What is the value of reputation?
How does a board prove the authenticity of its commitment to reputation and what are the consequences if it doesn't?
The market for corporate reputation has become one of increasing economic value as well as political and policy imperatives. More granular environmental, social and governance (ESG) reporting is not only a listing requirement, it serves four core economic functions. It helps fend off hostile takeovers on grounds of poor governance by demonstrating aligning purpose, value and values; it attracts long-term patient investors; it has the potential to reduce the cost of capital by limiting banking oligopolies; and it deepens capital markets.
Critical to the development of the market in corporate reputation is whether the changes it implies are warranted. At its core, the debate focuses on whether “purpose” and “profit” are mutually exclusive or inextricably linked. The rapid increase in the issuance of green bonds and other niche ESG products suggests this is a market just beginning to demonstrate its potential advantage for corporates, investors and intermediaries. In just over a decade, the market has mushroomed from zero to issuance of US$200b per year.
While taking a stand on climate agendas, purchasers are safeguarding their own investment through much more substantive engagement in product design. They have much greater capacity to set the stringency of the terms to satisfy investment appetite at a global level. For the product manufacturer, the bond can be securitised, thereby deepening supply and demand. For the corporate itself, investment in the process has two further advantages. From a strategic perspective, it allows for virtue signalling while aligning purpose to more effective risk management. From a tactical perspective, it diversifies funding sources. For governments — especially those involved in handling the competing agendas associated with infrastructure projects — it reduces sovereign exposure to environmental risk.
With global energy demand set to increase by more than 25 per cent to 2040, the International Energy Agency (IEA) suggests that more than US$2 trillion of annual investment is necessary to finance the shift towards renewables. With the IEA suggesting 70 per cent of the financing will have to come from government — through offsets and guarantees — ESG credentialing has become an essential competitive tool for corporates and a safety device for exceptionally nervous political establishments across the globe.
“The message is clear,” stated IEA executive director Faith Birol in November 2018. “The world’s energy destiny lies with government decisions.”
While the science of climate change is settled, its political cost is not. Take, for example, the debate about the Adani coalmine in Queensland. For affluent inner-city constituents, opposition to the mine [could be interpreted by some as] cost-free virtue signalling. For people in outer suburbs wrestling with rising energy costs, the short-term cost of the shift to renewables competes with hard economic choices. For those in rural constituencies, dependent on the mine for employment, even the debate itself is an unaffordable luxury. Electoral management of the issue has necessitated mixed messaging and political confusion.
Such confusion is not confined to Australia. It is symptomatic of global political discontent that in Finland the knock-on economic impact of unevenly applied environmental commitments has seen a resurgence of populist rhetoric and support. In April’s general election, the Finns Party, which campaigned against climate change-related economic costs, won the second-highest number of parliamentary seats. It now holds a kingmaking role or source of discontent as official opposition.
According to corporate communications firm Edelman, which has been measuring discontent since 2001 through its annual global Trust Barometer, the primary cause of discontent is unease about whose interests are being served by the financial services industry at both wholesale and retail levels. Enhancing the quality and quantity of disclosure has become a key driving force, and herein lies the advantage of the green bond market and its facsimiles.
The process includes third-party verification of governance and transparency policies, and procedures underpinning the promises made. Critically, this occurs not just at the point of issue, but across the lifetime of the bond. While such verification does not solve an inherent conflict of interest if the rating agencies are paid by the issuer, it is feasible for independent evaluation to be undertaken or underwritten by the Organisation for Economic Cooperation and Development (OECD).
The OECD has revamped its own mission to enhance inclusive economic growth “leading to better lives”. Green bonds facilitate increasingly competitive and safer markets that combine social utility with a restoration of warranted trust in the operation of capital markets through increased engagement in product design and ongoing verification to ensure promises made are promises kept. The OECD has launched a global campaign to renegotiate a “new intergenerational social contract to restore the confidence of citizens in their institutions”. As its secretary-general, Angel Gurria, warned in June 2017, an approach based on “superficial changes” would be insufficient. “The truth is, this won’t work,” he said. “We are beyond quick fixes to address the discontent of citizens.” ”Businesses are increasingly realising that long-term financial performance by definition must be sustainable, which means pursuing good ESG practices.” Greg Medcraft, OECD
The OECD director of financial and enterprise affairs, Greg Medcraft, set out an ambitious agenda at the annual northern spring meetings of the International Monetary Fund and World Bank in Washington DC, in April, that explicitly endorsed the link between “value” and “values”.
“Businesses are increasingly recognising that long-term financial performance by definition must be sustainable — which means pursuing good environmental, social and governance practices,” said Medcraft. “This reflects operational needs and risk mitigation, such as resource constraints, climate change, the need to develop human capital, and ensuring taxation commensurate with adequate social programmes. But critically, it also reflects public expectations — the social licence to operate. If businesses do not do the right thing and break that licence, their customers, staff and investors will hold them to account.”
To be effective, this proposed social contract must begin within the corporation itself and extend across its local, regional and global supply chains. It must integrate law, morality and corporate practice. For Medcraft, the former chair of the Australian Securities and Investments Commission, the gap between value and values is theoretically bridgeable.
“While business is pursuing value, governments are pursuing values as the basis for policymaking,” said Medcraft. “That is to say, the normative decisions we have made as society about what kind of world we want to live in, and what outcomes our laws and markets should deliver. The good news is that in terms of outcomes, there is little difference between business value and social values because business needs to align its behaviour with what society expects.”
However, what society expects is hard to measure. It is even harder to align with business practice. While there is a fast-growing market for ESG indices and bonds, indicating the potential economic gains from alignment, debate over whether the corporation should shoulder the cost has led to diametrically opposed strategic approaches to investing. We are witnessing what Vanguard founder, the late John Bogle, termed “the battle for the soul of capitalism”.
For corporations seeking to manage the spillover, ESG reporting is a double-edged sword. This has been most notable in the high-profile takeover struggles for Procter & Gamble and Unilever. Both aspired to make a demonstrable impact on the environment, and both were accused by private equity consortia of messianic leadership that squandered shareholder return. Unilever survived intact, in large measure by moving its product chain upmarket to those prepared to pay premiums for sustainable products.
Procter & Gamble found itself caught in one of the most expensive proxy battles in history. It fended off a hostile bid for board representation only to then implement the cost-cutting measures demanded. BlackRock, the world’s largest single investor, has sought to break the deadlock with a 2019 compromise manifesto from its CEO, Larry Fink, titled Purpose & Profit. The manifesto could easily have come from the OECD.
For BlackRock, the solution is not either purpose or profit, but both. In other words, “purpose is not the sole pursuit of profits but the animating force for achieving them”, he argued in his 2019 annual letter to shareholders. BlackRock’s investment strategy is now informed by how individual companies within their portfolios meet these inextricably linked goals.”We seek to understand how a company’s purpose informs its strategy and culture to underpin sustainable financial performance.” Larry Fink, CEO BlackRock
“We have no intention of telling companies what their purpose should be — that is the role of your management team and board of directors. Rather, we seek to understand how a company’s purpose informs its strategy and culture to underpin sustainable financial performance,” he concluded.
What is missing is the actual purpose itself and extent to which one’s reputation for that purpose is warranted. What does it mean to be authentic? It is about making promises and being accountable to them. This is primarily the responsibility of the board, not shareholders, who — while ostensibly the owners of the corporation — are in reality rentiers of capital.
The authentic self is always constrained. In organisational terms, the nature of that moral or contractual constraint is determined by implicit or explicit responsibility to and for the community with which one interacts. Outside of these constraints, the constitutive goods of the articles of association or code of conduct can provide essential narrative content and structural context. This allows relative questions of how to frame absolute ones of why. Even if the motive itself remains suspect or requires stronger evidence, authenticity is a good practical starting point for governance design. In many ways, it is governing from the inside out.
For the board of directors, this requires an active balancing of three sources of organisational form and substance. The first necessitates that the actual lived practice reflects genuinely held inner values. The second requires this choice to be made purposively. The third gains legitimacy and sustainability only if the rationale reflects the inherently fragile social interdependence of the social world.
Authenticity, in a virtuous sense, therefore requires an enormous sea change in the definition of corporate reputation. Risk management systems must align thoughts, words and actions to achieve goals that contribute to social wellbeing, and not simply protect the interests of the corporate itself.
The critical task is to identify and make sense of that meaning, value and belonging. This begins within the workplace and the norms it values. Just as individuals influence culture, so too do cultures influence individuals. The norms are — or should be — subject to ongoing evaluation, contestation and external validation. However, it is only by making the journey that one can discover the logic and practice of authenticity.
It is time to divert from the populist destination. The train to mutually assured destruction has already left the station. One does not want to be on it when it arrives.
Professor Justin O’Brien, director of The Trust Project, is co-editor (with UTS Professor Thomas Clarke) of The Oxford Handbook of the Corporation (Oxford University Press, 2019) and author of Trust, Accountability and Purpose: The Regulation of Corporate Governance (Cambridge University Press).