Stakeholder capitalism: Moving forward from mere happy talk

Last July, the US Congress summoned CEOs from four of the largest tech companies for a hearing. Congress questioned the leaders of Amazon, Apple, Facebook, and Google about their alleged monopolistic practices and malign influence on democracy. The companies were held up as emblems of unfettered capitalism run amok.

Last summer also saw surging interest in social impact and sustainability in the business world. Billions of dollars flowed into responsible investment funds that focus on companies with strong performance on environmental, social, and governance issues, so-called “ESG funds”.

Only one problem. Check the top holdings of ESG funds at BlackRock, Vanguard, or many others and there they are again: Amazon, Apple, Facebook, and Google.

This is one of many ironies that plague efforts at capitalist reform today. It’s a movement with equal parts scepticism, cynicism, and idealism, because there is far more talk than action.

Happy talk

A year before the congressional hearing, we saw what may — or may not — prove to be a watershed moment in reforming capitalism.

The Business Roundtable issued its Statement on the Purpose of a Corporation, in which the CEOs of the largest corporations in the US recommitted to serving all their stakeholders. They pledged to work to benefit their customers, workers, communities, and the environment — in addition to shareholders.

Not to be outdone, the World Economic Forum followed up with their own statement last winter — the Davos Manifesto. “The purpose of a company is to engage all its stakeholders in shared and sustained value creation,” it reads.

Investors have made their own commitments. $11 trillion of assets have been committed to be divested from fossil fuels; $30 trillion of assets have now committed to ESG investing; and firms with $100 trillion of assets under management have committed to the Principles for Responsible Investment, an initiative begun by the United Nations that includes integrating ESG into investing.

The numbers behind these commitments are astronomical — so much so it’s a wonder we haven’t already fixed capitalism.

The problem is that while nine in ten business leaders agree that serving stakeholders beyond shareholders is important, 96% are satisfied with the job they’re already doing to serve customers, workers, communities, and the environment. And so evidence of stakeholder capitalism is everywhere but where it matters: in the lives of stakeholders.

Corporate philanthropy generates good press, but it’s less than a fifth of a percent of sales at the world’s largest corporations. Environmental and social scoring of companies is proliferating, but there is very little correlation between one agency’s ratings and another’s. And the Principles for Responsible Investment? Recent research has shown that there is no difference in the actions of investors who have signed on to the principles compared to those who have not.

We’ve constructed a Potemkin village of capitalist reform, where corporations and investors offer happy talk to appease the activists while leaving business fundamentals untouched.

The question is: What will it take to turn good intentions into enduring change?

A deeper purpose

Capitalism doesn’t have a publicity problem. It has a purpose problem. And to fix that, we need to hold corporations accountable to a purpose deeper than profit.

Much of this work is in the enlightened self-interest of companies themselves.

Over recent years, evidence has grown that a more stakeholder-oriented approach leads to greater business performance. In 2015, researchers aggregated results from thousands of empirical studies published over the preceding decades. They discovered that 63% of all studies found a positive correlation between ESG performance and financial performance. Only 8% found a negative correlation.

More recently, the strategy consulting firm McKinsey & Company published research with the academic Witold Henisz that identified the mechanisms through which ESG factors lead to value creation: top-line growth, cost reductions, fewer regulatory and legal interventions, productivity uplift, and investment and asset optimisation.

And all of this research is backwards-looking, based on historical data and sentiment that we know has only evolved. As a result, this research likely understates the benefit of focusing on public purpose and stakeholders.

Through the middle of the 19th century, corporations in the US put their public purpose into their charter. It was a legal requirement. The privileges of limited liability or legal personhood were granted by state legislatures only in exchange for a clear benefit to society.

The legal privileges persisted, but the requirements have not. Purpose now rarely extends beyond banal mission statements bandied about at corporate retreats and on website banners.

Legal charters still retain a vestigial structure that evinces the origin of the corporate form: an article requiring the company to state its purpose. But today, that purpose is almost always some form of the same narrow promise to follow the law. For example, according to the certificate of incorporation for Alphabet — Google’s parent company — its purpose is “to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware.”

Corporations organise private interests efficiently and productively, but they are powerful cars without steering wheels. Charters were meant to be the steering wheels.

Certain companies are recognising that there is power in orienting a company around a social or environmental purpose beyond profit. The French food giant Danone has taken the extraordinary step of putting purpose into its corporate charter, committing the company to “bring health through food to as many people as possible”.

Market fundamentalists — those Milton Friedman acolytes hewing to the more traditional ideology that companies must always and only maximise profits, trusting the invisible hand to deal with the rest — complain that such purpose must come at the cost of shareholder return.

But today, most value — even shareholder value — is driven by people. In 1975, 83% of the market value of the S&P 500 in the US was made up of tangible assets. Today, that ratio has flipped. Only 10% of the market value of our largest corporations is accounted for in tangible assets on the balance sheet. The rest is intangible, driven by creativity, trust, commitment, and goodwill. Companies seeking to maximise their value are forced to focus on what will best attract, motivate, and retain top talent. For younger generations, that’s often work with a deeper purpose than just profit.

Nonetheless, a global survey of 12,000 white collar workers across a range of industries found that half felt no connection to their company’s mission. This lines up with Gallup’s annual survey on engagement. More than half of American workers don’t feel engaged at work, and more than one in eight is so disengaged that they actually work against the interests of their employers — a half-trillion-dollar drag on the US economy.

We’ve seen significant momentum in the US and Europe, for example, in improving the diversity on corporate boards. State Street Global Advisors, an investor in 10,000 public companies, and others have made it a major part of their shareholder advocacy.

This is good. It’s important for us to improve who is represented on boards. But we should also consider whose interests those board members represent.

If boards continue to believe that their role is purely to maximise shareholder profits, then a more diverse board will not necessarily lead to better outcomes for workers, communities, or the environment. Meet the new boss, same as the old boss.

Managers may say that employees are their greatest asset, but shareholders know that employees aren’t on the balance sheet. They’re on the income statement — as an expense line meant to be minimised. And value-destructive disengagement within our workforce is the result.

With the majority of corporate value dependent on the ideas, efforts, and commitments of human beings, corporations must reorient themselves around a deeper purpose than profit. This is what stakeholders increasingly expect. Three quarters of people now say that CEOs should “take the lead on change rather than waiting for government to impose it”. Actions like Danone’s are not so much a breach of fiduciary duty as a realisation of its purpose.

Over the last two generations, successful corporate strategy has shifted from the realm of physics to psychology, from the detailed accounts on the balance sheet to softer assessments of human motivation. Business practices that were broadly accepted in the 1980s may be less socially acceptable today. As recent employee and consumer protests have shown, business leaders ignore these trends at their peril.

Creating accountability with measurement

To prevent corporate purpose from being yet another layer of happy talk, we need mandatory, standardised, and audited metrics that extend beyond the financial statements to account for a corporation’s social and environmental impact.

Over the last nearly 30 years, we’ve seen immense growth in corporate responsibility reporting. In KPMG’s analysis of the largest 250 corporations in the world, companies reporting on their corporate responsibility increased from 35% in 1999 to well over 90% in recent years.

However, most of this data is self-reported and bespoke — unstandardised and difficult to aggregate, even where it should be obvious, like in measurements of carbon emissions. In other areas, like social indicators, researchers have found that 92% of what’s measured is effort, not effect. Companies may report that they have an ESG policy, but not on their actual emissions, for example. An ESG policy is a good start, but it’s only a start.

Holding corporations accountable to a purpose deeper than profit will require expanded metrics by which to judge them. Investors should be demanding this, as some already are. Following the Davos Manifesto last year, the World Economic Forum published a report, Toward Common Metrics and Consistent Reporting of Sustainable Value Creation, that charts one possible path forward.

Ultimately, we get to decide what makes for successful corporate strategy. As employees, consumers, savers, investors, and voters, we set the parameters in which corporations must compete. And while that’s well accepted in some roles — consumer activism, for example, has deep roots — we’re still figuring out exactly what responsible investing looks like and how best to exercise our power as employees to push our corporations to better reflect our values.

Only when our largest corporations become oriented around a deeper purpose and the ESG metrics they report become mandatory, standardised, and audited will we start to see happy talk turn into substantive action.

Does this mean that ESG funds should divest from Amazon, Apple, Facebook, and Google, just as they have from tobacco and fossil fuels? Not necessarily. If we’re worried about Big Tech’s potentially malign influence, the answer probably isn’t less oversight by responsible investors. But ultimately, the responsibility resides in all of us, in our roles as consumers and employees of these companies, as investors in these funds, and, ultimately, as citizens of the countries that oversee them, to hold them accountable.

Until we can put purpose in a corporation’s charter, hold it accountable to that purpose, and align its business model with its purpose, we’ll get what we’ve got: a thin veneer of stakeholder rhetoric painted over the cracked foundation of shareholder primacy.

Michael O’Leary and Warren Valdmanis are co-authors of Accountable: How We Can Save Capitalism (Penguin Business). They were on the founding team of Bain Capital Double Impact, the firm’s impact investing strategy. O’Leary is now a managing director with Engine No. 1, and Valdmanis is a partner with Two Sigma Impact. The views they express are their own. To comment on this article or to suggest an idea for another article, contact Alexis See Tho, an FM magazine associate editor, at AlexisSeeTho@aicpa-cima.com.