Environmental, Social and Governance Trends and Development
Climate Scorecard. At this point, public companies are keenly aware of the growing emphasis shareholders place on companies’ practices in regard to environmental, social and governance (“ESG”) issues. In furtherance of that heightened focus on ESG issues, in August 2019, Institutional Shareholder Services (“ISS”) announced the introduction of a new Climate Awareness Scorecard, which ISS said will “appear in a range of select ISS Benchmark and Specialty policy research reports.”
According to ISS, the Scorecard “distills and harmonizes publicly available data and ISS proprietary analysis on a company’s climate change-related disclosures, practices, and performance record, including its industry risk group.” The Scorecard is divided into three sections.
The first section measures a company’s “climate risk exposure.” A company’s climate risk exposure is evaluated based on two factors: (i) the company’s Industry Climate Risk Exposure, for which each company is a low, medium, or high climate risk exposure based on its specific industry and business activities, and (ii) the company’s Incident-Based Risk Exposure, which indicates whether the company is violating the standards of the Paris Agreement or other universally accepted climate norms.
The second section of the Scorecard measures a company’s “climate performance.” A company’s climate performance is also evaluated based on two factors: (i) the company’s current climate performance, which evaluates the company’s current direct and indirect greenhouse gas (GHG) emissions relative to that of its peers, and (ii) the company’s Forward-Looking Climate Performance, where the company is assigned a Carbon Risk Category (Leader, Performer, Underperformer, or Laggard) and Rating (0-100 scale, where 100 is best).
The third section of the Scorecard measures a company’s “climate disclosure.” In this section, ISS attempts to rate each company on its disclosure across four categories: (i) climate governance, (ii) strategy, (iii) risk management, and (iv) metrics and targets. Classifications assigned within each category are Standard Unmet, Partial Alignment, Meets Standard, or Exemplifies Standard.
Director Diversity. Board diversity issues will remain front and center in 2020. We’ve discussed in each of the last several Corporate Communicators the push for diversity by institutional investors, such as BlackRock and State Street Global Advisors and the initiatives undertaken by the New York City Comptroller Boardroom Accountability Project. 2019 was also the first year that California public companies were required to come into compliance with California’s law requiring women on boards.
Following on this trend, 2019 brought a few new developments in the Board diversity arena. Taking California’s lead, additional states have been exploring and, in some cases, adopting laws related to diversity. For instance in September, Illinois enacted a law requiring publicly listed companies headquartered in Illinois to disclose information in their state filings about (1) the racial, ethnic and gender diversity of their boards of directors, (2) how demographic diversity is considered in their processes for identifying and appointing director nominees and executive officers, and (3) their policies and practices for promoting diversity, equity and inclusion among the board of directors and executive officers. While no other state has gone quite as far as California in mandating diversity on Boards, the Illinois approach, of mandated disclosure, does seem to be the current focus for several states.
The SEC also took action on the issue of Board diversity earlier this year with the adoption of two Regulation S-K compliance and disclosure interpretations (“C&DIs”). Pursuant to the new C&DIs, if a board or nominating committee has considered a person’s self-identified diversity characteristics such as race, gender, ethnicity, religion, nationality, disability, sexual orientation, or cultural background of an individual in determining whether to recommend the candidate as a director, and the individual has consented to the company’s disclosure of those characteristics, the company’s proxy statement must include a discussion identifying those characteristics and describing how they were considered. Under the C&DIs, a company’s description of its diversity policies (already required to be disclosed under Item 407 of Regulation S-K) must include a discussion of how the company considers the self-identified diversity attributes of nominees, as well as any other qualifications its diversity policy takes into account, such as diverse work experiences, military service, or socio-economic or demographic characteristics.
Workplace Equity. Investors’ focus on diversity and equitable treatment wasn’t limited to the Boardroom in 2019, as we’ve seen an increased focus by the investor community on workplace equity in general. For example, in 2019 investment management firm Arjuna Capital released its second annual Gender Pay Scorecard, which gave grades of “A” through “F” to 46 of the world’s largest companies based on gender and racial pay. Half of the companies ranked received a failing grade of “F,” while only one company was awarded an “A.”
Several activist shareholders have been targeting public companies to pressure added disclosure around pay gaps. Many of the requests (and in some cases proposals) in 2019 have focused on median pay gap, which seeks disclosure of the median compensation value among all females in the workplace compared to the median compensation value among all males in the workplace. This reflects a slight shift from the focus in prior years, where shareholder requests tended to focus on wage gap percentages, which accounted for differences in compensation based on various factors, such as work performed (i.e., “equal pay for equal work”). In other words, the new focus on median pay gap statistics may highlight a pay gap that wasn’t prevalent based on wage gap percentage reporting. While several companies have attempted to seek “no-action” letter relief from the SEC to omit these disclosures, they have generally been unsuccessful.
2020 Proxy Voting Guidelines Updates
As is the case each year around this time, ISS and Glass, Lewis & Co. (“Glass Lewis”) both recently updated their proxy voting guidelines for the 2020 proxy season. Below is a summary of the key policy updates for the U.S. market.
ISS Proxy Voting Updates
Problematic Governance and Capital Structures for Newly Public Companies. ISS has updated its policy for newly public companies to address multi-class capital structures with unequal voting rights. For these companies, ISS will generally vote against or withhold votes from the entire board (except new nominees, who will be considered on a case-by-case basis) if, prior to or in connection with the company’s public offering, the company or its board implemented a multi-class capital structure in which the classes have unequal voting rights without subjecting the multi-class capital structure to a “reasonable” time-based sunset. In assessing the reasonableness of a time-based sunset provision, ISS will consider the company’s lifespan, its post-IPO ownership structure and the board’s disclosed rationale for the sunset period selected, with any sunset period of more than seven years from the date of the IPO to be deemed unreasonable.
Similarly, ISS will now generally vote against or withhold votes from directors individually, committee members, or the entire board (except new nominees, who will be considered on a case-by-case basis) if, prior to or in connection with the company’s public offering, the company or its board adopted certain bylaw or charter provisions that are considered to be materially adverse to shareholder rights, such as supermajority vote requirements to amend a company’s charter or bylaws, a classified board structure and other “egregious” provisions. In assessing these provisions, ISS further clarified that a reasonable sunset provision will be considered a mitigating factor.
Independent Board Chair Shareholder Proposals. With respect to shareholder proposals requiring that the board chair position be filled by an independent director, ISS has updated its policy to explicitly list the types of factors that will be given substantial weight in ISS’ approach to evaluating these proposals, which generally codifies the existing ISS policy application.
Board Gender Diversity. As highlighted last year, starting in 2020 for Russell 3000 and S&P 1500 companies, ISS will now recommend against the chair of the nominating committee (or other directors on a case-by-case basis) if the board lacks a female director. ISS further updated the mitigating factors that it will consider when applying the policy, which includes: (i) until Feb. 1, 2021, a firm commitment, as stated in the proxy statement, to appoint at least one woman to the board within a year; (ii) the presence of a woman on the board at the preceding annual meeting and a firm commitment to appoint at least one woman to the board within a year; or (iii) other relevant factors as applicable.
Exemptions for New Director Nominees. ISS has revised its definition of “new nominee” to mean a director who is being presented for election by shareholders for the first time; therefore, a new nominee is not necessarily a person who just joined the board. When making recommendations on director nominees, ISS takes into consideration if a nominee should be held responsible for an action taken by the board before joining. ISS clarified that this case-by-case consideration only applies to new nominees that have served on the board for less than one year and will depend on the timing of the appointment and the problematic governance issue in question.
Board Attendance. ISS will generally vote against or withhold votes from directors who attend less than 75% of the aggregate of their board and committee meetings for the period for which they served, unless an acceptable reason for absences is disclosed in the proxy or another SEC filing. ISS has revised the policy to exclude nominees who served only part of the fiscal year.
Restrictions on Shareholders’ Rights. ISS will generally vote against or withhold votes from the members of the governance committee if the company’s governing documents impose undue restrictions on shareholders’ ability to amend the bylaws. ISS has updated its policy to include “subject matter restrictions” as an example of an undue restriction, which encompasses prohibitions on shareholders being able to amend the particular bylaws that govern their ability to amend the bylaws. Additionally, in order to address the general increase in the number of companies submitting proposals to shareholders seeking ratification or approval of requirements in excess of Rule 14a-8 regarding the submission of binding bylaw amendments, ISS will generally recommend shareholders vote against or withhold votes from the members of the governance committee until shareholders are provided with an “unfettered ability to amend the bylaws” or until a proposal providing for such unfettered right is submitted for shareholder approval.
Gender Pay Gap Proposals. ISS has expanded its policy relating to shareholder proposals requesting reports on a company’s gender pay data to now also include requests for pay data by race or ethnicity. Accordingly, ISS will consider these shareholder proposals on a case-by-case basis.
Glass Lewis Proxy Voting Updates
Key Committee Performance. In evaluating the performance of governance committee and compensation committee members, Glass Lewis has updated its policy as follows:
- Generally recommend voting against the governance committee chair when: (i) directors’ records for board and committee meeting attendance are not disclosed; or (ii) when it is indicated that a director attended less than 75% of board and committee meetings but disclosure is sufficiently vague that it is not possible to determine which specific director’s attendance was lacking.
- Generally recommend voting against all members of the compensation committee when the board adopts a frequency for its say-on-pay votes other than the frequency approved by a plurality of shareholders.
Excluded Shareholder Proposals. In cases where a company seeks to exclude a Rule 14a-8 shareholder proposal and the SEC declines to state a view on whether a proposal should be excluded, Glass Lewis takes the position that such proposal should be included in the company’s proxy statement. Accordingly, Glass Lewis will now recommend voting against the members of the governance committee if the company ultimately chooses to exclude the proposal from its proxy statement. Additionally, in light of the fact that the SEC may now orally, instead of in writing, respond to a company’s no-action request as it relates to a shareholder proposal, Glass Lewis expects companies to provide some disclosure concerning verbal no-action relief if granted by the SEC. As a result, Glass Lewis will now recommend voting against the members of the governance committee if a company excludes the proposal from its proxy statement without such disclosure.
Contractual Payments and Arrangements. Glass Lewis has clarified its policy for say-on-pay proposals with respect to the analysis of both ongoing and new contractual payments and executive entitlements. In particular, Glass Lewis has provided a list of certain executive employment terms that may result in a negative say-on-pay vote recommendation, which includes excessively broad change in control triggers; inappropriate severance entitlements; inadequately explained or excessive sign-on arrangements; guaranteed bonuses (especially as a multiyear occurrence); and failure to address any concerning practices in amended employment agreements.
Company Responsiveness to Low Support for Say-on-Pay Proposals. Glass Lewis has expanded its discussion of what it considers to be an appropriate response following low shareholder support for the prior say-on-pay proposal, which applies where a company has received 20% or greater opposition from shareholders. In such situations, Glass Lewis expects companies to provide robust disclosure of engagement activities and specific changes made in response to shareholder feedback. A failure to provide adequate disclosure may result in a negative say-on-pay vote recommendation.
Exclusive Forum Provisions. Glass Lewis will generally recommend voting against the governance committee chair where the board adopts an exclusive forum provision without shareholder approval. Glass Lewis has updated its policy to allow for an exception if it can be reasonably determined that the exclusive forum provision has been narrowly crafted to suit the unique circumstances facing the company.
Additional Compensation Related Clarifying Amendments
Glass Lewis has updated certain policies relating to compensation as follows:
- In reviewing say-on-pay proposals, Glass Lewis will review any significant changes or modifications, including post-fiscal year end changes and one-time awards, particularly where the changes touch upon issues that are material to Glass Lewis recommendations.
- With regards to short-term bonus or incentive plans, if a company has applied upward discretion, such as by lowering goals mid-year or increasing calculated payouts, Glass Lewis expects a robust discussion of why the decision was necessary.
- Glass Lewis has clarified that excessively broad definitions of “change in control” are potentially problematic as they may lead to situations where executives receive additional compensation where no meaningful change in status or duties has occurred. Additionally, Glass Lewis has stated that any arrangement that is not explicitly a double-trigger change in control arrangement may be considered a single-trigger or modified single-trigger arrangement.
Supermajority Vote Requirements for Controlled Companies. For controlled companies, in the event there is a shareholder proposal requesting the company eliminate any supermajority vote standard, Glass Lewis may now recommend that shareholders vote against such proposals. In these controlled company situations, Glass Lewis believes a supermajority vote provision may act to protect minority shareholders and should therefore be maintained.
Gender Pay Equity. In evaluating shareholder proposals that request that companies disclose their median gender pay ratios, Glass Lewis will review these on a case-by-case basis. However, to the extent a company has provided sufficient information concerning their diversity initiatives, as well as information concerning how they are ensuring gender pay equity, Glass Lewis will generally recommend against these shareholder proposals.
2019 Annual Meeting Recap
Below is a summary of certain developments and trends relating to the 2019 U.S. annual meeting proxy season:
Director Elections. According to a report published by Broadridge Financial Solutions and PwC in connection with the review of 4,059 public company annual meetings in 2019, the average overall shareholder support for directors in 2019 was approximately 95% of the shares cast compared to approximately 96% of the shares cast in 2018. However, while the average overall shareholder support was only down slightly year to year, the number of directors failing to receive majority support in 2019 increased 15% compared to 2018, while the number of directors failing to receive 70% support increased 23%. This reflects a generally increasing trend over the last five years regarding the number of directors who failed to reach these respective thresholds. Likely factors contributing to these trends are the fact that large institutional investors continue to adopt stricter over-boarding policies, as well as gender diversity policies.
Say-on-Pay. Shareholder support for say-on-pay proposals in 2019 remained generally consistent with 2018. Based on the corporate governance data as of September 30, 2019, collected by the EY Center for Board Matters for more than 3,000 U.S. public companies, overall shareholder support for say-on-pay proposals at S&P 500 companies was 90.5% in 2019, down from 91.2% in 2018. For Russell 3000 companies, overall shareholder support remained about the same in 2019 at approximately 90.7%. Additionally, the percentage of say-on-pay proposals at Russell 3000 companies in 2019 with less than 70% and 50% support was approximately 8.5% and 2.5%, respectively, which was largely in line with 2018 percentages.
Equity Compensation Plans. With regards to proposals for the approval of equity compensation plans, shareholder support continued to be strong at S&P 500 and Russell 3000 companies. Despite a slight increase in the percentage of these proposals with an “against” recommendation from ISS for 2019, all proposals for the approval of equity compensation plans at S&P 500 companies passed in 2019 and all but two proposals passed at Russell 3000 companies.
Shareholder Proposals. Continuing the trend from recent years, environmental and social (“E&S”) proposals represented the largest category of shareholder proposals submitted followed by corporate governance proposals. Key corporate governance proposal topics during the 2019 proxy season included those related to independent board chairs, shareholder written consent, elimination of supermajority voting, board composition and proxy access, while key E&S proposal topics included political spending, environmental and human capital management (e.g., gender pay gap, workplace diversity, sexual harassment). Despite a higher number of E&S proposals submitted, more corporate governance proposals reached a shareholder vote than any other category of proposals and represented the majority of proposals that passed at companies.