At the start of each year the Global Income investment team sets out the engagement plan for the year ahead, based on what we think the greatest governance and sustainability priorities are. This note aims to illustrate what our 2019 engagement plan means in practice.
This was how we started a recent conversation with the finance director of a FTSE 100 company we invest in. For some executives (and perhaps some fund managers), this might seem a strange question to ask. It is generally taken for granted that tax is a cost, similar to rent or the wage bill; and part of the job of any self-respecting finance director is to make the tax bill as low as possible, so as to maximise after-tax profits for shareholders. In which case, a finance director must feel justified in joining The Kinks in pleading, “save me, save me, save me from this squeeze”.
We think there is a better way for businesses and shareholders to think about tax. Rather than a cost, our view is that it should be seen as one of the mechanisms by which the benefits of conducting a business are distributed. Just as workers and shareholders are eligible to a share of the gains, so is the society that created the conditions for that activity in the first place – tax gives a company a ‘licence to operate’. Sustainably-managed businesses recognise the need to ensure the benefits of their businesses are distributed fairly to all three groups.
It is more than just a philosophical question, though. As the FTSE 100 finance director we spoke to explained, politicians and voters are increasingly concerned by their perception that multi-national businesses are going to extraordinary lengths to avoid paying “their fair share” in the communities where they operate. Because of our long-term time horizon, we think we are well placed to encourage companies to move in the right direction – and that over the long run our clients will benefit from this.
That is why tax responsibility is one of the three priorities we set for our 2019 Engagement Plan. We began by looking at where tax risks might be highest. For example, we compared the actual amount the businesses we invest in had paid to the tax authorities (“tax cash”) with the statutory rates in the countries where they operated. This highlighted some anomalies, which we investigated and used as a starting point for engagement.
As part of our investigations we found, for example, that insurance broker Arthur J. Gallagher has for some time invested in refined coal facilities that chemically treat coal to make it burn cleaner and release fewer pollutants and emissions. A noble cause, perhaps - but one which has nothing to do with broking insurance. The only reason the company was investing in these projects was to earn the US refined coal tax credits which Congress had temporarily made available for such investments. In other words, the company was doing it to reduce its tax bill, which in turn means that less money would be available to fund roads, teachers or tax inspectors for their community.
So far, we have had two useful conversations at a senior level with the company, challenging them over these structures. They told us that this was the first time an investor had questioned them as to whether these arrangements were responsible – normally, investors just want to understand how they impact post-tax earnings. We recommended that when these arrangements expire in the next few years, they should not look to replace them, even if that means the company’s tax bill goes up and its post-tax profits go down a little.
Sometimes encouragement can be just as powerful as challenge. The FTSE 100 finance director we spoke to said he had asked his team to review some of the tax arrangements he had inherited with “a critical eye”, to ensure that they were not just legal but fair. He gave us detailed examples of what this meant in practice – real decisions that had short-term financial consequences, but which were the responsible thing for the company to do. We believe our role as long-term shareholders is to strongly encourage him and the board on this initiative, both verbally and in writing, so that the importance that some of the company’s long-term shareholders place on these efforts is clear.
We also suggested that they could do a better job of explaining to the outside world what they are doing, and how they consider the “fairness” of their tax practices. Our holding Prudential produces an excellent report called Managing our tax affairs responsibly and sustainably, which we have used as an example of best practice: in our view many companies can learn from the way Prudential is approaching these issues.
These examples show some of the ingredients that can make for a successful engagement. We approached the companies as a supportive, long-term shareholder, who expect to be on their register in five years’ time, and so will be beneficiaries of any changes they make. We encouraged management teams to keep doing the things they were doing well. Where we felt that change was necessary, we tried to ensure our challenges were constructive, with a clear sense of what we were asking the companies to change. The engagements were jointly led by both investors and our governance and sustainability specialists. This ensured the companies knew that we consider these questions holistically.
But perhaps most importantly, we have not viewed these engagements as a one-off. Meaningful change doesn’t happen overnight. Indeed, it’s far too early to know if our conversations with Arthur J. Gallagher have ‘worked’. We will continue to explain our views to the company over the coming years, to persuade management of the importance of taking a more rounded view of what a ‘responsible’ tax policy is. But for us, it is worth the wait.
The views expressed in this article are those of the author and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved on the stated date and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
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Toby joined Baillie Gifford in 2006 and is an Investment Manager in the Global Income Growth Team and Joint Manager of The Scottish American Investment Company PLC (SAINTS). He has also been a member of the International Alpha Portfolio Construction Group since 2018. Since joining Baillie Gifford, Toby has also spent time as an Investment Analyst in the UK Equity Team and as a Global Sector Specialist. He graduated MA in English Literature from the University of Cambridge in 2006 and is a CFA Charterholder.