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During the COVID-19 crisis, many of the largest corporations in the U.S. turned a profit despite a challenging economic environment.
Who benefitted?
Their shareholders, who continued to receive dividends and increasing share prices.
Who didn't?
Thousands of their employees who were laid off.
These corporations chose the financial well-being of their shareholders over the livelihoods of their employees.
But were these corporations in the wrong?
According to the concept of fiduciary duty — a legal principle that states corporations are beholden to the financial interests of their shareholders first — they did the right thing, even though it had an adverse effect on the lives of many.
The next crisis — climate change — is already happening. Will fiduciary duty get in the way of meaningful climate action?
The Principal-Agent Relationship
A corporation is an agent of capital on behalf of a principal: its shareholders. It takes the investments of shareholders in the hopes of generating a financial return on that investment.
A corporation has a fiduciary duty to its shareholders, so it's legally obligated to focus on financial return. Shareholders can take legal action against the corporation if they believe the corporation has placed other interests ahead of their financial return.
Quiz
In response to which action by a company might its shareholders argue that a breach of fiduciary duty has occurred?
As long as the company does things to increase shareholder value that are legal, it's generally safe. Unfortunately, today that includes polluting the environment at the expense of future generations. Giving money to a cause that has little to do with the company's operations and has no value to shareholders (including through marketing) could in theory be considered a breach of fiduciary duty.
Fiduciary Duty & Ethical Investment
What happens when environmental, social, and governance (ESG) issues affect investment decisions?
Although interpretations can vary over time from jurisdiction to jurisdiction, fiduciaries generally can only consider ESG factors if they help or at least don't hurt the financial return of the underlying assets or investments.
An investor might want to put their assets towards an ethical activity. But if that activity can potentially lose money for the investor, what should their financial advisor do?
Let's look at some scenarios that put you in the shoes of someone with a fiduciary duty.
Coffee Cup Conundrum
You're a fund manager representing a large U.S. pension fund that holds stock in a large coffee chain.
The chain is facing a shareholder resolution that asks it to begin using fully recyclable materials going forward.
The cups are slightly more expensive but reduce the massive environmental waste caused by single-use cups. This initiative will reduce shareholder returns but create significant long-term benefits for society.
Your client has the right to vote on the resolution and have entrusted you to vote on their behalf.
Quiz
How should you vote?
As a fiduciary, you're meant to focus on value (what’s good for shareholders) rather than values (what’s good for society). If the two converge, great! But when they don't, you must put shareholder interests first. While the investment to change the company’s supply chain to newer, recyclable materials will help the world, shareholder interests come first if there’s no clear financial penalty for doing the irresponsible but more profitable option. In that situation, voting in favor of the resolution would breach the duty of care to your client (even if it’s the better decision for the environment).
Carbon Tax Complications
You are a fund manager who is deciding whether or not to buy shares in a company based in North Dakota with a large carbon footprint.
You’re not sure whether or not you should invest.
On the one hand...
Carbon emissions contribute to climate change and harm the planet.
Business leaders repeatedly claim that businesses can and will reduce their footprints voluntarily because it’s in their own long-term interests.
On the other hand...
You’re legally obligated to focus on shareholder return.
There’s currently no penalty for emitting carbon into the atmosphere. If regulators apply a carbon tax, this will eat into profits and become a poor investment.
Just as you’re about to make your decision, the government announces that it will delay the carbon tax for a few years, and likely price it far below what economists and climate activists are recommending.
Quiz
Should you buy the shares?
Even though carbon emissions contribute to climate change and harm all of us, your legal obligation is to focus on shareholder returns. If there’s no penalty for polluting, it’s often cheaper to burn fossil fuels. The fact that it would cause harm elsewhere on the planet — through forest fires in Australia and California or floods in Bangladesh — is very important to the world. But probably not to the return on your shares, at least not if the government doesn’t choose to penalize polluters.
Did you know?
Take Action
For a fiduciary, what feels like the right thing to do might actually be the wrong thing to do according to law.
If an investment benefits society but reduces shareholder value, someone acting as a fiduciary generally has no choice but to put shareholder value (profit) over society's values (purpose).
This Byte has been authored by
Steve Birek
Director of Learning Content at Rumie
Tariq Fancy
Social Entrepreneur