Who’s feeding the goose?

9 February, 2018

Jonathan Labrey, Chief Strategy Officer, IIRC, explores the key global trends that are driving a more inclusive and integrated economic model

Davos is the annual meeting place for leaders in government, business and investment to discuss the political, economic, social and (increasingly) environmental challenges facing the world. It is where past assumptions are challenged – for example, the late 20thcentury consensus that peace and stability would be 21st century norms, underpinned by globalization, greater interdependence between nations and respect for strong, liberal, multi-lateral institutions.

And so it was that the IIRC’s chief executive Richard Howitt arrived at the 48th annual meeting of the World Economic Forum, whose theme in 2018 was, “Creating a Shared Future in a Fractured World”. Fractured certainly, but as the IMF’s Christine Lagarde reasoned, the world is also growing faster than earlier expectations, with economic growth forecast to be a punchy 3.9% in both 2018 and 2019. As Richard pointed out, if the years immediately following the global financial crisis resulted in only modest incremental action towards more inclusive models of performance as economic actors were in a fight for survival, perhaps stronger growth allows us to lift our heads and create more systemic change?

“…when Narendra Modi warned delegates that globalization is under threat, and cited climate change as a key threat to the global economy, people listened.”

This question brings us to Davos itself. The high profile setting pulled back the curtain on two of the great systemic shifts that are taking place in the world in the early 21st century. First, the geopolitical shift in economic and political power from west to east, and from the northern hemisphere to the south, was laid bare. When it comes to trade, size matters, and so does geography. Last year, it was President Xi’s speech in defence of globalization that mesmerized the gathering. This year, when Narendra Modi, prime minister of India, warned delegates that globalization is under siege, and cited climate change as a key threat to the global economy, people listened.

“…long-term financial performance is dependent on more than a healthy balance sheet, but a healthy and harmonious world.”

And that brings us to the second of our two systemic shifts – the mainstream acceptance that the world’s risk profile has been turned on its head in the last ten years; in particular, that long-term financial performance is dependent on more than a healthy balance sheet, but a healthy and harmonious world.  When the World Economic Forum published its annual Global Risks Report for the first time in 2006, the top risks identified were financial – the collapse of asset prices key among them. Their January report highlighted climate and cyber-crime as the principal risks for 2018. The nature, both of risk and investment, are changing in our economy. In their new book, Capitalism without Capital, Jonathan Haskel and Stian Westlake reveal evidence showing that intangible investment is overtaking tangible investment in many leading economies. They argue that the lack of consensus over how to account for, manage and regulate intangibles is having a negative impact on productivity growth and amplifying social inequality. We are, after all, living in a world where, in some large countries, wages as a percentage of the economy are at an all-time low, while company profits as a percentage of the economy are at an all-time high.

“…how we account for, manage and regulate the intangible economy has a direct impact on productivity growth and social inequality.”

Richard Howitt’s point about seizing the opportunity of a growing world economy to bring about changes to the system of global finance was discussed by business and investment leaders at Davos. In a discussion called, Towards Better Capitalism, PepsiCo CEO Indra Nooyi said it was vital for companies with a long-term vision to, “start with an external view of the world which results in strategy”. She said that PepsiCo’s strategy was driven by the economic, social and environmental “megatrends” affecting the company’s sector. This allowed the Board to orient the business towards delivering long-term value. “Don’t question the strategy”, she would say to doubters, “question the megatrends, because the strategy flows from the megatrends”.

“Myopic companies are sowing the seeds of their own destruction, while those that create value over time will see higher returns.”

Nooyi said that she found investors “impatient” and that too much pressure was put on companies to, “lay the egg, rather than feed the goose”. She urged a greater focus on the education of investors to ensure they ask the most relevant questions. Theresa Whitmarsh, executive director of the Washington State Investment Board, echoed Nooyi’s points. She said that “time horizon” is critical in helping investors, “to reconcile fiduciary duty with societal and stakeholder concerns”.  Myopic companies are, “sowing the seeds of their own destruction”, while those that commit to, “creating value over time” will see higher returns.

This is why the work of CECP’s Strategic Investor Initiative (SII) is so valuable. In its recent letter to companies it set out three broad themes and seven questions which it recommended could form the basis of sustained dialogue between company boards and investors, to help elicit information about how companies are delivering long-term value. Critically, these questions focused on material financial issues, but also mega-trends, corporate purpose and long-term human capital management.

“Without a sense of purpose, no company, either public or private, can achieve its full potential” – Larry Fink

A further example of the increased frequency of demands from investors for broader-based information about company strategy and performance was BlackRock CEO Larry Fink’s annual letter to business leaders published in January. “To prosper over time”, wrote Fink, “every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers and the communities in which they operate. Without a sense of purpose, no company, either public or private, can achieve its full potential”.

Of course, integrated thinking and reporting are central to pulling this complex, interconnected and fragmented world together. Never has the need for cohesion in thought and expression been more important as the expectations on company CEOs to respond to the challenges of productivity, climate change and wage stagnation intensify. January’s Edelman global trust barometer revealed the worrying finding that trust in information has fallen significantly. In the words of Richard Edelman, “…we have a world without common facts and objective truth, weakening trust even as the global economy recovers”. Shouldn’t this message be a wake-up call to all of us?

The barometer this year did bring a change in the “ecosystem of trust”, where the credibility of “a person like yourself” declined but there is renewed confidence in experts and, “a fast recovering belief in CEOs (up from 37 percent to 44 percent)”. The survey showed that there are new expectations on company CEOs, with 70% of respondents identifying “building trust” as the number one job for chief executives, ahead of high quality products and services. Nearly two-thirds say they would like business to take the lead on policy change rather than wait for governments.

However rational and evidence-based the need for change is, we cannot expect change to occur automatically or by accident. Change will only be brought about by design. In his book, Microtrends: the small forces behind tomorrow’s big changes, Mark Penn argues that it is often the small changes that have the greatest impact over time. It explains why EY global chairman Mark Weinberger said recently that “what you report” is absolutely essential to driving change towards a more sustainable economic model. Weinberger pointed out that employee satisfaction was the greatest determinant of productivity performance and that the world must be smarter at identifying and measuring these new drivers of value and performance.

There is a lot riding on the outcome of this debate – a debate that crystalized at Davos but that is finding resonance in many boardrooms and investment houses, and even among progressive regulators such as the UK’s Financial Reporting Council, which is proposing the integration of non-financial information within mainstream annual reports for the first time. It is also urging companies to identify and report on their sources of value generation, more than a nod to the “six capitals” and “value creation” concepts which underpin the International <IR> Framework.

“Our corporate reporting system must be turbo-charged to break down barriers, remove silos and simplify the mission and purpose of business to support the delivery of long-term value.”

Perhaps the greatest opportunity of all lies in the largest inter-generational transfer of financial capital which is about to take place. Research from the Royal Bank of Canada shows that US $4 trillion of inheritance will pass from the “baby-boomer” generation to “millennials” over the next two or three decades. This will empower a generation that has shown impatience towards irresponsible and unsustainable business practices. If they shift their investment practices according to their values, we could be at the tipping point of a transformation in economic governance. The job of coalitions like the IIRC is to ensure the tools are available to facilitate sustainable investment decisions and create the economic framework that enables this change to happen.

A well-functioning economy depends on high quality disclosure. Our corporate reporting system must be turbo-charged to break down barriers between companies and their stakeholders, remove internal silos and simplify the mission and purpose of business to support the delivery of long-term value. If the world needs a financial incentive to change, there’s US $4 trillion at stake. Nothing less than a radical and urgent shift towards an inclusive and integrated economic model will meet the multiple and interconnected challenges of our age. It’s time to feed the goose.