Vol. 2: The Playbook on Purpose
Jessica Wirth Strine
I asked my six-year old son, recently: “what will you remember, when we look back on this time?” And he responded, “I’ll call it ‘The Serious Time.’”
It is a serious time indeed, and as investors and stakeholders globally reckon with the impacts of systemic inequalities and a global pandemic that affects every human being and economic system on this planet, many are converging on the same question: “is this a turning point?” Investors are indeed coalescing around the conclusion that we have entered an Age of ESG, one that requires a new accounting for a range of ESG concerns that have increasingly come into focus for investors in recent years. For each public company, this shift represents an opportunity to fully communicate its value proposition, starting with a clear articulation of the company’s corporate purpose.
For starters, we know that changes are underway, in the market and across society. In early March, economies worldwide ground to a virtual halt in response to the COVID-19 pandemic, and in late May, Americans took to the streets to raise their voices in support of the Black Lives Matter movement. In the intervening months, we saw the SEC issue guidance relating to public company quarterly earnings calls, noting that the pandemic has served as a “wake up call” as to the relevance of ESG disclosures. In June, we have seen a deluge of CEO letters, noting that ‘this time is different.’ And in January 2021, The World Economic Forum will convene in Davos to discuss “the Great Reset” of the global economy. Noting that the COVID-19 crisis has exposed the fallibility of our global health, financial, and energy systems, WEF executive chairman Klaus Schwab suggested that “this human tragedy must be a wake-up call. It is imperative that we re-imagine, rebuild, redesign, reinvigorate, and rebalance our world.”
In this “ESG Long View,” we explore the ways that investors are weighing “ESG assets” and “ESG liabilities” under this new corporate accounting, and suggest a framework for boards to communicate their corporate purpose – to investors, society, and all stakeholders – so as to capture maximum “ESG equity.”
The ESG Balance Sheet
Focus on non-financial measures of corporate value, and corporate purpose, was growing in ‘mainstream’ investment circles well before the start of the recent pandemic. Highlighted by well-publicized annual letters from Larry Fink of Blackrock, asset manager of over $7 trillion, and the Business Roundtable’s redefining the role of the corporation, investors and business leaders alike have recognized that “we are on the edge of a fundamental reshaping of finance,” “sustainability should be our new standard for investing,” and “each of our stakeholders is essential.” These public statements have coincided with a ‘mega-trend’ growth in ESG investing; some market observers predict that ESG-mandated assets in the U.S. could grow almost three times as fast as non-ESG assets, to comprise half of all managed investments by 2025. Against this backdrop, EOS at Federated Hermes, responsible for engaging and proxy voting on behalf of over $1 trillion in investments, has been even more pointed, calling for all companies to publish a one-page statement of purpose, issued by the company’s board of directors, that clearly articulates the company’s purpose and how commercial success harmonizes with social accountability and responsibility.
In this Age of ESG, it is increasingly common to recognize that the “shareholder + stakeholder” value quotient today has the potential of being much larger – sustainably – than the traditional shareholder value quotient has ever been. In defining the corporation’s role this way, the board and leadership of an organization are beholden to a new accounting, whereby the traditional balance sheet summation of “Total Assets = Total Liabilities + Total Equity” (or TA = TL + TE) – is being redefined.
Employing more tools and inputs than ever before, investors are no longer constrained by one dimension that begins and ends within the financial statements. In today’s economy, investors are focusing on non-financial measures of value on both sides of the balance sheet. While they may not be GAAP items, they matter to investors because they drive real value long-term, even in the context of the current crisis: according to BofA Global Research, across all regions, companies with below-median ESG scores have seen bigger downward EPS revisions this year, and vice versa.[1]
In evaluating the interplay between ESG and shareholder value, long-term investors are implicitly using an equation that looks more like this:
Under this construct, TE(ESG) = TA(ESG) – TL(ESG), and with these added elements defined as:
The Impact of Recent Crises
As corporations across the market calibrate their responses to current events and plan for the future, recognizing this new investor accounting has never been more important, and the value of corporate culture, ideology, and behavior in these pivotal times cannot be understated. The manner in which corporate boards respond to stakeholder concerns today will drive compounding value – or compounding value impairment – for many years to come. This calculus is manifest across all categories of ESG assets and ESG liabilities: reputation, brand, employee engagement & retention, social license to operate, culture, exposure to regulatory change, and exposure to evolving investor & market preferences. And the repercussions of impairments to these assets are increasingly known: as BofA Securities’ Equity and Quant Strategy team points out, ESG controversies have accounted for more than $500B in lost market value over the past five years, and ESG funds have been particularly quick to sell their holdings in controversy stocks.[2] Likewise, shareholders are reacting at the corporate ballot box: with several weeks remaining in the 2020 “proxy season,” a record 16 environmental and social shareholder proposals have passed at U.S. companies, and numerous others have received near-majority support. Even the most COVID-19-resilient companies are beginning to see mounting scrutiny from investors amidst pushback from stakeholders, including both shareholder proposals and public calls to address their role in combatting racism, keeping employees safe, and living their values. In each of these instances, shareholders and stakeholders alike are converging on these issues and are weighing in with their feet, their votes, and their asset allocation.
A Framework for Articulating Corporate Purpose
Now for the hard part: how to navigate it all, in a world where the assets and liabilities on corporate balance sheets are – on paper and in the most immediate sense – agnostic to the concerns of stakeholders, and must be managed nonetheless. For starters, every company in the world should be contemplating, defining, and doubling down on its individual Corporate Purpose, as a starting point toward maximizing and communicating its TE(ESG). While allowing for the obvious facts that every corporation is unique, SGP has built a playbook for developing a comprehensive statement of purpose, which begins with the following set of questions:
The exercise of answering these questions authentically, rooted in the long-term, is by no means easy. This is not simply a ‘mission & values statement,’ and a company’s answers must have substance and be tailored to their long-term value proposition; explaining why your company exists is not the right occasion to resort to boilerplate. The answers must also not be sugar-coated; all companies, regardless of their perceived ‘virtue’, face challenges and trade-offs amongst their stakeholders, and these trade-offs should be addressed head-on.
While Corporate Purpose may be conceptual in nature, and may even sound downright fluffy when done wrong, the crises we confront today present the opportunity – and increasingly, the imperative – to apply purpose in practice, and to thrive in a business environment that is driven by both shareholder and stakeholder expectations. Here we are, at a crossroads wherein EPS and ESG converge: the companies that are able to deliver on their purpose will thrive as the nature of the corporation continues to evolve.
[1] Savita Subramanian et al. “Bull market phenomenon? Quite the contrary.” Bank of America Global Research (March 25, 2020).
[2] Savita Subramanian and James Yeo, “What are your neighbors doing?” Bank of America Global Research (March 9, 2020).
SGP is an independent, practitioner-driven team of leading investor experts on corporate governance and ESG (environmental, social, and governance) strategy. Established in 2020, SGP brings over 50 years of experience at the largest passive and active asset management firms in the world, including expertise in proxy voting, company engagement, activism, company disclosure, and portfolio management. The firm’s partners bring multi-disciplinary backgrounds and a client-centric mindset, which enables them to create bespoke solutions for their clients.
To learn more about SGP, please visit our website at sgpgoverance.com or contact us directly by phone (215-273-9731) or email contact@sgpgovernance.com.
