What is the point of purpose?

Source: A Deeper Look at the Return on Purpose: Before and During a Crisis

Actions speak louder than words

However a high profile Harvard Business School study argues that nothing has changed: the companies involved have not amended their corporate governance guidelines to formally raise the status of stakeholders and still appear to prioritise shareholders in their documents and management compensation structures.

While this is disappointing, we do not agree with the conclusion that the BRT statement was just a greenwashing exercise. Greenwashing is about falsely communicating the environmental benefits of a product or service in order to make an entity seem more environmentally-friendly than it really is.

A more constructive reading of this result would be that the BRT statement was a way for companies to formally express their commitment to something that they were already doing and/or intending to do more of. This seems more consistent with the charts above which show steadily increasing interest in stakeholder capitalism over the last 20-30 years (rather than inflecting in the last few years since investors jumped on the bandwagon).

We are inclined to agree with JUST Capital that realigning corporate purpose doesn’t rely on formal governance reform or new regulations. After all, those are also mere statements and paper policies: what matters is corporate behaviour.

The latest polling from JUST, consistent with its findings at the height of the pandemic, does suggest that BRT signatories are practising what they preach. Most signatories rank in the top half of JUST’s annual ratings based on public opinion, and also based on quantitative measures on wages, greenhouse gas emissions, charitable contributions, and diversity and inclusion.

In other words, regardless of the formalities, these companies do appear to have enshrined stakeholder-centricity in their culture. Also encouraging is the finding that, on aggregate, two-thirds of the US public believe large companies are promoting more inclusive capitalism, a significant improvement since "the before times". This chimes with our view that the pandemic has ushered in a new social contract between companies and society, and demonstrated the role the private sector can play in societal problems.

Figure 2: Percentage of respondents who say large companies are doing well

Source: JUST Capital

Everyone’s a winner

Much of the discussion around the BRT statement takes it as read that there is some degree of trade-off between shareholders and stakeholders, such that shareholder returns are at risk from a more stakeholder-centric approach.

In fact, under Donald Trump the US narrowly avoided a formal ban on ESG investing as critics saw it as a violation of fiduciary duty. Readers will be unsurprised to hear that we would vehemently disagree.

As such, we wanted to highlight two recent studies that contribute to this debate.

Firstly, an important metastudy from New York University’s (NYU) Stern Center for Sustainable Business, pulling together the vast swathe of research on ESG and financial performance from 2015-20. The underlying studies vary in their metrics and definitions of ESG/sustainability, but aggregating over 1,000 studies should reveal a broad directional relationship and illustrate the range of possible outcomes.

The authors divide their studies into those focused on (a) operational performance such as margins and returns on capital, and (b) investment performance. The results were much clearer for the first group, with 58% of studies finding a positive relationship and only 8% an unambiguously negative one.

This seems to put to bed once and for all the argument that ESG undermines financial performance.

In fact, investing sustainably improves financial outcomes via innovation, higher operational efficiency and improved risk management. This is consistent with our concept of corporate karma.

On investment performance, the results are more mixed. This makes intuitive sense given that an efficient market should ascribe higher valuations to better performing companies. While in reality the market is thoroughly inefficient, it remains true that a "good" company is not always a good investment – valuation matters.

Still, the evidence is biased to the positive with only 14% of studies finding a negative relationship. We’re not surprised by the high proportion of "neutral" or "mixed" results given the complexity and subjectivity involved in measuring ESG.

The study’s other key findings are all supportive of our investment philosophy.

• The results are stronger over longer time horizons, consistent with our patient capital approach.
• Disclosure alone does not drive financial outcomes but needs to be complemented by performance and outcome measures. As we have discussed in the past, we believe strongly that ESG scoring or rating methodologies rely excessively on disclosure which leads them to favour larger companies and those in jurisdictions that mandate certain ESG disclosures.
• Partly as a result of this, ESG integration performed better than screening at generating investment returns.
• ESG investing is particularly valuable in down markets, as became clear during the COVID crisis.

Figure 3: Positive and/or neutral results for investing in sustainability dominate

Source: New York University’s (NYU) Stern Center for Sustainable Business

Purpose through the pandemic

The second study, from Fortuna Advisors, looks specifically at the nebulous concept of "purpose". This is closely related to our work on corporate culture. Like culture, corporate purpose must be clearly articulated and, more importantly, operationalised and internalised by employees and executives.

The authors propose that the board of directors issue and "own" a company’s purpose so that it is aligned with long-term strategy. This provides air cover for executives to make operational decisions that are aligned with long-term success rather than chasing each set of quarterly earnings. It also signals that purpose is a matter of the highest importance within the firm, and ensures continuity across different management teams. 

Prior research has found that "purpose-driven" companies outperform in terms of productivity, growth and employee retention. And, crucially, this results in significant outperformance, with companies recognised on both Fortune’s Most Admired Companies list and the JUST 100 list outperforming the S&P 500 .

In this study, the authors use a new metric to measure "purpose", developed by BERA Brand Management. BERA is the world’s largest brand equity assessment form and captures over one million consumer perceptions across 4,000 brands over time – though the authors focus on 104 "monobrands" that closely correlate to individual listed companies.

Consumers are asked for a list of characteristics and the degree to which they associate them with a given brand. BERA collects data on over 100 metrics, but the "purpose" score is an aggregate of 13 characteristics shown below.

Table 1: BERA’s top 10 companies by Brand Purpose Score

Source: BERA Brand Management

The advantage of this data set is that it shows you whether a company’s actions resonate with consumers, rather than relying on the company’s own statements to assess strength of purpose. While it can still be skewed by savvy marketing, this approach should be less vulnerable to greenwashing as customers will penalise a company whose actions are inconsistent with its stated purpose.

The authors compare purpose data collected monthly over 2020 – to capture the impact of COVID – with financial performance. The data reveals that "high purpose" companies on average outgrew "low purpose" peers even before pandemic but the gap widened significantly over 2020. This suggests that purpose-driven companies command higher customer engagement and loyalty, driving market share gains. Ethical considerations plausibly became even more relevant to consumers during the pandemic given the focus on corporate behaviour.

Figure 4: Revenue advantage of High Purpose companies

Source: A Deeper Look at the Return on Purpose: Before and During a Crisis

High Purpose companies also delivered stronger and more resilient profitability and returns on capital, in both accounting and cash terms. This is an important finding as it suggests investments in purpose are not coming at the expense of returns, rather they are returns-enhancing.

Brand and reputation are intangible assets, creating a competitive moat from which long-term profitable growth can be derived. For example, companies seen as "purpose-driven" have stronger pricing power because this feeds into a customer’s perception of value, and need to spend less on product promotions or discounting.

Figure 5: Profitability advantage of High Purpose companies

Source: A Deeper Look at the Return on Purpose: Before and During a Crisis

Interestingly, the authors do find that purpose, and the associated operational strength, is rewarded by the market in the form of higher valuation multiples.

This might imply that there’s no alpha to be achieved by identifying and investing in these companies because the superior returns are already priced in. But, consistent with the NYU study, the authors find that High Purpose companies delivered higher shareholder returns prior to and during the crisis.

This is consistent with our investment philosophy that the market tends to underappreciate and undervalue durable long-term growth especially when it derives from hard-to-measure characteristics. This study is not perfect. We would note particularly that the 13 purpose measures are specifically chosen to be those that show the strongest correlation with financial outcomes, which does seem rather circular.

Given the challenge in defining purpose, it’s possible that a different subset of measures would have given a different response.

Also it’s not clear whether purpose is a distinct measure or just a proxy for strong brand equity and reputation, or whether there could be inverse causality in that successful companies are more likely to be perceived as purposeful.

In reality it’s probably a bit of both, as strong financials enable a company to reinvest in purpose and reputation-building activities which creates a virtuous cycle. But even companies with low overall brand equity seem to benefit from being seen as purpose-driven.

There is a point to purpose

There is growing empirical evidence that a broader corporate purpose that goes beyond shareholder returns can be  beneficial for companies and investors in terms of financial outcomes, as well as benefiting society. This supports our long-standing intuition around "corporate karma" and the value of unquantifiable characteristics such as corporate culture.

The challenge is that assessing a company’s stakeholder relationships and culture requires looking beyond policies and statements. It involves digging deeper into a company’s approach to purpose, measuring and integrating considerations of environmental, social and governance factors into the investment process. And therein lies the opportunity for long-term, active, genuinely sustainable investors.