Stakeholder capitalism: Separating the genuine from the fake

MILTON Friedman versus Klaus Schwab - it was a battle between two worldviews.

In 1970, Friedman wrote his seminal essay on the role of the firm, effectively arguing that the "business of business is business" and that wider stakeholder considerations can be value-destructive.

In 1973, Klaus Schwab's Davos Manifesto argued that management must also serve employees and society, as a "trustee of the material universe for future generations". While Friedman may have won the sprint, Schwab may be winning the marathon.

Today, almost five years into the 15-year trek towards the UN Sustainable Development Goals (SDGs), the role of business in delivering social and environmental outcomes is squarely in the spotlight. To the extent that a company can command and drive resources more impactfully than the sum of its individual stakeholders, the company must be accountable for more than shareholder returns.

In August 2019, the Business Roundtable - whose members are chief executives of major US companies - issued a path-breaking declaration on the purpose of a corporation: to serve all stakeholders, moving away from shareholder primacy.

According to a comprehensive survey of global CEOs released by UN Global Compact and the consulting firm Accenture in September 2019, more than three-quarters of CEOs are now convinced that businesses should be making a greater contribution to social goals and that this is critical to building trust in their brands.

Clear gap

However, there is a clear gap between statements of what businesses should be doing and what they are actually doing. Only 21 per cent of CEOs believe that business is currently playing a critical role in contributing to SDGs.

Eighty-one percent of companies say that they are taking some action towards SDGs, which suggests that 19 per cent of those who chose to take this survey have not taken any action at all.

Small wonder that the convening objective of the World Economic Forum this year was to give concrete meaning to "stakeholder capitalism".

To be fair, we have come a long way.

Impact investing, green finance and tech-driven financial inclusion - now part of the speaking notes of CEOs in mainstream banks - were all on the fringes of the agenda just a few years ago.

The number of signatories to the UN Principles for Responsible Investment continues to grow at an accelerating pace - representing half of all institutional investors and US$83 trillion of assets under management - with a growing minority reporting on their new climate risk indicators.

Separately, the CFA Institute, which amended its mission statement to include the phrase "for the ultimate benefit of society", is helping to establish a standardised way for asset managers to report performance on their Environmental, Social and Governance (ESG) objectives.

To take another example, there are now only three all-male boards among the top 350 companies in the UK compared to 151 in 2010. The target of women comprising a minimum of 30 per cent of board members was achieved one year ahead of schedule.

Whichever way we look, either for reasons of social justice or for their enlightened self-interest, businesses and investors as a whole are moving in the right direction. So, what is the problem?

The first factor to acknowledge is the weight of expectations. In a political climate where the system is characterised as either broken or rigged, both the bar of expectations and the cost of failure are high.

On a backdrop of low trust, the tolerance for tokenism is that much lower. Self-congratulatory corporate communications must be supported by material, concrete action. In terms of landing their message, what might have worked last year will likely lose their potency this year.

Businesses must realise that they are operating in a market of asymmetric information - the classic case of Akerlof's lemons - where the proverbial good guys must signal credibly to separate themselves from the bad guys.

Credibility of signals - as opposed to vacuous virtue signalling - is determined by the cost of generating those signals. In some cases, transitions to sustainable business models might require some near-term sacrifice in financial return. It is far better to acknowledge those trade-offs and help educate stakeholders than to gloss over them.

There are at least two areas in which genuine proponents of stakeholder capitalism can signal their separation from the imposters:

Proportionality

Stakeholder capitalism doesn't work if it remains the focus of a silo'd, niche department while the rest of the firm dwarfs it in terms of resources and impact. Is US$20 million of impact investment cause for celebration when the company has revenues of US$20 billion and profits of US$5 billion?

Just how excited should we get when a company with US$1 billion in income "spends" US$10 million to ensure equal pay for equal work among male and female employees? To be clear, these are positive developments that would've deserved applause a few years ago. Over time, if the size of steps remains disproportionately small, a company can stand accused of impact-washing, possibly providing a fig-leaf to other parts of the business.

Optionality

Stakeholder capitalism is undermined when firms do not pre-commit to measurable objectives. Well-meaning rhetoric can come across as platitudes if they are not consistent with pre-defined objectives.

Which of the SDGs are you setting out to promote? How have you translated them in the context of your business? What actions do you intend to take? What outcomes do you expect?

How do you propose to report back on progress? How will you consult stakeholders and how will you ensure that there are adequate governance structures in place?

On too many occasions, it appears as though companies want to keep all options open, floating from goal to goal, based on what is convenient or fashionable in a given quarter. Targets are either not set or they are set for a long-term horizon without intermediate milestones.

While reporting is certainly not standardised across firms, they are often not standardised within the same firm across time. Random feel-good posts by executives on LinkedIn or gimmicky graphics on Instagram cannot be the yardstick of progress.

Commitment to a consistent reporting template (that the company may self-design to suit its unique objectives) should remove the fluidity and selectivity that contaminate credibility.

To the extent that a business has signed up to the principles of stakeholder capitalism, there must be an explicit role of the board and independent directors in the governance of implementation.

Finally, the coordination challenge and prisoners' dilemma faced by individual firms in volatile, competitive markets should not be underestimated. This will require collaborative leadership of the highest order.

To quote Orit Gadiesh of Bain & Company, "Leadership teams need to create forward-leaning agendas, together with other companies in the same industries". That leaning must now be harder and faster than ever before.