ESG – an acronym for Environment, Social, Governance, took centre stage in 2020. And rightly so.
Jon Hale, head of sustainability research at Morningstar, believes that investors can help/encourage/cajole companies to move toward a long-term stakeholder-centric model of corporate behaviour that is better for people and the planet and will be, over the long run, better for shareholders.
Here he writes about the changing perception of ESG.
- Investors watched how companies prioritized stakeholders during the Global Pandemic.
The effects of corporate responses to the pandemic on workers, customers, and communities were closely scrutinized in media and by organizations like JUST Capital, which created the COVID-19 Corporate Response Tracker. JUST Capital found that firms it assessed as doing the best jobs prioritizing workers had more resilient stock returns than those doing the worst. Researchers found that firms generating positive public sentiment about the way they responded to the pandemic and their effects on employees, suppliers, and broader society outperformed their counterparts during the market collapse in the first quarter.
Many investors have had the impression that sustainable investing is mostly about the environmental dimension of ESG, especially climate change. This focus on corporate responses to the pandemic created greater awareness among investors for the importance of the social dimension of environmental, social, and governance analysis.
Earlier in 2020, Calvert Research and Management CEO John Streuer said: "We believe that how companies respond to stakeholders during COVID-19 is likely to affect their reputations and drive long-term value for years to come. Calvert is closely monitoring company responses to this crisis as a key indicator of how resilient, prepared and accountable they might be in facing future risks.
“In times of crisis, companies and governments have an opportunity to take major steps forward in the eyes of their key stakeholders and establish or deepen a relationship built on trust. Those that perform well right now, serving their customers, employees and communities, will benefit in the long term, winning customer support and loyalty. Those that perform poorly, on the other hand, are likely to find that customers have long memories of crisis-era actions."
- The growing awareness that firms are part of a system.
There is a growing awareness that sustainability has a lot to do with systems thinking--understanding how a company fits in the bigger socioeconomic context and how its stakeholders interact to make it successful.
Parnassus has been focused on sustainability since its 1984 founding. In Navigating Turbulent Markets, Parnassus CIO and co-manager of Parnassus Core Equity, Todd Ahlsten, explains it well.
“Our investment team has deep experience thinking about ESG issues in the context of managing a portfolio, which can be helpful during a crisis. We are used to thinking about systems. For example, how companies interact with their communities, workers and supply chains is already an integral part of our process. These are the kinds of things we think about when developing a view on which companies are going to make it through the downturn, and which may likely do well as a result of this crisis."
- Shareholder primacy is giving way to the stakeholder-capitalism model, which focuses on creating sustainable long-term value that serves all stakeholders and creates positive societal impacts.
We need a new operating system, wrote Martin Whittaker, CEO of JUST Capital in Forbes, one in which “business drives value for all stakeholders, where long-term systems thinking supplants short-term opportunism, and where as many people as possible have a stake in the recovery.”
The old shareholder primacy model “is no longer fit for purpose,” says Whittaker. That’s because companies with a narrow focus on short-term profit maximization do so at the expense of long-term value creation, which ultimately imposes significant costs on shareholders and society. The result, already apparent prior to the pandemic, has been lower productivity and growing inequality, the latter worsened by holes in the social safety net.
Companies are seeing the need to focus on their stakeholders - employees, customers and communities. Those that don’t rise to the occasion will find it harder to recover, argues Jessica Alsford, head of sustainability research at Morgan Stanley:
“Corporate behaviour in a time of crisis--both in how companies treat employees and customers, and their impact on society in a time of need--can have lasting implications, both positive and negative. These factors can be linked to long-term performance and returns.”
When companies do things like increase healthcare benefits, hike pay for workers on the front lines, lower executive compensation to help avoid layoffs, and take extra steps to protect worker and customer safety, they will benefit from having a more engaged and productive workforce and a more loyal customer base during a recovery.
- The murder of George Floyd brought racism to the forefront and investors realised that have a role to play in fighting systemic racism.
Streur wrote in June 2020, "Ending racism is a responsibility of corporations, and corporations must recognize that their current effects to promote their core values, and diversity and inclusion programs, fall far short of what is needed today."
Through engagement and proxy voting, sustainable investors can push for change at the corporations they hold in their portfolios. Sustainable investors press companies on their diversity and inclusion policies, on the composition of their boards, on the way they compensate employees--particularly lower-wage workers whom we are more fully recognizing as essential during the pandemic, on labour relations generally, and on where corporate lobbying and political expenditures go.
Over the next year, you can bet that sustainable investors will closely question what corporations are doing to fight systemic racism. BlackRock, for example, announced that it will ask U.S. companies to disclose EEO-1 data on workforce race, gender, and ethnicity. This information is required by the U.S. Equal Employment Opportunity Commission, but companies are not required to make it public.
Investors can have a significant impact on corporate leadership, especially when investors are aligned with other stakeholders and the public. Lending the weight of your investments to the cause of greater corporate responsibility and stakeholder capitalism is one important tool for change you have at your disposal.
Investors have the means to drive change. An all-out attack on systemic racism requires every tool in the box.
