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Investors Urge More Companies to Go on Low Carb(on) Diet

More shareholders are taking their demands for better governance on climate change straight to the boardroom, particularly in the oil and gas industry.

When it comes to corporate behavior and climate change, shareholders are increasingly taking matters into their own hands, demanding better governance from boardrooms and tying executive pay to climate metrics. It represents a pivot for active investors, and a change in how boards respond to growing calls for companies to be more proactive about climate-related risks.

Better climate-related governance can be a positive for investors in the oil and gas industry, which is highly exposed to environmental risks.

In a recent report, “Signs of a Low-Carbon Future in Oil & Gas Corporate Governance,” Morgan Stanley’s global Sustainability investment team examines the shift toward carbon-focused corporate governance, particularly for the oil and gas industry. Amid growing awareness and acceptance of climate-related risks to business and operations worldwide, active shareholders have been filing more shareholder resolutions, essentially arguing that environmental and corporate stewardship are entwined. 

This represents a key turn by active shareholders, many of whom were previously focused on divestment. Now, “investors are seeking to make changes, instead of walking away,” says Morgan Stanley Sustainability Analyst Eva Zlotnicka, adding: “We see value in such engagement efforts.”

To analyze the relationship between climate-related activity and corporate governance, the analysts looked at shareholder proposals and executive compensation for 29 of the largest U.S., Canadian and European oil and gas companies covered by Morgan Stanley. (For specifics by company, ask your Morgan Stanley representative for the full report.)

Putting Climate on the Boardroom Agenda

In 2016, investors filed a record 175 climate-related resolutions with U.S. companies, of which 35% were for oil and gas entities, according to advocacy group Ceres. Most of the resolutions ask for better disclosure, as well as accountability, vis-à-vis executive compensation. Approximately 150 such resolutions have been filed so far in 2017, with 23% of those directed at oil and gas companies; 2018 will likely to be another busy year.

Better climate-related governance can be a positive for investors in the oil and gas industry, which is highly exposed to environmental risks—from extreme weather events that disrupt operations broadly, to worsening regional climate conditions that can affect social or political stability. “Without appropriate governance, environmental and social risks become more of a vulnerability, and environmental and social opportunities become less attainable,” says Zlotnicka.

Climate-related shareholder proposals generally fall into these three categories:

  1. Reporting and disclosure proposals that aim to give investors better information to assess the climate risk of the company or environmental performance. In North America, for example, most climate-related proposals have focused on better transparency.
  2. Goals and policy proposals that focus on goal-setting, targets, and policies or specific actions to improve environmental performance or climate exposure. In Europe, where reporting is already prevalent, shareholders are now pushing companies to turn their attention to goals and policies.
  3. Board and compensation proposals that seek a higher level of climate-change expertise or accountability on the board and management teams through compensation metrics. Companies unwilling to comply are more likely to face the ire of shareholders who stand ready to deploy governance mechanisms, such as withholding say-on-pay approvals.

Executive Pay Goes Green

Relative to others, the energy sector is a leader when it comes to linking executive compensation to environmental, social and governance (ESG) factors, says Zlotnicka. Of the 19 oil and gas companies that Morgan Stanley analyzed, with an eye toward executive compensation and climate, 14 included incentives tied to environmental reporting and practices.

Yet, the addition of shareholder approval to this equation may signal to investors that boards now recognize the growing risks from climate uncertainty and the innovation needed to sustain their companies, particularly in a low carbon future, Zlotnicka says, adding: “Pay package approval votes could continue to drop for those companies that do not address these issues.”

To be sure, regional differences can be quite sharp. For example, U.S. companies’ environmental incentives tend to focus on shorter-term metrics, while in Europe, 3-of-9 top companies analyzed by Morgan Stanley have linked environmental performance to long-term pay. “Given the cumulative and long-term nature of environmental risks, such as climate change, this is more in line with where we think it belongs in executive pay packages,” says Zlotnicka.

For more Morgan Stanley Research on climate-related governance, ask your Morgan Stanley representative or Financial Advisor for the full report, “Signs of a Low-Carbon Future in Oil & Gas Corporate Governance,” (Aug 9, 2017). Plus, more Ideas.