It’s very rare that corporate proxy elections make front-page news, but the shareholder vote at Exxon (XOM) this week was a notable exception, and for good reason.

Against the recommendation of Exxon’s own executives, two candidates were elected to the energy giant’s board on the pledge that they will push the company away from a business model focused on climate-damaging fossil fuel, and toward a greater focus on renewable energy. 

Given Exxon’s history of fighting the very idea that climate change exists and is driven by humans, this outcome is being cheered by the investing world’s environmental advocates as a big win.

But this vote can be seen through a much sharper lens.

It brings shareholder-driven climate governance to the fore. Contested board elections are won on concrete corporate governance considerations. The question among shareholders is usually this: Does the issue in question have a material impact on the future business prospects of the company?

Historically, investors—especially big institutional shareholders—have deferred to company management and rubber-stamped their recommendations. That’s especially the case when it comes to board candidates.

In this case, Exxon’s shareholders—the owners of the company—used the democratic process of voting in a proxy election to effect change. This vote comes against a backdrop of signs that big fund companies are increasingly willing to push back on company management on environmental, social and governance proposals.

And of course, climate governance is an especially important aspect of corporate governance for energy companies. Besides bringing much-needed board refreshment, Exxon’s new board members span a complementary skill set that includes relevant corporate leadership and renewable energy expertise.

Proxy contests involve a battle for board control via special provisions of the proxy process. They are often waged by activist hedge funds at underperforming companies with dysfunctional corporate governance. By forwarding competing director nominees for limited board seats, the challenger aims to shift board power and effect a strategic turnaround.

The proxy battle

In this case the fight was led by Engine No. 1, a newly formed activist hedge fund with a $50 million in Exxon. It contested four board seats with an alternate slate of four nominees. Although Engine No. 1 owns just 0.02 per cent of Exxon’s shares, it used this stake to pit its vision of the future against Exxon’s and attracted the support of some of the world’s largest investors.

The backstory is that Exxon sees world demand for oil and gas rising through to 2040, justifying continued investment in oil and gas production. Engine No. 1 sees growing long-term business risk for Exxon as the world transitions away from fossil fuels, and it sees opportunity in redirecting capital toward renewable energy.

In 1977—more than 10 years before the general public became aware of "climate change"—Exxon’s own scientists connected its business of extracting, refining, and selling fossil fuels with rising global temperatures. Instead of sharing the science, Exxon became the chief engineer and driver of a highly coordinated industry-sponsored "climate denial machine" that operated for decades to undermine meaningful policy action. Exxon has continued to downplay the seriousness of climate change in its corporate communications and to project blame for fossil fuel demand onto individuals and developing countries.

Only after the current proxy contest began did Exxon make more deliberate moves to address investors’ concerns. It announced plans to commercialize its carbon capture and storage business, set modest emissions reduction targets, and padded its board with new directors. Critics viewed these measures as too little and too late.

Exxon’s failure to respond more proactively has eroded shareholder value and accentuated systemic risk across financial markets, the company’s shareholder critics say. Until as recently as 2019, Exxon did not have a lead independent director and historically did not support direct engagement between board members and shareholders. Exxon’s shareholders and all investors would have been better served by a board less insular and more willing to challenge senior corporate management’s world view. The competence of boards in managing climate risks and opportunities will prove critical to how well companies navigate the energy transition and, in aggregate, how well markets succeed in decarbonizing.

Engine No. 1’s vision was given a boost last week. The International Energy Agency’s new global energy sector roadmap to net zero emissions by 2050 calls for no new oil and gas fields to be approved for development from 2021. In addition, the White House issued an Executive Order on Climate-Related Financial Risk aimed at advancing measurement, transparency, and consideration of climate risk throughout the financial system.

The votes

The largest U.S. pension funds—CalPERS, CalSTRS, NY State Retirement System, and New York City Pension Plans—publicly sided with Engine No. 1’s vision, pledging to support the alternate slate ahead of the vote. As opinion leaders on matters of corporate governance, this gave the challengers a huge boost into the home stretch. 

Following the meeting, BlackRock, with a 6.7 per cent stake, confirmed its support for three of the four, noting concerns about the board’s skill set and Exxon’s strategic direction. Vanguard and State Street—Exxon’s other two significant institutional shareholders holding a combined 13.9 per cent stake—have yet to share their votes. ISS had recommended votes in support of three of the challengers and Glass Lewis recommended votes in support of two. 

Looking ahead, yesterday’s vote will likely ignite the market for climate leadership at large energy companies. 

Shareholder victories elsewhere in the 2021 proxy season—Chevron (CVX), ConocoPhillips (COP), and Phillips 66 (PSX) faced shareholder resolutions pressing for accelerated decarbonization targets—give boards a clear mandate: Steer a course toward net zero emissions by 2050. Large investors will be increasingly inclined to withhold support from directors that aren’t up to the task.