Leading US CEOs recently pledged to redefine the role of the corporation in society. But will they make good on their promises? Responsible investors need a clear way to evaluate whether a company is really making progress by doing good for both society and investors.
Earlier this month, 181 American CEOs cosigned a declaration stating that their businesses would include consideration for all stakeholders, not just shareholders. In a statement released by Business Roundtable, corporate leaders from Amazon to Xerox affirmed their commitment to support the environmental and social health of the communities in which they operate and to embrace sustainable practices across their businesses. Increasingly, executives are acknowledging that this approach is the best way to generate greater long-term economic value creation.
Doing Well While Doing Good
Yet skepticism abounds. Critics argue that executives will need to demonstrate accountability to prove that their intentions are true. And the concept isn’t new. Almost a decade ago, Michael Porter, a prominent Harvard Business School professor, promoted the concept of “corporate shared value.” His approach distinguished between simple corporate philanthropy and embedding sustainable practices directly into core business operations to gain a competitive advantage.
In principle, we agree with Porter’s approach and the Business Roundtable statement—as well as the cynics. In our view, financial success and social success aren’t mutually exclusive; rather, they reinforce each other. Pursuing a sustainable agenda that balances the needs of all stakeholders can tie companies to durable long-term growth opportunities, help improve profitability and reduce risk. But translating public relations into action is more challenging—and investors need better ways to measure the impact of corporate actions.
How to Measure Social Value Creation?
Measuring how much social value a company generates is exceptionally difficult. Data are lacking and reporting standards are flawed. What’s more, when assessing social change, it’s notoriously hard to separate cause and effect. But with a clearer understanding of how corporations contribute to creating social value, responsible investors can better assess these companies against their newly defined mission.
Companies impact society in two main ways: through the products they sell and their operational conduct. Firms can sell products that help (vaccines) or hurt (tobacco) society. Their behavior can be positive (fair gender pay) or negative (corruption and bribery). Investors can assess all companies—and portfolios—using these two dimensions of impact, in our view.
Companies in the upper right of the display below sell products with more positive social impact and have generally stronger business practices. These companies are currently creating more social value for stakeholders than peers in the lower left. As corporate strategy evolves, movement to the right (improved behavior) or toward the top (improved product mix) also signals social value creation.
This simple schematic analysis contains an important implication: every company can create social value for stakeholders. Signatories of the Business Roundtable statement, for example, include companies that sell coal, weapons and snack foods—industries that investors who are focused on social issues tend to avoid. While companies like these can’t do much to improve the social impact of their products, they can improve their own behavior.
Creating Sustainable Metrics
For investors, this framework is the first step toward building sustainable portfolios. For example, the United Nations Sustainable Development Goals (UN SDGs) can be used to measure the environmental and social impact of a company’s products. By mapping a company’s product offerings to the UN SDGs, we can measure the percentage of its revenues that are derived from products aligned or misaligned with UN SDG outcomes. Companies can then be plotted based on their net revenue exposure to the UN SDGs.
By focusing on companies that deliver profitable solutions to key social challenges such as health and wellness, clean energy, and gender equality, we believe investors can create portfolios with attractive growth, profitability and quality characteristics.
Corporate behavior can also be measured in several ways. Our security selection processes use proprietary environmental, social and governance (ESG) measurements. Yet we can also apply MSCI ESG ratings to create a simple proxy that tracks a company’s ESG behavior relative to its peers as well as changes in its behavior over time. For investors seeking to align their portfolio investments with highly sustainable companies, this can be an effective way to see if the portfolio meets their requirements.
The Alpha Connection
Even after identifying companies with sustainable products and behavior, there are many ways to build equity and fixed-income portfolios that balance risk, reward and responsibility. Different types of portfolios seek to deliver alpha in different ways, depending on their objectives. For example, portfolios that invest in certain sustainable products may benefit from strong long-term growth potential that is underappreciated by the market. Investment in companies with improving business behavior may benefit from reduced costs, higher profitability and lower regulatory risk.
Because different strategies balance these objectives differently, the same measurement metrics will not apply equally to all portfolios. But when we understand how a company intends to create social value (is the firm moving to the right, upward or both?), we can begin to think about appropriate metrics to track. Better metrics can also help guide more productive engagement efforts with management teams to help keep companies on track in the quest for social value creation.
CEOs have recognized that the role of the modern corporation has evolved. Now it’s time for investors to sharpen their game and develop more effective methods to measure the execution of an ambitious agenda to reshape the way companies operate in the 21st century.
Dan Roarty is Chief Investment Officer—Thematic and Sustainable Equities at AB.
The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time.