Over the last two years, Indian investors have lost substantial money thanks to what appears to be poor management in several companies. These include the meltdowns at IL&FS, Jet Airways, Reliance Capital, Dewan Housing and the like.
It was felt, erroneously, that after the 2009 Satyam scandal and the dramatic overhaul of the Companies Act in 2013, that a stronger ethical compass was in play across the corporate sector.
This belief has now proved to be overtly optimistic. It is clear that more needs to be done.
One obvious reaction would be to argue for more regulation, but it is unlikely to improve corporate behaviour unless large institutional investors take direct action. Thus far, their response when faced with an owner or promoter whose actions fail the classical smell test has been to simply sell shares of the stock.
This is a lazy response to a problem and does not provide enough of a disincentive to management.
That there are simply so many varied instances of irresponsible behaviour that it undoubtedly leads to a strong demand for the corporate sector — generally the largest contributor to growth, jobs and innovation as well as inequalities and emission — must take on a greater responsibility for the future of the societies they serve. There is clearly a lot more that the power of capital, on this scale, can do to actively bring about constructive corporate change.
This power ultimately rests with the owners of capital. Recognising this, the United Nations crafted the Principles for Responsible Investment which requires its signatories, of which there are over 1,500 now, to commit to integrating environmental, social and governance (ESG) issues in their portfolios.
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ESG issues cover a wide range of business elements which ensure the long term sustainable profitability of a company. Today, over $15 trillion of funds now adhere to some form of ESG thesis. The sheer scale of these funds implies that even small changes in their asset allocation strategies can have a material effect on the demand for individual company stocks and for national equity inflows.
ESG is, at its heart, about a long-term strategic view of ones’ business, which considers a range of risks and opportunities. However, thus far, investments in ESG have by and large remained exclusionary in nature, with large investors avoiding the most obviously negative industries or at best encouraging companies to adhere to a minimum level of responsibility.
Several issues have come to light in the past few years, which have raised questions over whether an exclusionary approach — merely avoiding investing in industries seen to have negative impacts like tobacco, gambling, weapons and so on — to corporate responsibility is simply too limiting in its scope.
First, Thomas Piketty’s seminal thesis on inequality has touched a chord in a world where the top 5 percent continue to garner a disproportionate share of income, while company owners continue to appear to be focused on job cuts which exacerbate inequalities.
Facebook’s use of customer data have now raised privacy issues to the attention of a public which, until now have been oblivious to the consequences of their data profligacy. Uber’s face-offs with its drivers has elevated the subject of how employees in the gig economy are treated. Perhaps most importantly, far too many climate disasters have come upon the globe, reducing the philosophical space that climate deniers used to have.
This requires an active and engaged approach to investing which in turn requires a much stronger sense of corporate responsibility to be embedded into general market behaviour. Asset owners need to nudge owners of listed entities to engage in behaviour which demonstrably address ESG issues.
Larry Fink, the chairman of Blackrock, which manages large assets, in his 2018 letter to shareholders did a great service to the spirit of responsible behaviour when he said that ESG approaches were core to any investment approach that they take.
So, what needs to be done? First, investors must shake off the mindset currently prevalent in listed markets, that short-term quarterly accounting numbers are the ultimate determinant of excellent performance. If there are obstacles to be overcome in this effort, these remain largely in our mindsets. There is an argument made that businesses should only focus on the lowest common denominator of short term shareholder return. This is clearly a very old fashioned 20th century approach.
In precisely the same manner in which manufacturing industries are expected to not only adhere to regulation but go beyond that if they have to be seen to be best in class, investment owners too, can be expected to run their businesses in a manner consistent with ESG principles while also achieving great returns.
Today, no manufacturing entity would be allowed to take the view that the reduction of emissions, or greater safety regulations, impacts productivity. On similar lines, no fund manager should be permitted to take the position that they would not be able to achieve the returns expected of them if they had to ensure that they only invested in responsible companies.
Pension funds, insurance companies and the like must therefore play a part in rebuilding some of the trust that financial institutions have lost. When governments and public shareholders observe that these principals who own shares on their behalf take positions that bring advantages to a larger slice of the populace it will mean a return to fiduciary duty as it was envisaged in the past.
Insurance regulator IRDA (Insurance Regulatory and Development Authority) has, as a part of its stewardship code, asked insurers to engage actively on issues of governance, succession planning and the like. It is unclear whether this is taken seriously by insurance company heads.
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Selling is the best policy?
Large institutional investors will argue that they anyway influence company managements by selling shares of companies whose actions they do not like. This is not sufficient. There needs to be a more proactive demand on companies to demonstrate long-term thinking. They can engage actively with board members, owners and managements of companies to place ESG factors at the forefront of their strategy. They can explicitly hold companies to account for their responses to issues such as climate change, employee safety, capital allocation, talent management, data privacy and a raft of other issues. They need to make clear that CEOs who cannot deliver returns while also being responsible cannot be considered to be best in class.
In addition to backing credible and responsible management teams, investors can choose to invest funds behind investment management teams which, in addition to partners with expertise, have operating partners who have the gravitas and track records to command the respect of corporate executives and push them on the path to change.
Several companies have been able to integrate responsible behaviour while being very successful. For companies such as Tata, this was so deeply ingrained in the DNA of senior management that even an utterance that countered the responsible ethic was frowned upon.
It has been heartening to see that leading cement companies such as Ultratech and Shree Cement, have, have committed to greenhouse gas emission reduction targets, aligned with a less than two degree increase in world temperature. Consumer goods firm Marico grew fifty fold between the mid 1990’s and today, largely on account of the astuteness of the promoters to professionalise the management of the company.
But these examples are by far away and few. More needs to be done, especially among the five hundred, small and mid cap companies listed on our exchanges whose ESG practices are under less scrutiny than their larger peers. By placing focus on these areas and long-term financial performance, asset owners will move companies to a place where other shareholders also back those companies which demonstrate responsible long run plans, set milestones for the same publicly and hold themselves accountable against those.
For decades, companies were judged by how they played the long game. This changed for the worse in the 1970s. Investors now need to work hard to push companies back to that place.
Govind Sankaranarayanan is the former chief operating officer of Tata Capital and is currently the vice-chairman of ECube Investment Advisors.