The importance of having a well-conceived climate strategy should be more evident to corporate boards now that a small hedge fund that owns just 0.02 percent of Exxon Mobil shares has won two seats on the oil giant’s board, and could potentially win an additional two seats that are undecided after an extremely close vote. The Exxon board losing two seats over its lack of attention to climate change sends a stern message to corporate directors that ESG issues are being taken seriously by investors, and a failure to engage shareholders on these issues could lead to their ouster.
Engine No. 1, a self-described “purpose-built” investment fund, began its “reenergize Exxon” campaign last year to persuade the company to lay out a serious plan that could lead to sustained future growth if the world moved away from the use of fossil fuels. Several years of stock price underperformance relative to its peers, a lack of “transformative energy experience” among board members and lack of attention to the business risks associated with carbon emissions were some of the reasons Engine No. 1 cited for a need to restructure the board. The hedge fund put forth a slate of four directors it hoped to add to Exxon’s board and won support from several of the oil company’s largest shareholders, including BlackRock, State Street and Vanguard.
At the annual meeting, the shareholders sided with Engine No. 1 and at least two board members will lose their positions on Exxon’s board. If directors on other company boards do not want to suffer the same sort of fate, they should consider the following:
Activists are using climate change related issues to influence board strategy.
Directors are risking receiving “against” votes regarding their reelection to the board if they continue to ignore shareholder concerns about ESG issues. Climate change has become a major issue this year as the intensity of major storms and the number of forest fires increases as the polar ice cap continues to melt. Since carbon emissions are considered the cause of these environmental problems, boards that do not have a climate strategy are going to have to explain, in great detail, why they don’t.
Boards should consider appointing a committee to study climate change and work with management to come back with recommendations that can be integrated into the current business strategy to improve long-term financial performance. At the very least, such a committee can provide evidence that climate strategy might not be the best move for the company if the board insists it does not want to address climate change. What shareholders want is for boards to follow steps that other companies are taking to make sure that climate change risk is being mitigated properly and any opportunities to shift to more profitable strategies are being acted upon. Failing to engage shareholders about climate strategy appears to be an invitation to activists to file a climate related shareholder proposal.
Failing to address climate strategy is eroding investor trust.
When the board doesn’t listen to its shareholders, it erodes investor trust. Exxon’s board has been asked to address climate change in prior years and consistently ignored its shareholders, yet financial performance did not improve significantly. Forcing investors to file a shareholder proposal before a board takes action on an issue is not a good way to ensure the reelection of its directors. There is a ton of evidence that shareholder believe climate change is a serious issue, so all boards (not just energy companies) must figure out how climate change will affect their industry and their company’s future productivity. How will increased air pollution affect your customers? Will increased natural disasters and rising sea levels destroy supply chains? How will a shift to clean energy sources affect your business? These are legitimate questions that investors are asking among themselves, and if the board refuses to answer these questions in straightforward fashion, shareholders will look for replacement directors who will.
Is the board prepared to adapt to climate change-related challenges?
Many of the challenges that climate change may present companies may not be fully known yet, so boards must be prepared to concede that they need help sorting out how they should address climate change. Boards may need to be proactive in bringing on a new board member with climate change related experience to help develop an appropriate climate change strategy that investors can be comfortable with. After putting up a fierce resistance to change, Exxon’s board offered to add two directors of its choosing, but the offer was rejected as “too little, too late.” Now the board could lose as many as four seats to the dissident shareholders.
Making changes in the best interest of the stakeholders is part of the board’s core responsibility, so making a hard assessment of the skill sets of directors and the ability of the board to handle specific challenges is essential to good corporate governance. It is almost always better for the board to make this type of assessment and change on its own than to cost the company millions of dollars in a proxy fight. Engine No. 1 made it clear that it felt the Exxon board lacked “transformative energy experience” which would have helped the board develop a viable plan to transition from fossil fuels to clean energy. There is no shame in accepting help when offered, but there is plenty of shame in being pushed out for refusing to accept help.