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Curing systemic portfolio risk through shareholder resolutions

A new generation of shareholder proposals are asking firms to look at economy-wide risks, not just those that pertain to an individual company

Never before has the world talked more about system risks than over the past 12 months. And it isn’t just the pandemic and climate change: health, governance, income inequality and structural racism all pose risks that are now being looked at more carefully. For shareholders, this has coalesced into something known as ‘systemic portfolio risk’.

This proxy season, two of the most prolific and successful proponents of shareholder resolutions, James McRitchie and his wife Myra Young, are preparing to address some of these risks. The couple have filed resolutions targeting fast food giant McDonalds, pharmacy CVS, drinks company Pepsico, Wall Street banks Goldman Sachs and JP Morgan Chase, and hotel chain Marriott International. 

So far, most of the companies are fiercely resisting even having the proposal on their proxy statement – mainly by sending so-called ‘no action’ letters to the US regulator the Securities and Exchange Commission (SEC).

‘What matters most to [diversified owners] is the performance of the whole stock market’ Frederick Alexander, CEO Shareholder Commons

There is one exception, though: in exchange for withdrawing the resolution, restaurant chain Yum! has agreed to undertake a study of the systemic costs of Antimicrobial Resistance (AMR) and “the stakeholders that ultimately absorb these costs”, addressing how antibiotics use in animal farming can threaten global health, the economy and shareholders.

Once the findings have been established (expected some time this year), Yum! “will discuss an optimal, global scenario for the food industry that would eliminate or internalise AMR costs and will address any competitive concerns that would make progress more difficult without such an approach”, it said. It will also assess how its policies, including lobbying and political expenditures, can affect “the realisation of the global scenario” and figure out how to quantify external AMR costs.

A similar proposal has been filed at McDonalds, but the company has yet to respond.

“Most investors are diversified owners of the stock market,” notes Frederick Alexander, CEO of non-profit The Shareholder Commons, which assisted McRitchie and Young in filing the resolutions and defending them at the SEC. “Because what matters most to them is the performance of the whole stock market, companies should not only be disclosing these risks, they should be making their decisions based on those broader factors.” 

“Yum! already has a lot of sustainability best practices in line with other leaders, but this takes them well beyond what any other company is doing. It’s a first, as far as I know, and it challenges other companies to do the same thing,” he continues. “People who work in corporations are caught up in this competitive bind, but if you start naming these systemic issues it becomes easier for everyone to remain within the guardrails necessary to preserve critical systemic value, like the efficacy of antimicrobial medicines.”

Alexander says that Yum!’s move essentially leapfrogs the EU’s recent progress on ‘double materiality’ and ‘outside-in/inside-out’ reporting, based on advice from the European Commission’s Technical Expert Group on Sustainable Finance. Double materiality refers to actions that have both a material financial and substantial environmental or social impact, while outside-in reporting looks at how sustainability risks and opportunities impact companies, and inside-out reporting describes companies’ impact on society and the environment.

Young and McRitchie filed their ‘systemic portfolio risk’ resolutions based on theories from two books by Jon Lukomnik (one co-authored with Jim Hawley): Moving Beyond Modern Portfolio Theory: Investing That Matters and The Third, System Stage of Corporate Governance: Why Institutional Investors Need to Move Beyond Modern Portfolio Theory.

The resolution at CVS calls on the pharmacy chain to report on the external public health costs created by its retail food business, asking: “How do such costs affect the vast majority of shareholders who rely on overall market returns?” The proposal focuses on the unpriced costs of obesity that could be caused by the company’s food sales – pharmacy food sales in the US generally comprise snacks and sugary soft drinks. CVS is seeking to exclude the proposal from its proxy statement.

A similar resolution was filed at Pepsico, which has also been challenged at the SEC. 

The proposal at Marriott focuses on the social costs stemming from the disparity between the pay of its CEO and the wages of its employees, asking again: “How do such costs affect the vast majority of its shareholders who rely on overall market returns?” Pay inequity imposes costs on the economy that lower GDP, the proposal argues, which in turn reduces equity value. “While the Company may profit by ignoring such costs, its diversified shareholders will ultimately pay them, and they have a right to ask what they are,” it continues. That proposal has also been challenged by the company.

And in two broadly similar proposals at Goldman Sachs and JPMorgan Chase, the pair ask for a report on the external costs of underwriting the multi-class equity offerings that provide control to insiders with high-vote stock, and contribute to “poor governance that harms investors as a class”. The resolution at Goldman Sachs notes that the bank told its own shareholders that “[u]sing multi-class voting to insulate management from its own shareholders comes at a significant long-term cost”. 

Both banks argue in their ‘no action’ letters that the proposals are too vague and misleading, and that they relate to ordinary business – specifically that they don’t focus on any “significant policy issue that transcends the company’s ordinary business operations”.

Responding to this pushback, TSC notes that it is precisely because multi-class share offerings are a significant policy issue that they should be included on the ballot. It points out that JPM’s own policies disfavour multiclass voting because it results in “systemic reductions in economic productivity and efficiency” and that such ownership structures have been deemed damaging to the economy by a number of key figures, including SEC Commissioners. 

The participation of these two banks in the trend “is a looming threat and implicates a critical policy issue”, it continues. 

It remains to be seen whether the recent appointment of John Coates as Acting Director of the SEC’s Division of Corporate Finance will lead to the regulator being more sympathetic to these kinds of resolutions than it has been under William Hinman, who has overseen the widespread rejection of such proposals in recent years. And even if it does, it may not happen in time for these resolutions to make it through this year and for shareholders to have their say.