Why the road to stakeholder capitalism begins with diverse boards

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Ronald P. O’Hanley, Chairman and Chief Executive Officer, State Street

1. Ronald P. O’Hanley Chairman and Chief Executive Officer, State Street

• Stakeholder capitalism aims to ensure economies improve society and protect the planet.

• We need diverse leadership in the boardroom to reflect various stakeholder interests.
• Investors, regulatory bodies and corporate boards are thinking beyond “profit at all costs”, but more can be done.

The age of stakeholder capitalism has arrived. The question is, how do businesses shift from an exclusive focus on financial performance for shareholders toward generating shared value for shareholders and other stakeholders? How do we make stakeholder capitalism more fully lived and felt.

I believe that the road begins with corporate boards. Specifically, high-quality, diverse, and independent board leadership that can navigate differing priorities and horizons among constituencies. I use the word diverse in its broadest sense: a definition that starts with non-uniformity of thought and encompasses race and ethnicity, gender and sexual orientation, religion and age, geographic and socioeconomic backgrounds, and more.

Diverse boards perform better

A Harvard Business School study found that women brought to the boardroom a different set of perspectives, experiences, angles, and viewpoints than their male counterparts. Similarly, a McKinsey study found that companies in the top quartile for gender diversity on executive teams were 25% more likely to have above average profitability than companies in the fourth quartile. Related to ethnic and cultural diversity, McKinsey found top quartile companies outperformed those in the fourth quartile by 36% in profitability.

What’s the World Economic Forum doing about diversity, equity and inclusion?

The COVID-19 pandemic and recent social and political unrest have created a profound sense of urgency for companies to actively work to tackle inequity.

The Forum’s work on Diversity, Equality, Inclusion and Social Justice is driven by the New Economy and Society Platform, which is focused on building prosperous, inclusive and just economies and societies. In addition to its work on economic growth, revival and transformation, work, wages and job creation, and education, skills and learning, the Platform takes an integrated and holistic approach to diversity, equity, inclusion and social justice, and aims to tackle exclusion, bias and discrimination related to race, gender, ability, sexual orientation and all other forms of human diversity.

The Platform produces data, standards and insights, such as the Global Gender Gap Report and the Diversity, Equity and Inclusion 4.0 Toolkit, and drives or supports action initiatives, such as Partnering for Racial Justice in Business, The Valuable 500 – Closing the Disability Inclusion Gap, Hardwiring Gender Parity in the Future of Work, Closing the Gender Gap Country Accelerators, the Partnership for Global LGBTI Equality, the Community of Chief Diversity and Inclusion Officers and the Global Future Council on Equity and Social Justice.

While these studies suggest that boards should consider business strategy through the lens of various stakeholder interests, it’s incumbant upon boards to reflect those constituencies in their own organizations.

Regulatory bodies and companies are paying attention

NASDAQ’s Board Diversity Rule, approved by the Securities and Exchange Commission (SEC) in August 2021, is a disclosure standard designed to foster board diversity and provide greater transparency to stakeholders. In 2020, Goldman Sachs – one of the largest underwriters of initial public offerings – announced it would not take companies public in the US or Western Europe if they did not have at least one diverse board member. In July 2021, the company doubled that requirement to two, one of which must be a woman. Another example is from our asset management business State Street Global Advisors’ Fearless Girl campaign, which began in 2017, and seeks to promote and advance gender representation on corporate boards.

How can boards advance diversity, equity and inclusion?

Recently, State Street Global Advisors partnered with Russell Reynolds Associates and The Ford Foundation to glean best practices for boards on how to advance racial and ethnic diversity, equity, and inclusion (DEI). We’ve highlighted three key recommendations below (see image for the full list):

• Build a board with diverse directors that have experience with DEI oversight. Boards must prioritize DEI in their director recruitment efforts, both to improve the diversity of the board itself and to recruit directors who understand the importance of overseeing DEI within the business. As boards are regularly refreshed, recruiting directors who value diverse perspectives is essential.
• Make racial equity an active part of the business strategy and culture, and work toward clear and quantitative KPIs. As one director said, “You need to get the board to treat DEI like any other important part of the strategy – we shouldn’t be treating this any differently than any other business process.”
• Make DEI both a strategic and tactical responsibility. Boards should address DEI at the full board level as a strategic conversation but also in committees at a tactical level.

Companies with ESG credentials are more resilient

The crises of the past two years have shined a powerful light on the interconnectedness of stakeholders and made a strong case for a multi-constituency approach. Investors are sitting up and taking note, as demonstrated by ESG stock performance during the pandemic. While fund performance varies and should be evaluated on an individual basis, the aggregate picture paints a convincing argument that companies with superior ESG practices display greater resilience and preserve long-term value more effectively than peers during times of market stress.

It is important to note here that most investors – such as pension funds and sovereign wealth funds – have long-term liabilities they need to meet on behalf of clients. These liabilities extend over years and in some cases decades, so investing with a focus on long-term returns and value preservation/creation is essential among these investors.

While the pandemic cast the notion of stakeholder capitalism in sharp relief, part of this conversation points to historic shifts from tangible to intangible assets. In the past, markets and investors measured company value using conventional financial yardsticks developed for asset-intensive businesses. This approach, however, no longer captures the full value picture – both in terms of risk and opportunity – because today it is often a company’s intangibles that are the real drivers of value. Consider certain tech and software companies: what are their significant hard assets?

The growing acceptance of ESG across the financial sector shows that investors are beginning to recognize the intangibles upon which we all depend. This newfound acknowledgment and pricing in of integral things that matter – including natural, human, and social capital – points to the interconnectedness of stakeholders and the need for boards to reflect that broader view.

Moving from shareholder to stakeholder

Milton Friedman declared in 1970 that in a free market public companies exist “solely to serve shareholders.” He also cautioned against permitting corporations to externalize costs on society. These days shareholder interests remain important, but climate change, technological disruption, a more fully intertwined global economy, and rising income inequality are illustrations of such externalities. No business – and certainly not publicly traded ones – exists in a vacuum.

This change in mindset is not insignificant. It represents shifting focus from maximizing short-term returns toward goals that help ensure longer-term value creation, including bolstering resiliency, increasing DEI, and paving the road to net-zero. Imagine a camera aperture opening to reveal a close-up shot of a quarterly statement and gradually widening to show a company’s factory floor, its shipping center, the community charity where its employees volunteer, the supply chain, carbon footprint, and finally its environmental vulnerabilities.

Putting this more comprehensive vision into practice begins with boards that can see, hear, appreciate, and thoughtfully weigh multiple constituent needs. Skillful, diverse board leadership can help businesses overcome myopic thinking and widen their view for the benefit of all.