Governance isn’t typically the topic that makes the man on the street jump up and down with trepidation. Not so for sustainable investment professionals apparently. This excitement was palpable at the Swedish House of Finance’s Annual Conference on corporate governance which took place on 27 August in Stockholm. The event was fully booked and packed with local sustainable investment ‘influencers’. Energised by the surrounding buzz, I also left with a doom-loaded question. Have we orchestrated our own demise by giving corporations too much power?
“Corporate Democracy” was the topic that stood out for me. In his keynote presentation and the panel that followed, Prof. Luigi Zingales, finance professor at Chicago Booth challenged the traditional profit maximisation model. Milton Friedman wrote in 1970 “The Social Responsibility of Business Is to Increase Its Profits”. Zingales, meanwhile, believes that shareholder value must include more than financial benefits. Not really a newsflash, but let’s hear him out. Here in the Nordics, where we pride ourselves for our collective corporate responsibility and advanced governance model, could we learn something from the country where “Greed is Good”?
Most institutional investors seem to hold the idea that board directors, provided they are picked for their ethical mindset, may be empowered to take the right decisions. Doing the right thing implies, I suppose, sacrificing some short-term profits in order to protect the community, locally or at large, or even future generations. The role of the board is to defend the interests of the shareholders, which typically means maximising profits, but often also minimising risks. Risk is the lever that sustainable investors and ESG proponents mostly rely on when claiming that companies can maximise shareholder value and willingly reduce negative externalities are the same time.
Typically, risks materialise where there are regulatory or legal consequences. Yet, Zingales explains, according to George Stigler in “The theory of economic regulation”, corporate actors are incentivised to demand regulations that benefit their business. The idea that in powerful firms unrestrained profit maximisation can be tamed by regulation is also inconsistent with evidence, Zingales adds. Lobbying is at the heart of American corporate life, and he goes as far as suggesting that it may be the duty of the CEO or even the board. Even the least financial literates understand why it makes sense for oil companies to lobby against promoting the transition to renewable energy.
What about reputation risk? It is often cited as a deterrent and an incentive to choose the right path. And yet, Zingales argue, reputation alone is not enough: IBM, for one, never got penalised for its role in the Holocaust. He is referring to the story unveiled in 2001 by investigative journalist Edwin Black, who displayed the involvement of US-invented ‘Hollerith’ punch cards in the deportation of Jews and other victims of the Nazi regime. Another more recent example that bothers Zingales is the divestment of Chemours by chemicals giant DuPont to avoid responsibility in the case of PFAS pollutants. What it means is that previous decisions to go ahead with reckless production of dangerous chemicals have had minimal negative consequences for the company or its shareholders.
In short, Zingales proposes to change the aim of companies. Instead of maximising shareholder ‘value’, they should target ‘welfare’. The one question that remains is how will this shift take place? Just like in the famous scene of ‘2001: a space odyssey’, super-computer Hal 9000 is preventing the human characters from disconnecting it. Can the system be re-calibrated now that corporates have the incentive to maximize profits at all costs and the tools to change the rules at will, thanks to lobbying which is an essential part of enabling the election of political candidates? Even investors in the US are being stripped of their ethical willpower, as evidenced by the hordes of asset managers leaving initiatives such as Climate Action 100+ or the Net Zero Asset Manager Initiative.
Back to our morally superior Nordic perspective. Can we smugly criticise and observe the irresponsible capitalism as practiced on the other size of the Atlantic? We are still affected by the consequences of reckless corporate behaviour. Climate change is one thing, PFAS another. We have managed to avoid a full opioid epidemic, but obesity figures are rapidly creeping up because of the quantities of processed food we are incentivised to consume. Microplastics are everywhere and single-use plastics lobbying is strong even in Brussels. No one is even thinking about divesting from the US market altogether and, especially when it comes to the packaged food industry, market leaders aren’t even based in America.
Weather we want it or not, we are complicit. For some reason, this take on governance reminds me of the controversial Milgram experiment, where subjects, over and over again, accept to inflict electric shocks to another individual simply because they are told to do so by an authoritative figure. Sometimes they protest, but usually, they continue. In the name of shareholder value or fiduciary duty, we actively support profit maximisation at any cost, even when we try to do what we can to mitigate the effects.
