Prior to the last financial crisis, the shareholder primacy model of corporate governance was unchallenged. Companies were run solely to the benefit of shareholders, with share price performance being the ultimate measure of a company’s success. Since then, sustainable investing has grown to become one of the most attractive investment strategies. As the integration of environmental, social and governance (ESG) factors into investment is progressively becoming mainstream, investors have placed greater focus on how companies “create value” for the longer term and what their “purpose” is.
The shift in mindset and in capital allocation have undoubtedly put management teams in a challenging situation whereby they need to balance the market’s demands for financial returns while ensuring that their actions are not detrimental to the interests of other stakeholders. As the coronavirus pandemic is providing an acid test to the sustainability claims of companies and investors, this crisis and its aftermath may make louder the calls for the adoption of a more stakeholder-oriented decision-making process at companies.
In an effort to provide clarity to the capital markets, SquareWell Partners brought together close to 20 institutional investors, managing a combined $7.2trn in assets, to communicate a set of broad principles and guidance as to what investors are expecting from their portfolio companies during this health crisis. While capitalism, in its current form, was not a discussion point, the responses clearly hinted that the differences and interests between short- and long-term investors will further widen with Covid-19.
SquareWell is already witnessing a shift in corporate behaviour. Most notably, companies across all sectors have been reconsidering their distributions to shareholders to preserve cash within the business and support its stakeholders. Such decisions are not easy for companies to take in today’s capital markets, especially for dividend stocks. The ammunition for a change in capital allocation comes not only from governments and regulators but also traditional long-term investors giving their “blessing” and a new wave of executives supported by their social or ethical ambitions.
In the US, companies receiving federal funds from the $2.3trn stimulus package will have to suspend share buybacks. Similarly, the French government asked companies relying on government support to scrap dividends or halt share buybacks. In the banking sector, the European Central Bank and the Bank of England have also acted swiftly, requesting banks to halt distribution to shareholders and focus their resources on supporting the economy.
One could have expected the opposite external pressure coming from those relying on these companies to perform: i.e. the shareholders. This isn’t the case. In a letter to portfolio companies, Legal & General Investment Management, managing £1.2trn of assets, stated that it is mindful that the suspension or reduction of payments to shareholders may be necessary to guarantee the long-term sustainability of the company. Notably, LGIM asked companies to “focus not only on shareholders” as these difficult times require “collaborative action across all businesses, organisations and governments to minimise, as much as possible, the negative impact it will have on the societies in which we all live and work.”
BMO Global Asset Management (with over £400bn of assets) also expects companies to reconsider their share buybacks programmes given the effects of the crisis, while UK asset manager Schroders (with close to £450bn of assets) asked companies that they “prioritise their key stakeholders, in particular employees but also customers and suppliers”, as doing so will benefit both the economy and investors. The influential global proxy adviser Institutional Shareholder Services (ISS) has also announced that it will support lower payouts provided that companies explain how the retained cash will be used.
Dividends and pay
The investor guidance facilitated by SquareWell echoed these individual communications from investors regarding dividends and share buybacks. More specifically, investors appreciate companies’ need to retain cash to navigate the current crisis and will lead them to potentially scrutinise more companies that continue making payments to shareholders than those that don’t. Given the need of investors to generate returns for their clients and the importance of dividend payments to achieve that aim, investors’ willingness to encourage companies in ensuring long-term sustainability at the expense of short-term returns may signal a shift in the shareholder primacy approach that has been prevalent to date.
The Covid-19 crisis is also starting to impact executive pay, where companies and executives can demonstrate they are walking the talk to embrace this new model. Among the companies tracked by SquareWell, pay cuts for senior executives and board members are becoming more common not only among sectors that are heavily hit by the crisis (such as airlines), but also among those that are better-positioned to sustain its effects. Some examples where executives have been agreeing to pay reductions include The Walt Disney Company, Rolls-Royce and French firm Kering. While investors are not explicitly requiring these pay reductions, the alignment between executives and employees has become a key focus for them in recent years.
Companies have also taken important actions to support their employees and communities that they serve in. For example, US retailer The Home Depot expanded its paid leave benefits for both full-time and part-time employees while French food maker Danone established a €250m facility to help its 15,000 small business partners and has taken steps to guarantee the income of all employees until the end of June. Another example is Italian bank IntesaSanpaolo, which donated €100m to support the healthcare sector during the fight against Covid-19. Numerous other companies have made monetary donations or even converted their production facilities for making essential products such as hand sanitiser or face masks to be provided to the healthcare sector.
Beyond the crisis
On environmental and social (E&S) issues, companies should not expect investors to take these matters off the engagement agenda. The discussion on E&S issues will be adjusted to take into account the impact of the crisis and, as stated by State Street Global Advisors’ president and CEO Cyrus Taraporevala in his letter to portfolio companies, there will be an increased focus on topics such as human capital, supply chain, etc. Therefore, even though investors recognise the need for companies to be focused on managing the current crisis, the current environment serves as an opportunity for companies to prove their “licence to operate”.
Covid-19 serves as a proof of the significant disruption that results from a global crisis. Some are tempted to remind and draw parallel with the other existing global challenge, climate change, which investors have been warning companies on the potential disruption that could result from an unplanned transition. The Covid-19 crisis is therefore likely to increase pressure on companies to improve their resilience and take meaningful actions to minimise the effects of the transition.
SquareWell believes that the current context will reveal to companies which of their shareholders have a long-term view and which do not. It is therefore of primary importance for companies to have a clearly articulated “equity story” that incorporates its approach to ESG issues, that will allow them to garner the support of long-term oriented investors and fend off the short-term oriented demands of the market. Whilst the navigation of the current crisis remains a management responsibility, issues like board expertise and director time commitment are therefore likely to receive more scrutiny even after the uncertainty abates.
Luca Giacalone is senior ESG analyst at shareholder advisory firm SquareWell.