Two Years Later, Has the Business Roundtable Statement Transformed Capitalism?

Two years after the Business Roundtable redefined its statement of Purpose of a Corporation to include “a fundamental commitment to all of our stakeholders” and not just shareholders, Alex Edmans asks: has it delivered on its promise?

August 19, 2019 was a historic day. The Business Roundtable (“BRT”), a group of the CEOs of major US companies, radically redefined its statement of the Purpose of a Corporation to include “a fundamental commitment to all of our stakeholders,” not just shareholders. Many applauded it for signaling a new, fairer model of capitalism. But it had equally vehement opponents: that same afternoon, the Council of Institutional Investors criticized the statement as a backward step for not only shareholders, but society. 

The strength of these responses—in both directions—suggests that people viewed the BRT statement as heralding a major change. But two years in, has it delivered on its promise? Views on this question are equally polarized: Some argue that shareholder capitalism is now dead; others lament that little has changed. BlackRock’s former head of sustainable investment, Tariq Fancy, claimed that ESG investing is “marketing hype, PR spin, and disingenuous promises.”

Commentators have the incentive to make extreme statements in either direction, since such statements most likely to be clicked on, shared, and quoted. But, as with most issues, reality is somewhere in the middle. There have been several marked shifts in line with the BRT statement, but many of them are actually detrimental to stakeholder capitalism. Note that it’s impossible to isolate the effects of the BRT statement, as we don’t know which changes would have happened anyway. So instead, I’ll discuss six recent trends without ascribing causality:

1. Legislation of ESG actions. For example, NASDAQ has proposed a requirement for boards to contain at least two minority directors. In the UK, the Financial Conduct Authority is consulting on whether to introduce “comply-or-explain” targets for diversity.

2. Measurement. Global consortia, such as the World Economic Forum, are devising an ever-increasing set of sustainability metrics for companies to report. Investors and stakeholders are demanding that companies report on their ESG performance, and many are doing so voluntarily. 

3. Pay–for-ESG. Two recent studies found that 51 percent of large US companies and 45 percent of leading UK firms use ESG metrics in their incentive plans, in contrast to the historic use of exclusively financial targets.

4. ESG activism. Traditionally, shareholders engaged with companies purely on financial grounds, such as payout policy. They’re increasingly taking action on ESG issues—for example, the investment firm Engine No. 1 successfully campaigned to elect three climate-focused directors to Exxon’s board. 

5. ESG stock selection. The use of ESG criteria in stock selection was formerly the exclusive domain of “socially responsible investors,” with explicit non-financial objectives. It’s now practiced by mainstream investors with purely financial goals. 

6. Changes in directors’ duties. The European Commission is considering redefining directors’ duties away from shareholders towards stakeholders. Some companies are voluntarily doing so by becoming Public Benefit Corporations, with a number—such as Lemonade, Vital Farms, Coursera, Broadway Financial Corporation and Zymergen—recently going public. 

These six trends are underpinned by a common set of three assumptions:

1. ESG performance always improves financial performance.
2. ESG performance can be measured.
3. Stakeholder capitalism requires moving away from shareholder capitalism. 

These changes only make sense if these assumptions are true—but they’re barely ever stated, because it’s taken-for-granted that they must be correct. However, each assumption is deeply flawed.

Let’s start with the first, the view that ESG always boosts profits. An oft-cited McKinsey report, entitled “Diversity wins,” argues that “the business case for gender and ethnic diversity in top teams is stronger than ever.” A study released by the UK regulator, the Financial Reporting Council (“FRC”), concluded that “gender-diverse boards are more effective than those without women.” Calls to disclose ESG metrics, tie CEO pay to ESG, or to use ESG in stock selection, are similarly based on the claim that they boost shareholder returns.

As a strong supporter of responsible business, who has written a book on the business case for ESG, I’d love this to be true. And as an ethnic minority, I’d particularly like diversity to improve financial performance. But here lies the problem: most people want these results to hold. Thus, due to confirmation bias, we accept these claims uncritically when the evidence is actually weak. Starting with diversity, the McKinsey study has been shown to be irreplicable even with their chosen performance measure (EBIT) and preferred methodology.  Moreover, there is no link between diversity and other performance measures—gross margin, return on assets, return on equity, sales growth, or total shareholder return—or when using more established methodologies. Turning to FRC study, out of 90 regressions investigating the link between diversity and profitability, not a single one finds a significant relationship. 

Turning to ESG more broadly, while the evidence suggests that some ESG dimensions, such as employee satisfaction, do boost long-term financial performance, those irrelevant for the company’s specific business model don’t. Thus, if investors demand the reporting of ESG factors, engage on them, or use them in stock selection, they should be selected carefully based on materiality. Instead, they’re often a knee-jerk reaction to the demands of pressure groups or whatever issue happens to be the order of the day.

Note that, even if there is no clear business case for ESG, there are strong moral and ethical cases. Using diversity as an example, many people—myself included—believe that companies have a responsibility to contribute to a diverse and inclusive society. Perhaps doing so may not maximize profits but many shareholders and stakeholders are willing to accept that trade-off—just as consumers buy organic food, despite its greater cost, due to non-financial considerations. However, if non-financial motives are the driver, we should be up-front about this. Instead, companies, investors, and regulators commonly advocate for ESG based on the claim that it will definitely boost profits. 

The second assumption is that ESG performance can be measured. If it can be, then it’s clear that it should be. Measurement allows investors and stakeholders to assess whether companies are “walking the talk,” thus holding CEOs accountable—particularly if their pay is linked to ESG. Moreover, if these metrics are comparable across companies, investors, employees, and customers can flock to the most sustainable ones. “Common sustainability metrics” are thus viewed as a panacea that will revolutionize the ESG industry.  

As a professor of finance, I believe in the power of data, but I also recognize its limitations. There are two main problems. The first is that metrics focus only on the quantitative and ignore the qualitative: You might measure employee well-being using worker wages, injuries, and turnover, but these fail to capture other critical dimensions such as meaningful work, skills development, and a vibrant culture. A common response is that a partial measure is better than no measure, but research consistently shows this is not the case. Measurement leads to the non-measured dimensions being deprioritized—“hitting the target, but missing the point.” For example, test scores lead to teachers teaching-to-the-test and ignoring other important dimensions of learning. Worse still, the CEO may manipulate measured performance—for example, reducing turnover by retaining underperforming staff—particularly if her pay is linked to them.

The second is that comparability is a red herring. It’s well known that ESG rating agencies disagree significantly on how to measure ESG performance—and for legitimate reasons. Different people have different views on the most important factors, such as the relative weight of employees versus the environment, or noise versus particulate pollution. Even if they agree that something is material, they may disagree on how to measure it—gender diversity might be captured by the number of women on the board, the composition of the workforce, or the gender pay gap. Which enlightened being gets to decide the one set of metrics that all companies should report? (“Report every single metric” is not a satisfactory answer, due to the reporting burden on companies and the confusion for investors and stakeholders).  

In addition, the ESG metrics that matter are inherently incomparable. “Do no harm” metrics such as carbon emissions, water usage, and workplace injuries can indeed be compared. But ESG is more about “actively doing good”—and here the metrics will depend on a company’s business model. Unilever measures the number of people it’s reached with its handwashing campaigns; MYbank gauges how many of its small business customers never previously received a loan from any bank. 

Indeed, the accounting profession has developed a common metric before: quarterly earnings. This achieved many of the benefits that people seek from ESG metrics. It shows which companies are actually delivering results, rather than talking a good game, and it’s comparable. Yet quarterly reporting leads to short-termist actions to hit earnings targets, and is far less material in some companies (e.g., fledgling tech firms) than others. 

This doesn’t mean that the trend towards measurement is unambiguously bad, but should be interpreted with caution. I’m often asked, “How do you measure sustainability?” This is the wrong question. Sustainability isn’t something that you can measure; it’s something you assess. This involves starting with quantitative metrics, but then supplementing them with qualitative information. Assessing a company purely on sustainability metrics is like hiring an employee purely on psychometric tests. 

The third assumption is that stakeholder capitalism should involve anti-shareholder capitalism: decoupling CEO pay from financial metrics and redefining directors’ duties. This is based on the assumption that the value a company creates is a fixed pie. Then, the only way to increase stakeholder value is to decrease shareholder value. Indeed, in one of the most evidence-based arguments that the BRT statement has been meaningless, law professors Lucian Bebchuk and Roberto Tallarita find that the BRT signatories have not changed their corporate governance guidelines or executive pay structures away from shareholder value.

But the pie is not fixed. Material stakeholder performance grows the pie and ultimately improves profits; as a result, directors or executives evaluated according to long-term shareholder value will invest in their stakeholders. As a result, it’s not necessary to move away from shareholder value, but instead to lengthen the horizon. Indeed, research has found that long-term CEO incentives have a positive causal effect on not only shareholder returns, but also innovation and stakeholder welfare. Jettisoning shareholder capitalism won’t lead to stakeholder capitalism, but managerial capitalism where the CEO pursues her own interest at the expense of both shareholders and stakeholders.

Overall, both camps are partly right and partly wrong. There’s been strong appetite and decisive action towards stakeholder capitalism, but this energy has not been backed up by expertise. Stakeholder capitalism has become such a popular topic that many talking heads have jumped on the bandwagon without conducting careful research on it, or at least examining the research. As a result, they end up advocating changes that sound radical but are likely to backfire. Some argue that the radical problems that society faces require radical solutions, but instead they require effective solutions. Time is limited, and so we must base our remedies on the best available evidence rather than shoot from the hip. As the fable of The Tortoise and The Hare teaches us, we need “more haste, less speed.”