Victory is at Hand: Time to Step Up

By Robert C. Hinkley

25 March 2021

The European Union (EU) is considering a major change to the way business is conducted. The change would expand the duty of corporate managers from exclusively working for the company’s benefit to also having a clearly defined responsibility for ensuring their companies do not harm the environment, their employees and the communities in which they operate.

Simply put, the proposal requires all companies to become socially responsible. Those which are now harming the environment or other elements of the public interest will need to find ways to stop. This change from a predatory form of capitalism to a more socially responsible capitalism is a welcome development. It should be supported both by socially responsible investors and the world’s largest shareholders.

Recent Developments

Socially responsible capitalism is an idea that’s been around for a while. In 1999 and 2000, Business Week and the Harris Poll organization took a poll to determine which statement Americans agreed with more strongly:

Corporations should have only one purpose—to make the most profit for their shareholders—and pursuit of that goal will be best for America in the long run,

Or,

Corporations should have more than one purpose. They also owe something to their workers and the communities in which they operate, and they should sometimes sacrifice some profit for the sake of making things better for their workers and communities.

When the poll was taken, the almost universally accepted wisdom in corporate boardrooms was that the business of corporations is to exclusively pursue and protect wealth for shareholders (the first statement). Yet, 95% of those polled said they agreed with the second statement more than the first. The poll didn’t ask Europeans what they were thinking at the time, but it’s probably safe to assume a large majority of Europeans felt more strongly about the second statement as well.

In the past twenty years, corporate managers have shown they are more receptive to the idea of increased environmental and social responsibility. Whether this is genuine or merely public relations and brand building in response to public opinion, doesn’t really matter. Corporate executives are increasingly going on record that companies should be better citizens.

In August 2019, CEOs from 181 of America’s largest companies publicly stated their companies should be run with more than just shareholders in mind. (https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans.) They declared the environment, employees and other elements of the public interest are important considerations as well. The EU’s current proposal takes the emergence of corporate citizenship one step further by proposing to make corporate social responsibility mandatory.

Corporate management’s change of message has been encouraged by various movements which prodded their companies to be better citizens. Among other things, trade associations of socially responsible businesses formed. The amount of money under the management of socially responsible investment funds grew dramatically. Business schools began offering courses that included instruction in improving corporate environmental, social and governance (ESG) behaviour. Impact investing and sustainable financing began.

Socially responsible investors try to lead by example. They invest in and showcase companies that mostly are already doing no harm to the environment or other elements of the public interest. This proves the concept, at least in the finance industry, that doing well while doing good is achievable.

Another important development of the last two decades has been the emergence of a large new category of investors with a different mindset from previous investors. These new investors are sometimes referred to as universal owners. Good examples include large pension funds, sovereign wealth funds and index funds. Their business models offer investors exposure to specific industries and the broader market rather than just individual stocks. It is reported that universal owners now may own more than 20% of all public companies.

Before the emergence of universal owners, investors who didn’t like the risks a company was taking had two choices. They could try to convince the company’s management to change its operations to mitigate or eliminate the risk or they could “vote with their feet” and simply sell the stock.

Universal owners don’t have those choices. Their business model depends on spreading the fund’s risk over a pre-determined group of stocks with a common characteristic (e.g., all the stocks in a particular industry or index). This strategy is passive. It relies on investments determined by pre-agreed criteria rather than the ongoing research, judgment and decision making of an investment advisor. This means universal investors have no ability to reduce risk by divesting themselves of individual stocks.

With no “exit” leverage to use to threaten, universal owners are left with trying to find ways to sweet-talk companies into being more responsible. One large family of funds has adopted a program it calls Investment Stewardship. Each year, the chairman of the fund’s advisor sends a letter to the CEOs of all companies in which the fund invests. The letter pleads with the companies to become more sustainable by adopting strategies for dealing with issues such as climate change.

The annual letter is a low-cost option. The chairman’s cajoling makes front page news in leading business publications, but because the law still requires CEOs to protect their company’s assets, the letter has little effect.

Both socially responsible investing and the gentle persuasion engaged in by universal owners makes for lots of press releases and headlines about improved corporate behaviour, but neither strategy is solving the problem of corporate abuse of the public interest. The destruction of the public interest (e.g., global warming, human rights violations and illness and death caused by dangerous products) continues.

Existing law encourages, if not requires, companies to protect their investments in businesses that are emitting greenhouse gases, violating human rights, manufacturing dangerous products and otherwise abusing the public interest. Without a change in the law, this behaviour is not going to stop.

Opportunity

The European Parliament (EP) now proposes to change the law. It will make mandatory what most people already thought was preferrable and the world’s largest stockholders now find desirable. The change in law will instil a conscience in corporations that has been missing for too long.

Business should be socially responsible. Big companies should first of all do no harm. Making money is not an excuse for simultaneously destroying the environment and other elements of the public interest. The destruction must cease.

If adopted, the EP proposal will allow socially responsible investors to achieve their ultimate goal—protection of the public interest by making all companies socially responsible. So far, the advocates have tried to achieve this goal by investing in and showcasing companies that already do no harm. In fairness, this was the corporate social responsibility equivalent of picking the low hanging fruit. Enactment of the EP proposal will allow the socially responsible investors to declare victory and move on to the hard work of reforming the behaviour of companies that are doing real harm.

The proposal gives also universal owners a low-cost opportunity to reduce sustainability risk in their portfolios.

Conclusion

Advocates for more socially responsible business and universal owners should all get behind the EP proposal. It has the potential to be a pivotal point on mankind’s road to survival and evolution. It’s a simple (but elegant) solution to the problem corporate abuse of the public interest, a problem that has plagued humanity for too long.

It’s time to move on to the heavy lifting of reforming companies which are doing the most harm to our planet, our people and our communities. The EP proposal is a necessary first step that will allow us to begin this important work. It is an idea whose time has come.

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