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End s-factor blindness

Sustainable capitalism is now in vogue. This is very welcome but advocates would have more credibility and impact if they paid greater attention to the ‘s’ (social) of ESG.

And I am talking as much about the 10% of the investment world that has signed up to ICGN and UN PRI as the majority that has not. When it comes to the ‘s’ of ESG, ‘responsible investors’ are largely indistinguishable from the 90% who make no such commitments.

Take corporate tax avoidance. Investors, including most ESG analysts, have been silent, with one or two honourable exceptions.

The same goes for human capital management (HCM), including the epidemic of employee discontent. This is despite a huge body of evidence that shows that HCM can be analysed rigorously and is hugely material to corporate performance.

Also widely ignored is record income inequality. This may be good for fund returns because of the greater profitability of corporations. But US firms are neither paying labour its (historic) share nor are they hiring in the US.  

Meanwhile, investors continue to be disinterested in not only the ‘quantum’ (totality) of compensation but also in intra-firm pay differentials between CEOs and other executives and between the CEO and median salary. This includes many investors who are active on corporate governance.

Whistleblowing, an obvious response to Macondo/BP-style organisational blowouts, is still resisted by many executives who, in parallel, also say their biggest worry is what they don’t know. And investors are still largely silent.

Some corporate titans – HSBC, Wal-Mart, Barclays – have been successfully prosecuted for money laundering, bribery and corrupt practices. Yet how many investors act as if these are isolated cases.

Finally, Harvard’s Clay Christensen has described how firms – with investor encouragement – have become more focused on (eventually self-defeating) innovation that cuts costs.   

The good news is this blindness to social factors creates an opportunity for investors. Progress will come from finding the connection between these apparently disparate manifestations, and then discovering good leverage points for systemic change, the tipping points.

My bet on the best leverage point is to replace the ideology of shareholder value maximisation.

Let’s use HCM as an illustration. Executives raise their share price because investors pay them to. When boom turns to bust, there is a change of CEO and the game starts again.
In practice, this boom and bust isn’t a concern for investors. Index investors have no reason to care whether a particular company is in the index or not. And active investors hope to ride the bubble and get off at the right time. The reality, as academics have repeatedly shown, is that making money on timing is impossible to do on any consistent basis.

For most employees (those without major share-price incentives), engagement is the result of working for a company that does useful things and operates fairly. Once that is lost, in order to deliver never-ending share price growth and executive bonuses then, of course, employees cease to be engaged.    

This shareholder ideology can be linked with all the other social responsibility failures listed above. The most responsible thing investors can do is acknowledge that by pushing shareholder value so forcefully, they have been a significant part of the problem.

A mea culpa has little value without changes in practice. One priority is for investors to strongly encourage companies to do integrated reporting to drive integrated thinking, both among corporate executives but also investors themselves – changes in investor behaviour on the back of this changed reporting is the key.

Putting the ‘s’ – the fairness factor – back into the equation will also be critical to make the ‘e’ and the ‘g’ aspects of sustainability real. This, if nothing else, is good reason for sustainable capitalists and corporate governance advocates to lead the way.

Raj Thamotheram is an independent strategic adviser, co-founder of PreventableSurprises.com and president of the Network for Sustainable Financial Markets

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