This is the first part of a three-part series on whether doing good results in doing well in business. As much as I'd like to state that this is true categorically, the story (and data) is not always black and white. To paraphrase Marilyn Vos Savant, who recorded the world's highest IQ, statistics can be used to support or undercut almost any argument.
In this first part, I will share some studies and arguments about how doing good or focusing on creating a positive impact for all stakeholders doesn't create business value. I will present the contrary perspective in part two.
Recently a few sustainability experts and investment managers questioned whether strong ESG (environmental, social, and governance) performance by companies correlated to better returns for investors. Tariq Fancy, former Chief Investment Officer for Sustainable Investing at Blackrock, claimed sustainable investing was no more than marketing and greenwashing.
ESG Investing is Imperfect
Felix Goltz, Research Director at Scientific Beta, found no evidence that ESG investment strategies outperformed more conventional portfolios. Instead, performance gains could be attributed to recent investor attention towards ESG. Thus over time, such gains would decline.
Part of the problem with constructing a sustainable investment portfolio is due to ESG's evolving nature: we are still in the early stages of learning what it means. Hans Taparia, professor at New York Stern School of Business, pointed out the problem with ESG ratings: the ratings are calculated based on how much the company's economic value is at risk due to ESG factors rather than the social and environmental impact that the company creates.
A PwC research found that while more than 81 percent of asset managers were committed to ESG goals, they were only prepared to take a reduction in return of 1 percent. This makes sense—presumably, the people they invest for want them to maximize portfolio return. So if asset managers are less confident with the financial performance of ESG-focused businesses, they would invest in what they know.
Survey participants were concerned with the quality of ESG data, including the accuracy of carbon emissions calculations. While some may assume carbon emissions calculation is straightforward, there is more than one approach and standard.
ESG May Not Grow Business
All the hype around ESG with investors and customers means that CEOs feel the pressure to do more and to do it all: be green, be ethical, be humane. Use renewable energy, improve data security, pay employees fairly, and don't forget to keep growing profits!
While almost two-thirds of CEOs surveyed by KPMG are putting purpose into their business plans and strategy, only a third of them say that their efforts improve financial performance. A quarter claimed their efforts actually reduced financial performance.
OCEG reported similar findings; a global non-profit think tank focused on advancing governance and compliance topics. According to their research, less than half of the surveyed executives believed that their ESG efforts would affect their company's financial performance. More than half claimed that they had minimal to no confidence in their organizations' ESG programs.
Even though CEOs are less confident that their ESG efforts will grow the business, their pay is increasingly linked to ESG performance. The public has often blamed salaries for the executives' short-term behavior, finding shortcuts to achieve their bonus at the expense of the company's long-term performance. The ratio of CEO pay to the average employee is often the villain when discussing capitalism and inequality.
So instead of just linking the executive salary to financial performance, half of the companies in the US and UK have linked payouts to financial and ESG performance. But incentives have a way of making people behave in unexpected ways, leading to unwanted results.
What are the appropriate ESG metrics to link to—social or environmental, and which ones? Who decides which metrics to prioritize on? Having too many metrics could nullify each other or complicate the final payout. Can we calculate the metrics? How accurate and consistent is the data?
“Woke Capitalism is Smoke and Mirrors”
Vivek Ramaswamy, chairman of biopharmaceutical company Roivant Sciences and author of Woke, Inc: In side Corporate America’s Social Justice Scam, argued that companies are virtue-signaling. When they say they care about social causes and the environment, they do so to gain more market share and profits.
He cited examples of businesses that made bold declarations on diversity and other social causes but arguably did so to divert attention from other company-related news. Goldman Sachs announced that it would not take any company public that did not have at least one diverse member on its board. Ramaswamy pointed out that the announcement came at a time when first, every S&P 500 company already satisfied this diversity criterion, and second, it had recently agreed to pay $5 billion in fines in the 1MDB Malaysian corruption scandal. Goldman Sachs wanted to redirect the public's focus by making the announcement.
Ramaswamy is not alone in his skepticism on stakeholder capitalism. Otis Rolley, a Senior Vice President at The Rockefeller Foundation, believed that companies had made little progress in taking action. Two years after the Business Roundtable (BRT) declared that companies should deliver value to all stakeholders, business leaders had done little to advance racial and social equity.
“We Have Not Progressed”
Two Harvard Law School directors seemed to agree with Rolley. They found that the signatories to the BRT declaration had not changed how they conducted business. Even though the signatory companies agreed to invest in employees and deal fairly with suppliers, none of them believed they needed to change their treatment of stakeholders. Their governance documents still seemed to reflect an investor-centric perspective.
Their study argued that the majority of the signatories have not linked their executive compensation with stakeholder interests—another indicator of the lack of intention to consider all business stakeholders’ interests. A substantial portion of the executive signatories' compensation was company stock, which aligned them closer to the share price and investors.
This study is in contrast with BRT’s own report. BRT reported that the signatories paid their employees above the median wage, invested in small businesses, and donated to charities. On top of this, the signatories outperformed the Russell 1000 Index. While the report cited impressive statistics, there are no comparative data to benchmark or provide context to the signatories' impact or if there was a change in the way business was done since the commitment to stakeholder capitalism in 2019.
Social Case Rather Than Business Case
There are challenges to stakeholder capitalism: the lack of a consistent framework and data, knowing what to measure and how to measure. So, investors and CEOs focus on financial performance and making decisions based on a sound business case.
But the traditional business case model leads to timid decisions, so what needs to get done is not done. There is value created in preserving and regenerating the environment, and for serving the community, value that does not fit neatly on the page of a business case.
While the World Economic Forum proposed a set of Stakeholder Capitalism metrics, there are other things that can't be measured yet have value. We can measure diversity in a company, but we can't consistently measure the inclusion and equity diverse employees experience within the organization. We can report on the amount spent on employee training, but not the quality of training and how it changes employees' mobility and lives. Other examples of hard to measure but no less important metrics are meaningful work and employee wellbeing.
Looking at La Sagrada Familia, Antonio Gaudi's cathedral in Barcelona, there doesn't seem to be a business case to continue this fantastical project. The first stone was laid in 1882, and at least $430 million has been spent on construction. The economic value returned upon completion would likely not match up to the money and efforts invested in the 139 years thus far.
Should construction have been stopped when the project overran timeline and budgets? A prudent finance manager would have halted the project if we discounted the future cash flows of expected future ticket sales. But this valuation methodology does not consider the social value created by this symbolic structure for the city.
Similarly, perhaps the commitment and investment in employees, community, and environmental wellbeing should not be boiled down to dollars and cents alone.