The Coalition for Inclusive Capitalism’s Embankment project, launched after a meeting of 10 CEOs the week following the Kraft Heinz attempt on Unilever, is trying to come up with new metrics to allow markets to reward long-term value. Terry Slavin reports
In the week after Paul Polman rebuffed a hostile takeover bid by Kraft Heinz last February, there was a meeting of 10 CEOs at Unilever’s London headquarters on the Victoria Embankment.
The meeting of CEOs, representing global multinationals, investment managers and pension funds, had been organised by the US-based Coalition for Inclusive Capitalism to look at solutions to the myopia of capital markets; and the timing could not have been better.
It used to be that a shareholder had a liability towards a firm he invests in; now shareholders come and go
Over the course of the weekend, Polman had succeeded in rallying Unilever’s board behind him to resist the $143bn assault by Kraft Heinz, which is controlled by Warren Buffett’s Berkshire Hathaway and private equity firm 3G Capital.
The board, led by Dr Marijn Dekkers, had to move quickly to repel the bid before stock markets opened on Monday, or risk Kraft getting support from activist investors, an increasingly active class of investors with a laser-like focus on short-term shareholder value who aim to infiltrate boards.
Polman has long been aware that capital markets are not meeting the needs of wider society. “We are really talking about a clash of two different economic models – between a long-term, sustainable business model for multiple stakeholders, and a model that is entirely focused on shareholder primacy,” the 61-year-old Dutchman told the Financial Times last December.
“The average holding period in a company now is 4.5 months,” he observed. “It used to be that a shareholder had a liability towards a company he invests in; now shareholders come and go.” He said activist investors are a growing threat because “they enter into companies, make it very uninteresting for anybody else to be on the boards and soon they dominate it. And they start running it for the short term.”
The disconnect between the type of corporate behaviour rewarded by markets and how society wants companies to behave is laid bare in the latest Edelman Trust barometer, which finds that 69% of respondents globally believe CEOs main job should be to ensure his or her company is trusted (well above increasing profits at 60% and above even ensuring high-quality products and services at 68%).
Accountancy was born 30 years ago, when 80% of the value of companies was represented by machinery and bricks and mortar
A recognition of the crisis at the heart of capitalism was the reason why Lynn Forester de Rothschild, chair of private investment company EL Rothschild, formed the Coalition for Inclusive Capitalism in 2014.
In 2016 EY had worked with the University of Cambridge to develop a theoretical framework to help companies measure and report long-term value in a meaningful way for capital markets, and the coalition had called the meeting at Unilever House to ask asset owners, asset managers and multinationals whether they would participate in an 18-month project to do a proof of concept of the framework.
By the end of the meeting the Embankment Project for Inclusive Capitalism was born, and last June it was launched publicly, with the backing of 20 CEOs, including Nestle’s Mark Schneider, PepsiCo’s Indra Nooyi, Alex Gorsky of Johnson & Johnson, Kurt Bock of BASF, Edward Breen of Dow Dupont and fund managers Black Rock, Schroders, Allianz and Vanguard. Another 11 CEOs have since joined.
In an interview with Ethical Corporation, Hywel Ball, EY’s UK head of assurance, who developed the EY framework and was at the Unilever meeting, explained that existing accountancy methods are no longer up to the job of accurately measuring market value: they were developed 30 years ago, when 80% of the value of companies was represented by tangible assets, like bricks and mortar and machinery.
“With the shift to the knowledge economy, the growth of intangibles [such as human and intellectual capital] has exploded,” Ball says. Tangibles now typically account for only 50% of market value, and in the case of the Fangs (Facebook, Amazon, Netflix, and Google) less than 10%.
The problem fund managers face in allocating capital on the basis of non-financial data is that while “companies have a lot of information [about non-financial performance] they don’t necessarily disclose it. And some of the stuff they do disclose investors just ignore,” Ball says.
Unless fund managers see value in what companies report, they are never going to get long-term value
He said this is because companies don’t give robust metrics and explain how they are relevant to their strategies. One example is when a company gives its employee engagement scores in its annual report. “But they don’t really articulate why employee engagement is important to the value they are delivering to their employees. They don’t say what their target is, what they are trying to achieve, they don’t give a trend. That’s no use to anyone outside their organisation. Unless fund managers see value in what companies report, they are never going to get it [long-term value].”
Over a series of workshops since June last year, the participants in the Embankment Project have tried to hammer out an agreement on metrics in each of the main value categories of human, consumer, and societal so that companies, fund managers and pension funds, which instruct the fund managers, can use them to set long-term mandates. The aim is to have a report with the new metrics signed off by CEOs published at the end of this year.
“There are two things going on [in the project]: to create the information and create the behavioural change to start disclosing it. And that requires trust and understanding on both sides,” Ball says.
One challenge the workshops have thrown up is the varying timelines for investment. For example, Canadian pension funds are required by law to invest for a 75-year cycle, compared to the five-year horizon of a typical long-term investment portfolio, who would themselves be critical of the two- to three-year tenure of the typical US CEO. “It was quite surprising how big an issue this is, how people are struggling to cope with the duration piece,” Ball says.
“The workshops have been fascinating in bringing together all the differing positions. The biggest surprise is how consistent everyone’s concern is about the underlying drivers and the need for change. There’s an overwhelming noise that we need to do something different.”
I’m worried about the drift towards private capital, with the wealth inequality that risks creating
Ball says one big factor driving the push for change, particularly in the US, is the flight of capital from publicly owned companies into private companies, which do not face the same short-termist pressures.
There are now at least 100 “unicorns” in the US, private businesses worth more than $1bn that are reaping the rewards of long-term investment growth, he points out. While in stock-listed companies wealth is spread to society at large via listed markets, not the least through pension funds, in private companies any wealth created stays with individuals.
“Unless we can make these capital markets work really well, I’m worried about the drift towards private capital, with the wealth inequality that risks creating.”
Asked whether he feels optimistic that the project can overcome the issues identified in the workshops, he says: “There are lots of challenges, but we aren’t trying to boil the ocean.”
It will be a series of data points, he says, rather than single-number valuations like the Natural Capital Protocol is seeking to put on ecosystem services.
“From our experience of people wanting to join the project, they agree those issues are big issues and we should try to find a solution … Hopefully by the end of the year we will get some sign-offs from CEOs and that will be a nudge for the market and catalyse a bit of change.”
Terry Slavin is editor of Ethical Corporation and a former correspondent for Guardian Sustainable Business. firstname.lastname@example.org
This article is part of the in-depth briefing Future of Capitalism: See also:Unilever Embankment Project capitalism Paul Polman EY Edelman trust barometer EL Rothschild