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Republished from hbr.com
By George SerafeimSakis Kotsantonis
Last week the world listened as Donald Trump announced, ‘We are out,’ proclaiming the U.S. withdrawal from the Paris climate accord. Such a move might create inertia for some companies and investors if they see it as evidence that “business as usual” is now the most likely climate scenario.
We call this the “Trump climate trap,” and it is a real danger. But another major action last week points in the opposite direction and leaves us more optimistic.
We witnessed a monumental event in a shareholder resolution calling on ExxonMobil, the world’s biggest publicly listed energy company, to disclose the impact on its business under a 2-degree scenario. (That means a world in which we have at least a 50% chance of limiting temperature increases to no more than 2 degrees Celsius.)
Despite the company’s board recommendation that investors to vote against the proposal, a striking 62.2% of the votes were in favor, providing a strong signal that climate change is an important financial risk and that shareholders want to know more about what companies are doing to transform their operations and products to remain competitive in a low-carbon world.
The success of the proposal requesting increased disclosure by ExxonMobil suggests that we have reached a tipping point within the investment community in the recognition of climate risks. Just a year ago a similar resolution at Exxon’s annual meeting received support from investors holding only 38.1% of shares. In very little time, the recognition that our economy will have to transform to decrease carbon emissions has gone from a minority view among Exxon shareholders to a majority view.
This transformation will not be easy, and we expect that while a number of companies will be able to adapt and grow their market share, others will go out of business in the process or shrink significantly.
In the meantime, more shareholder proposals will address climate change issues, raising important questions for boards of directors. Boards will have to demonstrate competence at monitoring the organization’s transformation process. In particular, boards will have to show that they understand two things.
They will need to demonstrate that they grasp how climate change and the adaptation to a low-carbon economy will affect different sectors. For example, directors of auto manufacturers and auto parts suppliers will need to understand how shared and autonomous mobility will accelerate electrification of the transportation sector, affecting car sales. Similarly, directors of power companies need to understand how advances in energy storage and information technology will accelerate development of micro-grids and the decentralization of the electric grid.
Boards will also have to communicate how the organization’s strategy is compatible with a low-carbon economy and what investments will need to be made to remain competitive. Capital expenditures, future acquisitions, research and development expenses, future financing needs, and payout policies, such as dividends and share repurchases, need to be assessed in part based on how they fit into a low-carbon world.
Boards are not the only ones under pressure. As our economies adapt, investors need to improve their practices in order to safeguard their portfolios. Investors can now go beyond “screening,” an exclusionary approach to their investment strategies, whereby companies are excluded from portfolios based on industry or because of negative environmental incidents such as spills or supply chain issues, to integrating environmental, social, and governance issues in their overall investment strategies. This requires scenario planning, thoughtful modeling of potential outcomes, an assessment of management’s capacity to drive transformational change in the business, and board capacity to choose and incentivize a competent management team. Improvements in the landscape of environmental data over the last few years, such as carbon footprinting, have provided the infrastructure for more sophisticated analysis. Using state of the art tools and databases developed by organizations such as Ceres and SASB to understand environmental impacts will be critical if the private sector is going to avoid the Trump climate trap.