ESG and the Purpose of Corporations: Back to Basics

The core topics covered by the ESG agenda are very relevant. It is common sense that everyone should care about the planet and avoid pollution; providing the same treatment to anyone is an essential goal in a free society, and improving corporate management is also a priority. But having said that, we also need to point out that, after becoming a hugely popular trend, an open debate on the pros and cons of the ESG agenda, as it has been conducted, has become unviable. Even without clear standards, the conclusion has been that either you comply, or you must be penalized. The strength of political correctness and semantic control further complicates this restriction. To better address this dilemma and understand how corporations should deal with the ESG agenda, we must first pose a fundamental question: what is the purpose of corporations?

On one side is the shareholder model, any corporation should be concerned with generating profit and long-term value, always putting the company and its shareholders (noting a subtle difference between the American and British models) first. By generating profits and maximizing the company’s value in the long term, and by focusing on shareholders, companies end up generating results that benefit their employees, suppliers, and society in general through tax collection and other initiatives. This would be the actual social function of the company, and this would be the effective fulfillment of the public interest.

Following this line of thought, the system of free exchange is decisive in generating wealth, and the public role should be directed only to ensure the integrity of such a contractual system. In this system of social cooperation, through which parties freely celebrate exchanges, development is generated, and poverty is reduced.

On the other side is the stakeholder model, which places the interests of shareholders and all others who can be directly or indirectly impacted by the company, no matter how complex the extent of that list may be, on equal footing. This model, which has Germany as a reference, includes several themes beyond profit in the strategic decisions to be made by those who manage the companies. In addition, it demands more public regulation. When making a strategic decision in this model, the company may eventually renounce profit due to other social impacts such a decision could entail.

In the shareholder model, customers may prefer to buy products and services from companies that care about protecting the environment and reducing environmental and social impacts. Similarly, investors may feel more secure investing in companies whose governance they consider solid, with management tools that ensure the correction of their internal processes, compliance with the law, and the implementation of a model focused, with transparency and consistency, on results. Companies will naturally consider all these aspects as they will positively impact their journey.

The risk of political interference is also considered in the shareholder model. The lesser the risk of governments trying to interfere in the smooth running of businesses, such as trying to appoint politically oriented people to management positions, the better. Governments increase risk, raise financial costs, harm business strategy, and penalize the company, its employees, and society itself.

Finally, both consumers and investors may freely choose companies that prioritize profit and long-term value generation and, at the same time, spontaneously take good care of their employees, respect people regardless of who they are, excel in management, and maintain a good relationship with the communities where they are situated.

In the stakeholder model by contrast, the attention to the ESG themes reverses the order of the other model. Doing so creates a fertile environment for the company to be a victim of confusion between political interests and private property. By the nature of the model, there is a demand for increasing the regulation. Such demand, even clarifying duties and procedures, eventually imposes transaction costs and bureaucracy on companies, which often cannot meet many requirements. This can also happen in environmental, social, and governance issues, as they require more bureaucratic internal inspection and auditing procedures, such as those that emerged with legislation that appeared after major corporate scandals, like VW, Enron, and WorldCom.

The public interference and the loss of balance between cause and consequence open space for a semantic war and tremendous pressure on companies, undermining private property and imposing, through regulation, what cannot be imposed through political pathways by legislative deliberations.

It also opens space for business decisions to be made based on new trends but not necessarily observing them. Companies can harm their results by following a more ideological orientation, while other companies can benefit from their competitors’ politically driven decisions.

The case of the energy company Glencore is an interesting example. At some point, while its competitors divested their businesses associated with carbon emissions, Glencore maintained its position (and even expanded it). When a significant increase in demand followed due to a series of externalities, Glencore saw its market value materially rise, in contrast with what its competitors observed.

Another example is the fast fashion industry. There is a rapidly growing number of firms who, without taking care of the environment, without prioritizing their employees, and disregarding tax rules, offer cheaper products and as a result gain market share rapidly, with great success among the public who, theoretically, could be more sensitive to the ESG agenda.

And there is the financial market, raising funds for allocation in businesses guided by the ESG agenda. In several cases, the costs charged for these investments are higher than those of traditional industry, and the financial results are worse. In other words, investors lose. To avoid this situation, managers quietly diversify green investments by moving to businesses of different sectors. This generates even more confusion in the criteria for certifying ESG businesses, undermining the credibility of this agenda, which also shows itself from this angle as more political than profit oriented.

The interference of ESG in the business world begets even more demand for government due to the increasing regulation it prompts. The increases in transaction costs and tax burdens on firms, whether ESG oriented or not, will open space for rent seeking- for companies to demand subsidies, grants, and pleas for market reserves through the imposition of licenses or the taxation of imports. This inevitability is the root of corruption. Could there be anything more contrary to the ESG agenda than such consequences of negative social impact?

Companies must care about their strategies. On the one hand, they must not lose sight of their reason for being, which is, by complying with the laws, to generate profit and value in the long term, prioritizing shareholders. For that, we should always get a more back-to-basic attitude. On the other hand, when seeking profit, corporations must strive to enchant customers with competitive products and services that, as much as possible, allow the identification and representation of feelings and values in an environment of freedom.

Emphasizing the success of corporations is crucial; their growth directly contributes to societal benefits. The wealth businesses generate plays a vital role in alleviating poverty. Since governments cannot and do not create value, introducing new agendas into corporate operations must be cautiously approached. Recognizing the importance of the ESG agenda and its implementation is essential. Yet, it is critical not to overlook the fundamental purpose of corporations: to generate profit while adhering to regulations and creating long-term value for shareholders.