MAKING CAPITAL MARKETS WORK FOR WORKERS, INVESTORS, AND THE PUBLIC: ESG DISCLOSURE AND CORPORATE LONG-TERMISM.

• Author: Green, Andy
• Position: Environmental, social, and governance - 2018 Leet Business Law Symposium: Fiduciary Duty, Corporate Goals, and Shareholder Activism

CONTENTS INTRODUCTION I. WHY ESG AND CORPORATE LONG-TERMISM? II. THE MARKET AND REGULATORS FAIL III. PATHS FORWARD CONCLUSION INTRODUCTION

America is being roiled by economic and societal dislocations. Collapsing middle class wages and wealth--driven by globalization, growing market concentration, and fallout from the financial crisis and Great Recession--are disrupting politics and social inclusiveness. Meanwhile, climate change puts trillions of dollars in public and private assets at risk. What role do America's companies have to play in addressing these challenges?

Some say the question is who do America's public companies work for--shareholders, CEOs and executives, workers, communities, or the public--and are the interests of those various stakeholders inherently in conflict? Recent decades have been dominated by a managerial ideology and practice that says companies work solely for the pecuniary interests of shareholders. Management, it is argued, is held accountable to shareholders through stock-based compensation, as well as through short-termist hedge funds, high-debt buyout private equity, and the broader market for corporate control. Workers, communities, and the public have little role in corporate governance as they, fundamentally, have interests that are inherently in conflict with shareholders.

In theory, this attention to shareholders checks management from wasting money that shareholders could better spend themselves. Yet even under its own logic, it also appears to widely overcorrect, inhibiting longer-term investments. (1) More troubling, it appears to do little to check the outsized growth in executive compensation, while also supercharging the pressures 011 companies to squeeze workers. The combined trends are well-represented in the newly disclosed pay ratio between CEOs and median workers, which shows extraordinarily high ratios of CEO to median worker pay across a wide range of industries. (2) The long-run stagnation of working class wages, and the enormous concentration of economic wealth and power at the top, are not simply theoretical challenges to social cohesion. (3) Their threat to the middle class way of life that defines America and its norm-driven approach to governance is very real. The return of extraordinary divisive forces in America, ones that threaten some of the very foundations of America's political order, are inextricably linked to the troubling economic outcomes for working Americans. (4)

Corporations stand at the center of a wide range of economic decision-making in America, with the results being felt by workers and society in myriad ways. The troubling economic trends affecting workers and inequality are mostly driven by powerful forces external to the corporation's decision-making hierarchy, such as globalization more than doubling the global labor force, attacks on collective bargaining through the regulatory process and in the courts, and weak antitrust enforcement. But the company's internal decision-making priorities-that is, corporate governance--has been a factor. And as such, it has a role to play in making the economy work for workers and communities.

The hopeful news is that there are important trends at work that hold the potential for corporate governance to play a more positive role in addressing these economic and societal challenges. As the Center for American Progress lays out in Corporate Long-Termism, Transparency, and the Public Interest, (5) on which this Article is based, the rise of long-term investors whose interests align more with those of workers, the environment, and communities opens the possibility for moving management and companies to act in ways that benefit all of these groups. Yet the shared interests of longer-term investors, workers, and the broader public in good jobs, a clean environment, and productivity-enhancing economic growth are stymied today by insufficient transparency and accountability in public (and, increasingly, private) company corporate governance. (6)

Regulators, in particular the Securities and Exchange Commission (SEC), need to catch up. In particular, shareholders and stakeholders need far more robust disclosure of environmental, social, and governance (ESG) information in a consistent, comparable, and reliable manner. (7) In addition, shareholders and stakeholders need enhanced tools to hold management accountable with respect to these long-termism-related matters.

Improved ESG disclosure and accountability is not just good for the public; it is good for shareholders. Some of the most under appreciated systemic vulnerabilities of the U.S. financial system--and hence U.S. economic growth--lay in correlated yet hidden risks, some of which improved ESG disclosure can help unmask. (8) Quality corporate disclosure may also be increasingly important to defending the public and the economy from the growing threat of misinformation.

It is unsurprising then that investors overwhelmingly demand expanded disclosure. (9) Indeed, ESG matters are squarely material to market performance, in particular risk management, with the perceived trade-off between performance and social responsibility no longer relevant. (10)

Markets cannot do this by themselves. Decades of self-help by investors and stakeholders has made some, but insufficient, progress. Sustainability reports are more prevalent than ever, private standard-setters have pioneered new models for disclosure, and long-term investors engage with companies more than ever. (11) Yet investors lack access to complete, consistent, high-quality, and verified ESG information. (12)

Corporate long-termism is not a panacea to the world's problems. Yet disclosure and accountability can better align investors, managers, and other stakeholders for positive long-term results for all. This Article summarizes some of the arguments for (and against) boosting long-termism, focusing on ESG information and case studies on worker training and climate change. The same approach applies to many other ESG matters.

The Article also summarizes several recommendations for how the SEC, under its own mandate or as directed by a new Congress, make progress. As laid out in the Center for American Progress report, the SEC and relevant policymakers should: directly mandate high quality, consistent ESG disclosure; look to external organizations for ESG disclosure standards; defend an investor-oriented, public-interest approach to disclosure, especially on questions of materiality; boost audit standards; bring enforcement actions and protect the rights of states and private investors; enhance board ESG expertise and focus on long-termism; and maintain the shareholder voice in favor of ESG and long-termism. (13)

1. WHY ESG AND CORPORATE LONG-TERMISM?

   American public companies matter greatly to the U.S. economy. They employ millions of people, help drive productivity growth, and offer many of the goods and services in the economy. (14) So how they perform matters a lot for how the economy evolves.

   Indeed, the very premise of the capital market is that it will allocate investments to the best economic uses. Of course, we know markets are imperfect. But the most basic protection against market imperfection is information. Today, ESG information is far too lacking, making it challenging for markets to effectively allocate capital in ways that make sense over the long term.

   Take, for example, worker training and climate change. Between 2001 and 2009, employers cut their training by more than 27 percent. (15) Yet this cut is not in line with the long-term interests of workers, the economy, or even the company. Many studies confirm that on-the-job training boosts productivity for workers, firms, and the entire economy. (16)

   Short-termist cost pressures are one of a number of reasons why companies reduce workforce training investment. (17) But financial markets also play a role. Worker training investments are grouped into other general and administrative expenses, which means companies that make those investments look more wasteful than others. A rather modest fix of worker training disclosure, modeled on how research and development (R&D) is disclosed, could help undue this perverse incentive. And indeed, unlike workforce training, R&D has risen in U.S. companies. (18)

   Climate change offers an even larger-scale example of why greater ESG disclosure is essential for risk management and effective capital allocation. (19) From energy sector asset valuation to the risks that extreme weather poses to crops, coastal property, and supply chains, (20) climate change poses a direct and indeed systemic threat to the economy and society. Without sufficient, comparable, and reliable assessments of what this means to individual companies and to the entire market, investors and the public are left in the dark, (21) and capital markets cannot do their most basic job.

   Ultimately, from political spending to human rights, tax strategies to cybersecurity risks, ESG covers a wide range of matters that are increasingly essential for how companies maintain and enhance their performance and manage their risks. (22) The old notion that an ESG focus and investor returns were inversely correlated is increasingly history. And indeed, academic research confirms that ESG information is important for long-term investment success and in particular the management of risk. In particular, one survey of 2,000 other academic studies highlights the correlation between ESG criteria and corporate financial performance. (23) Lower costs of capital and other benefits to companies and investors are also being shown to arise from considering ESG factors in decision-making. (24)

   Yet far too little is being disclosed, precisely as the demand for this information has reached extraordinary levels. As of the latest available data, ESG-focused investing accounts for more than $8.72 trillion in total assets under management--making it no...