Recognising that being a good corporate citizen is the right thing to do and pays off is something investors and the financial community need to think harder about, argue Vaidehee Sachdev and Matt Kirby.
Read this article to understand:
- The importance of business in addressing social inequality
- The evidence supporting the case for better employee treatment
- Whether investors can contribute to a fairer world and generate returns that meet their expectations
Do companies that behave as good corporate citizens outperform? Might their actions benefit everyone, creating profit and enhancing societies as well? These knotty questions have occupied academics and authors of investment literature for years but have come into sharper focus during the coronavirus pandemic.
The view from Professor Alex Edmans from London Business School is that it is possible to achieve ‘win-win’ outcomes, where the gain achieved by one stakeholder is not solely at the expense of another. (More from Edmans, here.)
This raises important questions: how can companies that are actively ‘doing good’ be identified? More ambitiously still, could an investment strategy that focuses solely on companies striving to be better citizens deliver the kind of financial performance investors expect, and change society for the better?
In this Q&A, Aviva Investors’ social pillar lead and impact analyst Vaidehee Sachdev (VS) and social transition fund manager Matt Kirby (MK) contemplate the challenges of investing to make the world a better place – to achieve positive social impact.
Has the financial sector turned a blind eye to exploitative corporate behaviour?
VS: The social impact of corporate behaviour has been one of the great blind spots of the financial industry. This is despite the obvious damage negative social impacts can induce at a company level, but also cumulative risks at a macro level.
We know society is characterised by unsustainable inequality in both the developed and developing world; millions of people do not have access to basic rights and resources. Of course, this is partly down to the failure of states to provide a decent standard of living for their citizens, but also because businesses and markets have failed to take account of their negative impacts on people.
We are further away from acknowledging the long-lasting damage of social inequality
The financial sector has only recently begun to accept the systemic risk climate change poses to investments. We are even further away from acknowledging the long-lasting damage and destabilising effects of social inequality. It's simply not efficient or healthy to have large sections of the population in working poverty, lacking access to basic resources or routinely denied their rights at work.
MK: The US economist James Galbraith suggests income inequality is the financial equivalent of high-blood pressure. It affects the whole body, can prefigure a crisis but is not unstoppable – it can be addressed. Conversely, measures to address inequality can bring positive benefits, improving social mobility and wellbeing, promoting employment, productivity and growth. Few businesses or financial institutions truly appreciate that and even less are willing to make the investments required to unlock this source of value.
What kind of social transition is needed?
VS: When we refer to the need for a social transition, what we are talking about is a shift away from business-as-usual to a situation where businesses and the financial sector are accountable for their negative impacts on people and society. Investors and companies have a part to play in this. Although we have some established legislation to protect certain rights in the workplace, these protections vary widely around the world. The evidence suggests that when companies and financial institutions treat their people poorly, there is little to compel them to remedy harms. That is now beginning to change with regulation, but investors should not be waiting for regulation to respond to the social impacts of actions carried out by companies in which they invest.
The consequences of ignoring the social transition are potentially devastating
The call for a social transition is about straightforward things – paying workers fairly, respecting human rights and providing people with access to basic services to enable them to live in dignity. But the consequences of ignoring these factors are potentially devastating.
When there are major and repeated shocks to the global economy such as pandemics or climate impacts, they hit the vulnerable the hardest, and over time their ability to recover and rebuild is diminished. Ultimately, this is damaging to people and communities, but is also unsustainable. As we saw at COP26, our ability to transition successfully as a global community to a low-carbon economy at the scale required depends on being able to bring everyone with us, not just the wealthy.
Why has it taken so long for investors to focus on social impact?
VS: Investors have been concerned about social issues for decades - the responsible investing industry was conceived in direct response to apartheid, for instance. Investors have also been complaining about social being the ‘neglected cousin’ in ESG for a while, so that implies they have had at least one eye on the ‘S’ factor. Despite all this, progress has been achingly slow on mainstreaming social issues.
One of the common reasons people cite as a barrier is the fact social is hard to define; it covers so many different topics that are hard to fit under one umbrella. But we should not be debating this anymore, because we are essentially talking about human rights. Social is about ensuring people have their rights respected; that is as much about ending modern slavery as it is about ensuring the workforce is an equitable and inclusive place for women and under-represented groups.
Other reasons usually centre on how much harder social is to measure. Because it is more difficult to quantify social impacts than environmental or financial factors, it does not mean you cannot measure them – you just have to change your research methods. You need to focus more on obtaining qualitative information, for instance, making connections between a company’s impacts and the context in which it operates, engaging stakeholders and understanding the relationships between social and environmental outcomes. All of this is time-consuming, painstaking work, but helps build a clearer picture of a company.
Evidence shows the strong relationship between social performance and long-term financial performance
MK: Social impact is difficult to quantify, but the mental obstacle can be overcome if you change your mindset to viewing profit as an outcome rather than a goal. There is a growing weight of evidence from academic studies highlighting the strong relationship between social performance and long-term financial performance.
There are compelling frameworks that highlight the most material stakeholders that companies should be investing in, and a wealth of case studies to draw from when determining what tools companies should be using to do so. History suggests concentrating on these relevant factors can be reflected in profits further down the road.
VS: Perhaps the biggest challenge to addressing social issues is that it requires a fundamental shift in the way companies do business. Ultimately, we are trying to get companies to hold a mirror up to themselves and take a hard, sometimes uncomfortable, look at their business models and structure and think about how financial success can be shared more equally across society.
MK: This can certainly be uncomfortable for some companies and shareholders, but it is important to ask questions - for example, about the incentives for CEOs and other senior executives. Should shareholders sacrifice profits today so that more value is created for all stakeholders in future? How is the business supporting the interests of all stakeholders over the longer term? We’re interested to know if business leaders recognise their role in society is broader than maximising profits in the short term.
What is preventing companies from doing more?
VS: One of the most obvious reasons is that investors are simply not raising these issues systematically, or in the numbers they should. It’s not good if one small but dedicated shareholder continuously raises the subject of human rights or decent wages, but the other top ten shareholders never mention it.
If you do not have buy-in from the top, it’s up to others to convince management
Barriers also exist within companies. Treating people well, respecting community rights and ensuring consumers are listened to is all good for the business in the long run. But if you do not have buy-in from the top, it’s up to others to convince management. That can be tricky when people and teams have different or competing priorities.
MK: The other big challenge is resource – collecting and analysing data on the workforce and other stakeholders requires time and commitment. This is particularly true for multinationals based in countries all over the world. Initially, it is about making that investment and seeing it as a strategic decision rather than a matter of compliance.
In many cases, drilling down into business practices can make for uncomfortable reading, and it requires resources to address issues properly if and when they are found. However, it is a risky strategy to ignore these because they may come back to haunt a company in the long run.
How much detail on companies’ social exposures can you see now in financial accounts? Could it be like climate, where we are starting to see lots of narrative at the front end and but very little detail elsewhere?
VS: Generally, company disclosures on social issues are poor. Often, companies excuse themselves by pointing to a lack of standardised reporting templates and frameworks, but soon that will change. For instance, the European Union’s Corporate Sustainability Reporting Directive (CSRD) will provide standardised metrics all companies will have to report against. In the States, the US Securities and Exchange Commission has also been considering mandatory disclosure on human capital topics.
We hope the EU regulation will encourage companies to report more comprehensively on their people impacts
We hope the EU regulation will encourage companies to report more comprehensively on their people impacts. Ideally, we would get a dedicated people report, covering all the company’s salient human rights issues and providing a range of quantitative and qualitative information. That will give us information on what companies are doing to address some of the challenges they are facing, but there is still a way to go.
MK: The more you look through a social value lens, the more you appreciate the diversity and range of ways companies are structured and operate.
We assess whether companies are truly aligned with their customers. It is about trust and efforts not to abuse those customers. It's about how companies aim to add value to customers today and develop better products for tomorrow. There are other issues for companies that are more geared to the supply chain; they might have overly complex arrangements and limited visibility, and there are countless examples where poor supply-chain management has had adverse financial impacts. Then there are questions about managing human capital and productivity right across the board. At a time when intangible assets are thought to account for over three quarters of the value of the S&P 500, we simply cannot afford to overlook human capital.
Every company represents a unique basket of opportunities and risks
What this means is that every company represents a unique basket of opportunities and risks, which is why it is so hard to call for any kind of blanket measurement. In my view, one critical factor that can determine success is transparency across an organisation. Employees must understand what is happening and feel empowered and motivated to contribute to long-term outcomes. I don't think management can credibly enforce a lot of the social measures that should be in place without these.
Our task is to look through the findings and try to establish whether what we know enhances our ability to anticipate any future earnings trajectory.
How will you measure social value and assess who is creating it?
VS: For publicly listed companies, we look at whether companies have met what we believe are their core social responsibilities. We use a framework developed by the World Benchmarking Alliance, an organisation we have worked closely with, to assess whether companies have a robust human rights approach, provide decent work and act as good corporate citizens, including paying their fair share of tax. For solutions providers (i.e., where the company’s product or service explicitly targets a specific social outcome) we also consider additional criteria to assess the credibility of their proposal.
We expect to see more companies provide greater disclosure on their supply chains
What is important – but often hard to obtain – is data on outcomes. A company may have very sophisticated policies and commitments, but this doesn’t necessarily tell us very much about what this means for people in its operations or value chain. That’s why we are encouraged by large, multinational consumer goods or apparel companies who have started to make living wage commitments. But the proof of the pudding will be in the implementation. Likewise, we expect to see more companies provide greater disclosure on their supply chains right down to tiers three and four (i.e., raw materials suppliers) because this signals they are starting to take the process of mapping their risks and impacts seriously.
MK: We draw on the work of hundreds of NGOs and independent data providers that analyse which industries or companies are carrying out sustainable or unsustainable activities. This information is being provided to the financial community at no charge but is either being overlooked or not used systematically to enhance decision making. It’s wasteful and arguably financially irresponsible. The information is varied and sometimes unstructured, so it is not possible to take a pure quantitative approach, but looking at the data in detail can be instructive, certainly compared to an approach that solely focuses on financials.
How will the research be translated into an investment strategy?
Note: The strategy has certain binding investment criteria (in line with specific objectives and exclusions). Outside these constraints, the investment manager retains discretion over investment decision making.
MK: There is very detailed research that informs what we do, based on which stakeholders are most affected by the way the company is doing business and what the company is doing to prevent or remedy negative impacts.
Firstly, we exclude companies from the investment universe that do not meet our firm’s baseline requirements. We will also apply exclusions where companies have clearly breached important international standards and norms. Additionally, we limit investment relating to fossil fuels and tobacco. We believe investing in these companies would put our clients’ capital at risk.
We compile data from a wide range of data to strengthen our view on a company
Then we have a social transition sleeve, which focuses on identifying companies that manage their social impacts well and where we think we can engage to encourage them to go further. We look for companies that are demonstrating good practices in our three thematic areas - respecting human rights, offering decent work, and behaving responsibly. To do this, we compile data from a wide range of sources to strengthen our view on a company.
Thirdly, we have a solutions sleeve, made up of companies enabling people to access basic resources and services. Provision or access to education, healthcare and financial resources are the main areas of focus. These are very exciting areas from an investment perspective.
In healthcare, for example, we have identified a company focused on democratising genetic testing, and another enabling the technology to support the World Health Organization’s (WHO) goal to eradicate the tuberculosis epidemic by 2035. There are also emerging market banks providing access to finance for underserved communities in Indonesia and India. We are also looking at an EdTech company that is one of a handful of publicly listed B-Corps (i.e., committed to balance purpose and profit), along with a company focused on bringing clean water and safe sanitation to more people, with less impact on the planet.
We look for each company in the solutions sleeve to offer a product or service that meets a social need for a specific group or underserved community and be transparent about its efforts to continue doing so. Broadly speaking, we’re interested in companies that offer solutions that will reduce, not exacerbate, the kind of inequalities we see in society today. We will certainly not be seeking companies making desirable technologies that only focus on higher-income consumers.
The transition and solutions sleeves map quite neatly onto the EU’s current thinking
The transition and solutions sleeves map quite neatly onto the EU’s current thinking with its social taxonomy and horizontal (how companies operate, promoting positive impacts and addressing negative impacts) and vertical (what companies do, improving accessibility of products and services for basic human needs) dimensions.
What will drive the performance of the strategy?
MK: Calculating a company's intrinsic value involves estimating its future cashflows, discounted back to today. In our view, companies with well-established governance and social frameworks are more likely to deliver cashflows in sustainable, predictable ways. Our process has been set up to ensure these variables are rigorously assessed. We believe only long-term investors can truly benefit from investing in companies that focus on social performance rather than profit alone, as it typically takes years for investments in material stakeholder factors to flow through to financial performance.
Only long-term investors can truly benefit from investing in companies that focus on social performance
Alex Edmans, professor of finance at London Business School, has done a lot of work on the performance aspect. He takes data on employee satisfaction from Forbes’ ‘Best Places to Work’ survey, and shows the leaders delivered shareholder returns that beat their peers by 2.3 to 3.8 per cent a year over a 28-year period. It is an example of where an intangible aspect relating to one stakeholder group is having a large and apparently sustainable impact on performance.
What is it that enforces the durability of value creation?
MK: In my view, it is about managing staff and customers, making supply chains work effectively and dealing with multiple stakeholders honestly. Our challenge is to understand each of these aspects better. But these features are not all new, of course. They have been discussed in investment literature for years and adopted by many of our most decorated long-term investors - fishing for clues in a constant effort to know more about companies or industries.
You cannot exploit communities because those problems are likely to come back to bite
The other side of the coin is risk, and the regulatory environment is strengthening. But it is important to look wider than that. If a company is not welcome in the community in which it operates, if it is creating a toxic culture or mismanaging its supply chain, that will inevitably affect its products and services. You cannot exploit communities because those problems are likely to come back to bite.
On the other hand, there is an opportunity associated with companies that step up to address their social responsibilities. As companies enable lower-income customers to access services such as finance or education, they can experience mutual benefits by expanding their services. We also value the fact responsible companies can benefit from government funding or contracts, particularly when a company’s activities help to plug gaps in the public provision of a service.
Was COVID-19 a tipping point that forced everyone to look more closely at the way social burdens are being carried?
VS: What was interesting about COVID-19 from a labour perspective was that companies with poor workforce practices were more exposed than those with better practices. For example, in the meatpacking and food processing and nursing home industries, where there were high rates of COVID-19 infections and deaths, workers were often working long shifts in close proximity to each other without appropriate safety precautions. These were also industries with a high proportion of migrant workers with limited voice or mechanisms to raise concerns. There has now been sustained pressure from investors on companies in those industries to address poor working conditions that pre-dated the pandemic.
Treating people better benefits people and the businesses
On the other hand, companies with better approaches towards their workers, providing them with paid sick leave and supporting them while unable to work, tended to experience lower infection rates, higher staff satisfaction and loyalty and outperformed other businesses. It encapsulates how treating people better benefits people and the businesses.
But outside the workplace and nearly two years into the pandemic, it is clear COVID-19’s legacy is one of deepening inequalities. Not only have millions of people been forced into poverty as a result, but we are also witnessing what WHO calls ‘vaccine apartheid’, where less than ten per cent of the world’s poorest countries have received one dose of the vaccine.
MK: COVID-19 has highlighted the varying attitude of companies towards people. Those with greater consideration and empowerment of staff, more robust supply chains and stronger relationships with regulators and governments are typically weathering the pandemic better than the laggards.
Some companies used 2020 as an opportunity to enhance the sustainability of their businesses
Some companies used 2020 as an opportunity to enhance the sustainability of their businesses, anticipating that investing in people could fuel expected (and often unexpected) returns in future. United Rentals, a company that rents out heavy equipment for industry and construction, issued all employees with shares to acknowledge their efforts during the pandemic. It also increased the minimum wage to $15 an hour and invested in culture workshops to encourage greater dialogue and action on racial justice and social equity.
Today, with the power balance shifting towards workers in a tight US labour market, companies that are stubbornly resistant to protecting, compensating and training their employees are likely to face significant disruption.
How will you engage with companies that are not addressing their social responsibilities? Are you prepared to divest?
VS: A big part of the success of this kind of strategy will depend on how we engage because we cannot expect to have direct impact through how capital is allocated alone. That is going to be a real power of this strategy, because no company is perfect. Every company has areas that it needs to address and improve.
What we are asking is reasonable, in my view! We are asking companies to have a robust and meaningful process in place on human rights due diligence. The process should include setting out how monitoring is embedded as part of a wider risk management process, reporting salient issues and having an action plan agreed to address any issues identified on the way.
Engaging with stakeholders and providing remedies are key
Without this, it’s impossible for investors and other stakeholders to know what the most important issues are and how they are being addressed or mitigated. The issues will differ from company to company. Engaging with stakeholders, including workers, communities and consumers, and providing remedies are key.
We also want to see companies make commitments to pay living wages across their direct operations and supply chains. Living wages are an important tool for addressing social inequality – paying a living wage should be part of the normal course of doing business. Ultimately, if we do not see progress on these and other areas, we will use that final lever and divest.
MK: The opportunity to engage offers us a window into the corporate culture and willingness of management to make the right decisions for the long term. Companies that are not willing to better themselves are not companies we want to invest in.
How do companies react when you start to drill down into these areas?
MK: I think all companies want to be challenged to be better businesses. That’s our goal too when we are talking to management about their social impacts. Sometimes it can be challenging where there is resistance, but equally we have seen leading firms actively seek guidance on how to improve their human rights due diligence approach or treatment of workers.
The challenging conversations are some of the most fruitful
VS: The challenging conversations are some of the most fruitful. You probably need a little discomfort to make progress, but we are not the only ones putting pressure on companies on these points; expectations from civil society, unions, policymakers and others are also growing.
Things take time to change. Take conversations around the living wage, for instance. Very few companies dive straight in with higher wage commitments because that has financial implications for the business and shareholders. What we do is make the case for why paying a living wage is important – not just for those receiving a pay rise, but for the long-term health of the business. It can take years before a company finally agrees to make a living wage commitment, let alone pay it.
To make progress, you need sustained pressure from every corner. But we are looking forward to those conversations; ultimately, we believe they will be worthwhile.