Corporate Responsibility & Sustainability Summary PDF

Stuvia - Koop en Verkoop de Beste Samenvattingen Corporate Responsibility SMV HW for HC 1 Paper: Theory of the firm: managerial behavior, agency costs and ownership structure – Jensen & Meckling J&M in...

Stuvia - Koop en Verkoop de Beste Samenvattingen Corporate Responsibility SMV HW for HC 1 Paper: Theory of the firm: managerial behavior, agency costs and ownership structure – Jensen & Meckling J&M investigated how ownership and managerial behavior can influence firm’s performance. They introduce the agency theory → owners (principals) and managers (agents) can have conflicting interests, leading to agency costs like monitoring costs and loss of value for the owners. These agency costs can be reduced by specifying property rights in contracts, as rights help to align their interests by providing incentives for agents to act in the best interest of shareholders. They discuss how different ownership structures (private/ public/ shareholder) influence interests. For example, the shareholder ownership tends to protect the interests of owners because they can quickly detect and correct value loss. The design of the ownership structure and contracts can influence managerial behavior → managers should be rewarded based on their performance. Video: Positive externality Normal situation Demand for trees. And there is a benefit associated with trees (control pests, improve air quality and better look) → positive externality → €10 per tree → creating this figure: Marginal benefit + external benefit for society. Green /// = benefit for society Yellow /// = consumer surplus Pink /// = producer surplus Orange /// = dead-weight loss → fix this, stimulate to plant more trees by giving a subsidy for those that buy/plant a tree → optimal quantity is produced → new figure: Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen → (consumer) surplus is higher! Video: Negative externality Normal situation /// = consumenten + producentensurplus Demand of supermarkets for plastic bag = marginal benefit, supply = marginal cost But there is a cost associated with plastic bags (litter & bad for environment) → negative externality → €0,02 per bag → creating this figure: ||| = positive surplus, lower than before since accounted for all costs and benefits in society. HC 1 The corporation in the Neo-classic model and its challenges Agenda Introduction Course organization The Neo-classic model of corporation Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen What is a corporation? Sole proprietorship (= eenmanszaak) ▪ Owner = firm ▪ Unlimited personal liability Partnership ▪ All partners are liable for the debt. ▪ Bijv. group of lawyers. Limited liability companies ▪ Firm as a legal entity with contractual rights and obligations. ▪ Limited liabilities. ▪ Separation of ownership and control. ▪ Joint stock ▪ Can be publicly listed or privately held companies. In this course, we focus on limited liability companies. Corporate profits flow to households Positive spillovers (technology, health care etc.) Negative spillovers (environmental and social impact) Adam Smith: the invisible hand ‘’It is not from the benevolence of the batcher, the brewer, or the baker that we expect our dinner, but from the, but from their regard to their own self-interest!’’ The system in which each firm and individual pursues their own interest is the best. The company and its stakeholders Customers Shareholders/ investors Suppliers Employees Local communities Governments and Public Bodies NNPOs/ NGOs Global Environment In the perfect world: Complete contract specifies… ▪ All rights and obligations of all parties. ▪ In every possible future state of the world. Perfect information ▪ No agency costs How to maximize social welfare in this Neo-classic model? Milton Friedman (1970) ‘’The one and only social responsibility of business – to use its resources and engage in activities designed to increase its profits…!’’ Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen By maximizing shareholder value, all other stakeholders also improve their welfare in the Neo-Classic model. ‘If you sell a lot, your suppliers also benefit as they sell a lot to you’. Friedman Doctrine ‘Only take care of business, not the other stakeholders.’ That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. He (the manager) is spending his own money or time or energy, not the money of his employers or the time or energy he has contracted to devote to their purposes. If these are ‘social responsibilities’, they are the social responsibilities of individuals, not of business. The Neo-Classic Model and externalities Positive externalities Bijv. employee training increases productivity and employee loyalty, but it also benefits others employers. Negative externalities Bijv. fertilizers from farming lead to ‘dead zones’ in the ocean. Pacific Gas & Electric company contaminating water for the neigbourhood (Film-Erin Brockovich, 2000) How to deal with externalities? Pigouvian Tax (by Arthur Cecil Pigou) ▪ To offset negative externalities with tax. ▪ To encourage positive externalities with subsidy. ▪ Government plays a central role in welfare economics. Coase Theorem (by Ronald Coase). ▪ The producer purchases rights to pollute. ▪ The producer invests in new technology or clean up pollution. ▪ Or the community is compensated for the negative externalities. ▪ Government taxes the polluter and compensates the victims. If there is no transaction cost, parties can always find efficient solutions. The Neo-Classic model – externalities Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Pay those that suffer from the externality directly. But: transaction costs! The Neo-Classic model – Challenges Incomplete contract ▪ Future generations and mother nature could join the negotiation today. ▪ Impossible to contract all possible future scenarios. ▪ Hard to measure and quantify the externalities. ▪ Accountability is quite a challenge! Information Asymmetry ▪ It’s hard to quantify firms’ impacts on environment. ▪ It’s hard to monitor and verify fims’ clean up acitivites → how do we verify what companies are saying? Accountability Who is responsible for the melting glaciers? How much compensation should be paid by whom? Who should be compensated? And by how much? Are the companies doing what they claim to do? Could shareholder value maximization work? Shareholders Are the residual owner of the firm. Have voting rights about firm decisions. Nominate board of directors. Challenges Incomplete contract ▪ Separation of ownership and control ▪ Managers pursue self-interest. Information Asymmetry ▪ Hard to monitor and verify… We will dive more into the corporate governance mechanisms next time. Corporate governance system Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Recap Smith: the invisible hands → corporations are legal entities, with separated ownership and control, and limited liabilities. Friedman: shareholder value maximization. Pigou: mitigating negative externalities with tax and encourage positive externalities with subsidy. Coase: efficient solutions for externalities (in the perfect world). But: externalities, incomplete contracting & information asymmetry. HW for HC 2 Paper: A Survey of Corporate Governance – Shleifer & Vishny Abstract: corporate governance = the way in which suppliers of finance to corporations assure themselves of getting a return on their investment. As product market competition would force firms to minimize costs and adopt rules to raise external capital at the lowest cost, it is a powerful force toward economic efficiency. But it (alone) cannot solve the problem of CG. It may reduce the returns on capital and hence cut the amount that managers can possibly expropriate, but it does not prevent them from expropriating the return after the capital is sunk. Solving this problem, requires something more than competition, as is shown in this survey. It researches how investors get the managers to give them back their money. The agency problem Role of legal and regulatory systems → they can protect investors and promote good governance. I The Agency Problem: the separation of ownership (shareholders want high revenues now) and control (managers want to invest for the long-term) = conflicting interests → agency costs to solve these are substantial and can result in inefficient allocation of resources. Mechanisms to mitigate the agency problem: Contract needed that specifies what the managers does with funds/ returns → but, future contingencies are hard to describe, so incomplete contracting. Management Discretion = the extent to which managers are given decision- making authority over the firm’s resources → needed to allow managers to make informed decisions, but too much authority leads to agency problems. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Incentive Contracts = tie managerial compensation to performance, thereby aligning the interests of managers and shareholders → must be designed carefully to avoid unintended consequences such as short-term focus. Evidence = agency costs are high in firms where the separation between ownership and control is high. They show some mechanisms that mitigate agency costs and improve firm performance: ▪ Monitoring by independent directors ▪ Monitoring by large shareholders (= concentrated ownership) HC 2 13 Corporate governance failures & structures Agenda Agency Costs Corporate Governance Mechanisms Agency Costs Jensen & Meckling (1976) Separation of ownership and control lead to agency problems. Agency problems exit in all organizations and all cooperative efforts. Corporation is a legal fiction that serves as a nexus of contracts among individuals. Agency costs ▪ Monitoring costs by the principal (shareholders/ employees): costs a principal makes to monitor and control the activities of the agents, in order to behave in the interests of the principal. ▪ Bonding costs by the agent (managers) - Bijv. managers need to disclose or announce investments. Costs for meetings (in terms of time). - Bijv. audit costs to monitor the manager. ▪ Residual losses (= remaining costs) = reduction in welfare experienced by the principal when its decisions differ from that of the agent (J&M, 1976). Agency costs Monitoring costs 1. Board of Directors to monitor managers and represent shareholder’s interest. 2. Large shareholders monitor management. 3. Shareholder activism to monitor and influence management. Bijv. Greta Thumberg in environmental activism. Signaling costs: 1. Managers pay dividends, signal to shareholders that the firm is profitable. 2. Timely and honest disclosure of crucial information to stakeholders (no greenwashing!). 3. Auditing of the financial and non-financial statements (costs for disclosure). Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Residual costs: 1. Managers pursue their own interest at the costs of the principals. Which agency costs does this entail? (paper J&M) Part of residual costs → managing shirking 6 types of agency costs in the corporate world CEO pursuing self-interests: Shirking Management perks Tunneling Management entrenchment Excessive risk taking: Empire building Accounting frauds Agency problems within organizations are costly too!! → Management accounting addresses this. Shirking Even talented managers may find themselves slacking if not properly disciplined (time in which they don’t work effectively). Extremely hard to monitor someone with unique skills and knowledge. ▪ This is why such a person is hired. ▪ It requires an expert to monitor an expert. CEO perks Executives tend to over-spend on perks. ▪ Fancy offices ▪ Corporate jets ▪ Dinners ▪ Parties Paper by David Yermack (JFE 2006) ▪ Manager using jet for private purposes → wasteful spending → this points to agency problems in control system. ▪ High usage firms suffer badly. ▪ Even more than direct costs associated! Tunneling The transfer of assets and profits out of firms for the benefit of those who control them. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Expropriation = the act of taking away money or property, especially for public use without payment to the owner, or for personal use illegally (Onteigening) Expropriation of funds (ways to exploit investors): Managerial theft of corporate assets. Favoring companies owned themselves or by relatives. Excessive compensation Limiting shareholder’s voting rights Shleifer & Vishny (1997) Manager is tunneling money from the business to itself. For example: company buys a car of the manager for 3 million = overpriced. Example of tunneling: FTX Largest company for crypto currency exchange Founder Sam Bankman-Fried (SBF) transferred $2 billion from FTX entities for personal use. SBF and five members of his inner circle transferred $3.2 billion into their personal accounts in the forms of ‘’payments and loans’’. Management entrenchment Managers make themselves important so that they don’t get fired. Management could protect their control right in the following anti-takeover mechanisms: Poison pills: to allow existing shareholders to purchase extra shares at discount – to dilute shares. Golden parachute: to give generous payment to executives after acquisition. Staggered board: classify board to prevent board being replaced at once: you cannot replace whole board but every year one of the members. Require supermajority for shareholders for shareholders to amend corporate charter (more than 50%). These are the reasons why hostile take-overs are costly or hard. Example of entrenchment: Twitter launches poison pill (see Canvas) Hostile takeover by Elon Musk → Twitter did not want him → management announced poison pills → existing shareholders can buy Twitter-shares at discount, with the aim to dilute the shareholding of an unwelcomed bidder → whatever Elon Musk was holding, was valued low. At some point, they agreed to the takeover of Elon Musk → he fired a lot of people. Empire building Managerial incentive to acquire another company. ▪ Prestige ▪ Job security ▪ Complexity of firm structure frustrates monitoring. Value destroying M&A’s ▪ Negative M&A announcement return Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen ▪ Overpayment for M&A (as witnessed by the rise of goodwill on balance sheet). The value of goodwill has grown the last years. Accounting frauds Many compensations targets are linked to short-term financial performance of the firm. Managerial Incentives to ▪ Inflate current profits (at the expense of future profits). ▪ Inflate expectations (over-emphasize good news). ▪ Hide or delay bad news (till after crucial date). For example: Enron, Wirecard. Agency costs – within organizations (internal control) Unauthorized risky trading: The Rogue Trader – Nick Leeson brought down Barings Bank ▪ He was future-contracts trader at Barings Bank and started to speculate on the market with unauthorized positions → big losses → he did not report but hided this loss → more speculative trade → BB bankrupt. The London Whale – derivate trader of JPMorgan that lost $6 billion. ▪ Bruno Iksil (= the London Whale) took great risks, leading to great losses but hided these as well. Agency costs – in the aggregate world Underdeveloped capital markets Over reliant on bank finance Concentrated share ownership Discounted share prices (is very bad, e.g., shareholders are not protected) Even… natural disasters and financial crisis!!! Corporate Governance Mechanisms The Dutch East Indian Company VOC 1602-1799 The first publicly listed company. Equity value of 6.5 million guilders 70 biggest shareholders appointed 17 board of directors (life-long appointment) 10 years no dividends, no accounting disclosure Origin of the world’s first stock exchange future market and short selling. VOC also shaped the corporate governance structure of today! VOC shaped the Corporate Governance structure First short sheller and shareholder activist Isaac le Maire. VOC revised charter under shareholder pressure in 1622 ▪ Financial disclosure regularly Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen ▪ Shareholders appoint independent auditors. ▪ All shareholders have equal independent auditors. ▪ Limited term for directors VOC also suffered agency problem internally ‘’The biggest challenge was the tendency of its men on the spot to trade on their own account or defraud the company. Traders sent to Indonesia traded on their own behalf → they gather money but don’t report it to the company (keep it themselves). This was partially countered by unusual compensation system, which linked remuneration to investments and sales’’ they increased the compensation for these traders, so they don’t need to ‘steal’. – the Ascent of Money. Types of Corporate Governance mechanisms Board of directors CEO compensation Financial and non-financial disclosure Internal and external auditor and credit rating agencies Shareholder activism and engagement Law and enforcement Board of directors monitors and advices the management Board diversity ▪ Gender diversity ▪ Skill diversity ▪ Cultural diversity Board independence ▪ Not as independent as it seems. ▪ CEO power CEO compensation aligns incentives Performance based compensation ▪ Base salary (benchmarking on industry and peers) ▪ Cash bonuses (performance based: financial, ESG, relative performance compensate for effort, not luck). ▪ Stock options (link executive reward with stock price appreciation). ▪ Stocks (making CEOs the partial owner of their company). ▪ Long-term-incentive-plan (based on 3-5 year rolling average performance). ▪ Retirement plans Relative performance evaluation ▪ Compare to peer group performance. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Disclosures improve transparency Financial disclosure = mandatory ▪ Standard format according to Generally Accepted Accounting Principles (GAAP) may materially affect ▪ Disclosing non-financial risks that may affect shareholder value. Non-financial disclosure = voluntary ▪ CSR reports ▪ Global Reporting Initiative (GRI) ▪ Climate related disclosure (SEC, EU) And ISSB Auditors provide assurance of disclosure quality Audit quality ▪ Independence - Pay model - Cross selling Incentives (auditors invest in the stock themselves → they want it to rise as well) - Audit tenure - Audit career at clients’ organization ▪ Time pressure ▪ Ethics Sarbanes-Oxley Act (SOX) 2002 required ▪ Mandatory audit rotation after 5 years and… ▪ Mandatory auditory rotation ▪ No cross selling Rating agencies to reduce information asymmetry Verschil weten!! Credit rating agencies ▪ Paid by the issuing company (of corporate bond) ▪ Provide rating on the financial solvency of the company. ▪ They failed in the financial crisis in 2008 → they got heavily regulated. Governance rating agencies ▪ Paid by investors ▪ Provide rating on the corporate governance quality ESG rating agencies ▪ Paid by investors ▪ Provide rating on the ESG impacts firms’ profitability (single materiality) ▪ Many players in an unregulated market… Shareholder activism influence management (more in HC 4) Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Institutional investors have the resources, the incentive and bargaining power to influence management on… Corporate governance ▪ CEO hiring/ firing, compensation ▪ Board structure ▪ Investment/ divest strategies Environment ▪ ExxonMobil commit to climate change. Social issues ▪ Carl Icahn pushes McDonald over animal rights. Law and enforcement protects investors Corporate Governance Code ▪ Stewardship role of the CEO and board members Legal origin and shareholder protection ▪ Common law vs. code law ▪ La Porta, Lopez-de-Silanes, Schleifer & Vishnny (1998) Enforcement ▪ Litigation risk also serves as a discipline mechanism. Corporate Governance Structure Company at the center Top: managers & board of directors Corporate Governance Structure of non-financial reporting How the company is connected to its stakeholders. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Institutional investors hire ESG rating agencies. HW for HC 3 Friedman: The Social Responsibility of Business is to increase its profits. CSR → ‘businesses’ are artificial persons and thus cannot have responsibilities, only people can. Therefore, CEOs are responsible to the owners of a firm (shareholders), also called his employers. He has direct responsibility to them, that is to conduct the business in accordance with their desires, generally; to maximize profits while conforming to the basic rules of society, both those embodied in law and in ethical custom → he is acting on behalf of the shareholders → he is agent, serving the interests of his principal(s). But: it is hard to measure the performance of a CEO. When a manager is spending his own money/time/ interests and not that of its employers, he can rather be seen as principal that is pursuing its own social responsibilities. But: as his actions reduce returns to stockholders/ raise the price to customers/ lowers the wages of employees → he is spending their money, in a different way than its shareholders would have done → taxation without representation → as his actions can restrain inflation/ improve the environment/ fight poverty, in effect he is imposing taxes and deciding how the tax proceeds shall be spent → he is actually a public employee or civil servant, who should normally be selected via political process normally. While a CEO, doesn’t know anything about that field of business. This difficulty of exercising ‘’social responsibility’’ illustrates the great virtue of private enterprises. They can do good, but only at their own expense. According to Friedman, it’s the role of the government, rather than businesses, to address social issues. HC 3 Shareholder versus Stakeholder capitalism Agenda The debate CSR & ESG The debate A debate in n1930s → ‘’to whom are corporate managers trustees?’’ Adolf Augustus Berle Jr. President Franklin Roosevelt’s Brain Trust Shareholder value maximization. Erwin Merrick Dodd Jr. The need for business to consider the welfare of other stakeholders. Shareholder value maximization doesn’t include externalities → too costly for society. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen The great depression calls for reflection about business and society. Shareholder primacy Milton Friedman → by maximizing shareholder value, all other stakeholders also improve their welfare in the Neo-Classic model. Friedman’s view about corporations Firms should make as much as money as possible while conforming to the basic rules of society, both those embodied in the law ant those embodied inn ethical custom. Thus, maximization of profits is constrained by law and ethical norms. Two views: Revenues – costs = profit Companies pay employees their salaries. Companies pays dividend to investors. It is up to them (employees and investors) to care for society → societal benefits and other projects. Companies should not be involved in advancing societal values. This task is delegated to employees and investors. Revenues – costs = profit Investor return Societal benefit (CSR investments of business) Companies should invest on behalf of their stakeholders. Firm that donates to charitable undertakings, is implicitly levying tax on shareholders, customers, and employees. Jensen & Mackling 1976 Very different from the stakeholder value maximization. A firm is just a web of relations, it has no personality and therefore no responsibility. Same conclusion as Friedman. Are shareholder and stakeholder interests aligned? Yes, theoretically, then maximizing shareholder value also in turn’s maximizes stakeholder value. In reality, the shareholder interests are NOT aligned. ▪ Risk preference: risk loving or risk aversion (payoff function) → shareholders have more risk (for return) than creditors. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen ▪ Time horizon: short-term (creditors) versus long-term (shareholders). ▪ Measurement of utility: hard to assign dollar value to human life and quality of life → hard to value pollution for example. ▪ Values → within shareholders, there are differences in values between big and small shareholders. Youtube: Michael Sandel – Putting a Price tag on Life. Economist Bentham came with the idea of maximizing utility, which is the ethical theory that actions should be chosen based on their ability to promote greatest overall happiness. It might seem to justify cost-benefit analyses of economists, as they can provide valuable information, but it is not morally justifiable as they cannot replace the need for moral and ethical considerations of human life. If someone smokes and dies earlier, it’s cheaper for society, as no costs for pension, health care, elderly housing etc. → no costs incurred for dead itself. Ford Pinto car: fuel tank was at the back of the car, when having an accident, it exploded → change the design (making car saver) was more expensive than to pay for costs when having accidents → human life should be valued higher. Hurricane Katrine So, according to Sandel, economic analysis can be useful sometimes, but it can prioritize economic interests over human life. Shareholder Theory Focus: Primarily on maximizing shareholder Payoffs of shareholders and creditors value. Objective: The main goal of a company is to increase the wealth of its shareholders, typically measured by stock price and dividends. Proponent: Associated with economist Milton Friedman, who argued that companies should prioritize the interests of shareholders above all else. Left corner: company value = low → shareholders don’t get anything but only creditors do. When more value → shareholders benefit. Shareholder payoff → call option (vgm). Creditor payoff → put option (vgm). Klopt dit? Shareholder theory Tensions between shareholder and stakeholders are largely resolved through market forces: ▪ Employees can leave ‘bad’ firms to work for ‘good’ firms. ▪ Customers can ignore ‘bad’ firms and buy from ‘good’ firms. ▪ Shareholders can sell ‘bad’ firms and buy ‘good’ firms. ▪ Repeated game serves as implicit contract. ▪ Technological advances make it easier to monitor and verify. Holding corporate managers accountable for the bottom line (= revenues – costs = profit) would simplify the problem. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Stakeholder Theory Focus: Broader consideration of various parties affected by the company's actions. Objective: A company should consider the They are accountable for their actions. interests of all stakeholders, including employees, customers, suppliers, the What are the challenges of the shareholder theory? community, and the environment, in addition Contractual incompleteness to shareholders. ▪ Shareholder primacy assume that every stakeholder holds contractual claims with the firm. ▪ Contractual incompleteness’ problems are all over the place (Grossman& Hart, 1986) Market inefficiencies ▪ Serious consequences of short-term shareholder value maximization at Proponent: Advocated by figures like R. the cost of other stakeholders. Edward Freeman, who argued that a ▪ Externality problems… business's long-term success depends on Legal constraints managing relationships with all stakeholders. ▪ In Germany and Austria, labor union, local government, and creditors representatives to the board so that not only shareholder interests are considered. Stakeholder theory Managers are agents of all stakeholders: ▪ To ensure that the ethical rights of no stakeholder are violated. ▪ And to balance the legitimate interests of the stakeholders when making decisions → internalizing social and environmental externalities. ▪ Looks like an ideal world. Difference Stakeholder theory take as stakeholders as an end (purpose) itself, but shareholder theory: stakeholders (customers/ employees) are a mean to serve the end. End = shareholder value. Alternative organizational forms according to Stakeholder model Private company ▪ Private equity or concentrated ownership → resolving agency problem. ▪ Long-term value creation (LTVC). Cooperation ▪ Groups of people working together for common or mutual benefit. ▪ Lack of access to external equity, limiting growth. B corporation (more about it during guest lecture). ▪ B Lab certified company meeting social and environmental standards. ▪ Connect salary of employees to inflation rate (= living wage) versus fixed wages (= minimum wage). Social enterprise of foundation ▪ Non-profit focusing on social or environmental goals. ▪ Governance may be a major challenge. Governmental organization with public objective ▪ Focus on public good. ▪ Efficiency may be a challenge. Renewed purpose of a corporation 2019 2007: In the Business Roundtable view, the paramount duty of management and of board of directors is to the corporative stockholders. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen 2019: they should not only serve shareholders, but also their stakeholders → value to their customers/ employees. Stakeholder value maximization ‘Stakeholder capitalism is not about politics. It is not a social or ideological agenda. It is not ‘’woke’’. It is capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper. This is the power of capitalism.’’ – Fink (2022) Challenges with stakeholder value maximization All stakeholders matter, no stakeholder has primacy. Conflicting interests among stakeholders. Multi-dimensional objectives undermine efficiency and profitability. It might be difficult to raise funds from investors. Differences shareholder vs stakeholder theory: But the world is changing… Primary Goal: Shareholder theory prioritizes profit maximization for shareholders, while stakeholder theory emphasizes the importance of balancing the needs of all stakeholders. Value Creation: Shareholder theory often views value creation narrowly in financial terms, whereas stakeholder theory recognizes the broader social and environmental impacts of business decisions. Long-term vs. Short-term: Stakeholder theory tends to focus on long-term sustainability, while shareholder theory can sometimes lead to short-term profit maximization. Environmental and social issues are becoming more important. Businesses have changed when the public came to expect and require different behavior. I predict that in the future, just as in the past, changes in public attitudes will be essential for changes in business’ environmental practices. – Jared Diamond In practice, many companies are finding ways to Global risks incorporate both theories, recognizing that long-term shareholder value can be enhanced by considering the interests of all stakeholders. LET OP: video in slides nog niet gezien Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Economic issues (like inflation) are not the major issues anymore. Corporation for the environment and society Patagonia’s bold move In September 2022, the founder Mr. Chouinard and family decided: ▪ To transfer 2% shares with voting rights to Patagonia Purpose Trust which ensures that the company remains committed to CSR. ▪ To donate 98% of remaining shares and all future profits to a new NGO Holdfast Collective in order to combat climate change. … What’s the guiding philosophy of the following institutions? Securities and Exchange Commission (SEC): shareholder primacy. Sustainability Accounting Standards Board (SASB) in the US: business disclose on sustainability but still shareholder primacy. International Sustainability Standards Board (ISSB) → shareholder primacy. Global Reporting Initiative (GRI) → stakeholder primacy. MSCI/ Sustainalytics: shareholder primacy. So, almost all focus on shareholders! CSR & ESG Motives for CSR Legitimacy theory: posits that for a corporation to continue to exist it must act in congruence with society’s values and norms (Dowling & Pfeiffer, 1975) = confirm to society expectations, gain social trust to operate. Peer pressure (do like others do) Brand differentiation → a way to charge a premium, compared to less sustainable competitors. Increased regulation Risk management → firm value can be preserved when managing risks (oil in Golf of Mexico). Discussion: what is the intrinsic motivation of firms? Agency problems or good governance? Mainly agency problems, but also good governance. Firms with better governance structure, tend to invest more in CSR. Ex post impacts of CSR Empirical studies found: ▪ Financial performance (mixed results) ▪ Lower reputational risk when having higher CSR. ▪ Higher employee loyalty. ▪ Higher customer loyalty ▪ … Complete literature review: Christensen, Hail & Leuz (2018) → idea for thesis. Purpose vs. profit OR purpose & profit Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Question: how do you see the relationship between profit and purpose? Should firms care more for purpose, and later on profit or other way around? Is there a positive or negative correlation between the two? For some positive and some negative. Positive: the more invest in CSR, the higher profit. Negative: the more invest in CSR, the lower profit. According to TIAS students: But: empirical studies found more positive impacts of CSR LET OP: Slide 31 staat niet in deze samenvatting! Different views on Sustainability - Rationalism: “meeting the needs of the present without compromising the ability of future generation meeting their needs” - Naturalism: bring industrial activities in harmony with nature, not to deplete natural resources beyond their natural rate of regeneration. - Humanism: our intrinsic desire to preserve life for Carroll and the CSR-pyramid ourselves and future generation. 1979/1991: Carolls’ Pyramid of CSR CSR entails the simultaneous fulfillment of the firm’s economic, legal, ethical, and philantrophical responsibilities. The focus should be on the total pyramid as a unified whole….. and not only on the bottom of the pyramid Comparable to needs pyramid of Maslow! Ideally, firm takes care of all the 4 simultaneously. Friedman: firms should be profitable, legal and ethical → firm at ethical level. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Stakeholder management 5 important questions: 1. Who are our stakeholders? 2. What are their stakes? 3. What opportunities and challenges are presented by our stakeholders? 4. What corporate social responsibilities (economic, legal, ethical, and philanthropic) do we have to our stakeholders? 5. What strategies, actions, or decisions should we take to best deal with these responsibilities? Put this in a matrix → The Stakeholder Matrix Analyze a stakeholder matrix for the TA! Maybe it is in their CSR-report, otherwise create it yourself, based on company’s disclosure. ESG Important to understand this! UN Sustainability Development Goals (SDGs) Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Recap Learning goals Understand the key differences between and the challenges of shareholders versus stakeholder theory. Understand the underlying forces for the rise of CSR/ ESG and how it affects firms’ financial and non-financial performances. HW for HC 4 Article: Is Coca Cola’s shareholder value negative? – Rajgopal Measuring stakeholder value → hard to identify negative externalities and how to value them. Rajgopal’s approach: 1. Market value of the equity capitalization of the company = shareholder value. 2. Identify negative externalities and assign a social cost per unit. ▪ Social cost of emissions, water use, unrecycled plastic, incremental health care costs for excess consumption of sugary drinks (diabetes), tax payoff to lobbying. 3. Identify positive externalities and give the business credit ▪ Employment, payments to supply chain, taxes the company pays to society. 4. Stakeholder value = shareholder value - negative externalities + positive externalities Critics: Rajgopal has imprecise estimates. Besides that, some costs associated with negative externalities will be passed on to the customer → demand will fall as Coke is price elastic → CC has less money to address these problems and long run shareholder returns. Lastly, detailed work, tradeoffs per region, is useful. But probably CC isn’t the real problem, regulation or customers are, as customers will buy their coke elsewhere if CC liquidates. Therefore, it’s better to let CC produce Coke, instead of an unorganized sector that will impose the negative externality without the scale to pay for it. Moreover, it’s hard to obtain information about externalities → ESG reports are insufficient. Resolving the social tradeoff will take decennia. And as companies innovate around these externalities over time, stakeholder value should be revised periodically. According to Rajgopal, investors should talk with companies to show them that negative externalities will lead to lower returns in the long run. This is better than regulation by the government, as it’s hard to define effective rules and monitor them. Article: Accounting for Climate Change – Kaplan & Ramanna = the first rigorous approach to ESG reporting. This paper is about the need for companies to incorporate climate change (because of GHG emissions) risks into their financial reporting as it can affect a company’s long-term viability and stakeholders need accurate information about this to make informed decisions. As ESG-reports are often made up of inaccurate, unverifiable, and contradictory data (as E, S, and G are separate concepts and can work inverse), these authors propose a remedy: the e-liability accounting system (environmental cost to society), whereby (GHG) emissions are measured using a combination of chemistry and engineering, and principles of cost accounting are applied to assign the emissions to individual outputs Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen across the entire value chain, using the example of a car-door manufacturer. This system requires two basic steps: 1. Calculate the net E-liabilities the company creates and eliminates each period, adding them to the E-liabilities it acquires and has accumulated. ▪ Engineers can estimate the quantity of GHG emissions from a company’s primary-source activities (scope 1 emissions). 2. Allocate the E-liabilities to the units of output produced by the company during the reporting period. ▪ Identical to activity-based costing for assigning overhead costs to multiple products produced in a given period. Benefits of E-liability accounting It eliminates the duplicative counting of emissions that is embedded in current scope 3 measurements (= emissions from upstream and downstream operations inn a company’s supply chain). It reduces incentives for gaming and manipulation → a company cannot reduce its reported scope 1 emissions simply by outsourcing production. It can apply a materiality threshold specific for GHG, regardless of the financial impact. A company’s end-of-period E-liability balance can be audited in much the same way that its financial asset and liability accounts are. How societies choose to fail (collapse) or succeed – Jared Diamond LET OP: video nog kijken Why societies collapsed (e.g. Mayans) and how we can learn from this. Factors contributing to collapse: climate change, ecological damage, overpopulation, unstable trade relations and political indecision. How can we learn from this, to avoid making the same mistakes: Adaptability to environment is crucial not to fail. As a global society, we must take responsibility for our actions and work together to create a more sustainable future. In concrete terms: reduce dependence on fossil fuels, reduce ecological footprint and develop sustainable economic systems that take into account the ecological limitations of our planet. HC 4 Agenda Environmental impacts of business How to account for climate change Environmental impacts of business Traditional economic model Cobb-Douglas model production depends on two factors: Q = f (K,L) If you have enough capital and labor, you can produce. They forget about a lot, for example externalities. Externalities!!! Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Industrial waste and household waste caused chemical reaction in Columbia rivers. According to the UN, 80% of the waste flow into rivers, lakes, and seas without filtering of processing. Polluting drinking water of 2 billion people in the world. Jared Diamond’s environmental factors Natural habitats are being destroyed (deforestation). Wild food reduction (hunters) Biodiversity loss Soil erosion Natural resource depletion Freshwater pollution Natural photosynthetic resources maximization (maximizing crop productivity) Human introduction of toxins and alien species Climate change induction Overpopulation Which factors are not related to business activities? Overpopulation How to deal with these externalities? Pigou: subsidy to encourage positive externalities and taxes to discourage negative ones. Kijk nog wat uitlegvideos!! Would carbon tax be a solution to our climate challenge? Is that sufficient? In 2012, the Gillard government introduced carbon tax on the big polluters in Australia. In 2014, the opposition Abbott government dumped carbon tax and replaced it by a $3 billion subsidy for the big polluters. Political uncertainty may limit the effectiveness of carbon tax. What’s the relationship among environment, society, and business? Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Left: they connect to each other Right: environment is the over coupling one, without that, it’s all zero → right one. Environmental constraints CC: water shortage. SABMiller: water shortage is problem, so they need to save water. Pacific Gas and Electric: they caused forest fires → they went bankrupt. Tragedy of the commons Mark Carney, former Governor of the Bank oof England and chairman of the Financial Stability Board. Biggest challenge to be effective together = tragedy of the commons → China wants the US to reduce pollution, so they can grow themselves, while US wants China to reduce. Conflict of interests Short-term interests of the decision makers and the long-term interests of society are conflicting. It is difficult for societies to make good decisions when there is a conflict between strongly held values that are good in some circumstances but bad in others. By Jared Diamond Jared Diamon’s 5 Factor Checklist Human impacts on the environment Climate change Relationship with neighboring societies Relationship with hostile societies Political, social economic, and cultural factors Where does our society stand? How about mankind? How about the collapse of business? Problem or opportunity? While management is problem-oriented; leadership is opportunity oriented. Instead of seeing a problem as segmented and mechanical – a broken part that needs to be Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen fixed – it’s seeing it as part of a living, synergistic whole. It’s looking at what is around a problem, what is connected to it, what can influence it, as well as the problem itself (Stephen Covey). Ecological economics production function Daly and Farley (2011) embody energy use and waste emissions: q + w = F(K, L, N; r, e) q: production of goods and services q: production of goods and services + w: waste w: waste N: Natural capital N: natural capital: r: natural resources & e: energy r: natural resources e: energy How to account for stakeholder value? Stakeholder value = market value of equity + positive externalities – negative externalities In the case of Coca-Cola: Check slides 35 - 38! Environmental and social externalities are super relevant for the politicians, society, and firms, but not incorporated in prices and decision making. Taxes the company pays to the government are not sufficient to mitigate all the losses in welfare. Voluntary disclosure on the environmental and social externalities are not complete. Reliable data is the crucial missing link. We need to make assumptions to fill these gaps and have imprecise estimates. TA: can you try to quantify then Environmental and Social externalities for the company? Two assumptions to calculate the Present Value of cashflows: Business goes on forever. Interest rate stays at 5% Lobby: convince politicians that ‘it’s not that bad’ → influence government. Environmental impacts – company specific analysis Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Single materiality: how do environmental and societal changes affect the firm? Double: also, how do the firm’s operations affect the environment and society? Natural disaster KLM: because of volcano in Iceland, no visibility, so flights got cancelled. So, not only disadvantage for environment, but also for firms. Accounting for climate change Challenges of the current ESG reporting ‘’ESG is more a buzzword than a solution.’’ ‘’ESG reports do not engage meaningfully with the moral trade-offs within the E, S, G domains.’’ ‘’Companies portray themselves in favorable light, … greenwashing’’ ‘’Little impact on corporate actions or external stakeholders” Greenhouse Gas (GHG) protocol from 2001 Scope 1: direct emissions from sources that are owned or controlled by a company, such as its production and transportation equipment. Scope 2: emissions at facilities that generate electricity bought and consumed by the company. Scope 3: emissions from upstream operations in a company’s supply chain and from downstream activities by the company’s customers and end-use consumers. Problems of the GHG Protocol Lack of accountability Double counting Incomplete reporting: scope 3 not reported at all! In March 2022, the SEC drafted rule for all US listed companies to disclosure their scope 1 and 2, and ideally also scope 3 emissions. E-liability ledger – proposal of Kaplan & Ramanna: Every party along the supply chain adds its net Scope 1 emission to each unit of product. When goods are transferred from one party to another, the e-liability is also transferred and accumulated. Consume could pay for the financial cost as well as carbon emission of the product. Video on E-liability on slide 44 Explaining key concepts Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Economic value added (EVA): aka economic profit, aims to calculate the true economic profit of a company. Activity-based accounting: a way to allocate cost, based on how much resources each product consumes. Cost drivers: time, head counts, square meters, etc. E-Liability Benefits More transparency, verifiability, and audibility on CO2 emissions along the supply chain. Capturing all economic activities (private and public sectors). Encourage competition on cleaner technology Consumers need to pay for the financial cost as well as the carbon cost. A good base for carbon tax. The carbon fund can be used for carbon offset projects. Challenges Implementation costs (all business of all supply chain need to account for carbon emission, to make this work). Resistance (political uncertainties, business lobby, costs, etc.) Misreporting incentives Who should manage the carbon fund? New agency problem! It does not cover the other pollutant substances, water pollution, etc. Recap Understanding the environmental externalities of business activities. Conducting industry and company specific analysis of environmental impacts. Applying stakeholder value analysis to your company of choice (follow the Cola example). Evaluating the challenges of the current ESG reporting systems Understanding the E-liability proposal to account for CO2 emission. HC 5 Guest lecture on CSR strategy implementation at AGEAS. Topic: the shift in AGEAS (an international insurance company, located in Europe, Brussel) from a shareholder to a stakeholder focus. Huge diversity of … Products: health, retirement, housing, savings, car, death cover. Customer groups: individuals, SMEs, self-employed persons, corporates. Channels: agents, bank, brokers, direct. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen But: the world is getting conscious… it went through many moments of change. Sustainability is not something new, but there is a new momentum → 2030 deadline implementation UN SDGs. Impact 24: putting sustainability at the heart of our strategy – Frank van den Borre 1. Sustainability is broad and technical a. CSR, CO2, PPP, UN SDGs, MSCI, Integrated Reporting, etc. b. The EU Green deal → making Europe the first net-zero carbon emission continent by 2050. c. Many international sustainability standards & reporting frameworks. d. The CSRD directive, 12 i. The 12 ESRS (European Sustainability & Reporting Standards) cover: cross cutting (general requirements and disclosures), environment, social & governance. ii. Standards to be implemented by end 2024. 2. Sustainability is a journey a. Long process i. Since the financial crisis in 2008: stabilization → financial repositioning → prepare for the future → solid insurance player. ii. Vision 2015 → Ambition 2018 → Connect 21 b. The world is getting conscious i. New societal themes: prevention, ageing, better infrastructure, mobility, sustainable cities, health, climate change. c. Connect 21 has set the scene i. Care, dare, deliver, share ⇒ society recognized as stakeholder → supporter of your life. d. From a stakeholder driven company, to an impact driven company ⇒ impact 24 i. Top performance in balance for all stakeholders ii. Targets: financial, non-financial, operating & sustainability. iii. Values: care, dare, deliver, share. 3. Sustainability is teamwork a. ESG touches upon every function of the company. b. Also, within AGEAS → this is reflected in their dedicated ESG Steering Committee → everyone is responsible for a part of the ESG goals. c. Don’t underestimate communication and avocation. 4. Sustainability is daring and transformational a. Implementing sustainability is to think differently i. We need: courage, optimism, daring, frontrunners, pioneers and excellence. ii. The crazy one, change things b. Sustainability is mainstream and here to stay Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen c. We all need to take our responsibility: individuals, corporates, government, NGOs, academic world, investors, media. 5. Sustainability is an opportunity and a value creator a. ESG (R-)evolution i. From compliance to strategic inclusion: the success key is seeing the opportunities b. Sustainability can drive value in several ways → it can unlock growth by stimulating top-line and bottom-line benefit i. Go down: cost ii. Go up: trust, innovation, talent, resilience c. Global sustainability leaders are bold & ambitious, but in many different ways. d. How to integrate sustainability in an overall corporate strategy? 6. Sustainability is at the heart of everything we do a. Ambition Impact24: sustainability at the heart of the business to drive growth and build a more inclusive and sustainable future. b. Our strategy structured around areas where AGEAS can make a positive impact → their people/ customers/ investments/ planet. 7. Sustainability is a matter of focus a. Sustainability = innovation i. Steve Jobs: “People think focus means saying yes to the thing you’ve got to focus on. But that’s not what it means at all. It means saying no to 100 other good ideas that there are.” b. AGEAS identified 14 relevant topics (with definitions) in their 1st ESG Materiality Survey in 2020 and received >1000 responses from various stakeholders: Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen The result: materiality matrix for AGEAS c. 4 impact areas of Impact24 (from small to big) i. Great place to grow → for our people ii. Product innovation → for our customers iii. Sustainability investments → for our investments iv. GHG emission reduction → for our planet d. A 5th focus: a good ESG Ratings from rating agencies. i. This is guided by the UN SDGs → they focus on 10 of them where AGEAS can make a difference. 8. Sustainability is close to our heart and part of our DNA a. From only financial to financial and societal value going hand in hand. 9. Sustainability is about delivering and measuring impact a. Integrating financials and non-financial measurements into one reporting → Impact24 includes non-financial targets for the 1st time. b. Project Tango: from scattered data sources towards a single data warehouse and reporting: Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen 10. Sustainability is about the heart, the head, the hands, and ambition a. Don’t look at the top of the mountain, but climb step by step. HW for HC 6 The following papers have exactly the opposite findings. The Perils and Questionable Promise of ESG-Based compensation With the rising support for stakeholder capitalism, companies have been increasingly using ESG-performance metrics for CEO compensation → it looks promising, but it has two structural problems: ESG metrics likely serve the interests of executives, not of stakeholders as it overlooks the agency problem of executive pay, and it is difficult for outside observers to check. ESG metrics commonly attempt to tie CEO pay to limited dimensions of the welfare of a limited subset of stakeholders. This paper provides empirical analysis of it with 100 S&P companies. Executive Compensation Tied to ESG Performance: International Evidence More companies incorporate ESG metrics in compensation schemes of their CEOs. This paper proves its usefulness as these metrices indeed improve the ESG performance. Findings of the paper: The use of these metrics is strongly associated with key firm fundamentals → ESG-based compensation is more common among firms with higher volatility, among larger firms with lower accounting performance and in firms that are less likely to be financially constrained. ESG pay is associated with the level of carbon emissions, the firm’s commitment to ESG, board characteristics, and the level of ownership. Firms with ESG pay indeed show less carbon emissions, but no better financial performance, so short-term shareholder value won’t rise. Pay for (ESG) performance → improvements in ESG indeed seem to result in higher variable payments. Institutional investors that have a large volume of assets under management or are located in a foreign country, exert a stronger influence on firms. Inclusion of ESG metrics in compensation contracts is more likely to occur after the firm is engaged by major institutional investors. The analysis links the reliance on these metrics to firm fundamentals, the geographic location of firms and the prevalence of shareholders. HC 6 Agenda Recap Social impacts of business ESG contracting and gender quota Case: climate change and coffee berry borer Climate change threatens the cultivation of coffee beans: the coffee berry borer is more widespread than ever. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen The coffee berry borer can cause yield losses of 35% and threatens the development of young coffee plants. Usual response was to develop plantations at higher altitudes, but the coffee berry borer seems to follow. There is no immediate risk for Starbucks’ coffee supply. Not in the coming 10 years. If you were the CEO of Starbucks, what would you do and why? Discussion points What are the costs of these investments? When are these costs incurred? What are the benefits of these investments? When are these benefits realized? Are these benefits certain? If we think about an income statement, where do these costs and benefits show up in the income statement? Investments in the R&D about coffee berry borer and new plants will be sizeable today and the coming years. The returns however might be: Materialized only in a few years (if at all) – timing difference between cost and benefit. Highly uncertain while costs are certain. Benefiting the shareholders only indirect. How to balance the financial, social, and environmental considerations? → Climate change also threat yield of cocoa and many other crops. Corporation for the environment and society Patagonia’s bold move In 2022, the founder Mr. Chouinard and family decided: ▪ To transfer all 2% shares with voting rights to Patagonia Purpose Trust which ensures that the company remains committed to CSR. ▪ To donate 98% of remaining shares and all future profits to a new NGO Holdfast Collective in order to combat climate change. The governance structure of non-financial reporting Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Social impacts of business Environmental and social impacts – company specific analysis f: a production function K: capital L: labor q: production of goods and services w: waste N: natural capital r: natural resources e: energy Traditional economic model: Q = f(K,L) Ecological economics production function: q + w = F(K,L,N; r,e) → is this complete? The deadly collapse of Rana Plaza in Bangladesh in 2013 Construction with substandard materials and ignores building safety codes. Workers were forced to continue working after the building was evacuated. More than 1000 garment workers died in the collapse. 13 Brands manufactured: Prada, Gucci, Primark, Walmart, etc… Elon Musks plants to layoff half of the Twitter workforce 3700 employees to be fired Remote work will not be allowed Minimum 40 hours work on site Meanwhile… Huge losses on advertisements Kingdom Holding Company of Saudi Arabia became the second largest owner of Twitter. Freedom of speech for extremists Account verification for money? L, N Ecological and social economics production function: q + w = F(K,LN,S,H; r,e) → Social and human capital are added to make the picture complete. S: social activities, contribution to community and relationships with community H: human capital, health, safety, gender equality, training, job satisfaction Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen S: social activities, contribution to community, and relationships with the community H: human capital, health, safety, gender equality, training, job satisfaction Social responsibilities – tax Tech giants used offshore tax heavens to avoid paying billions of taxes. EU as well as many developing countries miss out on billions of tax revenue. Public and law makers outraged by the scale of tax avoidance. Huge settlement to repay tax to some EU countries. Society and business challenges Globalization Automation and AI Inequality and wealth creation Digital disruption, social media, and access to electronic devices Changes to work, leisure time and education. Changes to individual rights and responsibilities, and family structures Changing demographics, including health and longevity Urbanization Religion Geopolitical uncertainties Positive social impact Negative social impact Agriculture (Cargill) Feeding the growing Child labor, food safety population, food safety, employment, paying tax Airline (KLM) Globalization and mobility, Noise for local community, tourism and leisure, tax, safety and job security for employment employees, strike Garment producer Affordable fast fashion, Poor working conditions, and retailer (H&M) paying tax, employment squeezing suppliers and workers, marketing mishaps Consulting firms Ensure trust and Audit quality insufficient to (EY) transparency in the financial detect frauds, stressful market, advice firms on tax working hours for employees and business transitions, employment, paying tax Oil and gas firms Fuel to the economic Endangering the livelihood of (BP) growth, tax, employment local communities, safety problems, lobbying for the firm’s interests Tech firms Employment, increase Privacy concerns, spreading (Facebook) social connectedness, fake news/ organize riots, enable social initiatives cyberbullying, losses in productivity, tax avoidance Insurance (AXA) Risk sharing improves Adverse selection & moral quality of life, reduce the hazard, discriminating based impacts of extreme events, on postcode/age/gender etc., Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen intertemporal risk missing market (no service in management, employment high-risk markets) Banking (ABN- Efficient allocation of capital, Too-big-to-fail, facilitating AMRO) thorough screening and money laundering, excessive monitoring, ensuring risk-taking lead to banking security/ fighting nationalization during fraud, employment financial crisis, excessive compensation and bonus culture Factors that affect the business of Cargill: war & strike. Philosophy of Inamori ‘’Create a wonderful corporate character’’ ‘’People have no greater calling than to serve the greater good of humankind and society.’’ – Dr. Kazuo Inamori Effective management of the company’s sustainability can Reaffirm the company’s license to operate in the eyes of governments and civil society. Increase efficiency Comply to increasing regulatory requirements Reduce the probability of fines Improve employee satisfaction and productivity Drive innovation and introduce new product lines ESG contracting and gender quota Incorporating ESG metrics in the compensation contracts How to translate the stakeholder focus into action? Including ESG metrics in the executive compensated package. ESG linked contract increase over the years. → Bebchuk and Tallarita (2022) about the Questionable promise of ESG-based compensation Research question: Which ESG contracts are implemented? Are ESG contracts effective to improve stakeholder welfare? Sample: S&P 100 (> 50% of the US stock market) ESG metrics: employee treatment, employee composition, customers, environment, community, suppliers. Key findings: ▪ ESG contract ties CEO attention to a subset of stakeholder welfare. ▪ ESG metrics have little transparency, impossible for outsiders to monitor/ verify, therefore worsens the agency problem. → Cohen et al. (2022) about executive compensation tied to ESG performance Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Research question: Which firms are more likely to have ESG contracts? What are the effects of these ESG contracts? Sample: Institutional Shareholder Service (ISS), Executive Compensation Analytics (ECA) → 12 000 firms from 26 countries. Firms with ESG metrics have the following characteristics: larger in firm size, lower profitability (ROA and returns), have more tangible assets, lower institutional ownership (more foreign IO), more CO2 emission. Key (empirical) findings: ▪ We observe huge variations across different countries when it comes to ESG contracting. ▪ Indeed, only a narrow set of stakeholder values are reflected in ESG contracts. ▪ ESG metric in general does not significantly reduce CO2 emission. ▪ Carbon-specific metric does significantly reduce CO2 emission. Gender diversity laws Benefits of female leadership ▪ More corporative ▪ Less risk taking ▪ Emotional support/ mentorship ▪ Higher ethical standards Norway pioneered the diversity regulation. ▪ 2005 mandate 40% female directors in publicly listed companies by 2007. ▪ 2022 mandate 40% female directors in large private companies. EU regulation ▪ 2022 mandate 40% of female non-executives in publicly listed companies by 2026. Binding regulation (delist or comply): BE, FR, IT, NW. Non-binding regulation (guideline): GE, SP, NL, UK, US. Gender Quota – Norway’s regulations All publicly listed companies need to have 40% female board member. Otherwise, delist from Oslo stock exchange. Ahern and Dittmar (2012) about the impact on firm valuation of mandated female board presentation. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Research question: What’s the impact of the mandatory gender quota regulation? Sample: 248 publicly listed Norwegian firms from 2001-2009 Key findings: ▪ Negative stock return (industry adjusted) on the announcement date - 3.5% for firms with no female board member. ▪ Lower market value (Tobin’s Q) for firms without female board member. ▪ New female directors have higher education, but less experience than the male directors. ▪ Companies are more likely to delist or undertake risks M&As. Eckbo et al. (2022) about valuation effects of Norway’s board gender-quota law How to reconcile the rising female director’s education and the significant negative market value? Research question: What’s the impacts of the mandatory gender quota regulation? Key findings: ▪ No significant negative impact on firm value. ▪ Methodological difficulties in conducting the empirical research. ▪ Sufficient number of female directors in supply avoided the negative impacts. Recap Social impacts of firms can be profound and significant. Firms need to make trade-offs between financial and social, environmental impacts. Should the decision-making process be guided by cost-benefit analysis or the philosophy of ‘’serving the greater good of mankind and society’’? There are conflicting findings on the ESG contracting, gender quota law and many other issues. How should we read and interpret HW for HC 7 Paper: The link between competitive advantage and CSR – Porter & Kramer They propose a new way to look at the relationship between business and society by introducing a framework companies can use to identify effects (positive & negative) they have on society, determine which to address and how. CSR can be seen as opportunity instead of cost, as the business applies its IN their activities and strategy, instead of a separated activity. If they address social and environmental issues in a way that creates ‘shared value’ for both business and society, a firm can gain a competitive advantage. Justifications for CSR: moral obligations (firms must do right for people and environment), sustainability, license to operate & reputation. However, all these have their own limitations and in general they focus on the tension between business and society, rather than on their interdependence. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Paper: How to reinvent capitalism – and unleash a wave of innovation and growth – Porter & Kramer Shared value: policies and practices that enhance the competitiveness of a company while simultaneously focusing on (the connections between) societal and economic progress, using value principles. Value creation = benefits relative to social and environmental costs. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Current focus on short-term profit maximization harms society and the environment. Therefore, companies must take responsibility to address social and environmental issue. Shared value has the power to unleash the next wave of global growth. More companies such as Google and Nestlé began with important shared value initiatives. Companies can create shared value opportunities in 3 ways: By reconceiving products and markets By redefining productivity in the value chain By enabling local cluster development Every firm should look at decisions and opportunities through shared value. This will lead to new approaches that generate greater innovation and sustainable growth for companies – and greater benefits for society. Connection between competitive advantage and social issues Example: Johnson & Johnson invests in employee wellness programs and thus saved millions on health care costs → company productivity raises (as employee absence lowers), while societal concerns are being addressed (as employees become healthier). Redefining Productivity in the Value Chain A company’s value chain inevitably affects and is affected by societal issues, such as natural resources, water use, health, and safety. These societal problems can create economic costs in the firm’s value chain, and therefore opportunities to create shared value arise. Important ways in which shared value thinking is transforming the value chain to unlock new economic value: energy use and logistics, resource use, procurement, distribution, employee productivity & location. → The principles of shared value apply to companies, as well as governments and non-profit organizations. Governments should promote the shared-value approach by laws and creating beneficial environment. Paper: Updating the Balanced Scorecard for Triple Bottom Line Strategies – Kaplan & McMillan The traditional BSC is focused on measuring financial performance but should be expanded to align better with the TBL-concept (PPP) as there is a growing need for more sustainable business practices and multi-stakeholder strategies. Therefore, they suggest expanding the financial key success factors of the BSC with KSF that are focused on the People and Planet elements. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen → Traditional BSC → BSC for multi-stakeholder TBL-strategies Financial → Outcomes, to encompass financial, environmental & societal metrics. Customer → Stakeholders, to reflect the interests of multiple participants in the ecosystem. Learning & Growth → Enablers, to include the new capabilities for collaboration and alignment. Example: HC 7 Triple Bottom Line and Create Shared Value Agenda Triple Bottom Line (TBL) Create Shared Value Triple Bottom Line (TBL) How to create a sustainable business? Niet in slides! Different views on Sustainability ▪ Rationalism: meet needs of the present (current generation) without compromising the ability of future generations to meet their needs. ▪ Naturalism: business activities should make sure that they are in harmony with nature, not to deplete natural resources beyond their natural rate of regeneration. ▪ Humanism: our intrinsic desire to preserve life for ourselves and future generations. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Zero-sum versus Growing the pie Business revenue should be divided between business itself (profits to investors) and value for society → the parts are not fixed, can be splitted in another way. Business must not just divide the pie, but let the pie grow itself → by creating value for society and for the business. Moet de video op slide 14 nog kijken! E.g., employee satisfaction and financial performance influence each other through higher employee productivity. Triple Bottom Line (TBL) By John Elkington in 1994 Intended as a holistic approach to sustainability. Looks familiar to the stakeholder value sum! Challenges of TBL Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Measurement: multiple units, lack of reliable data → hard to measure everything (like human value) in money. Time horizon: 1 year or 30 years → which horizon are we looking at? Not useful as an overall measure of business performance. Hard to compare across different companies → financial performance is easier to compare, but now we don’t have ratio of everything, no universal measurement. Not legally required, therefore not reported. Frustrated by the limited impact, Elkington ‘recalled’ the term in a 2018 Harvard Business Review article. Balance Score Card (BSC) updated Op slide 23 Kaplan & McMillan (2020) updating the BSC. Vision = goals of the business. Create Shared Value Move from traditional activities to quadrant with high impact: CSV-oriented activities. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Single materiality: how environmental and social changes may materially affect firm’s profitability Double Materiality: it is not just climate-related impacts on the company that can Inside-out or outside-in be material but also impacts of a company on the climate and society Inside-out: how business operations impose externalities on the environment and society. Outside-in: how external factors affect the well-being of business. Is familiar with single/ double materiality → double is both, while single is only the outside-in approach. Value Chain Analysis (Porter) – Inside-out Use the Value Chain Analysis to identify the positive and negative impact on society of the different activities in the company’s value chain. Diamond Framework (Porter) – Outside-in Use the Diamond Framework to better understand the linkages between the company and the brooader environment that affects the company’s ability to generate welfare. Gedownload door: rensdeenen | [email protected] € 912 per jaar Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. extra verdienen?  Stuvia - Koop en Verkoop de Beste Samenvattingen Look at firms in relation to society, other players interacting depending on these businesses. Inside-out: firms’ alone operations. Outside-in: putting the firms in a broader view, relationship with other players. Elements of Creating Shared Value Creating Shared Value involves creating economic value in a way that also creates value for society by addressing its needs and challenges. Reconceiving products and markets: create something new that is satisfying needs. ▪ Products to services. ▪ Contribute to society. Redefining productivity: create something that increases productivity.