sustainability – Escondido Framework

The paradox of the anti-woke investor

Fundsmith founder, Terry Smith – No Nonsense?

The Escondido Framework argues that all the market interfaces of the company (with customers for their goods or services – either B2B or B2C, labour, their own suppliers of goods and services, and providers of capital) are essentially similar.

Customers for goods and services make their decisions to purchases on the basis of a variety of characteristics of the offering: quality, product features, after-sales support, credit terms, price and more, and in relation to all of these, the competing alternatives. Employees consider not only the raw salary package, but the variety of employment terms, both hard and soft benefits, company culture and values, corporate reputation, risk, opportunities for career development, and that’s just the start of the list. Suppliers of goods and services also have complex decisions in terms of how they view their customers, whom to serve and how. It is not just a matter of price. For example: is this customer big enough to justify the effort to sell to them compared to the other potential customers out there; can we support the service levels and stock requirements to meet their demands; would our brand be damaged in the eyes of our premium customers if we sell to downmarket segments? And suppliers of funds to companies, whether equity, debt, or hybrid instruments, consider a wide range of trade-offs: risk (reflecting a wide variety of considerations: operational, financial structure, regulatory exposure), term, liquidity, income generation, value growth, portfolio diversification for starters.

So what should we make of the debate raging over ESG informed investment and rise of the vocal “anti-woke” investor?

The Escondido Framework is not a normative model, arguing over rights and wrongs of ESG investment. The model describes the world as it is, and highlights the shortcomings and incompleteness of other models of the organisation. Investors, alongside with consumers, suppliers and especially employees include ESG type considerations in the mix when deciding who to do business with and on what terms. Do I want to be complicit in the destruction of the planet, oppression of minorities, exploitation of disadvantaged populations – whether on a third world plantation or facing an early death through a predisposition to consume addictive toxins (alcohol, tobacco or opiates). ESG is a fact of life in all markets, the only question is the weight and precise form in which it plays into the consideration of all the parties (aka stakeholders) with whom companies interact.

There are conflicting accounts as to whether ESG focussed companies and investment funds deliver superior returns. Part of the problem is one of definition and the nature of the measures employed: movements in share price are a poor metric because any starting point in a share price measure has future performance expectations priced in. However, to the extent that robust taking ESG issues into considerations reflect long term strategic thinking and the combination of transparency to investors and quality in decision-making processes, it is hard to see why and how ESG would not offer great value creation over an “anti-woke” alternative.

The Financial Times has once again (Helen Thomas on 11 January, following an article by Harriet Agnew on 12 January last year) focussed on a spat between “anti-woke” investor Terry Smith of Fundsmith and the leadership of Unilever. Smith has mocked Unilever’s leadership in his annual letter to investors for highlighting its sustainability credentials and for “virtue-signalling ‘purpose’”. He takes issue with Unilever for “purposeful” brands. For example, he comments about soap that “when I last checked it was for washing” dismissing Unilever for talking about “inspiring women to rise above everyday sexist judgements and express their beauty and femininity”. But, as Thomas points out, “the huge success of Dove – one of Unilever’s biggest brands, held up as a marketing case study – suggests a bit of female empowerment and body positivity isn’t a stupid way to sell soap. Rather like efforts to make mayonnaise appealing to health-conscious millennials [Smith laid into Unilever’s account of the “purpose” of Hellman’s last year], Smith just isn’t the target market”.

He is on stronger ground in his criticism of Unilever, which has been subject to a raid by activist Norman Peltz who now has a seat on the board. He complains that Unilever has failed to engage with his fund which had been a long-term holder of Unilever stock and twelfth largest shareholder. Marketing to investors, involving both taking strategic marketing decisions about the proposition provided to the investor (ie the profile of the investment including characteristics such as those listed provide above) as well as communicating with the shareholders, is one of the core responsibilities of the chief executive.

Reading the Fundsmith shareholder letter, I take away the impression that Smith’s criticism of “virtue-signalling” reflects a politically informed discomfort with a company that responds to trends in society and to the new consensus about threats to the environment. However, his language elsewhere and his stated strategy to invest in good companies, hold onto shares for the long term, suggest that he doesn’t recognise that his fund should invest in companies that adopt the underling strategic approach of Unilever (even if not its failure to communicate adequately with large shareholders or its apparently inept approach to large transactions). Given the stated approach (effectively to emulate Warren Buffett), Smith ought to be able to leave his personal politics and any “anti-woke” tendencies outside in the carpark when he comes to work and to recognise the value of purpose and ESG when investing on behalf of his clients.

What We Owe Each Other, by Minouche Shafik

Minouche Shafik, Director of the London School of Economics

There is much to celebrate in Minouche Shafik’s argument that we need a new social contract[1], not least a title that uses the language of obligation and duty rather than employing the language of rights. This is even if she falls back, in her closing remarks, on answering her question of what it is that we owe to each, that it is “to muster the courage and sense of unity” that the Beveridge Report said was necessary for the “winning” of “freedom and want”. I was looking for more, and shouldn’t be too critical her effort at a rallying cry to round off the book when she has addressed a variety of policy measures, without being unduly prescriptive about their precise form, that would address “our interdependencies, provide minimum protections to all, share some risks collectively and ask everyone to contribute as much as they can for as long as they can….investing in people and building a new system of risk sharing to increase our overall well-being”.

Shafik’s underlying argument is that we need a new social contract to meet the needs and opportunities facing both individual society and global society in the 21^st century, including those of an environment threatened by global warming and the degradation from human activity, of an ageing population, of an inequity between generations, and of the alienation of communities left as others have prospered that as consequence poses a threat the liberal democracy. She is qualified for this task by her personal history which includes an affluent childhood in Egypt that exposed her to third world poverty around her before her family emigrated to the USA, a career largely “in the trenches of policymaking” spanning international institutions and in the central government and central banking in the UK, and finally her current appointment as Director of the London School of Economics in 2017 where she launched a programme of research, ‘Beveridge 2.00’, to rethink the welfare state.

Having spent many years in healthcare and the application of health economics, I felt initially that her chapter on health was skated over too much. But this was before I reflected that the chapters outside my own area of knowledge were throwing me snippets of valuable information and new insights that left me with respect for the ambition within her 189 very readable pages (Thomas Piketty could learn a thing or two from Minouche Shafik!). Plenty of the examples in this book are familiar, such as the marshmallow test, but others cited, such as the evidence of the value of quite modest investment in early years intervention, such as weekly hour-long visits by Jamaican community health workers for 2 years to encourage mothers to interact and play with their children to develop cognitive and personality skills that 20 years later yielded 42% higher earnings than the control group.

Shafik sensibly avoids too many narrowly defined prescriptions, reflecting on data presented in the book that different countries have successful applied different policy solutions (for example in how they fund and organise healthcare) to achieve broadly similar outcomes (even if the one nation in the case of healthcare that doesn’t do this in a coherent way – the United States – ends up spending far more in aggregate, and in terms of public money, than everywhere else only to realise worse outcomes). However, the general thrust of her argument in each area of policy is clear.

Shafik poses interesting questions around the intergenerational social contract. On one hand, younger generations are blessed with material well-being that the old generations could not have dreamt off. On the other hand, as David Willetts documented in the The Pinch[2], the millennials and generation Z have good reason to be aggrieved as they pay for the higher education and the home ownership enjoyed by their parents appears out of reach. Shafik recognises, in the emphasis that she places on investment in education in new social contract and various mechanisms for achieving this that she suggests. There is also the issue of the price that they and future generations will pay in terms of the environmental degradation resulting from the previous generations’ approach to achieving their wellbeing and economic growth. I am surprised at the complexity that she builds in to potential solutions to this when the solution should lie in regulation, a national income calculus that better reflects the value of the natural world that currently calculated GDP or national income, and environmentally based taxes that capture the externalities of industrial and agricultural activity that damages the environment.

The book also gives rise to a set of interesting questions about what this means for businesses. Where do they sit within this narrative? There are important lessons for the people who sit at the heart of businesses, the “controlling minds” in terms what they can do, both in relation to their own workforces, customers and suppliers, in terms of contribution to a new social contract. For the business to thrive, and sustain itself in the long term, the core lesson is that it should be a player, alongside the individual citizen, in such a new social contract. Otherwise, its profitability and in due course its survival will be undermined by the very same pressures the Shafik describes threatening both individuals and liberal democracy.

I have a fear about one element in the approach Shafik takes to the need for a new social contract. This relates to what goes into the “increase in our overall well-being”. Some of the steam that is driving populism is increasing material inequality and the sense that communities are being “left behind”. Some of this populism is a function of identity politics, which may be whipped up by the perception that communities with other identities (often, but not exclusively, framed by other ethnicities or immigrant groups) are posing an economic threat or gain an advantage. But the perception may nothing to do with actual material wellbeing. Indeed, in the case of some of the 52% of the British population voting for Brexit, or the potential majority in Scotland for independence from the UK, this may be a desire to escape from or avoid the “other” despite the prospect that of material disadvantage. Some may be seduced by arguments that “getting back control” will leave them better off materially, but many others take the view that independence from Europe or the UK is more important than the economic benefit of remaining part of the whole. There is, at least at an abstract level, a link between the communitarian spirit in Shafik’s argument for a social contract “that addresses our interdependencies” and the desire to be part of a union, whether of states sharing a continent or Kingdoms sharing a small archipelago at the continent’s north western edge. Those same people who resist the membership of the country they occupy in a union of countries are also likely to be those most resistant to her arguments for a renewed social contract.

[1] Shafik, Minouche (2021). What We Owe Each Other: A New Social Contract. ISBN 978-1847926272.

[2] Willetts, David (2010). The Pinch: How the Baby Boomers Took Their Children’s Future – And Why They Should Give It Back. ISBN 978-1848872318.

Applying the Escdondido Framework to Dark Ages Britain

I often wonder about the applicability of the Escondido Framework model of the firm to organisations in other cultures and at other times to the developed world in the 21^st century . One of the claims of the Escondido Framework is the degree to which it can be applied universally. Certainly, the model can be applied to public sector and third sector organisations, and can be applied wherever there is some sort of corporate collective structure that can be shown to create value that is greater than the sum of the efforts of the people who are working together within the structure if they were together in a set of discrete collaborations brought about by a set of separate agreements (whether explicit or implicit).

I have just completed reading Max Adams’ account of Britain in the 5^th to 7^th centuries, The First Kingdom[1]. This covers the period often known as the Dark Ages, following the departure of the Roman Empire and before settled control of England by Anglo-Saxon rulers in the Heptarchy. He pieces together the considerable research undertaken in recent years to describe a fragmentation of society, depopulation of most cities and towns and replacement by what may in many respects to a pre-Roman pattern of village economies and local tribal leadership, subject to incursions by Viking and north German raiding parties, but still with some loose links to continental Europe, with the Christianity that had arrived in the Roman period hanging on in places prior to reintroduction both from Ireland with Colme Cille (St Columba) and with St Augustine from Rome, and with continuing trade.

One of the key themes of the Escondido Framework is the identity of the corporation independent of stakeholders, the “societé anonyme” whose ultimate purpose is to survive, and which outlives its “controlling mind”. Adams marks the end of the period that he is describing by an important transition, from one in which the individual “kingdoms” were pretty fluid, some very small and sitting within and subject to other kingdoms (in a system described as Tribal Hidage), and most regimes pretty ephemeral.

“Victory on the battlefield and political success measured in tribute and booty secured the loyalty of secular élites for their king and his eligible successors; but for a life interest only. Defeat, if not fatal, weakened a king and exposed him to internal coup of external domination…..The luck of the tribe was invested so heavily in the person of its kings that when they died any imperium that they may have exercised over rival kings was void.

“As Bede so vividly described it, the pagan supernatural experience was in some sense like the passing of a sparrow into and out of a hall whose warmth and fellowship matched their brief period of Earth while all before and after was cold darkness unknown…..

“Pagan kingship was not stupidly irrational. Rulers were bound by conventions of honour, reciprocity and political pragmatism. They calculated odds as coolly – and with about as much reliance on superstition – as any politician or football coach whose tenure might be equally precarious.”[2]

But this changes with a new social contract, between church and king, that reflects the new world being constructed with the arrival of Christianity and the conversion of the rulers, whose souls continue after death. Adams cites a law of Wihtred, king of Kent 690 -725: “The Church shall enjoy immunity from taxation; and the king shall be prayed for” before noting:

“The rapid seventh-century establishment of monastic communities across the Insular kingdoms, supported by extensive, formerly royal estates and nurture by their relations with kings, parallels the history of secular territorial lordship founder on the right to exact and collect renders from lands and communities, but with a a critical difference. The unique brilliance of this new social contract was to convert landed assets otherwise held for a mere life interest – the so-called folcland held by the thegns and gesiths form the king, which returned to the royal portfolio on their death – into a freehold bocland of abbots and abbesses. Bocland or bookland – what we would call freehold – was fundamental to a relationship meant to last for eternity on Earth and in heaven. It allowed the church to invest in physical labour and material wealth in permanent settlements free from the obligation of military service and taxation; to capitalize agriculture an technology. It laid the foundations for a literate, institutional clerical caste and formation concepts of obligations owed by kings to their people.”

Permanence is the key word – even if in due course the success of the monastic corporations became the seed of their undoing at the Reformation. The monastery or convent was greater than the abbot or abbess. The kingdom also secured more permanence, even if an institutional fluidity remained until the major kingdoms of the Heptarchy progressively consolidate and became on under Athelstan in the 10^th century.

[1] Adams, Max (2021). The First Kingdom: Britain in the Age of Arthur. ISBN-13 : 978-1788543477

[2] Ibid. pp 398 -399.

Investors and consumers both need good sustainability reporting

The FT has been carrying stories for the past two weeks about improving the quality of information provided by companies to their investors on the environmental impact of their activities and the sustainability of their businesses in the face of climate change. It may just be a coincidence, or it may be a conscious decision of the editorial board, but the Fashion Editor writes in “Life and the Arts” section of the Weekend FT on the same subject under the headline “Sustainable fashion? There’s no such thing”

On 5^th November, Erkki Liikanen, Chair of the IFRS Foundation Trustees, delivered the keynote speech at the UNCTAD Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting, introducing the Trustees’ Consultation Paper on Sustainability Reporting.

On 9^th November, Rishi Sunak, Chancellor of the Exchequer, delivered a speech to the House of Commons on financial services. In the course of setting out his plans for supporting the City at the end of the transition period as the UK leaves the EU and plans to launch a Sovereign Green Bond, he declared:

“We’re announcing the UK’s intention to mandate climate disclosures by large companies and financial institutions across our economy, by 2025.

“Going further than recommended by the Taskforce on Climate-related Financial Disclosures.

“And the first G20 country to do so.

“We’re implementing a new ‘green taxonomy’, robustly classifying what we mean by ‘green’ to help firms and investors better understand the impact of their investments on the environment.”

On 10^th November, the Financial Reporting Council launched its Statement on Non-Financial Reporting Frameworks, opening with the preamble:

“Climate change is one of the defining issues of our time and, by its nature, material to companies’ long-term success. Boards have a responsibility to consider their impact on the environment and the likely consequences of any business decisions in the long-term. Our 2020 review of climate-related considerations in corporate reporting and auditing found that boards and companies, auditors, professional associations, regulators and standard-setters need to do more.”

before recommending that companies should try to report “against the Task Force on Climate-related Financial Disclosures’ (TCFD) 11 recommended disclosures and, with reference to their sector, using the Sustainability Accounting Standards Board (SASB) metrics” and setting out its own plans over the medium term to help “companies to achieve reporting under TCFD and SASB that meets the needs of investors”.

Today, 14^th November, the FT’s fashion editor writes about the dilemmas facing those of her readers who are concerned about the impact of their purchasing decisions. She recognises that the best way to live a sustainable life is to buy less, but also that her readers want to find ways, while supplementing and refreshing their wardrobes, to plot their way through the “greenwash” claims of the fashion brands. Both these consumers and some of the brands themselves want clearer and more reliable accreditation of products that come from supply chains that are, if not truly environmentally friendly, at least less environmental unfriendly.

Following up the themes in this article, I found a great piece written by Whitney Bauck in Fashionista, in April last year:

“If you’re aware that there are ethical issues baked into making clothes but don’t have time to do in-depth supply chain research every time you need a new pair of socks, there’s a good chance you’ve thought at some point: ‘If only someone could just tell me for sure if this brand is ethical or not.’

“You wouldn’t be alone in that desire. In years of writing about both sustainability and ethics, it’s a sentiment I’ve heard from fashion consumers a lot. While many people want to be more conscious with their consumption, they also wish it were easier to tell which brands are truly being kind to people and planet.

“If you fall into that category, there’s good news and bad news. The bad news is that a one-size-fits-all ethical fashion certification will probably never exist, partly because not everyone agrees on what qualifies as “ethical.” Should that word refer to job creation in impoverished communities or animal welfare? Should it mean making clothes from organic materials or recycled synthetic ones? Not every ethical fashion fan has the same standards or priorities, and that will always make a one-size-fits-all approach to ethical fashion certification difficult.”

I wrote in a blog post four years ago about the benefits that the team I led at WH Smith believed would arise from developing and selling green stationery ranges. The issues described by Lauren Indvik in the FT are nothing new. We faced similar challenges both in terms of selecting products and in terms demonstrating to our customers that buying these products would better than buying alternatives.

The challenges facing investors and consumers in taking environmental and other ethical considerations into account in what are otherwise commercial decisions are identical. Both investors and consumers want the best information, to put into the mix with the other things that influence their decisions – the complex trade-offs of exposure to multiple risks, timing, and return for the investor, or look, feel, comfort, durability, after sales support and cost* for the consumer.

The similarity between these challenges is evidence for the symmetry in all businesses – investors are customers for investment opportunities presented by the company, in the same way that consumers are customers for products and, indeed, that employees are customers for the jobs that companies provide. In an age when people – in their multiple roles as investors, consumers, and employees – want to invest in, buy from, and work for organisations that behave responsibly in relation to wider society and to the environment, they need reliable information to inform their decisions.

* and a host of other possible features depending on the product or service category

Moody’s says Lloyds’ ethnic diversity plan is ‘credit positive’

The Financial Times reports today that Lloyds Banking Group’s plans for promoting more black employees have been described by Moody’s as “credit positive”, the first time that a credit agency has explicitly linked a company’s stability to ethnic diversity measures. Moody’s has not gone as far as to upgrade Lloyd’s credit rating at this point, but it clearly indicates that Lloyds’ plans are “credit positive [implying that they have the potential to reduce the company’s cost of capital, even if not immediately] because they will improve staff diversity at all levels and reduce Lloyds’ exposure to social risk”.

Lloyds has stated that it recognises that some groups are under-represented in its ranks. Anyone viewing the current TV advertising campaign for its domestic mortgage lending arm, Halifax, showing a diverse mix of staff ready to serve customers despite working under Covid-19 restrictions at home, can see that Lloyds is not talking about front-line staff in this instance. It has set a target to increase five-fold the number of black staff in senior roles by 2025 and will be publishing data on its ethnicity pay gap.

Investors and rating agencies have been taking increasing account of environmental, social and governance (ESG) risks, reflecting the importance of sustainability, on all measures, to the corporation and to those who invest in it or lend to it. The note about Lloyds published by Moody’s on Thursday is a welcome acknowledgement of the work Lloyds is undertaking. Action of this sort should improve internal culture, communication, engagement and ultimately operational performance and profitability. The motivation behind showing a diverse face to the TV audience is that it contributes to winning customers and increasing revenue. The response of Moody’s suggests that yields benefits in addressing the capital market interface, ultimately increasing access to capital and reducing its cost.

Let us hope that Moody’s response to Lloyds’ efforts spurs others to recognise that action on equality, diversity and inclusion is good for business.

Shifting the dial on purposeful business: what can we learn from crises, past and present, in solving the problems of people and planet?

The fifth and final session of the British Academy Future of the Corporation – Purpose Summit was a disappointment after some of the high points of the earlier sessions, but was rescued by an inspiring closing contribution from Mohamed Amersi, whose Amersi Foundation is one of the principal sponsors of the Future of the Corporation programme.

The essential shortcoming of the session was that it failed to address its intended subject or answer the question set in its title. I was left with the impression that, particularly with the backdrop of the Covid-19 pandemic, the organisers felt that they would be failing to notice the elephant taking up most of the room if they didn’t address business purpose in times of crisis. As keynote speaker, Mark Carney tried to combine his experience as a central banker through the financial crisis and its aftermath with his appointment as UN Special Envoy for Climate Action and Finance. He made the case for a strategic reset to deliver “Net Zero” to address climate change, argued for corporations to be required to disclose how they contribute towards reducing carbon emissions, but did not manage to articulate how this relates corporate purpose. In Escondido Framework terms, the appetite of investors and consumers to do business with organisations that are addressing climate change and the restrictions and/or incentives provided by governments reduce carbon emissions shape the market interfaces of the firm, and the interest of the firm in its own sustainability should encourage it to behave sustainably, but they don’t change the corporate purpose.

Following Carney’s contribution, the session moved onto a panel discussion. As CEO of SSE, an electricity utility, Alistair Phillips-Davies had an easy job relating the changes made to his company’s corporate purpose in relation to the climate crisis. He further argued that clarity of corporate purpose helped everyone in his company respond appropriately to the current Covid-19 crisis, albeit that this sounded like a general statement about how it was good for the company’s reputation to be seen to behave responsibly when this latest crisis hit. The session then wandered, as it seemed unclear whether the discussion should be about how companies respond to crises, in particular whether they should be holistic and strategic or driven by short term financial optimisation, or whether companies should become principals in addressing the crises themselves, which seemed to be the line adopted by Ngaire Wood of the Blatavnik School.

I was left frustrated as Colin Mayer tried to sum up both this discussion and the material covered over the three days of the summit, ultimately feeling that we were left with a laundry list rather than an understanding of purpose, and that this final session had left the impression that the purpose of the organisation had been reduced to steering the organisation through the crisis. This may be consistent with the thesis that an organisation can be viewed as an organism whose purpose is to survive, but it falls short of the Escondido Framework understanding the purpose of the organisation is to create value for society than cannot be created through a set of atomised transactions.

Mohamed Amersi was given a few minutes to wrap up the summit and, for me, saved the day. He referred back to the 1850 charter of his family’s business which stated its duty to its “superior creator”, suppliers, those served [ie customers], the state, shareholders, surroundings and society. He described the challenges we face today as planetary sustainability, inequity and technology. He spoke of modern society by way of an analogy with an apartment block containing a flooded basement, crowded middle floors and a growing penthouse, but with a broken elevator. He despaired of top-down organisations in which no-one is actually in control and argued that is up to everyone to act – “If not you, who? If not now, when?”