Media

Not Everyone Likes ESG

Also Nam Tai corporate control and secret crypto founders.

Anti-ESG

If you are the chief executive officer of a public company, there are various environmental, social and governance things you could do. You could, like, switch your widget factory to use sustainably harvested natural widget materials instead of highly polluting fossil-fuel-derived widget materials or whatever. This would cost you more money and reduce profit margins, but. But something. But what? 

  1. “But it would be good for the planet, and you live on the planet, and you want your grandchildren to have” etc. is one form of argument but let’s rule it out. You are a fiduciary, you work for shareholders, you can only consider arguments about shareholders’ interests. Your grandchildren’s interest in a livable planet cannot outweigh your shareholders’ interest in somewhat higher profit margins. (There are forms of “stakeholder capitalism” that reject this view, but they strike me as somewhat undertheorized. Of course in practice you can expect CEOs not to be profit-maximizing psychopaths, but as a matter of constructing arguments about corporate finance, a CEO’s personal, societal and political preferences seem out of bounds compared to stuff about shareholders.)
  2. “But it would be good for the planet, and your shareholders live on the planet, and you want grandchildren to have a nice planet.” This strikes me as a pretty good argument? It is a somewhat strange corporate finance argument, but it is a thing that I think about a lot around here. Shouldn’t companies do what is in the actual interests of shareholders, what the shareholders actually want, rather than robotically maximize profits? This can play out in various ways — companies with lots of meme-driven retail shareholders can give their shareholders memes, companies with lots of union-pension-fund shareholders can treat their unionized workers well, companies with lots of large diversified shareholders can try to maximize economy-wide profits rather than their own profits, etc. — but certainly one way for it to play out might be “companies with shareholders who are humans living on Earth can try to make Earth livable.” One important reason that this is a strange corporate finance argument is that shareholders have heterogeneous desires. Everyone wants more money, or anyway it is convenient to assume that they do, but they might want different kinds of ESG stuff in different mixtures. (For instance, much ESG stuff is politically controversial, and your left-wing shareholders might want the opposite thing from your right-wing shareholders.) “We will maximize the long-term happiness and life satisfaction of our shareholders and their families” is probably a better goal than “we will maximize this year’s profit,” but it is certainly a much goal to quantify and measure and achieve.
  3. “But in the long run society will ban highly polluting fossil-fuel-derived widget materials, and companies that pollute will suffer legal and reputational consequences, so doing environmentally friendly things now might lead to lower short-term profits as you retool the widget factory but will lead to higher long-term profits as your business is more sustainable.” This is I think the standardESG argument. It uses ESG as a tool to get to profit maximization; you can feel good about yourself both as a person on Earth and also as a fiduciary value-maximizer. But this argument has some empirical content, and it can be true for some decisions and false for others. “We’re going to switch to recyclable packaging for our widgets at a cost of $0.02 per widget because our government relations team expects tough restrictions on non-recyclable packaging to be enacted in multiple jurisdictions in the next six months” is a version of this that sounds plausible, while “we are going to abandon our factories and let them return to nature because in the long run society will reject striving for material goods” seems less likely to maximize shareholder value. “We’re going to get out of the coal business because it seems like a long-run loser” is perhaps a good argument for a diversified commodities company that can sell its coal mines at a high price today and focus on businesses with better long-term prospects, but a less good (financial) argument for a pure-play coal miner. 
  4. “But your shareholders you to do good ESG things, because they believe Argument 2 (they are human, want their grandchildren to have nice things, etc.), because they correctly believe Argument 3 (you will have higher sustainable long-term profits), because they incorrectly believe Argument 3 but that’s their problem, and you can maximize the long-term value of your company by giving shareholders what they want even if it does not maximize the net present value of your projects, because (1) if shareholders like you they will buy stock and you will have access to cheap capital that you can use to do good business things and create fundamental value for shareholders and/or (2) if shareholders like you they will buy stock and your stock price will go up, which is shareholder value all by itself.” Something like that? “I’m just here to maximize my stock price,” you might say, “and right now stock prices go up when companies do ESG things, so I’m gonna do ESG things, and I don’t think it requires more corporate finance analysis than that.” As the CEO, you do whatever makes the stock go up, because markets are efficient and the stock price is better at this than you are. I sort of like this argument too. 1  I assume most CEOs would object to this, and I see their point, but there is something pleasing about the simplicity here.

Anyway here’s a guy

Unilever has “lost the plot” and its management prizes displaying its sustainability credentials at the expense of running the business, according to influential fund manager Terry Smith.

The founder of Fundsmith, a top-10 shareholder in Unilever whose stellar long-term record has helped him amass a large retail following, used his annual letter to investors on Tuesday to hit out at the global consumer goods group.

The maker of Dove soap, Hellmann’s mayonnaise and Magnum ice cream has set out ambitious climate and social targets and is trying to prove that sustainable business does drive superior financial performance.

Smith, a veteran stockpicker who runs the ?28.9bn flagship Fundsmith Equity Fund, wrote: “Unilever seems to be labouring under the weight of a management which is obsessed with publicly displaying sustainability credentials at the expense of focusing on the fundamentals of the business.” 

He said that while “the most obvious manifestation of this is the public spat it has become embroiled in over the refusal to supply Ben & Jerry’s ice cream in the West Bank?.?.?.?there are far more ludicrous examples which illustrate the problem”.

Smith added: “A company which feels it has to define the purpose of Hellmann’s mayonnaise has in our view clearly lost the plot. The Hellmann’s brand has existed since 1913 so we would guess that by now consumers have figured out its purpose (spoiler alert — salads and sandwiches).”

The high-profile of this sort of thing usually are at energy companies, where shareholders have deep disagreements about both the morality and the economics of drilling a lot of oil now versus investing a lot in green technology. Sometimes the solution proposed there is to split up the company into a green company that will appeal to ESG-focused investors, and a legacy-coal-and-oil company that will appeal to cash-flow-focused investors.

That seems less likely to work here. I don’t think Unilever will separate out its mission-driven mayo from its cynical opportunistic mayo. It’s really just the one mayo. The question is whether you will make the mayo in a way that appeals to your ESG-driven investors or one that doesn’t. One way to answer that question is to inquire into the financial logic and decide, to the satisfaction of the executives and the board and the shareholders, whether “sustainable business does drive superior financial performance.” Another way to answer that question is to say “well there sure are a lot of investors who own a lot of our shares and who keep asking us to do ESG stuff, and then there’s one guy writing a mean letter saying that we shouldn’t, so let’s do whatever minimizes the total quantity of shareholder complaining.” Minimizing shareholder complaining seems like a valid corporate finance goal? My sense is that right now the weight of shareholder energy is on the pro-ESG side, but I guess if you want to change that you have to start with one mean letter.

Who controls a company? 

It is sort of a miracle that hostile takeovers and proxy fights can work. You’ve got a company. The company is a collection of people who all go to the same building and do things together. The company is run by a chief executive officer and a board of directors, who tend to be pretty chummy with each other. The CEO hires the other executives, who hire the other employees. They all work with each other and tend to get along: They were hired by people who thought they’d fit in with the group, and if they don’t fit in they can be fired. As in any group there will be some infighting and dysfunction but it is basically a group of people who have come together for a common purpose and spend a lot of time together working toward that purpose.

And then one day some stranger shows up and says “I have bought 4% of your company and I want you to do different things.” And the board and the CEO and the executives and the employees are like “thanks but no” and go about their business. And then the stranger goes to some other shareholders — some other strangers, as far as the employees are concerned — and convinces them of the rightness of her vision, which is not shared by the board or CEO or executives or employees who are actually doing the work, and she comes back and says “I have bought your company and control it now, the board is fired, the CEO is fired, the rest of you employees can stay but you have to do what I say now.” 2  And it works! The executives and employees are like “okay I guess you’re the boss.” The CEO and the directors just leave and do something else. The customers and suppliers who worked with the company continue working with the company, and it’s the same company. It is no longer owned by the same people or run by the same people, but there is continuity of the corporate entity, and that fictitious entity actually matters in the real world. 

You could imagine it working. You could imagine the CEO barricading himself in his office and saying “who put you in charge? ‘Shareholders’? Sounds fake.” You could imagine the CEO sitting down at his computer and using his unchanged password to type an email to all staff saying “ignore these weirdos saying that they run the company, I run the company, keep doing your jobs.” You could imagine the employees saying “you know, I like working for my boss, and we share a sense of mission and a long history together, and these new people seem to want strange and different things, I guess I ignore them and keep listening to the CEO.” 

A company is built around a set of fairly thick social ties, and also around knowing the computer passwords and having keycards that work on the doors and stuff like that. And then it is connected to its shareholders by rather thin social ties, and when the shareholders decide to come in and mess with the internal workings it is strange that they 

I mean, it is not strange. It is straightforward textbook stuff. The way that corporate law works most places is that the shareholders more or less own the company, and a majority of them can get together and more or less fire the board and the executives if they’re unhappy with them, and the people appointed to run the company by the shareholders have the legal right to run the company, and if you stand in their way — if you barricade yourself in your office when the new shareholder-appointed CEO comes to kick you out — then the shareholders can go to court and get a court order telling you to clear out and call the police to enforce it. And in most places where hostile takeovers happen this is widely understood stuff, and there is a high degree of confidence that the courts and the police enforce it, so it would be foolish and self-destructive for the CEO to barricade himself in his office. And even if the employees like the old CEO and the old mission and find the new owners uncongenial, they just accept the system; they might grumble or even quit en masse but they won’t the takeover.

This is however a very U.S.-centric perspective and it’s not obvious that every company everywhere would work this way. It would be funny if you ran a proxy fight at a foreign company and got the shareholders to agree with you and ousted the board and installed a new chief executive officer and that CEO showed up at his first day of work and the old CEO was like “who put you in charge? ‘Shareholders’? Sounds fake.” And then you’d have to navigate a court system with less ironclad precedent for all of this stuff, and maybe in the end it would all work out, but it is not automatic and assumed the way it is in the U.S.

There’s a company called Nam Tai Property Inc. Nam Tai is incorporated in the British Virgin Islands and listed on the New York Stock Exchange, so it is in some rough sense a U.S. public company. (Here is its annual report for 2020, filed with the U.S. Securities and Exchange Commission.) But it is headquartered in Shenzhen, its business consists of developing and operating real estate in China, its assets are in China and it mainly operates through Chinese subsidiaries. Under Virgin Islands corporate law and U.S. securities law, you can go ahead and have a proxy fight. But then what?

Last year, a small hedge fund called IsZo Capital Management LP 3  “prevailed in a 16-month battle to wrest control of the New York-listed Chinese developer.” Sort of! Nam Tai’s largest shareholder is another Chinese property developer, Kaisa Group Holdings Ltd., and IsZo led Nam Tai’s shareholders in a revolt against the company’s Kaisa-connected board and management. This was a complicated fight: 

Before a shareholders’ meeting could be convened to consider the merits of the IsZo proposal, Nam Tai executed a transaction that dramatically strengthened Kaisa’s hand. The technology park developer sold $170 million of stock, mostly to its controlling shareholder, raising Kaisa’s stake to 43.9% from 23.9%.

But IsZo went to court (in the Virgin Islands) and a judge voided the transaction. “After appeals, the shareholders’ meeting finally went ahead [in November]. All IsZo’s slate of six candidates were elected, with support from more than 94% of holders unaffiliated with Kaisa.”

Having won at the shareholder meeting, IsZo captured certain key strategic positions. For instance: Nam Tai’s passwords for the U.S. Securities and Exchange Commission’s Edgar filing system. The board elected by the shareholders seems to control the filings. Here’s the press release that Nam Tai filed on Dec. 3, after the shareholder meeting, announcing the results of the meeting and the makeup of the new board. Normal stuff.

Controlling the board of directors of the U.S.-listed, Virgin Islands-incorporated public company is not, however, the same thing as controlling the operations of a Chinese property developer. Here is an open letter to shareholders that Nam Tai filed today

Dear Shareholders,

We want to update you on our path to securing total on-shore control of Nam Tai Property Inc. (“Nam Tai” or the “Company”) and its assets. In recent weeks, Jiabiao Wang, whom we believe to be a longtime ally of Kaisa Group Holdings Limited (collectively with its affiliates, “Kaisa Group”) and whom the reconstituted Board of Directors (the “Board”) has terminated from any role at Nam Tai, has obstructed an orderly handover of business assets in mainland China. ...

In direct contravention of the elected Board’s decisions and in what appears to be a flagrant violation of the law, Mr. Wang – evidently a long-time ally of Kaisa Group – is refusing to acknowledge his formal termination and facilitate an orderly handover of the on-shore business despite multiple visits and demands by the Board’s recently-appointed legal representative and the new management of the Company. Mr. Wang is currently preventing the new Board from accessing the Company’s and its subsidiaries’ business licenses, corporate seals (also known as chops) and several bank accounts. We believe Mr. Wang and Kaisa Group are also responsible for the following:

Issuing false and misleading communications to local stakeholders in China via the Company’s website and other channels;

Preventing the Board from communicating with the Company’s valued employees in China;

Refusing to provide access to the Company’s books and records and systems,

Purportedly engaging – without authorization – a Chinese law firm on behalf of the Company to assist with their efforts in obstructing the Board’s newly-appointed legal representative and management from accessing the Company, and;

Threatening – without any basis – legal action against the Board’s recently-appointed legal representative for trying to fulfill the Board’s assignments and instructions.

While we suspect Mr. Wang is authorizing unsanctioned compensation for himself and spending corporate funds on outside lawyers, he has no real authority to represent the Company, allocate its funds or commit to any kind of transaction with vendors and third parties. Any attempts by Mr. Wang to dispose of or transfer corporate assets are unauthorized and will not be recognized by the elected Board. The Board and its appointees have already notified third parties with whom Mr. Wang has interacted that any commitments by Mr. Wang are unauthorized and will not be honored, and the Board has publicized the fact that Mr. Wang has been terminated and therefore has no authority to act on behalf of any Nam Tai entity.

So the old CEO has barricaded himself in the office, apparently retains the loyalty of the staff (or at least their email addresses), and still has the corporate chops, the bank-account information and the passwords to the website (though not to Edgar). And it seems like he is telling “vendors and third parties” that he’s still the CEO, and the newly elected board is telling them that he isn’t. Who should they believe? The new board seems to have offshore control — it is legally in charge as far as the U.S. and the Virgin Islands are concerned, it makes the U.S. securities filings, etc. — but, for a Chinese property company, onshore control is really what you want. 4

Anyway the shareholders have very much called the cops — “The Board has responded by actively engaging with local government officials to address Mr. Wang and Kaisa Group’s apparent interference and uphold social stability” — and, you know, we’ll see!

Anti-charismatic founders

Stereotypically, the good sales pitch in crypto — to get people to buy your tokens and work on your projects — is to talk about decentralization; you want your project to be democratic and controlled by its community rather than by one absolute leader. Stereotypically, the good sales pitch that tech startups use to raise money from venture capitalists is about a charismatic visionary founder; VCs love to fund founders they believe in, and tend to empower those founders with absolute control. If you are raising money from venture capitalists to do a crypto thing, how do you balance these demands? Here’s a fun story from Kate Clark at the Information

Last year, Nader Al-Naji, founder of a crypto startup called BitClout, began using a pseudonym online—Diamondhands—to mask his true identity. In fact, he was so determined to conceal his real name that he bought a $500 piece of hardware to manipulate his voice so no one would recognize him during podcast and press interviews.

Al-Naji’s cloak-and-dagger routine was part of a curious tradition taking shape among a cohort of crypto entrepreneurs. By using a pseudonym, Al-Naji believed he would attract more developers to build software on top of Deso, the blockchain his startup by the same name is building for running decentralized social networks. He thought the gesture would make Deso seem less corporate, even though it had successfully sold tens of millions of dollars worth of tokens to investors including Andressen Horowitz and Sequoia Capital. And it offered a nod to crypto’s most revered figure: Satoshi Nakomoto, Bitcoin’s pseudonymous inventor.

“It makes people feel like this project can be owned by them now, not by a CEO or a board,” Al-Naji said.

What if , the pseudonymous founder of OlympusDAO, is actually Adam Neumann? Or a mid-level executive at Citadel Securities? Elon Musk, in his abundant free time? Martin Shkreli, from prison? A lot of great options really.

Things happen

Inflation Hits 39-Year High of 7%, Sets Stage for Fed Hike. Fed’s Powell Says Economy No Longer Needs Aggressive Stimulus. Citi to Exit Mexico Retail Banking, Its Biggest Branch Network. Mexican Billionaire Salinas Says He’s Interested in Citibanamex. UBS Targets Less-Wealthy Customers With Advice by Device. UBS’ Legal Battles Grow as Investor Pursues Class Action Lawsuit Over Options Strategy. Bank of America to Cut Overdraft Fees to $10 From $35. World’s Worst-Performing Bank Lent Billions to China Evergrande. The Renaissance Man of Venture Capital. UK financial watchdog to review cost of market data. Facebook loses second attempt to dismiss FTC antitrust caseCrypto Scams Are Biggest Threat to Investors in 2022, Regulators Say. A Million-Dollar Lawsuit Uncovers Backdoor Art World Contracts. Teen Hacker Claims Ability to Control 25 Teslas Worldwide. Two Los Angeles police officers were fired for “willfully abdicating their duty to assist a commanding officer’s response to a robbery in progress and playing a Pokemon mobile phone game while on duty.” People are

If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters . Thanks!

  1. If you are a CEO, you can just take this stuff as a given, but it is sort of a puzzle in the evaluation of ESG investing. Like one important question is: “Do ESG funds outperform non-ESG funds?” And one complexity of that question is that if you look at some time period and ESG stocks (by whatever metric)outperform non-ESG stocks, one possible explanation is “ESG stocks had higher earnings than non-ESG stocks because the world has already shifted such that being sustainable improves financial performance,” and another is “ESG stocks’ multiples expanded compared to non-ESG stocks because investors are slowly waking up to the fact that the world will soon shift such that being sustainable will improve financial performance,” and another is “ESG stocks’ multiples expanded compared to non-ESG stocks because investors have all piled into an ESG bubble that will burst soon,” and it is not easy to tell those latter two explanations apart. But if you’re a CEO maximizing stock price maybe you don’t care.

  2. I am not making any real distinction here between hostile takeovers and proxy fights. The shareholder might say “I have gotten a majority of shareholders to vote for my slate of directors at the annual meeting, so the majority of the board is fired, my friends are the majority now, they have fired the CEO,” etc. (Or: “They have not fired the CEO but they have some new things he has to do to avoid being fired.”) Or she might say “I have gotten a majority of shareholders to accept my tender offer and then completed a close-out merger to obtain 100% of the stock and replaced the board,” etc. Or various other things on a corporate control spectrum. In any case the point is that she has done some stuff with the shareholders, not with the board and executives, that gives her the right to appoint a new board and new executives.

  3. talked about IsZo because it is fighting with Jefferies Group LLCover some stocks that IsZo shorted to zero; if you short a stock to zero, your prime broker might refuse to close out the position, and it will sit in a weird limbo forever. IsZo keeps finding itself in weird limbos.

  4. I should say that Nam Tai, the Virgin Islands company, seems to actually own its Chinese subsidiaries. A lot of U.S.-listed Chinese companies are actually variable interest entities, or VIEs, with contractual rather than ownership relationships with their Chinese entities. I’m not sure I’d want to try a proxy fight there, though I would enjoy watching one.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:

Matt Levine[email protected]

To contact the editor responsible for this story:

Brooke Sample[email protected]

Votes: 
Share Content: 
 
X