Has era of sustainable capitalism arrived?
Some of the world’s largest companies and their investors are realising the connection between ESG principles and financial performance, says Jon Hale from Morningstar, Chicago.
We're entering a new era of sustainable capitalism, an attempt to make the global economy more resilient and work for more people over the long run. The evolution of global capitalism since the end of the Cold War has resulted in the world's largest corporations growing to almost unimaginable proportions, conferring on them enormous influence on the world today, while reducing the capacity of sovereign governments to regulate corporate activity in consistent and effective ways.
Sustainable capitalism acknowledges those central facts and asks corporate leaders to assume a greater level of social responsibility, taking into account the concerns of all stakeholders, not just those of shareholders. In essence, it asks investors to do the same thing as they evaluate companies and, as shareholders, engage with them.
None of this is to say that firms should no longer maximise shareholder value; it is to say that shareholder value is maximised when managers take a more holistic, responsible long-term view. More evidence that this new era is upon us came last week when BlackRock chairman and executive officer Larry Fink released his annual letter to CEOs.
Titled "A Sense of Purpose," the letter states flatly that companies need to do more than make profits. In order to prosper over the long run, Fink states, companies must serve a social purpose. These excerpts from the letter, which you can read in its entirety here, convey Fink's basic argument:
- "Society is demanding that companies, both public and private, serve a social purpose."
- "Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the community in which they operate."
- "To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society."
The New York Times columnist Andrew Ross Sorkin wrote that Fink's letter could be a "watershed moment on Wall Street" and one "that raises all sorts of questions about the very nature of capitalism."
Indeed, when the CEO of the world's largest asset manager, with more than $6 trillion of investor assets, makes these claims, it's safe to say the whole world is watching.
Fink's letter may well grab the attention of those who haven't been paying attention. But it did not come out of the blue. It reflects thinking and trends that have been in place for a while and that have been given added impetus in the aftermath of the financial crisis and by efforts to limit the impacts of climate change. And in the end, I doubt that what Fink says in his letter is going to create "a firestorm in the corner offices of companies everywhere," as Sorkin warns, because it already reflects the thinking of a growing number of corporate executives, like the 237 CEOs of large multinationals who recently pledged to begin disclosing the risks to their businesses from climate change.
Let's take a closer look at those quotes from Fink's letter:
"Society is demanding that companies, both public and private, serve a social purpose."
This statement reflects the realisation that companies, particularly large multinational corporations, have enormous influence on the world today, and governments are less effective regulators of global capitalism, because they are constrained by sovereign borders and because political institutions in many countries have grown increasingly dysfunctional.
Global capitalism is a system in which the power of sovereign governments is weaker and that of large corporations greater. Against that backdrop, corporate leadership is increasingly aware that corporate actions have consequences not just for shareholders but for society as a whole and even for the health of the planet.
In the absence of effective government regulation to set forth the rules of global capitalism, they have little choice but to make decisions based on the demands of all relevant stakeholders, including shareholders but not only shareholders, and on their own sense of responsibility.
"Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the community in which they operate."
Stakeholders are activated today around sustainability. Employees have largely lost out on wage gains during the rise of global capitalism, while shareholders have benefited, resulting in a more unequal distribution of wealth. That hardly seems sustainable over the long run in a consumer-based global economy.
Wages aside, companies are more focused than ever on providing best-in-class workplace benefits as they compete to attract talented workers, who themselves are attracted to companies with a social purpose. Customers and communities are also demanding sustainable solutions, from more healthy products to less wasteful packaging to lower carbon emissions.
"To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society."
Not all companies produce goods and services that clearly make a positive contribution to society. But all companies employ workers and they can treat them fairly, pay them a decent wage or salary, provide a safe workplace.
Large multinationals can also drive improvement in working conditions throughout their supply chains. Companies can reduce their carbon footprint and reduce their waste streams. Those that have prospered from making harmful products can work to mitigate their effects, as their long-term survival may well depend on it, given the healthier attitudes of consumers in many parts of the world.
This is what sustainability looks like
Before I even came across Fink's letter in the Times, I had already seen these items in the Chicago Tribune: McDonald's announced that by 2025 it will recycle packaging in all of its 37,000 restaurants around the world, and that all of its packaging will come from renewable, recycled, or certified sources where no deforestation occurs. A McDonald's spokesperson said recyclable packaging was the top concern of their consumers globally.
While undoubtedly a move that comes with a big price tag, the benefits include reduced waste (according to company estimates, each restaurant produces more than a tonne of waste every week), reduced use of natural resources, improved consumer experience, and better overall public relations.
Ford announced it will invest US$11 billion to bring 40 electrified vehicles to market by 2022, more than doubling the US$4.5 billion it planned to spend between 2015 and 2020. Ford expects fuel economy and pollution standards to get tougher "and rightfully so," said Raj Nair, Ford's head of North America operations.
These are everyday examples of companies doing what Fink suggests in his letter: connecting what they do with a bigger social purpose. I call it sustainable capitalism. Or maybe we should just call it enlightened self-interest.
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Jon Hale, Ph.D., CFA, is Morningstar's US-based head of sustainability research. A version of this article was originally published in the January 2018 issue of Morningstar FundInvestor.
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