Stakeholder engagement was a huge theme during the recent reporting cycle. Through its guidance on the strategic report and new Corporate Governance Code, the FRC has compelled reporters to provide more information on a broader range of stakeholders.
Does this mean we are moving away from shareholder capitalism towards stakeholder capitalism? The short answer is no, the outcome will be more nuanced - but there will be far-reaching implications for reporters.
A belief that capitalism is not working as well as it could has reignited a debate around the merits of shareholder value versus stakeholder value. New reporting initiatives are urging companies to think about why they exist and how they should meet the needs of a broader set of stakeholders.
For a generation of business leaders, delivering value for shareholders was their primary objective. This could only be achieved by making the best products, delivering the best service, and optimising employment. If companies delivered on this, then all of society would benefit. But competitive dynamics have changed. Globalisation needs global rules and consolidation means more industries are more concentrated, while the digital economy, exemplified by the likes of Facebook and Google, tends towards monopoly. Customers have seen service standards fall, been overcharged or seen their data misused. Employees meanwhile have felt the pain of wages that fail to keep up with the cost of living while profits have been channelled into tax havens.
While a small number of high-profile cases cast a shadow over the corporate sector, a sense that relationships with stakeholders were breaking down chimed with our ‘Belief in business: state of the nation’ research. It revealed a dramatic redefinition of our expectations of brands and organisations. On a positive note, there was a strong desire for change with four out of five of us thinking business is well placed to lead in society.
One clear outcome of all this: purpose has assumed greater importance. Getting companies to state their purpose beyond shareholder value - and holding them to it – is set to take on a broader role. Purpose has certainly become more prevalent in annual reports, but the quality is uneven. According to the FRC, too many resemble marketing slogans and don’t meet their criteria:
- Is the purpose relevant to the company and not just the sector?
- Is the purpose specific in what it proports to do?
- When you read the purpose is it clear what the company actually does?
- A purpose that doesn’t try to be everything and name checking every possible good thing
The collapse of Carillion was a turning point for regulators and led to a new requirement for companies to report on how the directors have carried out their section 172 duties under both the Companies Act (2006) and the updated UK Corporate Governance Code. The shareholder remains the primary focus for companies, but the renewed focus on section 172 recognised a feeling that other stakeholders were not been taken into account. It’s a rebalancing of priorities rather than a more wholesale shift to stakeholder capitalism. The FRC believes companies that are more transparent with all their stakeholders make better decisions.
For this to be effective, disclosures on stakeholder engagement must reflect a two-way dialogue with companies reporting on the actual issues raised by stakeholders, how the relevant parties reached an agreement and what the outcome was. From our review of 2019 reports, we believe it will take a while for companies to adjust and become comfortable with the increased level of transparency. Reporters are good at describing their stakeholders and communication channels, but more likely to talk about general issues than specific issues and outcomes. Stakeholder engagement pages will invite a wider audience to annual reports, but the information must reflect their own experience if the company is to credibly prove the FRC’s belief that better decisions are being made as a result of the process.
Shareholder value crystallised a clear objective for companies to maximise returns through share price appreciation and dividends. Accountability is straightforward when companies have one master. An increased focus on the needs of all stakeholders will compel companies to be more honest about the trade-offs that come with running a company. In a dynamic economy, competition is a fact of life. The transition to a low carbon economy will see winners and losers as capital and employees switch to greener industries. Integrated reporting, which has been around since 2013, encourages companies to report on these trade-offs, but few reporters have taken on the challenge.
A rounded view of all stakeholders gives investors a broader understanding of business. Investors seeking out the winners that will emerge from this unique recession are factoring in how well companies looked after their employees and suppliers during Covid-19. Time will tell if shareholder capitalism can adapt to encompass all stakeholders, but a contributing factor will be the quality of reporting on stakeholder engagement.
By Sean Bride, Senior Investor Engagement Consultant