Shareholder Engagement Is an Important New Skill for Boards

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Understand your shareholders’ concerns and establish a productive dialogue.

Shareholder engagement expertise is a new element directors and boards are adding to their skills matrix. Since 2010, when institutional investors began meeting with compensation committees about say-on-pay votes, shareholder/board engagement has become more frequent, and now board members are being called on to address an unlimited range of topics.

The Evolution of Shareholder Engagement

There was a time when investors engaged only with managers, but the say-on-pay vote made engagement with those being paid awkward. It was a natural evolution for shareholders to engage with boards. Those conversations gradually expanded to cover company practices better addressed by the board than by management, especially governance oversight. 

In recent years, topics have come to include traditional matters of corporate strategy and business performance, along with various agenda items under the heading of ESG. This refers to issues concerning the environment (such as greenhouse gas emissions), society (such as workforce diversity) and governance (such as board expertise). Much outreach these days blends topics, probing how a company relates the ESG agenda to its business strategy.
 
Enthusiasm for engagement across diverse topics puts a premium on directors with related expertise. Expertise in this area is twofold. It starts with the process of engagement — preparing for meetings by studying a company’s shareholder base and understanding what different shareholders prioritize. It encompasses the substance of the discussion — from comfortable topics of business strategy to thorny issues of public policy. Above all, the art of diplomacy is key.

Stepping Up to the Task

Based on my experience in shareholder engagement and recent consultations with a dozen others working in this area, few directors are eager to step up to this new, vast and undefined role. For one, directors historically have not been screened or chosen for skills associated with shareholder engagement. Many lack experience with capital markets or a sense of what shareholders want in terms of communication and responsiveness. In short, it’s not what they signed up for. That’s true of engagement on topics such as strategy and performance but especially on controversial issues like climate change and racial equity.
 
Moreover, in hard-fought proxy contests, activist shareholders have incentives to portray incumbents unflatteringly compared to activist nominees, discouraging incumbents from taking associated reputational risks. Another risk: few public company directors have the experience or fully understand the legal rules (such as Regulation Fair Disclosure) governing discussions with shareholders that prohibit selective disclosure of material nonpublic information. Another issue is whether a company’s CEO is supportive of director engagement with shareholders. 

A company’s investor relations personnel and general counsel can help directors with some of the technical challenges. A cottage industry led by universities, consulting firms and law firms is emerging to offer formal director training in the art of engagement. But, based on my decades working in professional education, there is no substitute for hands-on experience, whether immediate or vicarious. 

For immediate experience, directors new to shareholder engagement can shadow any of their fellow directors who do have such experience. The novice can participate along with the seasoned director as the latter prepares for an engagement meeting, conducts the meeting and distills a report to the full board seeking guidance and next steps. As such engagement appears likely to increase in coming years, here are some insights from my experience in this area. 

A Personal Journey in Engaging Shareholders

As nonexecutive vice chairman of Constellation Software Inc. (CSI), a $35 billion market cap Toronto Stock Exchange company, I have been engaging with institutional shareholders since 2019. Before then, such engagement was handled by management: our founder, also serving as president/board chair, and our chief financial officer, doubling as our investor relations manager.
 
One sticking point that came to a head in 2017 was board gender diversity, as the company’s relatively small board, which included several longtime managers, was all male. A shareholder proposal urging the immediate addition of women appeared on that year’s proxy, on which the shareholders split 42% in favor and 58% opposed. In accordance with CSI’s values, the board did not think it wise to conduct any search under preordained time frames or published qualification rules that the proponents prescribed.

Institutional investors increasingly signaled interest in speaking to an independent director about the issue, and I, along with our lead independent director, stepped up. The board undertook a director search in 2018, giving specific priority to adding women but without any timetables or quotas. We reported our progress through shareholder engagement and ultimately appointed our first female director in 2018.

Over the next three years, amid several board vacancies and newly created positions, we came to have five female directors, now representing one-third of the board. We think the approach we took — listening to the shareholders, explaining our efforts and adhering to our philosophy —  worked. The new female directors are adding great value and strengthening our board.
 
In further engagements during the past few years, a common inquiry concerned whether to separate the functions of our president and chairman. Governance purists prefer to separate them under the theory that the board oversees the officers and no chair can oversee him or herself. We had always combined the roles and explained the rationale: we had a distinguished founder, famed for capital allocation prowess, delivering sustained outsized returns on invested capital from the company’s inception. For a decade, at his suggestion, he was paid $1 annually (yes, one dollar).
 
Gradually, however, the internal dynamics of our board and the external goals expressed through shareholder engagement dovetailed. We separated the two functions. We did so on terms consistent with the board’s judgment of the best interests of the corporation and its shareholders. We balanced the requests of the large institutions that prioritize such governance purity with those of most other shareholders, especially our employee-shareholders, who value personalities and internal dynamics.

Establishing a Dialogue

Both of these examples teach the paramount lesson of board/shareholder engagement: the purpose is a dialogue — a two-way exchange of views, not a one-way dissertation. All too often, shareholders announce demands, believing a board must fall in line. Equally unproductive is the director who declares opposition to any overtures. Progress may take years, but an exchange of views is essential. Directors, therefore, do well to study and understand their interlocutor’s concerns and goals and evaluate whether those are in the best interests of the corporation and its shareholders. When that is not the case, the second job is to explain why, with reference to such factors as the company’s strategy, business model, organizational structure, employee demographics and shareholder base. 

For example, an institutional shareholder submitted an emissions proposal to the board for possible inclusion in our proxy, calling for a companywide, board-level policy on the subject. In our engagement, the shareholder began by stressing our outstanding performance and uniquely valuable business model. But the emissions proposal also stressed its view of a relationship between ecology and economics.
 
We explained that our emissions, as a software company, are among the lowest of any industry, so the benefits of such efforts would be below average. CSI employs 35,000 individuals in 125 countries in a highly decentralized structure. The costs of such a proposal would far outweigh the benefits. 

We also discussed the environment as a priority, specifically in the field of emissions disclosure, and offered to develop disclosure on this topic. It’s too soon to dive into details, but a good-faith resolution was found with more to come.
 
This engagement illustrates some of the skills valued highly in board/shareholder engagement: listening, understanding another’s viewpoint, explaining your company’s position and realities, then diplomatically developing a way forward. 

Investor Goals vs. Company Realities

Yet, as noted, sometimes the gap between an investor’s goal and a company’s reality is too wide to bridge. In that case, letting the matter go to a shareholder vote is likely in the best interests of the corporation and the shareholders. 

This recently occurred after an advocacy group working for a small institutional shareholder submitted a proposal on workforce diversity. The group explained its social significance, with which we agreed, and asked the board to oversee a top-down report on racial diversity across the company’s workforce, detailing any disparities and prescribing associated companywide policies.

We explained our decentralized model and international reach, observing that across the diverse cultures where CSI operates, the forms and subjects of unlawful discrimination, as well as the solutions, vary widely. Racial diversity and discrimination are quite different in Brazil, Pakistan and South Africa, for instance. Our human resources leadership joined the engagement, explaining how impressive diversity initiatives flourish through shared best practices across our collection of mostly small businesses, most of which would otherwise not even be aware of the issue of racial disparities. 

We believe that such an approach actually does more to prevent or dismantle racial disparities than would a top-down companywide prescription from the board. We also offered to provide formal disclosure of these views, but the proponent found this insufficient. As a result, the proposal recently appeared on the annual meeting agenda for a vote. The proposal won a majority of the shares voted at the meeting, though not a majority of shares outstanding, and exactly the same number of shareholders voted “for” as “against.” Amid such division, the board will work with management to balance the contending concerns.
 

Cultivating the Engagement of Shareholders

As with other expertise on a board, shareholder engagement is a skill that should be cultivated going forward. As with the audit committee or compensation committee, an ideal goal would be for one-third of the board (or the size of the average committee) to hone its skills. The board will then have more flexibility in both sharing the work and increasing subject-matter expertise. But one thing is certain: as the skills matrix evolves, having some directors with experience and interest in shareholder engagement will prove to be a valuable priority for most boards. 

Lawrence Cunningham is vice chairman of the board and director of Constellation Software Inc., founder and managing partner of Quality Shareholders Group and professor of corporate governance at George Washington University.

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