The Rise (and Fall?) of Prescriptive ESG Proposals

A review of 'Expanding Shareholder Voice: The Impact of SEC Guidance on Environmental and Social Proposals,' by Kenneth Khoo (National University of Singapore) and Roberto Tallarita (Harvard Law School). The prizewinning paper in the junior scholars category at the 2024 Berkeley-ECGI Corporate Governance Forum Prize.

What does shareholder democracy look like? It typically includes corporate annual meetings, a venue where big-money investors and, occasionally, regular folks with a share or two under their belt, get to vote on how companies are run. It’s the closest thing to a town hall for capitalism. But not all votes are created equal, especially when it comes to the thorny and divisive domain of ESG—environmental, social, and governance proposals.

For a while, ESG voting looked like it was hitting its stride. Shareholders were flexing their moral muscles, pushing companies to decarbonize, pay their employees more fairly, and do right by society. Support for ESG proposals climbed steadily, doubling from 2010 to 2021, as the world started to take climate change, social inequality, and corporate responsibility more seriously. 

But in 2022, something weird happened: support for ESG proposals nosedived. By 2023, it was in freefall. This isn’t just some minor fluctuation—it’s a dramatic U-turn. What happened? Did investors suddenly stop caring about the planet and people? Not quite. The culprit seems to be something a little more mundane: a change in U.S. securities regulation.

Enter the SEC’s 2021 Guidance

In their recent paper, Expanding Shareholder Voice: The Impact of SEC Guidance on Environmental and Social Proposals, which won a prize at the Berkeley-ECGI Corporate Governance Forum, Kenneth Khoo and Roberto Tallarita explore the consequences of a 2021 rule change by the Securities and Exchange Commission (SEC). This guidance allowed shareholders to submit ESG proposals that are, let’s say, a bit bossy. Instead of just asking companies to "consider doing better," these proposals could demand specific actions, detailed targets, and strict timelines. These are commonly described as “prescriptive” proposals.

Before the SEC’s rule change, companies could often keep these prescriptive proposals off the ballot by invoking the “ordinary business exclusion.” They’d argue that proposals dictating how they run their business were about ordinary business—and therefore not shareholder material. But the 2021 guidance threw that argument out the window. Suddenly, shareholders could demand specifics on the environmental and social policies which these shareholders would advocate for, and companies had to put those demands to a vote.

More Demands, Fewer Votes

You can probably guess what happened next. The floodgates opened, and although the number of proposals increased only modestly, their content became significantly more detailed and specific, with textual changes reflecting a marked rise in prescriptiveness. Shareholders began asking companies to adopt strict carbon emissions targets, phase out fossil fuels, or implement other sweeping reforms. These proposals are ambitious, but they’re also expensive, complex, and sometimes not so great for the bottom line.

Unsurprisingly, most investors weren’t thrilled about the costs. Shareholder support for these prescriptive proposals plummeted. According to Khoo and Tallarita, the decline in support for ESG proposals after 2021 can be directly linked to this prescriptiveness. While non-prescriptive ESG proposals still attracted some goodwill, their bossier cousins saw vote tallies dwindle to single digits.

Voting With Your Ideology (and Wallet)

But not all investors are created equal, and their reasons for supporting—or rejecting—prescriptive proposals are far from uniform. Khoo and Tallarita used machine learning to dig into the data, classifying proposals and tracking voting patterns across different types of institutional investors.

They found that investors vote along ideological lines. Funds with a strong ESG focus —the kind that post “green” and “sustainable” all over their marketing materials—are more likely to support prescriptive proposals. But even they aren’t going all in; there’s a limit to how much they’re willing to sacrifice returns for the sake of the planet. On the other hand, more financially conservative investors (think classic money managers who like dividends and low costs) overwhelmingly rejected these proposals. Even the "Big Three" passive index fund managers—BlackRock, Vanguard, and State Street—tended to align with the average shareholder’s cautious stance.

So, ideology matters, but money talks louder. When prescriptive ESG proposals start looking like a tax on returns, most investors hit the brakes.

The Great ESG Tug-of-War

This dynamic exposes the central tension in ESG investing: the tug-of-war between idealism and pragmatism. Investors like the idea of doing good, but they don’t like paying too much for it. Meanwhile, companies are caught in the middle. On one side, they face activist shareholders demanding ambitious reforms. On the other, they’ve got profit-minded shareholders ready to punish them if those reforms dent the bottom line.

The SEC’s 2021 guidance may have amplified this tension. By enabling more prescriptive proposals, it gave ESG activists a louder voice. But the backlash from investors suggests that most shareholders prefer ESG-lite—the kind of feel-good policies that don’t cost too much and let them sleep well at night.

If there’s a lesson here for ESG proponents, it’s that ambition needs to be tempered with strategy. Prescriptive proposals are a bold move, but they’re also risky. Investors might support vague aspirations to “be better,” but they balk at mandates that look expensive or impractical.

On the regulatory side, the SEC faces a tricky balancing act. Its 2021 guidance was a win for shareholder democracy, empowering investors to hold companies accountable. But democracy can be messy, and an expansion of shareholder voice can make it more challenging for managers to discern what shareholders truly want, especially when demands vary widely. 

The Future of ESG Voting

What’s next for ESG proposals? The decline in support for prescriptive proposals doesn’t necessarily mean the end of the road. Companies and shareholders alike are learning to navigate this new terrain. Activists may pivot to crafting proposals that are ambitious but not overly prescriptive, aiming to win broader support. Meanwhile, companies might use these votes as a barometer for how far they can push ESG initiatives without alienating investors.

As for the SEC, its 2021 Guidance has introduced a significant shift, giving shareholders a greater say in corporate strategy than ever before. The challenge now lies in navigating this expanded shareholder voice — finding common ground between idealism and pragmatism, between doing good and doing well.

-------------------------------------------

The ECGI does not, consistent with its constitutional purpose, have a view or opinion. If you wish to respond to this article, you can submit a blog article or 'letter to the editor' by clicking here.