ESG Integration and the Engagement by Institutional
Investors
How can institutional investors stimulate ESG performance in their investee companies and what legal mechanisms can they use?
Tess Clement (11076488) University of Amsterdam LL.M. Law & Finance dr. A.J.F. Lafarre Msc 17 July 2020
Abstract
With the implementation of the SRDII and the Dutch Stewardship Code in recent years, institutional investors are required to increase transparency and disclosure regarding their engagements, to focus more on the long-term performance of their investments and to take non-financial factors such as ESG into consideration in their investment decision-making process. The objective of this thesis is to examine the incentives and possibilities for institutional investors to stimulate ESG focus in their engagement with investee companies, focusing specifically on the Dutch market. Increased long-term firm performance and the fiduciary duty are the main incentives for institutional investors to stimulate ESG focus in their engagement. The legal mechanisms institutional investors can use to incentivize investee companies to increase ESG focus in their business strategies are Hirschman’s voice and exit. Exiting the engagement is more difficult and costly for institutional investors, specifically index funds. Institutional investors have different channels to voice their dissatisfaction (regarding ESG) with the investee company. The formal and binding decision-making tool is the use of voting at the AGMs.
This thesis analysed and compared the voting behaviour on management proposals regarding governance issues (G) of ten asset managers with shares in Dutch listed companies. The asset managers were chosen based on their ESG rating in the 2020 ShareAction report. The findings show that ESG+ asset managers dissent significantly more managerial proposals than ESG- asset managers, especially in the category Remuneration. ESG+ asset managers are likely more critical on management due to the great misalignment of interests between them. Based on the agency theory, management is generally short-term oriented which could be at the cost of shareholders. ESG+ asset managers, on the other hand, are more focused on the long-term firm value and the ESG performance of their investment. The findings of this thesis are the first step towards understanding how institutional investors can stimulate ESG focus in their engagement with investee companies. As engaging behind closed doors in private meetings is preferred by institutional investors, future research should include how institutional investors can stimulate ESG focus in their investee companies through the use of voice in private meetings. To make this possible, the EU or Dutch regulator will need to increase the transparency and disclosure obligations of institutional investors in The Netherlands to include engagement activities such as private meetings such as in the UK Stewardship Code 2020.
Table of Contents
Introduction ... 3
1. - Definitions and legal framework. ... 7
1.1 What are institutional investors? ... 7
1.2 Legal framework regarding shareholder engagement by institutional investors ... 9
1.2.1 Background ... 9
1.2.2 SRDII ... 10
1.2.3 The Dutch Financial Supervision Act ... 12
1.2.4 Dutch Stewardship Code ... 12
2. - Increasing ESG focus in the engagement ... 14
2.1 Incentives to increase ESG focus ... 14
2.1.1 Firm performance ... 14
2.1.2 Fiduciary duty - Institutional investor and beneficiary ... 16
2.1.3 Fiduciary duty - Asset manager and asset owner ... 17
2.2 Mechanisms to promote ESG focus ... 18
2.2.1 Hirschman’s voice and exit ... 18
2.2.2 Voice and exit in asset owner - asset manager arrangement ... 20
2.2.3 Remuneration ... 22
3. - Voting behaviour institutional investors in the Netherlands ... 23
3.1 Methodology ... 23
3.2 Sample construction ... 24
3.3 Empirical findings and statistical analysis ... 27
3.3.1 Voting behaviour of institutional investors ... 27
3.3.2 Voting behaviour per asset manager ... 28
3.3.3 Influence of country of origin ... 30
3.4.1 Remuneration ... 31
3.4.2 Corporate Structure ... 32
4. - Conclusion ... 33
Bibliography ... 36
Thesis Annexes ... 44
ANNEX 1 – Institutional investor selection based on ESG rating ... 44
ANNEX 2 – List of Dutch listed companies ... 45
ANNEX 3 – Independent sample t-tests ... 46
Introduction
Since the financial crisis in 2008, the role of shareholders and institutional investors in particular has been scrutinized. The crisis has shown that shareholders often “supported managers’ excessive short-term risk taking”1. The main criticisms concerned the low level of
monitoring and engagement by the institutional investors. Institutional investors were more focused on short term performance instead of “making investments based on the fundamentals (strategy, performance and governance) and longer term perspectives”2. Since then, the
European Commission (EC) has attempted to address these concerns by amending the Shareholder Rights Directive (SRDI)3. The objectives of the new Shareholder Rights Directive
(SRDII)4 include increasing the long-term engagement and the level of monitoring of investee
companies by institutional investors, as well as enhancing transparency.5 Increasing the
engagement and monitoring of companies by institutional investors “can help improve the financial and non-financial performance of companies” according to the EC.6
As indicators for the non-financial performance of companies, the EC mentions environmental, social and governance (ESG) factors for responsible investment.7 In practice,
there is not one specific guide or definition clarifying what issues are covered by the term ESG. However, there are certain factors which most professionals find relevant and include in their description of ESG: environmental issues include climate change (e.g. pollution) and natural resources extraction/utilization; social issues include human rights and labour standards; and governance issues include executive compensation, board composition (e.g. re/election, independency, and diversity) and (minority) shareholder rights (e.g. capital change).8
According to the United Nations Environment Programme Finance Initiative (UNEP FI), institutional investors had been taking ESG factors into account in their investment decisions even before the financial crisis in 2008. In 2005, UNEP FI published a report on the integration
1 COM 2014/213, p. 4. 2 Id.
3 Directive 2007/36/EC of the European Parliament and of the Council of 11 July 2007 on the exercise of certain rights of shareholders in listed companies 2007 O.J.L 184/17 (SRDI).
4 Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement, 2017 O.J. L 132/60 (SRDII). 5 COM 2014/213, p. 2.
6 SRDII, preamble 14. 7 Id.
8 For example, UNPRI’s description of ESG issues on https://www.unpri.org/esg-issues; Fidelity ‘ESG
Investing Flyer’, p. 1 available at https://institutional.fidelity.com/app/literature/item/9896524.html [last updated 15-06-2020]; Manulife, ‘2019 Sustainability Report and Public Accountability Statement’, p. 35; BlackRock, ‘ESG Integration’, available at https://www.blackrock.com/uk/individual/themes/sustainable-investing/esg-integration ; APG (2018), ‘Responsible Investment & Stewardship Policy’, p. 6, 15; APG (2018), ‘Corporate Governance Framework’, p. 9-13.
of ESG factors in investment policies of institutional investors in multiple jurisdictions.9 The
report concludes that, in all these jurisdictions, institutional investors may (arguably) be required by their fiduciary duty to integrate ESG factors in “an investment analysis so to more reliably predict financial performance”.10 However, the fiduciary duty relates to the
decision-making process of the investment and not the final decision. This means that institutional investors could claim to consider ESG factors in their investment strategy, but ultimately make the same (low/non-ESG) investment decisions as before.11
The SRDII requires institutional investors to include in their engagement policies how they plan to monitor investee companies on ESG factors (amongst other relevant matters).12
The enhanced transparency and disclosure requirements of the SRDII require institutional investors to publicly disclose their engagement policy (or explain why they don’t comply with the SRDII requirements) and “how they have exercised their voting rights.”13 In addition, asset
managers are required to annually disclose to the asset owner how their investment strategy complies with their arrangement.14 With the amendment of the SRDI and the increased
transparency and disclosure requirements, the EC aims to properly align the incentives and interests of the engaging parties (for example in relation to ESG), which could help develop a long-term engagement.15 Since there are multiple parties in the engagement process, the SRDII
and the proper alignment of incentives and interests applies to different relations between parties. In this thesis, the main relationships that are described are the relationship between 1) the institutional investor and the beneficiaries16; 2) the institutional investor and the investee
company; and 3) between two institutional investors. Generally, institutional investors are split into two categories, namely asset owners and asset managers.17 Asset owners (in short: pension
funds and insurance companies) provide the capital.18 Asset managers are institutions
9 The jurisdictions examined are France, Germany, Italy, Japan, Spain, the UK, and the US.
See UNEP Finance Initiative (2005), ‘A legal framework for the integration of environmental, social and governance issues into institutional investment’, available at
https://www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf . 10 Id., p. 13.
11 European Commission, DG Environment, Study on resource efficiency and fiduciary duties of investors (final report), ENV.F.1/ETU/2014/0002, p. 10.
12 Article 3g(1)(a) SRDII. 13 SRDII, preambles 17-18. 14 Article 3i(1) SRDII. 15 SRDII, preamble 19.
16 Beneficiaries are the people that will ultimately receive a pension or will benefit from a life insurance policy from the asset owner.
17 For example UN Principles for Responsible Investment; the Dutch Stewardship Code; and the UK Stewardship Code.
responsible for the day-to-day management of investments.19 The third relationship refers to
the event where an asset owner hires an asset manager to manage their funds.
A recent example of an institutional investor engaging with an investee company to align their interests regarding ESG is ABP, a Dutch pension fund, and Norilsk Nickel. Norilsk Nickel is a Russian mining company that was recently in the news for causing an oil leak in the North Pole region. In May 2020, Norilsk Nickel has caused an oil-spill in the Arctic region. ABP has been heavily criticized for investing (with ING) more than 1 billion euros in Norilsk Nickel, especially after the oil spill scandal. Instead of exiting their engagement with Norilsk Nickel, ABP has publicly stated that they have intensified their contact with the investee company.20
The objective of this thesis is to examine the incentives and possibilities for institutional investors to stimulate ESG focus in their engagement with their investee companies. The main research question being: How can institutional investors stimulate ESG performance in their investee companies and what legal mechanisms can they use? This is supported by the sub-questions: 1) What is the legal framework regarding engagement by institutional investors in the Netherlands? 2) What incentivizes institutional investors to increase ESG focus in their engagement and what legal mechanisms can they use to stimulate ESG performance in their investee companies? And 3) How do institutional investors vote regarding ESG in practice? Building on the second sub-question, sub-question three will analyse the voting behaviour as voting at annual general meetings (AGMs) is one of the most important legal mechanisms institutional investors can use. This thesis focuses specifically on the Dutch market and regulation, because the level of institutional investors’ share-ownership and the willingness of shareholders in Dutch listed companies to vote is relatively high compared to many other jurisdictions in Europe.21
Section 1 of this thesis will describe the definition of institutional investors used in this thesis and the legal framework with regard to the engagement policies of institutional investors. Amongst Dutch regulation and the Dutch Stewardship Code, the SRDII will be examined and how this Directive has been implemented into Dutch law. For the implementation of the SRDII in the Netherlands, three laws have been amended, namely the Dutch Civil Code (Boek 2 van 19 Id.
20 Smal, E. ‘Ngo’s hekelen investeringen ING en ABP in bedrijf achter Russische milieuramp’, NRC, 16-06-2020, available at https://www.nrc.nl/nieuws/2020/06/16/norilsk-nickel-ngos-hekelen-investeringen-ing-en-abp-in-bedrijf-achter-russische-milieuramp-a4003021.
21 Van der Elst, C. and Lafarre, A. (2020), ‘Shareholder Stewardship in the Netherlands: The Role of
Institutional Investors in a Stakeholder Oriented Jurisdiction’, European Corporate Governance Institute (ECGI) - Law Working Paper No. 492/2020, p. 7, 13, 15.
het Burgerlijk Wetboek), the Dutch Financial Supervision Act (Wet of het financieel toezicht) and the Dutch Giro Securities Transfer Act (Wet giraal effectenverkeer). The focus will be on the amendment of the Dutch Financial Supervision Act. Section 2 will start by examining the incentives for institutional investors to invest in assets with high ESG ratings and to stimulate ESG policies, specifically firm value and their fiduciary duties. Then, section 2 will examine what legal mechanisms can be used to incentivize investee companies and institutional investors to increase their ESG focus. Hirschman’s voice and exit are some of the mechanisms discussed in this section. In addition, Hirschman’s theory will be applied by analogy to the relationship between asset owners and asset managers. Section 3 will consist of an empirical analysis of the voting behaviour of institutional investors with shares in Dutch listed companies with regard to ESG, specifically regarding corporate governance factors. Section 4 will discuss and conclude.
1. - Definitions and legal framework. 1.1 What are institutional investors?
When the EC amended the SRDI, one of the main concerns was the responsibilities of institutional investors, especially, with regard to sustainability in their investments. To address the problem of short-termism, the SRDII sets requirements to enhance the long-term engagement between listed companies in the EU and their shareholders. The SRDII sets certain requirements specifically for institutional investors and asset managers as shareholders in companies with a registered office in an EU Member State. In the SRDII, a clear distinction has been made between institutional investors and asset managers. The SRDII defines institutional investors as: 1) life insurance companies within the meaning of the SolvencyII Directive or 2) institutions for occupational retirement provision (IORPs) within the meaning of the EU Directive on the activities and supervision of IORPs (briefly: pension funds).22 For
the purpose of SRDII, asset managers are defined as: 1) MiFID investment firms that provide portfolio management services to investors, 2) an AIFM (alternative investment fund manager) that is not exempted from the EU Directive on AIFMs, 3) a UCITS management company, or 4) a UCITS investment company which has not designated an external management company as its management.23
Before the SRDII, the Dutch Financial Supervision Act (Wft) defined institutional investors as investment institutions, UCITS, life insurance companies, pension funds or premium pension institutions.24 The same article in the Wft defines asset manager as ‘one that
manages individual assets’.25 The broader definition of institutional investor would suggest that
under Dutch law, asset managers are also institutional investors. However, for the implementation of the SRDII, the Wft was amended in 2019 and new definitions of institutional investor and asset manager were added. The new definitions of institutional investor and asset manager in the Wft refer directly to the SRDII and separate asset managers from institutional investors.26 Nonetheless, the original definitions of institutional investor and asset manager in
article 1:1 Wft have not been changed or removed. The SRDII definitions will exclusively apply for the purpose of the (new) chapter regarding transparency rules to promote long-term shareholder engagement. For the remaining chapters of the Wft, the original definitions will apply. The reason given for the separate definitions in the transparency chapter of the Wft, was
22 Article 2e SRDII. 23 Article 2f SRDII.
24 Article 1:1 Wft: institutionele belegger.
25 Article 1:1 Wft: vermogensbeheerder, translation by author. 26 Art. 5:87a (a) (b) Wft.
to implement the SRDII as policy neutral as possible.27 Having two different definitions of
institutional investor (and asset manager) could cause confusion in practice though.
The exclusion of asset managers from the definition of institutional investors in the SRDII conflicts with the framework of definition used by most. For example, United Nations Principles for Responsible Investment were developed by “a group of the world’s largest institutional investors” for institutional investors.28 Not only does the list of signatories mainly
consist of asset managers, some asset managers are even part of the founding signatories.29 In
addition, the list of signatories to the Climate Action 100+, “an investor initiative launched in 2017 to ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change”, includes a long list of asset managers, while the Signatory Statement calls all signatories institutional investors.30 The same goes for Eumedion, a foundation representing
“the interests of institutional investors in the field of corporate governance and sustainability.”31 On the Eumedion website, it states that “all institutional investors that hold
shares in Dutch listed companies can become a member of Eumedion.”32 The member list
includes insurance companies, pension funds and asset managers.33 34 Even the EC has
included asset managers in the definition of institutional investor for the report on fiduciary duties of investors.35
In practice and academics, the general consensus seems that the definition of institutional investors is “an institution that manages and invests other people’s money.”36 This
includes asset managers. Generally, a distinction is made between categories of institutional investors, namely asset owners and asset managers.37 Asset owners, such as “pension funds,
insurance companies, investment trusts and other collective investment vehicles” provide the
27 Kst-35058 nr. 3 (memorie van toelichting), p. 61. 28 See https://www.unpri.org/pri/about-the-pri.
29 See https://www.unpri.org/signatories/signatory-directory . 30 See http://www.climateaction100.org .
31 https://en.eumedion.nl/About-Eumedion.html . 32 Id.
33 For example, Robeco Groep N.V., BlackRock, APG Groep N.V. and PGGM Vermogensbeheer, available at https://en.eumedion.nl/About-Eumedion/Members.html.
34 In the Dutch Stewardship Code, drafted by Eumedion, the terms asset owner and asset manager are used instead. However, for the definition of asset owner, the Code references the definition of institutional investor in the SRDII, which excludes asset managers. For the definition of asset manager, the Code references the
definition of asset manager in the SRDII.
35 European Commission, DG Environment, Study on resource efficiency and fiduciary duties of investors (final report), ENV.F.1/ETU/2014/0002, p. 7.
36 Çelik, S. and Isaksson, M. (2014). ‘Institutional investors and ownership engagement’, OECD Journal:
Financial Market Trends, Volume 2013/2, p. 96.
37 For example UN Principles for Responsible Investment, and the Dutch Stewardship Code and the UK Stewardship Code.
capital.38 Asset managers are institutions responsible for the day-to-day management of
investments.39 Some asset owners manage their investments themselves through an asset
management arm connected to the asset owner. However, the outsourcing of asset management by asset owners to external asset managers has increased significantly in the last two decades.40
The outsourcing of management can create agency problems between the asset owner (principal) and the asset manager (agent). This is usually caused by the misalignment of interests of asset owners and asset managers and asymmetric information.41 By enhancing the
transparency and disclosure requirements and improving the engagement requirements in the SRDII, the EC aims to mitigate these problems.
For the purpose of this thesis, I will follow the general consensus of the definition of institutional investor and will include both asset owners and asset managers in this definition. In the chapters hereafter, if a distinction needs to be made between types of institutional investors, for example regarding the engagement policy requirements or the investment incentives, this distinction will be made between asset owners and asset managers. For the purpose of this thesis, the definition of asset owner will include pension funds and life insurance companies, and the definition of asset managers will follow the definition of the SRDII for asset managers.
1.2 Legal framework regarding shareholder engagement by institutional investors 1.2.1 Background
The SRDI came into force in 2007 to strengthen shareholders’ rights by establishing certain minimum standards on the exercise of voting rights. However, the SRDI fell short when it came to corporate governance. In December 2012, the European Commission (EC) published their Action Plan, announcing their plans on corporate governance reforms, focusing in particular on increasing transparency between companies and investors, and promoting long-term shareholder engagement. The aim was to make the existing corporate governance approach more efficient by improving the interaction between the companies and shareholders.42
38 2012 UK Stewardship Code, point 6. 39 Id.
40 Çelik, S. and Isaksson, M. (2014), ‘Institutional investors and ownership engagement’, OECD Journal: Financial Market Trends, Volume 2013/2, p. 102.
41 Ang, A. (2012), ‘Asset Owners and Delegated Managers’. Available at SSRN: https://ssrn.com/abstract=2103737, p. 4.
For the implementation of these initiatives, the EC published a Proposal to amend the SRDI in 2014.43 The EC noted that, since SRDI, certain shortcomings regarding corporate
governance in European listed companies have come to light. The two main problems were “insufficient engagement of shareholders and lack of adequate transparency.”44 One (of the
five) objectives of the Proposal was to “increase the level and quality of engagement of asset owners and asset managers with their investee companies”.45 To achieve this objective, the
amended Directive would set transparency requirements for institutional investors and asset managers regarding their voting, engagement and aspects of the arrangements between them. The SRDII went into force June 9, 2017 and Member States had until June 10, 2019 to implement the Directive in their national laws. It was implemented on December 1, 2019 in the Netherlands.
1.2.2 SRDII
The SRDII sets requirements for shareholders of EU listed companies for the exercise of certain shareholder rights. Institutional investors are required to either develop and publicly disclose a shareholder engagement policy or publicly disclose an explanation why they have chosen to deviate from the provision (“explain-or-comply basis”).46 The legal framework in
relation to the shareholder engagement and transparency obligations set by the SRDII can be divided into three sections: 1) engagement policy of institutional investors; 2) investment strategy of asset owners and arrangements with asset managers; and 3) transparency of asset managers (to asset owners).
Engagement policy of institutional investors
The engagement policy should describe how shareholder engagement is integrated in their investment strategy and how they will monitor the investee companies on financial and nonfinancial matters (such as ESG).47 Annually, the institutional investor should publicly
disclose information regarding the implementation of their engagement policy, including a general description of their voting behaviour, an explanation of the most significant votes and whether they have made use of proxy advisors. Further, the institutional investor shall disclose
43 COM 2014/213 44 Id., p. 2. 45 Id.
46 SRDII preamble 17. 47 Article 3g(1)(a) SRDII.
how they have voted in the general meetings of companies in which they hold shares.4849 If an
asset manager is used, the asset owner shall reference where the voting information has been published by the asset manager.50
Investment strategy of asset owners and arrangements with asset managers
Annually, the asset owners should publicly disclose information regarding their investment strategy and their arrangements with asset managers, explaining how the main elements of the asset owner’s investment strategy “are consistent with the profile and duration of their liabilities and how those elements contribute to long-term performance of their assets.”51 If an asset manager is used, the asset owner will publicly disclose certain key
elements of their arrangement, including how the asset owner “incentivises the asset manager to align its investment strategy and decisions with the profile and duration of the liabilities” of the asset owner, how the asset manager’s performance will be evaluated, and “how it incentivises the asset manager to engage in the best medium to long-term interest” of the asset owner. 52
Transparency of asset managers to asset owners
The asset manager will disclose annually “how their investment strategy and the implementation thereof contribute to the medium to long-term performance of the assets” of the asset owner.53 The disclosed information will include “reporting on the key material
medium to long-term risks associated with investments”54 and information whether (and to
what extent) the asset manager makes investment decisions “make investment decisions based on evaluation of medium to long-term performance of the investee company, including its non-financial performance”.55 This information indicates whether the asset manager focuses on
long-term and active asset management and considers ESG matters in their investment decision process.56 The asset manager shall also disclose to the asset owner whether (and to what extent)
48 Article 3g(1)(b) SRDII.
49 Insignificant votes (for example, votes on purely procedural matters) may be excluded from the disclosure to reduce the possible administrative burden (SRDII preamble 18).
50 Article 3g(2) SRDII.
51 Article 3h(1) SRDII and preamble 19. 52 Article 3h(2) SRDII and preamble 19. 53 SRDII, preamble 20.
54 Article 3i(1) SRDII. 55 Id.
conflicts of interests have arisen in connection with their engagement activities and how these conflicts have been dealt with.
1.2.3 The Dutch Financial Supervision Act
For the implementation of the SRDII, a new chapter was added to the Dutch Financial Supervision Act (Wft). Articles 2(e)(f)(g) and articles 3g-i of the SRDII have been implemented (and quite literally copied) by the Dutch legislator in chapter 5.6a of the Wft. Regarding the Member State options given in article 3i SRDII, the Dutch legislator has chosen to require asset managers, where they do “not manage the assets on a discretionary client-by-client basis”, to disclose (on request) to other investors of the funds, the information on how (the implementation of) their investment strategy complies with the arrangement “and contributes to the medium to long-term performance of the assets” of the asset owner or of the fund. Asset managers are however not required to disclose the above-mentioned core information together with the annual report. The Dutch legislator has decided not to make use of this Member State option, because the relationship between asset managers and asset owners is based on “bilateral contractual arrangements” and it’s up to the asset owner to determine whether they can properly evaluate the asset manager (or call the asset manager to account or end the relationship).57 Disclosing the key information with the annual report is therefore not
necessary.
Regarding the engagement policy of institutional investors, the SRDII and the Wft do not prescribe how institutional investors should monitor the investee companies on matters such as ESG. The Dutch Parliament stated in the explanatory memorandum that it’s up to the institutional investor to determine the manner in which they will do this. As an example, the Dutch Parliament refers to the Dutch Stewardship Code drafted by Eumedion.58
1.2.4 Dutch Stewardship Code
The Dutch Stewardship Code (the Code) was drafted by Eumedion, a foundation representing the interests of institutional investors, (and its 50+ members consisting of Dutch and foreign pension funds, life insurance companies and asset managers). The Code went into force January 1, 2019 and builds on and has replaced the Eumedion Best Practices. The Code’s provisions are not binding and have not (yet) become statutory or even been included in the
57 Kst-35058, nr. 3, Memorie van toelichting, p. 23. 58 Kst-35058, C, Memorie van Antwoord, p. 5.
Dutch corporate law framework.59 Still, Eumedion expects all its members to adhere to the
Code and calls on all institutional investors to give a meaningful substantiation to the principles of the Code.60 The Code applies to all Eumedion’s members (Dutch and foreign institutional
investors) holding shares in Dutch listed companies and contains eleven principles to guide institutional investors to fulfil their responsibilities with regard to shareholder engagement to contribute to the long-term value creation by the investee companies, and thus to the long-term return on their investments.61 The Code has integrated certain stewardship requirements of the
SRDII (as well as a number of best practices of the Dutch Corporate Governance Code / article 5:86 Wft) in its principles. Since the Code went into force at the beginning of 2019, many institutional investors had already developed and publicly disclosed an engagement policy before the SRDII was even officially implemented into Dutch law. Certain principles of the Code even go beyond the obligations set in the SRDII (and other current legislation).62
Based on the Code, the engagement policies of institutional investors should aim “at preserving and enhancing value for their beneficiaries and/or clients and should promote long-term value creation at Dutch listed investee companies.”63 In addition, institutional investors
are required to disclose their “full equity holding (long and short) at the request of” the Dutch listed investee company they are in dialogue with.64 The Code also requires full transparency
of the voting behaviour of institutional investors, meaning per investee company and per voting point or the reason for abstaining or voting against a certain point. The SRDII allows institutional investors to abstain from disclosing insignificant votes.65 Lastly, institutional
investors required to “abstain from voting if their short position in the Dutch listed investee company in question is larger than their long position.”66
59 Van der Elst, C. and Lafarre, A. (2020), ‘Shareholder Stewardship in the Netherlands: The Role of
Institutional Investors in a Stakeholder Oriented Jurisdiction’, European Corporate Governance Institute (ECGI) - Law Working Paper No. 492/2020, p. 11.
60 Cremers, M.A.J. and Rietveld, S. (2019), ‘Aandeelhoudersbetrokkenheid van institutionele beleggers bij Nederlandse beursvennootschappen en de Nederlandse Stewardship Code’, Tijdschrift voor de
Ondernemingsrechtpraktijk, nr. 4, June 2019, p. 42. 61 Id., p. 36.
62 Pensioenfondsfederatie, and Eumedion, Service document, ‘Verantwoord en betrokken aandeelhouderschap’, January 2019, p. 5.
63 Eumedion Stewardship Code, principle 1. 64 Id., principle 3.
65 Article 3g(1)(b) SRDII.
2. - Increasing ESG focus in the engagement
This chapter will discuss the relationship between institutional investors and investee companies, the relationship between institutional investors and the beneficiaries, and lastly the relationship between asset managers and asset owners. The first part of this chapter will focus on the incentives for institutional investors to pursue ESG investments and to promote ESG focus within investee companies, focusing especially on firm performance and the fiduciary duty of institutional investors. The second part of this chapter will focus on the legal mechanisms available to promote ESG focus in the relationship between institutional investors and investee companies, and the relationship between asset owners and asset managers.
2.1 Incentives to increase ESG focus 2.1.1 Firm performance
In their 2012 Action Plan, the EC emphasized the crucial role of institutional investors as shareholders in investee companies, in particular their role in promoting better governance. Better governance is in the best interest of the investee and institutional investor.67 The switch
in focus from shareholder rights to shareholder duties has led to new engagement obligations for institutional investors in the SRDII.68 One of the duties of shareholders is to ensure
“sustainable, long-term, corporate welfare”.69 Not only should institutional investors aim for
more long-term shareholder engagement, but they should also take ESG factors into account in their investment and voting decisions to ensure corporate welfare.
Empirical evidence shows that, according to institutional investors, the primary reason to use ESG information is financial and that ESG information is especially relevant to assess investment risk. Research has also shown that “ESG can uncover nonfinancial risks that may become costly for companies in the future”70, such as “environmental risk, litigation risk,
product risk or lower investor trust.”71 Most investors think that investee companies with
greater ESG performance signal a better “long-term approach to value creation” by the company.72 One of the first studies on the effect of ESG on firm performance showed that good
67 COM 2012/740, p. 3.
68 Van der Elst, C. (2019), ‘Shareholder engagement duties: the European move beyond stewardship’, in H.S. Birkmose and K. Sergakis (eds), Enforcing Shareholders’ Duties (Edward Elgar Publishing 2019), p. 61. 69 Tridimas, T. (2018), ‘Foreword’, in H.S. Birkmose and K. Sergakis (eds), Enforcing Shareholders’ Duties (Edward Elgar Publishing 2019), p. xii.
70 Hill, J. (2020), ‘Environmental, Social, and Governance (ESG) Investing: A Balanced Analysis of the Theory and Practice of a Sustainable Portfolio’, Elsevier inc., ISBN: 978-0-12-818692-3, p. 332.
71 Van Heijningen, K. (2019), ‘The impact of ESG factor materiality on stock performance of firms’, Erasmus Platform for Sustainable Value Creation Working Paper, p. 9.
72 Amel-Zadeh, A., and Serafeim, G. (2017), ‘Why and How investors Use ESG Information: Evidence from a Global Survey’, Harvard Business School Working Paper, No. 17-079, p. 13-15
corporate governance, specifically strong shareholder rights, has a strong positive effect on a firm’s results.73 Another found that ESG had a positive effect on shareholder rights and
counterbalanced the negative effect of management entrenchment on firm value.74
ESG-activities also give rise to “positive size-adjusted abnormal return”.75 A 2015 meta-study on
the relationship between ESG and financial performance, found that 90% of the reviewed studies found a non-negative relationship between ESG and the corporate financial performance of investee companies “and the large majority of studies find a positive relationship.”76 The effect of an increased focus and performance on ESG factors “can enhance
a firm’s various key value drivers: growth, profitability, capital efficiency and risk exposure.”77
Greater ESG improvements can lead, amongst others, to “better risk management, lower cost of capital, sustained competitiveness”, sale growth (through advertising) and “lower idiosyncratic risk of firms”.78 Another 2015 meta-study on ESG research, showed that the
majority of studies found that solid sustainability and ESG practices and standards lead to lower cost of capital, “better operational performance of firms”, and a positive effect on stock price performance.79
As shown above, there has been extensive academic research to investigate the effect of ESG factors on corporate financial performance. Overall, academic research suggests that there are indications that ESG factors have a positive effect on the long-term firm performance. However, a level of endogeneity and ambiguousness remains as there are likely unobservable factors that could affect the relationship between ESG performance and firm performance.80
As mentioned in the introduction, defining ESG is difficult and the material ESG factors and effects differ across studies. Though further research on the relationship between ESG and firm performance is necessary, empirical evidence, as of now, suggests that there are incentives to promote ESG standards in investee companies to increase the long-term firm value. This not 73 Gompers, P.A., Ishii, J.L., and Metrick, A. (2003), ‘Corporate Governance and Equity Prices’, Quarterly Journal of Economics, Vol. 118. No. 1, pp. 107-155.
74 Ferrell, A. and Liang, H. and Renneboog, L. (2016), ‘Socially Responsible Firms’, European Corporate Governance Institute (ECGI) - Finance Working Paper No. 432/2014, p. 31-32
75 Dimson, E., Karakas, O., Li, X. (2015), ‘Active Ownership’, Review of Financial Studies (RFS), Volume 28, Issue 12, p. 34-35.
76 Hill, J. (2020), “Environmental, Social, and Governance (ESG) Investing: A Balanced Analysis of the Theory and Practice of a Sustainable Portfolio”, Elsevier inc., ISBN: 978-0-12-818692-3, p. 331- 332.
77 Van Heijningen, K. (2019), ‘The impact of ESG factor materiality on stock performance of firms’, Erasmus Platform for Sustainable Value Creation Working Paper, p. 9.
78 Id., p. 9.
79 Clark, G. L., Feiner, A. and Viehs, M. (2015), ‘From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance’.
80Flammer, C. (2015), ‘Does corporate social responsibility lead to superior financial performance? A
regression discontinuity approach’, Management Science. Advance Access published February 19, 2015, 10.1287/mnsc.2014.2038. p. 2549.
only benefits the investee companies; it is beneficial for the institutional investors and their beneficiaries as well as increased firm performance and greater stock performance ultimately lead to a higher return on investment. In addition, according to institutional investors, ESG information is especially relevant to assess investment risk. Research has also shown that “ESG can uncover nonfinancial risks that may become costly for companies in the future.”81
Examples of these nonfinancial risks are “environmental risk, litigation risk, product risk or lower investor trust.”82 Institutional investors are bound by their fiduciary duty towards their
beneficiaries. This fiduciary duty is generally seen as requiring the institutional investor to maximize the financial returns to guarantee future benefits for their beneficiaries.83 By
promoting ESG factors in their investee companies, institutional investors may help increase the investee company’s performance. This could lead to higher financial returns on their investments and ultimately to the fulfilment of their fiduciary duty towards their beneficiaries.
2.1.2 Fiduciary duty - Institutional investor and beneficiary
As stated above, institutional investors have a fiduciary duty towards their beneficiaries. Institutional investors manage and invest money on behalf of beneficiaries to “secure (future) benefits in terms of financial returns.”84 Beneficiaries are the people that will ultimately receive
a pension or will benefit from a life insurance policy from the asset owner. The fiduciary duty of institutional investors protects these beneficiaries from abuse by the institutional investor. As a fiduciary for the beneficiaries, institutional investors agree to place the beneficiaries’ interests above their own.85 Traditionally, institutional investors interpreted their fiduciary duty
towards the beneficiaries as simply maximizing their financial returns. This is often realized through short- and medium-term investments without regard to non-financial performance factors such as ESG.86 However, the best interest of the beneficiaries does not consist of only
the financial interest and performance. The extra-financial (or non-financial) interests of the beneficiaries should also be considered when acting in their best interest. This includes ESG 81 Id.
82 Van Heijningen, K. (2019), ‘The impact of ESG factor materiality on stock performance of firms’, Erasmus Platform for Sustainable Value Creation Working Paper, p. 9.
83 Anand, A. and Puskas, C. (2019), “Legal and economic rationales for shareholder duties and their enforcement”, in H.S. Birkmose and K. Sergakis (eds), Enforcing Shareholders’ Duties (Edward Elgar Publishing 2019), p. 22.
84 European Commission, DG Environment, Study on resource efficiency and fiduciary duties of investors (final report), ENV.F.1/ETU/2014/0002, p. 7.
85 Anand, A. and Puskas, C. (2019), “Legal and economic rationales for shareholder duties and their enforcement”, in H.S. Birkmose and K. Sergakis (eds), Enforcing Shareholders’ Duties (Edward Elgar Publishing 2019), p. 22.
86 European Commission, DG Environment, Study on resource efficiency and fiduciary duties of investors (final report), ENV.F.1/ETU/2014/0002, p. 7.
factors.87 In a 2018 report on ESG engagement, Principles for Responsible Investment
(UNPRI), “the world’s leading proponent of responsible investment”88 and supported by the
United Nations, stated that by applying principles on ESG issues, institutional investors may be better aligned with the “broader objectives of society.”89
In their 2005 report on the integration of ESG issues into institutional investment, UNEP FI concluded that, in regard to the fiduciary duty, taking ESG issues into account is permissible when a decision needs to be made between two investments that are exactly the same financially. It is obligatory when ESG “concerns are financially relevant” and when it would have been unanimously supported by the beneficiaries.”90 Even though the conclusions
of the 2005 UNEP FI report have been criticized, UNEP FI stated in a follow-up report in 2015 that “a failure to consider long-term investment value drivers, which include environmental, social and governance issues, is a failure of fiduciary duty.”91 If a fiduciary breaches the
fiduciary principles (e.g. the institutional investor does not act in the best interest of the beneficiaries), the fiduciary may be held responsible, which could include restoring the possible economic losses as a result of the breach of duties.92
2.1.3 Fiduciary duty - Asset manager and asset owner
When asset owners outsource their asset management to external asset managers, a fiduciary duty arises for the asset manager. Like the fiduciary duty towards beneficiaries, an asset manager is required to put the interests of the asset owner above its own interests. Again, the best interest of the asset owner includes the non-financial interest as well as the financial interest of maximizing the financial returns. If the asset owner has strong commitments to ESG integration in their investment strategy and engagement policy, it is in the best interest of the asset owner that the asset manager takes these ESG concerns into account while investing on behalf of the asset owner. This interest of the asset owner should prevail over the interests of the asset manager to maximize their revenue or to decrease their expenses. The asset manager could also be held responsible if it breaches its fiduciary duty towards the asset owner, which includes restoring the possible economic losses of the breach of duties.
87 European Commission, DG Environment, Study on resource efficiency and fiduciary duties of investors (final report), ENV.F.1/ETU/2014/0002, p. 24.
88 UNPRI, ‘What is the PRI?’, available at https://www.unpri.org/pri/about-the-pri.
89 UNPRI (2018), ‘How ESG engagement creates value for investors and companies’, p. 2, available at https://www.unpri.org/download?ac=4637 .
90 European Commission, DG Environment, Study on resource efficiency and fiduciary duties of investors (final report), ENV.F.1/ETU/2014/0002, p. 25.
91 Id., p. 26. 92 Id., p. 23.
2.2 Mechanisms to promote ESG focus 2.2.1 Hirschman’s voice and exit
Asset owners give asset managers the power to invest their assets in investee companies, making asset managers shareholders in these investee companies. As shareholders, asset managers (by proxy of asset owners) can influence investee companies to increase their ESG focus by engaging with the investee companies. Hirschman’s theory of voice is usually used to define shareholder activism/engagement.93 Hirschman’s theory addresses how
shareholders can communicate their dissatisfaction with a company’s performance. Investors can keep their stock in the investee company and voice their concerns or they can sell their stock and exit.94 Shareholder engagement means to “change the status quo through ‘voice’,’
without a change in control of the firm.”95 Shareholders can communicate their concerns
directly to the investee company by engaging and using voice. There are different mechanisms for shareholders to voice their concerns and interests to the investee company.
Shareholders have several statutory rights under Dutch corporate law, including the right to vote, the right to submit shareholder proposals and the right to speak at AGMs.96 These
channels for investors to voice their dissatisfaction are public measures. Studies have shown that the preferred and most effective voice channel is to engage behind the scenes through private discussions with the investee company before taking public measures.9798 After private
discussions, voting at AGMs is the most popular channel of voice.99 The votes of shareholders
at AGMs are binding, meaning that the management of the investee company is required to implement the outcome of the vote (or in case of a dissenting result, not implement their proposal). Without the threat of a dissenting vote on management proposals at AGMs, other engagement mechanisms would be less effective.100 Engaging and using their voice is costly
for shareholders. It requires financial resources for shareholders to attend AGMs and to make 93 For example, Pacces, A.M. (2016), ‘Exit, Voice and Loyalty from the Perspective of Hedge Funds Activism in Corporate Governance’, ELR December 2016 | No. 4, p. 200; or Goodman, J., Louche, C., Van Cranenburgh, K.C. and Arenas, D. (2014), ‘Social Shareholder Engagement: The Dynamics of Voice and Exit’. J Bus Ethics 125, 193–210, p. 195.
94 Jahnke, P. (2019), ‘Ownership concentration and institutional investors’ governance through voice and exit’. Business and Politics, 21(3), p. 331.
95 Van der Elst, C. and Lafarre, A. (2020), ‘Shareholder Stewardship in the Netherlands: The Role of
Institutional Investors in a Stakeholder Oriented Jurisdiction’, European Corporate Governance Institute (ECGI) - Law Working Paper No. 492/2020, p. 5.
96 Articles 2:114a and 2:117 Burgerlijk Wetboek (Dutch Civil Code).
97 For example, McCahery, J.A., Sautner, Z., & Starks, L.T. (2016). Behind the scenes: The corporate governance preferences of institutional investors. The Journal of Finance, 71(6), p. 2912.
98 The use of private discussions is not observable, however.
99 McCahery, J.A., Sautner, Z., & Starks, L.T. (2016). Behind the scenes: The corporate governance preferences of institutional investors. The Journal of Finance, 71(6), p. 2167-2168, 2912.
100 Iliev, P., Lins, K., Miller, D., and Roth, L. (2015), ‘Shareholder voting and corporate governance around the world’, Review of Financial Studies 28, 2199.
an informed decision at AGMs, which requires shareholders to collect information on the investee company and to stay updated. For minority shareholders, the cost of voice often outweighs the benefit of voice, since a small stake means they have less influence on the company’s decision making and voting outcome at AGMs or when they engage behind the scenes.101 For institutional investors, the increased ownership concentration has reduced the
cost of voice as there are more resources (assets) available to cover the costs.102 In Europe,
engaging and using voice is “the third most popular responsible investment strategy” used by institutional investors.103
Exit is an alternative to voice. Shareholders can communicate their dissatisfaction with the investee company by exiting their investment.104 Shareholders can exit from the investee
company by selling their stock through liquid stock markets. This mechanism is not as direct as voice. The management will be alerted of their dissatisfying performance by the effect of the exit on the stock price and not directly from the institutional investors.105 The effect on the
stock price (and the accompanying financial harm to the investee company) depends on the size of the investor’s stake.106 The accessibility to exit and the cost of voice usually make exit
more attractive than voice for minority shareholders.107 For institutional investors with large
stakes in an investee company, the use of exit is often more costly than the use of voice, because of the (increasing) difficulty to sell their shares in an investee company “without substantial negative price effects”.108 The exit of a large institutional investor will cause the share price to
drop significantly, resulting in financial losses for the institutional investor.109 Therefore, it is
often more attractive for institutional investors to hold on to their shares and use voice to express their dissatisfaction.110 For index funds in particular, exit is a difficult option (or even
101 Solomon, D. (2017), ‘The Voice: The Minority Shareholder’s Perspective’, 17 Nevada Law Journal 739, p. 748, 750.
102 Jahnke, P. (2019), ‘Ownership concentration and institutional investors’ governance through voice and exit’. Business and Politics, 21(3), p. 347.
103 UNPRI (2018), ‘How ESG engagement creates value for investors and companies’, p. 5.
104 Hirschman, A.O. (1970), ‘Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States’. p. 22-24.
105 Pacces, A.M. (2016), ‘Exit, Voice and Loyalty from the Perspective of Hedge Funds Activism in Corporate Governance’, ELR December 2016 | No. 4, p. 200; Solomon, D. (2017), ‘The Voice: The Minority
Shareholder’s Perspective’, 17 Nevada Law Journal 739, p. 751, 755.
106 Solomon, D. (2017), ‘The Voice: The Minority Shareholder’s Perspective’, 17 Nevada Law Journal 739, p. 751, 755.
107 Pacces, A.M. (2016), ‘Exit, Voice and Loyalty from the Perspective of Hedge Funds Activism in Corporate Governance’, ELR December 2016 | No. 4, p. 200.
108 Jahnke, P. (2019), ‘Ownership concentration and institutional investors’ governance through voice and exit’. Business and Politics, 21(3), p. 334.
109 Solomon, D. (2017), ‘The Voice: The Minority Shareholder’s Perspective’, 17 Nevada Law Journal 739, p. 751, 755.
impossible). Index funds choose an index and the investment decisions to buy or sell follow that index. While an investee company remains in the index, the index fund cannot exit.111 This
does not mean that the index fund will automatically engage more. The business model of index funds entails diversification at minimum cost. Therefore, the costs and benefits of the engagement will need to be considered before an index fund decides to actively engage.112
2.2.2 Voice and exit in asset owner - asset manager arrangement
Voice and exit can be applied by analogy to the arrangement between asset owners and asset managers. In the arrangement between asset owners (principals) and asset managers (agents), agency problems can occur. If, for example, an asset manager’s remuneration is calculated as a percentage of the client’s portfolio, the asset manager may invest these assets with the goal of maximizing the investment’s financial return to increase their own remuneration. This could be at the cost of the best interest of the asset owner or in conflict with the investment strategy or engagement policy of the asset owner. Another example is when an asset manager passively invests (following a benchmark index) on behalf of the asset owner to keep a low expense rate. Passive asset management could be at the expense of maximizing the asset owner’s financial return or conflict with the asset owner’s investment strategy or engagement policy. An asset owner can incentivize an asset manager to align their interests and investment strategy (for example regarding ESG) by using the voice option. If an asset owner is dissatisfied with the service provided by/the performance of the asset manager, the asset owner can attempt to change the practices or policies of the asset manager by voicing their discontent. The asset manager is not obligated to listen to/follow the asset owner’s voice in this arrangement, but if an asset owner is a significantly large client, the asset manager is less likely to risk losing their client and will adjust their investment strategy or shareholder engagement policy.
Exit is another mechanism for asset owners to express their dissatisfaction with the asset managers’ performance/services. The exit option goes a step further than the voice option. Compared to the traditional theory of exit, in the arrangement between asset owners and asset managers, an asset owner cannot ‘sell’ the assets on a stock market. When the asset owner is
111 Bebchuk, L., and Hirst, S. (2019), ‘Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy’, Columbia Law Review 119(8), p. 2034.
112 Davies, P. (2020), ‘The UK Stewardship Code 2010-2020 from Saving the Company to Saving the Planet?’, European Corporate Governance Institute - Law Working Paper No. 506/2020, Available at
dissatisfied with the asset manager’s performance, the asset owner can decide to exit/end their arrangement by withdrawing the mandates given to the asset managers to manage their funds. If, for example, the asset manager passively invests on behalf of the asset owner by following the S&P 500 index, which includes coal companies and companies in the oil and gas sector, an asset owner with an investment strategy focused on ESG concerns could decide to exit their arrangement. It is less costly for asset owners to exit their arrangement with asset managers than it is for institutional investors to exit their investment in investee companies, since asset owners can transfer the mandate to a different asset manager without a negative price effect. However, when asset owners and asset managers are inextricably connected, the possibility of exiting the arrangement is significantly harder (or even impossible).113
The engagement between BlackRock and the $1.5tn Government Pension Investment Fund of Japan (GPIFJ) is an example of the misalignment of interests regarding ESG investment decisions between an asset manager and an asset owner. The misalignment of interests and investment strategies regarding ESG is what lead BlackRock to lose its largest client and a significant amount of their revenue as the asset owner expressed its dissatisfaction by using the exit option and withdrawing its assets from the asset manager. BlackRock is one of the asset managers that dominates the passive index fund industry114, meaning it mainly
follows the market index instead of actively analysing assets before choosing to invest (or not). However, in the yearly letters to BlackRock’s investee companies in 2018 and 2019, BlackRock CEO Larry Fink informed the companies that BlackRock would start focusing more on ESG instead of only financial return and, if they wanted to (continue to) receive support from BlackRock, the investee companies would need to do this as well.115 Still, these letters
were not enough. In 2019, the GPIF withdrew billions of dollars from BlackRock “as the world’s biggest pension fund put environmental, social and governance concerns at the centre
113 For example the arrangement between Dutch asset owner Stichting Pensioenfonds Zorg en Welzijn (PFZW) and Dutch asset manager PGGM. PFZW has outsourced their entire pension administration to PGGM.
https://www.pggm.nl/over-ons/onze-klanten/ ; or the arrangement between Dutch asset owner ABP and Dutch asset manager APG. In 2008, ABP was forced to transfer their pension administration to an independent administration organization, APG, to avoid unfair competition. ABP was the sole shareholder of APG in 2008, and still owns 92.16% of the shares in 2019. See APG Groep NV Jaarverslag 2008, p. 4 and Jaarverslag APG Groep NV 2019, p. 53.
114 Fichtner, J., Heemskerk, E. and Garcia-Bernardo, J. (2017). ‘Hidden power of the Big Three? Passive index funds, re-concentration of corporate ownership, and new financial risk’, Business and Politics, 19(2), 298-326. doi:10.1017/bap.2017.6.
115 Sorkin, A.R., ‘BlackRock’s Message: Contribute to Society, or Risk Losing Our Support’, NY Times,
15-01-2018; L. Fink’s 2019 letter to CEOs, available at https://www.blackrock.com/americas-offshore/2019-larry-fink-ceo-letter.
of its investment ethos.”116 Since losing these mandates from GPIFJ and the accompanying
negative publicity regarding their passive management strategy, BlackRock has joined the Climate Action 100+ initiative117 and has publicly stated that they will increase their ESG
considerations.118
2.2.3 Remuneration
Lastly, asset owners can incentivize asset managers to invest in assets with positive ESG ratings through the remuneration for asset management services. The SRDII requires asset owners to publicly disclose certain key elements of their arrangements with asset managers annually. The asset owners should specifically disclose, amongst other things, how they will evaluate the asset manager’s performance and remuneration.119 Asset managers who do not
follow and invest according to the interests of the asset owner (for example due to a misalignment of interests) risk the remuneration they receive for their investment management services to decrease.
116Mooney, A. and Walker, O. ‘BlackRock seeks to regain lost ground in climate fight’, Financial Times,
14-01-2020.
117 Henderson, R. ‘BlackRock joins climate action group after ‘greenwash’ criticism’, Financial Times, 09-01-2020.
118 For example: Henderson, R., Nauman, B., Edgecliffe-Johnson, A. (2020). ‘BlackRock shakes up business to focus on sustainable investing’. Financial Times. 14 January 2020; Mooney, A., Walker, O. (2020). ‘BlackRock seeks to regain lost ground in climate fight’. Financial Times. 14 January 2020; and Larry Fink’s letter to CEOs of 14 January 2020, available at https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter . 119 SRD II, preamble 19 and article 3h(2)(c) SRD II.
3. - Voting behaviour institutional investors in the Netherlands 3.1 Methodology
The aim of this chapter is to analyse the voting behaviour of institutional investors with regard to ESG in practice in the Netherlands. As stated in chapter two, institutional investors have many ways of exerting influence on investee companies. The reason for focusing on the use of voice through voting by institutional investors is that, after private discussions, voting is the most used channel of voice.120 In addition, there is (significantly more) data on the use of
voice through voting available to analyse and the voting result is binding for management. Data relating to the use of exit by institutional investors is not readily available since this tool is used in more extraordinary situations121 (e.g. when the use of voice has been unsuccessful) and not
publicly disclosed.
This analysis will specifically focus on how institutional investors vote on governance items at AGMs. As stated in the introduction, governance issues include executive compensation, board composition (e.g. re/election, independency, and diversity) and (minority) shareholder rights (e.g. capital change).122 The reason for focusing on governance related
voting items is that the voting policy of many institutional investors is limited to subjects regarding corporate governance.123
The hypothesis for this analysis is that institutional investors with a greater ESG focus will have a significantly higher disapproval rate than the institutional investors with a lower ESG focus.
The assumption is that institutional investors with a greater ESG focus are more focused on the long-term firm value and the non-financial performance of their investments instead of solely the highest financial return. These institutional investors will therefore be more critical on term oriented managers based on the agency theory. Managers are generally short-120 McCahery, J.A., Sautner, Z., and Starks, L.T. (2016), ‘Behind the scenes: The corporate governance
preferences of institutional investors’, The Journal of Finance, 71(6), p. 2167-2168, 2912.
121 For example the 2018 annual report of PGGM on responsible investment. In this report, PGGM acknowledged that Novartis was marked as a Global Compact Violator in 2018 due to bribery allegations. However, instead of exiting their engagement, PGGM kept Novartis in their portfolio, stating they were trying to exert their influence on the corporate governance of Novartis directly through voice.
122 For example, UNPRI’s description of ESG issues on https://www.unpri.org/esg-issues; Fidelity ‘ESG Investing Flyer’, p. 1 available at https://institutional.fidelity.com/app/literature/item/9896524.html; Manulife, ‘2019 Sustainability Report and Public Accountability Statement’, p. 35; BlackRock, ‘ESG Integration’, available at https://www.blackrock.com/uk/individual/themes/sustainable-investing/esg-integration ; APG (2018), ‘Responsible Investment & Stewardship Policy’, p. 6, 15; APG (2018), ‘Corporate Governance Framework’, p. 9-13.
term oriented as they have a limited term of office and their bonusses are often linked to short-term earnings. The objective of the management is likely to maximize its own value124 and will
therefore take actions that will increase the short-term returns, possibly at the expense of shareholders and the long-term firm value.125 When a company has free cash flow126, the
management of the company may want to retain the free cashflow to expand their business or invest in negative NPVs that had positive short-term returns of paying the shareholders dividends.127 However, ESG institutional investors might prefer no dividend payment as free
cashflow could entail more ESG investments.128 Incentive plans could help align the interests
of management with the ESG institutional investors by offering management shares or stock. However, excessive equity plans could cause management entrenchment, which is not desirable for shareholders.129 The assumption remains that ESG institutional investors will be
more critical on the management by dissenting more, based on the agency problem of different time horizons.130
3.2 Sample construction
For this thesis, a sample of ten asset managers holding shares in Dutch listed companies was constructed. If asset owners choose to have asset managers manage their assets, the managers are responsible for the day-to-day management of the investments. This means that asset managers are the closest link to the investee companies. For this reason, a sample of ten asset managers holding shares in Dutch listed companies was constructed for this thesis. The sample of ten asset managers has been chosen based on their ESG rating. The sample has been split into two groups: the first group of five asset managers will be the ‘More ESG focused’ group (hereafter: ESG+ group); and the second group of five asset managers will be the ‘Less ESG focused’ group (hereafter: ESG- group). The ESG ratings used in this analysis are based on a report by ShareAction, a UK non-profit organisation focused on improving responsible investment131. In 2017, ShareAction took over the Asset Owners Disclosure Project (AODP),
124 Douma, S., and Schreuder, H. (2017), ‘16. Economic approaches to corporate governance’, in Douma, S., and Schreuder, H., Economic approaches to organizations, Pearson Education Limited (Harlow, UK), p. 1-2. 125 Hill, J. (2020), “Environmental, Social, and Governance (ESG) Investing: A Balanced Analysis of the Theory and Practice of a Sustainable Portfolio”, Elsevier inc., ISBN: 978-0-12-818692-3, p. 46
126 This is the cash flow left after expenditures are deducted/paid from the cash generated by operations. 127 Douma, S., and Schreuder, H. (2017), ‘16. Economic approaches to corporate governance’, in Douma, S., and Schreuder, H., Economic approaches to organizations, Pearson Education Limited (Harlow, UK), p. 2. 128 Dimson, E., Karakas, O., Li, X. (2015), ‘Active Ownership’, Review of Financial Studies (RFS), Volume 28, Issue 12, p. 25.
129 Douma, S., and Schreuder, H. (2017), ‘16. Economic approaches to corporate governance’, in Douma, S., and Schreuder, H., Economic approaches to organizations, Pearson Education Limited (Harlow, UK), p. 11-14. 130 Id., p. 3
