Alternative viewpoint to shareholder primacy
an organization should not exist only to increase value for shareholders but to also address the needs of other stakeholders
What are some labels used to describe corporate and investor efforts to address stakeholder needs
SRI: Socially responsible investing
CSR: corporate social responsibility
ESG: Environmental, Social and Governance
What are some pressures from multiple factors?
a) money flowing into ESG investment funds
1995: 1 trillion, 2018: 12 trillion
b) ESG related to proxy proposals: consideration for ESG in proposals have increased
c) Institutional investors: the big 3 index funds have engaged in ESG advocacy campaigns
d) employee activism: employees in big companies like google, and amazon have become more socially aware
BCE Case
In Canada, stakeholder interest was prioritized through the BCE case. Directors may look at interests outside of the stakeholders
Bill C-97
passed in 2019, that pushes directors to look at the interest of shareholders and stakeholders when acting in the best interest of the corporation
Delaware Law (US)
is a director-friendly law that allows directors to act solely in the shareholder welfare and other interests are taken into account to promote shareholder welfare
Skadden Arp’s opinion
allows for shareholders to take in to account social issues as long as it does not hinder value maximization
what are some ESG metrics?
Sustainability Reports: link strategy and sustainable results
Human capital reports: diversity
Climate change impact report: potential impact on the firm from climate change risk
External ESG assesment
- Bloomberg gender equality index
- corporate responsibility magazine
- Ethisphere Institute: most ethical companies
- Newsweek green environment performance
why do shareholders and stakeholders have external assessments?
to better understand ESG metrics of a company
HIP Human Impact + Profit ESG Rating
assess 32 environmental and social factors. CEO pay ration, carbon emission, gender diversity, and lobbying expenses
6 pillars: management, health, wealth, equality and trust and scored on a scale of 10
TruValue Labs
assess companies in 26 dimensions across 6 categories: environmental, social, capital, human capital, business model, leadership and governance
data is sold to institutional investors for long and short-term trading strategies
Sustainalytics: Morning Star
- risk rating based on three categories: corporate governance risk, material ESG issue risk (identified by the company), and idiosyncratic ESG issue risk (unpredictable)
- identified by company exposure and second by how well managed the company is at handling risk
- used to evaluate stock portfolios
Issues with ESG ratings
- lack of uniformity
- no clear relationship between ratings and rankings and stock performance
- different methodologies, no clear understanding of which one is the best (mainly qualitative)
- no auditing of results
- a movement to tie this to executive pay
CGQ Institutional Shareholder Services (ISS)
A type of governance rating that was developed in 2002 called the Corporate governance Quotient (CGQ)
65 variables based on best practices in 8 categories
- board of directors, charter and by-laws, auditors, state incorporation, executive, and director compensation, qualitative factors, equity ownership management and board and director education
- each company gets to score out of 100
MSCI governance metrics
collects data on 96 dimensions 4 pillars
boards
compensation
ownership and control
accounting
MSCI ESG AGR model
financial model rating through audit integrity
AGR (accounting and governance risk) based on detailed financial reporting
scored as very aggressive, aggressive, average, conservative
CEO Activism
CEO activism has increased and is between 4-12% and concentrated in the US large companies
public believe they should support the environment, healthcare, poverty and taxes
Less contentious issues like gun control, abortion and religion
What are the three important corporate system devices that are created by debt?
a) disciplinary mechanism
b) monitoring through institutional lenders
c) monitoring through debt agencies and ratings
Explain debt as a disciplining mechanism.
- managers with big cash flows and little debt are protected from their mistakes
- lazy managers usually tend to run firms that are all equity
- can lead to complacency and inefficiency and investing in poor projects. Managers bear little cost
- fixed interest payments act as an obligation to the firm and impose discipline on management
- discourage superfluous spending by management
- debt has a covenant and if management breaks the covenant then the principal needs to be paid immediately
- debt provides more protection to investors than equity through explicit creditor right
- stops managers from value-enhancing capital expenditures when opportunities arise
Institutional lenders as corporate monitors
- banks will monitor
- forces firms to disclose private information
- the firm has to agree to covenants
Creditors play is debt
- risk-taking, and interest payment so excessive can not be made, in this case, creditors can force the firm into bankruptcy to recover at least some of their investment
Two function variable
direct cost: legal and other deadweight cost
indirect cost: cost arising because people perceive you to be in financial trouble
Probability of bankruptcy cost
as you borrow more, you increase the probability of bankruptcy and hence the expected bankruptcy cost
