Editorial note: This piece is sponsored by T. Rowe Price
Companies' social license to operate and wider stakeholder concerns are core governance considerations during this AGM season in Australia.
The recent history of corporate scandals relating to poor conduct - Rio Tinto, AMP Capital, Crown Resorts as well as others - as well as managing the impacts of COVID-19 and the uncertainty relating to what a post-COVID-19 economy looks like - has brought governance issues to the top of investors' agendas when engaging with the companies in which they're invested.
Underlying some of these considerations is the shift in the balance of power between the shareholder primacy model towards a wider stakeholder model - a model in which shareholder's needs, including return on investment - is balanced by consideration of other groups including employees, customers, and the community and economy at large.
The way a company is run and how it conducts itself does have bearing on its ability to generate long-term capital. A 2018 report by Regnan estimated that book value of ASX-listed companies represents only around half of market value, with the other half representing intangible assets.
The value of intangible assets has grown as manufacturing and resource sectors decline, and companies that create value from brand, reputation and human capital experience increased growth.
Regnan analysed ASX200 companies' performance from December 2007 to December 2016 and found that companies that managed conduct culture well, ranking highly on Regnan's ESG scores with either a four or a five, significantly outperformed those companies with low scores. Conversely, low scoring companies significantly underperformed the ASX200.
Investors and asset owners are engaging with companies on conduct, management of intangible assets such as social license to operate and whether companies are managing the shift towards a wider stakeholder lens. Key to this is board composition and management skill set.
The COVID-19 pandemic has brought these issues into stark relief, as companies manage employee occupational health and safety, financial hardship and wellbeing of customer base, and the overarching pandemic-related recession and government fiscal response to manage the fallout. Fund managers and asset owners that have spoken with FS Sustainability throughout the year have noted that these issues feature heavily in engagements with companies.
Companies are making efforts to disclose more information relating to key stakeholder issues. Both Medibank and Cleanaway have issued their first standalone sustainability reports this year, and in speaking with FS Sustainability, company spokespeople detailed the analysis of issues relating to employees, community and customers, with Cleanaway's head of investor relations also noting that their standalone report came as the result of engagement with super funds pressing for disclosure on those issues and more.
The continuing focus on intangible assets like conduct and social license to operate combined with the push to a wider stakeholder model of managing material risks and opportunities will continue to be issues of engagement with companies as well as action around AGMs.
Q&A with Randal Jenneke, Head of Australian Equities at T. Rowe Price
Q: How do you assess issues such as board composition and board renewal through the lens of voting at AGMs this season?
A: We are seeing Board diversity improve through better gender mix, which is a welcome development, but I would also add that real diversity is much broader than gender. If we have a board and there are 10 accountants or 10 lawyers, that's a narrow experience, even if it's five men and five women.
We're making good inroads around challenging the orthodoxy around gender mix, but there's a long way to go for true diversity on boards in terms of getting skill sets, getting that cognitive diversity onto boards to have more, tougher interactive conversations with a management team. When I look at the composition of a lot of boards, it's not there.
Q: Is there an evolution in terms of boards moving from shareholder primacy towards a stakeholder model?
A: You need to be thinking about all stakeholders, and I still think that a lot of boards don't have that mentality. Boards are stuck in the mentality of focusing on shareholders, and I think this is still very important, but when you think about the current environment, political influence is going to be more invasive than we think. Social factors are impacting on corporations and you need a broader focus on stakeholders.
COVID-19 has provided a great example of this right now, if you think about the challenge that companies have had in trying to work with state governments. We have this direct feedback from CEOs and management, and we would say that it's part of your job to build that engagement.
Q: How does conduct, culture and social licence to operate play into this?
A: They're all entwined with stakeholder relationships. Most companies have never really thought they needed to have a social licence to operate.
We're seeing that with some tech companies - they're front and centre, in the eyes of the regulator and governments like the US and quite rightly, because they're big, important companies that impact our daily lives. They require a really strong social license to operate.
The reason companies don't fully understand this is that it's hard to quantify what is a social license to operate. It's typically not until something crystallises and you can look at the financial cost, that's part of the cost of the social license.