Lessons for ESG activists: The case of Sainsbury's and the living wage

Sainsbury's, one of the UK's large supermarket chains, found itself in the crosshairs of ESG activism in 2022. That was when ShareAction, a well-known responsible investment NGO, filed the first Living Wage resolution in the UK.1

Among the 10 co-filers were blue-chip names in the UK investment world, including Legal and General, HSBC Asset Management, Fidelity International, Nest, and the Brunel Pension Partnership.

This Living Wage resolution was rejected by roughly five out of every six of the Sainsbury's investors that voted on the resolution at the company's Annual General Meeting on July 7, 2022. To understand how and why this measure failed to gain acceptance, it's useful to start by noting the difference between The Living Wage and the National Living Wage, which is briefly described in the box below.

ShareAction clearly saw its Living Wage resolution at Sainsbury's as the opening salvo in a battle it intended to conduct with the entire UK supermarket sector. It was also one of the NGO's first efforts to draw attention to the importance of the “S” in ESG. The proposal described the resolution as a “litmus test for investors’ social commitments amid the cost-of-living crisis.”

In an unusual move, Schroders, the well-known UK asset manager with one of the five largest investment positions in Sainsbury's, published ahead of the vote its rationale for its decision not to support the resolution. Kimberley Lewis, Head of Schroders’ Active Ownership group, wrote an article titled, “Why Sainsbury's AGM is a Pivotal Moment for ESG.”4 After pointing out that Sainsbury's is widely recognized as a well-run company that considers all important stakeholders in key decisions and has invested heavily in its employees, the article then expressed the concern that imposing this further restriction on Sainsbury's at a time when no other UK supermarket was a Living Wage Employer could undermine the company's competitive position, which would end up doing economic harm to many of its employees and customers as well as its investors.

Lewis closed her article with a warning against the unforeseen risks of applying ESG factors “in a blanket way and without due consideration,” describing it as “‘unthinking ESG’ … which harms the credibility of sustainable investing.” Along with this warning, she also expressed her view of the outcome of the impending resolution as “a test of whether important nuances in these debates can be heard”.

There is much that could be said about this resolution. We might start by asking how ShareAction could claim that the resolution—which requires the company to adopt a floor on employee pay set by a third party—would leave board discretion wholly unaffected and intact, because the Living Wage Foundation “would merely set the minimum level”. But while we are raising such questions about the NGO, we could also ask why Schroders, itself a Living Wage Employer, thinks that what is sauce for the goose should not be sauce for the gander too. Failure to explain its voting decision in the context of an Engagement Blueprint that encourages Living Wage adoption seems, if not an oversight, then at least a missed opportunity to provide clarity about its own convictions.

But my purpose here is more analytical than polemical, namely, to examine the claims on both sides of this debate when viewed through the lens of investor and board duties. To help with this analysis, I will start by providing a brief overview of the ESG decision-making principles that London Business School developed with The Investor Forum during 2021 in a project we called “What does stakeholder capitalism mean for investors?”5 Then I will go on to argue that, however, much the framework supports Schroders’ position, the underlying principles are not a free pass for companies and investors to ignore any ESG issue they find troublesome.

To illustrate this point, I'll also use the framework to evaluate another resolution, this one put forward in 2020 by a P&G shareholder on deforestation. In this case application of the principles leads to broad support for this resolution that, unlike the ShareAction resolution, not only passed but received the support of fully two thirds of its investors.

The impetus for the collaboration between The Investor Forum and London Business School was investors’ confusion and uncertainty about how to evaluate and respond to the multiple competing demands to act on ESG issues while lacking a clear framework for deciding which actions to pursue or support. The framework begins by recognizing asset managers’ fiduciary duty to act in the interests of their clients. Despite common rhetoric to the contrary, not all ESG initiatives work to increase shareholder value, even over the long term. Some simply cost money.

None of this should be construed as denying that asset owners and end beneficiaries have non-financial objectives and concerns that may well sometimes lead them to view such costs as worth bearing. But in such cases, asset managers’ fiduciary duty to act in the interests of their clients imposes on them a second obligation: when intending to pursue ESG initiatives and investments that are expected to sacrifice long-run value (presumably without undermining the company's competitive position), corporate boards must first seek and gain the clearest possible mandate from their investors to make such (again, presumably modest) sacrifices. Launching major ESG initiatives involving large capital commitments that are expected to reduce shareholder returns without such a mandate is courting investor disapproval and, eventually, removal.

Let's now try to apply these tests to the Sainsbury's case.

Our first principle—that shareholders should act on a stakeholder issue only when the stakeholder (or issue) is material to the company concerned—is a simple matter of prioritization. Sainsbury's employees are clearly an important contributor to, and have a material stake in, the company's long-run success.

But is the adoption of a Living Wage itself a material stakeholder issue, especially when Sainsbury's reports that the vast majority of its direct and indirect employees are already paid the Living Wage?

There are many lenses for assessing materiality. There is the traditional lens of financial materiality: stakeholder issues that clearly affect the profitability of the company. But in response to the criticism of this concept as too narrow, there is growing focus on impact materiality—cases in which corporate decisions impose hardship or “costs” on stakeholders, whether or not there is a discernible effect on corporate profits or value. And there is another version called dynamic materiality—involving those issues that, if unaddressed, could become financially material. For example, consumers’ concerns about corporate treatment of workers in supply chains could end up influencing consumer purchasing habits. Into this mix we also introduced the idea of intrinsic materiality, which applies to stakeholder issues relating to traditional social or moral expectations. Finally, stakeholder issues can be company specific or systemic, in the sense of affecting the economy as a whole rather than individual companies.

Let's start with financial materiality—does the issue of Sainsbury's Living Wage affect the long-run profitability and value of the company? ShareAction claimed that it does. In support of its proposal, Rachel Hargreaves, ShareAction's Campaigns Manager, stated that “research has consistently demonstrated a positive business case for Living Wage rates, even in low-margin sectors such as retail.” And consistent with Hargreaves’ argument, there is in fact a theory of “efficiency wages” that hypothesizes that companies choosing to pay above-market wages may get a payback in the form of higher-quality and more productive employees. Such a policy is widely viewed as a major contributor to the widely heralded success of the U.S. company CostCo.

But evidence about the more general case is mixed, and invariably contested. The possibility that higher wages can be repaid through higher productivity does not mean they are generally expected to be. And, of course, in all cases there is some level of wages at which the relationship will turn down and become sharply negative.

One of the most important tasks and responsibilities of Sainsbury's board and executive team is to determine to what extent, if at all, they want to deviate from market norms in how the company rewards their employees. The board and management are highly experienced, and by all accounts well-attuned to employee attitudes and have clear incentives to improve the company's long-term performance. Is it plausible that Sainsbury's shareholders know more than its management about the wage rates likely to maximize returns?

Moreover, it is not just Sainsbury's board that takes this view. No other UK supermarket is a Living Wage Employer, and this group includes both public and private companies, and those owned by families as well as by private equity firms. How likely is it that all of these companies and management teams are missing an easy win-win from increasing wages to increase long-run profits and value? The onus falls on those making this case to prove it. The shareholders supporting the resolutions have notably failed to provide convincing evidence.9

This seems to be a case of ESG irrational exuberance and overreach: the desire to claim that any and all ESG activity should be expected to improve long-run performance. But if Sainsbury's 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 simply be firing the boards and installing new managements.

But financial materiality, as we have already seen, is not the only form of materiality. What about impact materiality and systemic risk? Here the materiality is determined by the extent of the company's impact on stakeholders rather than stakeholders’ impact on long-run corporate profitability and value. There is little doubt that Sainsbury's could dramatically improve the standard of living of a great many of its employees by, say, increasing their wages by a fifth. But in the grand scheme of things, even the number of such employees is relatively small in number. And ShareAction, it's important to recognize, is going after a much bigger target—economy-wide inequality. As their Sainsbury's proposal states, “low pay drives inequality which slows economic growth and stokes instability, presenting material risks to investors.”

And there is in fact some evidence for the negative impact of inequality on growth. But that evidence is far more compelling in the case of developing, low-income than developed, high-income nations—and, here again, the evidence is mixed and disputed.10 Such is also true of the evidence for inequality being a major contributor to “systemic risk.” And as we shall see, the ability of shareholder action to affect such systemic risks is quite limited.

But if this appears to be the strongest form of materiality at work in the case of Sainsbury's, there are some major challenges for asset managers when attempting to take actions that purport to represent the moral views of their investor clients. I will later return to these challenges when taking up the question of companies’ need to seek, or at least clarify, client mandates for their ESG initiatives.

Our second principle, efficacy, states that investors should act only when confident about their ability to bring about the desired change in the real world, and in such a way that the stakeholder benefits exceed the associated costs.

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. But what about the wider impact on the systemic issue of inequality, which also seems clearly to motivate the proposal?

Here the overall consequences are much less certain. If the resolution is successful, that could lead to an industry-wide change in practices. But in what is at least an equally plausible outcome, it could simply make Sainsbury's uncompetitive, leading to loss of market share to companies not adopting the Living Wage policy. Also worth noting is the possibility that, even if investors were successful at passing resolutions at all the listed supermarkets, the steadily growing proportion of the UK market subject to private control, including Aldi, Asda, Lidl, and Morrisons, would use their lower wages to accelerate their growth in market share.

So, even though Sainsbury, Tesco, and Marks & Spencer could become the firms that determine wages in the economy, the alternative outcome is that they become less competitive and lose market share to private firms. We don't really know how such changes will play out. Therefore, while the Living Wage has symbolic appeal, it's efficacy is surrounded by 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 are very likely to be reflected in some combination of reduced returns to shareholders, reduced employment, and increased prices. Indeed, the study by researchers from Queen Mary University11 cited by ShareAction in support of their case mentions that adopters of the London Living Wage have tended to offset the higher wage costs through a variety of actions, including changes to contracting terms, reduction in headcount or hours, and changes in service specifications and supplies—and, in some cases, acceptance of reduced margin. And since there is no evidence suggesting that overall net stakeholder value will increase, the probable effect of a mandated Living Wage is a “wealth transfer” from one set of stakeholders to another. And most important to keep in mind, it's not just shareholders who would bear the costs, but also the customers who pay the higher prices, and the current or future workers who suffer from the potential reduction in employment at the company.

Overall, then, the proposal fails the test of efficacy.

The last of the tests in our report is comparative advantage. Here the shareholder should consider whether they (or the company whose shares they hold) is particularly well-positioned to address, or at least influence, the stakeholder issue. Even once they are satisfied that achieving the ESG outcome is in line with their clients’ interests, asset managers should be using client money to this end only when their actions have at least a reasonable prospect of influencing the desired outcomes.

So, if the stakeholder issue is viewed narrowly as the pay of the particular affected employees and contractors at Sainsbury's, then, yes, the company has comparative advantage. However, the ShareAction campaign has clearly cast a broader net, purporting as it does to address overall economic inequality.

Here it is not at all clear that investors or Sainsbury's have comparative advantage. System-wide issues such as the appropriate minimum wage levels run into many level-playing-field problems relating to competitiveness. In such cases, 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.

We often hear the argument that governments are failing to act on ESG issues. 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 rather well structured and mature process that is overseen by the Low Pay Commission2, a process that has support from across the political spectrum, and which takes into account a wide range of stakeholder and economic considerations. Indeed, the current Government has mandated the Low Pay Commission to increase the statutory National Living Wage towards two-thirds of median earnings as quickly as possible consistent with its mandate to consider employment levels and the health of the economy more broadly. So, of all the ESG issues that could be singled out, this is one where the institutions of Government appear to be among the most effective.

And that, in brief, is why the ShareAction proposal violates the principle of comparative advantage.

Our analysis up to this point shows that the rationale for shareholders supporting the Living Wage resolution at Sainsbury's rests on a shaky foundation. It is largely inconsistent with our three key principles of materiality, efficacy, and comparative advantage.

Nevertheless, when dealing with the question of materiality, I did allow for the possibility that investors’ collective sense of morality, of the need to distinguish right from clear wrong, could lead them to support the proposal, thereby outweighing the other considerations. In other words, investors should not support companies that become “bad actors.”

The problem with this argument, however, is that should such cases arise, asset managers would need to have crystal-clear mandates from their investor clients identifying and articulating such moral objections as their main reason to act. Without such mandates, asset managers would be using “other people's money” to pursue actions with no economic benefits in view and for which neither asset managers nor their investor clients are well-positioned to expect a successful outcome.

So, this begs the question: Why not just assume that most people would consider payment of the Living Wage a moral imperative? The answer to this question is, it's not at all clear how we establish this. As just noted, we have a political system that has resulted in a quite consistent and well-developed approach to setting a National Living Wage—one that, it's important to note, has not been subjected to the intense cross-party disagreement that has for long been the dominant note in UK politics. Indeed, the UK approach to minimum-wage setting has elicited a striking degree of bi-partisan unity that has persisted for over a decade among Labor, Coalition, and Conservative Governments. Thus, it surely seems reasonable to suppose that many if not most UK citizens view the National Living Wage as an adequate response to the problem of in-work pay rates.

Given the difficulty of assuming that clients’ views will differ from the prevailing political consensus, my recommendation was that investors voting in favor of the ShareAction proposal have a very clear and explicit mandate from their investor clients directing the asset managers to back the proposal with their (investors’) capital. The same asset managers should also clearly inform their investor clients of the potential for negative effects on shareholder returns, failure of the actions to lead to the desired social outcomes, and potential unintended. Including the possibility noted above of regressive distributional effects. Given all these possible outcomes, and the dearth of evidence about how things will play out, it would be foolhardy for investors to rely on the kind of “win-win” argument presented by ShareAction.

When I published these arguments in June of 2022, it clearly struck a chord. A number of investors contacted me to thank me for the reasoned analysis. Further suggesting the article was getting some traction, ShareAction published a rebuttal, to which I then felt obliged to respond.12

At the AGM that was held on Thursday July 7, 2022 to decide the proposal, 83.3% of investors voted against it, with only one in six supporting it. The vote thus failed not only to pass, but to meet the 20% level that the UK Corporate Governance Code and the Investment Association views as conveying a “significant” level of investor opposition to management. Notwithstanding this level of investor opposition to the proposal, ShareAction saw fit to evict Schroders from the Good Work Coalition they had established as an investor collaboration to engage with companies to encourage them to adopt better working practices.13

There are a number of important lessons for ESG activism that can be drawn from this case. After the AGM took place, I identified four.14

But having raised these concerns about the ShareAction proposal, I find it important to say that the principles we developed with The Investor Forum do not provide a free pass for investors to ignore ESG issues. To illustrate this, let's briefly consider a different shareholder proposal.

A number of large public companies have recently faced shareholder proposals relating to deforestation.17 In October 2020, the following resolution was filed at the P&G meeting:18

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.

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 intended to secure the support of major index funds.

But as I'll now demonstrate, the case could be made much stronger. What if the resolution had called for P&G to take action to reduce deforestation in its supply chains? How would this have squared with our principles?

Let us now briefly run through the application of the principles. And let's start with materiality. Green Century Capital Management made a case for financial materiality of the issue. There is a case for this. However, even if one remains unpersuaded by it, P&G by virtue of its supply chain clearly has a potentially material impact on the issue of deforestation. Given widespread concern about the environment, it is also reasonable to believe that the issue has intrinsic materiality in the eyes of a great many end clients of the asset manager.

What about 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 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 high probability that the net stakeholder benefits outweigh the costs by a very large margin, principally because of the gulf between cost of avoiding damage versus cost of remediation.

Third and last, what about the question of 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 enforcement by countries where authorities and institutions may be relatively weak. Therefore companies, and by extension investors, seem particularly well placed to act in this area.

And so, 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.

Consistent with this reasoning, the Proctor & Gamble resolution was supported by 67% of shareholders.

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.

But this needs to be done thoughtfully, with particular attention paid 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 around the concept of “doing well by doing good” that is predisposed to view all ESG activities as beneficial for long-term value. But clearly, 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 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 that Schroders was right to vote against the Living Wage resolution at Sainsbury's. Costs to shareholders appear almost certain while the net stakeholder value remains highly uncertain and, indeed, quite plausibly zero. There are unpredictable distributional effects since, as we have noted, many low-income stakeholders may be more harmed than helped by the proposal. Shareholders are not nearly as well-positioned to address the issue of minimum in-work wages as the UK Government. And as we have seen, the UK has developed a widely accepted and generally quite effective independent process backed by a political mandate to set minimum wage levels.

None of this, to be sure, should be taken to mean that Sainsbury's should absolve 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 the well-being of their 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.

Finally, I am by no means suggesting that shareholders and companies be given 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 engage companies on ESG issues; they must focus their energies and efforts where they can achieve the most effective outcomes and where there is most bang for their buck. Living Wage accreditation in the UK doesn't meet this test. And so the overwhelming majority of shareholders were right to follow Schroders in voting against the resolution at Sainsbury's AGM in July 2022.