Randy Kroszner:
I'm Randy Kroszner, I'm the Deputy Dean for Executive Programs here at Chicago Booth. And I speak to you from our wonderful new London campus. Now, what we're going to do is turn to a discussion with Mark Carney and I'm sure certainly everyone, well, I think everyone in the world knows Mark for his many roles that he has played. Recently, he was the Governor of the Bank of England, he'd been Governor of the Bank of Canada. I had met him a number of years ago when I was working in the US White House as a member of the President's Council of Economic Advisors, and he was working in the Finance Ministry in Canada. Mark has now retired from his role as Head of the Bank of England.
Randy Kroszner:
And he wears a number of hats now, he services the UN Special Envoy for Climate Action and Finance. He's Prime Minister Boris Johnson's special financial advisor for the COP26. He's recently joined Brookfield Asset Management as vice chair and Head of ESG and Impact Fund Investing. And also when he was at the Bank of England, he really helped to spur a global discussion and a regulatory focus for central bankers, and bank and financial regulators, on the issues of climate, and some of the risks associated with the climate. We heard about that earlier from the Hong Kong Stock Exchange, Katherine Ng told us that they have recently required all companies listed on the Hong Kong Stock Exchange, not just financial companies, to have a word level discussion of ESG, environment social and governance impact, and to produce that publicly. And also, she said that one of the main motivations for that was risk management, I think a very similar motivation to what Mark had.
Randy Kroszner:
The focus of what we're going to talk about here is, really thinking of the tough questions about shareholders and stakeholders. Now there may be some cases in which there's common ground, and some of the other speakers already have talked about some of the areas of common ground, where there may be some low hanging fruit that focusing on some of these corporate social responsibility issues, these broader purpose issues, can actually help the bottom line. But there may be some areas of conflict. And so we really want to try to get into the meat of that of conflict or common ground. Welcome Mark, thank you so much for joining us. And what I wanted to do is try to start with some definitions. You've thought a lot about shareholders and stakeholders, and so let's first try to think about what do you mean by, or what would we mean by stakeholders if we're trying to take stakeholders into account, how would we define that relative to shareholders?
Mark:
Okay, well, first off, thank you, Randy, for having me and for organizing what's an amazing day, and bringing the world together, virtually, around this important issue on this important anniversary. And let's hope this is as seminal as Friedman's New York Times essay was 50 years ago. And let me start, the stakeholder shareholder point... I'll start at a basic level, which is when a company thinks of its stakeholders, obviously, includes its shareholders, includes its creditors so the financial side of the equation, but very much its employees, its suppliers, its customers, the community in which it operates, and for the largest corporations, for the global corporations, elements of the global commons as well. And so if you're a tech company, it could be issues around global data privacy, global taxation, for example. If you have a sizable carbon footprint, the environment and on. And this will be I suspect a common theme to our discussion, and probably has been already, it's partly situation dependent, but certainly those broad elements out to the community for companies, the stakeholders would include all of those.
Randy Kroszner:
And so what are the challenges in trying to encompass the stakeholders is that we've built this infrastructure over the last, at least 50 years since Friedman wrote. But I think much before that, let's say at least over the last century, to really be able to be systematic about collecting data on and measuring something like shareholder value. Because if it's a public traded company, we have that in stock markets. Profits, now obviously there may be differences between accounting profits and economic profits, but we have a pretty well developed and systematic infrastructure for that. Well, how do we think about that when we're trying to encompass these broader set of stakeholders? How do we clarify what the objectives are and what the metrics are for them?
Mark:
Okay. Well, can I just start with the first part of your question, the setup to your question. Because I think it's a pretty important point. When you think back, the process, and Chicago Booth, obviously, global platform, but let's use the US as a specific example. Really formalization of accounting standards comes out of the Great Depression. One of the aspects of the New Deal is the creation of the SEC, and one of the charges to the SEC is in effect to come up with a form of standard accounting and disclosure practices in the United States. And that's something, you kindly reference our history, which went back to pre-crisis, but immediate during and after the crisis, I remember a number of discussions we had about disclosure, and information, and transparency in a variety of markets, such as the over-the-counter derivative markets, and what could be done in order to write that and work through the FSB and the US authorities, UK authorities, others have done that.
Mark:
The point of that is, out of crisis often comes improvements in measurement and valuation and understanding. And it's been a very long process and I'm not going to suggest that we've reached some perfection of financial disclosure, but it has been an iterative process and a long development process. And when you think about, and I'm interested in obviously a lot of informed people on this chat, their perspective, but when you think about on the sustainability side, it's a shorter period of time when even the Brundtland Commission is probably 30 years ago, defining sustainable growth, the SRI initiatives and the forerunners of ESG initiatives is late 60s, early 70s, and it's more a divestment type world. And it's really been gathering momentum over the course of the last decade.
Mark:
So it's still relatively young. Those are the first two points. So financial has taken a long period of time, this is a relatively young field. And if I may say so, and I, hopefully we have a chance to unpack this. It's a slightly confused field or confusing field, maybe it's a better way to put it, because quite often, in discussions around it, there are people mix disclosure, disclosure standards, or recommendations, because many of these aren't formal standards, with ESG ratings, with ESG investment strategies, which are very different things. Financial disclosure is not a credit rating, as you know, but credit rating agencies use financial disclosure in order to get there. But actual bond investors, fixed income investors might take note of the credit rating, but the better ones are actually diving into the financial disclosure and then using, and not manipulating, but analyzing that data in order to make those judgements.
Mark:
And I think it would be helpful to pull out from the sustainability world what's a recommendation, what's a potential standard, what's getting to where you started off at the beginning, what's getting to that divine coincidence, if you will, of sustainability and enterprise value creation, sustainability or ESG factors that influence enterprise value creation and what are beyond that, which are important for sustainability, environmental, social governance, broad factors being discussed, but perhaps don't directly impact today. They might in the future, but don't directly impact today, enterprise value, but it's still desirable to be disclosed for the purposes of broader stakeholders. And that's being disciplined about or understanding that is, I think, important to advance this debate.
Randy Kroszner:
I think that's right. So why don't we pursue that? And then we'll come back to some of the other parts of the question. So, especially, well, given all of the experiences that you've had, where should we push to be able to get more data? Obviously we were just talking in the previous session about more data, about diversity and inclusion. So there's a lot of discussion about that, but in, let's say, some of these broader climate issues that you've thought a lot about, where could we really make the most progress in trying to get more information, be more systematic about that?
Mark:
Okay. And I'll just link the very briefly to what I just said, which is, I think that most of what I'm about to say are factors that either influence... That will influence enterprise value creation. So it's of interest to broader stakeholders, it's certainly of interest to the global commons, but it will likely affect, it either is affecting or will affect, either the risk or opportunity profile or both of companies. So what do we need? We need consistent, comparable, comprehensive disclosure around climate related risks. That was what that's something called the TCFD. I think most people will be familiar with it now, which Mike Bloomberg ran, which was, in my way of thinking, the right way to do these things, which is the objective is set either by private consensus or by the public sector. In this case the G20 asked for this. But the charge is to a broad sway, the private sector, the providers and users of capital, because they know what's decision useful, what's material within a certain area and informed by industry experts and others.
Mark:
And that's what the TCFD was. And what it came up with, and this is fundamental in my view. This is fundamental, this is the building block of all other climate related disclosure is you need obviously the static disclosures. So what's the scope one, scope two and scope three emissions of companies. But you need to know how those are governed. So the risk management aspects around that, who reports. And you need, because it's climate and past is not prologue, unlike often the case say in consumer finance or other issues where you can look at historic data and it can tell you a fair bit about what's going to happen in the future, past is not prologue because it's dynamic. You need some form of forward looking disclosure, which is different than we're familiar with on the financial side or much on the financial side, around scenario analysis. In other words, how are these climate related risks, in the company's judgment, potentially going to impact them? And what are they doing about it?
Mark:
So that's a building block. That's the first big building block. I think what's becoming more apparent, and this is related to it, from a climate perspective is understanding what the strategy is of a company in a world that's moving or many parts of the world that are moving towards net zero, or at least have the stated objective of moving towards that zero. So what is the net zero transition plan of a company? Does it have one? That's the first question. That is a legitimate disclosure question. Do you have a plan? You might not.
Mark:
You might think either you're going to wind up the company before 2050, the normal date for net zero attainment, or it's just not relevant for some reason to you, and you can perhaps explain why it isn't relevant, or you have plan. And if you have a plan and then the follow on questions are okay, 2050 is a long way off, how do we measure... What are the short term milestones and metrics with which you... What's your strategy and how do you manage to that? And then obvious follow on questions. This is in the category of best disclosure, but is senior executive compensation tied to some of these metrics? Is this one of the things that influences it? And again, reporting around that. So those are the types of issues I think are there.
Mark:
Last point, if I may, which this is a financial ecosystem. So what I'm talking about is largely the disclosure of the users of capital, but what about the disclosure of the providers of capital? Is it enough if I'm running a fund to just say, "Oh, I have an ESG rating, which says X, black box type ESG rating, or should I be disclosing my footprint or carbon intensity or the extent to which I'm on a path to net zero?" And that last point, the technology, if I can aggrandized it to that, the financial technology there is under development. There are some companies, some big asset pools of money who do disclose metrics around this, which were pretty interesting. I think one of the questions for the industry globally is, what works? What is reliable disclosure around these issues around transition?
Mark:
So that's a host of things. Less anyone gets overwhelmed by that, a lot of that is in train. The TCFD, there's 1,350 of the world's largest companies are disclosing against those metrics. There were a number of initiatives and this gets to the de-confusing things, if I can try... I was going to say coin of phrase, but I don't think anyone will use that, but de-confuse...
PART 1 OF 4 ENDS [00:16:04]
Mark:
I was going to say coined a phrase, but I don't think anyone will use that. But [inaudible 00:16:03] confuse things.
Randy Kroszner:
That's confusing.
Mark:
Clarify things. Because it is confusing, how about clarify things. To clarify things. Is that there's a number of initiatives that are using the TCFD as a base to more formalize this. So the EU disclosure initiative would be one example. The IFRS has recently launched a sustainability consultation, could be another opportunity there.
Randy Kroszner:
Okay, great. Now, lets... Because that was very important to think about metrics. Think about how you might measure these things. But let's now come back up to the objectives. So how do you determine the objectives? Why is it net zero by 2050? Why is net zero the right objective? Why should that be the priority for these companies? Because once we move away from shareholder value maximization, there are a lot of priorities that could come in. Not only within climate, but also between climate and other priorities in the social sphere. So how do you manage that? How do you deal with that very big picture question?
Mark:
Yeah. Okay. So I think there's certain things, there are certain social governmental regulatory initiatives that are big enough, and broad enough, that companies need to make a call on whether it's material to them or not. So we're in the sort of comply or explain zone. So I'm sitting here in Canada, working in part for the UK Prime Minister, if you're in either of those jurisdictions, or 120 other countries around the world, where there is a net zero target, both in Canada and the UK, it's legislated, it's a legislated target.
Mark:
You kind of have to have a view, as a company that's operating there, whether it's relevant or not. So you have to have a net zero plan. I mean, it's now come to that point. Now your plan may be, "I have no plan, because I'm going to exit stage left before 2050," or for whatever reason, but that's a disclosure requirements.
Mark:
So that one falls into the camp, I think. And I think increasingly that will be obvious that some judgment about whether or not something has material on a comply or explain basis, around the bigger aspects of climate. Okay? Now, within climate, and let's use the SDG, as often are used, sustainable development goals are often used in purpose-driven corporations or purpose driven disclosure, if you will, within climate, clean water is an SDG. Okay? It may not be relevant to me, and it's not that broader societal drive that every company has to disclose.
Mark:
And so it just may not be on point. Whereas other social issues, quote, "Social issues," environmental, social issues, maybe material to my business or, to my competitiveness, or broadly speaking, to my enterprise value. And then I am very much expected to disclose that. And I think one of the challenges in this broader set, I'm just going to bring it up one level, if I can. Which is that there are... And I know some of the standards [inaudible 00:19:29] are thinking about this now. Which is, let's say we have this relatively clearly defined, it changes a bit over time, but a bucket of financial disclosure; what's relevant materially financially? We're all relatively familiar with that.
Mark:
Then there are some environmental social governance issues, which are material to enterprise value creation. Okay? If you're in the energy sector, climate related issues are material. It depends on the path [inaudible 00:20:00] policy. It depends on technological. You've got to have a view. And if I'm in bed or lending to you, I've got to know what your view is in order for me to make a judgment on that. Then there are some broader issues, broader social issues, which may or may not be relevant to you, but may become relevant to you over time. So that sort of concept of dynamic materiality. Now, you have to make a judgment, whether you think you want to disclose that.
Mark:
And I, as a stakeholder, I'm going to broaden it out. Not just as an investor or lender, but as a stakeholder, I may want to know how you impact those various aspects. So some sort of species loss or something else like that. And if I can make this a little more tangible, so in that first bucket, the financial, we have FASBI in the US, or IFRS, financial accounting, right?
Mark:
Those are the disclosure around it. In that second area, where there is material sustainability issues could affect my financial, that's what SASB tries to do, the Sustainable Accounting Standards Board. In that broadest area, that's something like the Global Reporting Initiative, will ask for a bunch of, there's a very wide range of sustainability things, many of which, in the judgment of the company and its lenders and creditors, may not affect that enterprise value.
Mark:
And they're right, but from a broader stakeholder perspective, people will want to have that disclosure, and that's... Okay. In my judgment, that's pretty important to know those distinctions and work through those distinctions, and be clearer. And I think one of the challenges, if I may, and I'll head back to you. For the authorities, of which I'm no longer one, but the authorities on the disclosure side and standard setting side, is okay, shouldn't efforts be made to start to formalize some of this. Particularly, what's in that second bucket, if you will, of broader sustainability disclosure, that's potentially material, to enterprise value creation.
Mark:
And that's, I think the EU's looking at that. That's what the IRFS has just announced. They're having a consultation on it. And I think people who are interested in these issues, who care about these issues, I mean, these are places to really weigh in.
Randy Kroszner:
So we have these, these different buckets, as you described. Some of them are more material, some of them might be dynamically material, but there's a lot of judgment that goes into that. I mean, the simple thing about value maximization is you've got sort of a clear bottom line for shareholders, and you may want something more than value maximization, but you kind of agree on that as a key goal.
Randy Kroszner:
So how do you avoid the problem of, as some people have criticized the business round table approach, and some of these new approaches, as accountability to everyone means accountability to no one? So we can try to improve some of these metrics. But as you mentioned, we're still far off on them. But even putting that aside, even if we had better measures, how do we choose amongst all these? And as you said, one of the key things you have to do is try to give the right incentives to senior management and the CEO.
Randy Kroszner:
But if you've got 10 different objectives, how do you work that out to... Lets say we did have the data. How would you actually structure the incentive package for them to reach those? How would you [inaudible 00:23:44] amongst them? And then how would you structure the incentive package?
Mark:
Well, I think first it's situation specific. I mean, it's complicated to run a large corporation. It's complicated to run a large institution. You don't maximize just to one thing, or to your maximum across time. And recognizing that some degree of balance is required, maybe different degrees of balance in different cultures, different jurisdictions, and different degrees of balance over time. That's part of the point of dynamic materiality. People care, the weight that's being placed on, rightly in my view, on certain social issues, and inclusion, and others has changed fairly substantially and steadily, and then very substantially.
Mark:
And it's just in a different order of magnitude. I mean, reading Friedman's essay, it's from centuries ago, it's not just [inaudible 00:24:48] from that perspective. And I think Robby was saying that, "Okay, but recognize the norms of the time as opposed to the norms of the," but the norms of today are relevant to the value creation of today.
Randy Kroszner:
For sure.
Mark:
That's the first point. The second is that the expectation is that the judgment of, I want to know as an investor, I would want to know as an investor, what is the judgment of a company of which of these factors are particularly relevant to them? And if I had the view that a certain ESG driver, it should be relevant, then I want to be able to challenge them.
Mark:
Then I'll make a judgment whether or not that's there. And I'm sure this has been brought out [inaudible 00:25:36] I haven't had a chance to see everything, I'm going to benefit from the fact that it's being recorded to go through it, that this has been brought up. There's a number of channels, of course, over time where ESG quote unquote, or sustainability factors, are going to drive enterprise value.
Mark:
People often go to this, but it is true. I think my experience in running organizations, and certainly a lot of the research backs this up. I mean, the human capital dimension of it is very, very strong. And the alignment of company values, ability to attract and retain is there, it's absolutely there. And companies have to be sensitive to those factors, because it's ultimately going to have the impact. Social license, this is where it gets more nebulous, because it's kind of there until it's not.
Mark:
And when it goes, it's very, very hard to get it back. And you want to be a little careful not to read every sustainability factor into the maintenance of license. But equally, being a good corporate citizen in that regard, is good for business. If I'm kind of try to put it in Friedman-esque terms. And, I think he had, and we talked about this the other day, sort of lovely phrase about the rules of society prevailing norms. Well, the rule of society and prevailing social norms, are beyond shareholder value maximization. I mean, I think that seems like a little addendum, but you could drive a very large [crosstalk 00:27:34] through it.
Randy Kroszner:
No. And I think that's one of the key challenges, because I think one of the things that Friedman tried to do, is I sometimes call it the Friedman separation theorem. They can separate all the things that the corporation does, for all the things that are done in the political sphere. And I think this discussion suggests, and the earlier discussion suggests, that it's sometimes not so easy to pull those two things apart.
Randy Kroszner:
Because you could say, as I think Friedman said, well, just leave it for the corporations [inaudible 00:28:03] shareholder value maximization. And then there's a political process that can determine some of these other things, whether there should be disclosure around climate, whether there should be net zero carbon emissions by 2050 or 2070, or no regulation of that at all. And that those are completely separable realms.
Randy Kroszner:
But I think what's happened today is it's much more... I think when Friedman was arguing that it was separable, I think it's much more difficult today to separate those two. But I think that's where one of the challenge's comes in, what should be the board of directors and the shareholders pushing the senior management to do? As opposed to those people going to their elected representatives and saying, "Well, we need this in this sphere and we need this other thing in this sphere."
Mark:
Well, yes, it is, again, you're putting your finger on it. It's difficult. And because it's difficult, and because it's situation specific, it can't be generalized. And there does need to be at least an effort made to draw, I think, the connection over time between the environmental social or governance factors. Although, let's be honest, like most of the governance factors are good governance. I mean, it's not that hard to... That's just, really? You don't have good governance?
Mark:
I mean, if you disagree with one of the sort of accepted governance principles, then just put your hand up and explain why that's wrong and kind of move on. And that's part of the reason this is a subset of it, but in jurisdictions like the UK, where you have advisory motions, say on pay for example, and where actually there's an emerging debate, I would say, on transition, which is yeah, okay. The authorities won't be prescriptive. And I'll be clear, I'm not an authority here, but not prescriptive about what your transition plan is.
Mark:
But just like there's an advisory vote on pay every year, we'll have an advisory vote on your transition plan, whether it is fit for purpose to use the phrase, where you are right now, right? You're in the UK right now. I mean, one of the phrases around this or concepts, I should say, it's more than phrase, is around enlightened shareholder value. Or, if you're coming from an investor side, its shared value, which is where is that confluence, or that divine coincidence, if you will, often over a slightly longer time horizon. Longer time horizon for the cash flows to materialize if you will. But between the broader set of stakeholders and the shareholders, and the shareholders as the residual claimant.
Mark:
And part of it's having, not the courage, but the discipline to think that through. And then if you're challenged, as a company on, "Why don't you care about X?" Well, to come clean on it. But I'll make, again, I'm going to retreat to an even a higher level, if I may, which I think catching the bits that I've caught, there is an element of this, I think in some of the discussion. Which is that I think Andrew Hill was, and I'm going to misquote him, but I think he had sort of extreme shareholder value. I think he used that. And the way I think a bit about, there's of course, as always with Friedman, there's a lot of insight of what he says, to some extent, in isolation. If you don't think about the dynamic consequences of what he said-
PART 2 OF 4 ENDS [00:32:04]
Mark:
... if you don't think about the dynamic consequences of what he said, how it gets interpreted, and how pure shareholder value maximization, to the exclusion of others, actually corrodes some of the underpinnings of the system or can corrode some of the underpinnings of the system. If every relationship is purely contractual and ... That's one of the things. So slightly straying from your question, but one of the things, at least what I felt in understanding this issue, is that there is a recognition that done properly, for example, a purpose-driven corporation, so it has a clear objective that it's trying to accomplish, that understanding obviously empowers and enthuses the workers within another set of stakeholders because they're trying to solve an issue.
Mark:
But also, for the suppliers and even sometimes the customers and/or the communities understands what it is trying to accomplish and there's that broader relationship and support that doesn't have to all be captured within a contractual framework that optimizes everybody's return, but ultimately makes people better off. There's that dynamic to all of this, that when you reduce it too far down to shareholder value maximization, über alles at to the exclusion of everything else, then you ultimately corrode those other factors to your detriment.
Randy Kroszner:
This is a-
Mark:
But you can't go to the other extreme, which everything that matters to the community matters to the corporation gets internalized. Right?
Randy Kroszner:
Right. No, I think that's the tough choice, and exactly the issue that you were raising is something that Rigo and Andrew had talked about. Also in the earlier discussion, in Asia, there's a lot of discussion of the role of ethics and morality, and that institutions get their legitimacy in that broader societal realm and that broader role of ethics and morality. If these institutions are not seen as pursuing reasonable purposes, then they don't have legitimacy and they're not going to get support. So you're talking more broadly for the integrity of markets, integrity of capitalism more generally. Obviously, we've seen a lot of challenges to that recently. I think that very nicely fits in with that discussion.
Randy Kroszner:
But how do we make those tough choices? Let's say it is difficult to figure out what's in the political realm and what's in the corporate realm. But let's say that there are a few things that either you want to impose on everyone, let's say, like net zero by 2050, or that you want to impose on a particular corporation. How do you then deal with shareholders who would say, "That's not appropriate to do that. I'm a longterm pensioner. I want my pension fund and I want my investment fund to maximize the returns for me because otherwise, I'm going to be impoverished when I get old. What about the value of me as a retiree, being able to have a reasonable life?" Shouldn't that also get some-
Mark:
Absolutely.
Randy Kroszner:
So how do you-
Mark:
Let's go directly to the example. Just to be clear, I'm not imposing net zero. Society is elected governments who-
Randy Kroszner:
Sure, sure.
Mark:
[crosstalk 00:35:40] things and put that in place. With broad, but in Canada, it's not bipartisan. It's cross-party support, legislative passed it. Okay. That's the [inaudible 00:35:52] to the country. So now as a company, I have a couple of issues. You know this, but it's useful to step back. I've got two sets of risks/opportunities around climate potentially, but certainly risks. I have the physical risks, which gradually manifest and mount over time. It depends on what the world does on climate there. But the bigger one that, and this is the thing that we identified as the FSB and Mike Bloomberg and through the TCFD, the bigger one for most companies is so-called transition risk, right?
Mark:
So where the country is today, let's take Canada, and what are the suite of policies that are going to come into place over time that are going to move Canada towards net zero? How will those affect my operating environment as a company? Okay, I've got to think about that. I've got to make a judgment about when certain regulation is going to come into play or support for an alternative fuel or power source, which may affect my competitiveness positively, negatively come into play, or a price on pollution. Where may that go over time? All of these things, how do they affect it? That is going to affect my bottom line. That's going to affect my competitiveness and my bottom line. That's going to affect the pensioner, ultimately, whose money I've been entrusted with.
Mark:
So that is absolutely an example where the ESG factors directly impact the financial factors. Now, one of the difficult things always to say, but it happens if you have a long enough Chicago seminar is that financial markets, they're not perfectly efficient and it sometimes takes a while for particularly big structural changes to then be pulled forward into the present valuation of companies. Particularly big cross-cutting structural changes, whether it's future of artificial intelligence, big geotectonic plates changing in trade, and climate policy and climate risk.
Randy Kroszner:
Right.
Mark:
So there's a big debate, which was ... I happened to raise it about five years ago, and I got a lot of blowback for it around stranded assets in fossil fuel. It wasn't my idea. I didn't originate the idea. Just mentioned it happened to agree with it. Now that has been pulled forward into the price, starting to be pulled forward. Now, you can argue whether it's fully priced in or not, but it's being pulled forward and you're seeing carbon price and other assumptions changing and climate assumptions changing for big energy companies. BP would be an example, to say, look, actually, some of these reserves are not worth what they used to be because of future climate policy and where we think climate risk. Okay.
Mark:
Now that's an example where the disclosure of these relevant factors, including the transition risks, five years ago, 10 years ago, would have been material information. That's one of the things TCFD, material information. Different investors would have a different view. Some of them would think ... Some investors would have thought, "Actually, we don't think the UK is ever going to have a net zero strategy or 120 countries will, or the carbon price will go to X or whatever will happen. So we'll take this side of the trade. Others may have a different view."
Mark:
Fast forward, maybe things haven't moved as much as they necessarily need to in order to get to net zero, arguably. But stuff is coming in and it's increasingly credible that they will move in that direction and that's being pulled into the price. So that's a case where you have absolute alignment. It could have been the case, just to one last point. It could have been the case that nothing happened in the intervening five years on climate policy and nothing happened in terms of the social consensus coming around the need for more credible climate policies, effective climate policies.
Mark:
In that case, would the disclosure five years ago have been wrong? No, my view, no, because that was a risk. You could take an informed view or your view of the relative probability that these transition risks crystallized. Lo and behold, if you listened to my speech and followed my logic, you would've pulled it forward. As a central banker, you have to find things that you said in the past-
Randy Kroszner:
Sure.
Mark:
... that turned out to be relevant in order to rebalance. I'm finding that in retirement, as you've noted in my retirement.
Randy Kroszner:
Yes, yes. Actually, a few questions have come in to take some of the discussion that we have, but apply it rather than the climate realm, with respect to some of the recent issues on health and pharmaceuticals, because there's similar kinds of things that are happening now about very large investments that are being made to try to discover vaccines or prophylactics that would help to reduce the impact of COVID-19. Then the question of, "Well, what will the companies be able to charge?"
Randy Kroszner:
So obviously, there's a broad social purpose of trying to fight the pandemic, but there's also a rate of return for the companies. So how do you think about those kinds of trade offs and in particular, one of the questions focused on, "Well, don't all these companies have very important lobbying arms that go to the US Congress, to the Canadian legislature, to the UK legislature, whether it's pharmaceutical companies, whether it's energy companies, and don't they get what they want anyway?"
Randy Kroszner:
So those are two separate issues. One, let's apply this in the current context, and then second, that broader political economy realms of is there a separation between what the company is doing and the political realm, or is the political realm really subject to what the companies want in value maximization.
Mark:
Okay. Yeah. It's a great question. Well, on the first one, one of the things which I think predated just predated when you were at the Council of Economic Advisors in the international realm, but correct me if I'm wrong, that was a G7 initiative called Advance Market Commitments. The idea was, and big money was put up for ... the idea was for diseases that only affected or principally affected the poorest countries in the world. The issue being fairly obvious, the incentives for the drug companies to work on these diseases, the classic example was pneumococcus, was relatively low because they couldn't earn the big patent return on the investment. So they just didn't invest in them.
Mark:
So what the G7 did, along with the Gates Foundation, was to put up a bunch of money to give the patent for return, if you will, the monopoly returned for that period of time. Then to ensure that it was incentive compatible for the countries that use the drug, assuming the drug was developed, for them to pay the marginal cost of production, which, as you know, it normally is very low. So there's some incentive because you bake into for it. So it wasn't going to be wasted, but it was going to be used.
Mark:
I have to say around, and I don't mean to dodge the question around this issue, it has struck me that ... some element of that would have been desirable. The point is to do it ex ante-
Randy Kroszner:
Right.
Mark:
... as opposed to example post, and we are going to face, hopefully, we are all going to face this issue, which is that there will be a vaccine or vaccines that are credible. The issue will be rapid global deployment and support from those who have to those who haven't for that rapid global deployment. But I will say, I guess, just to ... Sorry, I'm thinking out loud. One of the issues of course is the companies haven't had to be told to go and put all the effort into finding the vaccines.
Mark:
I do think ... I will give them the benefit of the doubt that there has been very dedicated efforts for the greater good to find the vaccine and then figure out how it's going to be sold and distributed down the road. So I'm not sure that this conflict has come in. I think the greater social good has been internalized in a number of companies, and they probably will not make the monopoly profit on the vaccine, anywhere near the monopoly profit on the vaccines that they got, nor do they intend to, and that's to their great credit.
Mark:
I'm not sure their shareholders and ... Well, we'll see, we'll see. Somebody ... you never know in the US. Somebody might sue, but I don't think so. On the question of lobby, it's very ... the political economy question is very interesting. It's one of the ... different countries have different dynamics here. It is very different in a place like Canada, where very restricted in terms of what can be spent by lobbyists or donated to politicians. It just doesn't have the force it does in the US or to some extent, it does in the EU. I think that I wouldn't be ... I'm not as cynical around these issues to think that it'll just cut. I do think that the ... fortunately, we still have popular consensus. A social consensus does weigh on these issues and it does lead to change. It takes longer.
Mark:
Sorry to jump around, but I guess my experience has been that if you're a company and you can sense where social consensus is going, ultimately, that's where the country is going to end up. That's ultimately if, and you might as well go with the flow and think about particularly what the social consensus is forming around. In other words, what's the objective? And then figure out how you can be part of that solution, or if you're part of the problem, how to stop being part of the problem before you ... and don't wait for the regulation to come in. Governments move slowly, relative to social consensus. We are in a world where, first off, it's the right thing to do. So it's embarrassing even.
Mark:
One of the things is once you figure out that something's really bad and you know it as a company, continuing to do it just because you're allowed to do it for the moment on a regulatory basis is not really a defensible position. We're an environment where that social license can be chipped away pretty quickly if you do that, if you need an economic incentive for it as well. Sorry.
Randy Kroszner:
For sure. I think that's exactly right. One of the other questions that have come in actually related to this, is that you talked about how it took the shock of the Great Depression to change a lot of disclosure. Do you see the COVID-19 shock either changing some-
PART 3 OF 4 ENDS [00:48:04]
Randy Kroszner:
... the COVID-19 shock, either changing some of the disclosures more broadly and the role of these broader societal issues, or specifically do you see something changing with respect to pharmaceutical firms? Because you can see, exactly as you were describing, in some sense, they saw the writing on the wall. There was going to be no way for them to make an investment and then say, "Ah, if we're the first, we're going to get a zillion percent return and charge a fortune for this." That was just not going to function in today's society. So is there something about this shock that is going to change the way pharmaceuticals firms work on a permanent basis or the way some of these other social purpose issues will be integrated into the way corporations operate going forward?
Mark:
I think there is something to it. The question is how long it will endure. Without question, companies have been judged or are being judged relative to loftier statements of purpose, or I think you touched on this earlier, probably the business round table and what's the actual performance of those companies. I would say in that regard, this is a dynamic, or it's an iterative process. I mean, first thing is admitting you have a problem or admitting you have an issue, you have an objective, and then you work hard towards that objective, and then people should be held to account, but it doesn't mean the objective is wrong, first point.
Mark:
Second is that COVID, yeah, definitely has increased the scrutiny. How have companies particularly taking care of their employees, and by extension their communities through employees, to what extent they've just fallen back on government support or they've tried to support in their own way? How concerned have they been for employee health and other factors, and then how much they're part of a solution here. We have ... It's a moment of, and it's a long moment of where there's a need for solidarity. I mean, you've got to support your extended family, your friends, within your community, and then as a company, the broader global climate you've got to come together for. So I think in and of that, the scrutiny is there, first point. Maybe that's the second.
Mark:
The third is a reset moment in two respects. First for company strategy, there's relatively few companies coming into this that had the right strategy coming, that the pre-COVID strategy is just reinforced COVID dynamics. There's eCommerce platforms for which that's the case. Clearly the medium over which we're having this conversation, that was the case for them as well. But for virtually everybody else, you've got to reset your strategy. Think about it. And, again, I'm sorry to fall back on climate, but within the climate context, if you're resetting your strategy in this environment and you've got a net zero target in your country, well, then where does net zero fit into your strategy? It's a pretty obvious question that you just have to ask and answer.
Mark:
But in that reset, the other side of the reset is the public policy reset. Fiscal, monetary, leave that to one side, but then on the regulatory side and how the system is organized. And I think just to bring it directly to where you want on this set of issues, it's, okay. We have a bunch of either private initiatives or NGO initiatives, but non-governmental initiatives around ... It's CASB, it's CDP, it's CDSP, it's GRI, it's IIGC, it's the World Economic Forum effort to try to pull some of this stuff together, but we have all these initiatives. So what are the authorities doing, whether it's IOSCO, the securities regulators, the IFRS, FASBI the SEC, the FSB, what are they doing to actually help answer the questions you and I have been trying to tease out a bit of, okay, what's the sort of set of sustained ESG or sustainability reporting metrics?
Mark:
Let's carve them to a core, and which ones, and this is the tougher one, but how do you then have a process or some discipline around those to say, "Oh, these are the ones where we think there is an ultimate [crosstalk 00:52:57] enterprise value?" And these are other ones that we think we should report or that society wants companies to report, but they don't necessarily ... That's where you get into that balancing conflict and you make a judgment about good corporate citizenship. And that's pretty important now., because I think that the system has reached the point where there was a lot of good out there, but there's almost too much good out there. There's confusion, and there needs to be deconfusion otherwise known as clarity brought to bear on it.
Randy Kroszner:
No, I think in some sense, that's kind of where we had started, because this is one of the key challenges when you have so many different objectives, and there are many good things that are out there. There are many good things we can do. It becomes very difficult to set the priority, and so you have to be able to, as I think it was Malak in the previous session said, "If you can't measure it, you can't manage it," so it's very difficult to give guidance to senior management or a CEO if you just say, "Do this." But it's very difficult to say, "Well, how do I measure this," whether it's reducing the climate risk, whether it's improving health outcomes, whether it's reducing inequality. There are some broad metrics can be used, but then you have to be able to draw the line between what the company can do and those outcomes. That's extraordinarily difficult, and so trying to set those priorities, I think is super important and super difficult, whether it's done in the private sector realm or the public sector realm.
Mark:
Can I just jump in on it, because, that is critical thing. And two points; one is there is an initiative that's been underway for 18 months or so of something called the International Business Council of the World Economic Forum with the big four accounting firms, or maybe it's the big six accounting firms working through all of the ESG metrics and saying, "These are the primary ones that should be disclosed for everybody in any industry, and then here's some specific across all of them." And they draw on these existing standards of recommendations for them, and that's sort of out for consultation and consideration, and it's the first comprehensive effort that's been made, and it's being made by both companies, users and providers of capital. So it's a pretty interesting starting point of trying to get to that. That's the first point.
Mark:
The second point is what they say is, part and parcel of signing up to that as a company is, "Okay, you're going to disclose all of this, or you're going to say why you didn't disclose something." So you're actually going to make that judgment that water isn't important to my business because X right. Clean water, it doesn't matter. Now, if it does matter, you're in trouble, right? I mean, that's the corollary or if I take a different view.
Mark:
And then the third point is just to think about, from an investor perspective, again, from an ESG, and we all know that the sort of aggregate ESG ratings have very low correlation between each other. It's like 0.3 or so, so you can end up in very different places depending on which ESG aggregate rating you choose, and that points to some need in the improvement of aggregate ratings. I won't say which direction they should go, but it really tells you as an investor that you want to be figuring out what are the relevant ESG components for a given company. Now, I'm pretty interested in what you would say, Randy, if it were your company. You're the CEO or CFO, and you say X, Y, Z is relevant. But I might want to run the numbers on broader set of metrics and see whether there's other materialities or sensitivities that I've found in similar companies in similar industries and maybe for you as well. And that is a much more integrated approach to ESG. It's pulling together the social governance, environmental into the enterprise value creation in a way that has some linkages.
Mark:
It does though mean, just for absolute clarity, that there will be things outside of that box, things that the company either it doesn't think that it is ultimate material that it may have an impact on, right? It may not think ... On the outside going in, it's not material, but the inside going out, it's material, and then broader stakeholder society have to take a view on that, but that's a much cleaner system. We have the elements of that system, but that's a much cleaner and arguably a much more effective system over time for both social and economic goals, and economic goals are social goals as well. It's important to remember that.
Mark:
We want dynamism at the heart, and maybe as we're coming close to the end of the time, but just to make the point that a system where companies are looking to provide solutions for society because society cares about things, and minimize their collateral damage, if you will, while they're doing it, that's a market-driven system that is very effective and will make a lot of money for shareholders over time. And Milton would be happy about that, I hope.
Randy Kroszner:
Yep. And so that's a perfect way to conclude, because we're trying to look at where's the common ground? So where is it by pursuing these social purposes that actually can be maximizing shareholder value or at least be consistent with it, and then where the rubber really hits the road, where there's some things where it's going to be very difficult if you actually pursue a particular goal. Let's say reduction in carbon emissions, that may be really not very helpful to the owners of oil and gas companies, and so that's a really tough trade off that has to be made. But we can't make these trade offs without the data, and that's one of the great things that I think Chicago has always been focused on, whether it was in the previous panel focusing on diversity and inclusion without the data, and just to understand what's happening on inclusion, and then trying to look at the consequences of it.
Randy Kroszner:
You can't analyze it. You can't figure out what's going to be effective and what's not. Much of our discussion was just about those issues, trying to define what are the objectives that we're looking at. What would be the best data to get at that, and then we can try to make some progress towards seeing, well, what's going to be effective and what's not? What are the trade offs that we're making? I mean much like the Chicago research on security prices. CRSP put together those databases in the 1960s and 1970s that allowed us to measure risk in addition to return. There are a lot of other risks related to these broader social issues that we might want to have data to try to assess, and whether we do that through the political process or through the corporate process that's part of the political economy, we can discuss that, but we need the data to be able to make these kinds of assessments.
Randy Kroszner:
And so I really appreciate you taking the time to be with us. I thought it was a really fruitful discussion facing a lot of the tough issues. Did we solve them all? No, but I think a lot of people are trying to avoid facing them, just saying, "Oh, well, sure. I agree with Milton Friedman, and I agree with all the social purpose stuff." In some cases that works, but in some cases it doesn't. We sometimes have to make those hard choices, and I think focusing people on those tough choices is something that's really, really important.
Randy Kroszner:
So I wanted to thank you very much. I want to thank all of our speakers for today. I also want to thank Ally Batty, MacKenzie Ellis and Abby Holzer, who have been crucial to putting all this together, Frank Schultz, who has made sure that all the technology works. And for those of you who are interested in the kinds of debates that we've been having today, whether they're the big picture moral and ethical debates, or whether they're more specific concrete debates on accounting, I encourage you to think about programs at Chicago Booth. Thank you very much. Bye-bye.