SI Debate: Stewardship is dead, long live stewardship!

Institutional investors often have a long-term investment horizon, a professional approach toward investing, and a sufficient degree of influence in terms of voting power. This means they can use their ownership status to bring desirable change to their portfolio companies, the economy and society as a whole.

Now, with climate change, geopolitics, tariff wars and the increasingly politicized debate on sustainable investing dominating the news, this trend does not get a lot of attention. But shareholders should be concerned about it.

Control rights for shareholders are nearly as old as the first listed company. Shareholders are co-owners and as such will always want to have some degree of influence to make sure that management’s interests are aligned with theirs. Up until a decade ago, institutional investors hardly ever made use of their shareholder rights or actively tried to exert influence, especially compared to large block holders or activist hedge funds.

This was logical, as institutional investors often are widely invested, and at the same time only hold a fraction of most investee companies in a portfolio. The effort simply did not outweigh the benefits of change.

If shareholders were unhappy about a company, it was common practice for them to ‘vote with their feet’, meaning they would sell the stock and simply invest somewhere else. Using Albert Hirschman’s influential treatise, ‘Exit, Voice and Loyalty’, we can say that institutional investors, given their available options, tended to prioritize exit and loyalty over their voice option.

Two recent crises have changed that. A wave of accounting scandals in the late 1980s and early 1990s have led to a reevaluation of shareholder rights, in terms of board representation, incentive structures and disclosures toward shareholders. The global financial crisis of 2008 taught us to be mindful of incentive structures, and that a sole focus on profitability might ignore systemic risk.

The evaluation of this crisis called for more monitoring and active stewardship from institutional investors. It also led to investors applying a more long-term holistic approach to analyzing companies, meaning they started to consider non-financial issues, such as financially material ESG information, as part of their investment research.

A reaction to these crises saw the emergence of the ability to vote via proxy, the ‘Say on Pay’ concept introduced in the US in 2010, and the launch of various stewardship codes in Europe (and later other regions). This led to institutional shareholders exercising their voting rights, participating at shareholders meetings and introducing engagement policies.

Over the last couple of years, institutional investors have built up stewardship teams and are using engagement as an important tool with which to implement their sustainability approach. However, this now seems to be changing, and it seems that several recent trends might flag that effective stewardship by institutional investors is on the wane.

The first worrying trend is to make listing for companies more attractive by allowing founders to keep control, and lessen the scrutiny of markets. This has led to more leniency in the use of dual share classes in markets like Italy, and also for young listings in the UK.

While many of these provisions are fine for start-up companies coming to the market, many tech companies (especially in the US) have kept these control provisions in place, making stewardship more difficult. The old ‘one share, one vote’ principle seems to have gone out of the window.

Secondly, a harsher stance toward shareholders seems to have become common ground. Last year, ExxonMobil’s lawsuit against Arjuna Capital and Follow This showed that companies might bare their teeth if they think shareholder rights are being used against their best interests.

Additionally, congressional investigations into alleged climate collusion between institutional investors and proxy advisors have put something of a chill on investors’ willingness to work together and be vocal about these topics. But should shareholders not be allowed to address issues they find financially or otherwise relevant? If these issues are not in the best interests of the company, they will surely be voted down?

Historically, there have been differences in how fiduciary duty is defined in an Anglo-Saxon or Rhineland model. The former has been more focused on purely financial returns, while the latter adopts a broader stakeholder approach. But like many things nowadays, the polarization seems to have increased.

In Europe and increasingly in Asia, regulators are asking the financial industry to be transparent about adverse impacts from their operations. In Europe, many asset owners do not only focus on ‘pecuniary’ factors, but also believe that their values should be reflected in their portfolios and stewardship activities. In the US these days, it seems like a crime to even take sustainability into account, let alone talk about ESG issues affecting companies.

In the most ‘free’ market in the world, it is now becoming quite challenging to use all available shareholder rights to influence companies on ESG topics. Several investors have left collaborative engagement initiatives on climate, while investors generally are less eager to collaborate. We expect both the amount of shareholder resolutions and their support rates to drop during the upcoming AGM proxy voting season.

So, is this the demise of stewardship? Probably not just yet, and there might even be some positive outcomes for those institutions who remain engaged with their portfolio companies. In the coming years, the engagement of institutional investors will probably be less public, and will be less escalated in the public domain. With the increasingly polarized public debate around environmental and social resolutions, this might be a more effective strategy to facilitate the sustainable business progress we were hoping for.

Furthermore, a ‘simple’, binary message stating that ESG is good or bad does not do justice to the breadth and the complexity of ESG issues that companies and investors are facing. Progress for a sustainable economy starts with understanding the real context of a company’s business, and then exploring the opportunities and limitations in a dialogue.

Institutional investors also will need to make sure they can better explain the added value and relevance of their engagement objectives to companies, clients and other stakeholders. Stewardship that is only aimed at impact without any regard for the added value it would give to business makes no sense, and in itself is not durable or sustainable.

At the same time, institutional investors should be allowed to follow their own investment conviction on sustainability topics. Topics related to human capital management, corporate governance, risk management on cybersecurity or readiness for transition are often an intangible asset, and therefore there will be varying degrees of investors pricing in such topics.

Even if the added value and materiality of these topics are not yet fully apparent to all market participants, institutional investors should be able to follow their own thinking in order to capture such value, and align their stewardship practices accordingly.