Stakeholders and Stakeholder Activism

This chapter is from the book

Corporate Governance Matters, 4th Edition

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This chapter is from the book

This chapter is from the book 

Corporate Governance Matters, 4th Edition

Learn More Buy

External Assessment of ESG

Shareholders’ and stakeholders’ demands to better understand corporate ESG initiatives has spawned a cottage industry of third-party organizations that publish rankings and ratings of companies on various environmental and social dimensions. Examples of these rankings include:

• Bloomberg Gender-Equality Index: Measures how companies “invest in women in the workplace, the supply chain, and in the communities in which they operate.”⁵⁵

• Corporate Responsibility Magazine Best Corporate Citizens: “Recognizes outstanding environmental, social and governance (ESG) transparency and performance among the 1,000 largest U.S. public companies.”⁵⁶

• Ethisphere Institute Most Ethical Companies: “Recognizes [companies] for setting the global standards of business integrity and corporate citizenship.”⁵⁷

• Fortune Best Workplaces for Diversity: Ranks companies that “create inclusive cultures for women and people of all genders, people of color, LGBTQ people, employees who are Boomers or older, and people who have disabilities.”⁵⁸

• Newsweek Green: Compiles “environmental performance assessments of the world’s largest publicly traded companies.”

Examples of ratings include:

• FTSE Russell: “Allows investors to understand a company’s exposure to, and management of, ESG issues in multiple dimensions.”⁵⁹

• HIP Investor Ratings: “Intended to be an indicator for future risk, return potential, and net impact on society, our quantitative analysis of fundamentals systematically identifies the drivers of the 90 percent of market value that cannot be found on the balance sheet.”⁶⁰

• MSCI ESG: “Aim to measure a company’s management of financially relevant ESG risks and opportunities.”⁶¹

• Sustainalytics: “Designed to help investors identify and understand financial material ESG risks at the security and portfolio level and how they might affect the long-term performance for equity and fixed income investments.”⁶²

• TruValue Labs: “Applies artificial intelligence to uncover opportunities and risks hidden in massive volumes of unstructured data, including real ESG behavior that has a material impact on company value.”⁶³

These ranking and rating organizations employ diverse methodologies. Some rely on information publicly disclosed in financial statements or sustainability reports. Some rely on proprietary surveys distributed to the company or its employees. Others incorporate information derived from the media and even press releases. Multiple sources of information are sometimes combined to arrive at the assessment.

We examine the methodologies of selected firms and the predictability of their ratings in greater detail in Chapter 14. However, several issues are worth noting here. The first issue is the availability of information. Disclosure of ESG data is primarily voluntary, and more information is available for large corporations than for small ones, because of the former’s more extensive disclosure practices, larger investor relations departments, and greater media coverage. As such, an ESG rating firm must determine how to evaluate companies with different disclosure practices.

The second issue is how to assign weightings to ESG dimensions to generate an overall score. The concept of ESG includes a broad array of somewhat disparate environmental, social, and ethical issues. On the one hand, a ranking such as the Bloomberg Gender Equality Index makes an assessment of one ESG dimension, so weightings are less of an issue in this case. On the other hand, the Corporate Responsibility Magazine Best Corporate Citizens ranking takes a broad view and must decide how to incorporate difficult-to-relate variables into a single outcome. This includes a determination of how to compute an overall score when an individual data element is not publicly available.

The third challenge is materiality. As discussed earlier in regard to the SASB standards, various ESG dimensions have different relevance to different industries. How should the environmental stewardship of an energy or manufacturing company be compared to that of a technology or service company, given their different exposures to environmental challenges (carbon emissions, pollution, waste, and so on)? Should a company be compared only against its industry peers to determine which ones handle these matters better, or can companies in different industries be compared against each other?

Each ranking or rating firm makes choices on these questions. In consequence, the ratings assigned to companies vary considerably depending on which firm assigns them. For example, MSCI ESG gives Tesla Motors one of its highest ratings for environmental performance, but FTSE Russell gives Tesla a low score on environment because its model does not take into account emissions from a company’s cars but includes only emissions from its factories. FTSE also penalizes Tesla in its social rankings because Tesla discloses little information about its practices, whereas MSCI assumes that if a company does not disclose information on a dimension that its performance is in line with industry averages. In another example, Sustainalytics gives ExxonMobil a relatively high ranking because it assigns a 40 percent weight to social issues, whereas MSCI ranks the company lower because it gives a 17 percent weight to social issues.⁶⁴

On average, large U.S. companies tend to receive high scores across the ranking and rating providers. Whether this is due to greater availability of information about these firms, their willingness to engage with rating providers to supplement information, their embrace of and willingness to invest in stakeholder initiatives, or methodological biases by the rating firms is not known.

An analysis of 11 prominent rankings of companies based on environmental, climate-related, human rights, gender, diversity, and social responsibility factors shows that 68 percent of the Fortune 100 companies are recognized on at least one ESG list. The combined market value of these companies is $9.4 trillion, which comprises 84 percent of the market value of the entire Fortune 100. Cisco Systems appears on the most lists (eight); Microsoft appears on seven; and Bank of America, HP, Procter & Gamble, and Prudential Financial each appear on six lists. Even companies that have been widely criticized by advocacy groups for their business practices are rated highly by third-party observers for ESG factors. For example, Chevron appears on the Dow Jones sustainability index and the Forbes list of best corporate citizens. Walmart is listed on Bloomberg’s gender equality index. Comcast appears on DiversityInc’s top 50 corporations for diversity. General Electric is named to Ethisphere Institute’s list of most ethical companies. Perhaps unexpectedly, Berkshire Hathaway is not named on this list, nor does it appear on any of the 11 lists reviewed (see Table 13.1).⁶⁵

Table 13.1 Fortune 100 Companies Appearing on the Most ESG Rankings

Based on rankings published between 2017 and 2019.

Source: Loosey-Goosey Governance (2019).

Research has examined the relationship between sustainability scores and firm performance and risk. Berg, Lo, Rigobon, Singh, and Zhang (2023) found a positive association between ESG ratings and risk-adjusted returns.⁶⁶ By contrast, Bansal, Yu, and Yaron (2022) found that highly rated ESG stocks outperform lowly rated ESG stocks in good economic times but underperform during bad times—the opposite of what ratings providers intend.⁶⁷

Margolis, Elfenbein, and Walsh (2009) conducted a meta-analysis of 251 studies between 1972 and 2007. They found a small, positive association between CSR and performance. However, they also noted that this positive association declined throughout the measurement period; that is, the effects of CSR were stronger in earlier studies and weaker in later studies. They concluded:

After thirty-five years of research, the preponderance of evidence indicates a mildly positive relationship between corporate social performance and corporate financial performance. The overall average effect … across all studies is statistically significant, but, on an absolute basis, it is small.⁶⁸

Krueger, Alves, and van Dijk (2024) studied the performance of more than 16,000 companies in 48 countries over the period 2001 to 2020. They found little relation between ESG and performance.⁶⁹

Atz, Liu, Bruno, and Van Holt (2022) provided a substantial literature review of more than 1,100 primary peer-reviewed papers and 27 meta-analyses on ESG and sustainable investing published between 2015 and 2020. They concluded that “the financial performance of ESG investing has on average been indistinguishable from conventional investing.”⁷⁰ In general, research on ESG, similar to all observational studies, suffers from questions about causality. That is, does a commitment to environmental or social goals make a company more profitable, or are more profitable companies able to spend more on these activities?

Despite pressure on companies to engage in ESG-related activities and corporate efforts to disclose their commitment to these initiatives, our ability to assess ESG quality remains limited. Inconsistent metrics, voluntary disclosure, and lack of comparability across firms account for much of the problem. Furthermore, it is not clear whether the metrics that third-party firms develop to measure companies on ESG dimensions are accurate or reliable. (We address this issue in more detail in Chapter 14.)

As such, requiring all companies to incorporate a stakeholder orientation into their corporate planning—beyond the extent to which they already do so—would likely have unintended consequences and potentially harm shareholders, employees, and outside stakeholders alike. Governance systems today—which emphasize shareholder returns, accountability of management to a board of directors, clearly defined performance metrics, and a capital market that disciplines companies for poor performance—might have their shortcomings, but the objective nature of stock price and operating returns are effective gauges for measuring performance and risk.

One solution (and one that many companies currently embrace) is to include relevant ESG factors as key performance indicators in awarding compensation—along with other nonfinancial factors such as customer satisfaction, employee engagement, and product innovation (see the following sidebar). This gives companies more discretion and allows shareholders and stakeholders to monitor for the adoption of policies most relevant to their situation and interests. It does not solve the problem of comparability across companies, particularly when a company chooses not to disclose proprietary information for competitive reasons, but it lessens the risk that management will be held accountable for meeting measures without a proven correlation to value, thereby weakening board oversight. (An interesting, related question is whether CEO activism—the practice of CEOs taking a personal stance on social, environmental, or political issues—is in the best interests of a company. See the subsequent sidebar.)

The greatest challenge, and greatest opportunity, for ESG advocates is to incorporate a stakeholder orientation within a shareholder mandate, without disrupting the positive benefits that the current system accrues to shareholders and stakeholders alike.

CEO ACTIVISM

In recent years, we have seen CEOs take a personal stance on social, environmental, or political issues. Examples include the following:

• Apple CEO’s opposition to Indiana’s religious freedom law on the basis that it was discriminatory to gay rights⁷⁷

• Citigroup CEO’s restriction on financing to companies that sell certain categories of firearms⁷⁸

• Costco CEO’s call for an increase in the federal minimum wage⁷⁹

• Goldman Sachs CEO’s criticism of U.S. immigration policies⁸⁰

• NRG Energy CEO’s call for a tax on carbon emissions⁸¹

• Salesforce CEO’s advocacy for the homeless⁸²

• Starbucks CEO’s activism on race relations⁸³

One review found that CEOs are most likely to take a public stance on diversity, including gender, racial, or sexual-orientation diversity or equality. They are next most likely to take public positions on environmental matters, followed by immigration and human rights, other social issues, and politics.⁸⁴

Still, the overall rate of CEO activism is low and concentrated among the largest U.S. companies. Ottenello, Song, and Sotelo (2024) analyzed the earnings conference call transcripts of more than 13,000 firms between 2008 and 2022 and found expressions of CEO activism among only 3 to 5 percent of CEOs each year. Even following a surge in activism in 2020, the frequency of activism did not exceed 10 percent.⁸⁵

CEO activism raises several questions. First, is it appropriate for a CEO to leverage their public position to advocate for an issue that might be divisive to their shareholders, employees, or customers? Second, should a board intervene if the CEO’s public expression of a personal belief has the potential to impact the company’s reputation or performance? Third, how can we distinguish between a company’s official position on an ESG-related issue and a CEO’s personal belief?

Research shows that CEO activism can be a double-edged sword. A 2018 survey found that, by a two-to-one margin, the public supports a CEO’s right to advocate on environmental, social, and political issues. The public’s view of advocacy, however, varies considerably by topic. They are most in favor of advocacy about the environment, healthcare, poverty, and taxes. Support is mixed about diversity and equality. Contentious issues—such as gun control and abortion—and politics and religion garner the most public opposition (see Figure 13.1).⁸⁶

FIGURE 13.1 Figure 13.1 Public reaction to CEO activism by topic.

Note: Net favorability calculated as the percentage of respondents who select “thank you for speaking up” minus the percent of respondents who select “keep your mouth shut.” Excludes respondents who select “no opinion.”

Source: 2018 CEO Activism Survey, Stanford Survey Series (October 2018).

Respondents are significantly more likely to remember products they stopped using or used less because of the position the CEO took than products they started using or used more. If true, this relationship suggests that CEOs who take positions to build loyalty with employees, customers, or constituents might also inadvertently alienate segments of these populations.

The actual impact of CEO activism on purchase behavior is essentially unknown. Chatterji and Toffel (2018) found that CEO activism can “increase consumers’ intentions to purchase the company’s products” but only to the degree that there is “alignment between the CEO’s message and individuals’ policy preferences.”⁸⁷ Korschun, Aggarwal, Rafieian, and Swain (2016) found that CEO activism is viewed positively by consumers if the company is considered “values-oriented” but negatively otherwise. These authors argue that the impact of CEO activism on purchase behavior is driven by the degree of “perceived corporate hypocrisy.”⁸⁸ Hou and Poliquin (2023) found that customer visits decline 3 percent following CEO activism and that customer behavior is asymmetrically impacted based on political identification. The effects of activism dissipate after 10 weeks.⁸⁹

Finally, Mkrtchyan, Sandvik, and Xu (2024) found that CEO activism improves employee satisfaction when that activism is aligned with employee ideology. They found CEO activism increases corporate value when it attracts research and development employees who share those environmental, social, or political viewpoints.⁹⁰