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Welcome to our November newsletter. In this month's edition, we're excited to introduce a new team member and highlight the shareholder proposal initiative that she is spearheading to elevate our theory of change via the
proxy process. We also touch on the impact of current events (election, anyone?) in addressing systemic issues, and opine on the problems with private equity in the latest going private attempt at Dunkin'. As always, please reach out if you would like to further discuss any of the below or to get more involved with our work.
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Many of our readers will know Sara Murphy, whose prior postings include the Investor Responsibility Research Center (IRRC) and the Fortis Investments/BNP Paribas SRI teams. We are very excited to
welcome this veteran ESG warrior to our team as senior strategic consultant. She will bring her expertise and leadership to our engagement efforts and is heading up our shareholder proposal and voting policy initiatives this fall. She also wrote this month’s Ramble (below), so make sure to read and share it when it is posted on Medium! To get in touch with Sara, you can send her an email at [email protected].
PROPOSALPALOOZA
As mentioned above, our efforts to catalyze a new type of shareholder proposal are in full swing. The federal securities laws provide public company shareholders with the right to bring proposals to annual shareholder meetings. Investors often use this opportunity to raise issues around social and environmental impact. This practice has
created a healthy dialogue that has moved companies forward on many fronts, especially with respect to disclosing environmental information, political contributions, and human rights policies.
The Shareholder Commons is collaborating with asset owners and shareholder activists to make proposals that will specifically focus on the costs that these impacts may have on investors’ diversified portfolios. The proposals ask companies to either (1) disclose these impacts or (2) change their corporate governance structure in order to allow the companies to fully
account for these costs. We hope these proposals will help to illustrate the need for business and investors to shift to a systems-first paradigm.
To give a sense of how this looks in practice, here is an excerpt from a sample proposal we drafted for Walmart:
The consequences of these costs for our shareholders, the vast majority of whom are diversified, are enormous. As of June 2020, the top 10 holders of our shares include mutual fund managers BlackRock, State Street, Vanguard and Fidelity, whose clients are generally indexed or otherwise broadly diversified investors.
Such shareholders are unalterably harmed when companies following Delaware’s “shareholder primacy” model harm the economy, as the relationship between GDP and the value of a diversified portfolio is positively correlated in the long term. (Fama 1990.) While our company may profit individually by ignoring costs that it can externalize long term, its
diversified shareholders internalize them and may prefer to convert to a PBC, both in order to reduce those costs and to ensure that the commitment made to stakeholder values is authentic and lasting.
We are still looking for additional proponents to sponsor proposals in the upcoming proxy season. Note that TSC has retained legal counsel to
review these proposals and will provide necessary support to create the best chance we can to facilitate inclusion in proxy statements, as well as to explain the importance of these proposals to stakeholders, resulting in a relatively light lift for investors with huge impact potential in advancing a systems-first investment management theory.
If you are interested in learning how you can engage with and support this effort, please check out our project brief. If you're ready to commit to sponsoring a
proposal, you can fill out this form to indicate which companies you'd like to engage. We would
be more than happy to set up a time to discuss these opportunities with you one on one, so don't hesitate to contact us if you'd like to chat.
NOVEMBER RAMBLE:
THE POLITICAL WILD CARD
Speculation and considerable anxiety abound as to how the outcome of the November 3rd election will affect efforts to address the profound environmental and social costs and risks created by irresponsible business practices and poor capital stewardship. It’s no secret that the Trump administration has exacerbated these trends with its aggressively
deregulatory agenda and will surely continue to do so in the event of a second term.
A Biden presidency would likely toughen corporate ESG requirements. Indeed, when Biden rolled out his economic plan this summer, he described the idea that corporations only exist to deliver profits to shareholders as “an absolute farce.”
But if Biden replaces Trump, there will be fewer easy opportunities for companies to score points simply by expressing outrage – think U.S. withdrawal from the Paris Agreement, immigration policies that exclude much-needed workers, and failure to clearly and consistently denounce white supremacy – and more tough choices to make about specific policies and legislation. Even with strong
regulation, business will have to work deliberately to address structural issues from racial injustice to environmental degradation. CEOs who hope to be seen as leaders will have to use their market power, not just their voice, to drive systemic change.
On the other hand, a second Trump term would likely redouble pressure on the business world, as civil society and the public will see that avenue as the only viable pathway toward urgently needed change. Indeed, we’ve been seeing this throughout Trump’s current presidency as younger consumers and employees demand better social and environmental performance from companies, and the relentless
rise of social media – for all its flaws – makes it harder to conceal corporate malfeasance. Companies apparently feel the heat. No matter what you make of the authenticity and impact of statements of corporate purpose, net-zero commitments, and diversity and inclusion campaigns, the very fact that businesses think these are necessary is an important sign.
And then, of course, 2020 brought us a pandemic that seems tailor-made to expose the fissures and interdependencies in our economic system. There’s no telling how we emerge from this, but business is unlikely to proceed as usual no matter who sits in the Oval Office.
Companies will increasingly be expected to ensure the stability of the basic underpinnings of a thriving economy and society – clean air and water, a stable climate, abundant and regenerative natural resources, an educated and engaged pool of talent, robust global and local markets filled with people with enough wealth to buy your products, and much more. If
the next administration fails to protect or enhance those pillars of a strong economy, or even actively undermines them, then business will face stronger-than-ever demands to take action, pick up the slack, and render federal (in)action irrelevant. If government is derelict in its duties, business will be expected to lead.
The bottom line: The outcome of the election will change the form of environmental and social pressure on capital markets, but not the fact of it.
Sara E. Murphy
Senior Strategic Consultant
DONUTS FOR THOUGHT
Last weekend, the story broke that private equity sponsor Roark Capital was in talks to purchase Dunkin’ Brands Group, the publicly traded donut giant, for more than $9 billion in cash, a 20% premium to its current trading price. The premium works out to almost $1.5B, which might look like a home run for investors. The required shareholder vote is thus
unlikely to pose a problem.
But perhaps it should.
As our subscribers know, The Shareholder Commons is encouraging a new lens for investor success: the first question that diversified investors should ask when taking action is whether that action is good for systems that support their entire portfolio. In this case, for example, the $1.5B premium will be chimerical if the transaction externalizes costs that will, over the long run, damage
diversified portfolios by a greater amount.
Where would such costs come from? There are myriad opportunities for value destruction to stakeholders that ultimately manifest in diversified portfolios. When the deal is announced, look for a discussion of “synergies”—corporate speak for lay-offs. Laying off workers in the midst of a pandemic and recession can do lasting economic harm as people struggle to find work, and
some number eventually fall out of the workforce, with concomitant damage to productivity and GDP growth.
These transactions can spell bad news for the environment as well, because privately-held companies generally report less data. For example, Dunkin’ reports its Scope 1 and 2 carbon emissions, but this writer has not found such a report for Roark’s restaurant business—just some self-congratulatory statistics on energy use. Without such reporting, PE companies, which are incentivized by their
business model to quickly increase cash flows, are unlikely to comply with the Paris Accord, which is designed to preserve trillions of dollars in economic value that benefits all investors. These effects are real and are felt by investors: The World Health Organization and the consultancy McKinsey have determined that climate change and air pollution combine to impose annual environmental costs that equal more than 2.5% of global GDP. That kind of reduction in productivity, year after
year, will ultimately take a huge toll on the return of a diversified portfolio.
The structure of private equity itself can drain value from equity investors as a class. The transactions rely on significant debt, which can often lead to bankruptcy: in the first five months of 2020, 41 private equity-backed companies filed for bankruptcy, resulting in displacement and disruption and likely hundreds of millions spent on professional fees instead of productive activity. Not
coincidentally, the private equity industry is based on the idea of “carried interest,” where the private equity sponsor takes 20% (give or take) of the upside from its investors (in addition to an annual fee of around 2% of the assets under management). This heads-I-win-tails-you-lose arrangement means that these investors (often the same institutions that are the public investors in the company being taken private) take the risk of losing their entire investment, while the sponsors can only
win. This ultimately means that less of the economic pie goes to saver-shareholders and more to finance professionals.
The largest investors in Dunkin’ are fund managers BlackRock and Vanguard, whose clients are generally indexed or otherwise broadly diversified investors. Such investors are unalterably harmed when companies chasing short-term premiums ignore the harms a buyer may do to the economy, because the relationship between GDP and the value of a diversified portfolio is positively
correlated in the long term. While Dunkin’ executives with lots of shares may profit individually by ignoring the long-term costs of a going private transaction, its shareholders will internalize them through their diversified investments. These citizen shareholders (or their representatives) should only approve transactions that protect society and the environment from the techniques so often used to make quick money in private equity.
If and when a deal is announced for the sale of Dunkin’, we hope that before voting on the transaction, the fund managers and pension trustees managing money for ordinary citizens—who are relying on a healthy market to fund retirement, education and other long-term needs—will consider the true cost of the transaction to their beneficiaries.
THAT'S ALL FOR NOW
Thanks for reading. As we enter into what is likely to be a contentious election week ahead, we encourage everyone to take some time to disconnect from the news cycle and reconnect with what is most important - family, nature, oneself.
From all of us at TSC, we wish you all safety, sanity, and health in the month ahead. And don’t forget to
breathe.
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