The widespread loss of trust in shareholder value and calls for a move to a more stakeholder-oriented model are undeniable. Expectations of investors to address societal problems are growing. However, the only source of legitimacy for investor action comes from client mandates and fiduciary duty. Sometimes addressing stakeholder issues will be consistent with long-term shareholder value creation. But not always. Pursuing stakeholder interests at a cost to clients without their consent is a misappropriation of property rights.
Yet the way in which stakeholder issues make their way into the decision-making process can seem chaotic at times. The client mandate or fund prospectus is often a technical document that doesn’t explain how clients should expect investors to act on stakeholder issues. The risk then is that the asset manager’s own priorities take over, perhaps motivated by marketing considerations. Interest groups take advantage of societal concerns to push a particular agenda, and the loudest and most effective campaigners win. Investor governance departments then promote a range of issues that appear to companies on the receiving end to be uninformed and disconnected from business priorities or the investment thesis. So investors need to get much better at prioritising, and articulating why they are prioritising, stakeholder issues.
In order for investors to have a mandate for action on a stakeholder issue, the stakeholder should be material.
The following three-part test was developed as part of a year-long collaboration during 2021 between The Investor Forum and the Centre for Corporate Governance at London Business School, titled: What does stakeholder capitalism mean for investors? Investors have legitimacy to act on a stakeholder issue when all three parts of the test are met.
In order for investors to have a mandate for action on a stakeholder issue, the stakeholder should be material. Investors are used to thinking about stakeholders that have a material impact on a company’s financial performance. But materiality operates in two directions: a company that has a large negative impact on a stakeholder may well find that at some point the same stakeholder becomes financially material to the company. Carbon emissions are a great example of where companies have had a material impact on the environment for a long time, but only recently has this impact translated into a material financial issue for the companies themselves as a result of a combination of increased scientific knowledge, changing consumer attitudes and evolving economic and regulatory pathways towards net zero.
Another reason for action is intrinsic materiality: clients have non-financial goals and preferences for how their portfolio is managed regardless of whether that reduces returns, or the issue may reflect a desirable minimum standard on a societal basis – for example human rights standards.
There should be a realistic prospect of investor action bringing about change in the real world. Investors only have indirect impact, through the influence they have on investee company actions. For this reason, the influence investors can have on real-world outcomes is often less than claimed.
Claiming credit for real-world impact that cannot be justified by the evidence is simply green-washing. Integrity relating to claims for real-world impacts will be an important part of trustworthy stakeholder-oriented behaviour by the investment industry.
3. Comparative advantage
Investors should act where they are well-placed to address the issue, either individually or collectively, and when compared with other actors, for example government or stakeholders themselves.
Just because an issue is important does not mean that everyone should act upon it. The list of “systemic issues” on which investors are urged to act has grown to include climate change, inequality, human rights, diversity, deforestation, biodiversity, antimicrobial resistance, artificial intelligence, and fair distribution of COVID-19 vaccines.
In a number of stakeholder areas there is significant risk of investors being drawn into promoting activity that is fundamentally political in nature
While these issues are all important, not all of them have systemic valuation impacts across the market that can usefully be addressed by investors. We either need to admit that some of these objectives are being pursued for non-financial reasons, and get the clear mandate from clients to do that, or recognise that there may be other parties than investors better placed to pursue them, in particular government.
This links to the topic of political legitimacy. In a number of stakeholder areas there is significant risk of investors being drawn into promoting activity that is fundamentally political in nature. Everybody wants their issue to be prioritised. But one person’s essential priority is another person’s grave error. Although investors’ clients are drawn from across society, on a vote-weighted basis they are not politically representative. There is risk of investor action on stakeholder issues decreasing, rather than increasing, trust if it is seen to be a way that an elite, formed of investors’ most valuable client segments, can use their financial firepower to bypass the political process.
So investors need to be thoughtful about getting too far ahead of political consensus on the stakeholder issues they act on. Of course, the role of investor (and broader business) leadership is relevant here. Business can play a role in influencing societal attitudes, as well as responding to them. This has arguably happened in relation to climate change where investor and corporate action on the issue has made it easier for government itself to act. But it is a delicate balance.
The investor community has a legitimate role in addressing stakeholder issues. However, investors need to be extremely clear on their mandate for pursuing such issues.
An underemphasised area is the role investors can play to support and maintain the robust institutions and regulation essential to the functioning of capitalism, through influencing responsible corporate lobbying activity, tax policies and so on. This is less politically fraught, although even here one person’s enabling regulation is another’s overweening interference of the state.
The investor community has a legitimate role in addressing stakeholder issues. However, investors need to be extremely clear on their mandate for pursuing such issues and on the likely overall effectiveness of their actions. Only on this foundation can investors reconcile responsiveness to stakeholder issues with adherence to fiduciary duty. And through that process create the circumstances for shareholder value to be seen as part of the solution rather than part of the problem.
This is what stakeholder capitalism means for investors.
Dr Tom Gosling is an ECGI Executive Fellow and an Executive Fellow in the Department of Finance at LBS. Tom also works with the Centre for Corporate Governance and the Leadership Institute at LBS.
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