In 1970, influential economist Milton Friedman made a bold proclamation in an essay for The New York Times that changed the face of business ethics. Friedman famously argued that enterprises have just one social responsibility: increasing their profits. His greed-is-good ethos made life simple for Corporate America, which likely explains why it was so attractive to captains of industry.
When your only reason for being is to pass returns along to your shareholders, issues like environmental damage or diversity in the workplace can fall off your radar screen.
A recent Mercer study (summarized by Cooley’s PubCo blog) suggests that we appear to be entering the twilight of what has come to be known as shareholder theory. Instead, a growing number of shadow regulators such as institutional investors and corporate activists are demanding that companies account for their corporate governance practices, environmental and social impacts, and more. In the words of BlackRock CEO Larry Fink: “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”
Prominent investment houses have joined BlackRock in prodding companies and their management teams to do more than stack their bank accounts. In fact, one of BlackRock’s peers, Prudential Financial Inc., is taking its own steps to align its executives’ incentives with the firm’s environmental, social and governance (ESG) platform.
In its most recent proxy statement, Prudential describes a carrot-and-stick approach:
In keeping with our commitment to diversity and inclusion in practice, the performance shares and units awarded to executives at the senior vice president level and above (and equivalents) in February 2018 were made subject to a performance objective intended to improve the representation of diverse persons among our senior management over the 2018 through 2020 performance period:
If we meet our goal of increased representation of diverse persons by five percentage points or more over this period, payouts will be increased by up to 10%.
If there is no change in representation, payouts will be decreased by 5%.
If such representation decreases over this period, payouts will be decreased by up to 10%.
Similarly, oil companies Chevron Corp. and Royal Dutch Shell are moving forward with plans to tie compensation packages to their goals for reducing greenhouse gas emissions.
Given the growing calls on Capitol Hill for companies to enhance climate-related corporate disclosures, sustainability targets seem likely to take on a greater role in executive compensation packages. If so, keep an eye on how companies establish performance metrics. Consensus on appropriate ESG standards is lacking. The new approach may leave compensation committees longing for the days when they only worried about the bottom line.