Robert Eccles, a visiting professor of management practice at Saïd Business School at the University of Oxford, says that the global investment community’s interest in environmental, social, and governance (ESG) issues has finally reached a tipping point. Large asset management firms and pensions funds are now pressuring corporate leaders to improve sustainability practices in material ways that both benefit their firms’ bottom line and create broader impact. They’re also advocating for more uniform metrics and industry standards. Eccles is the author of the HBR article “The Investor Revolution.”
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ALISON BEARD: Welcome to the HBR IdeaCast from Harvard Business Review. I’m Alison Beard.
What issues do the world’s largest investors care about most, right now? What do the big asset management firms, and government pensions funds, want to see from their portfolio companies?
According to research conducted by our guest today, there is one area that’s top of mind for everyone, and it may surprise you. Investors want business leaders to focus on ESG, or environmental, social and governance metrics.
That means progress on ESG isn’t just a nice-to-have anymore. It’s something shareholders will demand, because they believe it’s going to drive everything else they care about. Growth, market share, profitability. So, for any company keen to attract capital, sustainability has to become a focus.
Robert Eccles is a visiting professor of management practice at Saïd Business School at the University of Oxford. He’s the coauthor of the HBR article “The Investor Revolution.” Robert, welcome to the show.
ROBERT ECCLES: Thank you very much. Nice to be here.
ALISON BEARD: So, you say at the start of the article that a lot of business leaders seem to think that ESG issues still aren’t totally mainstream. Why do you think that is?
ROBERT ECCLES: You know, I think there’s a couple of things that go into it. They will say, when you talk to people in the corporate community, maybe the investors care about it, but we don’t know, because they never ask us about it.
Historically, I think companies came to sustainability long before the investment community, to give them credit. A lot of it had to do with sustainability reporting that started in the late 1990s. It was not a side show, but it was definitely not mainstream. They did good things, mostly ancillary to what the company’s business was. They picked the low-hanging fruit – carbon emissions, turn off the water and lights at night and stuff. But it really wasn’t integrated into the business.
And I think what changed was, as people began to realize that these environmental, social, and governance issues mattered to financial performance, both the corporate community and the investment community started to see things differently.
Because historically, when you talked about sustainability on the investor side, people thought about socially responsible investing, where you were excluding stocks and industries that you didn’t like, or companies that you didn’t like, or even countries, like South Africa under Apartheid, and there was the belief that if you put in these values-based on exclusions, then you were going to lose returns.
ALISON BEARD: And you studied large outside managers, like BlackRock, State Street, Vanguard, large pension funds from California, Japan, Sweden. Has there been a tipping point among those large investors that now this is one of their very top priorities?
ROBERT ECCLES: So, I think we’re at the tipping point. I think it’s a top priority. I think the degree to which the commitment to “sustainability” or sustainable investing is, it varies. There’s data that shows over 50 percent, a little over 50 percent, of assets are invested in sustainable investing in Europe. It’s about a third in Canada.
It’s about 25 percent in the United States, which people find surprising, Bank of America Merrill Lynch did a study. They asked their corporate clients what percentage of their assets they thought were held by sustainable investing shops, and they thought it was 5 percent.
So, what you see is, at the top of the house, the chief executive officers, the chief investment officers of the BlackRocks, of the State Streets, of the Vanguards, they know that it’s important to take these factors into account from a fiduciary point of view. From running a returns point of view.
The trick is to push that down. This is a massive cultural change, right? It’s one thing for the top to say we think this is important. Inside these organizations, there’s all these portfolio managers, and they’re fairly autonomous, as they should be, they’re professionals, and they need to make their own judgments.
And so that’s kind of where the frontier is, is convincing the portfolio managers, who have historically built only financial models. And when the portfolio managers have a conviction that understanding the company’s ESG performance – on the material issues, which vary a lot by sector – and they start factoring that into their models, and they start factoring that into the conversations that they’re having with the CEO’s and the CFO’s, that’s a game changer.
When the CEO and the CFO are hearing about sustainability themes from the people who buy and sell their stock, then that makes it become very real. Has that happened yet in a broad scale? No. Is it happening now? Yes.
ALISON BEARD: So many funds say that they consider ESG as it becomes more important to the financial health of their portfolio companies, but that’s very different than committing to bail on a company that’s otherwise successful but isn’t making progress on these issues. So, what concrete steps can asset managers, pension funds, take to make sure that they are pushing for real change?
ROBERT ECCLES: So, it’s a good question, and it comes down to reporting and metrics and standards.
ALISON BEARD: And those are incredibly hard to measure, even within an industry or a country, never mind across.
ROBERT ECCLES: They’re hard, but they’re not impossible. And so, I always like to tell a little story about accounting standards.
ALISON BEARD: OK.
ROBERT ECCLES: I know it sounds boring.
ALISON BEARD: I’m sure it’s going to be a fascinating one.
ROBERT ECCLES: I know it sounds boring, but it’s really important. They didn’t always exist. So, in the United States, before the Securities and Exchange Commission was formed, there was a gazillion little accounting firms, and they all had their own accounting standards, and they all had their own auditing approaches.
Listed companies didn’t have to report. They did it on a voluntary basis. A lot of them didn’t report revenues. They thought it was information their competitors would use against them. So, there was the crash of ’29, there was the Great Depression, and in ’33 and ’34, the SEC was formed, and they said our mission is to protector investors through transparency.
And the accounting community pushed back and said “Oh my gosh, this is as much art as it is science. You can’t standardize this.” And companies said “We’re unique, and we have to have our own way of reporting,” and they said “oh my god, if we have to report our revenues, the sky will fall.” Well, we got there.
That is a bedrock for the capital markets that everybody takes for granted. It’s apples-to-apples comparisons, audited to say that they did it right, and investors really rely upon financial information to make decisions.
Think of it as plumbing or infrastructure. We don’t have that plumbing or infrastructure for environmental, social and governance information, and I think until we do, it’s going to be very difficult for companies to manage their performance, to report on their performance, for investors to be able to evaluate their performance.
Progress has been made. There’s a group called Global Reporting Initiative, which was started in the late ‘90s. I was the founding chairman of something called the Sustainability Accounting Standards Board. What these groups are doing are trying to identify for particular industries – so a bank’s carbon emissions is the bank itself for nonmaterial, but it’s approach to systemic risk is, whereas as for a big chemical company, carbon emissions are important. What are those material issues that matter to financial performance, how to report on them in a way that you can have apples-to-apples comparisons? It’s a little bit of a Wild West out there, but I think it’s improving pretty quickly.
ALISON BEARD: Will it eventually require government intervention?
ROBERT ECCLES: So, the blunt answer is yes. Yes. It will, we, so everybody goes “oh, well, if this is so good, and investors really want it, and companies think it’s to their benefit, then market forces will work.” No. Market forces didn’t get us financial accounting standards. It took a crisis, right? And, I know it’s unpopular, particularly in this country, particularly at this point in time, to say the government should step in at some point.
Europe is further along. They’ve got their Accounting Director for Nonfinancial Information. The way I would see it playing out in the United States – it won’t happen in the next year or two. But let’s say investors start adopting some set of standards, and they become relatively common, and companies find that it’s a good basis for the conversations that they’re having with their investors.
Then when you get enough of a critical mass, then I think the investment community goes to the SEC and says “remember, SEC, your role is to protect us through transparency, we find this information useful, it would be better if we got it from every company – because probably the companies that are performing poorly aren’t reporting. It would be better if it was to a set of standards, so we can compare apples-to-apples. It would be better if it was audited, so we knew that there was some degree of reliability.”
And if there was already enough of this happening in the corporate community, then I think the SEC would be less nervous about this sort of pushback that they get when there’s things that come through legislation, like Sarbanes-Oxley, and then people freak out and say “you put this big reporting burden on me.”
ALISON BEARD: Right. ESG, there are three really huge buckets, environmental, social, governance. So, do investors want companies to be thinking across all of them? Is there some stage at which they get parsed out?
ROBERT ECCLES: So, good question. I think E, S, and G, probably the first initial separation is that the G is not the same as the E and the S.
ALISON BEARD: Right.
ROBERT ECCLES: So, just good governance is important, period. An argument could be made that if you have the appropriate corporate governance at the board level, then the relevant environmental and social issues will be managed properly. That it is the duty of the board who represents the interests of the corporation, not what everybody believes they have to put shareholders first.
The board of directors is responsible for the intergenerational viability and vitality of the company. When the board recognizes that there are material environmental and social issues, and sees to it that management is managing and reporting on those to them, I think you start to get some structure to it.
And going back to the Sustainability Accounting Standards Board, so what they’ve done is created a classification system, there’s 11 sectors, it subdivides into 77 industries, through industry working groups of companies, investors, NGOs, intermediaries, have identified what the material issues are, out of a list of 26 ESG issues.
And so I gave some examples – a pharmaceutical company, access to medicine, safety, and clinical trials, those are material issues. Supply chain is not. Pharmaceutical companies don’t have a supply chain. Agriculture companies do. Fast-moving consumer goods companies do, that have long supply chains and developing markets.
So, what they’ve done is identify those issues that both represent risk factors, and opportunities, and what’s interesting, when you look at the work they’ve done, is it’s a relatively small number. So what’s material from an investor point of view, it’s five, it’s six or seven things that really matter.
Then I think you need to separate out ESG. ESG is not the same thing as impact, right? So, the materiality definition of SASB, is like FASB, is like the International Accounting Standards Board, it’s essentially those things that matter to investors.
Impact is about those things that matter to the world. And increasingly, people are looking at impact through the lens of the sustainable development goals. So, companies product externalities from their products and services. There’s externalities from oil and gas, which we all well know. There’s externalities from sodas and candy bars, and fatty foods, and all of this.
And so, on the one hand, yes, a company should manage its material issues from an investor point of view. The big investors, the big passive investors that aren’t going to sell a stock, BlackRock has $7 trillion in assets under management. They’re universal owners. CalPERS – $350 billion, they’re a universal owner. Which means that they can’t diversify away from the marker.
So, if the world goes to hell, from climate change, from income inequality, they’re screwed, so they’re not going to be able to get their returns. So, not only do they are about ESG, but the frontier now is they care about impact. They want to know what the externalities are that are being created by the companies that they invest in, because when you aggregate up all those externalities, it affects the state of the world.
ALISON BEARD: Right. And is that focus on good for the world filtering down from those huge asset managers, who have to care about it, to the broader investment community? To companies who know that it doesn’t actually affect their bottom line in the short to medium term?
ROBERT ECCLES: The good for the world question is a really tough one, right? Because of the beneficiaries, people like you and me, well maybe you more than me, because I’m a lot older than you, what’s long-term for you is longer than what’s long-term for me.
They want to know that they’re going to be able to continue to get the returns 20, 30, 40 years from now, or for their children. For companies, what you see is the millennials, not surprisingly, they are concerned about the state of the world. And the really big asset owners and asset managers can think about the state of the world.
In fairness to companies, it’s harder, right, because any one company’s externalities, unless there’s laws, or taxes, or regulations that makes them internalize them, they can be very responsible, and they can have less negative externalities, if they’re managing the ESG issues well, but they’re still producing negative externalities, and they could be behaving very well by the rules of the game and being really responsible.
So you get to a deeper question, one I don’t even really touch on in my article, which is – but there’s interesting work being done about – what is the role of the corporation in society? So, there’s a great book called Prosperity that my colleague, Colin Mayer, wrote at Oxford.
When you look at the history of the corporation, the form that we have now, it’s a relatively recent invention. It’s maybe 120 years old. In the 1900s, corporations were formed with a limited lifespan to do a particular thing, like go build a canal. The canal is built, and it’s done, and you got the tolls, and you wrap it up.
Then, we got corporations that could have an eternal life, they could have very broad charters, and the etiologies have been that they have to put shareholders first, so there’s a big and important question about what is the role of the corporation in society?
ALISON BEARD: Whether we’re pushing for progress on ESG or progress on impact, what do companies, like oil and gas companies, like airlines, even like Uber, who has been criticized for not treating its workforce very well, is crowding our streets, taxing our infrastructure, how do all of those companies get ready for this new world, where investors of all sorts are going to care about ESG and impact?
ROBERT ECCLES: I think it really starts with the board of directors. And I’ve mentioned this little idea that I’ve been working on with the guy named Tim Youmans for some time now, and we call it the “statement of purpose”. So, the board should publish one, two-page max, statement of purpose, where they give their view of what the role of the corporation is in society.
And we’re being very values neutral. If the board wants to come out and say: “our view, as the board of directors – who are the highest body representing the corporation – we think the purpose of this company is to deliver short-term earnings, on a consistent basis, to short-term shareholders,” then that’s their call. They can do that as the board. Just be transparent and say this is what you think this company is about.
People will make their decisions. They may want to work there, maybe they won’t. Maybe they’ll want to buy their products, maybe they won’t. The board can say “well no, we think that there is a broader purpose. We understand we owe our investors good returns over the long term, we don’t have to go quarter by quarter.”
And if you’re in Uber, the board could say “we believe Uber has a responsibility to the communities in which our drivers operate. We need to think about what this means for traffic congestion, and we need to think about what this means for taxi companies, and whether they should be allowed, we need to think about, do we pay them fairly?”
You can’t say every stakeholder is equally important, right? So, the company has to identify. In an oil and gas company, the board would take a position on whether they think climate change is real or not, and what the company is doing to address it. Do they have targets willing to report according to the task force on financially related climate disclosures? I have a campaign with Tim and Hermes Equity Ownership Services – we want every listed company’s board of directors to publish a statement of purpose by 2025.
ALISON BEARD: So, when you’re talking to corporate leaders about this, or even investors about putting on the pressure, how do you respond when people say, I’m not going to go first? I’m going to wait for critical mass. How do you respond? How do you persuade them?
ROBERT ECCLES: So, the line I like to use is, everybody wants to be a leader, nobody wants to go first, as you said. Everybody wants to go to heaven, nobody wants to die. It’s like decide, do you want to be a leader, or do you want to be a fast follower, or do you want to be a lagger? And, I can’t make that decision for people.
I think if we could get enough companies, in enough industries, in some of the major markets, to take this step, then it becomes less scary to other people. I have a company that I’m talking to that is quite serious about all of this. If you knew who they were, you’d be shocked. And if this company does the things that they’re talking about doing, people will be shocked, they will be a poster child – it’s hard to find poster children, right, Unilever is a poster child, Novo Nordisk, right? And my argument is going to be, if this company can do this, every company can. So, stay tuned.
ALISON BEARD: Right. So, I was going to ask about companies that you think are doing a great job already. You would put Unilever and Novo Nordisk in that category?
ROBERT ECCLES: Yeah, I would. Novo Nordisk was one of the very first companies to publish an integrated report back in 2002 or 2003, or something like that. I think Unilever under Paul Polman has been great. He’s a hard act to follow, so I’m not even sure who the next CEO is, but there’s a Brazilian company called Natura, which also was one of the first companies to do integrated reporting.
But what’s interesting is, I can’t rattle off ten. Isn’t that telling, right? And so I go around, and I remember having a conversation with Paul once. He was going you know, any company can do this, it’s not that big a deal, it’s not that hard. I said Paul, “you keep saying that. But most companies don’t, right, so what’s the deal?”
He said “I’ve got a very supportive board.” The board supported him when there was that hostile takeover that Kraft was attempting. And there’s work that’s been done by McKinsey, which shows that one of the biggest pressures for short-term earnings on CEOs is their own board of directors.
And I’m not trying to say that the boards of directors are culprits, but, but let’s be honest, boards of directors on the whole are – they look more like me than they look like you. They’re boys, not girls. They’re older, not younger. They grew up in a certain era, they see the world in a certain way. In the United States, they are heavily compliance focused. CEOs are getting ESG, boards of directors aren’t, but I think getting to the board is important.
ALISON BEARD: What about asset managers and pension funds, who have done a good job of pushing that idea of caring about ESG, making investment decisions based on it, and then even taking the step further of caring about impact, down to the people on the ground, who are interacting with companies. Who’s done a good job of that?
ROBERT ECCLES: So, I think there’s some – let me say one thing about the relationship between asset owners and asset managers, which is, they need to improve their relationships a little bit, too, right.
Because as I said, ESG and long-termism are two sides of the same coin, so when asset owners are telling their asset managers, we want you to focus on ESG issues, or tell us how that fits into the strategy, or want you to engage with companies, but oh by the way, we’re going to evaluate your performance every year and benchmark you, it’s like well come on, it’s like–
ALISON BEARD: Yeah, there’s a disconnect.
ROBERT ECCLES: There’s a disconnect there. So, I think these contracts between the asset owners and the asset managers need to become longer term as well, and maybe there’s nonfinancial metrics that should go into that. If you look at the top 10-12 asset managers, I think there’s 13 in the world that have a trillion dollars or more, to varying degrees, they’re all quite serious about this. BlackRock I think is.
ALISON BEARD: But serious enough to make it more than a consideration in their fund management?
ROBERT ECCLES: I think that they’re going down that path. Would I say that every single fund incorporates this? No. And some of this is the mandates they get from clients.
But we’ve talked about all of these different groups. We haven’t talked about individual citizens very much, those are called civil society, and we all wear different hats. We work for a company, we buy stuff from the companies, we invest in the companies, and if their voices were heard, if there’s a way for their voices to be heard, to say this is what we expect from the people who manage our money, in terms of the companies that they invest in, that’s an important force, because in the end, it’s our money.
The asset owners are managing money for the beneficiaries, for the pension fund, or whatever it is, and they allocate it to the asset managers. But to the extent that civil society can be mobilized, then that will make a big difference.
ALISON BEARD: They’re not only the investors, they’re also the consumers.
ROBERT ECCLES: They’re the consumers. If these things matter to them, and it determines whether they want to work for the company, or they want to buy stuff from the company, or they want to invest in this company, that is a sea change, that is a game changer.
ALISON BEARD: Great, that’s a terrific note to end on. Thank you so much for coming in.
ROBERT ECCLES: Thank you.
ALISON BEARD: That’s Robert Eccles, a visiting professor of management practice at Saïd Business School at the University of Oxford. He’s the coauthor of the HBR article, “The Investor Revolution.” You can find it in the May-June issue of Harvard Business Review.
This episode was produced by Mary Dooe, we get technical help from Rob Eckhardt, and Adam Buchholz is our audio product manager. Thanks for listening to the HBR IdeaCast. I’m Alison Beard.
