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June 23, 2023updated 06 Jul 2023 12:09pm

Systemic risk: The companies externalising their costs to society

Externalising costs to society reduces the risk to companies in the short-term, but loads the risk onto the whole of society. This needs to stop.

By Paul Hodgson

Externalising risk, Facebook, engagement
Stop engaging with Facebook. Shareholder values are “not aligned” with senior execs. (Photo by Paparacy via Shutterstock)
  • The Shareholder Commons highlights 22 votes at companies that address so-called systemic risk caused by those companies’ strategies.
  • The resolutions deal with eight forms of systemic risk, from prioritising profits over people to paying less than the living wage.
  • As You Sow filed five resolutions asking companies to disclose how they protect pension plan beneficiaries from climate risk in default corporate retirement plans.

A group of new shareholder proposals addresses the distinction between voting to optimise the financial performance of individual companies and voting to optimise overall market returns.

A vote against a resolution for an oil company to reduce its Scope 3 greenhouse gas emissions might create good short-term returns, but it creates systemic risk to the global economy by contributing to climate-related disasters.

In investment terms, systemic risk is generally taken to mean the possibility that “an event at the company level could trigger severe instability or collapse an entire industry or economy”. The classic modern example is the 2008 financial crisis.

But to Sara Murphy, chief strategy officer at investor advisor Shareholder Commons, the concept of systemic risk has shifted in its meaning: “It’s all about externalising costs to society that reduces the risk to companies in the short-term, but loads the risk onto the whole of society – including shareholders trying to maximise returns and the companies themselves – in the long run.”

A series of shareholder proposals filed this year, including Majority Action, Climate Votes and members of the Interfaith Center for Corporate Responsibility (ICCR), detail the varieties of systemic risk that can damage the economy. The common thread is companies prioritising short-term profitability over long-term value creation.

‘Just vote no’ campaigns targeting the directors at each of the Wall St banks – because of their continued fossil fuel financing – and at the electric utility American Electric Power are designed to highlight “the risk that the climate crisis poses to the entire economy (and consequently to diversified portfolios)”. Capital Monitor has already reported the proposals calling for Scope 3 emissions reductions at ExxonMobil, Chevron, BP and Shell, which Shareholder Commons recommended supporting because of systemic risk.

Proposals at Amazon, Meta Platforms and Alphabet call for the protection of digital and human rights to counteract and mitigate the “risks to the social institutions that sustain a resilient economy” created by their activities. More specifically, the Shareholder Commons filed one of its own proposals at Meta that calls on the remuneration committee to design executive incentives that are “consistently calibrated with the costs externalised by company operations, including costs imposed on the global economy and the environment”.

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The germ of an idea…

A proposal with the fast-food chain McDonald’s addresses the use of antimicrobials in its supply chain, which contribute to antimicrobial resistance, as “a $100trn threat to the global economy” and health care systems. Another from Rights CoLab at BlackRock asks for a report on improving investment returns by engineering “decarbonisation in the real economy”. And two from ICCR at retailers Kroger and Dollar Tree on how their decisions to pay their workers less than a living wage externalise those costs onto society.

Finally, James McRitchie filed a resolution at State Street that asks for a report on the “conflict of interest between executives of portfolio corporations and company clients, whose investments could benefit from reductions in the social and environmental costs those corporations externalise”.

It asks for a change in stewardship and any other actions that could help mitigate this conflict, including: “a. Assessing systemic impacts on diversified portfolios; b. Soliciting input from clients; c. Initiatives to modify executive incentives; and d. Adopting voting policies that account for portfolio impacts of externalised costs.”

Committing what many would consider a cardinal investment sin, Murphy notes that stewarding long-term portfolio-level returns can mean individual companies must lose value, even in the long term.

“The logical conclusion for investors can, in some cases, be that the value of an individual security in their holdings actually needs to fall, even over the long term, so as to maximize the value of the rest of the portfolio.” This would almost certainly be the case for a company like ExxonMobil which is fighting the transition to a clean energy future.

Risk: Engage then propose?

On another front, shareholder advocate As You Sow is running a campaign highlighting the disconnect between companies’ sustainability goals and their retirement plan investments. As an example, it cites Microsoft, which at the same time as pledging to become carbon negative by 2030, has more than $2.5bn of its employees’ retirement plan invested in fossil fuel companies. It’s an investment policy that is inherently systemically risky as well as risky for those younger employees with long-term investment horizons.

As You Sow has engaged several companies about such practices and has now filed shareholder resolutions at Amazon, communications company Comcast, Campbell Soup, Microsoft and Netflix. The resolutions ask companies to align their retirement investment practices with their publicly stated sustainability goals.

But Murphy questions the value of shareholders engaging with companies in the first place: “Many investors have a policy to exhaust engagement avenues before filing shareholder proposals. Such engagement can sometimes be effective if one’s objective is to extract marginal concessions that comport with the company’s imperative to maximise internal financial returns and minimize enterprise risk.”

On Meta (formally known as Facebook) in particular, Murphy says: “Frankly, no amount of engagement with Facebook is going to get Zuckerberg and the rest of the board — whose incentives are decidedly not aligned with those of diversified investors — to take any action in keeping with the concept of losing value”.

Murphy adds: “It’s high time we dropped the false gentility of the engagement-first policy and started deploying tougher, more effective forms of shareholder action, including withholding campaigns and the implementation of system-wide guardrails.”

The guardrails, developed by the Shareholder Commons with the Centre for the Study of Existential Risk and Jesus College, University of Cambridge, set out a series of “rules” that companies must be made to follow in order to avoid inflicting any further economy-wide damage. There are guardrails in the areas of ending fossil fuel use, making the food chain safer, biodiversity, wage inequality and decent work, corporate taxes and lobbying.

An example of one of these guardrails is: “[A] company does not use artificially fragmented structures or contracts to avoid establishing a taxable presence in jurisdictions in which it does business.” Thus, avoiding passing the costs of public sector funding on to other entities and individuals.

Murphy adds: “The issues we’re raising are existential, and no amount of polite discussion is going to lead us to the correct result.”

So, if engagement is not a useful avenue, Capital Monitor asks Murphy what the alternative is: “Our objective pertains to the overall value of diversified portfolios, not the value of individual holdings within those portfolios. We are working to address the fundamental fact that companies can and do maximise their internal financial returns by externalising costs to society and the environment, but diversified investors end up absorbing those costs in other parts of their portfolios. That’s a bad trade.”

It might be argued that shareholder resolutions suffer from the same disadvantages as engagement as they target individual companies, rather than whole portfolios.

In some cases, the proposals are asking not just for behavioural change but for information about how a company’s activities are contributing to systemic risk. Such information is inherently useful if only to inform other shareholders that their short-term investment decisions and their lack of support for other shareholder resolutions that, if adopted, might mitigate portfolio risk, are going to hurt their long-term investments.

With the lowering of support for ESG resolutions in the US this year, it feels as if long-term investors are losing the fight over holding companies accountable, and its especially disheartening when considering support levels had been on the rise.

According to the research house Sustainable Investments Institute (SSI), climate change resolutions won an average of 23% support in 2023 so far, down from 36.6% last year. Proposals on human rights received 21.6% of votes, compared to just under a third in 2022. While one bad year does not necessarily mean that shareholder proposals are no longer a useful tool in combating systemic risk, other alternatives – no votes for directors – generally fare worse with even less support.

So, who is going to impose those system-wide guardrails?

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