What will it take to ease companies and investors into a capitalism that’s more willing to reward long-term value creation and is less frenzied and focused on the short-term? The much-heralded white paper recently released by Generation Investment Management – the London-based sustainable investing outfit co-founded by Al Gore and David Blood – outlines five steps “for immediate adoption that will accelerate the mainstreaming of Sustainable Capitalism by 2020.” But some market observers – especially in the U.S. – aren’t entirely on board with the recommendations in the paper, though they tend to agree heartily with the problems the paper identifies.
Talking to Responsible Investor, Mark Scorsolini, manager of corporate strategy at PSEG, a New Jersey-based gas and electric company, said: “I think the paper does a good job of diagnosing the problem correctly, but doesn’t necessarily prescribe the right remedy.”
The paper’s five “key actions for immediate adoption” include: quantifying the impact of a yet-to-be determined price on carbon and other externalities and factoring that impact into investment decisions; mandating reporting of ESG factors with companies’ annual reports; discontinuing the practice of issuing quarterly earnings guidance; aligning compensation policies with long-term value creation; and designing and issuing securities that encourage long-term investing.
But U.S. companies resist seeing themselves as the lead actors in the push for a different, more sustainable version of capitalism, pointing to the laws, protocols and psychologies that form the market they operate within.Perhaps most importantly, compared to their counterparts in Europe, Stateside executives are held to a relatively narrow definition of “fiduciary responsibility.” In the U.S., a public company’s central goal legally must be the maximization of shareholder value. In the words of the American Law Institute, in its Principles of Corporate Governance: “A corporation should have as its objective the conduct of business activities with a view to enhancing corporate profit and shareholder gain.”
This conception of American companies’ highest responsibility means that U.S. executives reading the suggestions for immediate action in the Generation paper say they can’t help but feel miscast as the main bearers of the burden of change.
“Executives have a fiduciary duty to maximize value for shareholders,” says Mark Scorsolini, “and if they’re taking resources or attention away from things that maximize their performance, they could be considered to be failing that duty.”
That doesn’t mean, of course, that American companies are making no moves toward improving their sustainability and environmental impact. For its part, PSEG is a recognized leader in sustainability, having developed initiatives around renewable energy and energy efficiency. It was one of two U.S. utility companies to qualify for the Dow Jones Sustainability World Index in September 2011. Scorsolini says the efforts to green-up operations were a response to calls from customers and other community stakeholders. However from the perspective of PSEG’s standing among investors, he says the company isn’t likely to
earn points for investing in improving its carbon footprint, especially in advance of a price being placed on carbon in the U.S: “We’ve been ahead of the curve in reporting and in environmental performance, and the market has lagged.” PSEG doesn’t publish an integrated report, though it does publish standalone sustainability reports. Scorsolini says “it’s only a matter of time” before the sustainability data are integrated into PSEG’s annual report. Still, he believes that mandating integrated reporting, as the Generation paper recommends, puts the cart before the horse in the push for sustainable capitalism: “Even if we did an integrated report, it wouldn’t correct the problem,” he says. “Our ESG performance is important to us, but it’s not material in our earnings and value until the day those externalities are priced into the market.”
Meredith Adler, a New York-based financial analyst who covers food and drug chains at Barclays Capital, agrees that making ESG data available to investors in integrated reports isn’t likely to move markets in the absence of regulatory pressures, like a tax on carbon: “Most of my companies have some sort of sustainability effort, but I have to say, I never hear anyone questioned about it,” she says. “I think it’s great that they do it. But do I factor it into my thinking about the business? Not a whole lot.”
One body that’s firmly in favor of a steady move toward standardized integrated reporting is the World Federation of Exchanges, the trade organization for the world’s regulated exchanges. Peter Clifford, deputy secretary general of the WFE, says it makes sense, given the role of an exchange: “You do need standards, and that’s really what an exchange does,” he says. “You’re making standards so you can compare investments or risk management techniques in a standardized format.” In 2011, the WFE gave its annual Award for Excellence to South Africa’s Mervin King for his work in developing a framework for integrated reporting. But Clifford says he’s not convinced stock exchanges are actually well suited tooversee a mandate around integrated reporting or requiring listed companies to disclose specific ESG data, as the Generation white paper suggests. For one thing, he says, exchanges are often just enforcers of regulations passed down from separate regulatory bodies, and don’t necessarily have the authority to enact listing policies on their own. Secondly, requiring more disclosure could create a “tradeoff,” he says, where exchanges run the risk of “putting so many burdens on companies that they don’t go public and don’t have to disclose anything.” Barclay’s Adler says that an unsavory tradeoff could also result from the white paper’s suggestions: ending the practice of issuing quarterly earnings guidance. While the recommendation is meant to lessen investors’ – and therefore executives’ – fervent concern for short-term results, Adler says a widespread discontinuance of the practice would only lead to more pronounced swings in the market when results are released. “The guidance isn’t influencing behavior so that it’s more short term,” she says. “It’s the fact that circumstances are changing regularly. All that happens if you don’t have quarterly guidance is increased volatility.” Adler has an unlikely echo on this argument (at least to a point) in James Allison, head of investor relations at Unilever, a company that effectively ditched guidance in 2009 and has “never regretted it,” he says. The company stopped issuing guidance and moved to half-yearly reporting when Paul Polman assumed the role of CEO, responding to the company’s belief that “if you allow the market to get very focused on the details in your income statement, balance sheet and cash flow every single quarter, there is a risk that you start to manage your business around that,” Allison says. “You end up constraining yourself because you’re trying to meet the market’s expectations in a period that is unnaturally small.” Allison adds that while a few U.S. investors weren’t keen on the idea when Unilever first announced it, the company has since not received a single complaint
about its decision to discontinue the practice. Where Allison agrees with Barclay’s Adler is in that it wouldn’t be prudent to give up on issuing guidance altogether: “You can’t get away with saying nothing,” Allison says. “Because then the market will make its own mind up and you have consensus. If the market gets it wrong, we have to say something, because the market can get carried away and later on there’s crushing disappointment. You can’t have that kind of volatility.” Unilever’s solution is to communicate soft guidance. In other words, instead of offering specific earnings growth estimates in percentages and operating margin growth in basis points, the company announces that its executives expect growth ahead of the market and steady and sustainable operating margin improvement. Allison says this compromise has worked remarkably well for Unilever, and a handful of other companies have followed suit. Another place where a discernable shift is taking place is in the area of compensation plan structure. Russell Miller, founder and managing director at ClearBridge Compensation Group, a New York-basedconsultant to companies on executive compensation policies, says he’s been noticing a trend favoring longer-term compensation packages in the U.S. since before the financial crisis, with a heightened focus on the topic after that point. “The markets are looking for long-term sustainable value creation,” Miller says, “and companies have responded by shifting to compensation weighted toward the long term.” Where companies haven’t moved as quickly, he says, is in the area of linking compensation to measures of ESG health. He argues that companies aren’t in the position to strongly value ESG data before mainstream investors have indicated that they do. “Companies themselves don’t determine what drives their value, the markets determine that,” he says. “So to the extent that ESG becomes a key value driver for markets, companies will increase the importance of ESG in their compensation plans.” “But I think it’s challenging for companies to try to get too far ahead of the market,” he adds. “If the market never catches up, they’re managing against priorities that are not in sync with the market’s view of what’s important.”