Boardrooms are having to deal with a new kind of crisis

Traditionally a corporate crisis is a financial one, and those are usually system wide – affecting companies across the spectrum.  Occasionally of course, an individual company will be affected by a financial crisis all on its own.  A perfect local example is Blue Sky Alternative Investments. 

In either case the demands on company management is straightforward enough.  Look after shareholders by maximising profitability and the market will eventually come around to support the company.

However, we have been seeing a new kind of corporate crisis again and again in recent years.  This is a crisis of confidence from consumers, and more broadly the community of citizens who may or may not be customers.

There is no better example of this than the Royal Commission currently in play.  How many times has Counsel Assisting asked one of the bank providers whether their policies or actions ‘would meet community expectations’?  How many columns of news print have then been dedicated to detailing the errors of the banks and contrasted this to the outcomes of industry superannuation funds?  The latest headline I have read on this topic is instructive - “Industry super may gain 1 in 5 members of retail funds due to Hayne” (AFR 3 Sep 2018).

Perhaps what is even more worrisome for bank shareholders, is that regulators and even more so policy makers are hypersensitive to the rising standard of community expectations.  One irony is that these bank shareholders now include most Australians who have reached working age thanks to superannuation. 

There are those that think there are two sorts of folk, and those that don’t.  Perhaps we can say that there are those that think maximising sales and profitability is incompatible with meeting these community standards.  Boardrooms are now having to deal with a growing list of standards that are influencing discussions, and perhaps even decisions.  Here are a few of the most commonly quoted:

  • corporate social responsibility (CSR),
  • environmental, social & governance (ESG),
  • community standards and expectations (CS&E)

The current catch-all for these is the 'Social Licence to Operate'.  While we might be reading a few new terms in the financial press lately, these issues aren’t especially new to institutional investors who have been grappling with ways to combine profitable investments with corporate citizenship formally at least since 2005.  That’s when the UN’s Principles of Responsible Investing were first launched and has since been adopted by almost all of Australia’s largest investors. 

An article in the aptly named Social Responsibility Journal highlights how long the evolution of this mindset has been:

In the 1950’s the primary focus was on businesses' responsibilities to society and doing good deeds for society. In the 1960’s key events, people and ideas were instrumental in characterizing the social changes ushered in during this decade. In the 1970’s business managers applied the traditional management functions when dealing with CSR issues, while, in the 1980’s, business and social interest came closer and firms became more responsive to their stakeholders. During the 1990’s the idea of CSR became almost universally approved, also CSR was coupled with strategy literature and finally, in the 2000’s, CSR became definitively an important strategic issue - Rosamaria C. Moura‐Leite, Robert C. Padgett, (2011)

Some might argue against that the idea of corporate social responsibility has become universally adopted.  It would nonetheless take a brave board to ignore the trend by leaving broader community expectations out of their discussions.  This is because ultimately the board does set the tone from the top.  Yes, management may be incentivised to meet a range of relatively short-term financial hurdles, but ultimately shareholders and other stakeholders leave the long-term sustainability of every company in the hands of its directors. 

Can a management team who focus too much on CSR get higher pay and bonuses?  Probably not.  Can a management team who ignore CSR get fired?  With the right crisis – absolutely. 

So are we more or less likely to see corporate crises stemming from CSR failings going forward?  I see two factors at play here.  The first relates to the economy, while the second relates to technology.

Economists like myself were taught to think that we should experience a recession or financial crisis on average every four years.  When we have a financial crisis everyone from workers to shareholders gets worried and that gives regulators and policy makers plenty of things to work on to ensure the global economy can maintain ‘system security’.  Issues of community standards and corporate social responsibility get pushed aside for a few years.

Since the 1990’s financial crises have occurred far less often than once every four years.  This has probably been a crucial factor in keeping debates around system stability in the background and providing the space for CSR issues to be raised.  While I can’t say when the next financial crisis will be – I can be pretty confident that regulators such as ASIC and APRA will move a significant proportion of their attention to the issues raised in the Hayne Royal Commission rather than focus on system stability.

Technology is the other big factor contributing to awareness of social factors.  If ten years ago, a consumer had a gripe about how they were treated, they would tell 10 friends and maybe, just maybe they would feel the need to write a letter to the editor who maybe, just maybe would publish it.  Today anyone with a social media account is a publisher and their 10 ‘friends’ are now 1000+ connections. 

The economy will continue to have its ups and downs.  The pendulum of focus from policy makers and regulators will continue to oscillate between system stability and corporate social responsibility.  But consumers are now entrenched as publishers who are emboldened to express their views when they see something that doesn’t meet their personal view of community standards.  Companies with poor community standards can no longer rely on consumers having limited avenues to be heard.

So how can a board find the right tone? Is this a debate between staying profitable and doing the right thing?  Are there really two sorts of folk?

This is one area I believe that an institutional investor’s mindset, using a Responsible Investing framework, can be instructive.  Long term profit maximisation is not incompatible with a Responsible Investing mindset.  Let me repeat that: institutional investors who have signed up to the UN’s Principles for Responsible Investment still want their portfolio holdings to maximise profits – sustainably.

For many consumers and policy makers, the take-away from the Royal Commission is evidence that a legion of corporates can’t be trusted.  This is a shame but not surprising.  There is also an optimistic take-away for management, their fiduciaries and their shareholders – and that is the realisation that going forward there will be greater attention paid to aligning the interests of consumers and shareholders. 

Whether this attention leads to genuine alignment or just lip service will depend on whether fiduciaries are prepared to accept decisions that favour short-term wins over long-term sustainability.  Corporate social responsibility has just become corporate social governance.

- James Dick

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