30 June 2022

Schroders is right to vote against the shareholder resolution that would force Sainsbury’s to become an accredited Living Wage Employer. But this doesn’t mean that all ESG resolutions should be rejected.

This blog develops a brief LinkedIn comment I posted. The feedback I received on that post persuaded me that it is very difficult to address this topic without getting into some of the detail and nuance. Therefore, I apologise in advance that it’s a rather long article. However, I think you’ll find it worthwhile.

In this article I show how a framework of principles for assessing ESG issues can help distinguish those shareholder proposals that warrant support from those that do not. I will argue that the Sainsbury’s Living Wage proposal falls into the latter category.

The framework was developed by London Business School in collaboration with The Investor Forum during a year-long project on “What does stakeholder capitalism mean for investors?”. I should state that all views in this article are my own and cannot be attributed to London Business School or The Investor Forum or to any of the companies or investors mentioned, and of course reasonable people can come to different conclusions on these matters .

In the cross-hairs

Sainsbury’s, one of the UK’s large supermarkets, is the latest company to find itself in the cross-hairs of ESG activism. The responsible investment NGO, ShareAction, tabled the first Living Wage resolution in the UK. The resolution will be voted on at the AGM on 7 July 2022. The proposal is brief:

“To promote the long-term success of the Company, given developing expectations on rewarding key workers, the opportunities and risks associated with the increase costs of living for workers in the UK, and growing expectations that responsible businesses pay the real Living Wage, we as shareholders direct the Company to accredit as a Living Wage Employer by July 2023.

A commitment to pay the “real” Living Wage to all workers is in line with the recent investments by Sainsbury’s in direct employees’ pay. This should be done at reasonable expense and nothing in the resolution should be read as limiting the board’s discretion to take decisions in the best interests of the Company.” 

The list of ten co-filers included some blue-chip names in the UK investment world including Legal and General, HSBC Asset Management, Fidelity International, Nest, and the Brunel Pension Partnership. The difference between The Living Wage and the National Living Wage is briefly described in the box below.

Briefing: The Living Wage and the National Living Wage

The Living Wage is a non-statutory concept overseen by the Living Wage Foundation. An accredited Living Wage Employer must commit to paying all directly employed staff, and any third party contracted staff providing a service for the company, at least the “real Living Wage”, which is currently £11.05 per hour in London and £9.90 per hour in the rest of the UK. This compares with the statutory National Living Wage, which is £9.50 for those 23 and over regardless of location. Those aged 22 and under are subject to the National Minimum Wage, which runs from £9.18 per hour down to £4.81 per hour for those under 18 or apprentices.

The Living Wage is calculated on a bottom up basis and is designed to reflect what is required in order to live a decent life in the UK. By contrast, the rather confusingly renamed National Living Wage is a statutory minimum set within a framework that aspires towards a Government target that it should reach two-thirds of median UK earnings by 2024. The rate of progression is decided on advice from the Low Pay Commission, taking economic conditions into account and with an aim of avoiding negative effects on employment and the economy overall. The Commission takes into account the views of employer and employee stakeholders in coming to its recommendation.

ShareAction clearly sees the resolution as an opening salvo in a battle with the supermarket sector and an example of the importance of the “S” in ESG. They describe the resolution as a “litmus test for investors’ social commitments amid the cost-of-living crisis.”

Sainsbury’s management is recommending that investors vote against the proposal. The company points out that the vast majority of direct employees and contractors are already paid the Living Wage. (Indeed following dialogue on the resolution they announced an intention to bring the pay of all direct employees in line with the current Living Wage.) But they also do not want to have colleague and contractor pay changes decided by an external body, the Living Wage Foundation: “We want to ensure we have the flexibility to pay the right rate of pay and benefits to our colleagues, considering the needs of all our stakeholders and the specific circumstances and company performance at that time.” They go on to say (in bold): “Fundamentally, we believe it is right for the Company and our stakeholders to make independent decisions regarding pay and benefits, rather than have them determined by a separate external body.”

Head above the parapet

In an unusual move Schroders, a top five investor in Sainsbury’s, published a rationale for their decision not to support the resolution. Kimberley Lewis, Head of Active Onwership at the asset manager wrote an article titled: “Why Sainsbury’s AGM is a pivotal moment for ESG”.

She makes the argument that Sainsbury’s is well-run and considers wider stakeholders in key decisions and is definitely not a laggard when it comes to their approach to investment in employees. But Schroders is concerned that imposing this further restriction on Sainsbury’s, when no other UK supermarket is a Living Wage Employer, could inhibit the company’s ability to remain competitive, which could ultimately be worse for its employees, customers and investors.

Lewis then takes a swipe at the risk of applying ESG factors “in a blanket way and without due consideration, as ’unthinking ESG’ … which harms the credibility of sustainable investing”. She says that the resolution “is a test of whether important nuances in these debates can be heard.”

Analysing the arguments

There is a lot that could be discussed about this resolution. We could ask how a resolution that appears fundamentally to limit the board’s discretion should, as the resolution claims, be read as not limiting the board’s discretion. We could raise an eyebrow at ShareAction’s claim that the resolution does not result in Sainsbury’s losing control over pay levels because the Living Wage Foundation “would merely set the minimum level”. We could ask why Schroders, itself a Living Wage Employer, thinks that what is sauce for the goose should not be sauce for the gander too.

But the purpose of this note is more analytical than polemical. And indeed I think that ShareAction and Schroders have both got a lot right here. It’s great to see shareholders using the tools at their disposal to get important ESG issues on the table, and ultimately the vote will show how important this issue is to UK investors. But at the same time, I congratulate Schroders for having the guts to put their head above the parapet to explain why this one’s not for them. In a world where investors come under an increasing volume of ESG demands on an ever-wider range of issues, investors will have to explain what they are not doing, and why, as well as what they are.

Instead what I want to do in this note is to analyse the resolution against the ESG decision-making principles that London Business School developed with The Investor Forum during 2021 in a project on “What does stakeholder capitalism mean for investors”. I tried to do this in summary form in a post on LinkedIn but inevitably failed to capture the nuance.

I will argue that the framework supports Schroders’ position. But contrary to some of the comments I received, the principles are not a free pass for companies and investors to ignore any ESG issue. To prove this, I’ll also use the framework to analyse another resolution put forward in 2020 by a P&G shareholder on deforestation. In this case application of the principles supports the resolution, which was indeed passed.

The Framework

London Business School and The Investor Forum collaborated on a project in 2021 leading to a report entitled “What does stakeholder capitalism mean for investors?”. We were concerned that investors were facing multiple competing demands to act on ESG issues but lacked a clear framework to decide which actions to pursue. Investors have a fiduciary duty to act in the interests of their clients. Despite common rhetoric to the contrary, not all ESG initiatives add to shareholder value even over the long term. Some simply cost money. Of course, asset owners and end beneficiaries have non-financial objectives which may mean they consider these costs worthwhile. But an asset manager’s fiduciary duty to act in the interests of its clients means that they need a very clear mandate if they are going to pursue ESG issues in these circumstances. 

In our report we suggested a three part test to determine whether investors have a mandate to act on an ESG issue:

• Materiality. In order for investors to have a mandate to act on a stakeholder issue, it should be material, recognising the complex nature of materiality.

• Efficacy. There should be a realistic prospect of investor action bringing about the desired change in the real world, such that the stakeholder benefit exceeds the cost incurred.

• Comparative advantage. Investors should act where they are well-placed to address the issue, individually or collectively, and compared with other parties, particularly government or stakeholders themselves.

 I’ll now illustrate these issues by reference to the Sainsbury’s case.

Materiality

Our first principle is that shareholders should only act on a stakeholder issue when the stakeholder (or issue) is material to the company concerned. This is a simple matter of prioritisation.

Sainsbury’s employees are clearly a material stakeholder to the company. But is Living Wage adoption a material stakeholder issue itself? Recall that Sainsbury’s assert that the vast majority of their direct and indirect employees are already paid the Living Wage.

There are many materiality lenses, as we describe in our report. There is the traditional lens of financial materiality: stakeholder issues that have a financial impact on the company. But this view is now criticized as being too narrow. There is increasing focus on impact materiality: where the company has impact on a stakeholder regardless of the impact of the stakeholder on the company. Dynamic materiality means that issues can migrate from being impact material to financially material – for example, consumers may become concerned about treatment of workers in supply chains, which could influence purchasing habits. We added a concept of intrinsic materiality, which is where there is interest in a stakeholder issue for intrinsic reasons relating to morality, purpose, or society expectations. Finally, stakeholder issues may be company specific or may be systemic, in terms of being an issue that applies across the economy.

Let’s start with financial materiality – is this issue one that affects the financial performance of the company? ShareAction asserts that it is. Rachel Hargreaves, Campaigns Manager at ShareAction said: “research has consistently demonstrated a positive business case for Living Wage rates, even in low-margin sectors such as retail”. There is indeed a theory of “efficiency wages” whereby companies paying more than strictly necessary according to the market may get a payback in terms of higher productivity from employees. CostCo in the US famously adopted this policy, paying above market wage levels.

However, the evidence is mixed and contested. And the fact that higher wages can be repaid through higher productivity does not mean that they always will be. There is clearly a level of wages at which the relationship will break down. Sainsbury’s board and executive team is highly experienced, by all accounts well-attuned to employee attitudes, and strongly incentivised to improve the company’s long-term performance. Is it really plausible that Sainsbury’s shareholders are more knowledgeable than management about the wage rates that maximise returns?

Moreover, it is not just Sainsbury’s board that takes this view. No other UK supermarket is a Living Wage Employer, and this includes both publicly and privately owned companies, family owned and private equity owned. It is possible that all of these companies and management teams are missing an easy win-win of increasing wages to increase profits. But the onus must be on those making this case to prove it. The shareholders supporting the resolutions have notably not done so.

This seems to be a case of ESG cakeism: the desire to claim that any given ESG activity improves performance. If the management and every other management team in the UK supermarket sector is missing this obvious way to increase long-term value, then rather than filing a Living Wage resolution, investors should be firing the board and installing new management.

But financial materiality is not the only form of materiality. There is also impact materiality and systemic risk. Here the materiality is determined by the company’s impact on the stakeholder rather than the stakeholder’s impact on the company. There is undoubtedly a material impact that Sainsbury’s can have on affected employees through increasing wages. These are directly rather small in number. But ShareAction has a bigger target – economy-wide inequality. They go on to say: “low pay drives inequality which slows economic growth and stokes instability, presenting material risks to investors”.

There is indeed some evidence for the negative impact of inequality on growth. However, the evidence for this is stronger in low income than high income countries, and overall the evidence is extremely mixed. So the case for it being a “systemic risk” seems contestable. And as we shall see, the ability of shareholder action to affect such systemic risks is quite limited.

But maybe it is instead a matter of what we refer to in our report as intrinsic materiality. This is where a stakeholder is important for intrinsic reasons relating to morality or the company’s purpose. ShareAction is also pushing on this front. Rachel Hargreaves, Campaigns Manager at ShareAction said: “The is no excuse for a highly profitable company with multimillion pound executive salaries refusing to guarantee all its staff, including subcontracted workers, a basic standard of living … the moral case [is] compelling…”

This seems the strongest materiality case, one based on intrinsic factors that may reflect investors’ clients moral views. I will return to what acting on such a case would require in terms of client mandates.

Efficacy

Our second principle, efficacy, states that investors should only act when they can bring about the desired change in the real world such that the stakeholder benefit exceeds the cost.

If the desired benefit is to increase the wages of affected Sainsbury’s employees and contractors, then clearly the Shareholder Resolution would directly achieve this. However, what about the wider impact on the systemic issue of inequality, which also seems clearly to motivate the proposal? Here the impact is much less certain.

If the resolution is successful, that could lead to an industry-wide change in practices. Or it could simply make Sainsbury’s uncompetitive, leading to loss of market share to companies not adopting the Living Wage policy. In this context, it is worth noting that even if investors were successful at passing resolutions at all the listed supermarkets, that would leave unaffected the increasing proportion of the UK market that is subject to private control, including Aldi, Asda, Lidl, and Morrisons. It is possible that Sainsbury, Tesco, and Marks & Spencer could become the firms determining wages in the economy. Or they could simply become less competitive and lose market share to private firms. We don’t know. Therefore, while the action has symbolism, it’s real efficacy must be in doubt.

Furthermore, does the stakeholder benefit outweigh the cost of the action? Again, this is very unclear. The additional costs of fulfilling the Living Wage commitment would be reflected in some combination of reduced returns to shareholders, reduced employment, and increased prices. There is no evidence to suggest that net stakeholder value will be created, and the action likely simply results in a transfer from one set of stakeholders to another. And importantly, not just shareholders would bear the cost.

Indeed some of the stakeholders who would bear costs (pension fund members, customers, and employees who might lose their jobs) might themselves be low paid, so it is not even obvious that the net redistribution would be progressive.

Overall, this suggests that the proposal fails the test of efficacy.

Comparative advantage

The final test in our report is the one of comparative advantage. Here the shareholder should consider whether they (or their investee company) is particularly well placed to address the stakeholder issue. This links to fiduciary duty in that asset managers should be using client money to pursue ESG objectives only when they are particularly well-placed to deliver results.

If the issue is viewed narrowly as the pay of the particular affected employees and contractors at Sainsbury’s, then the company has comparative advantage. However, the campaign is clearly drawn more broadly as addressing inequality in society overall. 

Here it is not at all clear that investors or Sainsbury’s have comparative advantage. As described above, if successful, even on an industry-wide basis, the action involves a transfer of income / wealth between shareholders, employees, and customers that has very uncertain distributional effects. It could be, net-net, progressive or regressive.

System-wide issues such as appropriate minimum wage levels run into many level-playing-field problems relating to competitiveness. This is why governments are generally best suited to address the issue of inequality directly through minimum wages, progressive taxation, and benefits (and in the longer term through policies on education, health, and housing).

Sometimes the argument is made that governments are failing to act. But the area of minimum wage rates in the UK seems to be one area where this criticism is unfounded. The UK Government has established a quite progressive policy on minimum wages with rapid increases in recent years overseen by a rather well structured and mature process overseen by the Low Pay Commission.

As such the proposal fails the principle of comparative advantage.

Investor preferences

The analysis above shows that the rationale for shareholders supporting the Living Wage resolution at Sainsbury’s appears shaky. It can be argued that it fails on all three principles of materiality, efficacy, and comparative advantage.

But in the section on materiality, I did allow for the fact that there could be intrinsic reasons why investors may want to support the proposal, moral factors that outweigh any of the considerations above.

This is indeed possible. However, in such a case, an asset manager would need to have an extremely clear mandate from their clients that this is indeed their moral view. This is because the asset manager will be using shareholders’ money to pursue an action that is unlikely to have material impact and which they are not well placed to undertake.

Can we not just assume that most people would consider payment of the Living Wage a moral necessity? I don’t see how. We have a political system that has resulted in a quite consistent and well-developed approach to setting a National Living Wage, which is not the subject of severe cross-party disagreement and indeed has persisted across Labour, Coalition, and Conservative Governments. It therefore seems reasonable to suppose that many citizens view the National Living Wage to be an adequate solution to the problem of in-work pay rates.

As a result, an investor voting in favour of the proposal should have a very clear and explicit mandate from their end clients that this issue is one on which they wish to spend money. They should also clearly inform their investors that there could be negative impacts on company returns, uncertain effectiveness of the action, and potential unintended negative consequences for other stakeholder groups, and overall distributional effects that could be progressive or regressive.  It is dangerous for investors to rely on a “win-win” argument, given the lack of evidence that this would in fact play out.

Not a free pass

When I published my slightly hurried version of this analysis on LinkedIn, I received a couple of comments to the effect that the principles I outlined were toothless and gave management and investors a free pass to ignore any ESG issue. I’d now like to demonstrate why this is not the case, with reference to a different shareholder proposal.

Recently a number of companies have faced shareholder proposals relating to deforestation. In October 2020, a resolution was filed at the P&G meeting as follows:

“Shareholders request P&G issue a report assessing if and how it could increase the scale, pace, and rigor of its efforts to eliminate deforestation and the degradation of intact forests in its supply chains.”

This, admittedly fairly limited, proposal was supported by 67% of P&G’s shareholders.

The rationale provided by the filer, Green Century Capital Management, was couched in terms of shareholder value considerations: the risk of supply chain disruption due to environmental degradation; competitive effects from falling behind peers on deforestation policies; and reputational and related financial risk. This presumably was to secure support of major index funds. As I’ll now demonstrate, the case is much stronger than this.

What if the resolution had been even stronger and demanded that P&G take action to reduce deforestation in its supply chains? How would this have fared against our principles?

As this blog is already long enough, I will run through the principles only briefly.

First materiality. Green Century Capital Management argued for financial materiality of the issue. There is a case for this. However, even if that is not accepted, P&G, through its supply chain, clearly has impact materiality on the issue of deforestation. Given widespread concern for the environment, it is also reasonable to believe that there may be an aspect of intrinsic materiality in the eyes of end clients of the asset manager.

Second efficacy. Large companies have significant ability to influence supplier practices through their supply chain. Moreover, there is very limited ability to reverse deforestation once it has occurred. It is significantly cheaper to avoid deforestation in the first place than it is to remedy the effects once it has happened. Finally, innovation in new practices that enable production of goods without deforestation can have positive spill-over effects across an industry. Admittedly the competitive concerns outlined above still apply. But in this case there seems to be a strong probability that the net stakeholder benefits outweigh the costs by a very large margin, principally because of the asymmetry between cost of avoiding damage versus cost of remediation.

Third comparative advantage. Deforestation is an area where effective government regulation is difficult to define and put in place and enforcement is extremely difficult. It requires collaboration between national governments and requires enforcement by countries where authorities and institutions may be relatively weak. Therefore companies, and by extension investors, are particularly well placed to act in this area.  

Therefore, in the case of action on deforestation, the principles of materiality, efficacy at reasonable cost, and comparative advantage are all likely to be met in many cases. Investors still need to be sure that they have a mandate from their clients given that some costs may arise. But the costs are likely to be manageable relative to the benefits and asset managers may even be able to rely on general pro-social sentiments of end investors as a mandate for action.  

The Proctor & Gamble resolution was in fact supported by 67% of shareholders. In my view a stronger resolution demanding action, not just a report, would also have warranted support.

Nuance matters

The recognition that shareholders have non-financial as well as financial preferences is welcome, as is the increased willingness of shareholders and their representatives to use their rights to seek to influence companies on ESG issues. ShareAction and Schroders have done us a service by enabling us to have this important debate on an “S” issue within the ESG universe, even if it is already clear which way the court of public opinion will likely decide.

But this needs to be done thoughtfully, with particular regard to the likely effectiveness of the action and its potential costs, considered in the context of asset managers’ fiduciary duty to, and mandates from, clients.  

A rather lazy narrative has grown up, based around “doing well by doing good” that all ESG activities are beneficial for long-term value. But they are not. ESG interventions often involve trade-offs between shareholder value (even over the long-term) and stakeholder value. Moreover, they often result in trade-offs between different categories of non-shareholder stakeholders.

Asset managers need to be careful to undertake a rigorous analysis to figure out which ESG issues to act on and which to leave alone. The framework of principles we developed with The Investor Forum helps to do just this.

Thoughtful consideration of the principles suggests to me that Schroders is right to vote against the Living Wage resolution at Sainsbury’s. Costs to shareholders are very likely yet the net stakeholder value created is highly uncertain and indeed quite plausibly zero. There are unpredictable distributional effects given that low income stakeholders may be harmed as well as benefited by the proposal. Shareholders are not well-placed to address the issue of minimum in-work wages compared with the Government, and in the UK we have a well-established and quite effective independent process backed by a political mandate to set minimum wage levels. The Low Pay Commission makes its recommendation about how quickly the Government’s long-term objective can be achieved taking into account the impact on the economy and employment levels more broadly as well as the living standards of current workers. It therefore balances various stakeholder perspectives. By contrast, the Living Wage is set by an unelected body from the singular perspective of current workers who don’t lose their job.

This does not mean that Sainsbury’s should divorce itself from responsibility for thoughtfully considering the level of fair pay for workers and contractors . The Living Wage provides a useful and relevant framework for this purpose. Investors should continue to engage with Sainsbury’s to understand how they are ensuring wellbeing of employees and monitoring conditions in supply chains. But the case is not made for investors to force upon the board a particular course of action on pay .

Moreover, I am not proposing that shareholders and companies should get a free pass on ESG. I’ve used the example of deforestation to show how the principles can lead to the conclusion that investors should support an ESG-related resolution. 

But shareholders don’t have unlimited capacity to take on ESG issues at companies and so they should focus where they can achieve the most effective outcomes and where there is most bang for buck.

Living Wage accreditation in the UK doesn’t meet this test. Shareholder therefore should follow Schroders and vote against the resolution at Sainsbury’s upcoming AGM.