Managing Global Transitioning Challenges with the ESG Tool
Professor Ismail Ertürk, The University of Manchester
Today, firms globally are faced with two historically significant forces: 1) Transitioning from a shareholder value maximisation purpose to stakeholder value purpose 2) Transitioning to an economy of net-zero
Since the 1980s maximising shareholder value has been the dominant firm objective. The belief was that scarce capital resources in an economy can be most efficiently used if managers make investment decisions to maximise shareholder value. And this efficiency would be priced in the stock market with the companies maximising shareholder value achieving highest market capitalisation.
Paying CEOs and executives in equity-based remuneration would align the interests of the managers and owners of the firm. However, after almost 40 years of experimentation this governance mechanism has not delivered the efficiency and economic growth it promised. Yes, in the US, where the shareholder value maximisation principle was born and is practiced more widely we have companies with very high stock market valuations and CEOs with very high pay.
However, the income and wealth inequality in the US and in Europe has worsened by historical standards. Fiscal conditions of the governments have worsened making investments in infrastructure very difficult. Shareholder value maximisation principle has given the US and Europe rich corporations and CEOs but poor societies and government. Consequently today even International Monetary Fund advices governments to control corporate power and improve income and wealth distribution to achieve economic growth. Corporations themselves too realised that there is social pressure on them to change their priorities from maximising shareholder value to improving well-being of all stakeholders, employees, consumers, communities, small suppliers.
How this transitioning is going to happen is a big challenge for todays firms. And in parallel to this force, there is a global movement to reduce global warming to 1.5 centigrade above pre-industrial level. Governments globally agreed, first in Paris in 2015 and then in Glasgow in 2021, under the United Nations umbrella, to become carbon neutral. Therefore firms today operate under national and international conditions where carbon emissions have to be controlled and firms themselves have to report their net-zero targets. And it is not just carbon emissions but also general environmental concerns and bio-diversity affect behaviour of companies because consumers increasingly are sensitive to environmental consequences of their purchases, especially the younger generations. Both of these forces, transitioning to stakeholder value-driven firm and transitioning to a net-zero economy, that companies face translate into developing a formal ESG (environmental, social and governance) strategy and reporting ESG performance in addition to financial performance.
Access to capital, cost of capital and future viability for companies, now, will depend on how successfully they formulate and execute ESG strategies.
How ESG is measured in valuations and how enhanced green technology helps companies with purpose