Autor: Edouard Dubois and Ali Saribas, SquareWell Partners Ltd
Calls for a more responsible capitalism have gone louder in recent years. A major shift happened last August 2019 when the Business Roundtable (BRT) published a ‘Statement on the Purpose of a Corporation’. For the first time, the BRT, an organisation that represents the CEOs of America’s largest companies, embraced the concepts of corporate purpose and stakeholder capitalism. This was followed by the World Economic Forum’s Davos Manifesto which highlighted that a company serves not only its shareholders, but all its stakeholders. Meanwhile, investors are placing greater focus on how companies “create value” for the longer term and what their “purpose” is. They have been progressively integrating environmental, social and governance (ESG) factors in their investment decisions while they have experienced a rise of inflows in their sustainable investing products.
The shift in mindset and in capital allocation have undoubtedly put management teams in a challenging situation whereby they need to balance the market’s demands for financial returns while ensuring that their actions are not detrimental to the interests of other stakeholders. As the coronavirus pandemic is providing an acid test to the sustainability claims of companies and investors, this crisis and its aftermath may accelerate the adoption of a more stakeholder-oriented decision-making process at companies. In the words of the historian Yuval Noah Harari: “That is the nature of emergencies. They fast-forward historical processes. Decisions that in normal times could take years of deliberation are passed in a matter of hours.”
SquareWell has already witnessed evidence of this shift of behaviour from some investors who have pushed their portfolio companies during the crisis to prioritize their other stakeholders. For example, Legal & General Investment Management (“LGIM”), managing more than $1 trillion of assets, is reported to have sent a letter to portfolio companies that the suspension or reduction of payments to shareholders may be necessary to guarantee the long-term sustainability of the company. BMO Global Asset Management (with over $500 billion of assets) expects companies to reconsider their share buybacks programs given the effects of the crisis, while UK asset manager Schroders (with over $500 billion of assets) asked companies that they “prioritize their key stakeholders, in particular employees but also customers and suppliers”, as doing so will benefit both the economy and investors.
In this journey to a more responsible capitalism, companies that have defined their purpose will have a head start as they should be better at managing the tradeoffs between their different stakeholders. Some shareholders like BlackRock have been quite vocal in their support of the concept of corporate purpose but most have remained silent. Therefore, SquareWell Partners decided to go directly to the source and aggregated the views of investors collectively managing approximately $22.1 trillion in assets in order to understand how relevant the concept of purpose is seen on the investor side.
1. Corporate Purpose—is it relevant?
Alex Edmans, Professor at London Business School and author of “Grow the Pie: How Great Companies Deliver Both Purpose and Profit”, highlights in the Forward to the Survey that there is increasing evidence that there is a business case for purpose and that it is in investor’s interest to hold companies accountable for purpose, rather than viewing it as an unnecessary distraction. Indeed, Professor Edmans argues that while business reformers have argued that purpose can only become a reality if shareholder primacy is challenged, investors are not the enemy but partners in the repurposing of business. Professor Edmans points to the rigorous evidence that shareholder engagement doesn’t simply change the division of the pie, extracting profit at the expense of society, but instead grows the pie, making companies more productive and innovative, benefiting both shareholders and stakeholders alike.
Investors agree as 76% of them are already expecting companies to have defined their purpose and 93% think it is a necessary foundation to set a long-term business that creates value and strengthens corporate culture.
Are you expecting companies to have defined their purpose?
Why do you think it is important for companies to define its purpose (you can pick more than one)?
An overwhelming 93% of respondents identify the board as responsible for defining the company’s purpose compared to just 55% that identify the senior management team (including the CEO) as having this responsibility; however, investors identified the management team and the board as equally responsible for implementation. In their engagements with shareholders, board members will need to be able to explain what their corporate purpose is and what was the process to define it, or why they do not believe the concept to be relevant or useful.
Who is responsible for defining the company’s purpose (you can pick more than one)?
2. Corporate Purpose—How should it be disclosed and implemented?
When the BRT published their Statement on Corporate Purpose last year, the Council of Institutional Investors (CII) quickly published a response to remind companies that they should not forget that they are accountable to their owners. While the CII appreciates the BRT’s focus on long-term value creation, the CII warned that “stakeholder governance” and “sustainability” should not become “hiding places for poor management, or for stalling needed change”. In the same manner, investors expect the corporate purpose to have a tangible impact in the strategic decisions made by the board and the management. The survey highlights that for investors how purpose is implemented to be more important than how it is formulated. Investors are concerned by the possibility of “purpose-washing” by companies, i.e. defining a purpose as a mere marketing slogan, a façade to hide behind. In other words, companies will need to “walk the talk” regarding their purpose as their shareholders expect consistent disclosure regarding how the purpose has been fulfilled and reviewed by the board.
For 75% of the respondents, companies should come up with Key Performance Indicators (KPI) to measure their progress on fulfilling their purpose. Such KPI should then be included in variable incentive mechanisms of executives according to 59% of the investors surveyed. Companies should also assess if their purpose and these KPIs are aligned with the Sustainable Development Goals developed by the United Nations.
Would you expect the company to come up with KPIs to measure its progress on fulfilling its purpose?
Would you expect such KPIs to be included in executive pay programs?
While the Survey evidences a strong interest from the investor community regarding corporate purpose, these are still early days and only 21% of investors have already included the concept in their evaluation of ESG risks and opportunities. This could change quickly however as almost two-third of the surveyed investors are engaging with companies on their corporate purpose, which is the first step for them to evaluate the relevance of the topic. Companies that are successful in achieving this alignment between their purpose, their culture, their long-term strategy, their executive remuneration and their societal impact will have a much more attractive equity story to tell the market.
After the generalisation of Say-on-Pay, some shareholders are now asking a Say-on-Sustainability but only a third of participating investors would welcome a Say-on-Purpose. In the French market where companies have the opportunity to amend their bylaws to define their “raison d’être”, which requires shareholder approval, less than ten companies have taken the leap. Most companies are reluctant as they fear creating new legal risks while they are not convinced of the benefits. The ones which have done so received very high level of shareholder support though.
Sabastian Niles, a Partner at the Wachtell, Lipton, Rosen & Katz law firm, concludes the Survey by suggesting its results show that how companies define and articulate their purpose, organize the business of the board and management to achieve and monitor implementation of the purpose and engage with investors to win their support and partnership in delivering on purpose will increasingly impact how a company and its leadership are assessed and valued. The current pandemic crisis is laying bare for all to see which stakeholders companies are prioritizing and how they have integrated sustainability considerations in their culture and operations. Companies that had already defined their corporate purpose will most likely be in a better situation than their peers as the purpose should provide to board members a compass, a counterpoint to short-term financial metrics. Investors will use this crisis to re-assess how resilient and sustainable their investee companies really are.
As Alex Edmans says, “To reach the land of profit, follow the road of purpose.”
The full results of the survey are available here.