As you consider the various mechanisms by which ESG factors could influence the bottom line.wnd the pathways by which they show up on the PNL, you probably noticed a pattern. Except in rare instances, such as rising sea levels or extreme weather events. The environmental, social, and governance factors impacted by a firm don't directly impact the firm's profits and loss statements. Instead, the impact of their firm has on the environment triggers a reaction. A reaction from governments, customers, employees, or members of civil society. While employees, customers, and communities were directly impacted within the S factor. The financial impacts were caused both by their reactions and those of other stakeholders. Employees as well as governments, customers, and communities all reacted to labor conditions. Customers as well as governments, employees, and communities all reacted to the treatment of customers and so on. Similarly, governance factors which traditionally were thought to focus on the challenge of shareholders properly incentive managers. Were expanded to consider relations with government and civil society stakeholders. In short, the majority of ESG factors' financial impacts occur through the actions and reactions of a company's stakeholders. Who were either directly or indirectly affected by the harm or benefit that firms caused on ESG issues. The movement to address ESG issues is this part of a broader movement, to reconceive the firm. Not just as a place where owners delegate to managers, the responsibility to supervise workers. But a place where managers seek harmony among all the stakeholders of an organization, both internal and external. While some of that effort arises on narrow business questions like price and cost. Many of the issues that motivate external stakeholders fall outside the narrow scope of business discussions. And in the realm of the ESG factors we've surveyed, absent attention to those ESG factors and other issues of concern to stakeholders. A manager may secure short term financial performance, but the expense of conflict with stakeholders that will impact future financial performance. If all managers and investors understood these feedback mechanisms, the mechanisms by which climate change. Pollution, resource depletion, treatment of employees, customers and communities. As well as internal and external governance would impact long term financial performance. We could craft the appropriate incentives, the appropriate monitoring and evaluation systems and the best trading algorithms. But the data measuring these constructs is flawed, and our knowledge of these linkages and feedback mechanisms is still nascent. As a result, managers and investors are working with incomplete data, with an incomplete model of the determinants of long term financial performance. In the simple, narrow view of the firm, stakeholders are there, but the primary focus is on a small group of them. Managers, customers, and employees, sometimes, suppliers, in that narrow view represented by what is known as the value stick. The manager's fundamental challenge is to find a way to increase value captured by the firm. By either raising customer willingness to pay for a product, decreasing supplier's willingness to supply. Or finding a way in bargaining and negotiations to raise the price to capture more customer surplus, or lower cost to increase margins. Think how much of our ESG discussion is omitted from this simplistic version of the management problem. Where the feedbacks to the natural environment, which alter future government policies, community support, and customer willingness to pay. What about the means by which the treatment of employees, customers, and communities alters costs, alters willingness to pay. In short, we need to embed this value stick within a more complex system of stakeholder relations. All stakeholders come together, they all choose whether to make the contributions that alter willingness to pay, willingness to supply, price and cost. All stakeholders bargain upfront or after the fact as to whether they think the division of benefits was fair or unfair. In recent years, a growing chorus of stakeholders as well as executives and investors have called for such efforts. Prominent among them, starting in 2015, has been Larry Fink, he's the CEO of Blackrock. The largest institutional investor and asset manager, who has among the largest ownership stakes in almost every globally publicly traded corporation. In his annual letter to CEOs of the companies in which he invests, he is increasingly called for more attention to stakeholder interests. In 2017, he asked for evidence that the companies in which he was invested were attentive to external and environmental factors. That could impact the company, an attentive and recognizing the company's role as a member of the communities in which it operates. In 2018, he wrote that to prosper over time, every company must not only deliver financial performance. But also show how it makes a positive contribution to society or else, it will ultimately lose the license to operate from key stakeholders. In 2019, he wrote that society is increasingly looking to companies to address pressing social and economic issues. Companies that fulfill their purpose and responsibility to stakeholders reap rewards over the long term, companies that ignore them stumble and fail. In 2020, he wrote that climate risk is investment risk, and climate risk will impact prices, costs, and demand across the entire economy, driving a profound reassessment of risk and of asset values. In the near future and sooner than most anticipate, Fink wrote, there will be a significant reallocation of capital. And in 2021, he wrote that the $288 billion dollars invested in sustainable assets in 2020 was but the beginning of a long and rapidly accelerating transition. One that will unfold over many years and reshape asset prices of every type. We know that climate risk is investment risk, said Fink, but we also believe that the climate transition presents a historic investment opportunity. We have seen how purposeful corporations with better environmental, social and governance profiles have outperformed their peers. Given how central the energy transition will be to every company's growth prospects. We are thereby asking companies to disclose a plan for how their business model will be compatible with the net zero economy. That is one where global warming is limited to well below 2 degrees Celsius. Consistent with the global aspirations of net zero greenhouse gas emissions by 2050. We are asking you to disclose how this plan is incorporated into your long term strategy, wrote Fink, and reviewed by your board of directors. During this same window of time, the business roundtable reformulated its statement of the purpose of the corporation. That since 1978, had championed the logic of Milton Friedman. Who famously argued that the goal of a firm should be to maximize shareholder value. In 2019, that statement was rewritten to better reflect the logic of the founder of stakeholder theory, Ed Freeman. In this new statement, the purpose of the corporation is to deliver value to customers, to invest in employees. To deal fairly and ethically with suppliers and to support the communities in which they work. As well as generating long term sustainable value for shareholders. The challenge is not to conceive of the firm in this manner, but to make it tractable for strategy and for investment. How can we operationalize the stakeholder value based strategy. And measure whether our firm or potential firm in which we seek to invest is performing relatively well or poorly?
