How businesses, societies and investors can work together to address the major environmental and social challenges facing the world through responsible capitalism.
Based on returns to shareholders since the onslaught of COVID-19, capitalism has arguably navigated this extreme challenge successfully so far. But this is not being achieved sustainably if employees, customers and the wider world aren’t benefiting or are paying the cost.
How can ‘responsible capitalism’ redress the balance?
The forces at play here can be illustrated in a perhaps unlikely way by the history of the Prussian forest, first published in our 2019 report Responsible capitalism.
Imagine it’s the middle of the 18th century and you’re standing in a forest in what is now Germany. The scene is blissfully sylvan, filled with trees, plants and creatures and, for the Prussian state that owns it, the forest is also a flourishing, profitable source of wood.
Then, you‘re standing in the same forest at the end of the 19th century – only you don’t recognise it. The elm, beech and alder trees are gone, as is the cornucopia of flora and most of the fauna and it’s eerily silent.
There are no mushrooms to gather, the forest floor is patchy and the soil is thin and grey. The villagers no longer live symbiotically with the forest nor have a stake in it. Only row after regimented row of Norway spruce stand before you, and many of them look rather sickly.
So what happened?
The Prussian state used a short-sighted fiscal lens to reduce the whole ecosystem to a single number – the annual revenue yield of timber. Everything deemed unrelated to maximising yield, like birds or fungi, was ignored and everything thought to impede production efficiency, including domestic pasture or fertile underbrush, was eliminated.
But the state’s dismissal of this vast array of elements and relationships as a mere ‘source of wood’ came back to haunt it.
A combination of degraded soil and depleted nutrients, plus the trees’ increased susceptibility to disease due to uniformity and lack of diversity, meant that production losses reached 20% to 30% by the second and third generation of conifers.
Everything is connected
This story is something of a parable for present-day capitalism.
Economic growth, and productivity growth in particular, has fallen to worryingly low levels and incremental return on investment has plunged.
In advanced economies, real wages have stagnated and inequality has risen, lowering economic growth further because the average worker is more likely to spend additional income than the average wealthy capital owner. This means lower interest rates and prospective returns on both equities and bonds, with investors reducing their return targets or being exposed to greater risk of loss.
Everything is connected – the whole ecosystem matters.
We believe executives, shareholders and investment managers have acted like the Prussian state. During the 20th century the concept of the company was reduced to a narrow set of short-term profit metrics. Its complex relations with society, the economy and the environment were ignored or subordinated in favour of maximising profits.
This reductionist strategy is short-sighted, jeopardises future profit and brings other negative consequences for the broader socioeconomic ecosystem.
Acting in your own interest
We believe executives and investors must consider a new approach and acknowledge that:
We can – and must – adopt a sustainable approach in the post-pandemic recovery.
Even if you believe the world works best when capital owners act in their own self-interest, this approach still works. The ecosystem matters for shareholder value over the long term. Societal problems and the prospective collapse of investment returns are linked, just as the solutions for society and for investors seeking higher returns are linked.
Don't confuse strategy with results
There is a substantial body of evidence suggesting businesses with the most sustainable practices perform better than their peers.
This indicates that a positive and negative screening approach that assesses which ESG factors are material to each industry is likely to achieve the best results.
One study shows that investing in stocks ranking highly on material corporate responsibility factors can generate an astounding 3% to 5% annual excess return relative to those which rank poorly, even after taking other factors like value or size into account.
It also finds significant benefits to accounting-based measures of success such as return on sales, not just share price returns, suggesting good corporate social responsibility leads to better performance.
Indeed, several papers link good CSR with better immunity from crises like the financial crash of 2008-09 or the Covid-19 pandemic. Managers can no longer hide behind market forces or assumptions that pursuing a climate-responsible agenda runs counter to shareholders’ wishes or hurts shareholder value.
In short, there’s overwhelming evidence to prove that companies that behave more responsibly are associated with higher returns on capital, lower costs of capital, reduced risk of something 'blowing up' and higher share price returns.
Most of our clients are long-term investors. Many have endowments with infinite time horizons, others are motivated by intergenerational wealth creation for their families. Therefore, we must ensure we don’t diminish the investment returns of tomorrow through today’s investment decisions.
We’re not dismissing the notion of maximising shareholder value, but we see it as a result, not a strategy. The only way to sustain those results is to ensure public companies maintain vibrant, symbiotic relationships with employees, customers, suppliers, natural resources and society at large.
Make no mistake, businesses and their investors have a strong stake in the existance of a flourishing socioeconomic ecosystem.
When natural ecosystems break down due to a loss of biodiversity, it also creates multiple risks for businesses and investors.
Our entire planet is suffering from biodiversity loss. This has several drivers, including changing land use, pollution and climate change, that are having serious consequences for the vital ecosystem services that biodiversity provides. These services sustain life on land and under water, and therefore our wider economy and society.
‘Loss’ can refer to raw materials, environmental disruption or reduced resilience to climate change. Healthy societies, resilient economies and thriving businesses all rely on nature.
However, the following statistics reveal the state of nature around the globe and a situation that urgently needs to change:
Biodiversity is an area of focus for us, we believe it’s vital we develop ways to comparably assess the impact and dependencies of our investments on biodiversity, so we can both limit the damage to ecosystems and contribute to the protection and restoration of nature.
Given that most businesses depend on biodiversity, either directly or through their supply chains, understanding these complex relationships isn’t only important for ESG investors focusing on societal benefits – getting it right will benefit all stakeholders.
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