One takeaway from that review, was that the obsession with shareholder value had negative consequences. On the face of it, investors should be glad management relentlessly prioritise increasing earnings per share (EPS) and progressive dividend policies. But history is littered with companies that had good runs growing profits before sinking to obscurity.
Before you even consider examples of financial engineering, some businesses’ myopic focus on their current fiscal year (or even quarter) has meant a failure to implement strategies for developing new markets and revenue streams. For the buy-and-hold investor, the most prized companies are those that continue to innovate, delight their customers (and win new ones), and find new ways to leverage their economic assets. True sustainability is being ready when the cash cow divisions of today cease to be lucrative.
In a talk to the CFA Society UK, the professor gave fallen chemicals giant ICI as an example of a company which didn’t recognise that fact. Years of strategic mismanagement resulted in its failure, but Kay recounts a member of the company’s corporate and social responsibility team was still at pains to point out they had done brilliantly on CSR. The irony of course being that the business didn’t sustain itself as an independent company and it was eventually taken over and absorbed by AkzoNobel.
Today, companies are falling over themselves to show they’re green on the environment and right-on when it comes to social issues. There is a risk, however, of an “Emperor’s new clothes” syndrome – trying to green wash or woke wash corporate images, and all the while meaningful progress is stunted by the same inefficiencies that drag on productivity and profits growth.
True, corporate citizenship more than ever is material for companies due to Environmental, Social and Governance (ESG) scores affecting their cost of capital. That said, a lack of uniformity in taxonomy and the divergence between ratings assigned by the likes of FTSE, MSCI, Sustainalytics and Refinitiv reinforces their subjectiveness. It is hard, therefore, for investors to truly judge companies’ moral fibre or pick the winners of tomorrow on that basis.
While ESG metrics are undoubtedly becoming more sophisticated, the starting point for impact investing and finding long-term growth, could simply come from looking at the third part of the acronym; namely the ‘G’ for governance. That means going back to basics.
Good boards and good governance focus on what’s best for the company
Legally, one of the seven responsibilities for a board of directors is to act in the best interests of the company, which isn’t necessarily the same as acting in the short-term interests of shareholders, who may demand jam today. The definition of what promotes the success of a business includes the impact of its decisions on society and the environment; its employees; high standards of business conduct (dealings with suppliers, distributors and customers); how fairly all members of the company (including shareholders) are treated.
Consider a list like that, already defined, and you wonder: surely everything is covered off. So, why the need for a new lexicon? If the framework exists, then it’s a question of enforcement.
Branch out to other duties under the Companies Act 2006 and the rules are comprehensive. Exercise reasonable skill, care, and diligence; avoid conflicts of interest; declare personal interests in a transaction; preserve independent judgement. On top of these, new ESG accreditations seem like a boiler plate exercise.
Being cynical, companies can focus on areas that are peripheral to their activities to fluff overall ESG scores. Hiving off environmental and social impact scores can dilute penalties for governance factors like board structure and remuneration. It is governance that sets the tone within a business and executive pay, for example, contributes massively to gender or ethnic pay gaps. But what would a CEO rather do: reduce their compensation (a governance matter), or champion positive discrimination (which falls under social) at a pay grade they’ll never traverse again?
When it comes to the environment, many industries need to be judged on tailored criteria but progress against the recommendations of activist investors can also be a governance metric. Scrutinising the level of responsiveness as part of a drive to optimise the behaviour of the board, may help to deliver the best sustainability outcomes. In the broader sense that includes environmental and social aspects, but the focus on the board makes it impossible to divert attention from business strategy, which fundamentally is what matters.
