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Summary Sustainable Finance & Value Creation
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Summary of all mandatory papers, lecture notes and sample exam questions.
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Lesson 30-1Sustainable Finance & Enhanced Value Creation
The traditional view of Shareholder Value Maximization (SVM) is creating value for shareholders and
corporate governance should prevent execs to pursue own interest. Enhanced Shareholder Value
Maximization on the other hand is a more pluralistic approach. The view is to weigh and balance a
plurality of independent constituencies (stakeholders).
The legal origin of a country can explain which approach is used. Across Europe we use civil law
(based on law textbook) where the stakeholder is embedded in law. The US however is based on
common law (jurisprudentie), with shareholder primacy. In most states constituency status are
adopted so firms can consider the interest of shareholders without violating shareholder primacy. In
the UK the stakeholders are mentioned in the UK co Act since 2016. This Act basically means that
directors should consider stakeholder in order to promote the success of the company for the benefit
of its own shareholders.
It's already shown that there is support for the enhanced SVM view.
US business Roundtable; none of the signatories express explicitly a willingness to trade-off
shareholder value and stakeholder benefits, however many of them do embrace an ESV
approach.
Corporate purpose statements: guidelines of some business state that shareholders long-
term interest will be advanced by responsible addressing the concern of other stakeholders
essential to the company’s success.
A speaker on the world economic forum expressed stakeholder capitalism as a form of
capitalism in which cos seek LT value creation by taking into account the needs of all their
stakeholders and society at large. LT value = loan amount /value of the asset
The big3 institutional investors urged CEOs to serve their full set of stakeholders, to manage
systemic risk and promote racial, ethnic and gender diversity and to tackle climate change.
Their view is to avoid endorsement of a pluralistic conception of stakeholder capitalism and
explicitly stress stakeholder concerns to the extent that these concerns matter for
shareholder value. (doing well by doing good)
o E.g. many proposals on climate change stress “regulatory risk” of upcoming
environmental restrictions that would dramatically change value of co’s assets
and therefore recommend that co pivot to greener projects to protect
shareholder value against such a risk.
To invest in ESVM business face a trade-off between shareholders and stakeholders. Businesses have
many more opportunities to improve stakeholder welfare further at expense of shareholders.
Examples in slides.
There are certain conditions for Equivalence of SVm and ESVM
1) Corporate leaders are not myopic (kortzichtig) and consider LT consequences of their
choices on LT shareholder value
2) Corporate leaders are well informed about consequences of their choices
3) Courts avoid micromanagement of corporate decisions and defer to the discretion of
corporate leaders under the business judgement rules
4) Only changes in actual treatment of stakeholders, and not merely linguistic changes in
formulation of decision are taken to be actual changes (so no greenwashing).
, Lesson 30-1
As ESVM is still a rising topic, there are still some questions remained unanswered;
- Can ESVM be abused to invest in stakeholders beyond the legal cover?
- Can ESVM be abused to seemingly care about stakeholder interests paying attention to
stakeholder interest is strategy to allay public concerns, rebuild social trust in business or
mitigate costs of regulatory and public backlash.
Thus we conclude: ESVM could be help to focus on stakeholder constraints on value. However it can
also be unhelpful, but harmless, or worse it could be counter-productive if it induces misperceptions
and illusionary misperceptions or destroys value.
The paper of Hart and Zingales (2002) find that SVM is good under the following conditions:
1) Perfectly competitive economy with no agent table to affect prices
2) No externalities
In this case SVM would mean that an increase in value increases wealth of shareholders without
anyone being worse off. However the problem with SVM is that these conditions are not fulfilled
because of the following reasons:
1) SVM breaks down under imperfect competition. There is the danger of monopoly power in
the goods market.
2) Common ownership. Shareholders maximize value of portfolio rather than of individual
firm.
3) Externalities, for example pollution. ESVM would say you need to compensate each
affected person. However, there is regulation for additional emissions tax with no proceeds
redistributed. SVM makes shareholders better of and no one worse off as everyone is
compensated for the harm experienced. Friedman would say that individual shareholders
can use part of profit to invest in institutes that work for preserving environment. However,
damage-inducing activities are often inseparable from production activities. Regulation is
suboptimal
The solution Hart and Zingales find is Shareholder Welfare Maximization (SWM). This is a
combination of SVM + regulation and/or shareholder voting on ESG issues. The problem with this is
that voting outcome is binding in Europe but non-binding in US and UK. Further, institutional
investors will only vote in favor of LT financial return of clients. There is also the question if
shareholders will put in the effort to vote and analyze, do they have the time and means to study
proposals and consequences? A solution to this problem is a form of delegated voting; ISS. As a firm
you can agree with ISS voting proposal on the agenda at the AGM. As a shareholder you can join an
voters profile and ask ISS to vote according to the profile. The requirement for this is that mutual
funds have a clearly spelled out voting policy.
Corporate purpose statement
Suppose doing good is valuable, will you earn a higher return in investing in ‘good’ companies?
- Handing capital to ‘good’ business at more favorable terms as lower cost of capital. Given
lower risk, lower return in equilibrium. Thus, sin stocks earn higher returns.
- If out of equilibrium a shock happens (thus ESG score goes up), the demand goes up and
therefore the price goes up. A high initial return then reflects longer term higher prices and
lower returns.
, Lesson 30-1
One can also argue that there is no need for a corporate purpose statement as firms do not state
that their only goal is to make money for its shareholders; firms do automatically consider
stakeholders. Further, it is also no good as commitment to honor contract with stakeholders as every
contract is incomplete and not all stakeholders have contract. That is why we need corporate
governance mechanisms. Think of board elections, representation and executive pay.
The shareholder is not protected by contracts, as it is the residual claimant. Commitment to
shareholder returns is important, legal shareholder protection is needed and focus on shareholder
primacy. However, keep in mind not everything can be regulated, scandals will keep happening. And
what about lobbying? Regulation may not reflect the democratic consensus and therefore lobbying
keep existing. Friedman agreed in principle with: managers’ “responsibility is to conduct
the business in accordance with [shareholders’] desires, which generally will be to make as much
money as possible while conforming to the basic rules of the society, both those embodied in
law and those embodied in ethical custom”. However friedman wrote: it was wrong for managers “to
make [corporate] expenditures on reducing pollution beyond the amount that is in the best interests
of the corporation or that is required by law in order to contribute to the social objective of improving
the environment.”
There exist an causality problem between CP statement and profit/value, and it is therefore
endogenous. Even if one could show that purpose statements cause success, the policy implications
would be doubly unclear. Statements may only work for the few firms that voluntary adopted them
and may be counterproductive for other firms. Second, a regulator can only set a minimum
requirements for mandatory purpose statements, which might end up different from voluntary
purpose statements, which may be richer in content.
, Lesson 30-1
On the foundations of Corporate Social Responsibility
Liang, H. and L. Renneboog, 2017, On the Foundations of Corporate Social Responsibility,
Journal of Finance 72 (2), 853-910.
Main question:
What fundamental forces steer companies to behave as good citizens rather than as pure profit
maximizers? Why do some firms want to be more socially responsible rather than pure profit
maximizers? More importantly, why do firms in some countries engage more in CSR than firms in
other countries?
Methodology
The classical explanation of why companies do CSR is that it enhances profitability and firm value, aka
doing well by doing good. Corporate laws address agency conflicts between manages and
shareholders, and between controlling and minority shareholders. Common law is widely known as a
more discretion-oriented system that supports private market outcomes, places fewer ex ante
restrictions on managerial behavior (but discourages inappropriate or unacceptable behavior by
means of relying on ex post sanctions such as litigation or other judicial mechanism) and favors
shareholder protection. Civil law is known for the state’s tendency to intervene in economic life
trough rules and regulations and embracing stakeholder view.
The data measures corporations engagement in and compliance to ESG issues. Engagement refers to
a firm’s voluntary initiation of CSR projects, while compliance refers to regulatory mandated conduct
that a firm has to or is encouraged to follow. They make use of CSR rating agencies, which are
financially independent from the rated firms such that conflicts of interest are largely avoided, in
contrast to credit rating agencies.
Y* is the overall IVA rating which aggregates all environmental and social dimensions of CSR. Legal
refers to the legal tradition adopted by the country where the firm is headquartered. There are 5
legal origins: English common law, French civil law, German civil law, Scandinavian civil law and
socialist law. X is the vector of firm-level financial and governance variables. They use proxy firm size
by the logarithm of the total assets of the company. They control for firm performance by ROA and
Tobin’s Q. They control for a country’s level of economic development by using the logarithm of the
GDP per capital and a globalization index. Z is a vector of country-level control variables, to control
for the effects of political institutions, which may both shape and reflect social preferences for CSR.
They proxy this by Political Executive Constrains (potential expropriation by the political elites), which
is the only measure that is clearly not a consequence of dictatorial choices and can at least loosely be
thought of as relating to constraints to governments. Second they use Corruption Control which
measures the extent to which politicians are constrained form pursuing their self-interest (trough
corruption). Third they use the World Bank Index of a country’s regulatory quality to proxy for the
government’s effectiveness in taking CSR and dealing with market externalities. Further, in the model
they include different types of blockholder ownership as they are proxies for investor preferences,
which may favor different corporate CSR policies.
Lastly, they use quasi-natural experiments and diff-in-diff analysis to check for causation.
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