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Governance

Climate change, diversity will be on agenda for 2018

Kellie Huennekens thinks investors want corporate boards to have a range of diversity.

Building off momentum from 2017, board diversity and climate change are expected to take center stage in the 2018 proxy season.

The drumbeat is getting louder on both, said Kellie Huennekens, Washington-based associate director of the Ernst & Young LLP's Center for Board Matters, which provides corporate board directors with insight and education on governance issues and trends.

"As we continue to navigate a very challenging, competitive business environment," investors are looking for "a wide range of perspectives for boards to better challenge each other and think differently, and position (boards) to see around the corner," Ms. Huennekens said on investors' push for greater board diversity.

While some institutional investors have been pushing for greater gender diversity on boards for decades, the push has become broader, with investors looking for diversity in expertise and personal attributes like gender, age and ethnicity, Ms. Huennekens said.

Aside from board diversity and climate change, other issues expected to play a prominent role this proxy season are proxy access, director elections, ​gender pay equity and executive compensation, sources said.

A number of events in 2017 put the spotlight on board diversity and laid the groundwork for 2018 and beyond, sources said.

Those events included State Street Global Advisors and BlackRock (BLK) Inc. (BLK) casting votes against directors on corporate boards that lacked gender diversity; New York City Comptroller Scott Stringer and the $191.1 billion New York City Retirement Systems expanding their boardroom accountability project to focus on board diversity; and proxy-voting advisory firm Glass, Lewis & Co. announcing it will be issuing recommendations against nominating chairmen on all-male boards starting in 2019.

The onus is expected to be on midcap and small-cap companies where all-male boards are more prevalent, said Kern McPherson, senior director, North American research, at Glass Lewis in San Francisco. Only three S&P 500 companies have all male boards — Centene Corp., Dentsply Sirona Inc., and TransDigm Group Inc., Mr. McPherson said.

Amy Borrus, Washington-based deputy director of the Council of Institutional Investors, said she also expects the "barrage" of news reports on sexual harassment allegations in 2017 will give gender-related issues a boost in 2018.

There is "growing interest in corporate culture generally," Ms. Borrus said. "All of the attention on sexual harassment and sexual misconduct put a spotlight on how important it is for boards to focus on corporate culture."

In engagement conversations, board members should not be surprised if investors ask what the board is doing to mitigate sexual harassment and misconduct and how they are gauging employee views, Ms. Borrus said. "There will be a lot of pressure on the board to take responsibility and to really look carefully at corporate culture," she said.

Not a lot going for votes

While it's still a little early for shareholder proposals, Patrick McGurn, special counsel and head of strategic research and analysis at Institutional Shareholder Services Inc., Rockville, Md., predicted that only a limited number of board diversity proposals will go to a vote. Others will be withdrawn following investor engagement with companies.

"Shareholder proposal submissions (on board diversity) could eclipse 2017's 37 offerings, but negotiated withdrawal should continue to whittle away most of the resolutions prior to meeting dates. In 2017, only nine (board diversity) proposals actually made their way onto ballots" at U.S. companies, Mr. McGurn said.

At two companies — Cognex Corp. and Hudson Pacific Properties Inc. — the proposals received majority support from shareholders. Both proposals were supported by the $348.7 billion California Public Employees' Retirement System, Sacramento; the $221.7 billion California State Teachers' Retirement System, West Sacramento; the $146 billion Texas Teacher Retirement System, Austin; and the $195.6 billion Florida State Board of Administration, Tallahassee.

Mr. McPherson said that among the approximately 1,500 global companies Glass Lewis has engaged with over the past year, the push around diversity and board refreshment has become a much more prominent part of the dialogue and is something that many companies will be wrestling with — whether they lack female representation or not.

In the past, diversity disclosures were "very boilerplate," but investor expectations regarding the level of detail have increased, Mr. McPherson said, pointing to Mr. Stringer's expanded boardroom accountability project as an example. In September, the New York City comptroller issued letters to 151 companies — 80% of which were in the S&P 500 — requesting they disclose the race and gender of their directors, which has rarely been released publicly. Another area the comptroller is seeking information on is how these boards think about tenure and refreshing with new directors.

Focus on climate change

Climate change and sustainability are also expected to be key areas of institutional investor focus in 2018. Investors will continue to focus on disclosure of business risks associated with climate change through engagement conversations and proposals, CII's Ms. Borrus said.

Last year marked a major development with climate change-related proposals receiving majority support for the first time, sources said.

At Exxon Mobil Corp., Occidental Petroleum Corp. and PPL Corp., proposals calling on the companies to disclose the viability of their businesses under the 2-degree scenario — the concept of limiting the average global temperature increase to 2 degrees Celsius — were supported by a majority of shareholders, including large money managers BlackRock (BLK), Vanguard Group Inc. and SSGA, which all voted for at least two of the proposals. At Dominion Energy Inc. and Duke Energy Corp., similar proposals received near majority support from shareholders. Among the proposals' filers were CalPERS and the $201.3 billion New York State Common Retirement Fund, Albany.

Responding to the voting results, PPL released a climate assessment in November, while Exxon Mobil pledged in an 8-K filing in December to enhance its disclosures "in the near future." An Exxon Mobil spokesman declined to provide a timeline for the company's enhanced disclosure.

Looking ahead, Mr. McPherson said he expects to see greater support for shareholder proposals where there appears to be real material connections between a company's bottom line and climate risk. Investors "are getting smarter" about defining material risks tied to climate change, he said.

Beyond fossil-fuel companies, Mr. McPherson said he expects climate change proposals to be put forth at companies like real estate investment trusts that have properties on coastlines or commodities that might be affected by changes in weather.

In Mr. McGurn's view, climate change-related proposals could overtake proxy access as the most prevalent shareholder proposal type in 2018. According to ISS' Voting Analytics database, 88 climate change proposals were submitted at U.S. companies in 2017, with 49 making it onto ballots.

He also noted, however, that given strong levels of support for these proposals in 2017, "more boards may opt to negotiate with proponents so the number of proposals reaching ballots (in 2018) may actually fall short of 2017's 49."

Proxy issues

Meanwhile, issues percolating on Capitol Hill include potentially stronger regulations on proxy-voting advisory firms and tighter shareholder proposal processes.

On Dec. 20, the House of Representatives passed a measure that would require proxy firms to register with the Securities and Exchange Commission, disclose potential conflicts of interest and codes of ethics, and make public their methodologies for formulating proxy recommendations and analyses. Additionally, the Financial CHOICE Act passed by the House in June included tighter restrictions on shareholder processes for submitting corporate proposals and voting for corporate board directors. It remains to be seen if both bills gain traction in the Senate. The measures do not have Senate counterparts nor Senate committees talking about them.

It also remains to be seen whether the SEC takes up proxy-system changes this year.