is no standard practice and each company needs to sort out what makes sense based on their businesses, circumstances, and resources.

Ferracone: How does this provide companies with a competitive advantage, if any?

Conlon: What’s becoming very clear is companies that communicate effectively about ESG have an advantage in competing for capital today.

Companies need to develop a communications strategy and narrative around ESG that addresses material risks and how they are linked to the company’s strategy, risk management controls, and plans for creating sustainable long-term value for all stakeholders. These linkages need to be meaningful to investors and measurable. It’s important to note that ESG databases are proliferating rapidly. In the absence of any information provided by a company, investors will rely on the databases and rating agencies to form opinions.

Ideally, ESG should be addressed thoroughly and broadly in venues such as earnings calls, annual reports, face-to-face meetings with institutional investors, IR websites, proxy statements, SEC filings, investor presentations, CSR reports, news media, and even social media channels.

Ferracone: Over the past few years, activist investors have created a lot of anxiety in the boardroom, to say the least. Though not the corporate raiders of yore, where do you see activist investors today in terms of their influence with shareholders, especially considering the fact that many institutional shareholders are passive?

Conlon: By nearly every measure, 2018 was a record year for activism. According to Activist Insight, 284 companies that are $500 million or larger in market cap were targeted around the world. Among these, more than $65 billion was spent on activist campaigns and a record 194 board seats were won (up 42% from the previous year), mostly through settlements. Companies of all sizes and circumstances were targeted – even closely held companies and companies with friendly shareholders.

Relative to the corporate raiders of the past who were focused solely on opportunities that would generate immediate returns through a few bold actions, today’s activists look a lot more like old-fashioned value investors. In 2018, activist hedge funds put nearly $75 billion to work, more than double the amount in 2016, according to Deloitte. As capital continues to flow into activist funds, they have money to put to work and have to consider a wider range of opportunities across the market cap spectrum. As a result, they are generally taking a more patient approach.

Ferracone: How can companies minimize the threat of an activist investor?

Conlon: 2018 activity was marked by an increase in settlements resulting in board refreshment in lieu of expensive and distracting proxy fights, a shift that supports the idea that boards are becoming more open to board refreshment as a way to positively impact company performance and returns. Activists continue to look for financial and operational issues as well as strategic initiatives that could drive value, and there is now a growing focus on ESG concerns as a point of entry.

Bottom line, no company is immune from an activist attack and every company needs three foundational approaches: (1) a strong and strategic investor relations program that starts with a compelling presentation that addresses the plan for long-term value creation; (2) a program to engage with both active and passive investors; and (3) a plan to effectively manage a potential activist attack that starts with a vulnerability assessment that considers the evolving threat landscape. Management and IR officers also should be informing boards about valuation issues, investor sentiment, and activist activity in their sector, and generally encouraging directors to think like activists.

Ferracone: To wrap up, I’d like to ask you for a good example of how companies and investors are getting on the same page when it comes to long-term investing.

Conlon: For many years the quarterly earnings cycle has dominated investor communications. With the shift to passive investing, however, we’re seeing a groundswell of support for a return to communication that is less focused on quarterly results and instead addresses a company’s long-term vision, strategy, and outlook. This is being driven primarily by passive investors who are by definition long-term holders. The interesting thing here is that the long-term buy-and-hold investors that are coveted by every publicly traded company in the U.S. also are jumping on the bandwagon.

One example of an effective response to this is the Strategic Investor Initiative’s (SII) CEO-investor forum. This forum brings together corporate leaders and long-term investors (active and passive) to engage on best practices for communicating a long-term story for value creation. The SII has hosted two such events to date, featuring 14 CEOs of companies with a combined $1 trillion market cap and investors representing more than $25 trillion in assets under management. Additional forums are in the works.

In a call to action accompanying the rollout of the forums, the SII recently published a letter in collaboration with Harvard Law School and leading intuitional investors emphasizing important considerations for corporate leaders as they step up to “help meet new informational needs of long-term institutional investors.” Investor Letter to CEOs: The Strategic Investor Initiative.

The ultimate objective is to develop frameworks and protocols that help companies articulate sustainable long-term investment stories that connect their purposes to the profit engines of the companies. It’s a win-win; companies that do right by all of their stakeholders are best positioned for long-term success.

Ferracone: Moira, as always, I appreciate your insights. Thank you for this recap of how “passive” investors flex their muscles.

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