What do Milton Friedman and Xi JinPing have in common? They agree that the job of regulating society, for good of course, is something for governments not corporations to busy themselves with.
Milton Friedman elaborated on this in the 1970s (see link below) pointing out that if firms concern themselves with social good at the expense of shareholder gains then a tax is being levied on society by unelected leaders contrary to basic tenants of American democracy.
A look at markets today reveals the same concerns. Do we want Blackrock, Vanguard and corporate CEOs setting agendas for social change or should elected leaders take charge and ask nothing more of corporate stewards than they abide by the rules?
This conundrum is at the heart of lively debate and research in the U.S. but Professor Emeritus Bradford Cornell of UCLA Anderson and Adjunct Professor in Finance Jason C. Hsu of Rayliant Global Advisors and UCLA Anderson wanted to take a closer look at how China is framing the discussion.
On the E-front: China has committed to a policy of carbon neutrality by 2060 and mandated companies to report progress toward this goal. Moreover, the government has promulgated a number of other environmental initiatives and expects companies to do their utmost (or else!) to comply.
On the S-front: just last year the government shut down the cram-school industry and introduced fixed hours for children’s video gaming. It didn’t wait for companies in the space to progress these policies. It’s also reigning in the residential property market with a view to making sure developers provide affordable accommodation to the mass of the population.
[On the G-front. Not in the paper but I’d note the Party has taken steps in recent years to make sure they’re represented at the highest level in China’s public companies and Articles of Association clearly reflect this. Just one example, read here SHE AoA Shanghai Electric’s (2727) most recent Articles . You won’t have dig deep to find the reference, it’s Article #1! ]
The researchers wonder whether the invisible hand of the market or well-meaning pressure from ESG-sensitive investors would have resulted in outcomes that so directly address top-of-mind issues for most families in China? [Er, no. Of course, they wouldn’t.]
The authors digress into one of the common arguments for ESG investing i.e. that it leads to higher firm valuations. As they point out if indeed that were the case stock prices would simply adjust quickly to reflect this and in an all-things-being-equal world there can be no advantage to investors in the long term (even if the assumption were true).
They elaborate: ” … investors in green companies have generally reaped a one-time windfall during the boom in sustainable investing, long-run equilibrium risk adjusted returns for green companies should be no higher than those for brown companies and may well be less for two reasons. First, if investors receive a non-pecuniary benefit from holding green companies, then the financial return is likely to be depressed compared to that for brown companies even in an efficient market. Second, to the extent that there are market inefficiencies, the prices of green companies appear to have been driven to frothy levels in both China and the United States implying that future returns will be lower.”
The key takeaway for investors in China is to be reminded when addressing a company’s ESG credentials what they are, in fact, addressing are the policies of China Inc.
My two-pennyworth here. This misunderstanding of China-risk is at the heart of the tech-wreck China is in the throes of and is another example of Western analysis applied to China that’s turned out to be both inappropriate and costly.
Practitioners should read the paper in full and it can be accessed via this link Who Should Drive ESG Investing?.
Milton Friedman from 1970 is also required reading in this context and for those not familiar with his New York Times article I’ve linked to it here Milton Friedman NYT 1970. Written 50+-years ago it reads like it was penned last week. Pure gold.
Happy Sunday.