Sustainability:Shareholders Versus Stakeholders

Earlier there was a big battle, Kraft Heinz wanted to take over Unilever, and it was a battle of the systems. Kraft Heinz, the US food company, represents the shareholder model, aiming at short-term profits. By contrast Unilever represents the stakeholder model, looking beyond the financial return also at social and environmental dimensions. So, it was a big battle between the two. 

What happened? Kraft Heinz offered a large amount of money, but Unilever refused, they did not want to give up their sustainable business model. In the end they were saved by Warren Buffett. He saved the day for them because Warren Buffett, the face of American capitalism, does not believe in hostile takeover. So, the bidding stopped when Unilever said no. But what was happening, a clash of models in finance.

So, on the one hand, the shareholder model, driven by maximizing profits short term. On the other hand, the stakeholder model, looking beyond shareholders, but also at employees, customers, society, even broader, the environment, take a more holistic approach. And Unilever felt that the stakeholder model, which they are adopting, is more inclusive to sustainability. Finance can finance the sustainable companies and stop financing the unsustainable companies even if they have a higher return. But why would finance give up its return and do that? And I think that is the core issue, and that is the question about what is the objective of finance? And what I would like to do is to rank these three factors, these three dimensions, the financial dimension, the social dimension, and the environmental dimension. And if you look at this, what they call a wedding cake, it starts with a foundation, that is the environment, that is our planet Earth. 

And we all understand that we need a viable planet for society to thrive, the second layer. The next thing if we want to have a vibrant society, we need an economic system to organize production and   consumption. It is quite clear that the economic system is the final bit of the equation, not the starting point. But if you open any economic or finance book, it starts with the economy as the centre, and I would argue it is the end. The environment and social dimension are more important. So how to rank these three factors, the f for finance, the s for social, and the e for environment? So here I have a little table and it will walk you through it. 

So, in the first one we get the shareholder model, which maximizes financial return and is aimed at the short term. The second one is a stakeholder model that looks beyond the financial return at employees, clients, society, environment. So basically financial, social, and environmental values are combined. They are together, optimized. And it is important to note that we now get the switch from the short to the long term, and that is crucial, this long-term orientation. But if psychologists would say, behavioural psychologists would say, we all focus on the short term. So how do we get to this long term, and the whole financial system is built on the short term. Quarterly financial reporting and if something happens with a company, you must explain it after stock exchanges close, and the next morning you must give a full press release. So quarterly financial reporting, your performance or successors each quarter, benchmarks against the market. Are you doing better or worse? And I am arguing for a long-term approach. How do we get there? I think there are three factors at work. 

The first is just plain self-interest of the financial industry. So, if global warming goes further, then at some point climate policy will adopt carbon taxes or, even further, may ban fossil fuels completely. We have now the big debate on closing our coal-powered station, and the government has the power to do it overnight. It is when that happens, and high carbon tax, then the big oil and coal companies become worthless. That is what we call technically stranded assets. So as an investor you do not want stranded asset on your balance sheet. If global warming leads to regions, which are really affected by all these flooding’s, then what follows is always economic decline, and that means poor markets for your products. So that is the self-interest reason. 

The second reason for going from short to long term is pressure from society. I already said it a bit before, it is no longer acceptable that if you buy your clothes that child labour is used or underpayment. So, it has got this reputation risk for companies and the investors behind it. And the third one is related to that, that are the shifting preferences of managers in the financial industry, in the incorporates. Younger generation are increasingly paying attention to the social and environmental factors and in that way this s and the e factor gets into the equation. Okay, so we see these factors at work, but still how to get there and, economists will want, I would not say small, a big bias is where are the incentives. So, let us start with the first incentive. You can see social and environmental dimensions as risk factors. Okay, we discussed the flooding, the reputation risk if you use child labour or use underpayment. You see that happening, for example, with Apple, these discussions. So, what do finance people like to do? They love to manage future risks. Risk management is a core course in any finance curriculum. So, we can see it, we can manage the risk is one reason to look up the long term. The second one is I complained about these quarterly reporting, quarterly benchmarking. One way to get managers to think beyond the next quarter is to defer their pay. For example, if part of their salary is dependent on how the company is doing, the performance of the company in three years’ time, they start to think, what is the impact of my decision on the company in three years’ time? So, in that way you bring the future today in the pay package of the manager.

 The third thing you could do is long term investors rewarding for their engagement with the corporate, so they stay with the firm. And if, for example, if they stay for longer than three years, they get extra shares, we call that loyalty shares. There is one way of making that investor stay longer with the companies because at the other end of the equation is high frequency trading, sometimes only half a share one minute in that portfolio. So, we want engagement of the investor with the firm. This is all theory, let me give some real concrete examples. Institutional investors are now increasingly using ESG, that's environmental, social, and governance, factors in their investment decisions. To give an example, some Dutch pension funds have pledged to half the carbon footprint of their investments before 2020. So that is an actual example of investors who want to reduce the environmental impact of their investments. So, they are buying companies who are lower carbon and are selling the high carbon assets. Also, banking can have its impact. Earlier Phillips, the big electronics company, got a 1 billion credit facility from a syndicate of International Banks. And the interest rate is linked to the sustainability performance, and it can be measured independently by outside parties. If sustainability goes up, then the interest rate goes down and, of course, vice versa. In that way Phillips, who has this mission, better health for people and sustainability, it is part of their sustainability program, but at the same time bankers can incorporate these sustainability challenges into their lending practice.

There are also limits to sustainable finance and these limits are there. The first one is if you look at what is happening in the financial sector, then the short term is still extremely dominant. Especially in the Anglo-Saxon economic blocks, their short term and shareholder thinking is still at the forefront. So, a large part of finance is still unsustainable. However, I mentioned the forces, that the part of finance, which is looking at sustainability, it increases, but we must admit we are at the low part today. The second thing is the private sector cannot do it on its own. If I talk about the social and environmental challenges, then we all know what the obvious answer is, government regulation. So, the government must do its part. Only the threat of carbon taxes or actual carbon taxes like a Scandinavia, which is ahead of the game, makes that investors will start to sell the high carbon assets because they hate stranded assets on the balance sheet. So, we also need the government to do its part. Now I come to an end, how can we make this happen? How can you and I make this happen? 

The first step is we see in the financial industry coalitions of financial firms 30 to40% who already start to adopt principles of responsible investment. So that is a very good starting point, that 30 to 40% of financial firms avoid child labour, care about the carbon footprint of their investments. Even one step further there is, although it is tiny, 1%, I just measured it, 1% of global assets, it is a tiny group of financial firms who put social and environmental factors first and financial return second. That is happening because they really believe that with a sustainable economy, we can leave the planet for current and future generations. Now I coming to you, even if we are students, we may become future leaders in the financial industry and we will have a choice of what type of financials to institution you want to work. profit-driven financial firm, or a firm who cares about long term value creation? And then I mean long term value, financial, social, and environmental value. That is the choice in your professional career you are facing. But this does not only affect economists or finance people or consultants, but also consumers, and you can inform ourselves about the sustainability of products and vote with our wallet, so we can be a responsible consumer. And sustainable finance is about the future, our future, thank you.