Stakeholder capitalism: the sustainability of firm value
By Anna Hawley, CFA; Travis Cooke, CFA and Joshua Kazdin, CFA
As companies seek long-term success, the focus is increasingly on the relationships they have with a range of stakeholders. What does this momentum mean for the future of investment and business performance metrics that go beyond traditional financial metrics? BlackRock’s systematic experts discuss how they use sustainable investing and a data-driven approach to identify characteristics that seek to benefit both shareholders and stakeholders in the search for sustainable alpha opportunities .
The business of business is (more than) business
For decades, the subject of capitalism has sparked discussions about what is at the heart of creating long-term value for businesses and societies. In an increasingly interconnected world, there is greater demand for understanding how companies foster relationships between employees, customers and communities alongside asset owners. Larry Fink underscored the power of this dynamic in his Letter to CEOs 2022explaining that “a company must create value for all of its stakeholders and be appreciated by them in order to deliver long-term value to its shareholders”.1
This evolution of our conception of market economies has generated interest in sustainable investment as a way to embed the positive impact of stakeholders in all businesses. Investor flows and corporate commitments followed, with sustainable assets exceeding $4 trillion globally2 and businesses are increasingly recognizing the importance of social and environmental factors to their business. It has also enhanced our analytical approach as systematic investors – providing new data and powerful insight into which companies are poised to outperform as the economy evolves.
Over a decade ago, we began to explore the role of sustainability not just as an ethically based allocation decision, but as an additional lens for understanding investment opportunities and economic behavior. We found that sustainability and profitability were closely linked, providing a clearer view of business characteristics and opportunities alongside traditional financial measures. Sustainability has since become entrenched in our investment approach for its ability to deliver better results for shareholders and stakeholders – solving what we call the double bottom line.
The intersection of durability and tangibility
Sustainable insights help uncover potential indicators of business success that drive sustainable value creation. The challenge facing investors is ensuring that this information is validated and linked to meaningful results. Common ESG metrics and standards often lack substantiated evidence of business impact or fail to demonstrate a link to key stakeholder groups and social issues. As a result, investors may not effectively capture the expected benefits.
In our view, harnessing the potential of sustainability requires a data-driven approach with strong analytical capabilities and validated insights. Our research aims to reveal tangible indicators of performance and societal improvements across a range of internal and external stakeholders.
Internal Stakeholder Example: Employee Sentiment
Although intangible assets remain difficult to measure, human capital is generally the most important asset of any organization. Employees play a key role in the success of the company. They drive new innovation, set the pace of productivity, and act as brand ambassadors to the public and potential employees. We have found that companies with more satisfied employees tend to experience lower future employee turnover, which further benefits business results. Employee perspectives provide an inside view of a company’s overall strength and its potential to outperform its peers.
Our systematic capabilities allow us to extract insights from granular employee views at scale. Collecting data from public networks and employee review sites, we apply natural language processing techniques to gauge sentiment and satisfaction. Machine learning capabilities help us capture more detail, associating keywords with general themes such as innovation, teamwork and respect. Below, our research reveals a strong link between employee sentiment and the performance potential generated by productivity improvements.
The impact of employee sentiment on company performance
Company returns with highest and lowest employee sentiment
In Larry Fink’s Letter to CEOs 2022, he explains how workers demand more from their employers – a characteristic of capitalism that fosters competition and pushes companies to improve.3 Companies that prioritize employee relationships strive for a more engaged and satisfied workforce (stakeholder outcome) with better outperformance potential (result for shareholders).
Example of an external stakeholder: consumer financial protection
The financial well-being of consumers is central to a thriving economic system. Companies that are committed to building mutually beneficial relationships with their customers can enjoy better business results.
Our research on financial consumer protection has shown a link between real-time consumer feedback and the soundness of financial companies. We collect alternative data showing geographically tagged consumer complaints about financial products through publicly available US government online data portals.4 Our research has shown that higher levels of complaints are linked to lower levels of debt relative to income in all counties5 and higher non-performing loans for financial institutions controlling total deposits.6 Banks that receive more complaints and negative feedback may not be promoting consumer well-being (stakeholder outcome) and are more likely to experience negative financial results (result for shareholders).
Long-term value via the double bottom line
Within the BlackRock Sustainable Advantage Large Cap Core Fund (MUTF:BIRIX), we leverage this sustainability information along with many other indicators of business success. As companies strive to create long-term value, they are tasked with considering the extent of their impact on a wider range of stakeholders. How Does Employee Sentiment Drive Productivity and Innovation? How does the financial health of consumers affect their ability to do business? These are just a few of the questions central to getting a sustainable alpha.
Through a robust systematic process bolstered by big data and scientific testing, we analyze complex stakeholder relationships diligently and at scale. The cumulative impact of this information makes it possible to improve shareholder and stakeholder results, capturing better results by solving the double bottom line.
1Source: Letter to CEOs 2022 from Larry Fink: The Power of Capitalism, January 2022.
2Sources: Morningstar, Simfund, Broadridge. Data includes sustainable mutual funds, ETFs, institutional and alternative assets under management, as defined by third-party data sources, excluding integration/engagement indicators. MF and ETF data as of October 21, institutional and alternative data as of June 21.
3Source: Letter to CEOs 2022 from Larry Fink: The Power of Capitalism, January 2022.
4Source: Consumer Financial Protection Bureau data, 2011 – 2020.
5Source: BlackRock analysis of Consumer Financial Protection Bureau data showing consumer complaints and New York Federal Reserve showing household debt levels relative to income, 2011 – 2020.
6Source: BlackRock analysis of Consumer Financial Protection Bureau data showing consumer complaints and Worldscope (company records) showing non-performing loans, 2011 – 2020.
This Publish originally appeared on iShares Market Insights.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.