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Navigating Uncertainty and the Future

April 01, 2020

The Raj & Kamla Gupta Governance Institute believes it is essential during this period of isolation brought on by COVID-19 that we continue our mission of modernizing boardrooms through practical dialogue in order to navigate these unprecedented times together. During this webinar, Rob Main of Sustainable Governance Partners shares his expert insights on how directors should navigate these turbulent times while addressing the business imperatives looming on the horizon.

Listen to the “Navigating Uncertainty and the Future”

Webinar Transcript

Patricia Connolly: Hello. My name is Patricia Connolly and I am the Executive Director of the Raj & Kamla Gupta Governance Institute at Drexel University’s LeBow College of Business. During this period of isolation and uncertainty, I wanted to find a way to communicate with directors and CEOs to provide a worthwhile perspective and practical insights.

The global pandemic is first and foremost a human tragedy. It’s impacting hundreds of thousands of people and it continues to have an increasing impact on the global economy. Though we’ve experienced a dramatic change in life and work and the near term is highly uncertain, equity markets remain open and the expectation is that public companies will continue to operate, engage with shareholders and conduct annual shareholder meetings. With that as the backdrop, the Gupta Governance Institute will be bringing a series of thought leadership to our stakeholders to help directors and CEOs identify the issues most important to investors and provide some practical advice on how to proceed amidst this environment.

Today’s discussion will be the first of the series providing a high-level overview of what directors and CEOs need to be thinking about when navigating today’s unprecedented times while still addressing the business imperatives looming on the horizon. I am pleased today to be joined by Rob Main who is a leading corporate governance and ESG expert and a managing partner at SGP - Sustainable Governance Partners, which is an independent advisory firm that advises companies on corporate governance and ESG strategy. Specifically, SGP helps companies with shareholder engagement, proxy voting issues, ESG strategy and communication and activism defense. Rob has over 20 years of asset management industry experience, and before starting at SGP, he led Vanguard’s US investment stewardship efforts which include proxy voting engagement and industry advocacy.

Rob, again, thank you for talking with us today, it is imperative that we discuss the current environment. We know that boards are prepared and have robust risk mitigation plans in place, but we face unprecedented times. What should companies and directors be focused on?

Rob Main: Good morning Patti, I first want to thank you and the Raj & Kamla Gupta Governance Institute for including me in this conversation. But as you mentioned, we’re in a very unique period in our country. We’re in the midst of an unthinkable crisis and it’s impossible to predict the future. But here’s what we know: stock prices are down dramatically, economic activity has ground to a halt in many areas, and the severity and duration of this crisis is impossible to predict.

The other reality is that companies of all shapes and sizes and across industries are fighting for survival each day and their management teams are facing extremely difficult decisions that as of a few weeks ago, were not in the realm of possibility, including decisions related to operations, short term liquidity, employees and capital spending. In this environment, investors expect the CEO and the senior leadership team to be exclusively focused on managing the business. But it’s also crucial time for directors, both individually, and for boards overall at public companies. Investors expect directors to provide perspective, insights, and appropriate oversight on a growing number of topics and they especially look for that wisdom in challenging times like today.

Connolly: What are you hearing? What are boardroom discussions focused on?

Main: So candidly Patti, it’s all over the map. Every industry and company are different, but it appears the conversations are centered on three primary topics. First, it’s COVID- 19, the risks and the response. Second, is any impact on short and long-term company strategy. And third, it’s communications with key stakeholders. In this moment, like any other, there’s no one size fits all solution and I think companies are actively trying to balance the tradeoffs between their short-term financial needs and some of their longer-term strategic priorities.

But let me just provide a little more color on the three topics I mentioned. So first, with respect to the COVID-19 response, directors and the senior leadership team, but specifically the CEO, are staying in very close communications to be able to digest the impact and to figure out not only the company’s near term, but ongoing response. Suffice to say, the, the traditional cadence of meetings has changed dramatically in the last few weeks. And leading boards have already adopted a new cadence of communication. From a strategy perspective, directors are actively reviewing strategic business changes, asking questions when necessary, and providing their expertise and insights.

I think experienced board members who have been through and led through various crises are especially valuable during these trying times, as they have the bruises and scar tissue from prior situations that are incredibly valuable right now.

And then finally on stakeholder communication, companies are acutely aware that stakeholder communication is incredibly important in this moment, and directors should stand ready to help companies with communicating with investors, regulators, and other important stakeholders, because it is times like these where long-term strategic relationships are incredibly valuable.

Connolly: Rob, I couldn’t agree more communications are vital, and given their importance, how should boards communicate with their investors? What information should they include?

Main: It’s a great question. I think for a lot of us it feels like the world is changed overnight. I think what hasn’t changed though is that a company’s long-term shareholders; index funds, asset owners and long-term fundamental active managers, who look to hold a stock for multiple years, they continue to look to directors to be effective stewards, and they really believe that sustainable governance matters. Again, especially in moments like this.

Here we are in late March. We’re sort of on the eve of 2020 proxy season and this is a time of year when directors will actively engage with some of their key investors. And again, this two-way dialogue is incredibly important. One of the reasons it’s incredibly important is for directors to engage directly with some of the big index investors. This might be the only time during the year that they’re actually going to communicate, and it’s really important that directors customize that communication to their different categories of investors. A conversation with an index investor, which is primarily going to focus on governance and oversight, is going to look a lot different than the conversation with a fundamental investor who might want to dig more into strategy and capital allocation. So again, I think it’s really important for companies to make sure they’re tailoring their message to the specific audience that they’re communicating with. But I think it goes without saying that, there’s probably two topics that are going to be top of mind for every investor. It’s going to be COVID response and process and board involvement as the first and then again, the fact that we’re going to be in proxy season very soon, I think investors are going to want to hear about relevant annual meeting topics that the company wants to discuss.

Connolly: Great. Let me pivot for a moment here. Before the turbulence of the last few weeks, there were important themes influencing companies’ relationships with their investors. Can you talk about a few of those things and have they changed given COVID-19?

Main: So clearly COVID-19 is the dominant theme currently and nothing else is even close. However, coming into the year we thought there were a few themes that would be both front and center for 2020, but also themes that would be enduring for years to come. I’ll highlight the theme and then we can talk a little bit about its impact.

So, the first theme that we have to highlight is this idea of investor concentration. And what I mean by that is, in the last decade we’ve seen investors gravitate away from fundamental traditional stock picking mandates and moving assets to index funds. So, what that has meant is that now we have the “big three”, BlackRock, State Street and Vanguard, and they now own over 20% of most US companies. So individually and as a group they’re a very important shareholder base for every US company. So, the impact is that companies need to be acutely aware of how BlackRock, State Street and Vanguard approach ESG issues, proxy voting and engagement. Because their stance on issues is going to shape governance norms, it’s going to shape disclosure standards, and their votes could determine outcomes at annual meetings.

Connolly: Before these recent events, I was hearing a lot about heightened attention to ESG. Is that one of the themes that you also saw?

Main: So, that was number two for us. We think we’ve really gotten to the inflection point here in the US, where I think there is now broad consensus that ESG policies represent material risks and opportunities to financial performance. I think this has the potential to be a longer-term secular trend, actually, we think it will be a secular trend. Maybe a different way to think about it is that, ESG issues can impact both sides of the PE ratio. So, it’s going to assess or impact both the markets of valuation of the valuation of the company, but it also could impact long-term financial performance. So again, from an impact perspective, investors now expect ESG factors to be integrated into a company’s strategy and they expect it to be disclosed in public reports. For index investors, they’re looking at this disclosure as an indication of governance quality. On the other side, fundamental active investors who are under increasingly massive pressure to deliver alpha are focusing more and more on sustainability issues and variables beyond the financial statements in the pursuit of drivers of intrinsic value.

Connolly: How about the focus on stakeholders, corporate purpose and long-termism? How does that fit in?

Main: This would be the third theme that we would highlight. From conversations and from dialogue with market participants, there seems to be growing pressure on companies from investors, regulators, and other stakeholders to think beyond the traditional bottom line and consider other objectives. I think there’s been two points, or two publications that have really hammered this point home in the last six months. The first was the Business Roundtable’s letter in 2019 and the second was BlackRock’s letter to CEOs at the beginning of 2020. Both cases focused more on sustainability topics and bringing to light this idea of stakeholder capitalism. So, I think the impact is that companies are going to have to wrestle with the evolving demands from their investors because there is a renewed debate from many stakeholders; regulators, employees, and communities, about the real purpose of the corporation. There’s also a question around whether shareholder interests really should come first.

So let me give you a practical example of a topic that feeds into this category, or falls under this banner that’s very relevant right now in the midst of this crisis, and that is human capital management. I mean the human toll of the coronavirus is hard to fathom. Obviously, it starts with health and safety, but encompasses widespread layoffs, sick leaves, and we could be in for a period of potentially sustained unemployment; and for companies, many identify their employees as their greatest asset.

But I think we’re in this really difficult moment where there has to be an honest conversation about employee wages are a recurring expense, but there isn’t the offset on the other side of recurring revenue. So, it’s possible and likely the companies will want to address a couple things. Number one, they’re going to want to understand the near-term tradeoff between compressed margins and longer-term workforce preservation. I think there’ll be more and more questions about how the crisis is going to impact workers. Then I think the longer-term question would be how the decisions a company makes today will have long-term implications.

So, if a company makes hard decisions today, is that going to impact their ability to attract and retain employees in the future? These are really hard decisions that every company is going to have to work through. I think of what might happen in proxy season and a little bit beyond, and I think this is the one theme that really does bear watching because again, given the crisis, I’m not sure the volume level around stakeholder capitalism. I’m not sure it’s going to be turned up as much as it may have been anticipated just a few more months previously. But, I do think that once we are on the other side of the crisis, investors are going to be talking more and more to directors and management teams about corporate purpose. Our view is that investors will come to see board and management’s articulation of purpose as sort of a next generation corporate governance best practice.

Connolly: Rob, given we are in this crisis, what do you expect to see as we move into the proxy season?

Main: So, we’re almost there. I always think of what used to be Tax Day, April 15th, is the day that things really intensify. I guess tax day will be delayed this year, but you know, as we head into, the US proxy voting season, I’ve had the chance to talk to a lot of different asset managers, owners and companies. There’s a couple things that are front of mind for me as I think about this season.

First, I think there’s been some questions around, how is the situation, how’s the crisis going to impact voting? How’s it going to affect engagement? And maybe focusing on voting first, I really think investors are going to stick to the policies that they’ve already established. So, companies and directors should not expect deviations from stated philosophies and guidelines that their investors have in place.

Candidly, in recent days, my conviction on this point has strengthened a bit as we’ve seen a number of large investors make public comments to the same effect, reinforcing that they’re sticking to their policies that they implemented before the crisis. So, for example, directors and companies should expect BlackRock to focus on topics such as board composition, environmental risks and opportunities, corporate strategy, capital allocation and human capital management. And I think importantly, one of the deviations or changes that BlackRock has put in place for this year is that it does seem like there’s going to be the possibility that they are going to hold directors more accountable and potentially vote against them if the company’s not making progress in some of these key areas. So, I think the bottom line from a voting perspective is that despite the Coronavirus, companies should not expect a pass from investors in 2020.

Connolly: Let’s just stay on shareholder engagement and ESG. It has ramped up significantly, but do you expect it to change in the current environment? It sounds like that’s not going to be the case.

Main: I have a lot of thoughts here, I’ll try to be concise. I do think that the form of engagements is going to change, and I think the substance will continue to expand. I think it’s going to continue to expand beyond what I think of as the classic governance topics of board composition, executive pay, and shareholder rights. So, I think we’ll see an expansion of the topics that will be in discussions. But let me run through a couple other thoughts that I think hopefully will be relevant and practical for folks.

First, I think directors should be willing to engage with shareholders. Director involvement has continued to increase in engagement in recent years, and I think it has become best practice. So that’s first and foremost. Second, given the crisis, face-to-face meetings are not going to happen, but similar to most industries, I think there is going to be a shift towards using more video conferencing. And from the dialogue I’ve had with companies and investors, and personal experience, I think the technology is easy to use and is a good substitute for in-person meetings. Even looking beyond the current situation, I think video conferencing is one trend that’s more likely to stick longer term. The other point I make around engagement with investors is that I think it’s possible that the length of an engagement, so how many minutes that they’re spending on the phone with some of their key investors, that could be compressed.

Proxy voting teams are working from home, they’re going to probably be even more stretched than they have been historically. I think there’s potential that the time for engagements will be compressed, which might mean even more of a laser focus on a specific ballot item if that’s the purpose of the call. As an example, let’s say there’s a concern a company has about say on pay, and the company decides to be proactive and reaches out to many of their biggest investors. I would suggest a three-part playbook. Number one, reach out to your investor with clarity, being really specific about what you want to discuss and why. Number two, I think concise, investor-specific materials to support the company’s perspective will be really worthwhile. And then three, companies should be prepared to have a very focused conversation including the head of the compensation committee.

I’ll make just a couple of other comments around where things are headed beyond the immediacy of proxy season. I think the topical highway of governance is rapidly expanding, the three-lane highway of board composition, shareholder compensation, and shareholder rights is expanding to include relevant environmental and social topics that are more industry and company specific. So, if we use the 429 shareholder resolutions in the US as context, companies should expect more discussion on climate change, political spending, and diversity inclusion, as about two thirds of proposals have focused on those three key topics.

And then again, just looking even further beyond proxy season and hopefully when we’re on the other side of the COVID-19 crisis, there’s going to continue to be a push for companies to produce external reporting on material ESG issues. And from where I sit, it seems like the standards being put forth by the Sustainability Accounting Standards Board, or SASB, have really gained momentum, including support from Larry Fink in his 2020 letter to CEOs. I do think there’s the potential that SASB will become the standard as we look out over the next couple of years. What’s certain is that investors will be looking for companies to produce more external disclosure related to ESG risks.

Connolly: Thank you, Rob. As we conclude today’s discussion, I know you and your colleagues are talking to a number of directors, CEOs, and various companies. Could you share with us what advice you have to give at this time?

Main: This is always a hard one. But if I think about it from an investor perspective, in times of great uncertainty, the role of the board of directors as a strategic asset is incredibly important. So, I would hope that executives are leveraging unique experiences and the broad set of perspectives that their board members bring. Hopefully pulling together or harnessing the power of that diversity towards the end of making better decisions. Again, from my seat, a board built for sustainable long-term success is armed with the breadth of knowledge and experience that augments that of the management team. It brings that needed outside perspective and plays the dual roles of both challenging and supporting the C-Suite, so that the company can respond to risks and opportunities with the long-term in mind.

And finally, one other thought. In times of great duress, we should all be learning – so this advice extends to investors, market participants, directors and senior business leaders – never stop asking the question, “What am I learning?”, as we navigate the economic, financial, business and human implications of this crisis so that we all emerge better and stronger for the future. 

Connolly: That’s great advice to end this conversation on. I want to thank you so much for taking your time today to chat. It’s important for directors and CEOs be thinking about and addressing the impact of these events, while still anchoring in the long-term. I appreciate your willingness to share your expert insights with the Gupta Governance Institute’s stakeholders.

I also would like to thank you, the audience, for taking the time to listen to this discussion. Please fill out the response form to provide your feedback, what topics you would like to hear about or questions you would like answered in our subsequent discussions. On behalf of the Raj and Kamla Gupta Governance Institute at Drexel University, thank you and take care.