Research is showing that companies with stronger ESG scores tend to outperform others financiallyI
n recent years, many companies have been jettisoning the shareholder primacy model and have instead been embracing the stakeholder model of capitalism, in which they seek to create value for all stakeholders, including employees, customers, suppliers and wider society, while delivering financial returns to shareholders. Some firms even put purpose above profits, or at least believe that they are inextricably linked.
Yet while those recent years saw more interest in responsible capitalism than ever before, those promises on stakeholder value are now being put to the test as the Covid-19 pandemic scars economies across the globe. “It’s easy to stand for what you say you stand for when you’re flush with cash and things go your way,” says Associate Professor Bidhan L. Parmar, Darden’s Shannon Smith Emerging Scholar in Business. “But when the chips are down, do you honor your word?”
Parmar sees the current mixture of tensions as the acid test for companies’ commitment to the stakeholder model. Those tensions include matters of health and safety, the stresses that accompany pandemic life, and issues of justice and equality, all of which touch the workforce and the workplace — even a virtual one.
Business and stakeholder reactions
Some businesses have stepped up and taken better care of their employees. Other companies have faced tough choices in cutting costs to shore up the bottom line. Executing those hard decisions with respect and communication can have a massive effect not just on assuaging concerns, but on the future of those companies. “As long as the process is fair and people understand why decisions are made, they are able to tolerate those cuts better,” says Parmar. “If there is no justification given, then stakeholders rebel.”
In other cases, shortages of qualified workers have constrained business growth. “Clearly, one thing coming out of Covid-19
is that companies are vying for top talent. People trapped in jobs they didn’t really like are saying: Life is short, and we need to spend time doing things that are worthwhile,” he says. “It’s a draw for talent when companies embrace the idea that all stakeholders matter.”
Another driving factor of company behavior is pressure from investors who are allocating far more capital to companies with strong environmental, social and governance (ESG)
credentials and divesting firms with poor ESG records. “Stakeholder groups are becoming more powerful, and they believe companies can do good and do well at the same time,” Parmar says, emphasizing the fact that doing good for the world and doing well financially do not have to be mutually exclusive phenomena.
This belief is held by another group of stakeholders, too: “Customers
are looking at the ESG record of companies when they make purchase decisions. They are holding corporations to account more than ever before,” Parmar notes.
A chance to rebuild better
Some businesses and plenty of politicians see this moment in time as a chance not just to rebuild the economy after coronavirus but to build it back better and greener than before. “It is a fantastic opportunity,” says Parmar. “Companies that can use this energy will be in a great position to move forward.”
The first step is to unearth a firm’s wider purpose beyond profits, he explains, and then embody those values authentically in terms of processes and products or services.
“Responsible business — people sometimes think about this as a kind of corporate PR, a way to mask poor practices elsewhere in the value chain,” he says, offering the example of “greenwashing,” when a company presents itself as environmentally responsible without fully living up to the promise.
Indeed, companies that want to embrace responsible capitalism
are confronted with plenty of hurdles, not least the challenge of measuring something as vague as purpose. “Organizations need to get good at collecting data and having a diversity of perspectives,” he says. “That underlying way in which managers work together to come up with a hypothesis has to be strong for this trend of responsible capitalism to continue.” He underscores the risk that what doesn’t get measured doesn’t get done: “When managers take shortcuts, it’s easy to fall back on the shareholder value maxim, as it simplifies the world.”
A collective effort
One area of contention with some shareholders has been dividends, with many companies slashing payouts in the pandemic. In past economic downturns, these payments tended to quickly recover, but Parmar predicts that coronavirus has catalyzed a more permanent shift in how companies are spending their free cash flows. “Each of these outlays of cash has to be connected to a logic, which says this is how we can better serve all our stakeholders.”
This is not about a choice between impact or income; he highlights a growing body of research showing that companies with stronger ESG scores tend to outperform others financially
. “There is an increasing amount of research that shows in certain contexts at certain times there is a connection between taking care of stakeholders and making profit
Leaders of companies are being called upon to address issues far beyond the confines of the corporate world and step into society’s thorniest debates, from immigration to LGBTQ rights. Will leaders
of business take the improbable opportunity handed to them to make a positive impact on the world?
“Ultimately, each of these large institutions of society, government and business has to do its part,” says Parmar. “No one institution can make up for another institution that isn’t pulling its weight. While business is feeling some of that pressure, it has to be a collective effort if we are to deliver on the promises of stakeholder capitalism.”
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[This article has been reproduced with permission from University Of Virginia's Darden School Of Business. This piece originally appeared on Darden Ideas to Action.]