How We Evaluate CEOs Is Changing, and That’s a Good Thing
Harvard Business Review just published its 2016 ranking of the Best Performing CEOs in the World. The ranking methodology is primarily based on lifetime financial performance, but was updated in 2015 to include a rating of each company's environmental and social governance (ESG) performance, too. This ESG data, weighted at 20 percent of the CEO’s overall score, has made a significant impact on the rankings. The Washington Post reports for example that Jeff Bezos, who ranked number one in 2014, would have stayed in first place if ESG ratings were not taken into account. In the 2016 ranking, Bezos comes in at number 76.
It is a good sign for sustainability practitioners that HBR is taking ESG into account in its ranking system, but it worries me that including these factors have pushed a company with top-ranked, long-term financial returns into a much lower place on the list. We would all like to think that paying attention to ESG is consistent with stronger long-term returns. According to CDP’s A List, companies which make up the STOXX Global Climate Change Leaders Index have earned 6 percent higher returns over the past four years compared to the STOXX Global 1800. This implies that a company that scores poorly on ESG should not have featured highly in a long-term financial returns ranking in the first place.
A couple of things to think about in considering this:
First, ESG ranking systems are notoriously difficult to get right. Where does poverty fit into a ranking for any particular company compared to health impact or carbon emissions or deforestation? How does one judge nutrition impact — is it by the programs a company has in place on genetic modification, sugar, labelling and advertising, or is it by the calorie and protein per unit of sales revenue? To what extent should Amazon be judged by its impact on literacy and access to books vs. working conditions or the carbon emissions of its servers? (For more on sustainability and materiality, check out the recently released Navigator tool from the Sustainability Accounting Standards Board.)
Second, the Washington Post points out from an interview with Michael Jantzi of Sustainalytics, a research firm that specializes in analyzing ESG performance, that European shareholders value ESG issues more than American shareholders. So an ESG-attentive company with a predominance of European shareholders will be rewarded in its share price more so than the same company with a predominance of U.S. shareholders.
Is this because European shareholders believe that ESG is an indicator of a better managed and ultimately better performing company, or because European shareholders take a different view of the role of a company in society, one that is inclusive of a broader impact on society and the environment? Are European shareholders willing to invest in a company partly because of its more attentive approach to environment and society, irrespective of whether or not it has an impact on longer-term returns?
I cannot speak for all of Europe, but there certainly is a strong argument to be made that companies should not be judged by financial returns alone. Last month, Tom Wilson, chairman and CEO of the Allstate Corporation and vice chairman of the U.S. Chamber of Commerce, said in the Washington Post, "We must broaden our evaluation of corporations beyond share prices to provide space, light and water for their role to grow." He argued that it isn’t enough for companies to maximize profits for shareholders, they must also be a force for good in society. This is not a trivial observation coming from a company CEO and senior non-executive leader of the U.S. Chamber, who is likely under continual pressure to let nothing get in the way of maximizing short-term financial returns. Putting Wilson’s principles into action, Allstate has embraced a $15/hour minimum wage and taken the position that climate change poses a significant risk to its business.
I applaud HBR for including ESG factors in its ranking of best performing CEOs. Companies need to continue to rebuild trust (as they have been doing according to Edelman's 2016 Trust Barometer), and irrespective of the difficulty of measurement, their role in society must be broader than purely financial returns.