ESG – What’s Old Is New Again

Fifty years ago this January, Adolf Berle delivered one of his last lectures at Columbia Business School, on the importance of social responsibility in corporate governance (Berle died in 1971).

Daniel Labovitz, GMAG

Berle is in many ways the father of the concept of environmental, social and governance (ESG) standards for corporations.  In 1932, as a young professor at Columbia Law School, Berle was the co-author of “The Modern Corporation and Private Property,” a seminal text on corporate governance.  Berle’s insight was that the means of economic production was concentrated in only a handful of large public companies – 200 at most – and that these companies had power and reach that rivaled national sovereigns.

While some saw this as justification for greater antitrust enforcement, Berle believed that breaking up these companies would lead to massive economic inefficiencies.  He instead argued for regulations to enforce “business statesmanship” – essentially the notion that corporations and their leaders had already begun to take on certain social responsibilities alongside their profit motives, and that corporate law should be updated to reflect that reality.

Some questioned (and still question today) whether anyone other than shareholders can impose an ongoing “social” obligation on a for-profit corporation.  The basis for Berle’s conclusion was eminently logical, however: he observed that the size and scale of these corporations required owners (shareholders) to delegate managerial functions to a class of professional managers who would run the company, reducing shareholders to the role of passive investors. On paper, the new managerial class nominally worked for the owners and were supposed to be guided by maximizing their profit, but the facts on the ground pointed in the opposite direction: managers, and not owners, controlled the allocation of the firms’ resources, and shareholders rarely objected (successfully) when managers directed those resources toward the managers’ priorities – including higher pay and equity for the managers themselves – rather than the owners’ interests. Berle speculated that having thus conceded that non-owners (i.e., managers) could set the corporation’s priorities, shareholders would not be in a strong position to object if other non-owners (i.e., the community) demanded that corporations direct resources to community priorities alongside the priorities established by managers. As Berle put it,

“[Managers] have placed the community in a position to demand that the modern corporation serve not alone the owners or [management] but all society…Should the corporate leaders, for example, set forth a program comprising fair wages, security to employees, reasonable service to their public, and stabilization of business, all of which would divert a portion of the profits from the owner of passive property, and should the community generally accept such a scheme as a logical and human solution of industrial difficulties, the interests of passive property owners would have to give way.”

What is so interesting about Berle’s conclusion is its relevance today. To wit, 88 years after Berle’s treatise and 50 years after Berle lectured a new generation of business students on ESG, Larry Fink, the chairman of Blackrock, essentially said the same in his recent open letter to CEOs and investors:

“The importance of serving stakeholders and embracing purpose is becoming increasingly central to the way that companies understand their role in society. As I have written in past letters, a company cannot achieve long-term profits without embracing purpose and considering the needs of a broad range of stakeholders.”

Fink is not alone in his insistence on corporations as agents of social good: In September 2018, State Street Global Advisors announced that it would vote against director slates that don’t have a female director. Last summer, 181 corporations signed on to the Business Roundtable’s “Statement on the Purpose of a Corporation”, which included a commitment to embrace sustainable practices, foster diversity and inclusion, support the communities in which they work, and improve transparency and engagement with stakeholders. At the most recent Davos meeting in January, David Solomon announced that Goldman Sachs will no longer take a company public if it does not have a director who is either female or diverse.

Clearly, the more things change, the more they stay the same. What is also clear is that Berle’s vision is essentially the new reality – as Fink wrote in his letter, “while government must lead the way in this transition, companies and investors also have a meaningful role to play.”

ESG standards are the way to measure and evaluate how companies are doing in executing that meaningful role. The markets would do well to pay attention.