Acadian Asset Management: Engagement tipping points

Give a brief overview of your initiative, its objectives, and why you decided to undertake it.

Engaging with a company can sometimes seem an arduous task. On the one hand, a company may be tempted to overlook or dismiss an investor’s concerns if it feels that the investor lacks shareholder power and/or is a lone voice in its call for change. On the other hand, collaborative engagements benefit from combined shareholder power, yet may be hampered by the free-rider problem that can inhibit individual investors from working together.

Here we describe an engagement tactic that seeks to overcome the challenge by starting with the end goal in mind. We leverage unstructured data and data science techniques to analyse a company’s supply chain, and identify the power dynamics at play to create a ‘tipping point’ based on the Theory of Change.

Supply chain monitoring typically starts from the premise that companies require their first-tier suppliers to adhere to codes and procedures. These suppliers, in turn, require compliance from their suppliers. The hope is to create a cascade of compliance throughout the supply chain. While this is the theory, the reality is very different. Indeed, our approach is motivated by the observation that the COVID-19 pandemic and Russian invasion of Ukraine have placed significant strains on supply chains, bringing supply chain management into sharp focus, and shining a light on concerns ranging from exploitative working conditions and inequities to human rights abuses in violation of the UN Guiding Principles on Business and Human Rights.

To tackle engagements based on real-world outcomes, we introduce Stakeholder Influence, an engagement tactic that simultaneously targets a company by identifying its eco-community - consisting of its most influential customers, suppliers, and competitors. We demonstrate how the power dynamic created by targeting economic relationships can incentivise a broad range of companies and investors to address human rights issues in their supply chains. We show how this can create a positively reinforcing relationship that aligns directly to Active Ownership 2.0.

 

Describe how your initiative is aligned to Active Ownership 2.0.

We start by identifying a target company for engagement. We utilise publicly available data to map the economic relationships between the target company and its customers, suppliers, and competitors. This data can be sourced from regulatory filings, conflict mineral reports, company press releases, and earnings call transcripts.

Drawing upon a data science technique known as network centrality, we next quantify the influence that each customer and supplier has within the broader supply chain network. We refer to this as Stakeholder Influence. One way to quantify Stakeholder Influence is to count the links that one company has to other companies within the network. A high count indicates a strong influence within the network. This metric quantifies not just direct influence, but also influence over other companies more than one link away.

Stakeholder Influence identifies the influential customers within the target company’s supply chain, as well as influential competitor relationships among the target company’s customers. Our key innovation is to target engagements identified by the interaction of suppliers and customers within an eco-community. The customer-supplier link creates channels that transmit not just the flow of goods, but also ideas, risk, and innovation spillovers, while the competitor relationship is vital to a well-functioning free market economy because it fosters innovation and the provision of higher-quality goods and services.

Creating an engagement tipping point

Central to our approach is the disclosure to all companies in an eco-community that we are engaging on the same ESG issue. In fact, it is this power dynamic of the customers’ influence on the supplier and the customers’ peer pressure on each other that motivates all parties to act together to realise change. Examples of how real-world outcomes play out include:

• The customers hold a certain amount of sway with suppliers as they often have the option to find substitute suppliers if unhappy with the product and terms of relationship.
• If the two customers of the target are also competitors, this can act as a further impetus for change through peer pressure. A company does not want to be viewed as a laggard when compared to a competitor, especially knowing that there is a relationship between the asset owner that is engaging with both customers that are competitors.
• Additionally, there may be an implicit understanding by the customer to act, as it could be subject to the same tactic of engagement applied to another layer up the supply chain. The customer should want to remediate risks to its business and recognise that the supplier is creating a risk to them either through association or through disruptions in the supply chain.
• Similarly, knowing that a customer has two suppliers that are competitors, one of which has an ESG concern and one of which does not, may also provide additional motivation on behalf of the target company to act.

Alignment to Active Ownership 2.0

In our view, Stakeholder Influence offers new avenues for direct and collaboration engagements:

• Outcomes. By mapping supply chain linkages to identify eco-communities between customers, suppliers, and competitors, we can locate tipping points that show which economic levers have the greatest ex-ante impact for change. By definition, the identification of these relationships ensures that economic interests are aligned with a common goal.
• Common goals. Our approach identifies power dynamics within supply chains and creates an economic incentive for all companies to act together to address systemic issues. That is, our Stakeholder Influence measure goes further than simply identifying where to prioritise engagement resources. It determines how to maximise the likelihood of achieving an economically meaningful impact across the entire supply chain network.
• Collaborative action. Our approach enables individual investors, each with holdings in different companies, to work together and target the same end goal. This is because our eco-community measure broadens the scope of direct and collaborative engagements beyond the initial company. Furthermore, the ability to analyse how an engagement action propagates through a network enables investors, NGOs, and regulators to quantify the probability that a given action will impact the overall outcome. This, in turn, directly addresses the free-rider problem, as each party engaging within the eco-community must work together to achieve an optimal outcome.

One challenge we sometimes face with engagements is the inability to enter a dialogue when the contact details of companies are missing from their websites. Stakeholder Influence offers a way to bypass this limitation. That is, even if the contact details of one company are not available, targeting the other companies in the eco-community can be sufficient to create a tipping point.

A further challenge is the perception that investors cannot engage unless they hold large positions in companies. Stakeholder Influence relies upon identifying economic links where companies within the eco-community are incentivised to change their behaviour, independent of investors’ interests. Consequently, we believe our approach offers broad appeal to generate real-world outcomes.

 

The results achieved in the initiative to date, including: evaluation of its success against the objectives; any adjustments to plans going forward; and any insights learned from this project that can be applied more broadly?

Stakeholder Influence engagements

A direct engagement with a shipping company with allegations of labour discrimination: We identified 17 direct customers, and a further 130 customers with two degrees of separation. In total, we identified 750 connections by expanding to all direct and indirect customers. The sheer number of relationships highlights the interconnectedness across regions and sectors. We targeted specific eco-community relationships within the network, which resulted in the re-evaluation of the company’s due diligence and supplier assessment practices.

A direct engagement with an autos company where we identified a supplier connection to the Uyghur region in China: Our discussion with the company led to the termination of the supplier and a tightening of its audit and procurement processes.

A direct engagement with a materials company that scored well on health and safety metrics, including Lost Time Injury Rate, but had seen escalating accidents across the rest of its supply chain: We demonstrated to the company how the impact of accidents could propagate across the network, measurable by production shutdowns, regulatory fines, and negative earnings surprises.

Lessons learned

In our view, the ability to locate engagement tipping points offers vast potential for information sharing and constructive, collaborative engagement. Indeed, we have presented our engagement tactic at a human rights and modern slavery initiative to broaden the initial scope of engagements and increase investor participation.

Our engagement analysis seeks to span across industries, regions, and traditional GICS classifications and can shed light on ‘hidden’ economic linkages. Moreover, in our experience, an empirical approach can offer unique insights often not known to the companies themselves. Many of our engagements have been successful, in our view because of the targeted nature of our feedback. Some companies have shared with us that their procurement teams didn’t have the resources to map out supply chains and would benefit from using our approach. Our intention is to provide transparency so that others can replicate our work for use in both direct and collaborative engagements. The supply chain network and centrality measures are reproducible using open software such as Gephi.

Going forward, we plan to expand the variety of our engagements. Over the past year, we have applied the approach to target companies with human rights concerns. This approach can be equally applied to environmental issues, including supply chain mapping of Scope 3 emissions and broader biodiversity concerns.