EDITOR’S NOTE: Wells Fargo, after three long years, has seemingly emerged from the bottom of the barrel to a point where it is no longer the “least ethical” corporation in the country. Read more here.
One of the longest-running debates in business — it probably dates back to the early 70s — is the investment viability of social responsibility. Everybody believes that businesses should “do the right thing,” e.g. obey the law, compensate employees fairly, respect the environment and invest in their communities. But should we make investment decisions based on those criteria alone? Consensus breaks down pretty quickly at that point.
On one hand, we have the Larry Finks of the world. Fink, the CEO of BlackRock, famously said in the company’s 2020 Investment Stewardship Report that corporate responsibility — or in today’s parlance, ESG for Environmental, Social and Governance standards — is central to “long-term value creation” for its investors. On the other hand, we have the Milton Friedmans of the world. Friedman famously stated in a 1970 essay that “the social responsibility of business is to increase its profits.” A vocal Friedmanite, Andy Puzder, the CEO of CKE Restaurants (Carl’s Jr., Hardee’s) argues this week in the Wall Street Journal that while a lot of fund managers talk up ESG, they quietly go about investing in companies that maximize shareholder returns.
I’m not going to trot out the old Harry Truman remark about one-handed economists, but we’ve got to find a way beyond this false dichotomy. Corporate responsibility (OK, ESG) and profitability aren’t mutually exclusive. In fact, they’re closely connected.
Way back in the 1990s, when I was on the Corporate Affairs team at Bank of America, CEO Dick Rosenberg launched an environmental initiative at the company. It was a sincere and substantive enterprise effort years before it became fashionable to go green. Among its aims was to curtail lending to businesses that did not demonstrate environmental responsibility, a principle at which some of the bank’s commercial credit officers looked askance. After all, what are a few emission violations when some fat loan fees are on the table? But a very smart and respected lending officer made an astute point that turned the tide. If a company demonstrated repeated violations of environmental regulations, he asked, what does that say about the quality of its management? And if you are extending credit to a poorly managed company, what does that mean for the performance of your loan book?
Or how about a bank (no names here, but its symbol is an old stagecoach) that shows contempt for its customers by signing them up for services they never requested? This business practice, which was meant to boost profits, drove the company’s market cap into a ditch — down from $322 billion in 2018 to $94 billion in 2020. It’s still digging its way out.
Or how about the utility out on the West Coast that decided it would rather return money to shareholders than do basic maintenance on its transmission lines and pipelines? Not so smart. In 2011, one of its pipelines exploded in a suburban neighborhood, killing eight people. In 2018, one of its old transmission lines, which hadn’t been maintained for decades, ignited the Camp Fire, which razed an entire town and killed 85 people. Market cap cratered from $36 billion in 2017 to $2 billion in 2019 and it now faces 33 criminal charges.
You get the point. Socially responsible companies may not always deliver the highest shareholder returns, but irresponsible companies eventually succumb to gravity. Adherence to good environmental, social and governance guidelines generally reflect the quality and integrity of management.
Mr. Puzder, in his WSJ piece, alleges that BlackRock’s investment criteria, which focuses on companies promoting ESG standards, is sacrificing returns it could otherwise gain. Moreover, he uses some pretzel logic to claim that the only place to address political, social or environmental concerns is at the ballot box — not through investment decisions. ESG investing, he argues, “cut(s) out the political process while billing the costs to middle- and working-class families.”
This is a fallacious argument and I think, to some extent, politically motivated — but those are deep and dark waters I’m not going near. The truth is that companies that deliver consistent returns over long periods of time are by definition ESG companies; they are environmentally responsible, demonstrate respect for the communities where they do business and operate with transparency and accountability. Honoring ESG principles and making profits is not an “either/or” proposition. It’s an “and” proposition. If a company ignores ESG to boost profits, like Wells Fargo or PG&E (oops, I let the names slip!), they’ll eventually reap what they sow.
As you can tell by now, I’m tired of this old argument — the false dichotomy of investing through a lens of ESG or shareholders returns. I’ll focus on the latter, because I know that sustained returns come from operating responsibly across all dimensions of the business. There is such a thing as moral gravity and it’s strong.