B Lab’s Jay Coen Gilbert and Rick Alexander suggest “universal owners” can prosper by improving the market, not beating it
That two-dollar fast-food burger could cost up to $200 when you add in its carbon footprint, water use, degradation of the soil and the additional health care required by its production and distribution.
Former World Bank economist Raj Patel, in his classic “The Value of Nothing,” explained how our current market system allows manufacturers to earn a tidy profit and consumers to pay only $2 for the burger. By allowing the true cost of their products to be transferred to others, our capital markets encourage investors and corporations to make choices that degrade the quality of life for all of us and future generations.
Jay Coen Gilbert, co-founder of B Lab, sat down with Rick Alexander, B Lab’s head of legal policy, to talk about how such “negative externalities” have become material risks. That’s especially true for so-called “universal owners” with broadly diversified portfolios that mean they effectively “own the market.” This includes not only huge pension and sovereign wealth funds, but even individual investors with indexed 401(k) and other retirement funds that depend on steady, long-term overall market returns.
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Beating the market
“Maximize shareholder value” (described more here) is still the prime directive of the capital markets. The idea that corporations should only focus on increasing shareholder wealth. This makes ignoring the true cost of environmental and social degradation a “winning” business strategy.
Changing this belief system is complicated by the multilayered nature of investing. A worker’s pension funds may be managed by a pension trustee. That trustee may hire investment advisers, who provide guidance on where to invest. Some of those investments will go to stock funds that invest in an array of companies. Those funds will have their own managers and advisers, who ultimately decide where to invest and how to vote shares in companies in which they have invested.
No one in this complicated web is thinking about the effect of their behavior on economic, natural or societal outcomes. The effect these individual investment choices have, not only on the people and planet, but on the market itself, is outside the decision-making process. Investment managers are too busy trying to “beat the market.”
This is risky business and a shirking of responsibility, Alexander argues. An expert in corporate governance, Alexander argues that these universal investors can best fulfill their fiduciary duties to generate long-term returns by focusing not on “beating the market,” but on “improving the market.” Benefit corporation governance, which accounts for the impact of decisions on all stakeholders, is a new a powerful tool to help them do just that, he says.
Jay Coen Gilbert: What pushback do you get when you discuss benefit corporations and shareholder primacy with investors, entrepreneurs, legislators and others?
Rick Alexander: I spend a lot of my time talking with lawyers, entrepreneurs and investors, increasingly with large institutional investors. While investors may agree that this seems like a better path to a better world, they are running other people’s money, so adopting a new approach doesn’t work for them if it carries even a hint that other money managers might earn better returns. So how do we move forward?
I’ve started to focus on the theory of the universal owner — a recognition that most people who own equity in public corporations, from large institutional investors to the average person who has a 401(k), are diversified and basically “own the market.”
It turns out that when you look at an investor like that, 80% of the return comes from the performance of the market itself. And when you realize that a lot of an individual company’s performance is also market-based, you really get up to numbers where more like 90% of these universal investors’ returns comes from the market doing well.
A corporate law system that encourages people to maximize shareholder value — and by extension create what economists call “negative externalities” — actually hurts all of our portfolios. As universal investors, we’re invested in the entire system, so what we should want people to do is to avoid negative effects and unnecessary risks with respect to the system, because the system is what we’re really invested in.
So, if everyone recognizes that we’re in the same boat and pulls in the same direction, our portfolios will do better and the world will actually do better.
Gilbert: How is this kind of thinking showing up in larger, global institutional investors and asset owners?
Alexander: I may be the eternal optimist, but I do see the beginnings of that. There’s this parallel story of how those universal investors, the institutional investors, over the last 15 years, having gained a lot of power. In the 2017 proxy season, there were 500 examples of institutional investors engaging with individual companies to say, “Do this better. Do that better. Do something this way.”
We’re at the beginning of starting to see a shift, where those institutions are starting to think systemically. One remarkable example is New York State Common Retirement Fund, the third biggest pension fund in the U.S., with more than $190 billion under management, put out an ESG report earlier this year in which they specifically said that they had two responsibilities: One was to oversee the performance of companies in their portfolio; and the second was to oversee the performance of systems in which their investments were invested in. That’s pretty clearly saying that the fund is going to tell companies to lower their carbon emissions and things like that, because those things are going to hurt our portfolios in the long run.
This year was also the first year that climate-change resolutions — shareholder-proposed resolutions that shareholders put forward to their board at an annual meeting — passed at two major companies, Occidental Petroleum and Exxon Mobil, with the support of institutions like BlackRock. I think we are just at the cusp of beginning to see institutions take systemic management issues seriously.
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Gilbert: I was sitting next to you at a World Economic Forum event. You were talking about how, in other aspects of our lives, we think about multiple variables, as friends, parents, etc. You asked, “Why would we not do the same thing when it comes to how we invest our money?”
Alexander: I don’t want to live my life one way, to try to treat people right, to think about the people I work with and make sure they’re doing OK — and then go home and open my 401(k) and say, “Oh, that’s great, it went up this month,” without thinking about the fact that the reason my portfolio went up is because I’m invested in a company that has figured out how to get more carbon out of the ground faster, and another that has figured out how to shrink its production costs, but puts others’ lives in danger in doing so. I want to integrate my life into how I invest.
The truth is that today, directors already have to think about all of these things the market has named “externalities.” Directors can’t harm the system too much because people will notice and criticize. All you’re doing in a benefit corporation is moving shareholder return from being the goal to being a constraint, just as other stakeholders concerns are constraints.
Directors need to provide a fair return to shareholders, just like they need to treat the environment well, just like they need to treat their workers well, just like they need to treat the community well. It’s not really changing what the board considers at all. It’s just changing the perspective.
Rick Alexander’s new book, “Benefit Corporation Law and Governance: Pursuing Profit and Purpose,” is a guide for entrepreneurs, investors, lawyers, policymakers and others. Follow his writing on B the Change and the benefit corporation website.