Good Corporations Benefit ALL Stakeholders

I have just completed a summer program at Yale University. At the Yale Young Global Scholars' Politics, Law, and Economics session, I had several discussions about the role of corporations in society. A number of individuals expressed strong views against corporations, and the profit motive. A common sentiment was that in order to seek profits for shareholders, corporations must abuse their workers' rights, and the environment they operate in.

Unfortunately, it is true that some corporations do mistreat their workers and their environment. However, I believe it is wrong to think that this benefits shareholders. Mistreating workers leads to dissatisfaction, poor customer service, and high worker turnover. Similarly, a company which destroys the local environment may face backlash from workers and customers in the community.  Over time, dissatisfaction and backlash kill a company.

Thus, seeking sustainable, long-term profits for shareholders and caring for other stakeholders aren't mutually exclusive - to me, the two are synonymous.

What is ESG investing? Does it work?

ESG refers to the Environmental, Social and Corporate Governance. ESG investors often evaluate companies solely on a range of ESG metrics, and allocate capital to companies with "high ESG scores". Over the last few years, "ESG funds" have outperformed "non-ESG" ones. Consequently, they have gained popularity, with ESG-focussed asset managers receiving record inflows of capital in 2018, and Q1 2019.

I have attended two lectures - one at Columbia University, and another at Yale - about ESG investing in order to understand the reasons for its rise. I frequently hear people saying that being ESG-investing generates better returns. I partly disagree with this statement.

Just because you invest based on ESG scores does not mean you will necessarily generate better returns; ultimately, all that counts is that you buy businesses for less than they are worth. That being said, I do not believe that an evaluation of a company's ESG standards is futile. Indeed, I advocate considering how a company thinks of Corporate Social and Environmental Responsibility; a company which is fulfilling its responsibility to its employees, and attempting to reduce the negative effects of its operation is likely to be better managed. And, a better management is likely to create more long-term value for shareholders.

Thus, I wish to suggest that ESG should be one of many factors that drives a capital allocation decision. Having tweaked the layman's definition of "ESG investing", I can say that there is no such thing as ESG vs. non-ESG investing: all investors must consider ESG standards when evaluating a company. 

Insider ownership is great, insider control is less so.

As an investor, one feels comfortable when founders/executives have a significant portion of their net-worth in their company’s stock. This is because it indicates that they believe in the company’s future success. This also ensures that their interests are aligned with those of minority stakeholders. Indeed, the fact that Mr. Howard Marks’ income was entirely from his stock holding in Oaktree Capital Management was a source of comfort for me when I invested in the company.

However, in some companies (generally tech companies, and nowadays in other newly listed companies) founders are not only personally invested, but they control the company through controlling stakes, or shares with supervoting rights. This has its positives. Firms with such ownership can take a longer-term view and not succumb to the short-term performance pressures exerted by the capital markets, which tend to have shorter investment horizons than those required by businesses investing for the long term. However, total control is a double edged sword and can also be dangerous. This is because when one/few individual(s) has complete control over a company they cannot be held accountable. Thus, their decisions receive less scrutiny and less challenge. Furthermore, the controlling shareholders could act to serve their personal interest at the expense of minority shareholders. For example, they could engage in related party transactions that may destroy value, or even sell the company at low valuations, whilst securing a better deal for themselves. The latter may well have occurred in Oaktree’s sale to Brookfield, in which I feel that minority investors received less than intrinsic value, while the management team will be bought out over a longer time period, and appears to have a potentially more favourable deal. It was frustrating to have trusted the alignment of my interests with Mr. Marks’, only to realise that super voting shares meant interests were not completely aligned after all.

My conclusion is that controlling founder ownership by visionary entrepreneurs is often a positive attribute of an investment. However, we must be keenly aware of the risks as interests are not completely aligned. 

Never Settle

Never settling results in better decision making, increased openness to opportunities and ultimately a better outcome. For me, 'never settle' has a few particularly significant meanings. 

Firstly, never settling is about constantly striving. That is seeking to develop or improve one's skills in - and a knowledge and understanding of - a particular field. This may range from working to improve one's written communication skills and develop a better understanding of Physics, to attempting to increase the distance one can run. Often, this will involve repeatedly seeking out and attempting to resolve personal shortcomings. This will not only lead you to become better at something, but will also reinforce the importance of hard work and industry. 

Secondly, never settling is about being openminded - and not fixed in one's views. In the investing world, where you must have a strong view before you act, never settling is about having "strong views, which are loosely held". This is essential if one wants to be able to evaluate facts objectively and make good decisions.

Thirdly, never settling is about constantly seeking opportunities, and embracing change, instead of becoming increasingly comfortable with the status quo. This may be about being willing to move countries if a better opportunity presents itself, and being willing to seek mentors from different fields, or about choosing to be an early adopter, or even an innovator. This will lead to personal growth.

The 'never settle' mindset is very powerful. Thus, I encourage you to ask yourself what 'never settling' means for you, and I urge you to subscribe to this philosophy.

A note on inequality and the case for inheritance tax

The most toxic form of social inequality is unequal access to opportunity. Inequality of opportunity compounds the issue of inequitable distribution of wealth. This is very dangerous, because it reduces social mobility, and extended periods of low social mobility can result in disillusionment, which could culminate in radical revolutions.

Warren Buffett once said, "Someone is sitting in the shade today because someone planted a tree a long time ago". This is true. The efforts of a generation can - and often do - bear fruits for several generations. Well educated, wealthy individuals are likely to ensure that their children receive an excellent education, and are likely to be able to facilitate their offspring's extracurricular pursuits. In effect, the offspring of wealthy individuals have more capital invested into them to try to ensure their future success. So, they are more likely to be (financially) successful. Hence, their success compounds from one generation to the next. Meanwhile, parents who are struggling financially often do not have the means to allow their offspring to pursue passions, let alone the time to look after their offspring's physical and mental wellbeing. Thus, their families may become victims of the poverty trap. As if this were not enough, wealthy individuals are also able to bequeath more assets. As a consequence, the gap between the wealthy and the ‘less-privileged’ widens over time.

So, financial inequality is the most important driver of unequal distribution of opportunities, as the inequality of outcome for one generation affects the outcomes of the next generation.

Yet, we must not abandon the idea of unequal outcomes, as this would serve as disincentive for hard work. Indeed, we must embrace inequality of outcome with open arms. Those who have consistently worked hard see themselves benefit from these efforts, whilst those who have worked less hard enjoy fewer benefits; whilst there is luck involved, I am inclined to believe that in aggregate, and over a long period of time, the impacts of luck are insignificant in comparison with the impacts of persistent hard work. So, an unequal distribution is largely equitable.

Furthermore, it is not right to close a gap by pulling people back. Instead, we must pull people forward. So, the real cause of this problem lies in our inability and unwillingness to try to close the opportunity gap. In order to achieve this, governments must attempt to offer a high quality of universal healthcare and education. Collectively, these services would unleash people from the shackles of the poverty trap.

Thus, the question arises, “how will governments fund such extensive public services?” To me the answer is blindingly obvious: raise inheritance taxes. In addition to paying for the universal services, this would encourage people to spend money, and so would allow money to trickle through the economy. It would also force each generation to start afresh.

Unfortunately, this is an unpopular solution; people are strongly opposed to the ‘death’ tax. Thus, one significant cause of the multifaceted problem - unequal opportunity - is people's unwillingness to forgo the right to bequeath their wealth.