How to return control of companies to their owners

LONDON (Reuters Breakingviews) - The question of how public companies can be held accountable to their owners has vexed minds for centuries. Free-market enthusiasts argue that the best solution is that companies focus on maximising their profits. The doctrine of shareholder value has fallen out of favour. But the growing involvement of large institutional investors in thorny questions of social governance creates a host of new problems. Fortunately, modern technology may come to the rescue.

A boardroom is seen in New York City, New York, U.S., June 3, 2021. REUTERS/Andrew Kelly

In a famous 1970 opinion piece here in the New York Times, Milton Friedman argued that the social responsibility of business was to increase its profits. Corporate executives, as employees of the firm, were responsible to owners and should, the Nobel laureate economist said, “conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of society.” If executives were distracted by their “social responsibility” they would act against the owners’ interests.

More than half a century later, it’s not obvious that investors are only interested in maximising profits. Many also want companies to address environmental and other social concerns. That’s all very well when investors expressing such views are the underlying beneficiaries. But it’s another matter when investment managers – the agents of the real owners – get involved.

Over the past few years, the investment world has embraced environmental, social and governance (ESG) issues with fervour. Shareholders are out, stakeholders are in. As the World Economic Forum’s Davos Manifesto 2020 here proclaims, “a company serves not only its shareholders, but all its stakeholders.” In her new book, “Share Power here”, Merryn Somerset Webb cites the head of a large UK institutional investor arguing that fund managers must “embed the environmental, social and governance factors that matter to savers at the heart of the investment process”, adding for good measure that “what is good for equity shareholders is not always in the interest of everyone who matters”.

A 2021 survey by the French bank Natixis found that more than 70% of investing institutions now claim to pursue so-called impact investing. Top of the list are the mammoth providers of index funds – BlackRock, Vanguard and State Street – which together manage assets worth well over $20 trillion. In 2018, BlackRock Chief Executive Larry Fink instructed managers at companies whose shares are held by the asset manager that, “every company must not only deliver financial performance but also show how it makes a positive contribution to society.” “We are on the edge of a fundamental reshaping of finance,” he wrote in 2020. The following year, Fink added that BlackRock would use shareholder votes to get companies to reduce climate emissions.

If investors can do good while doing well, what’s not to like? For a start, there’s the thorny issue of investment returns. Many claim that fulfilling social responsibilities boosts long-term returns. But limiting the investment universe or the scope of a company’s activities is bound to impact performance. Somerset Webb cites a 2008 study here which found that so-called sin stocks – shares of companies that sell tobacco, armaments and so forth – outperformed the overall market in 21 countries between 1970 and 2007. The U.S. Department of Labor has stipulated that pension funds must not place ESG requirements above financial returns.

There’s another problem. As Friedman pointed out, the notion of a company’s social responsibility is ill-defined. There are also inevitable trade-offs. The interests of various stakeholders may conflict. How does an energy company balance investors’ demands to reduce investment in fossil fuels with their customers’ need to keep down fuel costs? What social concerns should take priority? Should a company forego an opportunity to shift manufacturing abroad in order to maintain high-paid jobs at home?

Savers aren’t likely to have exactly the same social preferences any more than they are likely to vote for the same political party. Besides, many still adhere to Friedman’s old-fashioned views. A recent study by the Centre for Policy Studies, a UK think tank, found that 45% of people thought that businesses should avoid taking political positions.

Furthermore, the social priorities of professional fund managers may differ from those of their clients. For example, it’s noticeable that the question of corporate pay has remained relatively low on their agendas. That’s not surprising since professional investors are among the best-paid people on earth: Larry Fink’s total compensation in 2020 was close to $30 million. Private shareholders are four times more likely to vote against bloated executive pay packages than institutional investors, according to Somerset Webb.

The most pressing issue, however, is the political clout that the three big investment firms wield when voting on behalf of their clients. Charlie Munger, Warren Buffett’s long-time business partner, recently warned about the “enormous transfer” of power over corporate decision-making to a select few. “We have a new bunch of emperors, and they’re the people who vote the shares in the index funds,” the Berkshire Hathaway vice chairman said.

There’s a way out of this impasse, according to Somerset Webb. Technology now exists which enables institutional investors to return corporate governance decisions to the actual owners of companies. Legal & General, a large British investment firm, is using software to directly connect more than 50,000 of its clients to the companies they own. U.S. Securities and Exchange Commissioner Allison Herren Lee has called for more transparency in the way investors’ money is voted. She suggests that blockchain technology could be used to record beneficial ownership and execute votes.

Last year, BlackRock announced that it would give its largest clients a say in shareholder votes. But this just hands power from one set of fund managers to another. Somerset Webb argues that most people nowadays own shares through pensions and other savings vehicles. If they want to use their capital to change corporate behaviour, let them have their say.

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- Edward Chancellor’s “The Price of Time: The Real Story of Interest” will be published by Penguin on July 7.


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