CEOs are increasingly facing the conflict of short-term profitability pressures versus long-term sustainability issues. Social profit (in terms of sustainability and social good) and financial profit are increasingly intertwined, as savvy shareholders and an informed public demand corporations, large and small alike, use their influence for the good of the masses.
The concepts of social and financial profit may no longer be at loggerheads, however the approach each CEO takes to balancing short-term incentives with long term sustainability issues should not be a decision taken lightly. Just why a CEO should care about sustainability issues, and the degree to which they should care, is a matter up for debate.
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Fundamentally, the CEO has a duty to act on behalf of those who vote for them, which is typically the board of directors and shareholders. In a one-dimensional world, the interests of these parties would be to maximise the profitability of the company above all else (lawfully). Given shareholders get to vote and elect the board, some could argue the importance of the profit objective. After all, why should a CEO extend the boundaries of these responsibilities?
The answer is two-fold. First, it makes business sense. Second, it’s where stakeholder expectations have shifted.
Sustainability drives financial success
Proponents argue rewarding social performance at the top stimulates managers to
improve corporate image and reputation, create in-tangible assets, and positively influence long-term organisational survival. At the same time, socially responsible firms can attract and retain better partners, customers, and employees than poor performers.
Sustainability objectives offer downside protection too. We’ve all seen the power of “social shaming” whereby society can vilify companies for their behaviour, regardless of whether it is legal. The recent example of social shaming after mining giant RIO Tinto destroyed a 46,000 year old Aboriginal heritage site in the Pilbara illustrates this point perfectly. Negative press and boycotts can be extremely powerful.
Sustainability-focused or more “legitimate firms” run less risk of such social sanctions, as well as legal sanctions, costly penalties, high insurance premiums, and significant environmental remediation costs.
Companies are increasingly moving away from the perspective that social engagement acts as a diversion of business resources from their proper use, to one that recognises and rewards activities considering the interests of multiple stakeholders. Whether it be employees, customers, communities, governmental officials, and/or environmental groups.
In one of Blackrock’s infamous CEO letters, Larry Fink put companies on notice, saying: “to prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”
Fink, at the helm of a $6 trillion investment firm, wants CEOs to know shareholder value alone will no longer cut it. He stated the mantra upon which companies must be run should be stakeholder value AND running companies with a purpose for the long term. Shareholders are agreeing.
In recent years, large institutional investors (insurance companies, superannuation funds) are flexing their shareholder activism by paying closer attention to the social behaviour of the firms they invest in.
Elevate Super was purpose-built to track our investment portfolio against the Sustainable Development Goals. We wanted to give customers transparency on the impact their investments are making, and hope this will also help bring sustainability to be front of mind for companies.
One area we support is advocating for tobacco-free finance, with tobacco killing more than 8 million people globally every year according to the World Health Organisation. We’ve partnered with Tobacco Free Portfolios, a not-for-profit made up of a team of medical doctors, ethics experts and sustainable finance professionals set up to work with finance leaders to put tobacco-free finance on the agenda and help improve global health.
“We all need to work together to achieve the SDGs and we should not underestimate the power of our money to do good.” – Dr Bronwyn King AO, CEO at Tobacco Free Portfolios.
A Morningstar report showed 177 shareholder initiatives addressing social and environmental concerns were voted at U.S. companies’ annual general meetings (and averaged 29% support) during the 2019 proxy season – a record high for the second year in a row.
Australian proxy voting advisory firm Ownership Matters, stand true to their name. They believe shareholders don’t just have rights but are also responsible for generating change in order for the market to operate effectively. Market commentators have gone so far as to say institutional investors wield more power than governments when it comes to shaping climate action.
How do CEOs go about balancing sustainability with profit?
Kevin Chin, CEO of B Corp Arowana believes profit and purpose can go hand in hand. He referenced venture capital firms as an example of purpose-driven companies with shareholders that have an 8 to 10-year investment horizon and don’t always expect profits along the way.
Chin’s top sustainability tip is to hire like-minded employees who don’t live for the annual bonus check (as many in the finance industry do). As well as this, he believes it helps to have shareholders with a similar investment time frame and objective: “Employees and shareholders must be onboard”.
No discussion about CEO motives would be complete without delving into incentives as executives are unlikely to pursue socially responsible practices unless appropriate incentives are in place.
As legendary investor Charlie Munger maintained, get the incentives right. People will behave as they are incentivised to behave, and company leaders are no exception. Studies have found it’s now increasingly popular to find sustainability-related terms/targets in compensation contracts.
“Companies concerned about sustainability are likely to link executive compensation to sustainability in recognition of the view that management needs to be compensated for the increased risks associated with long-term social strategies.” – Al-Shaer, H., Zaman, M. CEO Compensation and Sustainability Reporting Assurance: Evidence from the UK. J Bus Ethics 158, 233–252 (2019).
This is a good way to ensure CEOs are not just profit-focused but contribute to the long-term strategy of a company.
Companies and CEOs alike should not claim to advocate for every social value but instead focus on those most appropriate to their own contexts (as opposed to those values that may be the passion project of a CEO).
In this case, a good chairman is essential, as well as carefully constructed, long-term management incentives linking relevant sustainability issues with the financial wellbeing of the company.
The question of just what a CEO should care about is ultimately a balance they have to strike. Every business should think about the role social issues can and should play in strategy. That way, it can build trust with consumers, shareholders and other stakeholders, as well as mitigate risks appropriately. Above all, the CEO must do their best to maintain this precarious balance; remaining wary of tipping towards one shareholder or direction over another.