Three years since the Business Roundtable dedicated its CEOs to pursuing a stakeholder-driven capitalism and just months before the pandemic helped fuel record growth of ESG (Environmental, Social, and Governance) investing, the backlash against both has been intense. But for George Serafeim, one of the foremost academics studying stakeholder capitalism and ESG, that’s a good thing.
As he writes in the introduction to his new book, “Purpose and Profit,” Serafeim spent much of his career trying to even bring the topics up for debate. In 2011, a year into his tenure as professor at Harvard Business School, he gave a presentation on the subject to an audience of about 100 “senior investment professionals across major financial institutions.” The feedback? Non-financial metrics are irrelevant. Friends, he remembers, told him that he was stubbornly sinking his academic career with the topic.
But he was convinced of his research’s findings of a link between companies’ dedication to purpose-driven, long-term, stakeholder-driven investments and market outperformance of their peers. As his research grew, it also caught the momentum of shifts in society that soon led to a massive shift in how he and his work were received. He founded and still leads the Impact-Weighted Accounts Project at HBS, which oversees and promotes an evolving framework for measuring the business impact of non-financial metrics relevant to executives and investors alike.
His new book draws on that research, as well as his experiences teaching future business leaders in the “Reimagining Capitalism” class he’s co-taught with Rebecca Henderson. We spoke with Serafeim from his office in Cambridge about his career, where he stands on the debates around Tesla’s ESG scores and Danone’s struggles with living up to stakeholder capitalism rhetoric, and why he’s hopeful about the future of business.
The following transcript has been edited for length and clarity.
Your book covers different aspects of a movement that’ve been evolving over years now, but would you say that what it comes down to for you is impact-weighted accounting principles? Is that a core path to progress?
I think it’s a core path to progress, but it’s not the only piece. The “why” rests on understanding the interconnection between the ideas of accountability, transparency, and meritocracy.
As a society, do we want the people that manage not only financial capital, but also human, natural, social, and intellectual capital, to be accountable for their impact on all of those elements? That’s the only way to have actual meritocracy.
And so, if we do want to have a system where people are held accountable for their impact on the environment and society, then we should have an accounting system that reflects those impacts, as well.
What would you say is the current state of progress on those principles, in terms of conversations you’re having with corporate leaders?
Broadly speaking, measurement and accountability around operating impact is a process that started decades ago, and I would say has fundamentally accelerated in the last 10 years, especially so in the last few years. You see that with the creation of SASB and the increasing adoption of its standards, for example, the adoption across dozens of countries around the world of listing requirements and guidelines for ESG reporting, the creation of the International Sustainability Standards Board, and so forth.
So the question is how do we actually move forward? We take all that work on non-financial metrics and focus on what matters, which is the measurement of outcomes instead of effort, and then the valuation of those outcomes. Because if you don’t have valuation, then it’s very hard to make resource allocation decisions when those resources are scarce. You need some type of prioritization mechanism.
Is Tesla ESG Friendly or Not?
We’ve been seeing, especially over the last year or two, that there are so many ways to interpret what ESG is even going to mean. For example, in your book, you cite multiple times the example of Tesla leading with purpose around climate impact, but on the other hand, you have its CEO Elon Musk constantly saying ESG is stupid and a movement that can’t work. He’s pointed specifically to S&P docking Tesla from its main ESG fund for “S” reasons while a fossil fuel company like ExxonMobil can make it into an ESG fund. JUST Capital has dinged Tesla for some of the same reasons in our Rankings. Where do you stand on this?
That discussion goes to how one creates an ESG analysis framework and what relevant measurements, attributions, and prioritization it has.
So on the one side to me, it’s certain that Tesla has really moved forward not only itself in displacing internal combustion engine vehicles, but it has really accelerated movement across the whole industry. From there, if you ask the question, if this company grows, will its positive impact grow as well? I think the answer is yes.
Now, if you have a framework where it says that’s good, but look at some of the governance concerns, look at some of the work practice concerns, then you get a company that might have a bunch of controversies and be excluded. You can see how you can get two very different outcomes, but I can actually see why somebody like Elon Musk would be very frustrated if a best-in-class framework ends up with a portfolio that includes an oil and gas company and excludes Tesla, where he would be like, “What are you talking about?”
Tesla is certainly a firm that I would include in a sustainable investing portfolio. While they need to work on the “S” and the “G” sides, the potential impact of the “E” effect seems to me to be an overwhelming one.
So you think Musk has a point that we might be losing sight of the ball if an ESG framework is leading to them being penalized?
I think he has a point that we should be clear about our priorities. And I believe that valuation is a very, very important element of that, because it allows us to be much more clear about which impacts should be prioritized over the long term. Now, that doesn’t mean that you should say, well, because you are having a big environmental benefit, you can have terrible everything else.
What Does the “S” Even Mean, Really?
Looking at the “S” specifically, at JUST Capital, we’re trying to help bring clarity to that because it is all over the place. We know, for example, that there is popular support for DEI initiatives and pay equity, but then the challenge becomes how to measure the impact of a company that says it is investing in diversity or has achieved pay equity across demographics. How can you take something that has popular stakeholder support and tie it to a direct financial impact that will allow us to evaluate companies in a new way?
When it comes to the impact on employment, we use wages as the evaluation mechanism. We start by asking the question, “Is this a company that is creating a lot of jobs?” Jobs have inherently huge social utility. And then we also ask how good those jobs are. We ask, for example, if the company is paying a living wage across locations, and if there is equal pay. We then ask whether there’s a diverse set of people working at the company relative to the local demographics, and if there is opportunity and career advancement inside the organization.
Wages can be a mechanism by which you can unify all of those seemingly different elements. They have unique characteristics but all connect to whether you’re getting paid.
So is the way you see it that the “S” is unified through wages and then a core benefit of it is stability of the company, a resiliency, maybe?
It’s about stability, but not just about people staying there, because sometimes that can be a negative thing. It’s about attracting the right people and keeping the right people, but also growing them inside the organization.
What We Can Learn From Emmanuel Faber’s Ouster
In your book you include a discussion of the Danone board’s dismissal of Emmanuel Faber as CEO last year. That move could easily be seen as a catastrophic failure for stakeholder capitalism because he was an icon of the movement. Can you tell me how you processed all of that?
Let me start by saying that indeed Emmanuel is very purpose-driven personally, and he’s a fantastic leader.
The narrative that you would have gotten from the media is that Danone is an impact company and it faced a lot of pushback because the financial results were not good. You connect the dots and it becomes the story of how being an impact company was detrimental to its competitiveness and affected its financial results.
But we took a step back and we used impact weighted accounts to assess the first part of that narrative. We asked if, within consumer good companies, it was a positive-impact company or one that was in the transformation of potentially getting there but isn’t there yet. We found it was the latter.
You wrote that you found General Mills actually outperformed it on several sustainability metrics.
Right. So now, if you’re going to write an article, it’s not that Danone is struggling because it is a positive-impact company, it’s because it is having financial challenges.
In order for us to be able to understand all of these things at a much deeper level, we need to be able to make an assessment of the first statement, about whether it’s a positive-impact company, because the second statement, on whether it is financially healthy, we can make very well. We have a financial accounting infrastructure that allows us to look at it and say whether this company is delivering on return on capital.
You cannot say a company is having a positive impact because of its pronouncements around what it wants to do.
Hope for a Bright Future Beyond the Backlash
Are you concerned about the growing pushback around ESG and stakeholder capitalism? And on the flipside, what are you most hopeful about?
The pushback is a good thing. There are valid criticisms in there, and I have written many of them when it comes to metrics and measurement. Valid criticisms are actually improving you, much like when you’re an athlete – if your coach is always telling you’re doing everything right, you’re never going to improve.
But even when those criticisms are invalid, the fact that they exist is a good thing, potentially. It’s a sign that ESG is having real impact. I remember a time when nobody wanted to talk about ESG because it was irrelevant, frankly. It was a very niche topic that wasn’t really affecting an organization’s ability to attract talent, or compete, or attract capital, and so forth.
I wouldn’t say that I’m concerned, and I would say that I’m more on the hopeful side that there is a tremendous amount of talent that is going into the broader ESG space. It’s all about how we can have an economy in which people feel that they can bring their own individual purpose to their workplace and that they feel that they have the agency to create change within an existing organization, as entrepreneurs in organizations that they create, and as allocators of capital.
There is a tremendous amount of energy, I can tell you that. I have the pleasure of observing hundreds of young business leaders every year from my position at Harvard, and I have witnessed a tremendous amount of enthusiasm to exercise that agency and ask themselves, “How can I have more impact throughout my career?”
Depending on how you prioritize and define your theory of change in terms of impact, you might want to join organizations that are perfectly aligned to begin with, or you might want to join organizations that are not perfectly aligned but where you could create change. What makes me very excited is that if we can create more transparency in the system around those impacts, more and more talented people are going to be able to unlock their innovative and creative capacity in that whole space. And I think that is extremely important.