“The business of business is business” or so claims the Friedman doctrine – a mantra that has been followed religiously by most entrepreneurs in the past few decades. But are profits truly the be-all and end-all for enterprises?
For decades, the sole primacy of shareholders has been the focus of many companies. Managers followed the need to maximise the yield for their owners. Yet driven by performance-related bonuses as well as short tenures, companies might reach out for the low-lying fruits and forgo investments that would create value only in the long-term, such as research and development or employee training. Such behaviour inevitably enthroned quarterly financials as the sole success metric.
Yet over the years, a slow but steady shift in mentality is starting to evolve. Investors themselves are increasingly taking interest in the environmental, social and governance (ESG) aspects of target companies. Ninety-seven per cent of investors surveyed in the Global CCaSS Investor Survey 2018 by EY, stated that they do evaluate the companies’ non-financial disclosures.
Moreover, a growing group of businessmen, investors and civil society members are recognising that businesses are able to create much more value over and above profits. This does not just refer to corporate social responsibility (CSR) activities or philanthropy, but rather a continuous and more inclusive approach across the entire supply chain.
A growing group of businessmen, investors and civil society members are recognising that businesses are able to create much more value over and above profits
Despite sounding like an oxymoron, Inclusive Capitalism is a movement that stands by the belief that businesses should work to create an economy that benefits all and whose value goes beyond the financial profit bottom line. Indeed, a study by Brand Finance (2018) shows that statements such as balance sheets only illustrate a mere 20 per cent of the total company’s value, especially since tangible assets are increasingly being replaced by intangibles such as employees’ knowledge and digitisation.
So, the question is “Why keep using financial short-term metrics to measure the success of companies?” Financial measures have been tried and tested, are widely accepted globally, are fairly simple to apply, and most importantly, they are comparable. The same cannot be said of ‘long-term intangibles’. The greatest obstacle is that there is no consensus or consistency on which and how intangible assets and stakeholder values are to be measured and reported. Hence, for lack of better tools, and reliable and verifiable measures, companies have no alternative than to resort to traditional ‘financials’.
In an attempt to target this lacuna, in 2017, EY partnered with Inclusive Capitalism and launched the Embankment Project for Inclusive Capitalism (EPIC). Along with around 30 asset managers, owners and companies (with circa $30 trillion of assets under management), they have undertaken an 18-month project to identify and create new metrics to measure and demonstrate long-term value to financial markets. They aimed to reach a consensus on how businesses create value and how this can be measured to assist businesses and investors in their decision-making processes.
Despite the diversity of the players, their respective industries and roles, the workshops led to the identification of four major categories of ‘intangible assets’ that are worth quantifying; namely (i) talent, (ii) innovation and customer trends, (iii) society and the environment, and (iv)corporate governance. Such aspects have often been identified as important by investors but were often regarded as too abstract to quantify and report. EPIC has set the ball rolling on finding various comparable metrics for each category. The full report can be downloaded from www.epic-value.com.
In no way is this exercise a ‘fait accompli’. The metrics proposed still need to be tested, discussed and consensus obtained by the major players. More research is definitely needed, yet the willingness to embark on such an ambitious exercise can be considered as a step towards a better and more inclusive economy.
Maria Giulia Pace is an economist at EY Malta’s Economic Advisory and Climate Change and Sustainability Services team.
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