How ESG Concerns Turn Business Decisions into Moral Obligations: McDonald's Set to Leave Russia

Pressure on ESG

A corporation's long-term health and prosperity is still a significantly undervalued figure when compared to short-term profit. Latest developments include letters to Blackrock from attorneys general and state legislation proposals from republican states, which criticize investment decisions, based on ESG factors. The letters want “neutrality” in investment decisions instead of a net zero climate agenda as the main strategic consideration. However, in the world of the war in Ukraine, the suffering European economy, the Nord Stream pipeline leak, and the oil supply cut, even Switzerland showed how difficult it can be to stay neutral. These factors have not only caused slowdowns in the European economy and could deter Europe from attaining climate-neutral status by 2050, but also forced companies to make hard economic decisions; Leaving Russia, sometimes at a cost, is one of them. Although it appears to be a moral obligation forced by public opinion, companies have no other plausible option. This article considers McDonald's decision to exit the Russian market and why ESG concerns turn business decisions into moral obligations.

The "S" Factor

While society has created some structure for environmental issues, the social part of ESG is more unclear. While we can find weakness in the social considerations of law firms that continued to work with government-owned Russian companies, it may be more difficult when we consider restaurants selling hamburgers to Russians. Although there are past examples of U.S. companies exiting foreign markets such as Cuba or Iran, their reasons were different. Cuban business exiting was connected with the expropriation of all U.S. businesses, and Iran with the U.S. withdrawal from the Nuclear deal. A more precise example is South Africa, where companies, including Coca-Cola, in a protest against apartheid exited the South African market. However, the withdrawal process was much longer and was carried out by selling companies to local businessmen while maintaining a presence through licensing agreements or distribution contracts. ESG concerns have increased the speed of decision-making. While the first companies to take actions reflecting shifting public views probably don't get much of a clear competitive advantage, being last to shift could be incredibly costly for a company in a global economy. The embodiment of this principle has become a Yale professor's “naughty-or-nice” list of Western companies which continue to operate and Russia. The desire to get off this notorious list has forced companies to exit the Russian market.

McDonald's Decision to Exit Russia

After more than 30 years of Russian operations, McDonald’s decided to exit from Russia, because of the "humanitarian crisis caused by the war in Ukraine, and the precipitating unpredictable operating environment”. McDonald’s reported a charge of $1.2 billion after the sale of all of its Russian business and a decrease in revenue of 9% after closing restaurants in Russia and Ukraine. Cost-benefit analysis may be complicated in this case. McDonald’s suffered a big loss, and another restaurant chain (a poor imitation of McDonald's) rose to the occasion. However, the alternative decision could be much worse.

McDonald's Could Continue its Business in Russia

Long-Term Reputational Damage - Yale management professor Jeffrey Sonnenfeld created a list of international companies both leaving and staying in Russia. This list not only pressures companies to pull out of Russia but also increases the speed of decision-making. While getting on this list is not a large problem, staying on the list too long may be unbelievably costly in this viral economy.

Logistic and Payment Problems - In 2018, McDonald's increased the use of local Russian products to 98% on the background of sanctions and political pressure in Russia, which could help if McDonald's had decided to stay. However, the payment problems are real: the U.S. has sanctioned 80% of total banking assets in Russia, including its 10 largest banks. Some banks were included in the SDN list, and some of the others had difficulty managing SWIFT payments.

Employees - After announcing the “partial mobilization”, all people from 18 to 55 years are at risk of being mobilized. Since this announcement, some businesses launched a massive lobbying process for exempting their employees from mobilization. Despite some success in this area for the IT or financial industry, it’s clear that restaurants will not be on this exemption list. Thus, McDonald's could face not only a lack of employees due to mobilization but also a legal requirement to cooperate in transmitting draft cards to employees, who are called for the army.

Nationalization - Russia has considered nationalizing western businesses that closed operations after the invasion of Ukraine. Some of the companies have written off their assets in Russia, stepping away from the country with nothing. Taking into account the size of McDonald's business in Russia and 62,000 employees, this risk should not be undervalued.

McDonalds Could Transfer Management to Local Franchisees

This decision would not mitigate reputation risk, because trademark and other IP rights would stay in Russia. This restructuring would have been possible almost 4 decades ago in South Africa, because of the lack of social pressure from ESG principles, which has since been boosted through modern Internet usage. Now this decision would not change anything, because customers associate the company with IP rights, not the company structure. Also, it could be hard to control franchisees in current circumstances for all of the western companies.

McDonald's Could Leave Russia Completely Without a Call Option

After selling, McDonald's received a 15-year call option. Unlike Starbucks, which exited the Russian market completely, McDonald's received an option to buy back its restaurants. However, a reason for that could be pragmatic: while Starbucks’ Russian business accounted for less than 1% of the company's annual revenue, restaurants in Russia and Ukraine generated about 9% of McDonald's global revenue.

Although the exercise price of this call option is unclear, the sale price of all of McDonald's assets was “far lower than market price” and had been a “symbolic” figure. If the exercise price of the call option is similar to this “symbolic” amount, the value of this call option should discount the McDonald's price of the deal. Therefore, the exclusion of McDonald's call option requirement could increase the total price of the deal. However, McDonald's would not get a mechanism to return to Russia. Moreover, given the global economy, this is not a time when McDonald's could get the best price possible.

Was It the Right Decision?

All in all, McDonald's decision seems quite logical and efficient, when considering alternatives. The blind pursuit of profit could have led McDonald's to the wrong decision. Continued Russian operations could have provoked additional risks and much more uncertainty about the future. An ESG policy has created a structure for decision-making, based on environmental, social, and governance considerations. Shifting in public opinion has transformed some of these considerations into the “duty” of the company through numerous “naughty-or-nice” lists and other publications. The speed of information transmission increased in the 21st century, boosting decision-making processes. As a result, ESG concerns have turned business decisions into moral obligations.

Stanislav Liaptcev serves as a Graduate Editor of the NYU Journal of Law & Business. He is pursuing a Corporation LL.M. at the New York University School of Law as a Dean’s Graduate Scholar. Prior to attending NYU, Stanislav practiced corporate law for nine years with a focus on mergers and acquisitions, joint ventures, private equity, venture capital, and other cross-border transactions at prestigious law firms in Russia and as an independent consultant.