1. Challenging the pernicious orthodoxy of short-termism

Sustainable Capitalism - February 15, 2012

(Editor’s note: what follows is the Introduction to a large position paper.  The full paper can be viewed at the link below. A long list of the experts who contributed to the development of this paper is included in the appendix.)

http://www.generationim.com/media/pdf-generation-sustainable-capitalism-v1.pdf

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The challenges facing the planet today are unprecedented and extraordinary; climate change, water scarcity, poverty, disease, growing inequality of income and wealth, demographic shifts, trans-border and internal migration, urbanization and a global economy in a state of constant dramatic volatility and flux, to name but a few. While governments and civil society will need to be part of the solution to these massive challenges, ultimately it will be companies and investors that will mobilize the capital needed to overcome them.

To address these sustainability challenges, we advocate for a paradigm shift to Sustainable Capitalism; a framework that seeks to maximize long-term economic value creation by reforming markets to address real needs while considering all costs and stakeholders. The objective of this paper is twofold. First, we make the economic case for mainstreaming Sustainable Capitalism by highlighting the fact that it does not represent a trade-off with profit maximization but instead actually fosters superior long-term value creation. Second, we recommend five key actions for immediate adoption that will accelerate the mainstreaming of Sustainable Capitalism by 2020:

1. Identify and incorporate risks from stranded assets;

2. Mandate integrated reporting;

3. End the default practice of issuing quarterly earnings guidance;

4. Align compensation structures with long-term sustainable performance; and

5. Encourage long-term investing with loyalty-driven securities.

In addition, we also believe that there are five broader ideas that merit ongoing support and attention. Specifically, we think there is a need to:

i. Reinforce sustainability as a fiduciary issue;

ii. Create advisory services for sustainable asset management;

iii. Expand the range and depth of sustainable investment products;

iv. Reconsider the appropriate definition for growth beyond GDP; and

v. Integrate sustainability into business education at all levels.

Ben Franklin famously said, “You may delay, but time will not, and lost time is never found again.” We have the opportunity to rebuild for the long term and an obligation to seize it. Sustainable Capitalism will create opportunities and rewards but it will also mean challenging the pernicious orthodoxy of short-termism. Now is the time to accelerate the transition.

We have often said the market is long on short and short on long. Yet, remarkably, even after enduring the global financial crisis – caused in significant part by short-term, unsustainable strategies and actions by both companies and investors – many of us are still content to embrace short-termism in nearly all aspects of our lives. From investing, to living beyond our means, to relying on instant opinion polls and tolerating a political discourse based upon sound bites, tweets, and 30-second TV commercials, we focus far too frequently on instant gratification and immediate results. As a result of this short-term perspective, we are – in economist Herman Daly’s prescient phrase – driving our economies and our planet into liquidation.

Before the crisis and since, we, and others, have called for a more long-term and responsible form of capitalism, what we call Sustainable Capitalism. Sustainable Capitalism seeks to maximize long-term economic value creation. It explicitly integrates environmental, social, and governance (ESG) factors into strategy, the measurement of outputs and the assessment of both risks and opportunities. 

Sustainable Capitalism encourages us to generate financial returns in a long-term and responsible manner, and calls for internalizing negative externalities through appropriate pricing.

For companies, this means internalizing the business case for sustainability and adapting business models accordingly, with C-level and board support. It means talking openly and candidly about the need to build businesses for the long term and rewarding investors who endorse this approach. In addition, this more responsible approach can be and should be supported by the adoption of integrated reporting (defined on p 4).

For asset owners, this means embracing the long term and sustainability as value-creating tools. In particular, it means recognizing the risks that stranded assets carry (defined on p 3) and embracing ways to reshape incentives across the investment value chain. Consultants and advisers will be critical in facilitating this change and are urged to adopt similar long-term sustainability-orientated principles.

For asset managers, this means investing for the long term and adopting incentive structures that reward such behavior. It means carefully considering the effect of sustainability factors on the valuation of companies and then changing their mindsets and financial models in response.

For governments, this means understanding that there are serious and on-going fundamental market failures that threaten not only the future of our companies and investments, but also the sustainability of our planet. It means not just focusing on global treaties, government policy and legal solutions at summits but also understanding and adopting the more immediate changes that can be made to alter incentives and behaviors, and partnering with business to find solutions.

For Non-Governmental Organizations (NGOs), this means clearly defining their role in the economic system. It means developing a better understanding of the motivations of companies and investors and identifying ways to encourage them to change through appropriate methods of impactful engagement. It means drawing attention to unsustainable practices in financial markets and lobbying not just on single issues but for structural changes in the way that the global economy deals with the challenge of sustainability.

For the media, this means challenging companies – and commentators – to do more than just talk about sustainability and holding companies to a high standard when evaluating their actions. It means encouraging the adoption of integrated reporting and celebrating those companies that prove the business case for sustainability. It also means providing a forum for debate in order to win over the mainstream.