ESG (Environmental, Sustainability, Governance) continues to be in the news these days. Prong Three – Governance usually does not get as much play as the first two but last week we saw a prime example of governance. It was the stunning defeat of Exxon management for at least two or perhaps three Board of Director seats. These Exxon Mobil Corp. (Exxon) nominated Directors were defeated by a slate nominated by Exxon shareholders, Engine No. 1, who, according to the Wall Street Journal (WSJ), “ran a six-month, $30 million campaign centered on pushing the oil giant to commit to carbon neutrality.” In other words, another prong of ESG, Environmental. There were several interesting points in this series of events culminating in the Board election and several important lessons for the compliance professional around ESG.
I do not know if Exxon had its collective head buried in the sand, was so arrogant that it believed it was infallible, something else or a combination of all of the above. It all started poorly for Exxon when they refused to listen to their shareholders. Engine No. 1 reached out to Exxon to seek nominees who would commit the company to a long-term carbon neutral approach. According to the New York Times (NYT), “On Jan. 22, Exxon’s C.E.O., Darren Woods, and lead independent director, Ken Frazier, held a Zoom call with Engine No. 1 executives. During the meeting, Frazier struck a conciliatory tone — at one point, he held up a peace sign — but said the company didn’t consider Engine No. 1’s nominees to be qualified. Charlie Penner, the fund’s head of active engagement, said the company should reconsider, and insisted on all four of its candidates taking seats on Exxon’s board. After the call, both sides girded for battle, with Exxon naming new board members later without Engine No. 1’s input.”
But Exxon was not simply ignoring Engine No. 1; they treated other investors the same. The NYT reported that Anne Simpson, head of corporate governance at California Public Employees’ Retirement System (CalPERS), said, “It has been like pulling teeth to get Exxon directors to talk to investors.” But it was more than CalPERS, it included such hedge fund heavy weights as State Street Global Advisors, T. Rowe Price, Vanguard and a host of others. According to the WSJ, “For Engine No. 1, launched by investor Chris James with roughly $250 million under management, the campaign was a referendum on its focus of combining environmental concerns with a company’s financial outlook.” Quoted in the NYT, James said, “Our overall goal is really greater transparency.”
The non-sensical approach of Exxon seems evident now. They violated one of the basic laws of capitalism; that is shareholders are the owners of the company, not management. Nell Minow, writing in the Harvard Law School Journal on Corporate Governance, said “corporations, like the US government, were set up with a series of checks and balances, and one of them was the ability of investors to replace directors if they were unhappy with the direction of the company.” Moreover, “The entire system of capitalism is based on a credible mechanism for minimizing agency costs. If investors have no recourse when they are not satisfied with an investment other than selling the stock when it is undervalued, the cost of capital will reflect additional risk. And when it becomes intolerable, a group like Engine No. 1 will recognize the potential for creating value by leveraging shareholder discontent to support meaningful change.” Whether Exxon’s intolerance was through incompetence or arrogance, we may never know.
The cost to Exxon was quite high. Already perceived as leading the fight against moving towards carbon neutrality, perhaps this vote will portend a shift in Exxon thinking; although this heavily depends on a corporate culture willing to listen. Think about this for a moment, these investors who voted against the Exxon Board candidates did so with the knowledge that they may well be sacrificing short term financial interest for a longer term play. While such thinking is certainly refreshing, it is usually lacking.
What is the role of compliance? Matt Kelly, in a Radical Compliance blog post, discussed a “Materiality Map” of corporate ESG concerns, citing to one in graphic form of Bank of America (BOA). BOA polled 30 executives and 15 leaders of various ESG groups, “to determine which ESG issues are most relevant to both external stakeholders and the company’s core business strategy.” From there, BOA “identified 29 ESG issues — everything from ethical behavior to retail branch location strategy; greenhouse gas emissions to investor activism and proxy voting — and mapped those issues on a coordinate grid. That let Bank of America define each issue by how important it was to the business.” That sounds precisely like a risk assessment to me as BOA used it to help build out their ESG program moving forward.
In the BOA Materiality Map, the ‘G’ in ESG (governance) was seen as transparency. That brings up another area in which compliance can help lead a corporate ESG effort. The Department of Justice (DOJ) said in the 2020 Update to the Evaluation of Corporate Compliance Programs, that the compliance function should lead a company’s institutional justice and fairness effort. Part of that includes being transparent with stakeholders by engaging with them; not simply talking but also listening. Minow said “I have spent more than thirty years studying corporate failure and the one constant indicator is responding to criticism with hostility instead of constructive engagement. Every board should make sure that does not happen… They should expect a lot more interest from shareholders in the quality of the board, with emphasis on independence that goes beyond resume disclosures. Wise boards will solicit suggestions from investors and make sure that all directors know that their obligation as fiduciaries is to shareholders, not executives, and that their actions make that message clear to shareholders as well.”
Exxon management should well heed Minow’s words. If it continues to fight its own shareholders and investors about what they want for the company, they may find themselves working elsewhere. For every compliance professional never forget the ‘G’ in ESG.
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