ESG & Shareholder Activism in Silicon Valley: Prepare for Impact

The Emerging ESG Tsunami in Silicon Valley

Growing awareness of environmental, social, and governance (ESG) factors might lead companies to believe the peak of ESG concern has already passed.

However, this is not the case; we are actually in the initial phases of a significant shift – an ESG tsunami is rapidly approaching Silicon Valley and beyond.

Broadening ESG Focus

Increased scrutiny regarding ESG considerations extends far beyond the technology industry alone.

This expansion is largely fueled by wider societal shifts, notably the heightened emphasis on climate change and related sustainability concerns.

The demand for greater ESG accountability is primarily driven by diverse investor groups, encompassing pension funds and a new wave of younger, individual investors.

Investor Pressure and Competitive Landscape

Financial institutions seeking to attract capital are now compelled to prioritize the ESG dimension to maintain a competitive edge.

This includes mutual funds, venture capital funds, and hedge funds, all of which must demonstrate a commitment to responsible investing.

A Turning Point in Investor Influence

While ESG awareness has been steadily increasing, investor influence reached a critical juncture in the spring of 2021.

Successful campaigns by shareholder activists at energy companies, particularly the proxy contest spearheaded by Engine No. 1, marked a significant turning point.

For the first time, ESG-related investor pressure – specifically concerning climate change – directly resulted in substantial changes to a public company’s board of directors.

Leveraging ESG in Activist Campaigns

Activist shareholders are now utilizing emerging and potent ESG themes as leverage in their campaigns.

These campaigns aim to influence control and reshape the strategies of public companies, demonstrating the growing power of ESG considerations in corporate governance.

Will the Technology Sector Face Increased Scrutiny?

Throughout history, investor focus on governance within public companies – the “G” in ESG – has followed a pattern of addressing concerns sequentially. Success on one issue prompts a shift to the next. A prime illustration of this is the transition towards annual elections for all directors, replacing the previous system of staggered, three-year terms for a portion of the board, often referred to as a “classified board.”

In 2007, a majority – 55% – of U.S. public companies within the S&P 1500 utilized a classified board structure. However, by 2021, sustained governance campaigns led by shareholders had reduced this figure to 26%. Classified boards are now nearly absent among the largest public companies, those holding the most significant weight in investor portfolios. Consequently, investors largely consider the issue of annually elected boards resolved, and their attention is now turning towards other areas of concern.

We anticipate a similar progression unfolding presently. Aeisha Mastagni, a portfolio manager at CalSTRS and a key figure in Engine No. 1’s recent proxy contest, expressed her hope that this contest would serve as a catalyst for change across all industries, not solely within the energy sector.

Given that climate change initiatives initially targeted the energy sector, the logical question arises: which industry will be next?

Several factors suggest the technology sector is poised to be the subsequent focus. Firstly, the technology sector currently represents the largest portion of the economy, based on market capitalization, accounting for approximately one-third of the S&P 500. Moreover, six of the largest companies within the S&P 500 are technology companies.

Even modest improvements in performance at large corporations can generate substantial financial gains, exceeding the impact of larger improvements at smaller firms. Furthermore, the actions of technology companies often exert considerable influence on other industries and society as a whole.

This has already manifested in heightened scrutiny from Congress, potentially bolstering investor support for campaigns targeting technology companies. Notably, a similar effort was previously undertaken: in 2008, Charlie Penner, then of JANA Partners, launched an ESG-focused campaign at Apple.

ESG and Shareholder Activism in the Public Technology Sector

The integration of ESG (Environmental, Social, and Governance) concerns into shareholder activist campaigns aimed at influencing board composition is now a demonstrable reality. While the extent to which activists will prioritize ESG themes remains to be seen, investors are increasingly aware of their potential to garner support from a broad spectrum of institutional investors.

Failure to address an ESG-focused activist campaign could expose institutional investors to criticism for neglecting client priorities and potentially jeopardize future investments from ESG-conscious sources.

Key ESG Challenges for Technology Companies

The technology sector faces a diverse range of ESG challenges, offering multiple avenues for activist intervention. These areas include societal impact, diversity and inclusion initiatives, safeguarding customer privacy, ensuring robust data security, responsible product design and lifecycle management, efficient energy consumption, ethical supply chain practices, fair competition, and fostering positive employee engagement.

The specific relevance of these factors varies depending on the technology subsector. For instance, semiconductor and electronics manufacturing industries are particularly vulnerable to ESG risks concerning emissions, water usage, waste management, and the health and safety of their workforce.

IT and telecommunications companies encounter unique challenges related to systemic risk management. Furthermore, many technology firms struggle with achieving diversity within their employee base and leadership positions.

Evolving Perception of ESG Issues

The breadth of potential ESG issues within the technology sector presents numerous opportunities for activist investors. Many of technology’s most pressing ESG concerns have been fundamental business considerations for years, predating their widespread association with ESG principles.

Protecting customer privacy and ensuring data security serve as prime examples. Companies operating in this space are well-accustomed to recognizing the importance of these issues to their core business operations.

However, the rise of the ESG movement has amplified the need for technology companies to demonstrate strong performance and transparency in these critical areas.

From Business Challenge to ESG Concern

Just five years ago, a significant incident or controversy related to customer privacy, data security, or competition practices might have been treated as a standard business challenge. Today, an activist can reframe the same event as an ESG deficiency, indicative of a major “governance failure” and a “systemic risk” to the company’s long-term value.

Activist investors can also position ESG-related issues as a moral imperative, advocating for reform not only to “do the right thing” but also to protect the company’s reputation and maintain its social license to operate.

As public acceptance of ESG arguments grows, it may become increasingly difficult for institutional investors to disregard activist campaigns that incorporate these moral dimensions into their messaging.

Prioritized Steps for Tech Companies Regarding ESG

Numerous factors are driving tech firms to prioritize ESG (Environmental, Social, and Governance) considerations, encompassing both ethical obligations and the need to appeal to investors. For publicly traded entities, a deficient ESG standing can be leveraged by activist shareholders. Consequently, organizations within the technology industry should carefully consider the following guidance.

Integrating ESG into Corporate Narrative

Incorporate ESG principles and key messaging into the company’s overarching narrative. Publicly listed companies must also be prepared to substantiate their performance should they face scrutiny from shareholder activists.

It’s crucial not to underestimate the potential for shareholders – whether activist-minded or not – who express interest or raise concerns regarding ESG practices. Present engagement may evolve into future activist campaigns.

A company should be equipped to articulate its ESG program’s core areas at a strategic level, enabling a swift response to any public critique.

Benchmarking Against Industry Standards

Assess the ESG performance and reporting practices of competitor organizations. Evaluation is often conducted on a comparative basis.

While leadership in ESG is advantageous, maintaining alignment with industry peers is essential. Leverage established disclosure frameworks like the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI) as guides for disclosure strategies within your sector.

Phased Implementation for Emerging Companies

For smaller, rapidly expanding companies, a measured and strategic approach to ESG program development and disclosure is often beneficial.

Demonstrating a well-considered plan for integrating ESG metrics at suitable stages of company growth can be more impactful than prematurely allocating limited resources to full implementation.

Begin by concentrating on the most significant objectives and progressively expand your ESG program over time.

Disclaimer: This article is intended solely for informational purposes and does not provide legal counsel. Access to this information does not establish an attorney-client relationship. Readers should consult with qualified professionals before acting on this information. The views expressed herein do not necessarily reflect those of Sidley Austin LLP.