Profit without Honor
National Review Online, June 15, 2020
The socially responsible investing (SRI) bandwagon rolls on.
Longtime hedge fund manager Paul Tudor Jones on Wednesday critiqued the long-held belief that companies should exist for the sole purpose of generating profits.
Jones, whose remarks came during a JUST Capital event with CNBC’s Andrew Ross Sorkin, said [that it’s] a philosophy that allows corporate boards to neglect issues of equity in the workplace and ultimately undermine the stability of broader U.S. society.
“When you just look and say that the only thing that a company has to worry about is making a profit, it gives that company a pass not to pay attention to pay equity, not to pay attention to gender equity, not to pay attention to racial equality. Not to pay attention to a whole host of social factors that at the end of the day are the basis and the foundation of a strong, vibrant society,” Jones said.
But these are matters best hashed out in public debate and where necessary, legislatures, not boardrooms.
Jones was essentially taking aim at those, most famously Milton Friedman, who have had no time for the concept of corporate social responsibility, a nonsense Friedman trashed for both for its shaky logic and its insidiousness:
The discussions of the “social responsibilities of business” are notable for their analytical looseness and lack of rigor. . . . What does it mean to say that the corporate executive has a “social responsibility” in his capacity as businessman? If this statement is not pure rhetoric, it must mean that he is to act in some way that is not in the interest of his employers.
However, for SRI activists, corporate social responsibility’s “analytical looseness” is a feature, not a bug, opening the door for an endless list of ‘moral’ obligations to be heaped on corporations led, increasingly, by managements either too weak, too scared, or too puffed up by self-importance to push back in the name of the shareholders for whom, in theory, they work.
That said, it’s often conveniently forgotten that when Friedman argued that management’s duty is to a company’s owners (its shareholders) — and thus almost invariably involves maximizing their financial return — he also explained that this obligation is qualified both by custom and by law:
In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. 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 their basic rules of the society, both those embodied in law and those embodied in ethical custom. [my emphasis added]
The meaning of “ethical custom” can be debated, but the word “custom” implies a practice that has been around for a long time and is widely accepted: That a company should treat its employees decently almost certainly counts, even if “decently” can be interpreted in very different ways.
That is where the law steps in. We do not, as a species, find it easy to come to a consensus on what is right, so, in a democracy, we vote for legislators who decide what the rules should be. And Friedman is unambiguous — rules “embodied in law” should be obeyed by those running a company.
For Jones to describe Friedman-style views as “very narrow, myopic and transactional” looks to me as if he were taking aim at a caricature, created, perhaps in the era — the 1980s — in which he first rose to prominence on Wall Street. For him to blame (at least as CNBC reports it) those views “for helping to undermine the social and civil rights changes sought throughout the 1960s” is to read the last few decades in a manner unrelated to any discernable reality.
The event at which Jones was speaking was co-hosted by JUST Capital, an organization boasting a name redolent of self-satisfaction and “social justice,” which he co-founded and of which he is now chairman.
Friedrich Hayek:
I am certain . . . that nothing has done so much to destroy the juridical safeguards of individual freedom as the striving after this mirage of social justice.
This “mirage” may prove no less destructive of shareholders’ legitimate expectations that a company in which they have invested — which they own — should be run for their benefit. It is an attack on property rights. And, as such, it is an attack on individual rights, and of a type that rarely just stops at property.
Turn to JUST’s website to find that
JUST Capital is the only independent nonprofit that tracks, analyzes, and engages with large corporations and their investors on how they perform on the public’s priorities. Our research, rankings, indexes, and data-driven tools empower all market participants to help build a more just economy. We are neutral and data-driven — an honest broker working to move the vision of stakeholder capitalism from rhetoric to reality.
Leaving aside the fact that “stakeholder capitalism” is, at its core, a form of corporatism, an ideology with a miserable and disreputable history, what’s most interesting about that statement is the claim that JUST measures corporations by the extent to which they match up to what (based on polling) the public thinks that companies’ priorities should be.
In collaboration with NORC at the University of Chicago, JUST Capital asked a representative sample of more than 4,000 Americans to compare 29 different business Issues on a head-to-head basis, producing a reliable hierarchy of Issues ranked in order of priority. We then assigned each Issue to the stakeholder it most impacts.
The results do not make pretty reading for shareholders. Top of the list was “pays a fair wage,” bottom was “generates returns for investors.” That is not quite as bleak (for the shareholder) as it looks. Among priorities ranked above investor return were “follows laws and regulations,” something with which Friedman would agree. Others, however, conjure up images of a harnessed, and (judging by some of the priorities) emaciated capitalism: Paying a “fair share” (whatever that might mean) of taxes, contributing to “community development” and “giv[ing] back to local communities” are all ranked ahead of shareholder return.
Like a good number of those in the SRI ecosphere, JUST also has a range of products on offer. For example, its “ESG data can be used for asset management ESG integration and investment product development” (ESG is the acronym for a usefully indeterminate set of Environmental, Social and Governance criteria against which companies can be measured by ‘socially responsible’ investors).
In June 2018, Goldman Sachs Asset Management launched the Goldman Sachs JUST U.S. Large Cap Equity ETF, which seeks to provide investment results that closely correspond, before fees and expenses, to the performance of the JULCD JUST US Large Cap Diversified Index, an index “designed by JUST Capital, based upon its annual ranking of the just corporate behavior of America’s largest corporations.”
“Just corporate behavior.”
Our Rankings, investable indexes, and in-depth financial analysis demonstrate the business and investor case for just business behavior. We have one goal: to drive investment capital toward more just companies, thereby incentivizing a more just and equitable marketplace.
“Just companies.”
To be fair, it should be noted (as CNBC did) that “the fund is outperforming the S&P 500 year to date as well as over the last 12 months with a gain of 12.07% through Tuesday’s close.”
And again, looking at the JULCD Index itself (which includes the top 50 percent of Russell 1000 companies ranked by JUST Capital by industry and . . . constructed to match its industry weights), it had, between its inception and the end of the first quarter of 2020, consistently outperformed the Russell 1000.
If investors wish to put their money to work in a way aligned with their beliefs, that should be up to them. JUST’s work on projects to help that is only for the good. The more choice the better. If the transparency of JUST’s methodology enables such investors to make more informed selections, then that is even better still.
And if the JUST/Goldman ETF or other socially responsible funds can deliver outperformance sustained by more than the weight of money now being allocated to ESG-conscious stocks, then flintier-eyed investors will take a look, raising the possibility of a win-win all round, although it will still be worth asking how E, S, and G weigh up against each other. As I noted in a post a couple of weeks ago, there is some evidence that outperformance comes from the relatively uncontroversial G (governance), with the E (environmental) and the S (social) detracting from performance — a not altogether unsurprising result, however, well, unjust some might find it.
As I also noted, Bloomberg’s John Authers has drawn attention to a possible clash between ESG’s constituent parts, and how that might relate to the outperformance of some socially responsible funds:
It is possible that ESG is undermining itself — or at least that the E and the S are in conflict with each other. Vincent Deluard, of INTL FCStone Inc., suggests that ESG funds are people-unfriendly. Tech and pharma companies tend to look good by ESG criteria, but they tend to be virtual as well as virtuous. These are the kind of companies that need relatively few workers, and which churn out hefty profit margins. When Deluard looked at how the big ETFs’ portfolios varied from the Russell 3000, the results were spectacular. They are full of very profitable companies with very few employees. . . . A further look at companies’ market cap per employee showed that investing in the current stock market darlings who are making their shareholders rich is a very inefficient way to invest in boosting employment. They include hot names like Netflix Inc., Nvidia Corp., MasterCard Inc. and Facebook Inc. . . .
The problem, Deluard suggests, is that ESG investing, intentionally or otherwise, rewards exactly the corporate behavior that is creating alarm. Companies with few buildings, few formal employees, and a light carbon footprint tend to show up well on ESG screens. But allocating capital to them leads to a deepening of inequality and intensify the problem of under-unemployment. On the face of it, they aren’t the companies that should be receiving capital if employment is to recover swiftly. If investors want to behave with the interests of “stakeholders” rather than “shareholders” in mind, and that is surely central to the ESG philosophy, then their current approach is directly counter-productive. No good turn goes unpunished.
For his part, Friedman was none too impressed by executives who talked about corporate social responsibility. They were, he argued, “unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.”
That was in 1970. Ideological battles have moved on since then, but the underlying threat to a free society posed by the ESG warriors, whether in the name of the environment, “equity” or what Jones breezily referred to “a whole host of social factors,” should not be ignored.
If shareholders are just another class of stakeholder, then their money — and sometimes a lot of money — can be spent by company managements in pursuit of an agenda set by largely unaccountable activists.
The traditional answer to this has been that shareholders can install a new board that does pay attention to what they want. If they cannot be bothered to vote the bums out, then they can hardly complain. But that picture changes dramatically if ideologically motivated investors who indirectly or directly control large blocks of stock are prepared to support policies that may hit the earnings of the company in which they are invested.
If those investors are putting their own money at risk, that is their decision to take. It is more complicated when they are managing money on behalf of others, and when those others have little or no say. If the latter have chosen to invest on socially responsible lines, there is no problem. But what if someone is a state employee, say, and that state’s retirement fund invests the money reserved for his or her pension — money, incidentally, that will have come from taxpayers — and that fund, like many state retirement funds, is using ESG as a material investment benchmark? The actual and prospective pensioners will have little say, and neither, realistically, will taxpayers. Equally, where company 401(k)s offer a range of mutual funds, there is a growing chance that those funds, regardless of how they are labeled, and, increasingly, even if they are passive funds, will, if they vote at shareholder meetings, be following the SRI rulebook. What then, of investor choice?
Moreover, the ever-larger amounts of money earmarked, openly or otherwise, to invest in the stock of companies that satisfy ESG criteria will create a snowball effect, leading many managements to decide that it is easier to submit than to push back, even if they believe that it is not in their firms’ economic interest, something that will reduce the number of investments open to investors interested solely in return still further.
It is difficult to be optimistic about what this all means for the profitability of the companies on which America’s prosperity depends, but it seems that we are not supposed to worry about that.