In this article the Amrop Board Services Practice and corporate governance specialist Peter Verhezen re-visit assumptions of ‘shareholder primacy’ and its link with fiduciary duty. We find out how and why sustainable performance is increasingly important not only for organizations, but for investors.
The Investors Are At The Door
In the past 3 years some of the world’s most famous multinationals have been the targets of high-profile takeover bids. From pharmaceutical company Allergan, to FMCG giant Unilever, and PPG Industries, a major producer of paints, coatings and specialty materials. All bids were rejected by the organizations’ boards, in part due to strategic differences - a conflict of interest between stakeholder and shareholder value.
There is a Core Dilemma
How to react to a takeover bid (or other investment proposition)? The discussion boils down to two perspectives: short-term profit maximization, versus longer-term value optimization. Is the investor short-termist, playing or trading stock on the capital markets? Or seeking ROI over a longer period, caring for critical stakeholders (employees, customers and even the wider community)? Surely, many argue, any top executive should above all else enrich the owners of the company he/she is leading? Isn’t this what fiduciary duty is all about? The answer, we argue, is no – if ‘owners’ are taken to mean ‘short-term shareholders.’
The Throne of shareholder supremacy Is Wobbling
Over forty years the concept of ‘fiduciary duty’ has fallen prey to a series of misinterpretations, to the point that it is now widely taken to mean ‘shareholder primacy’. The idea that shareholders should ultimately dictate the functioning of a company provides a robust platform for short-term stakeholder activism, and it has faced some serious counter-arguments over the years. Two recent rebuttals include an HBR article: “The Error at the Heart of Corporate Leadership,” and a dismissal of shareholder primacy by Lynn Stout as an abstract economic theory that lacks support form history, law, or empirical evidence.
3 flaws in the shareholder primacy argument
- Ignoring key stakeholders can create an existential threat. Without an engaged, proficient work force or loyal customer base, a company will underperform - also financially. And acting in a socially or environmentally responsible way is an increasingly important factor in how people choose where to work or what to buy.
- Shareholders are not a single ‘entity’. Different shareholders have different motivations and time perspectives.
- Many shareholders – particularly activist or hedge fund - are essentially risk-takers. They are providing capital to enhance short-term performance and their own portfolios. They should be distinguished from block holding investors, or significant owners in family conglomerates.
It’s Time to Re-Frame ‘Fiduciary Duty’
Executives are not ‘agents’ of shareholders, whose job is to ‘serve’ their interests as the organization’s ‘owners’. Their duty should be seen as loyalty to the organization and its sustainable/long-term value. And that needs to extend beyond organizational walls: to customers, employees, lenders, and other relevant stakeholders. If shareholders could be seen as first among equals, they are certainly not the only major player a responsible organization must consider.
Investors Have Their Sights On ESG
If potential suitors must demonstrate care for the long-term interests of organizations, so too must target organizations. In its 2016 Report on US Sustainable and Responsible Investing Trends, the US SIF (Forum for Sustainable and Responsible Investment) found ESG integration (Environmental, Social and Governance) was the most common strategy for investors in asset-weighted terms: 62% practice it across $1.5 trillion in assets. 300 money managers practice it in some form, so that “as much as $5.8 trillion could be engaged in ESG integration.
These findings are echoed by “Why and How Investors Use ESG Information”, a survey of 413 senior, largely mainstream, investment professionals with $31 trillion in Assets Under Management (43% of global institutional AUM). The authors find 82% using ESG data because it is “financially material to investment performance”. Many do so due to growing client demand or formal mandates. Yet they face barriers: incompatible reporting across firms, a lack of reporting standards, and the costs of gathering and analyzing ESG data.
“Current gaps in leadership thinking and practice give Boards serious food for thought,” says Svein Ruud, Leader of the Amrop Global Board Services Practice. “Many with whom we interact are painfully aware that it is time to address their willingness and ability to make sustainable decisions – as individuals and as boards. There is a growing hunger for wise leadership. At Amrop we have also re-defined our own core purpose as an organization: our new Mission is “shaping sustainable success through inspiring leaders.” Clients can increasingly expect this philosophy to guide our advisory approach when it comes to board hiring and functionality.”
4 Leading Questions
- If your Board received a takeover bid today, to what extent would its response be led by ‘shareholder primacy’?
- What kind of an organization does your Board envision? At what moral level should it operate?
- How important are non-financial objectives? What value do individual Board Members attribute to sustainability, and ESG criteria? What beliefs? Where are the zones of tension?
- To what extent are ESG criteria embedded in corporate reporting, and convincing?