(Editor's Note: This report reflects the discussion held by the inaugural S&P Global Ratings Sustainable Finance Scientific Council on Dec. 3, 2020.)
- Companies are increasingly adopting stakeholder capitalism, focusing on long-term value creation for customers, employees, society, and the environment rather than just short-term value for shareholders.
- Realizing the full potential of stakeholder capitalism will require additional approaches to sustainability performance measurement and disclosure.
- The COVID-19 pandemic is sharpening the focus on stakeholder management: substantial government support to corporations has raised expectations of corporate responsibility to society.
A Delicate Balance Between Stakeholder And Shareholder Interests
Although broadly defined, the core premise of stakeholder capitalism is to find a balance and compromise in meeting the needs and serving the interests of all stakeholders: customers, employees, suppliers, communities, society, and the environment, as well as shareholders. It implies a company's purpose is to create sustainable long-term and shared value for all. Value creation is not just about profit maximization for shareholders but instead encapsulates a more holistic purpose, aligning the broader values of a corporation with those of society, while taking into account externalities, as Mark Carney, former governor of the Bank of England, described it in his recent BBC Reith Lecture in December 2020.
Traditionally, market focus on quarterly financial performance has kept pressure on management to meet shareholders' expectations. Companies have considered it paramount to maximize financial value, echoing Milton Friedman's belief that "the only social responsibility of business is to increase its profits". But what about a firm's value for society as a whole?
Over the past two decades, growing awareness of structural, environmental, and social trends threatening the long-term stability of the overall operating environment, together with the perceived responsibility of short-term focused shareholder value maximization strategies for past recent crises, have popularized the concept of stakeholder value as a means to promote a more sustainable development both for individual companies and for society as a whole. Recent high-profile public statements from the Business Roundtable, World Economic Forum, and BlackRock CEO Larry Fink's annual letter to CEOs all illustrate broadening support for stakeholder value and may possibly indicate a paradigm shift. Corporations are also embracing the concept, as reflected in the "enterprise à mission" created by the Pacte Law in France or the Benefit Corporation (B-Corp) in the U.S.
Yet, the "value" created by the pursuit of stakeholder capitalism is difficult to measure, which limits its current operational effectiveness. It requires the enhancement and standardization of nonfinancial disclosure around different metrics to ensure more transparency and accountability. Ignoring externalities such as global warming, increasing social fragmentation, and unrest may eventually backfire on a corporation's long-term operating environment and profitability. Ongoing shifts in stakeholder expectations vis-à-vis corporations may have tangible business and financial consequences. The balance between stakeholder and shareholder interests has become a delicate one.
Stakeholder Interests Are Not Always Aligned
Shareholders' and other stakeholders' interests can sometimes conflict and corporations have to make tradeoffs between clashing priorities and demands. This is no simple task. Even within each stakeholder group, for example, there are significant nuances. For example, the balance between different shareholders is an important factor for stakeholder capitalism and calls for debate on how best to allocate voting powers between majority and minority shareholders. Should each share hold equal voting rights (one share, one vote), or should shareholders holding shares for a longer period of time be granted additional voting rights (loyalty shares) as currently happens in some European countries?
Similarly, there are various types of customers, ranging from one-time buyers to loyal and regular customers. Each subset has a different level of importance to a company, which creates the challenge of deciding whose interests should be prioritized, and to what extent. Yet, even if a satisfactory compromise is reached, through what framework should businesses measure the value created?
In 2020, the race between AstraZeneca, Moderna, and Pfizer to develop a viable COVID-19 vaccine produced a clear example of this. When it came to pricing, AstraZeneca's vaccine proved by far the cheapest option, as it appeared to be prioritizing wider societal needs before reverting to commercial pricing. The Moderna and Pfizer vaccines, on the other hand, were more expensive, despite development costs being similar. As such, as Professor Rebecca Henderson has said, the "value" created by the AstraZeneca vaccine lies, first and foremost, in its ability to vaccinate a large proportion of society--particularly those in developing nations who need it most.
For some, this challenge of managing the often-contradictory interests of various stakeholder groups, suggests not only a fundamental limitation to stakeholder capitalism, but a potentially insurmountable impotence when it comes to addressing today's global challenges. Eugene F. Fama, winner of the Nobel Prize in Economics in 2013, goes as far as arguing "stakeholder capitalism does not exist. It is indefinite and ineffective. It is the easy alibi, the perfect sparring partner to ensure that the shareholder vision of the company continues to spread its doxa. It is too weak an alternative." The presence of externalities--which can be significant but are difficult to assess and value, in particular in the short term--further compound the difficulty of achieving better stakeholder interest alignment.
Such limitations became particularly evident in May 2020 amid the COVID crisis, when 11 major shareholders of the French multinational oil and gas company Total SE proposed that the company adopt absolute decarbonization targets for all its activities at the company's annual general assembly. Yet only 16% of voters were in favor of the motion.
True Value for Stakeholders Requires Better Disclosure
Realizing the full potential of stakeholder capitalism requires companies to transform their core principles into practice and embrace additional approaches to sustainability performance measurement and disclosure. This is not new. In 1997 the Global Reporting Initiative (GRI) was the first to recognize the importance of comprehensive reporting for all stakeholders. Pressure to report on sustainable value creation has been growing ever since.
In September 2020, the World Economic Forum released guidance in collaboration with the big four global accountancy firms on measuring stakeholder capitalism by providing a methodology built using metrics from existing reporting standards from the GRI and the Sustainability Accounting Standards Board, among others. This report suggested companies track their shared value contribution by defining metrics organized into four pillars--Principles of Governance, Planet, People, and Prosperity--to increase the comparability of sustainability reporting (see chart 1). At the same time, the five main global sustainability standard setters jointly agreed to work together on a single coherent global set of reporting standards. But many believe there is still a long way to go to achieve credibility and standardization in the field of integrated reporting.
Positively, this issue is being tackled by various high-profile institutions responsible for global reporting standards, such as the IFRS Foundation, which has recently consulted on the establishment of a Sustainability Standards Board. It can be unclear to companies what exactly they are either being asked or required to disclose and how to disclose on sustainability matters. This often means that data which is publicly disclosed is insufficient to perform detailed, comparable, and up-to-date analysis and benchmarking of sustainability performance, a key requirement to determine value creation for stakeholders. A set of standardized minimum data reporting and collection standards for auditable disclosures, using common definitions of key performance indicators (KPIs), could facilitate comparability in this regard.
There is also a case for defining and implementing a new accounting system, and integrating environmental and social performance measures for companies, in order to propose real prices for goods and services that integrate negative externalities. Indeed, financiers are increasingly requiring companies to demonstrate their commitment to sustainable development goals (SDGs)--as well as other global issues such as climate change, biodiversity depletion, and widening social inequality--with KPIs.
Another important question when it comes to stakeholder-aligned reporting is whether the indirect ESG impact of a company should be measured, along with the direct impact. Just as scope one, two, and three greenhouse gas (GHG) emissions are increasingly being disclosed under the GHG Protocol, should companies also disclose their "scope three" ESG impact of their activities, such as knock-on environmental and social effects across their supply chains? After all, in today's globalized business arena, companies do not operate in a vacuum.
Where Does All This Leave Fiduciary Duty?
Traditionally, under corporate law, the fiduciary duty of a corporation is to act in the best interest of its shareholders, rather than serving its own interests. Loyalty and prudence are recognized as the most important duties, ensuring that fiduciaries act in good faith, avoiding conflicts of interest, and acting with due diligence. In line with the Friedman doctrine, this has been historically interpreted by most as the pursuit of profit maximization. Yet, stakeholder capitalism challenges this view, suggesting directors should expand their fiduciary duty by also considering the effects of board decisions on all stakeholders. But there is currently no legal requirement to meet the interests of all stakeholders, with all the challenges of defining who these may be.
The UN-supported Principles for Responsible Investment (PRI), the UN Environment Programme Finance Initiative (UNEP FI), and many others have pointed to the importance of redefining the concept of fiduciary duty to encourage long-term sustainable growth and the economic health of companies. UNEP FI, in collaboration with lawyers Freshfields, published a report in 2005 that questioned whether the best interests of savers should only be defined as financial interest. "Indeed," it argues, "many people wonder what good an extra percent or three of patrimony are worth if the society in which they are to enjoy retirement and in which their descendants will live deteriorates."
Paul Watchman, a sustainable finance veteran, expands on this point: "The concept of fiduciary duty is organic, not static. It will continue to evolve as society changes, not least in response to the urgent need for us to move towards an environmentally, economically, and socially sustainable financial system." Some progressive asset owners and pension funds have long argued the case for rebooting the concept of fiduciary duty. It could be that their day has come.
COVID Shines A Light On What Society Values
The growth of sustainable investing could be seen as a reflection of stakeholder capitalism taking root. Companies that have focused on sustainability issues have empirically been shown to achieve lower costs, enhance employee productivity, mitigate risk, and generate new growth opportunities. Effective sustainability performance is also said to strengthen corporate resilience. Research from Bank of America Merrill Lynch even suggests that the integration of ESG initiatives and greater stakeholder engagement could help prevent around 90% of bankruptcies.
The COVID-19 crisis has sharpened the focus on stakeholder value. The pandemic has reaffirmed the materiality of sustainability-related risks and the deep links between businesses and their stakeholders across the value chains. In response to the pandemic, governments have provided substantial support to corporations to prevent economic collapse. This in turn has raised expectations about corporate responsibility and the purpose of corporations. Companies are now expected to invest more in employee health and wellbeing, safety protocols, fortifying cyber security, and ensuring business continuity.
By ignoring certain stakeholders, a company that chooses to act as if nothing has changed may suffer the negative consequences. The appearance of unduly profiting from the pandemic or excessively bowing to shareholder interests could result not only in reputational damage but also extend to undermining a company's license to operate. Insufficient consideration paid to all stakeholders in decision-making has backfired on a number of companies. In contrast, other businesses are taking actions that may ultimately strengthen employee engagement, brand, reputation, and ultimately business resiliency.
According to S&P Dow Jones Indices, the S&P 500 ESG Index outperformed the S&P 500 by 2.21% (see chart 2) since its launch in January 2019. It suffered fewer losses and recovered faster than the S&P 500 during the pandemic. COVID-19 may have acted as stimulus for sustainability-related growth but also, indirectly, as an opportunity for corporations to refocus their priorities in line with market expectations around sustainable growth.
Indeed, this data goes some way to illustrate the positive link between sustainability alignment and financial growth. But to better understand the role of sustainability as a risk-mitigation measure, other metrics could also be compared, such as the risk-return ratio and the volatility of each index.
It remains uncertain how much the COVID-19 crisis will lead to lasting fundamental changes. But it is likely that effective stakeholder management will become increasingly important for companies to successfully operate in a world of weakened public finances, social scars, and environmental degradation. In "The Anatomy of Sustainability", Julia Meyer notes "one can use the COVID-19-induced market crash as a natural experiment for stress-testing the extent and nature of market sentiment for sustainability, when uncertainty increases. Indeed, recent experimental evidence supports the empirically-drawn premise that sustainability is valued in times of uncertainty."
Protecting Values And Creating Value: Whose Responsibility Is It?
Following the stakeholder approach can raise issues around accountability because environmental, societal, and economic issues may end up being tackled by non-democratically elected leaders. Indeed, corporations may argue they are paying taxes to governments to cover these very matters. Yet, the same companies' decisions on product and raw-material sourcing, what they produce, where goods and services are sold, and how they treat their employees and interact with communities can all have huge sustainability impacts and lead to stakeholder value creation or destruction.
In some sub-Saharan African countries, where governments have deprioritized many social responsibilities, the duty of care has fallen on the shoulders of a few private sector firms--and even financial institutions--which are perceived by the public as having sufficient funds to tackle these issues. So, in markets like these, where should social responsibility end for private business, and where should it begin for governments? The lines are not clear cut. When it comes to addressing the impact of a pandemic or climate change, an effective partnership of public and private bodies is required in order to achieve tangible change. It can't be just one or the other.
Yet, the purpose of a corporation is being redefined. The aim is to increase economic and societal resilience by accelerating inclusive economics and societies (creating jobs, re-skilling, lowering unemployment) while shaping a new concept for economic integration and digital revolution. A more inclusive and holistic approach is even more crucial during the current volatile times in which many people are without their jobs and companies are forced to shut. The values that a corporation embraces can be as important as the value that it creates. From a stakeholder perspective, the two are inextricably linked.
The authors would like to acknowledge the contributions of Klara Kunsic of Maastricht University and Hamish Monk of Moorgate Finn Partners to this research.
S&P Global research
- S&P Global Response to IFRS Foundation Consultation Paper on Sustainability Reporting, Dec. 30, 2020
- Sustainable Finance Addresses Social Justice As COVID-19 Raises The Stakes, Nov. 10, 2020
- The ESG Lens On COVID-19, Part 1, April 20, 2020
- The ESG Lens On COVID-19, Part 2: How Companies Deal With Disruption, April 28, 2020
- COVID-19: A Test Of The Stakeholder Approach, April, 2020
- Fiduciary duty in the 21st century - Final report, UNEP FI, 2019
- Measuring Stakeholder Capitalism Towards Common Metrics and Consistent Reporting of Sustainable Value Creation, World Economic Forum, September 2020
- Where companies with a long-term view outperform their peers, McKinsey Global Institute, February 2017
- ESG Matters – Global, Bank of America Merrill Lynch, November 2019
- 4 ways stakeholder capitalism can create a more resilient post-COVID MENA region, World Economic Forum, June 2020
This report does not constitute a rating action.
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