The hardest things to see are often right in front of you. This is the case with respect to the radical redirection of corporate governance under way in the United States borne of the reality that ordinary people, not faceless financial firms or Wall Street titans, actually own Corporate America.
At its core, this raises the most basic corporate governance question: what is a company’s purpose? Debate over this culminated in the stakeholder capitalism notion pronounced by the Business Roundtable and signed onto by almost 200 public company CEOs shortly before the pandemic, which rejected the shareholder primacy theory, long the foundation of corporate governance. Special interest groups, emboldened by breathless media coverage and the last administration’s calls to end shareholder capitalism, elevated ESG over financial interests in assessing corporate performance, a step further than the Business Roundtable took.
Money management firms quickly formed ESG-focused funds that poured money into seemingly countless “green” start ups and sided with social purpose proxy proponents and shareholder activists on most issues. For their part, the proxy advisory firms began grading directors based on climate impact and other ESG topics instead of the financial performance of their companies. Not surprisingly, companies, especially big ones, raced to be out front on these issues.
But, as so often happens in a connected world, things went too far too fast, so much so that we are now in the midst of a radical realignment of fundamental corporate governance concepts. It would be mistaken to dismiss this as just partisan politics – it is more than that and also more than just a Newtonian, equal-and-opposite reaction to exploiting stakeholder governance to achieve political objectives.
There are three main forces at work here.
First, is the recognition that, while sustainability remains a vital consideration, climate change is not an immediate existential risk that justifies spending trillions of public and private funds on unproven ventures that, at their Paris Accord extreme, would require radical change in peoples’ everyday lives. Nor does it justify requiring companies to spend huge amounts to satisfy one-size-fits-all ESG reporting requirements of use to nobody but academics, anonymous regulators and the professional firms required to verify the reports.
Second, the billions poured into ESG-focused investment vehicles and start-ups failed to produce acceptable financial returns and have been largely shuttered or repurposed.
Finally, and most importantly, there was the realization that most companies already embraced and were willing to report publicly on underlying ESG issues, particularly sustainability and equality and employed decision-making methodologies predicated on trying to do the right thing for all corporate constituents. For them, there was no fundamental problem to solve in the first instance unless ESG goals were to be pursued to facially unfair extremes.
Many examples exist: the SEC’s reversal of support for social mission shareholder proposals, the world’s largest financial firm severing ties with the proxy advisory duopoly and changes to state corporate laws to reset the balance between companies and strike suit lawyers and investors lacking a meaningful financial interest in the companies they seek to influence.
This is not at all a fad borne of politics or social media, but the reorientation of share ownership back to where it belongs: the individual owner, predicated on the recognition that people, not largely anonymous financial institutions, actually own Corporate America through investment vehicles that those institutions just happen to manage. Big companies, for the first time in decades, are refocusing IR/PR programs on individual investors. For their part, the investment firms that manage trillions of other people’s money are hearing footsteps from regulators and others questioning how they can exercise voting rights that the real owners would likely oppose and, as a result, are increasingly passing voting rights back to the individual owners. Similarly, while there is yet much to do to get this to work better, companies are taking steps intended to facilitate pass-through voting to the actual beneficial owner, simplifying the proxy machinery and even setting up mechanisms by which individual shareholders (who overwhelmingly support management and generally hold, not trade, investments) can give standing voting instructions.
With company-provided pensions a thing of the past and Social Security hardly enough to pay the rent, people count on their 401(k) and other investments for retirement. To be sure, they want their companies to encourage equal opportunity and operate sustainable businesses. But all of that is consequential, not causal. This was at the heart of a little noticed federal court ruling last summer that a major airline’s 401(k) plan trustees breached their duty of loyalty to plan participants by allowing ESG interests to influence plan management. The same thing could of course be said for others whose job it is to invest other people’s money.
At bottom, the tide turned on social purpose stakeholder capitalism because it became an end, not a means to an end, and was taken to extremes – most companies support key ESG objectives already, recognizing that they are essential to the operation of any company positioned to succeed in the 21st century. But this is so only if connected to the real purpose of the enterprise – to operate for the long-term benefit of its shareholders, rather than the accomplishment of abstract societal or political objectives. That is to say, ESG considerations are important means to an end, not an end of themselves no matter what the loudest voices on electronic and social media might say.
This is predicated on the bedrock principle that boards of directors are entrusted to oversee management of companies and are best equipped to decide how to balance company objectives, not single-purpose organizations who see everything through a narrow, black or white decision-making prism. The core principles that made much of the stakeholder governance either redundant or too extreme need to be embedded in every layer, and undoubtedly at the top, of every company. That is, the corporate governance revolution requires walking the talk.
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