Investor Calls For NYSE Investigation Into McDonald's Largest Franchisee

In a letter to the New York Stock Exchange, CtW Investment Group accused the burger chain's franchisee in Latin America, listed on the exchange, of a litany of governance problems.

CtW Investment Group, which manages and advises union pension funds, has asked the New York Stock Exchange to review the corporate governance of Arcos Dorados, the publicly traded franchisee of McDonald's locations in Latin America and the Caribbean.

The company, headquartered in Buenos Aires but domiciled in the British Virgin Islands, has been publicly traded since 2011. Arcos Dorados ("Golden Arches" in Spanish) is the biggest McDonald's franchisee, with 2,062 restaurants, including some 812 in Brazil and 365 in the Caribbean.

CtW, an active corporate gadfly that often calls for reforms at big companies, said the corporate governance structure at Arcos Dorados lacks adequate independence from CEO and Chair Woods Staton, who also controls the company's Class B shares, which hold a majority of voting rights in the company.

The union movement and its allies have waged a full-court press attack against McDonald's and its franchisees in recent years, with actions against the company ranging from protests against the poor nutritional value of its food to worker- and union-led rallies for higher pay and a number of legal complaints.

An NYSE investigation could lead to a delisting of the company, which would degrade the value of the approximately 250,000 shares that CtW-advised funds own. But CtW said it wants to see reform, not delisting. "What we're asking is for the NYSE to take a closer look and reassure shareholders that there isn't private benefits of control going to the CEO," said Michael Pryce-Jones, a senior analyst at CtW. "No shareholder wants a delisting; we want the NYSE to protect the shareholders and take a closer look."

Arcos Dorados and McDonald's did not respond to requests for comment.

The most serious allegations concern Arcos Dorados' relationship with one of its suppliers, Axionlog, which was spun off from the company in 2011 and is fully owned by Staton, the Arcos Dorados CEO. Axionlog, based in Argentina, does food distribution and storage for McDonald's franchises and other food businesses in Latin America. The companies still work together.

CtW says Arcos Dorados swallowed a $13.3 million loss in 2014, after it adjusted the exchange rate of money owed to Axionlog as the U.S. dollar strengthened against the Venezuelan bolivar. Arcos Dorados canceled the receivable at the end of 2014.

CtW also said some fees paid to Axionlog jumped 27% between 2011 and 2014 despite a decline in the value of the product received. In the 2011 fiscal year, Arcos Dorados paid $42 million in logistics services fees along with $293 million for food and paper supplies, a ratio of about 9%. By 2014, that ratio jumped to 29%, when it bought $155 million worth of supplies and paid $45 million in fees, according to company documents.

"The escalation of the logistics services fees under these circumstances raises questions, though, about the board's monitoring of this ongoing related party transaction," CtW said in its complaint. "If the proportion of logistics services fees relative to the value of supplies purchased through Axionlog in 2011 had remained constant through 2014, AD would have paid Axionlog over $71 million less."

"Publicly available information suggests that the arrangement between AD and Axionlog is very advantageous for Axionlog," CtW said in its complaint.

CtW is not the only group to complain about corporate governance at McDonald's largest franchisee. The proxy advisory group Institutional Shareholder Services, which advises large investors in how they should vote their shares, has for the past three years recommended shareholders withhold votes for some directors. This year, ISS recommended withholding votes for Staton, faulting the CEO and chair for "failing to establish a board on which a majority are independent directors."

The company's shares now trade at just above $6, down from $10.20 a year ago. The company first sold shares to the public in April, 2011 at $17. The company's revenues in 2014 declined almost 13% to $914 million, while its profit fell to $10 million from $32 million in 2013, largely thanks to poorer results and large losses on foreign exchange.

Arcos Dorados has two classes of stock, Class A and Class B. The A shares are publicly traded on the NYSE and give shareholders one vote, while the Class B shares give five votes per share and are controlled by Staton through a British Virgin Islands-based holding company. The result is that Staton has 40% economic control of the company's stock but 76% of the voting rights. That voting control means the board is loaded with company executives and Staton associates. Several current and former colleagues of Staton serve on the board.

One of the board's independent directors, Michael Chu, was a founding partner of the Argentine private equity firm Pegasus Capital and is now a senior advisor there. Staton was also partner, but told the Argentine newspaper La Nación in 2010 that he no longer has day-to-day involvement in its operations.

Appealing to the NYSE is an unusual move for a shareholder activist like CtW, especially if the process could result in a delisting.

"Traditional accountability mechanisms, such as replacing directors or a change of control, are not available at AD," CtW said in its complaint, noting Staton's control of the company's voting stock, as well as McDonald's right to Staton's stake in the company at 80% of its market value under certain circumstances, including the death or incapacity of Staton.

CtW typically pursues companies by holding campaigns for shareholders to vote no on board members or to vote against an executive's pay package. Last year, CtW campaigned for McDonald's shareholders to vote against then-CEO Don Thompson's compensation package in a "say on pay" vote. Thompson announced he was leaving the company in late January; in February, CtW called for new McDonald's board members, saying there is "no diversity among the board members in terms of their experiences and backgrounds." Pryce-Jones said that going through the NYSE to urge an investigation that could lead to a delisting is a first for CtW.

"You have a poorly performing stock with a bad governance structure with what looks like private benefits of control," Pryce-Jones said.