How Exxon Lost a Board Battle With a Small Hedge Fund

The oil giant’s unexpected boardroom defeat by an activist investor hinged on a few key moments.

By Michael J. de la Merced

May 28, 2021

Early this year, leaders of Exxon Mobil, the vast oil company descended from the Standard Oil empire, found themselves in an unusual situation: defending the oil giant against a tiny activist investor calling for a major shake-up in the name of climate change. Even more unusually, they were on the back foot.

This week, that investment firm, Engine No. 1, scored a stunning victory, winning at least two seats on Exxon’s board in a shareholder vote. It may yet place a third nominee, as votes from Exxon’s annual investor meeting on Wednesday continue to be counted.

It was one of the biggest upsets in the history of corporate board fights, putting Engine No. 1 on the map as a new force in the business of shareholder activism. The back story of its victory also shows how it took advantage of several factors — including an oil producer’s history of dismissing investors and a growing desire among mutual funds for environmentally responsible investing — to turn the tables on a titan of corporate America.

“This is a milestone in climate-driven activism,” said Edward Rock, a professor at the New York University School of Law.

Shareholder activism, in which investors buy a stake in a company with the aim of shaking up its strategy, is a tactic that has minted billions, made stars of financiers like Carl C. Icahn and forced changes at blue-chip companies like AT&T and Procter & Gamble.

Engine No. 1, which has $250 million in assets under management, is a minnow, making its victory all the more momentous.

The fund’s founder, Chris James, made his money as a technology investor at hedge funds like Andor Capital Management and Partners Fund Management. In creating Engine No. 1, he decided to focus on the growing field of so-called impact investing, which asserts that focusing on issues like climate can bolster the bottom line as well.

“If you have a big negative impact on a community or environment, there’s a whole flywheel of things that is taking place,” Mr. James said in an interview, emphasizing his belief in a relationship between social good and economic performance.

Charles Penner, Engine No. 1’s head of active engagement, is a veteran of shareholder activism. While at Jana Partners, Mr. Penner was deeply involved in drives against the likes of Whole Foods, which led to a $305 million profit for his fund after the grocery chain agreed to sell itself to Amazon. In 2018, he rallied investors to push Apple to consider its products’ mental health effects, particularly on children.

Early last year, Mr. Penner left Jana with ambitions of setting up his own fund. But as the pandemic hit, he held talks to join Mr. James’s nascent firm — and brought with him an ambitious idea he had been weighing for some time: Exxon.

The $250 billion behemoth was ripe for disruption, the two believed: Exxon was lagging rivals in pursuing ways to reduce its carbon footprint, which would eventually cost the company financially. Its board lacked the expertise to pursue a more aggressive plan, they thought. And the oil giant had a reputation for being highhanded with its shareholders.

The key to victory, according to two people with knowledge of Engine No. 1’s strategy, who spoke on the condition of anonymity to discuss private talks, was winning over big mutual-fund investors who have been pledging to make their portfolios greener. Exxon’s top three shareholders — Vanguard, BlackRock and State Street, which together own one-fifth of the company’s stock — had promised to reduce the carbon emissions of the companies they invest in to zero by 2050.

Engine No. 1 announced its campaign against Exxon in December. A pension fund for teachers in California and the endowment of the Church of England endorsed the effort.

After a flurry of phone calls, Exxon’s chief executive, Darren W. Woods, and lead independent director, Kenneth Frazier, held a Zoom call with Engine No. 1 executives on Jan. 22. During the meeting, according to two people with knowledge of the matter, who spoke on the condition of anonymity to discuss private talks, Mr. Frazier struck a conciliatory tone — at one point, he flashed a peace sign, one of the people said — but said the company did not consider Engine No. 1’s nominees to be qualified. Mr. Penner answered that the company should reconsider, and insisted on all four of its proposed candidates taking seats on Exxon’s 12-member board.

After the call, both sides girded for battle.

Over the next five months, a war of words ensued, as the company’s directors and activist insurgents put out statement after statement, each side making its case. These efforts cost Engine No. 1 over $15 million, according to a person with knowledge of the matter.

For Exxon, the focus was persuading investors that it had viable plans to prepare for a lower-carbon future, while also arguing that Engine No. 1 had presented an unworkable alternative plan and unqualified board nominees. The company added new directors to its board without Engine No. 1’s input, a move that infuriated the fund.

In early March, Exxon’s executives hoped they had turned the tide. The company reached a settlement with a far bigger investor, the hedge fund D.E. Shaw, which had also been calling for changes in strategy. The  company used that agreement to put pressure on Engine No. 1 to call off its fight, and Engine No. 1 briefly worried that the D.E. Shaw agreement could undercut support for its campaign from other big investors.

But by April, Engine No. 1 had gained prominent new backers in its campaign, including huge public pension funds for California and New York State.

As the annual meeting approached, Exxon’s leaders knew they were in trouble. Influential shareholder advisory firms recommended that investors vote for at least two of Engine No. 1’s four nominees. Vanguard, BlackRock and State Street didn’t think the company was going far enough, and voted for at least some of Engine No. 1’s directors and issued statements explaining their decisions.

By Wednesday, preliminary vote counts before the shareholder meeting appeared to show Engine No. 1 winning at least two seats. In the middle of the meeting, Exxon unexpectedly called for a one-hour recess, saying it was needed to count votes. Both sides reached out to investors to try to persuade them to hold firm, though supporters of the activist campaign worried that Exxon was trying to get shareholders to change their ballots in its favor.

In the end, many of Exxon’s top institutional investors voted for Engine No. 1’s candidates, while individual shareholders tended to favor the company’s nominees. The final results — including whether the fund can claim a third director position — aren’t expected until next week, at the earliest.

The scale of the victory was comparable to few other activist campaigns, such as when the hedge fund Starboard Value replaced the entire board of Darden, the parent company of Red Lobster. That victory helped cement Starboard’s reputation as a top-tier activist.

Engine No. 1, with only one campaign, is now poised to join these ranks. Its victory over Exxon will help Engine No. 1 expand, as the firm prepares to raise money from outside investors this year, two people with knowledge of those plans said. (Mr. James declined to comment.)

For companies, what happens next, according to Professor Rock of New York University, is that the community of bankers and lawyers who help defend against activist investors will probably urge their clients to have credible climate-change strategies.

“The corps of advisers is going to be saying to boards, ‘You’re going to want to prevent Engine No. 1 from coming after you next,’” Professor Rock said.

Engine No. 1 is studying potential new targets — including other big companies — two people with knowledge of the firm’s plans said, though it has yet to decide whom to take on next.

“We’re going to keep looking for good opportunities to make the case for change to long-term-minded investors,” Mr. Penner of Engine No. 1 said. “We’re seeking opportunities to make structural change that make business sense.”

And Engine No. 1 has ambitions beyond shareholder activism. It plans to pursue other investment strategies, always with a socially minded focus, including working with companies more quietly, out of public view.

Clifford Krauss and Hiroko Tabuchi contributed reporting.

Michael de la Merced joined The Times as a reporter in 2006, covering Wall Street and finance. Among his main coverage areas are mergers and acquisitions, bankruptcies and the private equity industry.

A version of this article appears in print on May 29, 2021, Section B, Page 3 of the New York edition with the headline: How a Small Hedge Fund Was Able to Beat Exxon in a Board Battle.

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