The Activist Investor

In this episode Christine speaks to Sara from The Shareholder Commons, a US-based non-profit organisation dedicated to redesigning the creative engine of market capitalism.

Show Notes

In this episode Christine speaks to Sara from The Shareholder Commons, a non-profit organisation dedicated to redesigning the creative engine of market capitalism.

In this episode we hear:
  • How maximising your returns is still the goal, even when it comes to ESG.
  • Why investment portfolios need to operate more like families.
  • Why we can’t just take individual companies to task + the whole system needs an overhaul.
  • How companies are just changing the rules instead of changing their behaviour.
  • And why divestment is a ‘comfortable mirage’.

What is The Activist Investor?

A podcast about taking ownership of the world around you through shareholder activism. Join the Tulipshare community as they speak to people all around the world about how the underdogs can take on the Goliaths of capitalism.

Christine:
Hello and welcome to The Activist Investor, a brand new podcast by Tulip Share discussing all things related to shareholder activism. I'm joined this week by a very exciting guest from the Shareholder Commons. Sarah, would you like to introduce yourself?

Sara:
Hi, I'm Sara. I'm the chief strategy officer at the Shareholder Commons.

Christine:
Well, welcome Sarah. We're very glad to have you today. If you don't mind, I thought we'd get straight to it. Would you mind just talking us through what the Shareholder Commons is and why it was created?

Sara:
Sure. We were founded to try to deal with a singular problem in the ESG space, the environmental, social and governance movement that tries to get companies to do a better job on those things. And that is that investors focus on single companies when they think about their investments and they look for those companies to maximize their enterprise value, when in fact the factor that matters the most to a diversified portfolio. And it's worth mentioning that the vast majority of investors are diversified.

The thing that matters most to those portfolios is systemic health, the health of the economy on which their investments depend. By most estimates, that accounts for something on the order of 90% of portfolio values. And yet investors and even ESG activists tend to focus on that 10% that is created by the enterprise value of individual stocks in a portfolio.And as long as we're doing that, we're never, ever going to solve for major systemic problems such as climate change, such as public health crises, you name it.

It's worth saying I come myself from the background of ESG integration, the type of activism that says, hey, company X, you need to understand that your behavior contributing to climate change creates, you name it, reputational risk, regulatory risk and so forth. That's the sort of company value arguments that we've all been making, including me.

But those have really built in limits to them because there are a lot of scenarios under which companies actually rationally should continue to admit a whole lot of greenhouse gas emissions because it's better for their own enterprise value. And if we don't grapple with that, we're not going to fix that problem. And we're definitely seeing how those limitations are coming to bear in the marketplace right now.

So our organization tries to deal with the reality that even if you just stick with a portfolio maximizing strategy, which most of us do, we are funding our retirement. You have to attend to systemic threats if you actually want to see your portfolio grow and maximize your prosperity.

Christine:
And that brings me nicely actually to my next question, which is part of our challenge. Shareholder activists is getting other shareholders to actually back our proposal. And often those other shareholders just want to see returns on their investments. So what is the Shareholder Commons take on this cross section between optimizing both returns and ESG?

Sara:
Yeah, and I think that goes to the crux of what we're trying to do. People misconstrue what all of that actually means, how you practice that returns maximization. They think it means maximize every single company's value and that somehow your portfolio will be the sum of its parts. But that's not how any of this works. Not really.

The way a lot of companies are able to maximize their own enterprise value right now is by externalizing costs onto the broader marketplace. But diversified shareholders, those of us who have 401 KS or IRAs or you name your vehicle, pensions, other companies in their portfolios are absorbing those external costs. Right?

And again, I'll just stick with the climate change example because it's one with which people are familiar. If one company is spewing greenhouse gases all over the place and they're making lots of money from whatever fossil fuel exploration and sales, that's great for that company. But it's directly costing the rest of the portfolio in terms of climate change costs, rising temperatures, interruptions to business and so forth.

So we're actually sticking very firmly with you maximize your returns. That is what we're in this for. That's what everybody is investing for.

But understand that the way to maximize your returns can sometimes mean that you need an individual company in your portfolio to forfeit a certain amount of value in the service of the broader portfolio.

And just to sort of give a little analogy, it's sort of like let's say you have ten kids, right, and you've got one of them is super healthy because you've been feeding them or whatever. The thing is you've been doing it, but you're taking food from the other nine kids, right. Does that strategy give you a healthy family? It does not. Right?

And in order to have a healthy family, the best strategy might be to take a bit of food from that one kid and share it with the other kids, right? But we don't do that as investors. We have, frankly, this fantasy that if every single company does whatever it needs to do to maximize its internal financial returns that the whole thing will just work. And it's not true. Demonstrably not true.

Christine:
I love that. What a clear explanation. And also I agree we have to approach ESG problems with the family mentality or nothing will change. And I feel like the 2022 proxy season, the one that just happened, we, or I certainly started out feeling like it was going to be a big year of change. I mean, there were a huge amount of climate change related shareholder proposals on the ballots, but a lot of the big institutional investors like BlackRock and Vanguard voted overwhelmingly against those climate critical resolutions.

And so I wanted to know what you think is the key here to changing the way these institutional investors think and act and I guess getting them to act more like that healthy family, to use your analogy.

Sara:
Yeah. And here again, I think that the important factor here is to really emphasize the importance of the systemic risks that a lot of these issues raise. And I think, frankly, the misstep a lot of us have been making is to focus on individual company arguments. And of course, BlackRock, Vanguard, Fidelity, they're all still focused on individual company returns too, right? They're making the same mistake I just described.

And I think that shareholder activists need to do a better job of demonstrating that in the main, most investors are diversified and therefore they need their fiduciaries to focus on systemic risks that undermine diversified portfolios. And that's what those institutions are simply not doing. They say they are, but they're not. And I think as long as we keep the focus on individual companies, that's going to continue to be the problem.

Another thing that investor activists should think about is there's a particular problem around the demand side and supply side of some of these issues. Like in the climate change issue, we keep focusing on supply side companies, right? But they're not going to reduce their production, they're not going to reduce their sales. It's economic suicide in a sense. Right?

And of course it's something that needs to happen, but the real incentive for that to happen is likely to come from the demand side of the equation. So we don't just want ExxonMobil and Chevron and BP to reduce their exploration and their fossil fuels exploitation sales. We want your UPS and your three M and your buyers and so forth to reduce their consumption of those products. That's how we helped to draw that down as well.

But right now, the most rational response for a company to those pressures is not to change their behavior, it's to go lobby, to change the rules of the game. And they've done that incredibly successfully. Companies have never been freer to do whatever they want than right now. In a sense, the shareholder activism that we've been trying to do around ESG integration and doing this one company at a time approach, it's fighting up against a leviathan.

And so we have to focus more heavily on the systemic effect and make sure that our fiduciaries and the managers of our money remember that very few of us just hold one stock and yet they're voting and they're stewarding those assets as if we did well.

Christine:
You speak about changing the demand side of things. What kind of things do you think could change the demand?

Sara:
Well, so that's where innovation around. I don't want to step too far outside of my expertise. We deal with the investment mechanisms, not necessarily the nittygritty of the solutions, but we know that there are alternative energies and so forth, alternative fuels. Name the vehicle that companies can shift to and they are shifting to it, right, but only within the confines of the economic incentives they face, because investors aren't imposing any parameters on their investment companies right now as a matter of course you can't do it company by company.

Investors have to do this across the board and to say, these are the parameters within which we want you to operate. We call them guardrails the parameters within which we want you to operate. If you don't, we're going to vote against your directors, we're going to deny you debt until you fall in line. And that's a very different thing than to say, hey you individual company you, please go make a change. But your competitive landscape isn't changing at all.

Christine:
You said something else just then that struck me, and that was that companies have never been free or to do what they want. And when you consider the power that many of these corporations have, I mean, some of them are economically larger than countries. I wonder if you feel like shareholder activism is one of the few checks and balances that we have. What would happen if we took shareholder activism out of the equation? Would these corporations, as a default, always be destructive?

Sara:
Yeah, I mean, again, this is where I think that we have to start enhancing our approach. I do think that shareholder activism is a necessary check. I wouldn't be doing this work if I didn't. It is a necessary check because the regulatory mechanism, which is by far the most effective way to constrain behavior has been completely co opted by corporate influence. And so the very best mechanism we have for controlling for systemic risks has been undermined. So here we are then with investors, with diversified shareholders saying, okay, then you need to grapple with this. This is why I think the individual company approach is going to fail us.

We're not going to make enough progress quickly enough until we start changing the rules of the game ourselves, leveling the playing field ourselves, and having investors, our investment managers, our fiduciaries retail investors, everyone say if you're not operating within these parameters, we're voting against you, plain and simple.

And then when everyone is beholden to the same rules, which is what regulation is supposed to do, then they can compete on the good things, making the best product, providing the best service instead of plundering as many natural resources as they can find, externalizing their costs onto other marketplace players and so forth.

So we really have to take a systemic focus on that. And the other thing worth saying is for us, the way we envision a guardrail, these parameters within which companies should operate, that includes political influence activities. You cannot be said to be adhering to a climate change guardrail if you're out there trying to influence the public that climate change isn't real. If you're out there creating Facebook groups called Moms for Fracking and all this nonsense that they're doing now, you have to align all of those activities to be seen to be adhering to those standards and they can't do it alone.

We have a historical example here in the US. When David Crane, the CEO of NRG Energy and Electric Utility tried to pivot fully to being a climate change mitigator instead of contributor investors drummed him out of office. There is a cost to going it alone and it's real when companies say that they're not just making that up now, of course it's also an effective cover for the fact that they've managed to change the rules of the game themselves.

But this sort of collective action approach, this systemic approach is a critical response to those issues.

Christine:
And so with all that in mind, looking ahead to 2023 proxy season, what will be some of the shareholder commons main focuses?

Sara:
Continuing on what I was saying earlier in our efforts to try to make this not a company by company approach and rather a full playing field approach, we're going to be pushing further into supporting investors in implementing Guardrails on broad swaths of companies and using Director no votes. That's when you vote against directors on the slate for companies who don't comply.

We may stop filing shareholder proposals or at least do far fewer because we just think that we use them for educational purposes to try to get this broader systemic thought out there and get people thinking about what it means. But at the end of the day it's still a company by company tool. And so we're going to be working with investors around the world to start working on developing and implementing more of a Guardrail strategy around systemic issues. And the extent to which shareholder proposals play a role in that is to be determined but certainly we'll be doing fewer of them.

Christine:
Okay, my final question for you today and I'm hoping to leave our listeners with an optimistic picture of the future. What do you think our world looks like in 2050 if the shareholder commons succeeds in implementing your Guardrails and Tulip share succeeds in our visions of changing the corporate landscape? How does that look? I love that question. I think, at least in our case, I won't speak for Tulipshare, but I think at least in our case it would mean that we don't exist anymore.

If we do our jobs right. We'll work all ourselves out of them because investors will be opposing investor mediated guardrails on their investing companies that protect the commons and that ask companies to do the best thing they're supposed to do under capitalism. Which is to efficiently allocate resources and to compete on the basis of creating the best goods and services that can be had and not doing so by plundering the commons.

So that would be the vision of success and for Tulipshare, I mean really it's a version of the same, isn't it? Although I expect that there probably will still need to be some sort of activism around. There will always be individual companies going rogue in some special way. You still need to exist and we don't .

Christine
I guess someone’s gotta stick around, keep those guys in check.

Sara:
But I don't feel optimistic about this. I'm very worried. Like, look at the US. Talking about regulation again. What should be happening is better regulation. Our supreme Court just hobbled our environmental protection Agency's ability to regulate emissions. All the legislation that we've ever imagined passing is getting unwound right now, not strengthened. It's getting weakened. We're one of the world's biggest emitters. I mean, ESG integration and shareholder activism per se, at least as it's been practiced. We got companies ignoring these votes. I think that across the board, we have to step up our game, and it's going to take a critical mass.

Christine
And I suppose that's what the big worry is, especially as individuals who might feel powerless against huge corporations. Like, how do we get the right people to listen to these ESG related concerns? How do we achieve that critical mass? How do we get the attention we need from the people at the top? And a lot of individuals I know feel that they want to resort to divestment. They say, oh, this will send a message if I stop giving them my money.

Sara:
Divestment is a failure because all that does is you remove yourself. You don't have a voice anymore. And meanwhile, that company is still out there merrily imposing the same risks on you that it did before. There's never going to be enough divestment to actually starve the company of resources better to own it and practice active ownership and practice systemic stewardship and all of those things. I mean, divestment is a comfortable mirage. Wow. Comfortable mirage.

Christine:
That's poetic. I'm going to have to write that one down.

Sara:
New band name: comfortable mirage.

Christine:
Exactly. That feels like a perfect place to end this podcast episode. Sara, thank you so much for joining me. I really enjoyed speaking to you and learning all about what the shareholder commons is up to.

Sara:
Bye, Christine. Thanks.

Christine:
If you enjoyed today's episode, please don't forget to subscribe on whatever your favorite podcast platform is. Next week, we'll be speaking to the team behind Female Invest about what women want when it comes to investing. So I hope to see you there.