Tag Archives: ESG Scores

The Vampiric Nature of “Stakeholder” Capitalism

21 Thursday Jul 2022

Posted by in Capitalism, Human Welfare

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When so-called “stakeholders” are in charge of a company, or when non-owner “stakeholders” receive deference to their various goals from management, the actual owners have been displaced and no longer have control. That represents a kind of taking in which managers are complicit, failing to keep proper vigilance in their duty to maximize value for shareholders.

Ceding control to stakeholders represents a severe dislocation in the principle-agent relationship between owners and corporate management. Virginia Postrel is on-point in her discussion of the failures of “stakeholder capitalism”, but she might as well just say that it isn’t capitalism at all! And she’d be right!

Stakeholder capitalism represents a “theory” of the firm that accepts an array of different goals that often stand in conflict. This is the key point raised by Postrel. She cites Michael C. Jenner’s 2010 paper on stakeholder theory in which he notes the impossibility of maximizing any single-valued objective in the presence of a multi-dimensional corporate objective function. Thus, stakeholder objectives nearly always subvert management’s most important responsibility: maximizing value for owners.

And just who are these “stakeholders”? The designation potentially includes just about anyone and everyone: managers, customers and potential customers, suppliers and potential suppliers, employees, the pool of potential job applicants, union organizers, regulators, community members and organizations, local governing bodies, “underserved” populations, anyone with a grievance, environmental activists, and the children of tomorrow. Sure, owners are part of the broad set of stakeholders as well, but as Jenner more or less noted, who’s got time to maximize profits in the face of the myriad “claims” on company resources by the larger, blood-sucking hoard?

George Will aptly refers to stakeholder capitalism as “parasitic progressivism”. In fact, in his opening sentence, he notes that the very term “stakeholder” is a form of semantic infiltration, whereby the innocent (and ignorant) adoption of the term is a gateway to accepting the agenda. Will also notes that management deference to stakeholders violates fiduciary laws intended to protect owners, which include worker pensions and 401(k)s, as well as small investor IRAs, charitable organizations, and insurance companies funding life insurance policies and annuities.

This behavior is not merely parasitic — it is truly vampiric. Once bitten by the woke zombie corpses of stakeholder capitalism, either from within the organization or without, the curse of this deadly economic philosophy spreads. Human resource organizations impose diversity, equity, and inclusion training, rules, and hiring practices on operations. Suppliers might be imposed upon to not only deliver valued inputs, but to do so in a way that pleases multiple stakeholders. Woke fund managers, upon whom the firm might rely for capital, will insist on actions that promote social and environmental “justice”. It can go on and on, and no amount of appeasement is ever sufficient.

Unfortunately, there really are activist investors — actual stockholders — who encourage this misguided philosophy. If the majority of a firm’s owners wish to be accountable to the whims of particular non-owner stakeholders, that’s their right. Other investors would be wise to sell their shares… fast! Wastrels and incompetents have blown many a great and small fortune over the years, but capital markets are well-equipped to punish them, and eventually they will. Get woke, go broke!

The best way for a firm to maximize its contribution to society is to do its job well. That task involves producing a good or service that is valued by customers. By doing it well and efficiently, shareholders, customers, employees and society all win. This is the magic of mutually beneficial trade! Produce something that customers value highly while being mindful of tradeoffs that allow resource costs to be minimized. In general, the customers extract surplus value; shareholders extract surplus value; suppliers extract surplus value; and employees extract a surplus value because they receive wages at least as high as the lowest “reservation” wages they’d find acceptable. Here are some comments from Don Boudreaux on this general point:

“… regardless of how well or poorly managers are at running their companies in ways that maximize share values, there’s every reason to believe that managers will be much less competent at running their companies in ways that adequately satisfy ‘stakeholder’ interests. Not only is the definition of ‘stakeholder’ inherently open-ended and ambiguous, even the most skilled managers have no way to know how to trade-off the well-being of one set of ‘stakeholders’ for that of another set.”

This is very nearly a restatement of Jenner’s conclusion, but Jenner’s applies even when managers know specifics about the tradeoffs. Generally they don’t! Remember too that the firm, its shareholders, suppliers, and its employees are all subject to taxes on their surplus values, so their contribution to society exceeds their own gain. Moreover, many firms are already regulated precisely because lawmakers believe government has an interest in protecting larger classes of “stakeholders”. But beyond meeting regulatory requirements, to further insist that firms devote less than their remaining energies and resources to doing their jobs well, and to ask them to focus instead on the varied interests of external parties, whomever they might be, is ultimately a prescription for social harm.

A monster child of stakeholder theory is so-called ESG scoring. ESG stands for Environmental, Social, and Governance, and the scores are intended as “grades” for how well a firm is addressing these concerns. Proponents claim that high ESG’s are predictive of future returns, but that’s true only if lawmakers and regulators look upon these firms with favor and upon others with disfavor. ESG is basically a political tool. Otherwise, it is an economically illiterate notion foisted upon investors by political activists embedded in “woke” financial institutions like Blackrock and Bank of America. There be some real vampires! As David Henderson and Marc Joffe write, ESG fuels higher prices and obstructs economic growth. That’s because it formalizes the effort to serve “stakeholders”, thus raising the cost of actually producing and delivering the good or service one naturally presumes to be the firm’s primary mission. The shareholders pay the cost, as do customers and employees.

When I hear business people talk reverently about serving their “stakeholders” (and when I hear naive investment advisors wax glowingly about ESG scores), it sends up huge red flags. These individuals have lost sight of their valid objectives. They should be trying to run a business, not serving as a grab-bag for other interests. Serve your customers well and efficiently so as to maximize value for shareholders. Do so within the bounds of the law and ethics, but stick to your business mission and the parties to whom you are ultimately accountable!

Markets Deal With Scarcity, Left Screams “Price Gouging”

11 Monday Apr 2022

Posted by in Antitrust, Environmental Fascism, Oil Prices

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Democrats claim profiteering by oil companies is responsible for the sustained rise in oil prices since Joe Biden’s inauguration (really, his election). That’s among the more laughable attempts at gaslighting in recent memory, right up there with blaming market concentration for the sustained increase in inflation since Biden’s inauguration. At a hearing this week, congressional Democrats, frightened by the prospect of a beat-down just ahead in the mid-term elections, couldn’t resist making “price-gouging” accusations against oil producers. These pols stumble over their own contradictory talking points, insisting on more oil production only when they aren’t hastily sabotaging oil and gas output. Their dishonestly is galling, but so is the foolishness of voters who blindly accept the economic illiteracy issuing from that side of the aisle.

Break It Then Blame It

Those who level “price gouging” charges at oil companies are often the same people seeking to eliminate fossil fuel consumption by making those energy choices unaffordable. The latter is a bad look this close to mid-term elections, so they follow the playbook I described recently in “Break the Market, Blame It, Then Break It Some More“. And this post is instructive: “House Dem: Big Oil is profiteering by, er … doing what we demanded”.

Not only have the Democrats’ policies caused oil prices to soar; for many years they’ve been undermining the stability of the power grid via forced conversion into intermittent renewable energy sources like wind and solar, all while preventing the expansion of safe and carbon-free nuclear power generation. It’s ironic that these would-be industrial planners seem so eager to botch the job, though failure is all too typical of central planning. Just ask the Germans about their own hapless efforts at energy planning.

As economist Lawrence Summers, former Treasury Secretary under Barack Obama, said recently:

“Look, the net effect of the things the administration talks about in terms of micro policies to reduce inflation, this gouging talk is frivolous, nonserious, and utterly ineffectual. A gas price holiday would, ultimately, push up prices by raising demand. … The student loan relief … is injecting resources into the economy at a hundred billion dollar a year annual rate when the economy needs to be cooled off, not heated up. … The administration could be much more constructive than it has been with respect to energy supply.”

The market functions to allocate scarce resources. When conditions of scarcity become more acute, the market mechanism responds by pricing available supplies to both curtail use and incentivize delivery of additional quantities. That involves the processing of vast amounts of information, and it is a balancing at which the market performs extremely well relative to bumbling politicians and central planners, whose actions are too often at the root of acute scarcities.

Antitrust Nonsense

Of course, the Democrats have seized upon the inescapable fact that soaring oil prices cause profits to soar for anyone producing oil or holding stocks of oil. But oil company profits are notoriously volatile. Margins were negative for most of 2020, when demand weakened in the initial stages of the pandemic. And now, some companies are bracing for massive write-downs on abandoned drilling projects in Russia. The oil and gas business is certainly not known for high profit margins. Short-term profits, while they last, must be used to meet the physical or financial needs of the business.

The threats of antitrust action by the Biden Administration are an extension of the price-gouging narrative, even if the threat reflects an injudicious grasp of what it takes to prove collusion. It takes a fertile imagination to think western oil companies could successfully collude on pricing in a market dominated by the following players:

Fat chance. In any case, it’s a global market, and it’s impossible for western oil producers to dictate pricing. Even the OPEC cartel has been unable to dictate prices, not to mention keeping it’s members from violating production quotas. But if a successful conspiracy among oil companies to raise prices was possible, one would guess they’d have done it a lot sooner!

Nor is it possible for the oil majors to dictate prices at the pump, because retail prices are set independently. While the cost of crude oil is only about 54% of the cost of refined gas at retail, fluctuations in prices at the pump correlate strongly with crude oil prices. Here is a ten-year chart of daily price data, where the blue line is the price of West Texas Intermediate crude oil and the orange line is the average price of regular gas in the U.S.:

Here are the same two series for 2022 year-to-date:

Coerced Scarcity

Again, oil prices have been under upward pressure for over a year until a break in early March, following the steep run-up in the immediate wake of the Ukraine invasion. First there was Biden’s stultifying rhetoric, before and after the 2020 election, assisted by radical members of Congress. Then there were executive orders halting drilling on federal lands, killing the Keystone pipeline, efforts to shut down several other existing pipelines, and the imposition of regulatory penalties on drillers. In addition, unrest in certain parts of the Middle East curtailed production, compounded this year by the boycott on Russian oil (which, as a foreign policy matter, was far too late in coming).

However, existing facilities have been capable of squeezing out more oil and gas. Lo and behold, supply curves slope upward, even in the short-run! Despite all of Biden’s efforts to cripple domestic oil production, higher crude prices have brought forth some additional supplies. Biden’s raid on the Strategic Petroleum Reserve has also boosted supply for now, but its magnitude won’t help much, and it must be replaced for use during real U.S. national emergencies, which the war in Ukraine is not, as awful as it is.

That said, investing in new drilling capacity is not wise given the political climate created by Biden and the Democrats: they have been quite clear that they mean to crush the fossil fuel industry. For some time, the oil companies have been busy investing cash flows in “green” initiatives in an effort to bolster their ESG scores, a dubious exercise to say the least. Arguably, in this policy environment, the most responsible thing to do is to return some of the capital over which these firms are stewards to its rightful owners, many of whom are middle-class savers who hold oil stocks in their 401(k) funds. That approach is manifest in the recent stock buybacks and dividend payments oil companies have announced and defended before Congress.

Conclusion

A forced shutdown of fossil fuel energy was much ballyhooed by the Left as a part of Joe Biden’s agenda. Biden himself bought into the “Green New Deal”, imagining it might win him a vaunted place alongside FDR’s legacy in American history. The effort was unwise, but Biden is trying to hang onto the narrative and maintain his punitive measures against American oil companies. All the while, he begs OPEC producers to step up production, bending a knee to despots in countries such as Iran and Venezuela. Why, it’s as if their fossil fuels are somehow cleaner than those extracted in the U.S! The feeble Biden and congressional Democrats are proving just how mendacious they are. They can rightfully blame Vladimir Putin for the recent escalation in oil prices, but they bear much responsibility themselves for the burden of high gas prices, energy bills, and the unnecessary, ongoing scarcity victimizing the American public.

The SEC’s Absurd Climate Overreach

04 Monday Apr 2022

Posted by in Central Planning, Global Warming

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The Securities and Exchange Commission recently issued a proposed rule for reporting on climate change risk, and it is fairly outrageous. It asks that corporations report on their own direct greenhouse gas emissions (GHG – Scope 1), the emissions caused by their purchases of energy inputs (Scope 2), and the emissions caused by their “downstream” customers and “upstream” suppliers (Scope 3). This is another front in the Biden Administration’s efforts to bankrupt producers of fossil fuels and to force the private sector to radically alter its mix of energy inputs. The SEC’s proposed “disclosures” are sheer lunacy on several levels.

The SEC Mandate

If implemented, the rule would allow the SEC to stray well outside the bounds of its regulatory authority. The SEC’s role is not to regulate emissions or the environment. Rather, as its web site makes clear, the agency is charged with:

“… protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.”

Given this mission, the SEC requires management to disclose material financial risks. Are a firm’s GHG emissions really material risks? The first problem here is quite practical: John Cochrane notes the outrageous costs that would be associated with compliance:

“‘Disclosure’ usually means revealing something you know. A perfectly honest answer to ‘disclose what you know about your carbon emissions’ is, ‘we have no idea what our carbon emissions are.’ Back that up with every document the company has ever produced, and you have perfectly ‘disclosed.’ There is no asymmetric information, fraud, etc.

The SEC has already required the production of new information, and as Hester Peirce makes perfectly clear, the climate rules again make a huge dinner out of that appetizer: essentially telling companies to hire a huge number of climate consultants to generate new information, and also how to run businesses.”

In a separate post, Cochrane quotes SEC Commissioner Hester Peirce’s response to the proposed rule. She emphasizes that companies are already required to disclose all material risks. Perhaps they have properly declined to disclose climate risks because those risks are not material.

“Current SEC disclosure mandates are intended to provide investors with an accurate picture of the company’s present and prospective performance through managers’ own eyes. How are they thinking about the company? What opportunities and risks do the board and managers see? What are the material determinants of the company’s financial value?”

Identifying the Risk Causers

Regardless of the actual risks to a firm caused by climate change, the SEC’s proposed GHG disclosures put a more subtle issue into play. Peirce describes what amounts to a fundamental shift in the SEC’s philosophy regarding the motivation and purpose of disclosure:

The proposal, by contrast, tells corporate managers how regulators, doing the bidding of an array of non-investor stakeholders, expect them to run their companies. It identifies a set of risks and opportunities—some perhaps real, others clearly theoretical—that managers should be considering and even suggests specific ways to mitigate those risks. It forces investors to view companies through the eyes of a vocal set of stakeholders, for whom a company’s climate reputation is of equal or greater importance than a company’s financial performance.”

In other words, a major risk faced by these firms has nothing to do with climate change itself, but with perceptions of “climate-related” risks by other parties. That transforms the question of climate risk into something that is, in fact, regulatory and political. Is this the true nature of the SEC’s concern, all dressed up in the scientism typically relied upon by climate change activists?

The reaction of government bureaucrats to the risks they perceive is a palpable threat to investor well-being. For example, GHG emissions might lead to future regulatory sanctions from various government agencies, including fines, taxes, various sanctions, and mitigation mandates. In addition, with the growth of investment management based on what are essentially shambolic and ad hoc ESG scores, GHG or carbon emissions might lead to constraints on a firm’s access to capital. Just ask the oil and gas industry! That penalty is imposed by activist investors and fund managers who wish to force an unwise and premature end to the use of fossil fuels. There is also a threat that GHG disclosures themselves, based (as they will be) on flimsy estimates, could create litigation risk for many companies.

Much Ado About Nothing

While there are major regulatory and political risks to investors, let’s ask, for the sake of argument: how would one degree celcius of warming by the end of this century affect corporate results? Generally not at all. (The bounds described in the Paris Agreement are 1.5 to 2 degrees, but these are based on unrealistic scenarios — see links below.) It would happen gradually in any case, with ample opportunity to adapt to the operating environment. To think otherwise requires great leaps of imagination. For example, climate alarmists probably fancy that violent weather or wildfires will wipe out facilities, yet there is no reliable evidence that the mild warming experienced to-date has been associated with more violent weather or an increased incidence of wildfires (and see here). There are a great many “sacred cows” worshiped by climate-change neurotics, and the SEC undoubtedly harbors many of those shibboleths.

What probabilities can be attached to each incremental degree of warming that might occur over several decades. The evidence we’ve seen comes from so-called carbon-forcing models parameterized for unrealistically high carbon sensitivities and subjected to unrealistic carbon-concentration scenarios. Estimates of these probabilities are not reliable.

Furthermore, climate change risks, even if they could be measured reliably in the aggregate, cannot reasonably be allocated to individual firms. The magnitude of the firm’s own contribution to that risk is equivalent to the marginal reduction in risk if the firm implemented a realistic zero-carbon operating rule. For virtually any firm, we’re talking about something infinitesimal. It involves tremendous guesswork given that various parties around the globe take a flexible approach to emissions, and will continue to do so. The very suggestion of such an exercise is an act of hubris.

Back To The SEC’s Mandated Role

Let’s return to the practical problems associated with these kinds of disclosure requirements. Cochrane also points out that the onerous nature of the SEC proposal, and the regulatory and political threats it embodies, will hasten the transition away from public ownership in many industries.

“The fixed costs alone are huge. The trend to going private and abandoning public markets, at least in the U.S. will continue. The trend to large oligopolized politically compliant static businesses in the U.S. will continue.

I would bet these rules wind up in court, and that these are important issues. They should be.”

Unfortunately, private companies will still have to to deal with certain investors who would shackle their use of energy inputs and demand forms of diligence (… not to say “due”) of their own.

The SEC’s proposed climate risk disclosures are stunningly authoritarian, and they are designed to coalesce with other demands by the regulatory state to kill carbon-based energy and promote renewables. These alternative energy sources are, as yet, unable to offer an economical and stable supply of power. The fraudulent nature of the alleged risks make this all the more appalling. The SEC has effectively undertaken an effort to engage in corporatist industrial policy benefitting a certain class of “green” energy investors, exposing the proposal as yet another step on the road to fascism. Let’s hope Cochrane is right: already, 16 state attorneys general are preparing a legal challenge. May the courts ultimately see through the SEC’s sham!

ESG Scoring: Political Tool Disguised as Investment Guide

30 Wednesday Mar 2022

Posted by in Capital Markets, Corporatism, Environmental Fascism, Social Justice

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ESG scores are used to rate companies on “Environmental, Social, and Governance” criteria. The truth, however, is that ESGs are wholly subjective measures of company performance. There are many different ESG scores available, with no uniform standards for methodology, specific inputs, or weighting schemes. If you think quarterly earnings reports are manipulated, ESGs are an even more pliable tool for misleading investors. It is a market fad, and fund managers are using it as an excuse to charge higher fees to investors. But like any trending phenomenon, for a time, the focus on ESGs might feed-back positively to returns on favored companies. That won’t be sustainable, however, without legislative and regulatory cover, plus a little manipulative help from the ESG engineers and “Great Reset” propagandists.

It’s 100% Political, 0% Economic

ESGs are founded on prioritizing objectives that have little to do with shareholder value or any well-understood yardsticks of financial or operating performance. The demands on company resources for scoring highly on ESG are often nakedly political. This includes adoption of environmental goals such as fraudulent “zero carbon” impacts, the nebulous “sustainability” objective promoted by “green” activists, diversity, inclusion and equity initiatives, and support for activist groups such as Black Lives Matter and Antifa.

Concepts like “stakeholder value” are critical to the rationale for ESGs. “Stakeholders” can include employees, suppliers, and customers, as well as potential employees. suppliers, and customers. In other words, they can be just about anyone in the broader community, or more likely activists for “social change” whose interests have but the thinnest connection to the business’s productive activities. In essence, so-called stakeholder capitalism amounts to a ceding of control over corporate resources, and ultimately confiscation of wealth from equity owners.

Corporations have long engaged in various kinds of defensive actions, amounting to a modern-day trade in indulgences. No one will be upset about your gas-powered fleet if you buy enough carbon offsets, which just might neutralize the impact of the fleet on your ESG! On a more sinister level, ESG’s provide opportunities for cover against information that might be damaging to firms, such as the use of slave labor overseas. Flatter the right people, give to their causes, “partner” with them on pet initiatives, and your sins will be ignored and your ESG will climb! And ESGs are used in attempts to pacify leftist investors who see the corporation as a vessel for their own social objectives, quite apart from any mission it might have had as a productive enterprise.

Your ESG will shine if you do business that’s politically-favored, like renewable energy, despite its inefficiencies and significant environmental blemishes. But ESGs are not merely used to reward those anointed as virtuous by the Left. They are more forcefully used to punish firms in industries that are out of favor, or firms refusing to participate in buying off authoritarian crusaders. For example, you might be so berserk as to think fossil fuels and climate change represent imminent threats of catastrophe. Naturally, you’ll want to punish oil and gas producers. In fact, if you are in charge of ESG modeling, you might want to penalize almost any extraction industry, with certain exceptions: the massive extraction and disposal costs of renewables will pass without notice.

All these machinations occur despite the huge uncertainty surrounding flimsy, model-based predictions of warming and global catastrophe. Never mind that fossil fuels are still relied upon to provide for most of our energy needs and will be for some time to come, including base-load power generation when intermittency prevents renewables from meeting demand. The stability of the power grid depends upon the availability of carbon-based energy, which in fact is marvelously efficient. Yet the ESG crowd (not to mention the Biden Administration) seeks to drive up its cost, including the cost of capital, and these added costs fall most heavily on the poor.

ESG-guided efforts by activists to deny capital to certain segments of the energy sector may constitute antitrust violations. Some big players in the financial industry, who together manage trillions of dollars in investment funds, belong to an advocacy organization called Climate Action 100+. They coordinate on a mission to completely transform the energy industry via “green” investments and divestments of presumptively “dirty” concerns. These players and their clients have huge investments in green energy, and it is in their interest to provide cheap capital to those firms while denying capital to fossil fuel industries. As Arizona Attorney General Mark Brnovich writes at the link above, this is restraint of trade “hiding in plain sight”.

Manipulation

ESGs could be the mother of all principal-agent problems. Corporate CEOs, hired by ownership as stewards and managers of productive assets, are promoting these metrics and activities, which may not align with the interests of ownership. ESG’s are not standardized, and most users will have little insight into exactly how these “stakeholder” sausages are stuffed. In fact, much of the information used for ESGs is extremely ad hoc, not universally disclosed, and is often qualitative. The applicability of these scores to the universe of stocks, and their reliability in guiding investment decisions, is extremely questionable no matter what the investor’s objectives. And of course the models can be manipulated to produce scores that suit the preferences of money managers who have a stake in certain firms or industry segments, and who inflate their fees in exchange for ESG investment advice. And firms can certainly engage in deceptions that boost ESGs, as already discussed.

Like many cultural or consumer trends, investment trends can feed off themselves for a time. If there are enough “woke” investors, ESGs might well feed an unvirtuous cycle of stock purchases in which returns become positively correlated with wokeness. Such a divorce from business fundamentals will eventually take its toll on returns, especially when economic or other conditions present challenges, but that’s not the answer you’ll get from many stock pickers and investment pundits.

At the same time, there are ways in which the preoccupation with ESGs dovetails with the rents often sought in the political arena. Subsidies, for example, will be awarded to firms producing renewables. Politically favored firms are also likely to receive better regulatory treatment.

There are other ways in which firms engaging in wasteful activities can survive profitably, at least for a time. Monopoly power is one, and companies often develop a symbiosis with regulators that hampers smaller competitors. This is traditional rent-seeking corporatism in action, along with the “too-big-to-fail” regime. Sometimes sheer growth in demand for new technologies or networking potential helps to conceal waste. Hot opportunities can leave growing companies awash in cash, some of which will be burned in wasteful endeavors. ESG scoring offers them additional cover.

Cracks In the Edifice

John Cochrane notes a fundamental, long-term contradiction for those who invest based on ESGs: an influx of capital will tend to drive down returns in those firms and industries, while the returns on firms having low ESGs will be driven upward. Yet advocates claim you can invest for virtue and superior returns. That can’t outlast real market forces, especially as ESG efforts dilute any mission a firm might have as a productive enterprise.

Vladimir Putin’s brutal invasion of Ukraine has revealed other cracks in the ESG edifice. We now have parties arguing that defense stocks should be awarded ESG points! Also, that oil production by specific nations should be scored highly. There is also an awakening to the viability of nuclear power as an energy source. Then we have the problem of delivering on Biden’s promise to Europe of more liquified natural gas exports. That will be difficult given the way Biden has bludgeoned the industry, as well as the ESG conspiracy to deny it access to capital. Just watch the ESG hacks backpedal. Now, even the evangelists at Blackrock are wavering. To see the thread of supposed ESG consistency unravel would be enough to make you laugh if the entire conspiracy weren’t so grotesque.

Closing

The pretensions underlying “green” initiatives undertaken by large corporations are good mainly for virtue signaling, to collect public subsidies, and to earn better ESG scores. They are usually wasteful in a pure economic sense. The same is true of social justice and diversity initiatives, which can be perversely racist in their effects and undermine the rule of law.

Ultimately, we must recognize that the best contribution any producer can make to society is to create value for shareholders and customers by doing what it does well. The business world, however, has gone far astray in the direction of rank corporatism, and keep this in mind: any company supporting a sprawling HR department, pervasive diversity efforts, “sustainability” initiatives, and preoccupations with “stakeholder” outreach is distracted from its raison d’etre, its purpose as a business enterprise to produce something of value. It is probably captive to outside interests who have essentially commandeered management’s attention and shareholders’ resources.

When it comes to investing, I prefer absolute neutrality with respect to out-of-mission social goals. Sure, do no harm, but the focus should remain squarely on goals inherent in the creation of value for customers and shareholders.

It’s Time to Make Woke Corporations Hurt!

12 Wednesday May 2021

Posted by in Corporatism, Social Justice, Virtue Signaling

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It’s a BLM discount! You need only shout the magic words! Ah, but if “woke” corporations are sincere in their avowals to help end racial injustice, there is so much more they can do! In fact, let me describe an idea so good and rich that we really must partner with Black Lives Matter and Antifa to bring it on!

Yes, we know how much the social justice warriors of corporate America care about diversity, inclusion, and eliminating unconscious bias. Also, in their business practices, they are eager to avoid “disparate impacts” on “protected classes” of individuals. However, if they want to get serious, they need to put real money where their mouths are. The Fuzzy Logic blog (FLB) suggests that we dare corporations celebrating “wokeness” to offer free products and services to people of color (POC)!

There is a strong rationale under current law for a slightly less drastic version of this proposal. For example, in 2019, the median household income of African Americans was about 60% that of whites, but Disney charges blacks and whites the same admission price to their theme parks. That means it costs a black family proportionately more of their income than a white family to spend a day at the park in Orlando. That, my friends, is a disparate impact!

I’m not aware of any legal challenges along these lines, but it’s not as if “one price” is a business necessity, which would otherwise offer Disney a defense against such a claim. Disney already offers discounts to seniors and other groups. But why wait for the EEOC to take action when Disney can demonstrate its high-mindedness and good faith by offering race-based discounts right now?

It would be fun to see how the company reacts to pressure for that kind of action. Based on income disparities, the company could discount tickets by 40% to African Americans and by about 26% for Hispanics. Discounting should be extended to Disney Plus subscriptions as well. Those discounts can be revisited each year with appropriate adjustments until such time as income parity is achieved.

In reality, differential pricing is practiced broadly by American businesses. It’s called price discrimination, and it is generally legal. Higher prices tend to be charged to market segments with less elastic (price-sensitive) demand, and lower prices are offered to segments with more elastic demand. It is a rational and often profit-maximizing approach to pricing, but its practice tends to be more subtle than discriminating on price with respect to race or ethnicity. It’s safe to say that pressure to do so would be disruptive and unwelcome to these firms. So I still like the idea!

But again, FLB’s post goes much farther: given past injustices, why limit the reparations to a correction for the disparate impact of pricing? Something more radical is needed as this is a matter of conscience, not merely a legal hurdle to neutralize income disparities:

“These companies (and the many thousands more engaged in this woke crap) must put their own profits where their big, fat lying mouths are. There will be no government bailouts for them; they must pay for their part in condoning and pushing white supremacy for the past bazillion years, and they must pay with their own wealth, wealth they say they accumulated on the backs of black and brown people.”

Therefore, FLB insists that Disney should offer free admission and streaming on Disney Plus to certain racial and ethnic minorities for a period of several years…and free accommodations at Disney Hotels! What a tremendous show of good faith in wokeness that would be!

We’re picking on Disney, and it’s not alone in its professed racial consciousness and pursuit of equal outcomes. There are so many others! Coca-Cola could issue coupons redeemable at full price through a program of outreach in minority communities. Delta Airlines could institute a program of “Black Life Passports” to bona fide African Americans (meaning one must identify as such!) for discounted or free fares. Bank of America will probably want to exceed the minimum requirements under community banking law by offering free banking services and heavily discounted account management fees to African Americans. Amazon will no doubt want to offer free Prime memberships to certain minorities and perhaps throw in some freebies at Whole Foods as well. And Apple has plenty of merchandise to give away. Why wait for Joe Biden to offer free phones in the run-up to the 2024 election like his old boss did?

You probably won’t be happy about this proposal if you’re a corporate shareholder, but then you should not be happy to have witnessed increasing management preoccupation with social justice, and you should not have been happy as your “agents” lost sight of their fundamental missions as business organizations: to produce something well and thereby do well for customers and shareholders. The sad consequence of “stakeholder capitalism” is that everything a business is supposed to do gets done worse.

I recently discussed the assignment of “scores” to public companies for their focus and performance on environmental, social, and governance (ESG) factors. These ESG scores are used by “woke” fund managers and advisors to select or rate stocks. I personally have no wish to invest in companies seeking to boost their ESGs, but you can read all about that at the link. For our purposes here, ESGs might serve well as a tool for identifying entities most in need of pressure to offer discounts and freebies to POC.

It would be great to see agitation against the woke-most corporations for race-based discounts and free products. Perhaps a broad discussion of the idea would prompt social justice warriors to get on board. It might provide some laughs, but the real hope is to shake the corporate wokesters from their virtue-signaling stupor. Most shareholders wouldn’t like race-based discounts, of course, and that’s part of the idea. A conceivable defensive maneuver for our “target” entities would be a lobbying effort for government action such as tax-financed reparations. That won’t necessarily be cheap for them or their shareholders, however. Get woke, go broke!

Social Credit Scores, ESGs, and Portfolio Rot

29 Thursday Apr 2021

Posted by in Capital Markets, Corporatism, Environment, Social Justice

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As a small investor I resent very much the use of so-called “ESG scores” to guide investment decisions on my behalf. ESG stands for “Environmental, Social, and Governance” criteria for rating companies. These scores or grades are developed and assigned by various firms (Refinitiv, CSRHub, and many others) to public companies. The scores are then marketed to financial institutions. While ESGs from various sources are not yet standardized, a public company can attempt to improve its ESG scoring through adoption of environmental goals such as “zero” carbon, diversity and inclusion initiatives, and (less objectionably) by enhancing its systems and processes to ensure protection of shareholder and other interests.

Who Uses ESGs?

An investment fund, for example, might target firms with high ESG scores as a way of appealing to progressive investors. Or an institutional investor like a pension fund might wish to invest in high ESG stocks in order to avoid riling “woke” activist investors, thus keeping the hounds at bay. This is nothing new: many corporations engage in various kinds of defensive actions, which amount to modern day “selling of indulgences”.

An aggregate ESG score can be calculated for a fund or portfolio of stocks by weighting individual holdings by market value. And of course, an ESG score can be calculated for YOUR portfolio. As a “service” to clients, Merrill Lynch plans to do just that.

My first reaction was to give my ML financial advisor an earful. Of course, ML’s presumed objective is to guide you to make “better” investment decisions. However, I do not wish to reward firms with capital based on their “social” positioning, nor do I wish to encourage exercises in “wokeness”. I simply want to supply capital based on a firm’s business fundamentals.

My advisor was more than sympathetic, and I believe he’s sincere. The problem is that corporate wokeness is so ubiquitous that it becomes difficult to invest in equities at all without accepting some of it and just holding your nose. That goes for virtually all ETFs and index funds.

ESGs Are Not Consumer Scores

I’m obviously unhappy about this as a Merrill account holder, and also as a financial economist and a libertarian. But first, a few words about what is not happening, at least not yet. A number of conservative commentators (see here, and here) have described this as an assignment of “social credit scores” to consumers based on their individual or household behavior, much as the Chinese government now grades people on the quality of their citizenship. These conservative voices have reacted to ESG scores as if they incorporate information on your energy usage, for example, to grade you along the environmental dimension. That is not the case, though ESGs can be used to grade the stocks you own. And yes, that is rather Orwellian!

One day, if present trends continue, banks might have access to our energy usage through affiliations with utilities, smart car companies, and various data aggregators. And who knows? They might also use information on your political contributions and subscriptions to grade you on your social “wokeness”, but only if they have access to payment records. Traditional credit information will be used as it is now, to grade you on financial discipline, but your “consumer ESG” might be folded into credit approval decisions, for example, or any number of other decisions that affect your way of life. But except for credit scoring, none of this is happening today. All the consumer information outside of traditional credit scoring data is too scattered and incomplete. So far, ESGs are confined to evaluating companies, funds, and perhaps your portfolio.

ESGs and Returns

ESGs get plenty of favorable coverage from the financial press and even from academics. This post from The Motley Fool from 2019 demonstrates the kind of praise often heaped upon ESGs. Sure, firms who cater to various cultural trends will be rewarded if they convince interested buyers they do it well, whatever it is. That includes delivering goods and services that appeal in some way to environmental consciousness or social justice concerns. So I don’t doubt for a moment that money can be made in the effort. Still, there are several difficulties in quantitatively assessing the value of ESG scores for investment purposes.

First, ESG inputs, calculations, and weights are often proprietary, so you don’t get to see exactly how the sausage is stuffed. On that point, it’s worth noting that much of the information used for ESG’s is rather ad hoc, not universally disclosed, or qualitative. Thus, the applicability (and reliability) of these scores to the universe of stocks is questionable.

Second, inputs to ESGs represent a mix of elements with positive and negative firm-level effects. I already mentioned that ESGs reward good governance on behalf of shareholders. The environmental component is almost surely correlated with lines of business that qualify for government subsidies. More generally, it might reflect conservation of certain materials having a favorable impact on costs. And attempts to measure diversity might extract legitimately positive signals from the employment of highly productive individuals, many of whom have come from distant shores. So ESG scores almost certainly have a few solidly useful components for investors.

The proprietary nature of ESG calculations also raises the question of whether they can be engineered to produce a more positive association with returns. There’s no doubt that they can, but I’m not sure it can be confirmed one way or the other for a particular ESG variant.

Like cultural or consumer trends, investment trends can feed off themselves for a time. If there are enough “woke” investors, ESGs might well feed an unvirtuous cycle of stock purchases in which returns become positively correlated with wokeness. My thinking is that such a divorce from business fundamentals will eventually take its toll on returns, especially when economic or other conditions present challenges, but that’s not the answer you’ll get from many stock pickers and investment pundits.

Remember also that while a particular ESG might be positively correlated with returns, that does not make it the best or even a good tool for evaluating stocks. In fact, it might not even rank well relative to traditional metrics.

Finally, there is the question of causality. There are both innocent and pernicious reasons why certain profitable firms are able to spend exorbitantly on initiatives that coincidentally enhance their ESGs. More on that below.

Social and Economic Rot

Most of the “green” initiatives undertaken by large corporations are good mainly for virtue signaling or to collect public subsidies. They are often wasteful in a pure economic sense, meaning they create more waste and other costs than their environmental benefits. The same is true of social justice and diversity initiatives, which can be perversely racist in their effects and undermine the rule of law. And acts on behalf of “stakeholders” often sacrifice shareholders’ interests unnecessarily.

There are many ways in which firms engaging in wasteful activities can survive profitably, at least for a time. Monopoly power is one way, of course. Large companies often develop a symbiosis with regulators which hampers smaller competitors. This is traditional corporatism in action, along with the “too big to fail” regime. And again, sheer growth in demand for new technologies or networking potential can hide a lot of warts. Hot opportunities sometimes leave growing companies awash in cash, some of which will be burned in wasteful endeavors.

Ultimately, we must recognize that the best contribution any producer can make to society is to create value for shareholders and customers by doing what it does well. But to see how far the corporate world has gone in the other direction, keep this in mind: any company supporting a sprawling HR department, pervasive diversity efforts, “sustainability” initiatives, and preoccupations with “stakeholder” outreach is distracted from its raison d’etre, its purpose as a business enterprise to produce something of value. It is probably captive to certain outside interests who have essentially commandeered management’s attention and shareholders’ resources. And this is evidence of rot.

My reference to “portfolio rot” reflects my conviction is that it is a mistake to dilute investment objectives by rewarding virtue signals. They are usually economically wasteful, though sometimes they might be rewarded via government industrial policy, regulators, and the good graces of activists. But ultimately, this waste will degrade the economy, undermine social cohesion, and devalue assets generally.

What Can We Do?

Despite the grim implications of widespread ESG scoring, there are a few things you can do. First, simply avoid any funds that extol progressive activism, whether based on ESGs or along any dimension. If you invest in individual stocks, you can avoid the worst corporate offenders. Here is one guide that lists some of the “woke-most” companies by industry, and it provides links to more detailed reviews. I gave my advisor a list of firms from which I wanted to permanently divest, including Bank of America, which owns Merrill! I also listed various firms that are owned and operated by Chinese interests because I am repulsed by the Chinese regime’s human rights violations.

If you have the time, you can do a little more research before voting your proxies. That goes for shareholder, board, or management proposals as well as electing board members. You are very unlikely to swing the vote, but it might send a useful signal. I recently voted against a Unilever green initiative. I also researched each of the candidates for board seats, voting against a few based on their political, social and environmental positions and activities. Good information can be hard to get, however, so I abstained from a few others. This kind of thing is time consuming and I’m not sure I’m eager to do very much of it.

You can also support organizations like the American Conservative Union, which is “taking a stand against the increasingly divisive and partisan activism by public corporations and organizations that are caving to ‘woke’ pressure.” And there is Stop Corporate Tyranny, which is “a one-stop shop for educational resources exposing the Left’s nearly completed takeover of corporate America, along with resources and tools for everyday Americans to fight back against the Left’s woke and censoring mob in the corporate lane.”

People can make it harder for social credit scoring to enter the consumer realm by protecting their privacy. There will be obstacles, however, as sellers offer certain benefits and apply “nudges” to obtain their customers’ data, and it is often shared with other sellers. Sadly, one day those who guard their privacy most closely might find themselves punished in the normal course of trade due to their “thin” social credit files. There are many dark aspects to a world with social credit scoring!

Conservative Social Scoring?

There are at least two ETFs available that utilize conservative “social scoring systems” in picking stocks: EGIS and LYFE. Both are sponsored by 2ndVote Funds. EGIS has as its stated theme to invest in stocks which receive a favorable rating in support of the Second Amendment right to bear arms and/or in the interest of border security. LYFE seeks to meet its long-term return objectives in stocks with a favorable rating on the pro-life agenda. Both have reasonable expense ratios, as those things go. Unfortunately, my advisor says Merrill won’t allow those funds to be purchased until they have close to a full year of experience.

Are these two ETFs really so special? Are they really just marketing gimmicks? After all, I noticed that EGIS has Goldman Sachs in its top 10 holdings. While Goldman might not be the worst of its peers in terms of wokeness, it has stooped to some politically-motivated “cancel capers”. Moreover, do I really want to mix my investment objectives with my social preferences? Leftist investors are doing it, so countering might be well-advised if you can afford the risk of diluting your returns. My heart says yes, but my investor brain isn’t sure.

Closing

When it comes to investing, I’d prefer absolute neutrality with to respect social goals, other than the social goals inherent in the creation of value for customers and shareholders. Any emphasis on ESG scores is objectionable, but it’s a regrettable fact that we have to live with to some extent. If “social scoring” is unavoidable, then perhaps the themes adopted by 2ndVote Funds are worth trying as part of an investment approach. After all, given my personal blacklist of woke corporations, I’ve already succumbed to the temptation to invest based on social goals. And I feel pretty good about it. Unfortunately, it might mean I’ll sacrifice return and witness the continued descent of western society into a woke hellscape.