Background

Readers will know that society is changing rapidly. And it should be said, this is mostly for the better.
But as new attitudes take hold, accepted norms are challenged. One such example is the current debate about the role of the company.

Is it the purpose of a company to create wealth for shareholders by maximising profits?
Or does a company have broader responsibilities to other stakeholders and to society in general?
If one comes at the expense of the other, how is this reconciled?

The debate goes back to the creation of limited liability companies in the 19th century but following the economic stagnation of the 1970’s a school of economics (promulgated by Prof. Milton Friedman) emerged that championed wealth creation and proved hugely influential on those icons of capitalism such as US President Ronald Reagan and UK Prime Minister Margaret Thatcher.
Provided the law of the land was observed, the company was duty-bound to maximise profits.

The New Millenium

The Stump has noted previously that around 50% of people under the age of 30 have positive impressions of Socialism. This coincides with the prevalent notion that inequality has been rising. Even though this is demonstrably untrue in the overall sense, it is what people feel is the case. And as we know these days – what we think to be true is what is said to matter irrespective of the data.

In the opinion of the Stump, the excessive and unjustifiable rise in executive salaries in both corporate and government sectors has fostered that impression. Particularly so since the Global Financial Crisis of 2008/9 where it was the case that the financial wizards who caused the crisis and were in many instances bailed out by taxpayers, not only were exempted from suffering but made even more money while many people lost jobs, homes and community.
There has also been the spectacular growth of notable tech businesses (Google, Facebook, Amazon, Apple Etc) who enjoy monopoly-like power and have created fabulous wealth for a very small number of people.

In the past, the objectionable aspects of this might have been contained, but Social Media now provides the perfect platform to call out certain behaviour and air grievances.
The result has been the emergence of an activist class who use those platforms to drive change. It is the activists who are now pressuring companies and governments in matters of social responsibility, investment ethics, gender equality, emissions policy by adopting the concept that a company must have a “Social Licence” before it can legitimately conduct business. Indeed, the acronym ESG is used to describe the environmental, social and governance drivers of sustainable and ethical business practices.

The activists, even though they may have purchased a few shares to gain access to annual general meetings, are not overly concerned with the profitability of a company, other than to the extent they are prepared to inflict damage on that company to drive the agenda of social change. In some cases, such as the fossil fuel industries, the demands amount to nothing less than the cessation of that company or industry.

The Corporate Reaction

In the face of activist campaigns, the corporate response has often been feeble. Not only do companies become reticent to speak out in their own defence, they too often cave into activist pressure. This weakens their own moral authority and emboldens activists.

The group Sleeping Giants have agitated against Alan Jones and 2GB Radio on more than one occasion, and companies have pulled advertising even though most of the Tweets from that group were revealed as coming from a single account.

There are also instances where CEO’s place themselves at the vanguard of social policy, Qantas is a prime example. When the CEO does it, you can assume the Board approves of it.

These are not isolated cases and are making inroads into mainstream thinking.

In the US, the Business Roundtable which is a group of the most influential US corporates changed the policy they had adopted since 1997 to the effect that “the paramount duty of a board is to the stockholders”. They pronounced that from 2019 they believe in a social purpose as well as;

  • Delivering value to customers
  • Investing in employees
  • Dealing fairly with suppliers
  • Supporting communities
  • Generating long term value for shareholders in a transparent way

The Stump regards theses as “motherhood statements” of the kind that one would generally agree within any event. Indeed, they are necessary for running an efficient company.

A cursory look at the web site of just about any public company will tell you they aim to create shareholder value. It will also tell you about all the good work and values they subscribe to that could be grouped together under the ESG banner.

You will struggle to find an overt reference to profit maximisation. The implication is that the two are mutually sustaining. But there is very little evidence to support that, and it could be equally the case that ESG values taken to the extreme, destroy rather than enhance shareholder value. The reason is that the beneficiary of ESG are the other stakeholders.

The Disconnect

In Australia, the Committee for the Economic Development of Australia (CEDA) released a survey of community expectations to demonstrate how they compare to the priorities of business leaders. Titled Company Pulse 2019, it makes for a stunning read.

Not because of what it says about the role of the company, but because of what it says about how people believe a company should be run.

The clear message from the report is that most people think companies should place equal importance on ESG issues and further, that most of the key priorities should be directed to improving the pay, conditions and general welfare of employees.

Just to be clear – according to the report, people in Australia believe a company should be run like a worker collective.

The objective of increasing shareholder returns to fund expansion and take opportunities comes in near the bottom of the list.

So, between the ESG and the employee welfare as key (but not necessarily complementary in themselves) priorities, where does this leave the shareholder? Where does it even leave the employees themselves if companies are not to innovate and invest for the future?

Columnist Henry Ergas has questioned the methodology of the report observing that most Australians would hesitate to invest in companies that placed twice as much importance on employing more people than on increasing shareholder returns. How long do people really think that situation could endure?

The response of business leaders to these same questions is equally gobsmacking. Most say the customer is number one with the shareholder ranking down alongside employees in priority. The business leaders have forgotten who is risking capital to give them a job.

Conclusion

The question that occurs is what will happen when under public pressure companies move further along the ESG spectrum? If ESG was enshrined in the constitution and transparent to investors at least they would have the choice, but this is rarely the case.

ESG offers no guarantee of good behaviour. The aforementioned tech companies are very “woke” when it comes to ESG but are still accused regularly of unconscionable conduct and secretive and unethical practices.

In the case of Qantas, is its current profitability due to its ESG policies, or is it more because a flexible fare from Brisbane to Melbourne costs almost $600?

How does a pension fund reconcile its fiduciary duty to its members while divesting of lawful and profitable investments deemed not to meet ESG thresholds? The California State Pension Fund found itself in this situation when a member who was concerned that ESG policies (divesting alcohol and tobacco stocks) were endangering investment performance successfully campaigned for a seat on the board. In Australia, several Universities have divested fossil fuel stocks for example and missed the outperformance of those stocks in recent years. How is that helping the University endowment?

Those depending on optimum returns are not always pensioners or private savers. They include many not for profits and other charitable foundations that in themselves are doing a high public good.

If ESG has an altruistic motive, then employee primacy is merely self-serving. If employees do trump shareholders, then you would never invest in the same company you worked for.

The conclusion is that amongst the general public a company should do more than benefit its shareholders, it should also be socially acceptable and be relaxed about its bottom line.

The point is missed however that by remaining in business, growing and innovating it is producing things of more value than it consumes and is thus fulfilling the higher purpose for which it is designed. There are many other institutions better placed to be guardians of social policy.
Amongst shareholders who have skin in the game, the result would be clear. Shareholders want their companies to obey the law, honour contracts, provide safe and rewarding jobs for employees, and adopt ethical business practices. That is the price of entry, and it does not need ESG policy to achieve. After that, they want companies to maximise profits.

Jim Wheeler

 

Sources:
Business Roundtable release
CEDA Pulse report 2019
The Economist 24th August 2019
Henry Ergas The Australian 20th September 2019