Kezia Farnham

Senior Manager

ESG proxy voting & how it’s shaping the boardroom

Some shareholders vote to maximize their return, while others vote to maximize their social impact. But with environmental, social and governance (ESG) proxy voting, shareholders strike a careful balance between the two, using their vote to push corporations to act in the best interest of both people and profits.

As the focus on ESG has intensified, so has the role of the proxy vote — turning what once was the boardroom equivalent of an absentee ballot into a tool for change. This shift in shareholder sentiment has also slowly reshaped the boardroom and will continue to impact proxy seasons of the future. Boards can prepare by better understanding:

• What ESG proxy voting is
• Examples of issues that influence ESG proxy voting
• ESG proxy voting trends over the years
• Common proxy voting guidelines related to ESG
• How boards can manage ESG-related proxy votes

How has ESG influenced proxy voting?

Proxy voting is the practice through which shareholders vote by proxy, meaning they cast their vote on board proposals via a representative. Traditionally, this allows shareholders to express their opinions even if they can’t attend the annual meeting in person. But in recent years, proxy voting and ESG have become a shareholder’s secret weapon.

As ESG rose in prominence, not all boards acted quickly, causing shareholder activists to use proxy voting as a tool to advance their own ESG priorities. This has forced boards to take notice of ESG proxy voting, given how heavily ESG issues can sway shareholder sentiment around board proposals.

Some ESG issues more heavily impact proxy voting than others:

Examples of proxy voting for ESG

ESG encompasses a wide range of issues. Come voting time, some are more persuasive for shareholders than others. Over the years, ESG proxy voting has solidified shareholder interest in:

• Diversity: During proxy season 2023, shareholders offered 3% more social proposals than in 2022 and 24% more than in 2021, signaling a continued focus on social issues — one of which is diversity. Nondiscrimination and diversity-related proposals were also among the top five types of shareholder proposals.
• Compensation: The new Dodd-Frank rules linking performance and pay also lead to more ESG proxy voting related to compensation, with 108% more compensation-related proposals reaching voting cards in 2023 compared to 2022. These proposals range from limiting executive compensation to creating firm severance policies.
• Climate: From 2009 to 2022, shareholders initiated nearly 1,000 climate-related proposals. While not all of those proposals came to a vote, they still represented a strong and continued emphasis on the environmental impact of business operations.

ESG proxy voting and shareholder activism

For decades, investors have bought shares in companies and then used those shares to influence company decision-making. Investors who do are referred to as shareholder activists, and ESG proxy voting has become a significant tool they can use to influence change.

In fact, shareholder activism increased 36% from 2021 to 2022, then remained a hot topic during proxy season 2023 after corporate giants like Disney and Salesforce both faced proxy fights. But the relationship between ESG and proxy voting isn’t always linear, given that corporations have found new ways to respond.

The future of ESG proxy voting and shareholder activism will be shaped by:

1. The universal proxy card: In 2022, the SEC introduced a new proxy card format — the universal proxy card — that will display board proposals and shareholder proposals side-by-side. This gives shareholder proposals more prominence and may even solidify the use of proxy voting as an activist tool.
2. Wider adoption of ESG policies: ESG has also become more mainstream than it once was. While anti-ESG shareholders and board directors remain, many see both the monetary and social motives for more effective ESG policies. This might make ESG more inherent in board proposals rather than a late addition by shareholders.
3. More strategic board management: Boards have also improved at managing shareholder expectations. Modern proxy insights tools have helped boards better understand their shareholders to reach an agreement before a proxy fight ensues.

Common ESG proxy voting guidelines

Individual investors aren’t the only ones who’ve taken a strong stance on ESG through proxy voting. Institutional investors like the BlackRock proxy voting guidelines have also signaled support for ESG policies through their recommendations to shareholders.

These guidelines can influence how shareholders approach ESG proxy voting and include key topics like:

• Board governance: Many governance-related shareholder proposals focus on the board’s role. Proxy voting guidelines for governance may, for example, recommend voting for independent board directors and those who reliably and effectively execute their responsibilities.
• Mergers and acquisitions: These commonly trigger disagreements between boards and shareholders, as shareholders don’t always see the strategic benefit of a merger or acquisition. Pertaining to M&A, ESG proxy voting may consider whether the acquired company will boost share value, if it’s a strategic move and if the decision has been evaluated by an independent financial advisor.
• Sustainability: Representing the “e” in ESG, sustainability issues can easily trigger a proxy fight. Shareholders voting on proposals in this category might assess whether the proposal creates value through sustainability and if there’s a top-down sustainability strategy.

How to prepare for ESG proxy voting

Though proxy season lasts only a few months, preparing for ESG proxy voting and any other proposal that may arise is a year-round effort. That’s because the best boards proactively address shareholder concerns so that those concerns don’t turn into incendiary proposals.

Boards can stay ahead of shareholder sentiment by:

1. Disclosing compensation: Director and executive compensation packages have become controversial. Shareholders want to ensure that company leadership does not receive excessive compensation for their work
2. Start crafting more strategic compensation packages and offer visibility around both leaders’ pay and performance.
3. Enhancing board effectiveness: When companies look for new board members, they start by reviewing board members at other organizations. But this can lead to over-extended directors — or even interlocking directorates — who can’t offer the dedication shareholders expect. Consider limiting the number of boards directors can serve on, tracking the hours they serve and sharing that data with investors.
4. Increasing diversity on the board: More diverse boards are more effective because they draw on a deeper wealth of backgrounds and experiences. Shareholders want to see board diversity, which is why boards should actively review their policies and practices to ensure diversity is a crucial tenet in succession and recruitment planning.
5. Implementing ESG strategies: Boards can’t just talk the ESG talk. They must also put their opinions into practice by implementing far-reaching and successful ESG strategies. The board should set ESG goals and work with key teams like audit, risk and general counsel to develop steps forward.
6. Utilizing proxy insights: It’s not enough to guess what shareholders think and feel. Shareholder activism tools can offer direct insight into the issues influencing shareholder sentiment so boards can more effectively manage demands.

Manage proxy voting by mastering ESG

The most proactive boards will meet investors where they’re at, tackling ESG proxy voting by understanding and acting on the investor stewardship trends related to ESG.

Though ESG can be challenging to navigate, data can chart an objective path forward — one that aligns business interests with shareholder demands. Download the white paper from Diligent to tap into our ESG market intelligence on director pressures, investor activism and thought pieces from industry experts.