What Is ESG? pt.2

Shareholders, Stakeholders & ESG

Like ESG, the concept of stakeholder capitalism has been around since the mid-20th century, yet it has gotten a lot of ink in the global shift to decarbonization and the capital flight to ESG investing.

The World Economic Forum describes stakeholder capitalism as capitalism in which companies optimize short-term value for shareholders but also consider longer-term value creation by engaging with a company’s broader stakeholder community and society at large. To grasp this broadened scope of concern for business, it’s important to first understand the role shareholders play — that is, company owners.

In 1970, economics heavyweight Milton Friedman gave a full-throated defense of companies’ need to focus on one thing and one thing only: making as much money as possible for their owners. In Friedman’s world, owners rule, and anything else is, at best, a distraction, and at worst, socialism and villification of profit making.

Placing this charge to create as much profit as possible for owners first is what’s known as shareholder primacy, and it’s part of the fiduciary duty company directors owe their shareholders. A fiduciary manages property or money on behalf of someone else, placing that person’s, or beneficiary’s, needs first. Fiduciary duty is no joke, and if there is breach of that duty, a beneficiary can seek damages.

In 2019, the Business Roundtable issued a new Statement on the Purpose of a Corporation, which placed shareholder primacy last. The 181 CEO signers of some very large companies agreed to five commitments: creating customer value, investing in employees, fair dealing with suppliers, supporting communities in which they work and, lastly, creating long-term shareholder value. All five commitments are at home under the ESG umbrella.

Short Term Versus Long Term

One big difference between stakeholder capitalism and a laser focus on shareholder returns is time horizon. Eighty percent of CFOs said they would reduce discretionary spending on high-value net present value (NPV) activities like research and development and marketing for short-term gains. That is literally throwing longer-term value creation (5 to 7 years) under the bus in order to appease short-term investors, day traders and others focused on quarterly returns. In fact, companies that think longer-term have significantly better growth (47 percent revenue growth over 15 years).

One study affirmed that ESG improves financial performance, especially over longer time horizons. Another showed that companies with strong ESG ratings had mid- and long-term returns up to 3.8 percent higher compared with conventional investment approaches. And a survey of U.S. investment managers found that 90 percent believed ESG integration created better long-term performance.

Thirty-four years ago, Larry Fink co-founded BlackRock, now a leading investment firm with $8.07 trillion in assets under management (AUM). (For comparison, the U.S. GDP in 2022 was $26.13 trillion.)

Constellation of Stakeholders

Larry and BlackRock are heavyweights. In his 2022 letter to CEOs, Larry defines the top three things he identified in his countless discussion with leaders that make companies successful: 1) a clear purpose for a business, 2) consistent values and 3) delivering for key stakeholders. Larry describes the constellation of stakeholders surrounding a company as the groups and actors that every company needs to engage for success.

“It is capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper. This is the power of capitalism.”

Larry bats away the notion that stakeholder capitalism is woke or ideological or political. Instead, he and his team act as fiduciaries, and their top goal is to create value for owners and shareholders. If Larry says this means engaging stakeholders to create highest and best relationships and outcomes for AUM, his observation is born of three-and-a-half decades running one of the largest asset management firms on the planet.

“Putting your company’s purpose at the foundation of your relationships with your stakeholders is critical to long-term success.”

By this definition, shareholders are but one part of the stakeholder universe — an important member as shareholders provide capital. Yet one among many. And long-term focus rather than slavish short-termism, especially when coupled with ESG integration, really is the better way to create value for all involved.

Sadly, politicizing ESG misses the bigger point. ESG-integrated companies usually significantly outperform their conventional peers. Those dismissing ESG investments do their clients a disservice by potentially leaving money on the table — possibly a lot.

Big Glasses Consulting is neither a law or a financial services company, nor is it offering legal or financial advice. For legal ramifications of your investment strategy, discuss with your legal and financial advisors.