It’s interesting that the recent 50-year anniversary of Milton Friedman’s famous New York Times essay declaring ‘the social responsibility of business is to increase its profits’ came at a time when many leaders of the day are saying just the opposite. In the same month as the anniversary, Blackrock warned that ignoring sustainability undermines fiduciary duty. Just over a year earlier, 181 CEOs of the Business Roundtable committed to leading their companies for the benefit of all stakeholders. But do their actions match their words?
The statement of the Business Roundtable, whilst often referenced, was also met with scepticism. Simon Sinek declared himself supportive of the sentiment but sceptical of the sincerity. When BlackRock CEO, Larry Fink, first vocalised his support for sustainable investment, people called for action leading to a subsequent announcement in January this year that Blackrock would divest from thermal coal, however environmentalists remain wary. Edelman summed up the situation in May when they declared a moment of reckoning for business as the promise of stakeholder capitalism is tested by COVID-19.
There is certainly some way to go in ensuring integrity between words and actions, and research from Harvard Law School indicates that board approval is crucial to businesses achieving a genuine shift in how they operate.
Easy decision-making isn’t always good decision-making
Some claim that blaming Friedman for the way shareholder primacy took hold is giving him too much credit. Apparently, his essay reflected the mood of the day (notably different to that of today). However, taken as a doctrine it obviously appealed. As a decision-making framework it could be seen as ‘easy’, allowing for swift, clear and non-negotiable decisions. Perhaps it’s no wonder people took to it and have been reluctant to let it go.
By elevating one stakeholder (the shareholder) with one outcome (financial profits) complexities could be pushed aside. Leaders could, and in many cases felt they were obliged to, limit their thinking. In an ethical sense, they could turn a blind eye – and feel justified in doing so. Hence under this decision-making method business models that externalise costs to society and privatise profits, exploit the vulnerable and pollute the planet have flourished.
However, leaders are selected for the very opposite decision-making skills – they are promoted for their ability to wade through complexity, to exercise good judgement, for their rounded experience – qualities and skills that should mean they are able to make complex decisions that consider the ethics of trade-offs and seek to balance the interests of all stakeholders.
Fiduciary duty evolves to support a new doctrine
It’s not just the words of business leaders that have evolved, the law, or more rightly the interpretation of the rules that determine director’s obligations, have evolved as well – and they increasingly support an expanded notion of fiduciary duty with obligations to achieve more than just financial returns.
For years, Sarah Barker, Head of Climate Risk Governance at law firm Minter Ellison, has advised directors of their fiduciary duties and highlighted the risks of narrow interpretations of these obligations, particularly around climate. She is a regular speaker at the Cambridge Institute for Sustainability Leadership course hosted annually in Melbourne.
In our book, A Matter of Trust – The Practice of Ethics in Finance, Professor Paul Kofman and I cover in detail the evolving nature of fiduciary duty, both in Australia and globally. It’s already 5 years since the UN-backed Principles for Responsible Investment, based in the financial hub of London and led by Australian Fiona Reynolds, published Fiduciary Duty in the 21st Century, with the 4th Report released at the end of last year. In the first report they stated that fiduciary duty is not an obstacle to action on environmental, social and governance factors, and in the last (released in October 2019) they referred to ‘modern fiduciary duty’ concluding there have been fundamental changes in the expectations of fiduciaries.
The rise of legal cases, particularly class actions against boards, stand as a warning to directors of the expectation of an expanded notion of fiduciary duty. By the same token, the lack of cases against directors who have removed tobacco and are seriously incorporating ESG into investment portfolios, indicates such decisions can be made whilst maintaining director obligations.
A slow advance
For many, and particularly those in the responsible investment community, the move away from shareholder primacy is considered long overdue. Advances have stretched over decades – from the espousing of company values in the 1990s, to more serious corporate social responsibility (CSR) programs that moved beyond donations to impact, the championing of shared value, then ‘purpose’ and more recently the rise of ESG, leading to what the Financial Times has declared an intense battle to recruit ESG specialists.
Even in the face of a global pandemic, demand for Certified B Corporation status, the formal certification that verifies social and environmental performance with legal accountability to balance profit and purpose, has increased and is considered by some as critical to a COVID-19 business recovery. For those concerned about the viability of businesses under a new doctrine, Andrew Davies, the CEO of B Lab Australia and New Zealand, states, “B Corps around the world have developed successful business models by developing an impact-first approach and making binding commitments to consider wider stakeholders in their decisions and actions.” He welcomes a new generation of consumers, managers and increasingly owners who are developing this new doctrine which focuses on accountability to all stakeholders.
It would seem the tide has turned and even the singularly financially driven will find it difficult to keep a narrow lens. 1 in 4 US dollars is now invested under a socially responsible mandate, and responsible investment is positioned as mainstream in the latest report of the Responsible Investment Association of Australasia. If we turn to the markets, the S&P 500 ESG Index has shown resilience during COVID-19 with excess returns against the benchmark index and the Financial Times reported that sustainability-themed funds have seen record inflows.
The final step – verifying practices and disclosures
Leaders have done well in mastering the language of stakeholder engagement, but now they must follow through by turning words and good intent into practice and then disclosing their progress. If not, they risk being called out, not just by reporters and activists but by those who control investment.
The process we are now seeing, where formal consultation is underway to define ESG criteria and standards to improve ethical governance, is an important step. EY Global Chairman, Carmine Di Sibio, recently declared, “The time is now for companies to broaden their engagement with stakeholders,” as EY, along with the other big corporate accounting firms and partnered with the World Economic Forum, endorsed a new reporting framework for environmental, social, and governance standards. We’ve long relied on accountants to verify financial statements, now we will rely on them for much more – and everything, including the planet, will rely on it.