Innovatia

From “agent” to “stakeholder” theories of the firm In academia, the evolution of sustainability parallels the evolution of “theories of the firm”. Historically, the “agency theory of the firm” was

dominant in economics. Managers were consid- ered agents of the shareholders, hired to man- age the firm. To maximise firm value, managers focused on minimising management (or agen- cy) costs. From this perspective, many practic- es aimed at improving corporate sustainability were viewed as non-essential costs that reduced shareholder value. Such thinking naturally flowed into management of pension assets, as higher investment returns meant smaller em- ployer contributions were required to provide pension benefits to staff in retirement. Over the last 20 years, the dominance of the agency theory of the firm has declined. An ex- tensive literature now documents the impor- tance of good corporate governance practices to maximise firm value and also a growing list of best practices central to maximising profit- ability and firm value. This evidence has led to the emergence of a new paradigm referred to as the “stakeholder theory of the firm”. This asserts that firm value is maximised by ef- fectively managing the interests, concerns and incentives of all individuals who are stakehold- ers in a firm’s success – shareholders, manage- ment, labour, the environment and society at large. Shareholder wealth is maximised by moti- vating all stakeholders to seek the best possible outcome. Frequently cited examples include: • effective management of environmen- tal impacts to mitigate costly regulatory shocks • safe working conditions and fair wages to improve labour productivity • building customer loyalty and brand value via community-wide service and engage- ment

Investing for good

T he introduction of the Superannuation Guarantee Charge (SGC) in Australia in 1991 inextricably linked those saving for retirement with their eventual investment outcome. This is replacing taxpayer-funded pensions and corporate-de- fined benefit schemes, which had previously ensured that indi- viduals were provided with fixed retirement benefits regardless of investment outcomes. Today’s defined contribution world is based on individual investment choice and full ownership of the resultant specific investment outcome. This is naturally leading to a greater focus on how investment returns are derived. Many now question the merits of earning profits from com- panies that knowingly pollute the environment or profit from modern slavery or other unethical activities. Such actions result in broader costs being levied across the rest of the population. Principle-based investing is supported by economic theory that points to better-managed firms being better investments in the long term. According to the latest OECD estimates, the SGC has meant Australia will have one of the largest retirement savings markets in the world. This positions us to drive change within investment portfolios and through to corporate behaviour. It is critical we ensure that a vision to “invest for good” also delivers strong fi- nancial outcomes. Max Cappetta looks at how a company’s environmental, social and governance (ESG) practices are being powered by the collective assertion of control by individual investors through the retirement savings industry.

INNOVATIA

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