Book Excerpts

Learn the Business Mantra of the Future | EXCERPT

In Outlast, authors Mukund Rajan and Col. Rajeev Kumar draw upon their considerable experience of working for some of India’s largest organizations to present evidence and case studies that show that ESG is the mantra of the future. This is a timely must-read for all those who belong to, or aspire to be part of, the corporate world.

In a milieu where there is a significant new thrust on corporate responsibility in India, ESG is the acronym that features most regularly in discourses of key stakeholders, including asset managers, institutional investors, regulators and governments. As discussed earlier, ESG refers to the Environmental, Social and Governance criteria that influence the sustainability of businesses.

The ‘E’ in ESG encapsulates the natural resources a business consumes, the waste it discharges, the pollution it creates, the energy it uses, the carbon emissions it generates, its contribution to climate change and many other environmental impacts. The ‘S’ refers to the links and ties a business develops with the local community, the way it treats its own people and assures safe working conditions for them, its focus on diversity and inclusion, and its reputation as a trusted partner to stakeholders, including suppliers and customers. The ‘G’ deals with how a business is governed, including its systems and processes, board-effectiveness protocols, audit controls, approach to senior executive compensation, appropriate reliance on independent directors and compliance with the law.

ESG measures have become particularly important for business managers and investors. They offer a basis on which critical decisions linked with the sustainable growth of businesses can be taken. In particular, they help companies identify and manage risks to their business. This is the reason an increasing number of businesses and investors are undertaking some form of ESG assessment, which then feeds into their decision-making.

As we noted in the introduction, the most sophisticated investors in the world, accounting for over $100 trillion of invested funds, have subscribed to the UNPRI, which requires them to incorporate ESG principles into their decision-making processes, investment analysis, and ownership policies and practices, and seek appropriate disclosure on ESG issues by the entities in which they invest.

There have been other forms of responsible investing in the past. Going back through the centuries, investors have been guided by moral values, ethical codes or religious beliefs that have steered them away from controversial sectors such as slavery-derived products, weapons, pornography, alcohol and tobacco. Through the freedom struggle in India, some business families were deeply influenced by Mahatma Gandhi’s concept of trusteeship—his view that the wealthy are stewards of society’s resources and while the capitalist has the right to accumulate and maintain wealth, it must benefit society too. In more recent times, British management consultant John Elkington coined the term Triple Bottom Line (TBL) in 1994 and urged corporates to focus not just on financial profits, but also on the improvement of people’s lives and the planet; Elkington essentially wants to transform capitalism, calling upon companies to be not just the ‘best in the world’, but the ‘best for the world’.

Different strategies can be adopted in pursuit of responsible investing. According to the Global Sustainable Investment Alliance (GSIA), investors employ seven basic approaches: (1) negative/ exclusionary screening, wherein they exclude from portfolios or

funds certain sectors, companies or business practices based on ESG criteria; (2) positive/best-in-class screening, wherein they include, in a portfolio or fund certain sectors, companies or projects on the basis of ESG performance, relative to industry peers; (3) norms-based screening, under which investors require investments to meet minimum standards of business practices, based on global norms; (4) ESG integration, where investment managers systematically include ESG factors in their financial analysis; (5) sustainability investing, where investors back companies contributing to sustainability in areas such as clean energy, green technology and sustainable agriculture; (6) impact/community investing, where investors target investments, typically in private markets, aimed at solving social or environmental problems, and including community investing, where capital is directed to underserved individuals or communities, as well as to businesses with clear social or environmental purposes; and (7) corporate engagement or shareholder action, where investors use shareholder power to influence corporate behaviour by talking to senior management and/or boards, filing or co-filing proposals and undertaking proxy voting guided by ESG principles.

With ESG, a more comprehensive and integrated perspective on where to deploy capital is being taken by the world’s most sophisticated investors.

The changing dynamic of how businesses are expected to respond to ESG considerations is reflected in the significant change in the Business Roundtable’s stance in the US. The Business Roundtable’s members include the largest companies in the world such as Johnson & Johnson, Apple, Amazon, IBM, General Motors, 3M and JP Morgan Chase. The Roundtable had famously in the past spoken the language of Nobel Prize-winning American economist Milton Friedman, describing shareholder value creation as the principal responsibility of a corporate. In the 1970s, Milton Friedman had argued that the managers of firms are employees of the shareholders and the social responsibility of businesses is to increase their profits; social problems cannot be solved by corporations, and these must instead be the responsibility of the government.

For four decades, the Business Roundtable endorsed this principle of shareholder primacy, arguing that corporations exist principally to serve shareholders. But in a shift in stance heralded in August 2019, the Roundtable announced a modern standard of corporate responsibility, advocating value creation for all stakeholders. Its members agreed that:

While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders. We commit to:

Delivering value to our customers. We will further the tradition of American companies leading the way in meeting or exceeding customer expectations.

Investing in our employees. This starts with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world. We foster diversity and inclusion, dignity and respect.

Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other companies, large and small, that help us meet our missions.

Supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.

Generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders.

Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities and our country.

Lending his support to this changing view of corporate responsibility, Larry Fink, the head of the world’s largest money manager, BlackRock, had already famously warned in his annual letter to CEOs in 2018, ‘To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers and the communities in which they operate.’7

The ESG thrust of the largest US corporations belonging to the Business Roundtable, including many multinational enterprises and some of the largest institutional investors in the world, means that Indian companies that wish to be included in global supply chains or seek investment will need to pay much more attention to their ESG performance from now on.

There is some good news, though, for Indian companies that need to do more on ESG. There is a growing body of academic literature that demonstrates how organizations focussing on improving their ESG performance do better in terms of financial returns. A leading academic researcher, Professor George Serafeim of the Harvard Business School, has shown, in developed markets like the US, the correlation between material ESG actions and firm outcomes.12 ESG performance is correlated with better management or business model quality. Companies committed to better ESG performance are finding competitive advantages in product, labour and capital markets. With the expectation that firms with high ESG performance will have higher profitability in the future, investors are willing to pay a premium for these companies.

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