September 20, 2021

2021 Governance Updates: Getting ready for the Next Chapter

Executive Summary

  • COVID has accelerated the focus on ESG from governance (G) to human capital management (S)
  • ESG issues dominated this year’s proxy season, with human capital management and climate becoming more prominent in large cap company disclosures
  • Diversity mandates have arrived
  • More regulations around reporting are on the horizon from the SEC

2020 was a year like no other. Oversight became more complex, and with the resurgence of the COVID Delta variant, stakeholder prominence, activist investors, and social unrest, the role of corporate directors continues to expand to address social and climate issues.

As a result, it is no surprise that environmental, social and governance (ESG) issues dominated this year’s proxy season. But how did this year’s proxy season issues impact boards of directors? In this governance recap we focus on three areas: Shareholder Activism, Governance Trends in ESG, and Regulatory and Proxy Advisor developments.

Shareholder Activism

Shareholder Activism is gaining traction among stakeholders. Over the past several years, investors like BlackRock, State Street, and institutional investors like CalSTRS and CalPERS have been increasing staff dedicated to ESG issues. Though still primarily focused on value creation and returns, these “active owners/ passive investors” are now digging in on climate issues and the long-term sustainability of the businesses in which they invest, making their voices heard and votes count. Other areas around shareholder activism that have been important in 2021 include:

  • Shareholder proposals are on the rise. Shareholder proposals that made it to an actual vote for S&P 500 companies have remained consistent over the past five years, at approximately 350 per year; however, their success rate has increased. Nearly 15% of shareholders’ proposals passed in 2021, double the success rate of proposals put forward in 2017
  • Say on Pay (SOP) votes are moving in the opposite direction. The decline in Say on Pay votes reflects corporations not being responsive to guidelines during the COVID pandemic
  • Investor support for directors has declined. This year tallied a five-year low for director votes, with 8.7% of directors receiving less than 90% support (up from 5.5% in 2018). This is largely due to a lack of board diversity and/or responsiveness to stakeholder concerns

Governance Trends in ESG

Governance trends in ESG continue to provide momentum to stakeholder prominence. In 2019, Farient and our partners in the Global Governance and Executive Compensation (GECN) Group published our Global Trends Research:Seven Lessons from Engaged Investors. Following interviews with 25 of the largest global investors, it was clear that the investors were ramping up ESG stewardship staffing and directing their resources, energy, and engagement around climate, human capital management, and executive compensation. Two years after that research, these areas are moving beyond trends to expectations.

Proxy season disclosures this year showcased corporations stepping up their commitment to stakeholders, providing letters from CEOs and Compensation Committee Chairs in proxies that presented a human face of the corporation. To that end, this was a year of environmental and social impact:

  • COVID-19 changed the way companies think about stakeholders. COVID-19 accelerated the social aspects of ESG with companies disclosing how they provided for the physical, emotional, and financial well-being of employees and the communities in which they operate
  • Disclosures highlighted the areas of human capital management companies measure. Metrics became more prevalent across industries and included:
    • Health and safety
    • Diversity, Equity and Inclusion (DEI)
    • Training and development
    • Employee engagement
    • Voluntary terminations
  • The role of the compensation committee expanded. As ESG became important among all stakeholders, many compensation committees broadened their charters and the name of their committee (e.g., Compensation and Human Resource Committee, Compensation and Management Development Committee, Talent Management and Compensation Committee) to reflect their expanding responsibilities, which now cover a broader array of compensation, talent and broad-based HCM strategies
  • Transparent disclosures have become best practices for many companies. With investor pressure mounting, and the first year of HCM disclosures required for 10Ks, many companies are providing robust discussions around their practices, while others are just beginning the journey
  • Investors are hiring. Investors are increasing ESG stewards for deeper dives on corporate behavior. They are wielding their influence more broadly, both inside and outside of the proxy process which means more engagement throughout the year
  • Diversity, Equity, and Inclusion (DEI) initiatives are gaining momentum. Farient’s recent DEI research, Use of Diversity, Equity and Inclusion (DEI) Metrics in the S&P 500 highlights that 33% of large cap companies are including DEI in their short or long-term compensation plans and/or payout considerations
  • Diversity mandates have arrived. The SEC’s approval of NASDAQ’s board diversity proposal adds to the 10 states that currently have diversity mandates for companies headquartered in their jurisdictions. As of this writing, only 25% of Nasdaq-listed companies meet the proposed standard which includes:
    • Mandating companies listed on NASDAQ’s U.S. exchange to publicly disclose consistent, transparent diversity statistics regarding their board of directors
    • Requiring most Nasdaq-listed companies to have, or explain why they do not have, at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+

Regulatory Requirements and Proxy Advisor Developments

Regulatory Requirements and Proxy Advisor developments are evolving. With SEC chairman, Gary Gensler, in place and the administration working diligently to move beyond COVID, companies need to get ready for a renewed focus on regulations. This was the first year of required Human Capital Management disclosures in 10Ks. Though principled in the current requirement, this could become more prescriptive over the next few years. In addition, boards of directors should consider 2021 a launch pad for SEC regulations and increased proxy advisor scrutiny with some or all of the following developments materializing over the next couple of years:

  • The government is renewing its focus on regulations. The SEC is considering a variety of regulations including “Say on Climate” and more standardized reporting across the ESG landscape
  • The SEC may finalize outstanding Dodd Frank provisions. Rules for Pay and Performance Alignment reporting and Clawbacks may be finalized by the SEC
  • Unwanted attention to adjustments to executive compensation plans will be on the rise. While in-flight changes to compensation get a “thumbs- down” from proxy advisors and investors, pay programs need to be designed to perform appropriately in good times and bad
  • Standardized reporting on climate may be required. The SEC has said that they are considering mandatory climate disclosures in the near future and will be following companies closely to ensure that reporting around climate isn’t just marketing, but accurately reflects the company’s actions and impact

Conclusion: Governance Lessons Learned in 2021

Active owners / passive investors are using their voices and their votes. More than any other proxy season in the last decade, this season highlighted the importance of engagement and good-faith efforts for boards to act on investor concerns. Otherwise, investors will vote against pay programs. Moreover, investors continue to demonstrate that they can be powerful when working together to move the needle on ESG issues through “no” votes on directors who do not have the right skills or do not focus on the long- term growth, value creation and sustainability of the company. From a compensation and governance perspective, Farient encourages compensation committees to:

  • Resist changing in-flight compensation plans. There is significant pressure from proxy advisors and investors to let in-flight long-term incentive plans play out as planned
  • Understand Board diversity, equity and inclusion (DEI) requirements. Stakeholders care. DEI continues to garner attention and will only grow in prevalence from multiple directions. Examine your board recruitment processes and outcomes to meet new board composition requirements
  • Be prepared for detailed engagement with investors on ESG. Investors expect boards to provide effective oversight and execute on all aspects of governance. Get ready for more transparency, disclosure and engagement around environmental and social areas that impact the company’s long- term prospects
  • Measure what and how ESG gets done. Use of stakeholder incentives in pay plans, and in particular, DEI are growing in prevalence. Compensation committees should consider where they are on this journey and whether, and if so, how to include ESG in executive pay design
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