FULL EPISODE TRANSCRIPT
Welcome back to episode 66 of Count Me In. I am your host Adam Larson, and today you'll be hearing an important episode on ESG and the unique topic of stakeholder capitalism. Mitch spoke with John Stretch, a published author, lecturer and business consultant specializing in management accounting. John writes and facilitates workshops for various professional institutions with experience across many different industries. In this episode, he explains what the CFO's role is in managing stakeholder capitalism and increasing the value in the organization. Let's hear what he shared with Mitch now.
So as I said, if we can first explain what stakeholder capitalism is and why it's so important.
Mitchell, stakeholder capitalism is another way of thinking about how we manage organizations, not just corporations, but all kinds of organizations. And in a nutshell, it says dont took it all for the shareholders, leave something on the plate for customers and workers and employees and communities and even societies. It says doing good is good business sense, and another part of the stakeholder capitalism is that managers should take a view on longterm sustainability, not next year when they make decisions. And as a consequence develope better corporate governance to make to make those decisions. And you can ask, so what's the payoff? aAnd the answer is, there's a carrot and a stick. The big carrot is that stakeholder capital is going to make your company worth more in the long term then pure shareholder capitalism. I mean you just need to look at the high market to book ratios of top hundred companies who reinvest the profits in building brands and tech and know how rather than distribute them. And of course share prices are based on prospects of intellectuals as well as physical capital. In the old days we used to call that Goodwill, but today we classify intellectual capital into four groups of human relationships, structure and natural capital. And the stick is that if we adopt the diverse view, we can say that the old movement, Freedman idea of profit without social responsibility as in fact led to responsible decisions, inequalities, damage to the environment, and so on. That's the viewpoint, and so why is it important now? Because since the turn of the century, the world economy has been, it's changed. It's been based now on intellectual, not physical capital. And we know that the value of intangible assets has grown much faster than tangibles, even if it's not all reflected on company balance sheets. And it's actually been proven, there's a, it's a book that came out last year. Capitalism without Capital with two economists have actually proved that intellectual capitalism is growing much faster in the world than the tangibles. So to make the world a better place, make your company more valuable, you should build a combination of different kinds of wealth and stakeholder capitalism has got this vision of a responsible future in which short term thinking would actually be replaced a bit of long term thinking.
Now on this podcast we've had a number of conversations about reporting for ESG, and you've mentioned a little bit of ESG data already, and my next question is how do these types of capital that you are mentioning and talking about here really impact sustainability and the integrated reporting? Once again, particularly trying to give it a little bit of a finance and accounting perspective.
Okay, well, you know, I think of two overlapping circles, but for me ESG is, is more about the stick than the carrot that I mentioned earlier. ESG, Isabel sustainability. It's something that was coined in 1994 to describe as we will know, the, the ESG, Environmental, Social Governance, factors that not managers, not accountants, but investors should consider when they measuring the long term viability. So they talk about natural capital, diversity, human rights, consumer protection, and corporate governance of those things. So it's about protecting society, and so ESG today is about sustainability and corporate responsibility in the context of the fourth industrial revolution. And what are the ESG people come up with? They've come up with more reporting. So at the January, 2020 meeting in Davos, the world Economic Forum Table, this framework for reporting ESG aspects of business performance and risk, put together along with the big four accounting firms, and it says that companies should report more information, wage rights, local jobs, created gender differentiations. There is massive amount of detail here, and this revised framework is at the proposal stage. And in my view, it's going to take time to be accepted by the accounting bodies around the world. It doesn't address the cost of the systems for collecting the data and whether the the measures should be audited or whether it only apply to public companies and acceptance hasn't been universal. So it's going to take a bit of time, but on the other hand, integrated reporting and integrated thinking is the carrot, which is the other part of the circle, and, of course, managers want to measure the performance of their brands and their research and their software and their knowledge. But as you and I know, the financial accounting systems and not always very helpful and sometimes a bit contradictory, accounting by its nature is a conservative discipline. It's intended to be there all the influences of the income tax and the statutory financial reporting and the stock exchanges and so on. But intellectual capital, assets like recipes and brands, trademarks purchased from other firms,we sell the fixed assets and we write them down over the useful life. But if we do these things internally, we call them sum-costs and they included operating expenses. And so now you get a situation where the, the market value of companies is like 20 times the value of the tangible assets because everything's been written off. So the accounting profession has responded to this, this, this whole thing was saying, look, the financial reporting is one thing, but we have to have a disclosure process called integrated reporting. So open above the audited financial statements, we've got these integrated reports which communicate an organization strategy and governance. And so this leads to creation of value in these six capitals make them worth more and eventually to driving a share process. And that's integrated reporting. But reporting success impacts the share price. It impacts the decisions investors make. And so there's two integrated thinking is really the developed to address the process because it involves enormous trade-offs. The decisions that trade offs, the governance that build these forms of capital. You can't keep everybody happy all the time, and so you take them all into account and you make the trade offs. And if you want to see how companies look at those things and do those reports things. A lot of US companies are doing a very good job. Look at Coca Cola, look at Verizon, look at entails lost annual reports and you'll see that they've got a long way down the road in terms of integrated reporting.
So earlier you mentioned particularly environmental capital and you said we would get to that. So I would like to bring that back to light here. I know at Davos as you were talking about stakeholder capitalism was huge and everything you're talking about here, you just summarized everything very well, Bbut another big point of emphasis was climate change and other things that really affect ESG particular to environmental capital. So why should companies really be concerned about this environmental capital and how do you suggest they go about, you know, this awareness and whatever change it is implementing that for their organization.
Mitchell, I'm very glad you brought it up because it happens to be a hobby horse of mine and also something in which I'm near, which I've done some interesting professional work. So yeah, some companies in countries regard reducing the carbon footprint and reducing reliance on fossil fuels to be a grudge purchase, which has imposed by the authorities wile others see us in ongoing and voluntary commitment. But in a word it's managing for sustainability. There are three issues. There's first of all, controlling sustainable consumption. The second, preservation, maintaining biodiversity, and particularly the climate change being driven by the cheap fossil fuel. And the third area is rehabilitation. So then the question is how do you get companies to actually do it if it's a grudge purchase, you know? Well-governed companies should recognize that longterm sustainability depends on management and preservation of the natural capital. It's not just them, it's also right through the supply chain. You know, if you a manufacturer motor vehicles, the person who buys the vehicle is the person who actually puts the emissions into the environment, but you're just as responsible as the manufacturer. So how do you do it? Well as an example, I've been working for some years with a company in the fishing industry here, and the fishing industry is controlled by quarters and the quotas are allocated to individual companies on a year or 18 months basis, and it was a mess. Companies were managing for the short term over fishing the resource, poaching, under declaring the catches and so on. And this company put together a plan and went to the authorities. Tt was a 15 year plan and they said, if you give us the rights to a little piece of ocean for 15 years, here are the capital investments we'll make the kind of tool is the kind of technology, the kind of people that we will do to conserve the species. And they got this 15 years and today they're fishing a healthy and sustainable and paying stock. So it's really about you need to take a longterm view, and the authorities need to take a longterm view if you're going to have sustainable consumption and another part of this is the controversial topic of emissions trading. So, a way of processing those greenhouse gas emissions where people can actually trade the limits or the quotas if they come in under the limit that was given to them. And as I say, some people are in favor of this thing. Some people, others, I think there's tremendous potential for potential there. We probably don't have time to go into today, but imagine a world where you pay, shall we say $10 extra for every wine bottle that you buy. And you know that if you take, take it back to a particular place, you get five or $6 back and the other $4 are going to transport it back to the original manufacturer of those glass bottles. Who's going to rehabilitate that class and put it back into the system. So it's the same principle as the trading, as the emissions trading where you actually monetize the rehabilitation. Okay. And then the third part is of course rehabilitation itself, which nowadays, if you're going to get a mining license, you won't get it unless you've put in rehabilitation plans. And I think what I was stressed about as it has an impact on us financial professionals and data collection is absolutely crucial in managing natural capital, and it's quite challenging for us because it leads us into new scientific areas that we aren't necessarily used to.
I would like to wrap up this conversation and a lot of great information being shared here, but once again, very specifically to our management accounting audience, our finance and accounting professionals, the top of the organization from our function, the CFO, you know, what is their role in managing stakeholder capitalism?
There are three things that I talk to my clients about, and the first one is culture. Someone's got to lead this, this, the creation of an intellectual capital culture that says that these things are valuable, sustainable, where the company's got to go in the fourth I R and so on. And the person who needs to lead that is the CFO. It's not the CTO, it's not the marketing manager, the brand manager. It's going to lead the creation of that culture, and I'll explain why in a few moments. And they've got to create that awareness. Firstly amongst the accounting stuff and then the rest of the organization. This is where the future lies. Accountants need to become evangelists for integrated thinking, to ensure the company manages those tangibles actively not passively. That's the first principle, and the second thing that intellectual resources, even if they have been written off for years in the books are valuable assets, they're not costs. So those are the principles, the cultural principles that you've got to put in into the organization, driven by the CFO. The second thing is the management system. We experts at building management systems. We know how to do strategic planning, budgeting for costing, performance measures, management reporting. We are experts at that, but you need to tweak your management system so that you can measure and control all the elements of an organization. Six capitals because the management systems as you well know have been based for years on just one which which is actually financial financial returns. nd companies like Apple and Microsoft have actually gone a long way down the strip.Which I'm going to share with you when I answer the third question about making companies company's intellectual capital more valuable. So the third thing then in terms of what's the role of the CFO is to start building the right people. So the accounting staff should lead by example. . I’ve said, they need to be evangelical, and the business world is going to change very fast and get tougher. We've all read about this habit of lifelong learning, but it's absolutely essential, and what I say to accountants, you've got to learn to think like an entrepreneur. An entrepreneur takes total responsibility for themselves and for the organization, and for servicing their stakeholders, and that's the attitude you have to adopt. And so in return, of course, the CFO has got to demand there's very high levels of effort and performance from the staff because they are in themselves forms of very expensive forms of intellectual capital, and the company invest a lot of money in them every month. But in the same way that the CFO and the company has got to demand high levels of effort from these intellectual capital resources, the accountants themselves should make equally hard demands in the organization for job satisfaction and stimulation and growth and so on.
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