Why there is a big mistake in the backlash against ESG and stakeholder capitalism

Most boards of directors and institutional investors now recognize that certain environmental, social and governance (ESG) risks and opportunities can be financially material, i.e. they can affect the economic performance of companies. A growing proportion also subscribe to the related principle of corporate governance that companies should be run in the long-term interests of all their key stakeholders – including, but not limited to, shareholders. But while the ESG investing and stakeholder capitalism movements remain bottom-up, they are facing a backlash.

A group of critics focus on the inconsistent implementation of these frameworks by their champions. Some see this as hypocrisy and a sign of performative virtue – with CEOs and boards playing the rostrum of popular opinion or special interests on pet issues. Others attribute a darker pattern, saying it is an elaborate smokescreen to create the illusion of progress and undermine popular support for stronger government action.

A second group of detractors challenge the very premise ESG investing and stakeholder capitalism. Some argue that if they are financially significant, then by definition managers and directors focused on maximizing shareholder value already take them into account. Others argue that these concepts are inherently unworkable because they are intended to politicize decision-making within corporations, tangling them in ways that misallocate resources. Still others say that all stakeholder/shareholder dilemmas and trade-offs will inevitably be resolved in favor of the shareholders, so what’s the point?

Each of these reviews contains a grain of truth – just enough to make them effective as talking points or cautionary tales. But neither equates to anything close to a disqualifying argument. This is mainly due to the inescapable logic of financial materiality for directors, managers and investors who take their fiduciary responsibilities seriously. Attention to ESG issues and related stakeholder interests cannot be dismissed as mere public or political relations for the simple reason that history has shown – and recent disruptive changes in technology, the environment, the geopolitics and societal attitudes emphasize – that they are increasingly important factors in the preservation and creation of corporate value.

When it comes to preserving value, there is a long history of boards and investors being caught off guard by failures in their company’s management of ESG and stakeholder issues, leading to a sharp drop in value. the market value. Think of BP’s Deepwater Horizon explosion in the Gulf of Mexico; Volkswagen’s manipulation of emissions testing; Facebook data privacy breaches; Kobe Steel’s falsification of product safety data; the corruption offenses of Odebrecht, Siemens and Airbus; the sexual harassment scandals at Uber, Google and Weinstein Co.; etc

To research by Bank of America Merrill Lynch found that 15 of 17 S&P 500 bankruptcies from 2005 to 2015 involved companies with poor environmental and social scores five years prior to those events, and major ESG-related controversies were accompanied by spikes Steps. capitalization losses of half a trillion dollars for large US companies between 2013 and 2019.

The appropriate response to lax due diligence in the exercise of corporate governance is not to dismiss or rationalize the associated risks, but rather to apply greater rigor to understanding and mitigating them.

ESG and stakeholder considerations can also be important to company value creation. For example, climate change, water, biodiversity and other aspects of environmental stewardship have a significant impact on a company’s performance relative to its peers in a world where technology, regulation and the associated physical impacts evolve over years and sometimes months. The same applies to the management of intangible assets, in particular people. The continued cultivation of the talent, motivation, diversity and well-being of a company’s workforce, as well as the responsible development and management of its intellectual property, including new technologies, Process innovations and data are increasingly important drivers of business value creation in the Fourth Industrial Revolution.

Accounting and reporting practices have yet to adapt adequately to the growing importance of intangible assets in this new era. There is a significant discrepancy between market capitalization and reported assets, valued be about two to one. With half of market capitalization effectively unaccounted for, executives and investors have a biased view of their company’s ability to create long-term value if they only look at the financial aspects of its performance. Human capital – the skills, empowerment and creativity of a company’s workforce – has long been an area of ​​underinvestment by businesses and governments alike.

Thus, the economic case for rigorously integrating the non-financial and intangible aspects of business performance into a company’s core strategy and management practices is strong; these factors are critical to value creation and resilience in today’s more technologically disruptive, environmentally constrained, socially fragile and geopolitically uncertain business environment. For this reason, business leaders must transcend the traditional, segmented logic of shareholder and stakeholder considerations – exemplified by the concepts of shareholder primacy and corporate social responsibility. Rather, they should be effectively integrated through the systematic internalization of material ESG risks and opportunities into corporate governance, strategy, resource allocation and reporting.

Full ESG integration of this nature is what gives practical effect to the principles and values ​​of stakeholder capitalism – the way companies keep their word. sustainable business value creation. Seen in this light, the ESG and stakeholder capitalism movements are fundamentally about good governance – strengthening due diligence in exercising fiduciary responsibility in a profoundly changing business operating environment.

Criticism of weak or inconsistent implementation is fair game, and indeed most companies and investors are only beginning to rigorously integrate ESG considerations into their core decision-making processes. But those who seek to politicize ESG investing and stakeholder capitalism by conflating it with the broader cultural debate over “wokeism” or challenging the motivations of directors, executives and investors are seriously underestimating the changing nature commercial value creation.

The debate on how corporate and investor governance should adapt to the economic and social transformations of the 21^st century deserves a deeper and less controversial examination of what really matters for the performance of businesses and economies in this new era.

• The opinions expressed here are those of the authors only and are based on their forthcoming book Creation of sustainable corporate value: implementing stakeholder capitalism through comprehensive ESG integration.