Corporations Are Changing. Exhibit No. 1: Larry Fink's Letter
Sustainable investing is the means to achieve "stakeholder capitalism" and achieve competitive investment results.
If you had any previous doubt that the role of the corporation in society is changing, take a look at BlackRock chair Larry Fink's annual letter to CEOs, released this week. In it, the leader of the world's largest asset manager makes a succinct case for stakeholder capitalism:
"In today's globally interconnected world, a company must create value for and be valued by its full range of stakeholders in order to deliver long-term value for its shareholders." Truly great companies, he continues, share "a clear sense of purpose; consistent values; and, crucially, they recognize the importance of engaging with and delivering for their key stakeholders."
That view stands in sharp contrast with the idea that the role of the corporation in society is simply to make money for its shareholders by whatever legal means necessary. That has not always been the consensus view, but it's one that has held sway for nearly half a century.
The 21st century, so far, has proved to be a challenge to so-called shareholder primacy, and perhaps it will be its undoing. Systemic issues like the global financial crisis, climate change, and growing inequality have led to an increasing realization that a singular focus on shareholders may be causing problems like these or making them worse. Maximizing quarterly earnings may have created a lot of value for shareholders, as intended, but perhaps not for other corporate stakeholders: customers, employees, communities, and the planet itself.
Just as investors played a key role in the shareholder-primacy era, with an obsessive focus on short-term performance, they will also play a key role in the transition to the stakeholder capitalism era. Enter sustainable investors.
Sustainable investing is closely connected with stakeholder capitalism. In the Morningstar Sustainable Investing Framework, we define sustainable investing as a set of investment approaches that seek to deliver competitive financial results while also driving positive environmental, social, and corporate governance outcomes. Another way of saying that, for equity investing in particular, is to say that sustainable investing is a set of investment approaches intended to produce competitive investment returns and promote stakeholder capitalism.
Each sustainable investment approach promotes stakeholder capitalism in its own way. Some may exclude firms lacking a positive social purpose. Some may exclude or be underweight in companies that have high levels of material ESG risks or purchase them only if the ESG risks are priced into the stock. A sustainable strategy may favor companies with better--or best--ESG practices relative to their industry peers, regarding them as promising long-term investment opportunities. A strategy may focus on including companies with positive or net positive societal and environmental impacts. Most sustainable investors, and an increasing number of investors who don't use any of these other approaches, are using direct engagement with companies to urge improvement on ESG performance and a greater focus on long-term value creation. They are also, in record numbers, voting their proxies in favor of ESG-related proposals at company meetings.
Taken together, these sustainable investment approaches are leading companies to address material ESG issues they may have overlooked or not considered relevant. Today, few companies want to be excluded from or be underweight in ESG indexes, or otherwise singled out as poor ESG performers. They know it reflects poorly on broader stakeholder perceptions of the company, which affects reputation, brand, talent acquisition and retention, and even regulatory decisions. Sustainable investors are spurring companies to address issues that affect workers, customers, communities, and climate. Investing used to reinforce the idea of shareholder primacy. Today, sustainable investing is helping enable the transition toward stakeholder capitalism.
What's in it for investors? As Fink pointed out in his letter, "It is through effective stakeholder capitalism that capital is efficiently allocated, companies achieve durable profitability, and value is created and sustained over the long term."