Partner, EY EMEIA Public Policy Leader
Is the debate around shareholder primacy fundamentally a red herring?*
The notion that shareholders’ interests should trump the interests of all other company stakeholders has been repeatedly challenged since the financial crisis. Those who ask the question are often not saying that the interests of shareholders are unimportant, or that the pursuit of profit is irrelevant. They are saying instead that there are many others besides shareholders who have a legitimate interest in how companies behave and how they repay the privileges society has conferred on them such as limited liability and, in the case of public companies, the opportunity to access capital markets.
At the 23rd European Corporate Governance Conference, held in Bucharest in April, international corporate governance expert Professor Mervyn King talked about the concept of the ‘healthy company’. This is a concept that resonates strongly with me. If companies don’t acknowledge their important role as enablers of sustainable growth over the long-term, they will suffer increasingly fierce criticism from their stakeholders and ultimately compromise their place in the broader social and economic ecosystem. In other words, those privileges I mention above will be taken away.
Mind the expectations gap
Unfortunately, companies that want to respond positively to this challenge are wrestling with an expectations gap. This expectations gap is between the majority of stakeholders, who want companies to be more long-term focused and take better account of their interests, and financial markets, which are still largely focused on short-term results. For the gap to close, we need the financial system be part of the solution, rather than part of the problem. So how can we bring this change about?
The good news is that there is a growing community of investors who are already focused on sustainability issues because they know that they will have a financial impact, either positive or negative, further down the line. Among these investors are Vanguard, which has launched two exchange-traded funds with an environmental, social and governance (ESG) focus; State Street, which offers a number of ESG products; and BlackRock, which even has its own mission statement on sustainability. These investors recognize that a company that pollutes the atmosphere, or is careless with its energy consumption, is creating a liability that will have to be borne by someone, somewhere, at a later point in time. If the company does not end up bearing the cost directly, then society will end up paying the bill. That inequity will catch up with the company eventually in both financial and non-financial ways.
Metrics and money
If investors are to allocate capital towards companies that focus on the long-term interests of their stakeholders, they need to be able to identify these companies and compare them with their peers. Although more and more sustainability information has become available to investors in recent years, many are still not confident about using it — often because it comes from different sources and cannot necessarily be tied back to performance over time. EY recognizes this, which is why we co-founded the Embankment Project for Inclusive Capitalism. The project has set out a number of different value drivers that are important for companies looking to achieve sustainable and inclusive growth — value drivers such as talent, innovation, environmental commitments and corporate governance — and the potential metrics that could be used to assess them.
Within the investment community, it is often said that companies get the investors they deserve. So, we will know we have succeeded in providing investors with the metrics that they need to measure long-term value when the money really starts moving — when it is the most sustainable companies that get the most investment or investment at a cheaper rate. When this happens, we will see a real change in attitudes. Unsustainable companies will quickly realize that their more forward-looking peers are overtaking them because they have the backing of investors who prioritize a long-term vision, above short-term results.
Back to the boardroom
Alongside metrics, we also need to embed new ways of thinking into the boardroom. That doesn’t necessarily mean stuffing boards with tech entrepreneurs, but it does mean understanding upcoming generations — how they think and what their values are. There is an opportunity for boards to get support from their own ‘advisory group’– a collective of people from different generations and walks of life who act as a kind of strategic focus group in terms of bringing fresh views and perspectives into to the boardroom.
The role of boards is critical in making sure that the long-term viability of a company is not sacrificed at the altar of short-term profit. They can give investors a better picture of their company’s long-term value, which will influence investors’ attitudes and decisions. They can also invest in assurance about a company’s resilience so that stakeholders have a better understanding and more confidence in what the company does to protect jobs and supply chains. Good businesses that thrive in the long-term take risks, but they also mitigate against those risks coming to pass. That’s why, in today’s fast-moving and volatile world, companies must prepare — and prove that they are prepared — to withstand shocks. Or if they are not prepared, they need to be clear to their stakeholders about that reality. Some companies, though, will fail, and we have to accept that.
Ensuring the long-term success of our most significant businesses — and all the jobs and wealth they create — is a collective responsibility. Everyone in the ecosystem has a role to play — boards, management, investors, auditors, customers, employees, suppliers and regulators. Yet, it is down to boards to lead the way and to make sure that they put sustainability front and centre of their agendas, and publicly convey how they are committed to delivering long-term value.
Doing right by the environment, doing right by society, and doing right by employees isn’t just about doing the right thing. Since it should lead ultimately to better financial performance over time, it is also in the best interests of shareholders. In the end then, perhaps the debate around shareholder primacy is actually a red herring. Because focusing on long-term sustainable growth will provide shareholders with the greatest value of all.
* This perspective from Andrew Hobbs are his reflections on the discussions held at the 23rd European Corporate Governance Conference in Bucharest, Romania on 2 April 2019.