Corporate boards under pressure this proxy season after active 2022 period

As the 2023 annual general meeting season gets underway, institutional investors increasingly will hold corporate directors responsible when progress doesn't come fast enough on environmental, social and governance issues, following a 2022 proxy season that sent clear signals.

This year's growing list, while still dominated by how companies are addressing climate change, includes biodiversity, board diversity, racial equity and executive compensation. Some shareholders also want to see companies address cost-of-living challenges exacerbated by the war in Ukraine and an uneven post-pandemic recovery.

"We are expecting to see a lot (of ESG shareholder proposals) this year. We do expect boards to take them seriously," said Amy Wilson, London-based engagement lead for Europe with EOS at Federated Hermes Ltd., with $669 billion under management.

Last year, 30% of corporate directors in Russell 3000 companies up for election got less than 95% support from shareholders. While still a high level of support, votes under 100% can signal concerns.

Another telling vote, on executive compensation, saw average support at companies in the S&P 500 and Russell 3000 hit record lows, according to PricewaterhouseCoopers, which said that the reduced support "makes it clear that shareholders are scrutinizing board actions more than they have in the past."

Votes against corporate directors happen for many reasons. A growing reason among large asset owners is a lack of board diversity.

In 2022, the $311.5 billion California State Teachers' Retirement System, West Sacramento, enhanced its voting policy to allow for opposing the election of directors in companies that moved too slowly to achieve greater board diversity or make meaningful progress on climate change. This year, CalSTRS corporate governance staff will "further strengthen votes against boards failing to address these material topics," according to its latest policy issued this month.

Lack of gender diversity on boards "is now one of the top reasons why we vote against directors," said Aela Cozic, associate director, sustainable investing and portfolio manager at Fidelity International in London, whose firm, with $663.1 billion under management, now engages with companies on diversity at the executive level as well.

In addition to voting against directors without diverse boards this proxy season, New York state Comptroller Thomas P. DiNapoli introduced a series of shareholder proposals as part of the $242.3 billion Albany-based New York State Common Retirement Fund's ongoing efforts to increase corporate accountability for progress on diversity, equity and inclusion issues. Two of those proposals were co-filed by New York City Comptroller Brad Lander on behalf of the NYC Retirement Systems, with $243.6 billion in total pension system assets.

This year, Mr. DiNapoli is pushing Chipotle Mexican Grill Inc., Universal Health Services Inc. and Brinker International Inc. for independent racial equity audits of corporate practices related to civil rights, racial equity, diversity and inclusion, progress reports on DEI measures, and for some health-care companies, reporting on racial and ethnic disparities in health-care outcomes.

"There has been an unmistakable upsurge and breakthroughs on racial equity auditing" in proxy voting, said Eli Kasargod-Staub, executive director of shareholder advocacy group Majority Action in Washington. Shareholder proposals that had "an incredible first year" in 2021 saw more agreements reached in 2022, and more than two dozen have been filed this proxy season.

"There is nothing I can think of that has seen such a dramatic shift in the last two years," he said.

Investors also want to see a direct connection between executive compensation and company performance. ESG metrics are becoming more common in the executive compensation calculations, and investors are getting a boost from a new Securities Exchange Commission pay-for-performance rule adopted in August, that tracks actual compensation paid, including stock awards, pension benefits and other compensation, along with performance measures like total shareholder return and net income.

"It's a good metric," said Marc Hodak, a partner at executive compensation and corporate governance consultancy Farient Advisors LLC, based in Dallas. "This rule is actually providing useful information for investors during this proxy season. They'll be able to use that information in determining how to vote on say-on-pay packages," he said.

Before the rule, there was "little understanding of what was pay and what was performance," he said. With the information now in one place, "we are trying to use it as a way to tell the (company's) story. That's going to be one of the things that we all get to discover together," Mr. Hodak said.

European regulations also have companies putting remuneration to shareholder votes for the first time, which should address long-standing concerns on transparency around performance and discretionary pay or pension payments, said Antje Stobbe, Frankfurt-based head of stewardship at Allianz Global Investors. In 2022, AllianzGI voted against 43% of remuneration-related proposals globally and 78% in the U.S. A chief complaint against companies was they failed to adopt long-term incentives aligned with performance benchmarks rather than stock market moves.

While climate issues are now perennial ones at annual meetings, "the climate discussion has become a lot more sophisticated," said Ms. Wilson of EOS at Federated Hermes. "I think there are big expectations of companies. Our voting policies are about pushing for minimum standards … and clients are making climate part of their voting policy. Increasingly, institutional investors need to have a view on how well they think a company is doing on climate," she said.

Investors are also drawing a closer connection between biodiversity and climate change, and how companies address those, in both operations and supply chains. And, when it comes to achieving the climate goals of the Paris Agreement, deforestation is a big part of that conversation with shareholders.

In Europe, where the European Union plans to introduce new regulations on deforestation, "this will be a change for a lot of companies," said Ms. Cozic with Fidelity International. This year, the asset manager will engage with companies, but in 2024 will hold boards accountable through proxy voting at companies reliant on commodities linked to deforestation, such as palm oil, beef, and soy and timber, she said.

Interconnected to all types of ESG issues are shareholder concerns over political spending and lobbying practices, to make sure that companies are not working at cross purposes or just giving lip service.

This proxy season will have an interesting twist for U.S. companies caught in a growing ESG backlash: the filing of shareholder proposals seeking to derail initiatives on diversity, climate change or corporate transparency.

Some anti-ESG proposals were excluded or defeated last year but are not expected to go away in 2023. "You've got these anti-ESG forces pushing back," said Mr. Kasargod-Staub, who complains that the proposals "are not grounded in the clear economic and fiduciary reality" that shareholders face.

To navigate this proxy season, he said, "companies will have to exercise leadership."