Environmental, Social and Governance (ESG) investing is increasingly becoming a phenomenon on the world’s capital markets. ESG is a demand-driven aspect of investing, as today’s investors, especially the younger generations (partly gen. Y, the millennials, and younger), are not only concerned with the return and risk of their investments, but also the impact they are making with them. This impact can range from workplace diversity to environmental footprints, including hundreds of factors that are examined periodically for a growing number of companies worldwide. Based on their factor scores, companies are ranked and benchmarked against each other.
In our ESG blog series we already talked about the environmental and social factors of ESG, now let us have a look at how the governance pillar links to these. If you follow the markets, you will find that corporate governance issues make headlines on a regular basis with investors regularly pushing back on them, as such making corporate governance characteristics a part of the investment process through investing in well-governed companies as a way to mitigate risk is essential.
The corporate governance component relates to the board of directors and company oversight, as well as shareholder-friendly versus management-centric attitude.
- Executive compensation, bonuses, and perks: Executive compensation is an ongoing hot-button issue in corporate governance. Securities regulators in many countries, including the U.S. and the U.K. require publicly traded companies to allow shareholders to vote on executive compensation packages at regular intervals. Norway’s influential 1 trillion euros sovereign wealth fund focuses on curbing excessively high executive salaries at companies in which it invests, arguing that certain compensation structures work against the long-term interest of shareholders.
- Unequal voting rights: If you own one share in a company you would expect to have one vote but that is not always the case, a lot of family-run businesses or founder-led tech companies do everything in their power to suppress shareholder vote. For example Adam Neumann, WeWork CEO, set up a multi-class voting structure with major voters getting 20 votes per share – as opposed to the usual 10 votes per share – to ensure that he could maintain control of the company, which then received a pushback from investors. Also a study conducted by ISS not only found that companies with unequal voting rights underperform the rest on total shareholder return, revenue growth, and return on equity, but CEO pay was more than 40% higher at these companies.
- Whether chairman and CEO roles are separate: The two most authoritative positions in a boardroom are the CEO and the chairman. However, when these roles are combined, all the authority is vested in one individual, presenting a greater risk of governance issues. Elon Musk had to step down as Tesla chairman to settle fraud charges brought by the U.S. over claims he made saying he’d take his company private. As part of Musk’s settlement, both Tesla and Musk had to each pay a $20 million fine. Approximately 32% of companies score “F” on their ESG rating and performance-wise five-year shareholder returns are nearly 28% higher at companies with a separate CEO and chair.
Asset owners and portfolio managers overseeing trillions of dollars seek to incorporate ESG considerations into their investment process where investment firms have a unique sales opportunity to consider. By combining the product-level ESG features of an investment with the clients’ profile based on their ESG preferences and thus recommend products that suit them best in a hybrid advisory model. In order to understand where to start, click here and download our whitepaper, which gives a detailed overview of the growing popularity of ESG investments and explains the benefits of incorporating ESG-based profiling features in the investment ecosystem.