Purpose Based Business – Revisiting Capitalism for the Long Term
By: Andrew Liveris and Mark Wiseman
It has been a decade since Dominic Barton published “Capitalism for the Long Term” in the Harvard Business Review. At the time, Barton noted that much of the public blamed businesses and other private sector institutions for the financial crisis, and that, to address the demand that large organizations deliver better societal outcomes in lieu of focusing just on their shareholders, capitalism as we knew it, “needed to undergo a reckoning”. In fact, Barton’s paper was a driving force behind the establishment of Focusing Capital on the Long Term (FCLTGlobal) in 2016. FCLTGlobal is a non-profit organization supported by leading companies and investors worldwide that develops research and practical tools to drive long-term value creation for savers, and communities, and Dominic and I still deeply believe in the principals of long-termism on which we helped found and build FCLTGlobal. We continue to push organizations to shift their focus to the long-term in lieu of the short-term orientation that most companies have layered throughout their organizations.
Now, ten years after Barton published his pivotal article, business leaders once again find themselves in a society that is demanding more from their institutions beyond just enriching shareholders. As such, they are being forced to think about how our institutions should be altered to deliver better outcomes for the public at large. Many of the ideas suggested by Dominic Barton in 2011 can and should still be considered as leaders wrestle with the same issues that were raised post-2008. And, we ought to judge how well we have followed his advice over the past decade.
In his article, Barton made three key points - business and finance must jettison their short-term orientation and focus on the long-term; corporate leaders have to serve the interests of all major stakeholders; and public companies must increase boards’ ability to govern like owners.
There has been limited, but not nearly enough progress on the first piece of advice from Barton’s article. Organizations have made significant strides in shifting their focus from the short-term to the long-term in their earnings guidance practices; today only about 1 in 5 companies in the S&P 500 still provide quarterly guidance, an outdated practice that promotes short-termism and attracts transient, short-term shareholders.
While this progress is promising, there is still much work to do to continue to promote long-termism.
CEO tenure, one of the ways to measure the length of an organizations outlook, is still too short. The average tenure for today’s CEOs has now dipped to 6.9 years, down from 8.0 in 2016, showing that organizations continue to incentivize short-term results, when they should be giving CEOs longer runways to focus on generating sustainable value by making decisions with a focus on the long-term rather than immediate milestones, such as quarterly earnings.
That said, trust in business in general has increased, as this year’s Edelman Trust Barometer shows that business is the most trusted institution among the four studied (business, NGOs, government and media), and is the only institution seen as both ethical and competent. This indicates that some organizations (think Patagonia and Salesforce) have reoriented their focus to the long-term and delivering positive societal outcomes, and the public has noticed. Yet, there is still a long way to go for the majority of businesses.
Fortunately, organizations have made significant strides in the second area, as Barton counselled business leaders that “executives must infuse their organizations with the perspective that serving the interests of all major stakeholders—employees, suppliers, customers, creditors, communities, the environment—is not at odds with the goal of maximizing corporate value; on the contrary, it’s essential to achieving that goal”.
Today ESG factors are more prevalent than ever in corporate strategy and these considerations have become an increasingly important part of the investment process for asset owners and asset managers. According to Morningstar, ESG funds captured $51.1 billion of net new money from investors in 2020, a record and more than double the prior year. A BNP Paribas survey also showed that the percentage of both retail and institutional investors that apply ESG principles to at least a quarter of their portfolios jumped from 48 percent in 2017 to 75 percent globally in 2019. These trends indicate that corporations, asset managers, and asset owners alike are beginning to recognize the convergence of values and value; the concept that having strong values and serving the interests of all major stakeholders – beyond their shareholders – maximizes financial value in the long-term.
This progress cannot be just a trend that fades as business and investors prioritize other business strategies and investing principals. ESG principals must permeate a company’s strategy, akin to how many financial institutions permeated digitization throughout their entire corporate strategy. These companies did not just put banking statements online for customers, they revamped nearly every aspect of their business with digitization. Companies must do the same with ESG.
The area that still requires the most attention, focus, and resources going forward is Barton’s third recommendation – improving corporate boards. As Barton stated, “public companies must cure the ills stemming from dispersed and disengaged ownership by bolstering boards’ ability to govern like owners”.
Executive compensation, which is an important task of governance, continues to not incentivize executives to act like owners of their company. Certainly, this is a difficult problem to solve for numerous reasons, not the least of which is that according to FCLT, performance-linked pay motivates people effectively only for routine tasks (a CEO’s job is anything but). The suggestions made by Barton to remedy this, including linking executive compensation to metrics like innovation and efficiency instead of share price, extending the time frame for executive evaluations, and creating downside risk for executives have all largely gone unheeded.
Further, high frequency and payment for order flow traders, in addition to the surging retail traders, not only hold equities for short periods of time, but tend to be very disengaged shareholders. The rules suggested by Barton including giving two votes to shares held longer than a year or assigning voting rights based on the average turnover of an investor’s portfolio, have not been implemented in any meaningful way.
As Barton stated in his 2011 article, “while I remain convinced that capitalism is the economic system best suited to advancing the human condition, I’m equally persuaded that it must be renewed”. Many of the inadequacies exposed within our institutions during the 2008 financial crisis have once again been thrust into the spotlight as COVID-19 has ravaged our healthcare system and economy. The public is demanding that institutions of all types reinvent themselves to focus more on long-term societal well-being rather than quarterly earnings. and it is becoming increasingly difficult to disagree. We need to move faster and with more conviction to focus capital and capitalism on the long-term. Enterprises must earn the license to operate over the long-term. That right is granted by society, not the financial barons of Wall Street. Civil society is at the apex of all capitalist decision making, and business and government needs to re-align to this paradigm. Purpose based business has arrived.
Andrew Liveris is a former CEO and Chairman of The Dow Chemical Company. Liveris became CEO in 2004 and served as Chairman and CEO until 2018. He is currently Chairman of the Board of Lucid Motors and serves on the Boards of Worley, Aramco, IBM, and NOVONIX, and as an advisor to PIF, BlackRock, and Sumitomo Mitsui Bank. @LiverisAndrew | andrewliveris.org
Mark Wiseman is a Canadian investment manager and business executive and an industry-leading expert in alternatives and active equity investments. Wiseman currently serves as a senior advisor to Lazard, BCG and Hillhouse Capital, and is the Chair of the Alberta Investment Management Corporation. Until 2019, Wiseman was a Senior Managing Director at BlackRock and Chairman of BlackRock’s Global Investment Committee.