Ben Franklin advised businesses to “do well by doing good,” a creed embraced for centuries by America’s best managers and investors, from Henry Heinz to Warren Buffett. Nowadays, this corporate concept is coined as ESG principles — for “environmental, social and governance.”
I am often asked whether companies following ESG principles attract quality shareholders (QSs), the discerning minority of patient stock pickers, as opposed to the massive cohorts of passive indexers and transient traders. My answer is yes: QSs have been prospering by using such principles for decades, long before the United Nations popularized them in 2005.
I compared two recent ESG rankings, by Barron’s and Investors’ Business Daily, with rankings of companies by QS density produced by the Quality Shareholder Initiative at George Washington University. The Quality Shareholder Initiative has presented evidence that high density of QSs in a company is associated with superior corporate performance. The ESG and QS data correlate: the vast majority (80%) of high-ranking ESG companies also rank in the top half for QS density.
History suggests that QSs are attracted to ESG principles because they reflect long-term, company-specific thinking. Unlike past social movements, moreover, ESG keeps shareholder interests at the core of corporate mission, as documented in important new research by professors Dorothy Lund of The University of Southern California and Elizabeth Pollman of the University of Pennsylvania.
To put ESG in historical context, consider the debates over corporate purpose in the 1930s, following the Great Depression. One side, led by Columbia University law professor Adolf Berle, argued that corporate directors must be accountable to shareholders; the other, led by Harvard University law professor Merrick Dodd, urged a corporate pursuit of social objectives.
Both views went mainstream, as companies focused on shareholder profits while making substantial charitable donations. The accommodation remained uneasy, however, as some reformers, such as economist Howard Bowen, advocated greater “corporate social responsibility.”
In the 1970s, debate reignited on corporate purpose. Economists, echoing Berle, favored shareholder primacy, while critics, led by Ralph Nader, urged “taming” corporations to respond to “public needs.” The Naderites won many legislative milestones during the 1970s, from protecting consumers to the environment. But their assaults on corporate America went too far, it turned out, and an era focused solely on “shareholder value” followed.
In the takeover fights of the 1980s, insurgents stressed “shareholder value,” while embattled directors lobbied to consider “other constituencies,” especially employees and communities. Yet by urging prioritizing such constituents, advocates again overplayed their hand: in the end, directors could legally incorporate interests of other constituencies but only if those rationally related to shareholder interests, which held priority.
During the 1990s, critics again assailed shareholder primacy as “irresponsible.” Despite gaining some prominence, this movement likewise overshot its mark by advocating diverting corporate assets from shareholders to others.
Still, these movements planted important seeds. For one, they revealed excesses of the status quo. As indicated in a 1987 Congressional report, obsession with stock prices arose, and with it pressure to put short-term results over long-term gains. Boards started paying executives in corporate equity, riveting attention on stock price. Managers now publicized quarterly forecasts and hosted quarterly calls for investment analysts, stoking short-term pressure.
Researchers in the early 2000s, meanwhile, began finding correlations between certain practices deemed “socially responsible” and corporate financial performance, in categories from employee relations and pollution control to product quality and community involvement.
These dynamics set the stage in 2005 for the United Nations to issue its ESG principles. The U.N. said that “integrating ESG factors into corporate and investor decision making was critical for the security of investments, prosperity, and growing markets.” It unveiled its “Principles for Responsible Investment” at the New York Stock Exchange, citadel of shareholder primacy.
Unlike predecessors, these ESG principles stress factors that enhance long-term shareholder value, an approach that concurs with history, law, and practicalities. As a result, ESG went mainstream. Notably, the Business Roundtable in 2019 adopted a clear statement of what QSs have long known: shareholder returns are only possible when companies cater to customers and reward employees.
From the 1980s to the early 2000s, socially responsible companies, such as Ben & Jerry’s Ice Cream (founded in 1978) or The Body Shop (1976), stood out as unusual. Today, companies that fail to acknowledge ESG are outliers.
Topping the Barron’s/IBD lists of ESG companies are some founded within recent memory, including Nvidia (1993), Salesforce (1999) and Teledoc (2003)]. But most are venerable titans of American corporate history, founded in the 19th and 20th centuries: Kellogg (1906); Clorox (1913); Best Buy (1966); Texas Instruments (1951); Boise Cascade (1957)]; Colgate-Palmolive (1806); Procter & Gamble (1837); Tiffany (same) and Kimberly Clark (1872).
Quality Shareholders favor ESG’s emphasis on businesses and strategies that are “sustainable,” a fashionable word that QSs have been using for decades. Radical adaptations of ESG principles are doomed to fail. But so long as proponents keep ESG mainstream it will be a sustainable strategy for both businesses and investors, who will continue to do well by doing good, just as Ben Franklin advised.
Lawrence A. Cunningham is a professor and director of the Quality Shareholders Initiative at George Washington University. His books include “Quality Shareholders,” “Dear Shareholder” and “The Essays of Warren Buffett.” Cunningham owns stock in Berkshire Hathaway and is a shareholder, director and vice chairman of the board of Constellation Software.
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