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Shareholder value in a burning world

Oct 01,2020 - Last updated at Oct 01,2020

CAMBRIDGE – Does solving the climate crisis mean we need to change how publicly traded firms are run? Most corporate leaders believe they have a legal and moral duty to maximise shareholder value, and that they will be fired by angry investors if they do not. But many others worry that an obsession with profits is incompatible with environmental objectives.

After all, if fossil fuels are cheaper than renewables, maximizing shareholder value would seem to require the use of dirty energy. And if you are a fossil-fuel company, it is “rational” to spend hundreds of millions of dollars denying the reality of climate change and actively lobbying against regulation that addresses it.

Should we insist, then, that firms become “stakeholder-oriented”, generating “returns” not just for investors, but also for employees, customers, suppliers, and the broader community? It’s been done before. In the 1960s and 1970s, most firms claimed to have a responsibility to all of the constituencies they interacted with. And just last year, the Business Roundtable, representing the CEOs of America’s largest and most powerful corporations, offered a new definition of corporate purpose: “to promote an economy that serves all Americans”.

It’s a seductive vision. If I could wave a wand and transform every company into a “B corporation” – one certified for its “social and environmental performance” – I might do so. But, of course, I would then have to turn every investor into someone who is keen to fund these entities. Few investors are willing to relinquish that much power. Even if they could be forced to do so, much clearer standards about what constitutes stakeholder benefit would still be needed, not to mention agreements on how to make tradeoffs between competing interests. Without these conditions in place, telling managers to maximise stakeholder returns rather than shareholder value is an invitation for them to maximise their own interests at the expense of everyone else’s.

But there is hope yet. Corporate leaders are well aware that climate change is bad for business. It will be a lot harder to make money in a world where once-great coastal cities are underwater, agricultural failures produce massive waves of refugees, and unprecedented wildfires destroy hundreds of billions of dollars of property each year.

At the level of the entire economic system, there is no fundamental incompatibility between maximising profits and addressing climate change. But there is a massive collective-action problem: many individual firms simply have had no good business case for becoming a climate leader.

In recent years, however, many other firms have been investing aggressively to exploit immediate, profitable opportunities to address climate change. Investors did not pour more than $280 billion into the renewable-energy sector last year out of the goodness of their hearts. The most successful initial public offering of the last two decades was Beyond Meat, a plant-based burger company. And electric-vehicle manufacturer Tesla seems poised to become the most valuable company in the automotive industry. In these and many other cases, the pursuit of shareholder value is driving the kind of system-level innovation that can transform entire industries.

Moreover, some companies and sectors have turned to voluntary self-regulation. In November 2010, for example, the Consumer Goods Forum – comprising firms that together employ more than 10 million people – committed to achieving net-zero deforestation in the key sectors of soy, palm oil, beef, and paper. This was entirely consistent with profit maximisation. Growing consumer awareness of these sectors’ negative environmental impact had become a significant brand risk. Firms were increasingly worried about their ability to recruit talent or maintain viable supply chains. So, knowing that while costs might increase, they would increase equally for everyone, they took pre-competitive action.

To be sure, industry coalitions have rarely achieved their goals, because the temptation for individual firms to defect remains high. Nonetheless, the momentum behind coalition building in recent years has created a growing cohort of firms with strong economic interests in finding third parties to enforce cooperation. There are two obvious candidates for such a role: capital markets and governments.

Many of the world’s most significant pools of money are so large that for those managing them, climate change is not just an “externality.” For example, Hiro Mizuno, the former CIO of the Japanese Government Pension Fund (the largest pension fund in the world), believes that climate change is the most significant threat to the Fund’s ability to meet its obligations.

Massive institutional investors thus have strong incentives to push the firms in their portfolios toward climate action. And while they also face a collective-action problem, theirs should be easier to solve: The world’s wealth is so highly concentrated that there simply aren’t that many of them. Thus, Climate Action 100+ – a coalition of more than 450 investors controlling more than $40 trillion in assets – has been able to pressure some of the world’s most carbon-intensive companies to adopt concrete commitments for shifting away from fossil fuels.

The shareholder-value imperative is also leading firms to rediscover the central role of government in enforcing cooperation. Before the unfortunate arrival of President Jair Bolsonaro’s administration, the Brazilian public sector was playing a critical role in upholding an industry moratorium on soy production in the Amazon. And across the United States, thousands of firms are working with non-governmental organisations like CERES and “We are Still In” to support sensible carbon policies at the local and state levels. Having oriented their business models towards addressing climate change, these firms have strong incentives to push for measures that will compel their competitors to make the same choices.

To achieve a green recovery, we must reclaim the original promise of capitalism and its fundamental normative commitments to prosperity and freedom, not to making money at any cost. When markets are neither free nor fair, because major externalities like climate change are not properly priced, firms must embrace a goal beyond short-term profit maximisation.

An authentic public purpose can give firms the courage, creativity, and talent needed to bear the risk of exploring new business models. For the smart ones, climate commitments can confer a productive and competitive edge. Adopting a purpose does not mean abandoning investors. It is possible to change the world for the better and make money, to reconcile moral duty and fiduciary responsibility – and it is imperative that we find a way to do so at scale.

Rebecca Henderson is professor at Harvard University and the author of “Reimagining Capitalism in a World on Fire”.Copyright: Project Syndicate, 2020.

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