Topics:   Corporate Governance,ESG,Investor Relations,Risk Management

Topics:   Corporate Governance,ESG,Investor Relations,Risk Management

January 16, 2019

New Responsibilities for the Board: Cultivating Investor Trust

January 16, 2019

Recently published research has revealed new factors for boards of directors to cultivate investor trust in companies. The Edelman Trust Barometer: Institutional Investors surveyed more than 500 chief investment officers, portfolio managers, and buy-side analysts in five countries (the US, Canada, the UK, Germany, and Japan) representing firms that collectively manage over $4.5 trillion in assets.

The research identifies several new and emerging focus areas for the investment community in which the board has a direct role:

1. The reputation of the board itself impacts investor trust.

Boards of directors have historically operated behind closed doors. If you asked a director whether they believe their board should have a public reputation, most would respond with a resounding no. However, the research clearly shows otherwise. Ninety-four percent of investor respondents said they must trust a company’s board of directors before making or recommending an investment. Ninety-two percent also agreed that an engaged and effective board is important when considering a company in which to invest.

A board’s reputation is most acutely on display during times of severe corporate controversy or distress, during which the board’s actions come under a public microscope. Shareholder activism has similarly intensified the spotlight on boards. A board viewed as entrenched will be immediately vulnerable to public and personal attack. Beyond investors, employee groups, labor unions, and non-governmental organizations are also holding boards publicly accountable with increasing frequency.

In addition to the obvious characteristics of expertise and perspective, boards must now consider several reputational dimensions. A board must be known as truly independent, actively challenging management to ensure the organization is pursuing the best course to maximize value, and it must be seen as deeply in touch with strategy and its impact on society. Additionally, a board must be known for diverse thinking, with diverse perspectives necessary to anticipate the future.

2. Investors view environmental and social considerations as important as governance.

Investor focus on environmental, social, and corporate governance (ESG) issues is now pervasive. According to our research, 89 percent of investors say their firm has changed its voting and/or engagement policy to be more attentive to ESG risks, and 63 percent report this change has taken place in the past year. Importantly, in all five countries surveyed, investors strongly agree that environmental and social practices are as important as governance when it comes to investment criteria.

In the 2018 proxy season, environmental and social proposals were the largest category on proxy ballots, accounting for 55 percent of all shareholder proposals, with climate change and environmental issues ranking as the most common environmental and social proposal topic. Vanguard and BlackRock have both cited climate change as a priority issue for 2019. Furthermore, 98 percent of investors think public companies are urgently obligated to address one or more societal issues relevant to their business, with cybersecurity, income inequality, and workplace diversity as top priorities.

Boards of directors must take responsibility for ensuring their companies are considering impact on society and the environment, proactively pursuing ways to contribute as positive corporate citizens and communicating this to the investment community.

3. Investors care about corporate culture and expect boards to provide oversight.

Investors see the impact that healthy culture and engaged employees have on corporate performance. Countless examples of corporate crises show the value risk of not maintaining a healthy corporate culture. Our research found that two-thirds of investor respondents believe maintaining a healthy company culture and enforcing a corporate code of conduct at all levels of the company have a great deal of impact on their trust.

There is no question that boards historically believed that corporate culture was not their responsibility. Thankfully, this is changing. Recent research by PwC found that 87 percent of directors believe that an “inappropriate tone at the top leads to problems with corporate culture.”

Corporate culture has become the province of board oversight, and any board that is not proactively evaluating the health of its company’s culture is neglecting an important asset and possibly cultivating a powerful risk. The NACD emphasized the importance of the board’s role in corporate culture in a recent report, which recommended that “directors and company leaders should take a forward-looking, proactive approach to culture oversight in order to achieve a level of discipline that is comparable to leading practices in the management and oversight of risk….Shareholder communications should include a description of how the board carries out its responsibility for overseeing and actively monitoring the company’s culture.”

4. Investors expect boards to stay ahead of technology disruption.

A board must be known for having the capacity to steer a company ahead of technology disruption. Most industries are facing existential threats brought on by technology, creating real and present danger for corporate valuation and long-term viability. Investors expect boards to have the foresight to guide management in anticipating and overcoming these threats. To underscore this point, our research found that 95 percent of investors believe that a company’s investment in innovation impacts their level of trust, with 62 percent saying it impacts their trust a great deal.

Boards must proactively ensure they have cutting-edge technology expertise among their ranks, and they must actively challenge management to ensure the company has a plan to capitalize on technology innovation rather than become a victim of it.

In summary, expectations of boards of directors are rising, not only from the investment community but also across stakeholder groups. Investors, in particular, are prepared to take action if they do not see boards doing enough. Eight-seven percent of institutional investors say their firms are more interested in taking an activist approach, and 92 percent will support a reputable activist investor if they believe change is necessary at a company. Boards should therefore expect activism from any of their investors if they do not proactively embrace these issues and ensure their companies are on the right track.

Lex Suvanto is Global Managing Director of Edelman Financial Communications & Capital Markets.