Reimagining what it means to be a public company in the modern era
LTSE is helping companies reimagine what it means to be a public company in the modern era
An interview with Brian Tomlinson, Director of Research at the CEO Investor Forum at CECP.
I started my career doing leveraged buyouts prior to the 2008 financial crisis. After the crisis, I became a financial restructuring lawyer; essentially, loaning it out and then trying to get it back in the least value-destructive way possible. As a result of those experiences, I wanted to return to grad school and re-engage with public policy, thinking about how the financial system could operate differently.
That naturally pushed me towards the ESG space, which is about thinking through short-termism and areas where the market isn't considering issues that underlie value and value creation. I had a personal eureka moment sitting in Professor Rebecca Henderson's Reimagining Capitalism class at Harvard Business School when it dawned on me that you could actually “do ESG” for a living :)!
I'm the Director of Research at the CEO Investor Forum at CECP. My work is intended to enable companies to reorient their practice and disclosures towards the long-term. To do this, they need to be able to talk more to the capital markets about ESG - across the issue spectrum - and corporate purpose.
We’ve been working with issuers for the last several years to help them construct a disclosure stance that takes them from being overly short-term focused to having a longer-term stance in terms of both practice and disclosure. One of the ways we've been doing that is by hosting CEO Investor Forums. This is basically an investor conference where large cap CEOs come together to deliver a long-term plan to an audience of long-term investors. They spend more time discussing a longer-term time horizon and a broader set of themes compared to many other investor facing presentations. To support that work we have constructed guidance in the form of principles, frameworks and operational processes to enable companies to engage with that long-term imperative. You can find some of those here.
We start from the premise that short-termism is a problem. There's good evidence to indicate that short-termism can produce myopic decisions, particularly in terms of capital allocation.
The seminal example of short-termism would be a company cutting planned R&D investment or SG&A spend in order to hit a short-term earnings target. In the short-term that decision may appear rational, because if you miss an earnings target, then you're likely to receive a short-term negative impact on your stock price (and executives may have ST incentives tied to that stock price). However, over the long-term, cutting things that underlie value creation, like R&D, are value destructive. That's one of the problems with short-termism - often there is an incentive structure that renders it rational, but undermines long-term performance.
The seminal example of short-termism would be a company cutting planned R&D investment or SG&A spend in order to hit a short-term earnings target.
Every earnings call is implicated in the concerns around short-termism because they happen every 90 days. It takes management a significant amount of time to prepare the disclosures for the earnings call, particularly if they’re also issuing earnings guidance. There's a concern that not only does it involve management in lots of short-term thinking, it also then encourages the capital markets to think only about the short-term.
Then, in the context of ESG, what we've seen is that generally ESG has not really been part of the earnings call discourse at all; and yet earnings calls are to many investors and analysts the most important forum in which companies share their equity story. We wanted to think about barriers to addressing the issue on the earnings call, and then how we can respond to those challenges with advice, guidance and recommendations.
The analysts said they had low familiarity with ESG and the issuers said they didn’t want to start changing the content mix that they share on earnings calls because it will upset the analyst community. The issuers also had well-known concerns about comparability and data availability. These are basically a mirrored set of concerns from the analysts and from issuers. To address this, we developed a series of recommendations to help overcome some of those concerns.
One is to develop relevant ESG content in sequence. If you're not confidently sharing ESG content across your disclosure ecosystem, you're probably not going to immediately dive in and start sharing it on an earnings call. Therefore, you can follow a confidence building program to get you to the stage where you are confident sharing ESG information on the earnings call. You’ve seen the way in which companies have gone up that maturity curve. For example, you start with a sustainability report, then you move sustainability-type discussions onto a more investor facing footing using a framework like SASB. Maybe that gets you to a stage where you're more comfortable hosting an ESG call where you can engage with your ESG focused investors at a deeper level. Once you've gone through that work you’ve developed battle-tested content that can confidently be shared on an earnings call.
A few others would be:
In the usual way, it’s about getting started - not making the perfect the enemy of the good. It’s also about getting ahead of the oncoming wall of demand from the analyst community for more of this information as they realize its centrality to value.
In many ways I think that's quite simple - the CFO is now having to engage with ESG. Companies that are presenting ESG as CSR or doing so as branding essentially for reputational management or marketing exercises are going to be increasingly out of step with investor expectations - and be identified as laggards. It’s incumbent on companies to begin to share ESG metrics in a way that's relevant to financial performance and explain how that relationship exists within their business model, because many investors will have their own thesis on why particular issues are financially material for particular sectors.
“If a company is presenting ESG as CSR and is doing so as branding for reputational management or marketing exercises that is going to be increasingly out of step with investor expectations.”
For those companies that are integrating ESG fully into fundamental analysis, they're also looking at their models for how a particular issue of performance correlates to financial performance. Companies have to have their own story to tell and that means that the CFO has to engage with some level of confidence. You can help that process happen by convening the ecosystems that are ESG related within the firm from investor relations to corporate sustainability to human resources to strategy. Make sure that everyone is in the same room on a regular basis talking about their current issues, which metrics they have available and contexts in which they're comfortable sharing it. The CFO has to engage with this and take the finance function up through the ESG maturity curve.
Yes, definitely! ESG is a whole firm concept. One of the problems is that ESG kind of started in a silo. We need to ensure that companies are breaking down those silos and sharing across functions to ensure they know what ESG data they have, where it's located, who owns it and where it has or hasn’t been disclosed. In terms of managing disclosures, we've seen that the better the relationship between corporate sustainability and investor relations, the better the development of the disclosure mix and content level of ESG.
ESG is a whole firm concept.
So, for us that interaction between investor relations and corporate sustainability is absolutely key. I will also add to that it is the corporate secretarial function given across those three that gets you the full disclosure mixed with the capital markets and it also gets you the proxy statement and the sustainability report, all of which should be aligned and coherent.
Everyone’s talking about corporate purpose for a number of different reasons - a result of societal expectations, COVID-19, the Business Roundtable statement on the purpose of a corporation. What we wanted to do was to round out some of that conversation with evidence around whether corporate purpose from a particular angle has performance implications. We used a data set by BERA Brand Management, which looks at a variety of relevant purpose attributes that consumers associate with brands (such as inclusivity). Then we applied those purpose attributes to companies, allocating them to whether they were high purpose or low purpose brands. What we found was that the companies who are associated with high purpose have all sorts of capital markets benefits, significantly higher total shareholder return, significantly elevated return on invested capital etc.
Then what we wanted to do was to link that conversation around value and around purpose to how companies can start to operationalize that purpose. Corporate purpose should flow all the way from the corporate board through the organization to the brands and how consumers perceive the company. We make a number of recommendations in that area such as the Board of Directors having a purpose statement in which they identify their key stakeholders and the time horizon over which they manage their business. We highly recommend companies engage in a stakeholder and materiality assessment and understand how its stakeholder engagement maps to its value creation outputs. It is a really interesting paper because it essentially knits that sense of what the consumer perception is, what the operational processes are and some of the governance that needs to be put in place around corporate purpose as well.
Of course what we are not saying is that having a purpose inevitably means you are a good, well run or successful company - just to be clear...
Firstly, they are seeking to describe a link to financial value explaining why certain ESG attributes within their business drive a particular financial return. For instance, in the real estate space, buildings that have better green credentials are attracting higher rent premiums showing a really clear link between ESG performance and financial performance. To me, that's a very simple model of how companies can communicate why ESG investments make sense in conventional financial terms.
Secondly, those that use a financially material approach to their ESG across the board demonstrate what their mix of issues is and use a framework like SASB to provide a high minimum baseline of smart disclosure on ESG.
And thirdly, those companies who set targets across their key performance indicators on ESG, those are absolutely critical to long term value. They are demonstrating that they know where they're going, how they're going to get there and over what time period. There is some evidence that indicates that target setting is associated with higher ESG momentum, which makes intuitive sense. Often in our current markets those companies that have higher ESG momentum tend to have higher price momentum as well, so there are certain conventional benefits to doing this.
As a first step, using ongoing on season and offseason engagement with your investors to understand their approach to ESG is important. Those conversations are key so that you can know how to adjust your disclosure mix on ESG to meet their informational needs. Engage with frameworks that provide you with the kind of appropriate analytical architecture for preparing relevant investor ESG disclosures (eg SASB). And then, as I said, address ESG as a whole firm concept and try to get yourselves up the maturity curve as rapidly as possible to ensure that you're going to be meeting those investor expectations.
The remarkable thing about ESG, particularly in the United States, is how much progress it's made absent federal regulatory encouragement. In many ways, it's been a private ordering market based solutions response to essentially a fairly large market failure in terms of how markets think about environmental, social and governance information and performance. Now, the regulatory picture in the United States has obviously changed sharply with the new administration. In five years the question will be how will the regulatory engagement that we're likely to see over the next four years adjust how the industry develops.
We should expect extensions in federal regulation seeking some form of mandatory ESG disclosure. I’d at least expect guidance strongly encouraging TCFD reporting. The implications of that more broadly are simply an acceleration of the trends that we've seen, which are that ESG has gone from a peripheral conversation about markets and companies to being absolutely part of the mainstream conversation. Even those shorter-term elements of the capital markets, for instance your sell side analysts, are really starting to build out their research capacity around ESG because they can see that there is all this data suggesting it’s important. There's also this client demand for ESG enabled advice and analysis.
The conflation of ESG and CSR is very frustrating. We will still meet companies where we're trying to ask them to improve their mix of investor relevant ESG disclosures and the first place their minds go is to corporate citizenship, philanthropy, What's our foundation doing? I'm not dismissing those activities per se, it just isn’t what investors are asking for. I think that's a big and surprisingly enduring misconception. The ESG space is not about how you give away some of the money you make, it's about how you make your money.
The ESG space is not about how you give away some of the money you make, it's about how you make your money.
We're holding our CEO investor forum in June, co-convened with the Biopharma Sustainability Roundtable, where we'll have leading CEOs from at least five biopharma firms talking about their long term plans for sustainable value creation, including Pfizer, Moderna, Merck and J&J among others. That follows on from this period when we've seen our dependence on the biopharma industry (and its relationship with and support from governments) in a very clear way. We've also seen that societal issues managed poorly by the biopharma sector also have huge negative social impacts. So we've seen COVID-19 and we've seen the opioid crisis; a vast capacity to either heal or harm. Given the year we’ve had, I think that's an event that'll have a lot of interest for corporate managers, institutional investors and wider society.
For us, any ESG progress requires cross functional collaboration. We tend to work with investor relations and corporate sustainability. We also work with CEOs and CFOs and will give presentations to ESG working groups and boards of directors. There are so many functions that are implicated on the issuer side. If any of those functions want to get in touch with us at the CEO Investor Forum we would love to hear from them.
LTSE is helping companies reimagine what it means to be a public company in the modern era