March 2018. GrowthPolicy’s Devjani Roy interviewed George Serafeim, Jakurski Family Associate Professor of Business Administration at Harvard Business School, on employment, inequality, and the relationship between corporate purpose and financial performance. | Click here for more interviews like this one.
Links: George Serafeim’s faculty page at Harvard Business School| LinkedIn | Twitter | SSRN research page | His research papers on DASH (Digital Access to Scholarship at Harvard) For questions about this interview, contact Devjani Roy.
GrowthPolicy: Where will the jobs of the future come from?
George Serafeim: Working to achieve the Sustainable Development Goals (SDGs). Solving the climate challenge, completely changing our electricity infrastructure, our transportation system, and our energy generation, distribution, and storage. Solving the health crisis where non-communicable diseases, such as diabetes and heart diseases, are spreading and causing enormous pain to society. Building a healthcare system that keeps people healthy instead of just treating sick people. Creating cities and urban environments that are safe and with decent jobs. With increasing urbanization this will become more important. I can keep going. The point is that all nations have agreed to the SDGs and they represent tens of trillions in investments and opportunities for value creation. Hundreds of millions of jobs will be created aligned with achieving them.
GrowthPolicy: What should we do about income inequality?
George Serafeim: Way too many things to mention in a few words. But fundamentally we should develop a common understanding that inequality at the levels that it has recently reached is not good for anyone. We need to change our default view of the people that have fallen behind. As [with] proven innocent until guilty, we should start applying the same concept: people that fell behind are, in general, people that worked hard but got unlucky instead of people that are lazy and trying to live on welfare. Once we realize that human nature is not to live on handouts but to live with dignity, we can start changing our tax system, our educational system, and our healthcare system.
GrowthPolicy: In your recent article in Harvard Business Review, “Inclusive Growth: Profitable Strategies for Tackling Poverty and Inequality” (with Robert Kaplan and Eduardo Tugendhat), you argue that Corporate Social Responsibility (CSR) and sustainability initiatives fail to scale up successfully not because of poor execution but due to “the limited scale of [these] projects’ ambitions.” What can Chief Sustainability Officers (CSOs) do to change this, to think bigger in effect?
George Serafeim: Most programs try to provide point solutions. They do not see the ecosystem and trying to move forward in changing that ecosystem. Building partnerships is key here, both with other actors in the system, such as suppliers, customers, governments, and local NGOs, but even with other companies in the same industry, in some cases. No company on its own can tackle issues of human rights, climate change, inequality, poverty, and health care, on its own. This is why you see companies bundling together to provide solutions. Another element is bringing impact capital to the table. Impact capital could have lower cost of capital thereby making ecosystem changes possible. Moreover, it is a win-win all across. Impact investors that invest in ecosystem change along with companies and other organizations effectively de-risk their investment as they could have guaranteed uptake of the services or products coming out from the impact investment. As we argue in the paper, such collaborations to be effective need a well-defined governance framework and, importantly, alignment about what success looks like and what are the right metrics that everyone agrees to align with success. GrowthPolicy: In your paper “Investors as Stewards of the Commons?” you argue that investors can play a role in promoting social change. You note that index and quasi-index funds have an especially important role. Why is that?
George Serafeim: The types of collaborations I identify above are many times fragile and they lack commitment devices. Garrett Hardin’s seminal work on the tragedy of the commons highlights that individual companies acting independently according to their own self-interest behave contrary to the common good of all companies by depleting or spoiling that resource through their collective action. Therefore, you need stewards of the commons. Some investors fit the profile necessary for stewards of the commons: investors with a long time horizon and a significant common ownership of companies within the same industry or supply chain. Two types of investors satisfy both criteria. First, large, mostly passive asset managers such as BlackRock, State Street, and Vanguard. These investors hold significant shares of the equity, and as long as a company remains in the index they will keep holding the stock. Second, large pension funds such as Norges Bank Investment Management, AP, and the New York State Common Retirement Fund. They also tend to hold significant portions of the equity shares of many companies while matching assets to long-term liabilities. These investors now formally recognize the importance of environmental, social, and governance (ESG) issues for investment returns and stewardship. Large index investors have built teams that engage with companies in their portfolios, and large asset owners have been among the leaders in engaging with companies on environmental and social issues. This does not mean that other investors do not have a role to play in this theory of change. In fact, I suggest that two other types of investors, socially responsible investment funds and individual investors, play a key role in addressing free-rider problems at the large institutional investor level (i.e., temptation of one asset manager to free ride on the engagement efforts of other asset managers) and providing direct incentives for engagement to large institutional investors.
GrowthPolicy: In a recent paper yourself and co-authors provide the first empirical evidence on the role of corporate purpose for firms’ financial performance. What is the role of purpose in business? Isn’t that profit maximization?
George Serafeim: Whenever I speak with a business leader about this question, she or he always laughs with this question. People do not wake up in the morning going to work to maximize profits. They are thinking about how [do] we develop good products, what are the new services we can offer, how we can deliver effectively, what is the type of talent we need, how do we motivate people, how do we maintain an inclusive culture, etc. Profits are the byproduct of all these efforts and doing them well. In this paper, we show that when people inside the organization perceive their work as meaningful and there is broad agreement around that, especially across middle managers, firms exhibit superior performance in the future. Our hypothesis is that these results reflect the development of trust inside the organization, allowing some companies to become more innovative and efficient than their competitors.
GrowthPolicy: What, in your opinion, is the evolving role of the Chief Sustainability Officer (CSO) as a key change agent and decision maker, particularly in ensuring that the firm stays relevant through the three stages: Compliance, Efficiency, and Innovation?
George Serafeim: In our research we have found that those three stages, broadly speaking, describe well the stage of maturity of different companies. I would say ten years ago most companies were stuck at the compliance stage. Make sure that you do not break laws and that you do not cause major scandals that would disrupt your supply chain, brand, etc. Now more have moved to the efficiency stage. Mostly eliminating costs, becoming lenient, and better managing risks. Few are still at the innovation and growth stage where they understand that systems-level thinking is needed to unlock potential for new markets, new products, and providing solutions. CSOs that want to help their firm move along the maturity scale really need to promote diffusion of sustainability practices to the functions and business units aligning with business goals. Delegation of decision rights and finding the right business leaders to promote those practices in the whole organization is key. Putting sustainability in the periphery is a key risk.
GrowthPolicy: One of your most-cited research papers, “Corporate Social Responsibility and Access to Finance,” illustrates that a firm with superior CSR performance will actually face lower capital constraints, a finding that is in direct contrast with the commonly held belief that CSR hinders a firm’s ability to access capital. Explain to our readers why. What role do lower agency costs, greater stakeholder engagement, and increased transparency through CSR reporting play in the process?
George Serafeim: This requires first an understanding that industry-by-industry certain ESG metrics are financially material. For example, in a more recent study, “Material Sustainability Information and Stock Price Informativeness,” we show that metrics identified by the Sustainability Accounting Standards Board as financially material, when disclosed move stock prices. Investors respond to the disclosure of these metrics and firms that disclose more of this information exhibit better information environment with stock prices reflecting more firm-specific information. Lowering information asymmetry and providing better information reduces transaction costs while also lowering agency costs, [and] translates into better access to finance.