Capital Matters

Counting the Shareholder Out: When the Ruling Class Changes the Rules

A trader works on the floor of the New York Stock Exchange in New York City, March 10, 2020. (Andrew Kelly/Reuters)
A ‘socially responsible’ numbers game.

It comes as no surprise that Bloomberg News, which includes a section called Bloomberg Green, also features another called Good Business — a venue dedicated to “sustainable finance and leadership for a changing world.” His presidential campaign aside, Mike Bloomberg tends to get what he pays for.

It’s also not a surprise that Bloomberg journalist, Saijel Kishan, has written a piece  for Good Business headlined “How Wrong Was Milton Friedman? Harvard Team Quantifies the Ways.” In this context, the target of the Harvard correction squad is, above all, Friedman’s 1970 article for The New York Times Magazine on shareholder primacy, the one in which, Kishan relates:

Friedman . . . declared that a corporation choosing social responsibility over maximizing profits was practicing socialism — a “fundamentally subversive doctrine,” he called it in 1970. In a free society, Friedman said, “there is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”

Kishan gives herself only a few lines to describe that piece, which may explain why it is unclear whether Friedman was labeling socialism or a “corporation choosing social responsibility” as “fundamentally subversive.” Friedman had no fondness for socialism (#understatement), but in this case, he was referring to “social responsibility,” a notion he thought had implications far beyond the corporate sphere, none of them good:

The doctrine of “social responsibility” taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collective doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means.

When applied to corporations, most notably today through the idea of “stakeholder capitalism” — the belief that the managers of a company owe their primary duty to a hazily defined collection of “stakeholders” rather than to the shareholders — the betrayal is not just of those who own the business, but of democracy itself.

As I have argued in earlier articles, reducing a company’s shareholders to just another category of “stakeholder” effectively transfers the power that capital should confer away from its owners and into the hands of those who administer it. And that power is increasingly being used to support an agenda influenced by a cabal of activists, NGOs, representatives of the “international community,” and politicians too arrogant to go through the standard legislative process. Subversive? I’d say so.

Contrary to Kishan’s phrasing, Friedman did not regard this as a matter of corporations “choosing social responsibility.” Rather, he understood that this was a choice by a corporation’s managers and that it was taken at the expense of their shareholders.

After all, as Friedman put it:

A corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to [the] basic rules of the society, both those embodied in law and those embodied in ethical custom.

Friedman regarded the executive’s decision to spend shareholders’ money in the pursuit of some broader “social” aim as equivalent to a tax. This, Friedman goes on to argue,

raises political questions on two levels: principle and consequences. On the level of political principle, the imposition of taxes and the expenditure of tax proceeds are governmental functions. We have established elaborate constitutional, parliamentary and judicial provisions to control these functions, to assure that taxes are imposed so far as possible in accordance with the preferences and desires of the public — after all, “taxation  without representation” was one of the battle cries of the American Revolution. We have a system of checks and balances to separate the legislative function of imposing taxes and enacting expenditures from the executive function of collecting taxes and administering expenditure programs and from the judicial function of mediating disputes and interpreting the law.

The whole justification for permitting the corporate executive to be selected by the stockholders is that the executive is an agent serving the interests of his principal. This justification disappears when the corporate executive imposes taxes and spends the proceeds for “social” purposes. He becomes in effect a public employee, a civil servant, even though he remains in name an employee of a private enterprise. On grounds of political principle, it is intolerable that such civil servants — insofar as their actions in the name of social responsibility are real and not just window-dressing — should be selected as they are now. If they are to be civil servants, then they must be elected through a political process. If they are to impose taxes and make expenditures to foster “social” objectives, then political machinery must be set up to make the assessment of taxes and to determine through a political process the objectives to be served.

This is the basic reason why the doctrine of “social responsibility” involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce resources to alternative uses. . . .

Kishan correctly observes that “cracks in adherence” to shareholder primacy are showing:

Last year, the Business Roundtable, a group of the largest U.S. corporations, surprised many business leaders when members committed to broadening the beneficiaries of their firms’ work from simply shareholders to customers, employees, suppliers and communities.

To different categories of “stakeholder,” in other words.

A quick glance at the expanding reach of “woke capitalism” reveals that these ideas are not confined to the rising number of company leaders who have signed up to the Business Roundtable’s redefinition of the purpose of a corporation — a redefinition that has replaced shareholder capitalism with its parasitic stakeholder substitute.

The vise has been tightened further by the widespread adoption of SRI — “socially responsible” investing, often packaged as investing in a manner that measures up well against certain vaguely defined environmental, social, and governance (“ESG”) yardsticks — by various investment managers and those who sell to them. If investors freely wish to invest in ways that are in accord with their consciences, that’s fair enough, but in an era of ever more coercive forms of “liberalism,” the value put on free choice is not what it once was. To take one example, by the end of 2020 all active portfolios and advisory strategies of the investment giant BlackRock will, the company has explained,

be fully ESG integrated — meaning that, at the portfolio level, our portfolio managers will be accountable for appropriately managing exposure to ESG risks and documenting how those considerations have affected investment decisions.

As I noted in May:

Investors are free not to invest with BlackRock, but because BlackRock is so large, that doesn’t eliminate the problem that this new policy could pose. Before the coronavirus crisis began, BlackRock had over $7 trillion under management. If a company doesn’t play by BlackRock’s ESG rules, it risks shutting itself off from a potentially substantial source of capital and/or support for its share price. If a company’s management decides that it doesn’t want to run that risk, it may have to adopt policies that damage the business’s long-term prospects. That might help the share price, at least for a while, but it is hardly a desirable outcome.

Even if a company has no interest in having BlackRock as a shareholder, BlackRock may have an interest in it. Once BlackRock takes a stake in a company, the chances are that it will apply pressure on management, as any shareholder has the right to do. Most shareholders only do so to increase their return, but BlackRock, whatever its claims about the connection between “sustainability” and longer-term profitability, has other targets in mind:

“We have engaged with companies on sustainability-related questions for several years, urging management teams to make progress. . . .  Given the groundwork we have already laid and the growing investment risks surrounding sustainability, we will be increasingly disposed to vote against management when companies have not made sufficient progress.”

“Sustainability” can mean many things, but profit maximization is not one of them.

As I have argued before, stakeholder capitalism is an expression of corporatism:

A hydra-headed ideology with origins in the premodern, and a very mixed past — sometimes benign (it influenced the formation of West Germany’s social market economy) and sometimes not (it was a significant element in pre-war fascist theory). The different forms corporatism has taken make it tricky to define with precision, but they share a common core: the conviction that society should be organized by and for its principal interest groups — let’s get back to that word “stakeholders” — intermediated by, and ultimately subordinate to, the state. . . .

Thus it was not reassuring to learn that Joe Biden had picked Brian Deese to serve as director of the National Economic Council. While working in the Obama White House, Deese played a crucial role in negotiating the Paris climate deal, and later went on to become the global head of sustainable investing at BlackRock. He is the second BlackRock veteran to get the nod. Wally Adeyemo, Biden’s nominee for deputy treasury secretary, had been a senior adviser and interim chief of staff to Larry Fink, BlackRock’s chairman and CEO.

Meanwhile, as the Wall Street Journal noted, Tom Donilon, a former national-security adviser for President Obama and chairman of BlackRock’s think-tank arm — and, incidentally, brother of a key Biden adviser — will remain in the private sector. (He had reportedly been in the running for the top job at the CIA.) The same will be the case for Fink, the driving force behind BlackRock’s embrace of ESG and stakeholder capitalism. But to believe that Fink’s ability to whip companies into line will not be enhanced by his connections with the new administration would be remarkably naïve, and to misunderstand how corporatism — where there are no clear boundaries between private and public sectors — works.

Part of the essence of corporatism is its stress on at least the illusion of cooperation. Its underlying structure has some resemblance to that of an orchestra. But every concert needs a conductor. The only question is how domineering that conductor will be. Biden has called for “an end to the era of shareholder capitalism” and dismissed the argument that a company’s primary responsibility is to generate returns for shareholders as “untrue and a farce.” Factor in the BlackRock ascendancy, and what lies ahead is not difficult to guess.

This will please Harvard Business School professor George Serafeim, whom Bloomberg’s Kishan has identified as the leader of the “Friedman-busters.” Serafeim was (in his words) “doing ESG before it was cool,” a comment that, whatever its accuracy — fashionable is one thing, “cool” quite another — shows where he stands. Although this is nothing he has tried to conceal.

Serafeim has played different roles in the flourishing, and often profitable, ecosystem that both feeds off and nourishes SRI, stakeholder capitalism, and similar corporatist creeds. He is also the chairman of Greece’s National Corporate Governance Council, and was an early and (unpaid) member of the Standards Council of the Sustainability Accounting Standards Board (“SASB connects businesses and investors on the financial impacts of sustainability”). In 2013 Serafeim co-founded KKS Advisors, a consultancy set up to “advise leading organizations on bold and effective strategies that pave the way to a sustainable society.” Its reach is “global” and its focus is “on efforts which foster systemic change.” It’s language such as this, clarifying in its confident directness, that is a reminder both of the ambition of today’s corporatists and of their willingness to bypass the regular democratic process. But “systemic change” should be left to the voters to decide.

Meanwhile, an article that Serafeim wrote for the Harvard Business Review (September–October 2020), as part of its Making Sustainability Count series, offers more than a glimpse of the ecosystem in which he works. He relates how KKS recently cooperated with the Strategic Investor Initiative, an outgrowth of CECP (Chief Executives for Corporate Purpose: “Creating a Better World Through Business”), a “CEO-led coalition,” founded by Paul Newman. On its website CECP explains that it “believes that a company’s social strategy — how it engages with key stakeholders including employees, communities, investors, and customers — determines company success.” Ah, stakeholders.

CECP’s “affiliated companies include Accenture, Adobe, Aflac, Altria, American Airlines, American Express, Amgen, Applied Materials, and AstraZeneca — and that’s just some of the A’s. Inevitably, a major theme from CECP’s 2020 investor forum was that (my emphasis added):

Stakeholder capitalism has taken center stage in a very short amount of time. All eyes are on CEOs and their companies as they take intentional actions to operationalize what it means to put employees, customers, communities, investors, and suppliers at the core of business strategy and create long-term sustainable value for all.

Investors in the companies represented at this forum must have been delighted that they rated a mention.

Back to Serafeim in the HRB:

The implementation of an ESG strategy involves large operational and strategic changes. It must start at the top with the board and be diffused through the entire organization. . . .  The board should be the entity that ensures that ESG metrics are properly considered in executive compensation and are adequately measured and disclosed as part of the audit committee’s work. Indeed, my colleagues and I have found that one of the characteristics of organizations with high ESG performance is a process that deeply embeds ESG issues in the board’s work and in executive pay. . . .

Microsoft and other technology firms have tied executive compensation to workforce diversity targets.

But Serafeim wants the “metrics” to be taken much further than that:

Investors struggle to embed [ESG] metrics in financial models because it’s not clear what they mean or how they can affect the financials. One solution might be the creation of a system of impact-weighted accounting that could measure a firm’s environmental and social impacts (both positive and negative), convert them to monetary terms, and then reflect them in financial statements. Though the science to do this has yet to be perfected, such a system holds great promise for three reasons: It would translate impacts into units of measurement that business managers and investors understand; it would allow for the use of financial and business analysis tools to consider those impacts; and it would enable an aggregation and comparison of analyses across types of impact that would not be possible without standardized units of measurement.

Science!

At the Impact-Weighted Accounts Initiative (a Harvard Business School project that I lead), we are collaborating with the Global Steering Group for Impact Investing and the Impact Management Project on a simple approach: adjusting traditional accounting measures to consider the various types of impact that ESG actions might have.

Back to the ecosystem again.

The Global Steering Group for Impact Management is a charity established in the U.K. “to continue the work of the Social Impact Investment Taskforce established under the UK’s presidency of the G8. It currently covers 33 countries and brings together impact leaders from the worlds of finance, business, government and philanthropy.” Among its funders are the British taxpayer, the Ford Foundation, the MacArthur Foundation, the Rockefeller Foundation, and, well, you know how it goes.

The British taxpayer, the Ford Foundation, and the MacArthur Foundation pop up again as advisers — “a diverse group of thoughtful organisations, whose guidance and funding make this industry effort possible” — to the Impact Management Project (IMP), as do a number of companies including Aegon, Bank of America, and, wait for it, BlackRock. On top of that, the IMP boasts a “Structured Network,” which includes the Climate Disclosures Standards Board, Global Reporting Initiative (GRI: “Our mission is to enable organizations to be transparent and take responsibility for their impacts, enabled through the world’s most widely used standards for sustainability reporting — the GRI Standards”), our old friends at the Sustainability Accounting Standards Board, and various UN agencies. Then there are the IMP’s “Strategic Partners” — “a group of organisations whose partnership is essential for informing and/or disseminating standards of impact measurement and management to specific communities of practice.” These include IIX Global (“the pioneer in impact investing and the global leader in sustainability”), with “partners” that include the Rockefeller Foundation (again), JPMorgan, and the US taxpayer, Impact Alliance, the Impact Investing Institute, and Foro Impacto.

Finally, there is the IMP Practitioner Community, “a wide range of organisations who bring expertise and experience to the table to find agreement (norms) on technical topics and share best practices in implementation.” These include (and brace yourself for this): Atlas Impact Partners, Australian Impact Investments, Impact Investing Australia, Frank Impact, Social Impact Projection, the Hong Kong Institute of Social Impact Analysts (a member network of Social Value International, another rabbit hole that I’ll avoid today), Impacctt (“an award-winning ethical trade consultancy,” which should not be confused with ImPPPact), Impatrics, Impact Analytics, Impact Capital Managers (“a network of private capital fund managers . . . investing for financial returns and impact,” a network which includes Morgan Stanley and Bain Capital and is partnered with, among others, you guessed it, the Ford Foundation and the MacArthur Foundation), Impact Finance, Impact Invest, the Impact Investors Council, Impact Management Practitioner (“we use a stakeholder centered approach”), Impact Track, Impact Seed, Impact Square, Impactvest Capital, Impak Finance, and Impax Asset Management.

So yes, there is an ecosystem, and the observant will have noticed that a number of its participants have some variant of the word “impact” in their name. The GIIN (Global Impact Investing Network — supporters of which include the taxpayers of various countries, JPMorgan Chase & Co., the Ford Foundation, the MacArthur Foundation, and the Rockefeller Foundation) explains, in part, what is going on: “Impact Investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.”

To oversimplify, Impactworld is a part of the larger SRI–stakeholder ecosystem. It too is populated by the sincere, the misguided, and, of course, the opportunistic, who see the potential for both power and profit that this space offers. Beyond the obvious — looking at, say, the environmental impact of a given project, industry, or corporate activity — the twist represented by impact investing borrows an idea central to the marketing of ESG: that it is possible to do well by doing good. While that conceit, as it applies to ESG, relies, at best, either on facts that are temporary (as market prices will rapidly adjust to reflect any ESG advantage) or on the peddling of illusions, there is no reason that impact investing itself cannot work. The main question will be how the investment’s financial return can be balanced with that “positive, measurable social and environmental impact.”

Pay attention to that word “measurable,” a superficially simple concept that, in his discussion of impact, Serafeim takes to places where no shareholder interested in return should want it to go. Specifically, check out the passage flagged above, where Serafeim advocates “adjusting traditional accounting measures to consider the various types of impact that ESG actions might have.” Adjusting.

The mission statement of Harvard Business School’s Impact-Weighted Accounts Initiative (headed, as noted above, by Serafeim) spells out what such adjustments are meant to achieve:

To drive the creation of financial accounts that reflect a company’s financial, social, and environmental performance. Our ambition is to create accounting statements that transparently capture external impacts in a way that drives investor and managerial decision making.

The argument over factoring in “external impacts” (or, to old-timers like me, externalities) is nothing new. But Serafeim wants to take it much further than, for instance, debating the pricing of carbon emissions.

Kishan explains:

Profit and loss aren’t enough, says the Harvard Business School professor. Serafeim aims to do what no one has done before: Put a dollar value on the impact of products and operations on people and the planet, then add or subtract it from companies’ bottom lines.

Intel Corp. provides an example of both. Serafeim and his five-person team credited $6.9 billion to the chipmaker in 2018 for paying its employees well and for boosting local economies where it has offices. But they deducted $3.1 billion for what they said was a shortage of women employees, the difficulty of career advancement and not enough attention paid to workers’ health.

“Without monetizing impacts, we’re left with the illusion that businesses have no impact,” Serafeim said. Companies that show big profits can have enormous negative effects on society, he said. “They’re just cheating because they’re operating in a context that doesn’t price all those impacts.”

Serafeim’s research throws out the playbook of measuring business performance primarily by shareholder value.

“Throws out”? Well, what it does is replace Friedman’s undeniably objective measure of financial return with — whatever Serafeim’s computers may spit out — subjective judgments. It “throws out” Friedman, yes, but then the Inquisition “threw out” Galileo.

Kishan continues:

Serafeim’s goal is to value intangible, non-financial factors. By tapping machine-learning technology, Serafeim and his team evaluate products and services on factors that include how accessible and affordable they are, their health and safety, and the ability to recycle them.

This means charging credit-card companies for the medical costs of depression connected to indebtedness, debiting airlines for the human toll of flight cancellations and making food producers accountable for health issues related to obesity. Their calculations also credit automakers for the safety of their vehicles and companies that hire in areas of high joblessness.

On employment, the team assesses issues such as the quality of wages paid, the number of Black women in high-salary positions and the impacts of sexual harassment.

The hard, if infinitely debatable, numbers generated by Serafeim’s method might subject managers to a tougher standard of accountability than is normally associated with stakeholder capitalism, but they will act as an even more efficient solvent of the duty those managers ought to owe their shareholders. As an assault on property rights that’s bad enough, but by incentivizing management to shift its focus away from a conventionally measured bottom-line, this approach will be far more damaging to profitability than the usual ESG yardsticks. This will rob society as well as shareholders of the extra wealth that would otherwise have been created.

That such ideas are taken seriously — and by whom they are taken seriously — reflects the rot that is spreading within what passes for capitalism’s intellectual leadership, whether in business schools or the C-suite. The membership of the advisory councils of the Impact-Weighted Accounts Initiative (or Project, take your pick) includes the co-founder of a major private-equity firm, the CEO of a major British asset-management firm, a Morgan Stanley board member, a prince, a partner at McKinsey and, naturally, denizens of the sustainability ecosystem, such as asset managers, consultants, a former chief sustainability officer, the CEO of IMP, the CEO of the Value Balancing Alliance (“we integrate business into society and nature for a better future”), and so on.

What’s more, Kishan notes:

Already, about 60 companies globally, including Dutch bank ABN Amro Bank NV, Kenyan telecommunications firm Safaricom Plc and Sweden’s Volvo Group, have quantified some of their impacts, Serafeim said. French food producer Danone has introduced a metric called “carbon-adjusted” earnings per share.

Doubtless, others will follow their lead and almost certainly overtake them. When the ruling class changes the rules, it’s not easy to push back.

Recommended

The Latest