When the Business Roundtable, which represents large US corporations, issued a new Statement on the Purpose of a Corporation signed by 181 CEOs, it rekindled a debate neatly parted on ideological lines: one side cheered the post-Friedman return of managerial capitalism, the other warned that CEOs were abandoning the primacy of shareholder value to lessen their own accountability and as a pre-emptive strike against more radical proposals from neo-socialist lawmakers in the US and the UK.
The debate missed – I believe – key changes in investors’ attitude that weigh heavily on how corporations see themselves and the role they play in society: the increased focus on the long-term and the increasingly mainstream use of advocacy and – more broadly – ESG research to enhance portfolio returns.
The Long Term
A week after its first statement, the Business Roundtable issued a second press release on the role of corporations in response to the debate sparked by its first, where “long-term” was mentioned six times and where the CEOs stated:
“We have also called for a closer partnership between companies and investor groups to ensure that investors support companies that build long-term value by supporting the interests of all stakeholders” .
I believe the call went the opposite way: investors have been asking for sustainable long-term value and companies have only now just started to respond.
The size of long-term focused sovereign, pension and superannuation funds has grown rapidly. A well-known example is the Norwegian Sovereign Wealth Fund, whose size passed the US$1 trillion mark in 2017 and which owns approximately 1.5% of all global shares. The Australian Superannuation sector held A$2.6 trillion in assets in December 2018, which is higher than the market capitalization of the ASX200 index. The top-5 Australian Super funds alone account for nearly half a trillion dollars. Pension and superannuation funds have an inherent long-term focus and – like most investors – a preference for low volatility of returns.
Large and passive investors need a “better world” to improve their returns
In addition, investors have progressively endorsed low-cost passive strategies. As Bloomberg reported last August, US active managers’ inflows have been steadily declining from +US$333bn in 2009 to –US$506bn in 2018; in the same period passive managers enjoyed inflow growth from US$60bn in 2009 to US$156bn in 2018. This is a broad trend not limited to the US.Investors who own a bit of everything, either because they are so big that they have to, or because they have chosen to be passive and buy an index instead of individual stocks, have a vested interest in improving the performance of the whole economic system as a lever to improve their returns. Asset owners are increasingly pursuing this goal by engaging with corporate management and boards on environmental, social and governance (ESG) issues because –as University of Cambridge and London Business School professor Elroy Dimson has argued – it has the potential to improve their returns or – as research from a handful of European universities has highlighted – lower their risk.
Increasingly large and increasingly passive long-term investors have facilitated the mainstreaming of ESG advocacy and supported the integration of ESG research in a growing number of investment processes as both are effective tools to achieve high and sustainable long-term returns.
Several commentators appear to have interpreted the Business Roundtable’s renewed focus on stakeholders as paying lip service to civil society’s demand for a more principled economic system. Perhaps there is some truth to that. But I think they are actually doing what more and more investors are asking them to do: broadening their horizon and making decisions for the longer-term benefit of their companies (and shareholders). Investors are demanding this shift of focus not because they are good Samaritans but because it increases returns, lowers risk and makes financial sense.
By assuming that a focus on stakeholders (employees, customers, suppliers, shareholders and the wider community) reduces shareholder value, commentators betray a fundamental misunderstanding of what ESG research and advocacy strives to achieve. ESG work – when done well – underpins the quest for sustainable AND high returns. By focusing on governance, culture, strategy, the supply chain, how much attention corporate captains are paying to social changes, investors are moving beyond the risky quick buck and demanding to see how the foundations for future returns are being laid.
A long-term focus “is good business”, as the Economist asserted in its editorial on the role of corporations. Too often though, corporate leaders display lapses of judgement on this front, which is why savvy investors seeking high sustainable returns employ ESG research and advocacy, which has in turn underpinned the formal admission by 181 American CEOs that to best do their job they need to address the demands, needs and expectations of a broad set of stakeholders.
Maurizio Viani is an Australia-based investment analyst.