CI 2 Investors and Other Stakeholders
Lenders and owners are only part of the picture. A company operates inside a web of parties who depend on it and on whom it depends, and whose short-term and long-term aims may pull in different directions. A stakeholder is anyone, person or group, holding a genuine stake in the company, and their actions can either help or hinder the firm ability to reward shareholders and meet its obligations. An analyst has to fold these groups into any assessment of expected performance and risk.
The primary stakeholder groups and what they contribute are set out below.
| Stakeholder | Role in the corporation |
|---|---|
| Debt and equity investors | Supply the capital that finances the assets |
| Board of directors | Supervises the corporation and its activities |
| Managers | Execute the board strategy and run daily operations |
| Employees | Provide the human capital that delivers goods and services |
| Customers | Demand the products and services the company sells |
| Suppliers | Provide raw materials, goods, and outsourced services |
| Governments | Set rules, collect taxes, and provide public goods |
| Society and environment | Other people and the natural world affected by the company |
Shareholder theory versus stakeholder theory
Under the shareholder theory of corporate governance, owners elect a board that hires managers to serve owner interests, and every other party (creditors, employees, customers, even society) counts only insofar as it affects shareholder value. The stakeholder theory takes a wider view, holding that governance should weigh the interests of all stakeholders rather than owners alone; it is often proposed that environmental, social, and governance (ESG) aims sit explicitly among the board objectives. That broader mandate brings challenges: juggling several goals at once, defining and measuring non-shareholder objectives, competing with rivals who face no such constraints, and bearing the direct cost of meeting higher ESG standards.
The two theories are not necessarily opposed. In his 1970 essay arguing that the social responsibility of a business is to raise its profits, Milton Friedman conceded that a company taking a long view might well spend on its community or local institutions if doing so helps attract better staff, trims the wage bill, or reduces losses from theft and sabotage. Serving stakeholders and serving owners can point the same way over a long enough horizon.
Investors
Shares usually grant their holders specific rights, among them the exclusive vote on matters such as board composition, mergers, and the sale of assets. All lenders set out their requirements and rights when a debt contract begins, but private and public debtholders differ in important ways. Private lenders, such as banks offering loans, credit lines, and leases, often hold their investment to maturity. They tend to have direct contact with management and access to non-public information, which cuts information asymmetry, and because a single lender can be a vital funding source, especially for a smaller company, that lender may wield real influence. Their willingness to relax terms or extend more credit, or to refuse, can matter far more for a firm with limited market access than for one that can tap broad debt markets. Private lenders also vary widely in appetite and approach: a commercial real estate lessor may care mainly about lease payments and the upkeep of the property, another lender may hold both debt and equity or think in equity-like terms, and some specialize in lending to businesses near or already in bankruptcy.
Public debtholders, or bondholders, are frequently institutions and asset managers who rely on publicly available information, financial statements among it. They rarely hold much sway over operations and depend instead on the contract terms fixed at issuance. Gaining bondholder consent to change an existing agreement is generally harder than with a private lender, yet bondholders can carry weight when a distressed firm has to restructure its public debt.
Board of directors
Shareholders elect the board to advance their interests; the board hires the CEO and monitors the company and its management. Boards typically mix inside directors (founders and current or former managers) with independent directors who have no material tie to the company and may better speak for minority owners. Major exchanges set governance standards that listed firms must follow, and these often mandate a degree of director independence: the London Stock Exchange asks that at least half of a listed company directors be independent, and the Singapore Exchange rules call for a strong independent element with a majority of non-executive directors. Standards also commonly require a spread of backgrounds and skills, and directors are generally held to a high duty of prudence, care, and loyalty, with specifics varying by jurisdiction.
The single-tier board dominates in the USA and the UK, but a two-tier structure is common in Continental Europe and legally required in some countries such as Germany. There a separate supervisory board oversees the board of directors and is drawn from stakeholders including owners, employees, labor unions, the public, and sometimes government where the state holds a stake. The board of directors still handles strategy and oversight, while the supervisory board may appoint or remove board members and must sign off on certain decisions. Most boards hold elections for the whole slate at once, but some are staggered, with directors split into groups elected in successive years. Replacing a full staggered board takes several years, which limits how quickly owners can force a change of control; the trade-off is continuity, though it can also let short-termism creep into strategy. Staggered arrangements show up often across Australia and parts of Europe.
Managers, employees, customers, suppliers, and governments
Managers, led by the CEO, set and carry out strategy under the board oversight and run day-to-day operations. Senior executives are usually paid a cash salary plus an annual bonus in cash and stock, along with a stock-based incentive plan running several years, plus other benefits; beyond retaining talent, this pay mix is built to align manager interests with those of owners and other stakeholders.
Employees supply the labor and skills, or human capital, behind the company output, and in return look for competitive pay and benefits, development, job security, and a safe workplace. In some sectors and countries workers unionize to bargain collectively over pay and conditions. Employees may also hold equity through profit sharing, share purchase, or option plans; for most this is a minor part of total pay, though it can be significant in some cases.
Customers expect products and services that meet their needs at a fair price while satisfying quality and safety standards, and depending on the product they may seek support, guarantees, and after-sale service. Large customers can hold real sway, but the loyalty of retail customers also tends to track revenue and profit growth, and the environmental or social footprint of products matters more and more; boycotts and shareholder actions over such controversies can dent sales and profits.
Suppliers provide raw materials, intermediate goods, software, and outsourced functions such as call centers and payroll, and as short-term creditors their first concern is being paid on time. When a customer company is in distress, a supplier own finances and its willingness to extend further credit can suffer. Suppliers also have longer-term interests, since they seek durable, mutually beneficial ties, which count for most where products are specialized and at least one side has invested in the relationship through design, training, or customization. Governments, finally, work to advance the interests of their citizens and safeguard the economy; because companies shape output, capital flows, jobs, welfare, and the environment, regulators press for compliance with the law, and firms and their workers are a major source of tax revenue.
Volkswagen was wholly government owned from 1937 until it sold shares to the public in 1960. Lower Saxony, the German state where VW ranks as the largest private employer, held on to 20% of the voting rights, and a German statute (the Volkswagen law) enacted at the listing required more than 80% of votes to approve major matters, effectively handing the state a veto. After rival Porsche AG tried to take over VW in 2007, the two combined through an equity transaction that made the Porsche family the largest shareholder in VW. As of 31 December 2021 the voting rights split roughly into Porsche 53%, Lower Saxony 20%, the Qatar sovereign wealth fund (QIA) 17%, and a free float of 10%. Although the Porsche family majority gives it power over the board, the supervisory board is split evenly between labor and shareholder representatives, and Lower Saxony uses its stake and the Volkswagen law to side with labor in blocking domestic plant closures and cost cuts that would hurt union workers.
These scenarios apply the stakeholder and governance ideas to concrete judgement calls.
Both debt and equity investors increasingly look through a stakeholder lens rather than a purely shareholder one, giving weight to environmental, social, and governance (ESG) factors when they invest. Issuers likewise fold these factors into their strategy and into operating, investing, and financing choices. The factors that matter most to investors group as follows.
| Environmental | Social | Governance |
|---|---|---|
| Conservation of the natural world | Consideration of people and relationships | Standards for running a company |
| Climate change | Customer satisfaction | Board composition |
| Air and water pollution | Data protection and privacy | Audit committee structure |
| Biodiversity | Gender and diversity | Bribery and corruption |
| Deforestation | Employee engagement | Executive compensation |
| Energy efficiency | Community relations | Lobbying |
| Waste management | Human rights | Political contributions |
| Water scarcity | Labor standards | Whistleblower schemes |
Source: CFA Institute.
Factors such as voting rights, board composition, and pay practices are widely disclosed and easy to quantify, so analysts have long been able to gauge the soundness of a firm governance and understand what poor governance can cost. Building environmental and social factors into analysis has come more slowly, because it is often unclear which of the many issues actually move performance, along with how and when that happens.
Why ESG matters more now
Three forces have raised the profile of ESG. First, the direct financial hit from these factors has grown, with both owners and lenders taking heavy losses from environmental disasters, social controversies, and governance failures. Second, interest in the environmental and social impact of investments has risen, especially among younger clients who want new or inherited wealth and pension contributions managed with ESG in mind. Third, as governments prioritize climate and social policy, tighter regulation is forcing issuers to change how they operate to meet stricter criteria.
Issues on the environmental and social side, climate change and pollution among them, were long treated as negative externalities, costs that fell on society rather than on the company or its investors. Greater awareness and stronger rules are now pushing firms to internalize those costs in their income statements, whether explicitly or implicitly for responsible investors. Factors once dismissed as intangible or qualitative are becoming measurable as identification, analysis, and corporate disclosure improve.
Environmental factors
How much environmental factors matter varies sharply by industry. A factor is material when it is likely to have a significant effect on a company results or business model. In resource-intensive industries environmental factors often bite directly; elsewhere the effect may be material but indirect. Investors generally regard the following as material: pollution and waste, biodiversity, ecological footprint, climate change, and resource and land use.
Climate change is often split into physical and transition risk. Physical risk covers damage to assets from severe weather, expected to grow more frequent as the climate shifts; such damage can usually be insured or diversified away. Transition risk covers losses from the move to a lower-carbon economy, driven by regulation or changing demand: a coal producer, for instance, could see revenue fall sharply if utility customers switch to cleaner fuels and renewables. A particular form of transition risk is a stranded asset, an emission-heavy reserve that may become unviable and lose value; an oil well slated to produce from 2029 to 2059 might have to stop early because of regulation or uneconomic prices, a risk that is hard to assess given uncertainty over rules and break-even levels. Poor governance or errors in judgement can also trigger material environmental harm, such as oil spills, industrial contamination, or resource depletion, all of which can be costly in fines, litigation, cleanup, and reputation.
Social factors
Social factors concern how a firm treats, and how it affects, its employees, customers, and communities. Pay, turnover, worker health, training and safety, morale, diversity, customer data privacy, and community relations all feed into whether a company can sustain performance. Managing social risk well can lower costs through higher productivity, lower turnover, less litigation, and reduced reputational exposure. Data privacy and security, for example, cover how firms gather, use, and protect personal information, and in sectors such as internet software this can extend to government data requests that risk users civil and political rights, an area where a mishandled breach can materially damage both the business model and the financials.
Governance factors
Governance and stakeholder management cover a company ownership and voting structure, whether board skills fit current and future needs, how well pay aligns with results, the strength of shareholder rights against peers, and how effectively the firm manages long-term risk and sustainability. These questions, usually addressed in proxy statements, annual reports, and sustainability reports, reveal a great deal about management quality and sources of risk.
Environmental (Vale). In 2019 the collapse of Dam I at the Corrego do Feijao mine in Brumadinho, Brazil, released millions of tons of mud, killed 270 people, and contaminated the Paraopeba River. Vale, the mine owner, was later accused of concealing the dam instability; employees including its former CEO and its auditor were charged, and in 2021 Vale agreed to repair the damage and pay USD 7 billion to victims families. Social (data privacy). The 2019 Cost of a Data Breach report from IBM and the Ponemon Institute put the average breach at USD 3.9 million. Lax security at Equifax exposed personal records for more than 140 million US citizens in 2017, costing the firm hundreds of millions and drawing lawsuits and investigations, and Facebook shared over 80 million users data without consent, leading to a USD 5 billion US fine and a renaming to Meta Platforms in late 2021. Governance (Siemens). A 2006 police raid uncovered decades of bribery of foreign officials totaling over EUR 1 billion; Siemens faced more than EUR 3 billion in fines and other costs, both board chairmen stepped down, and for the first occasion in a 160-year history the firm brought in a CEO from outside and overhauled governance with a firmwide anti-corruption policy.
Evaluating ESG risks and opportunities
Because debt and equity are competing claims on the same cash flows, identifying and evaluating ESG factors works much the same way in credit analysis and in equity analysis; what differs is how a given factor hits the value of each claim. Once a material factor is spotted, it has to be quantified in financial terms, meaning its positive or negative effect on discounted future cash flows. For serious long-term adverse events, equity is usually struck first and hardest because it is the residual claim: in the Vale, Equifax, and Siemens cases all three firms saw share prices fall sharply. Debt claims are also affected but usually less so, unless the firm ability to pay interest and principal is threatened; in those same three cases each issuer cost of debt rose and each was downgraded soon after, with Vale briefly cut to speculative grade. In extreme cases lenders may force bankruptcy and suffer large losses in liquidation. Maturity matters too: an analyst who sees long-term stranded-asset risk at a coal company would expect a larger hit to debt maturing in ten years than to debt maturing in twelve months.
Analysts translate material ESG factors into projected financial statements and ratios, discounting expected cash flows at a suitable rate and using sensitivity or scenario analysis to weigh outcomes for each investor group. An analyst might, for example, raise a hotel company forecast operating costs to reflect the lost productivity, weaker customer satisfaction, and higher hiring and training expense that come with heavy staff turnover, or trim the discount rate for a food producer likely to win an edge by moving to a sustainable supply of a core ingredient.
These items apply the ESG framework to classification and materiality.