Investors are increasingly focusing on corporate engagement and the role it can play in their ESG process, according to Kirsten Temple, head of SRI and ESG at JANA Investment Advisers.
Does engagement lead to meaningful change in corporate behaviour and business direction, and, importantly, does this result in better risk/return outcomes for the investor?
Determining cause and effect is difficult, however academic research may provide some insights. Until recently, there was limited research on the efficacy of engagement on ESG issues, with most studies focusing on ‘activism’, where shareholders seek to assert their influence by publicly raising their concerns. This differs from engagement, which more typically involves meetings and calls with boards and management teams and is generally conducted in a less public manner.
Research on the effectiveness of activism has drawn mixed conclusions, both in relation to the impact that activism may have on driving actual change in the target company, and whether activism results in an improvement in investment outcomes.
Research conducted on ESG engagement appears to be telling a more consistent story thus far, with a number of recent studies concluding that successful corporate engagement can result in improved operating performance, reduced share price volatility and improved share price performance. A study of over 2000 ESG engagements with US companies over the 10 years to 2009 found that successful engagements were followed by cumulative excess returns of +4.4 per cent, most of which occurred in the 12 months following the engagement (Active Ownership (2012); Dimson, Karakaş & Li).
This supports earlier research conducted on a specific fund manager’s investment decisions which concluded that the manager’s outperformance of +4.9 per cent per annum was the result of successful engagements rather than stock picking (Returns to Shareholder Activism: Evidence from a Clinical Study of the Hermes UK Focus Fund (2009); Becht, Franks, Mayer & Rossi).
Earlier this year, Henley Business School released preliminary findings from research conducted on ESG engagements with companies in the extractives industry (research by Andreas Hoepner, Ioannis Oikonomou and Xiao Yan Zhou, yet to be published). The research utilised the Hermes Equity Ownership Services database, which included 167 engagements with 56 companies that were broadly split across environmental, social and governance issues. This is arguably the deepest research conducted on the topic to date.
The study found that companies that were the target of engagement generated an average outperformance of +4.4 per cent per annum and were associated with a lower risk profile relative to similar companies. Those that implemented strategies to deal with issues highlighted by the engagement process outperformed those that simply acknowledged the engagement efforts.
Further, those companies that responded negatively to attempts at engagement significantly underperformed other engaged companies. Interestingly, the study also found that the target of engagement efforts may influence outcomes. Engagements with the chair or with the corporate social responsibility team were associated with stronger outperformance than engagements with management teams. However, downside risk characteristics were more significantly improved following engagement with management teams.
While there are limitations to the research conducted to date, in that each of these academic studies utilised data from a single engagement services provider, the conclusions provide support for the case for engagement and learnings that may assist in the development of engagement practices.