Article: Can Capitalism Be Fixed By Making Companies More Just?

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JUST Capital seeks to make public companies more "just" by measuring and ranking their overall impact on society, based on the priorities most important to the average American. Ethan Rouen and Charles Wang explore whether capitalism is broken, JUST Capital's performance evaluation methodology is relevant to corporate managers, and if its strategies for exerting influence can be effective in improving corporate behavior.

Brian Kenny: 1776 was a banner year for the release of important written works topping everyone's summer reading list in the US that year would had to have been the Declaration of Independence, a short but compelling read with big implications for the future of the country and signed by all 56 authors. On the other side of the Atlantic, weighing in at a whopping 950 pages an equally compelling read that became every bit as important to the future of the United States, and the world, was Adam Smith's, The Wealth of Nations. This instant classic laid the foundation for the capitalist system as we know it today. The core of his thesis was that our need to fulfill our own self interest results in prosperity and people promote the public interest through their economic choices. In other words, everyone wins. Well, maybe not everyone. As we've learned over the last 250 years, capitalism is a pretty good system, but it's not perfect, so can we make it better?

Today we'll hear from Professors Ethan Rouen and Charlie Wang about their case entitled, Measuring Impact at JUST Capital. I'm your host, Brian Kenny, and you're listening to Cold Call recorded live in Klarman Hall studio at Harvard Business School. Ethan Rouen research focuses on understanding what gives rise to income inequality and how to measure inequality to develop strategies for addressing this important issue. Charlie Wang studies corporate governance and equity valuation, and you're both joining me in the studio today. Thanks for being here.


Ethan Rouen: Thanks for having us.

Charlie Wang: Thank you.

Brian Kenny: I really enjoyed this case, and I think people really enjoy hearing about it because it signals, I think to some extent a change, an important change in the way that we look at our capitalist system. So why don't we dive right in, Charlie, can you help us set up the case? Who's the protagonist and what's on their mind?

Charlie Wang: The case opens with Martin Whittaker, the CEO of JUST Capital, who is about to make an announcement of the 2019 rankings for America's Most JUST Corporations. A ranking that the company or the organization produces based on its own methodology, and a ranking that will be published in a special issue of Forbes. Now in 2018 that was by all means quite a smashing year for this organization. The rankings had been gaining traction and Goldman Sachs earlier in the year had launched successfully an ETF based on the JUST Capital rankings-

Brian Kenny: And ETF just for our listeners who don't know is?

Charlie Wang: An Exchange Traded Fund.

Brian Kenny: Thank you. Most of our listeners probably know that but just in case.

Charlie Wang: But at the same time Martin and his organization are deeply introspective about what it is that they do in particular, he's wondering whether the organization had taken the right approach for measuring corporation's impact on society as well as for influencing corporate behavior.

Brian Kenny: Those are big questions, and I will confess that working at Harvard Business School, we have a love hate relationship with rankings because business schools are ranked by multiple publications every year, and it's important to be represented in those things. But it also is pretty taxing on the institutions involved. So I want to talk more about rankings in general in regard to this case as we move forward. But Charlie, what prompted you to write the case? How did you hear about JUST.

Charlie Wang: I teach a course on financial analysis and valuation in the elective curriculum in our MBA program, a course that is focused on teaching students the tools of analyzing how corporate and management strategy impacts financial performance and the intrinsic value of an enterprise. So naturally corporate profits and stock prices are key performance metrics in our analytical framework. And yet there's been an increasing concern both in the public, and the policy sphere that this very focus on financial performance in stock prices is at the very heart of what ails our corporations and our economy at large. That such a focus in particular on the part of public market investors push us corporate managers to take certain actions that in fact produces undesirable outcomes for our society. So Ethan and I we're very interested in developing a case that would provide an opportunity for our students to reflect on the role of investors in capital markets, on our corporations and on society, to evaluate the degree to which our economic system might be failing us, and if so, what are the sources of these problems and what are some of the solutions? Ethan had been aware of JUST Capital because of the work that he did in his dissertation. And we thought that it was a particularly interesting case because of the thoughtful, rigorous, and scientific approach that it has taken to try to develop some solutions to help improve our economy. And so we thought it was important to bring this into the classroom floor for discussion.

Ethan Rouen: And just to build on it, just to put it in context of the class itself, in this class that Charlie teaches, these are the people who frequently go into investment banking and security analysis.

Brian Kenny: So tell us about JUST Capital, Ethan.

Ethan Rouen: So JUST's mission is to build a more just marketplace that better reflects the true priorities of the American public. It's founded by the billionaire Paul Tudor Jones, who believes along with JUST Capital that capitalism and business can and should be a force for good. But they believe that we are starting to wander away from that. And part of the reason that we can't make decisions based on that is that the information isn't available. Companies don't disclose information related to the issues that JUST is trying to tackle. And so through data collection and thoughtful measurement JUST measures companies based on their broader impact on society, and that's how they determine their rankings.

Brian Kenny: Would you consider this to be part of the ESG movement, the environmental, social, and governance movement that we're hearing a lot about these days?

Ethan Rouen: Yes. This is very much, that is at the heart of JUST's mission, it's to take into account these environmental, social, and governance issues.

Brian Kenny: So that sort of gets at the heart of in the intro where it is about capitalism and how it's an imperfect system. I guess I would ask as the case really delves into issues that people have with capitalism. Is capitalism broken for lack of a better word?

Ethan Rouen: I think that's above my pay grade to determine, but-

Brian Kenny: They're coming from Harvard Business School. That's quite a question so.

Ethan Rouen: I think more broadly, there is a growing contingent of people including titans of capitalism such as Jamie Dimon and Ray Dalio who believe that the cracks are beginning to form in the foundation of our capitalist system. This is a system that was developed generations ago, and the economy has evolved significantly since then. And so we're starting to see where capitalism might be creating some issues that need to be addressed and what JUST is doing as well as what these other titans are calling for, what's creating their concern is the belief that if we don't address this either through government regulation, through business action, or through broader societal movements, the whole system risks collapsing.

Brian Kenny: And it's interesting, we're sitting in Klarman Hall and that's named after Seth and Beth Klarman who made this building possible. Seth who's well known obviously in investment circles with Baupost Group has raised similar concerns about people's perspective on capitalism. Charlie, the case delves into some numbers particularly around the millennial generation. How do they feel? Do they trust capitalism?

Charlie Wang: I think there are some signs which could be concerning that among this particular sub demographic the usual support that we might take for granted in this country is certainly eroding. So in a well-known study, a survey that was done here at Harvard University, showed that about 51% of the respondents, the millennials, say that they do not support capitalism, and merely 42% of them say they did. And yet, in a separate survey, an overwhelming percent of these millennials identify corporations as being critical as part of the solutions to some of the world's biggest problems today, whether it's related to issues around the economy, healthcare, or the environment. And so as an optimist, I'd like to view this evidence as at least suggesting that even among these millennials, there's significant hope that capitalism could operate to produce a better world.

Brian Kenny: And maybe even a call to arms, it sounds like for business leaders to think differently about their role, right? It almost legitimizes their role in this instance.

Charlie Wang: I think one thing to take note of is in your reference to capitalism and Adam Smith, one of the important preconditions to what makes the invisible hand work is this idea that the actors in the economic system need to have all the information that they need to make the right decisions. And so one way you can think about what JUST Capital is trying to do is to provide that missing information or to perfect the informational endowment of our economic environment so that people can make the right choices and that would help to them produce a better set of outcomes.

Brian Kenny: Right. That makes perfect sense. Another thing the case delves into that which was counterintuitive to me because we're in a political climate right now on the verge of an election where people are talking about inequality, income inequality in particular. Ethan, can you talk a little bit what the case delves into and what the findings were? Because one of the exhibits to me was like a little bit mind blowing with regard to that.

Ethan Rouen: It's a complex picture and overall when we look at the introduction of capitalism, capitalism has played an important role in bringing people out of poverty, increasing living standards, increasing life expectancy. But it's also done this in ways that are not equally distributed. And so we, in the United States, we start to see income inequality growing and we see this both across countries and within countries. So overall there is some evidence depending on how you measure it, that inequality has fallen in the last 30, 35 years. In the United States though, the share of income going to the top 1% has gone from 10% in 1980 to 20% in recent years. And we've seen the exact flip for the bottom 50% so the bottom 50% of people used to have about 20% of the wages and now they have 10%.

Brian Kenny: Okay. So that gap is widening.

Ethan Rouen: Yes.

Brian Kenny: One of the things that JUST is trying to do is figure out what Americans think is important I guess so they can measure it against what their thesis is. How do they determine what's important to Americans?

Ethan Rouen: So JUST starts with focus groups. They go out and they actually ask the public what they think is most valuable to them. How corporations should be behaving and what corporations should prioritize. And so they conduct these focus groups around the United States. They do it every single year, and based on what the focus groups say, they create a list of priorities for companies.

Brian Kenny: What do they find? What are the priorities? Because in this political climate it would be great for the candidates maybe to know what the American's priorities are, too.

Ethan Rouen: I mean it's publicly available on JUST website. So just to be clear, these priorities shift slightly every year because they conduct these focus groups every single year. But in the most recent year there were seven main issues that came out. The four most important ones are treating workers and customers fairly, providing quality products, and minimizing the corporation's impact on the natural environment. And then we see within these categories, they drill down and get some sub categories. So treating workers fairly, that means worker safety, that means paying a fair wage.

Brian Kenny: And it gets quite granular actually. Because one of the exhibits shows how deep they dive on looking at these priorities.

Ethan Rouen: The magnifying glass exhibit. It's a very tiny print to fit all of their sub categories on one page.

Brian Kenny: Something I admire eyesight, I got a headache from that. So what do they weigh their priorities against?

Ethan Rouen: So again, consistent with the idea that they want the American public to drive this after they have their list of priorities? They go out and they survey tens of thousands of Americans and they asked them to rank these different issues in terms of in order of importance and based on how the American public ranks them that's how they decide to weight them. So again, treating employees fairly is the biggest one, comes up as the most important issue in these surveys. And so that gets the heaviest weighting.

Brian Kenny: So this sounds like too simple, right? Like they're asking people, which is kind of amazing, are there flaws in what they did?

Charlie Wang: One of the flaws I think you might say is does it actually make sense to ask the average American what corporations ought to be doing? The second is even if we buy into that premise, despite their best efforts one might argue that their measurement rubric is simply too complex. With each of the seven major issues of concern, there's various sub issues for each sub issue JUST Capital can use multiple performance metrics to evaluate. And altogether I think there's over 80 metrics that go into this measurement scheme. So I think even a rather smart and well-intentioned manager might find it difficult to understand where to start if they wanted to improve their rankings in terms of JUST Capital's measurement.

Ethan Rouen: And to build off of that really briefly, that's where the subjectivity comes in. JUST tries to remain objective in determining the issues, but the subjectivity comes in the measurement and that's a huge challenge. And there is no clear right or wrong answer there.

Charlie Wang: And so part of that is this question of whether or not the organization has really struck the right balance between parsimony and completeness in my view at least, I think they've really tried to go for completeness, but because of some of the complexity in terms of how you measure particular sub issues or performance along some particular sub issue, assumptions will have to be made. It's possible that the propagation of errors may produce more noisy overall performance than perhaps a more simplistic or parsimonious framework.

Brian Kenny: This is kind of a big deal because the implications or the consequences I guess are pretty high on this, if you rank somebody incorrectly, right? I mean it could affect stock performance and other things.

Charlie Wang: That's possible.

Brian Kenny: So the case talks about Goldman Sachs engaging with this and that seemed to be a big important element in sort of legitimizing what JUST Capital was trying to do. Why was Goldman Sachs interested in signing on?

Charlie Wang: I think Goldman had been interested in the possibility of creating an investment vehicle based on ESG investing, and had been slightly late to the game, but what it really liked about what JUST Capital was doing is that JUST sought to assess corporations on the basis of a fairly broad set of issues that mattered to Americans. So they liked this approach of understanding what matters to the average American and they believed that JUST Capital was approaching this issue with a very thoughtful, rigorous, and transparent measurement rubric, which is one of the common criticisms about ESG rankings, that it's often quite opaque and difficult to understand what's actually in the black box.

Brian Kenny: So how did Wall Street react to the launch of the ETF that was another I think turning point in the case when they came out with this ETF. What was the reaction of Wall Street? Was there cynicism there or was there acceptance or how was it looked at?

Charlie Wang: I think the launch of this ETF was viewed as being quite successful on the basis of the amount of capital that this JUST ETF was able to attract. By the end of the first trading day it had amassed over $250 million of assets, which made it the most successful ESG ETF launch up to that point.

Brian Kenny: You mentioned that Goldman Sachs was interested in getting into an ESG fund, how competitive is that landscape? Are there many such funds out there?

Charlie Wang: Yeah, it's certainly a space that's becoming increasingly crowded and just as a benchmark, in 2013 there were eight launches of sustainability funds that included mutual funds and ETFs, and in 2017 alone, there were 40, and this is particularly a big area of growth in ETFs. In 2018 when the JUST ETF launched, there were 14 other ETFs based on ESG themes that were launched. And, in 2019 in the first half of the year, there were a couple of blockbuster ETF launches, each of which attracted more than $800 million in assets.

Brian Kenny: Wow.

Charlie Wang: And each of which became the largest ETF launch, not just ESG ETF launch, but the largest ETF launch over the last 15 years.

Brian Kenny: All right. So that's certainly indicative of a change it sounds.

Charlie Wang: Certainly seems like it.

Brian Kenny: So, Ethan, JUST had a challenge, I would guess in terms of getting CEOs and companies more broadly to want to go along with this, because it's like I mentioned about the business school rankings, it's taxing on the institution to do the things that you need to do to perform well in the rankings. How were they able to sort of enlist CEOs to get behind this?

Ethan Rouen: This kind of response to the criticism we wrote earlier of the complexity and as well as the benefit of the black box. So I interviewed the head of sustainability for GM to talk about her relationship with JUST Capital and one of the things she touts is the transparency. We're starting to see that this matters not just to investors and customers but also to executives. I am hesitant to say it's a trend if it goes from zero to one, but we're starting to see that executives are being compensated based on ESG measures. And what the head of sustainability at GM said was that the benefit of justice, the transparency, we can see exactly why we scored what we did and we can also see the roadmap of how we can improve. What levers we need to pull in order to get better than we were the previous year.

Charlie Wang: I think in general we could think about three levers of influence that JUST Capital tries to pull. One is through the power of capital and then one is through the power of maybe you can call it praise and shame, and then the other is through the power of PR. The power of capital channel is through this ETF that somehow if they were able to amass enough capital that trade around to JUST Capital rankings, that there could be significant financial incentives for managers to perform well along these dimensions. They then use the power of praise and shame through their partnership with Forbes magazine by calling out among the largest companies in our market, the best corporate citizens, as well as the worst corporate citizens. And then they try to utilize the power of PR by providing these badges that the marketing teams inside companies can slap onto their products to make the products more attractive to consumers.

Brian Kenny: So there's both carrots and sticks involved in this approach.

Charlie Wang: I think JUST would like to would say that currently it's much more about the carrots. They don't like to emphasize the stick, but certainly it seems to me that there's always the threat of the stick. Now, whether or not managers would care about that stick, I'm not sure. But I do believe that managers often deeply care about their reputation and nobody likes to be on the bottom of any list.

Brian Kenny: And certainly in the age of social media, and we'll go back to the millennial generation a little bit. Bad news travels fast and millennials want to be associated with firms that they feel are doing the right thing, they've definitely got more of a mission focus. So I would imagine that also plays into this.

Ethan Rouen: And I think that's where JUST hopes to continue its growth and continue building its movement. When we were talking to Martin Whittaker, the CEO of JUST, one of the goals he said was, to have that JUST Capital badge on the side of an airplane of the highest ranked airline in the JUST rankings, to have it on a little blaze on GM because it's the best automotive company in their rankings, those kinds of things.

Charlie Wang: And at the same time, part of the challenge in utilizing that type of mechanism that could drive a change in corporate culture, if you will, is to get everybody else to take this particular way of measuring corporate impact seriously as the de facto or the standard for how you should think about corporate impact on society. But in the space, as we know, it's filled with alternative standards for measuring ESG performance from MSCIs, ESG rankings, to sustainanalytics, among others. And they can often provide conflicting rankings on company's performance. And so for this organization, part of the challenge is figuring out a strategy for getting everybody else to take their measurement seriously as the standard.

Brian Kenny: Right, and there's competition among these platforms, they want their ranking to be distinctive from someone else's because that's a source of revenue for them. So I would imagine this is open to the same potential for proliferation of different rankings.

Ethan Rouen: I think so. And to keep the comparison with the business school rankings, again this is subjective some things matter more than others. And one of the challenges that JUST and all these organizations face is that they're trying to fit a square peg into a round hole that every company, there are different aspects of ESG that are going to matter more or less. We have retail companies where pay should matter more than environmental impact. Oil and gas, clearly environment is an important issue. That's where the challenge is, I was talking to people about this a few weeks ago to some investment bankers and what I thought was a potential way for this to go, which is a challenge to JUST and these other rankings is to have some kind of industry adjusted or managerial adjusted measures of ESG much like we do with earnings. We have gap, which is a good way to generalize earnings, but each company is going to chafe against gap in a different way. And that's why they provide these manager adjust earnings.

Brian Kenny: Were there particular industries that did better in the rankings than others?

Charlie Wang: What we found was that firms in technology, software, semiconductor space seemed to be systematically put on the best performer list. But other firms in industries like retail, food and beverage, energy extraction-

Ethan Rouen: Tobacco.

Charlie Wang: Tobacco are systematically placed in the bottom of the barrel. So there's something about the measurement scheme here that gives a systematic advantage or disadvantage to certain types of companies. And it's plausible that this was one of the flaws, if you will, because one may argue that what is being reflected in these rankings could simply be the natural economic differences between the firms in these industries.

Ethan Rouen: And this goes back to the challenge in JUST’s defense, they also do within industry rankings. So you can get a sense of not just the best companies, but the best companies in the tobacco industry. At the same time, it's perhaps unsurprising that tech companies do really well because their environmental footprint is fairly small. They also are competing much for labor, so their pay tends to be much higher than a little margin retail company.

Brian Kenny: That makes perfect sense. And the priorities that they identify year after year are also going to reflect the current political discourse that's happening in the country, which certainly reflects on those industries as well. So do you think that they can actually succeed in their efforts to change corporate behavior? That's to either of you.

Ethan Rouen: I think there's a groundswell. I think JUST has an opportunity to play a role. I don't think JUST is going to be the single spark that creates this huge conflagration, but we are seeing in general a willingness to accept and address this. Again going back to GM, one of the things that attracted GM to JUST was that this woman said that the average American is our primary customer. We want to know what they care about and that's why we're following JUST's rankings.

Charlie Wang: I'm generally skeptical because I think it would be extremely difficult for them to establish their particular measurement scheme being basically the new kid on the block and to overtake the existing three standards and become the de facto ESG standard. And I think if they're able to achieve that much more optimistic about the opportunities that they have to try to exert some systematic influence on corporate behavior.

Brian Kenny: Could be a follow on case, right? That's what I'm hearing.

Ethan Rouen: Yes, and we should have disclosed this earlier on, but I think one of the most fun things about writing this case was that Charlie and I definitely have different views on a lot of the topics that were covered in this case. So that was a fun challenge to overcome while we were working on the case.

Brian Kenny: Should we have set this up as a point counterpart discussion?

Ethan Rouen: He would've won.

Brian Kenny: So, well, you've taught this in class? Yes.

Ethan Rouen: Yes.

Brian Kenny: I'm just curious I don't want you to give away any secrets, but what was the general reaction? Were there any big surprises or insights for you?

Charlie Wang: Most students were, I think readily accepting of this premise that capitalism is inherently flawed and can produce certain undesirable outcomes. But they were quite split among, I think along two issues. One is the issue of whether or not public companies are in fact at the root of this problem and therefore students questioned whether or not targeting public companies is the right way to go about addressing what ails our economic system. Many of our students say, "Look, we really should be spending a lot more time trying to fix our political system, not our public companies." The other issue where students were quite split is the question of whether or not JUST Capital's approach is sensible, both in terms of whether it's measuring the right things, whether they've struck the right degree of complexity, as well as whether or not its approach for incentivizing behavior is likely to be effective what we just talked about. And I think there were many students who were very enthusiastic and I think praise the organization for taking on such important problems and thought the solutions were creative, but there were many other students who were skeptical about whether the power of capital through ETFs, the power of praising or shaming or the power of PR could in fact systematically get the companies in America to pollute less, pay higher wages along among other things.

Ethan Rouen: And I taught financial reporting and control the intro accounting class. I've taught that for the last two years and I think this debate pervades the school at this point. I think that students are less likely to disagree on the concerns than they are on the solutions and that's where the focus has been, which is a hopeful thing to think about that they are aware of the issues and they want to come up with solutions.

Charlie Wang: One last thing I'll mention is, and this really came as a surprise to me because walking into the class, I expected that the overwhelming majority of our students will say, "Yes, capitalism is A, broken and B, there are lots and lots of ways in which we can try and fix the system." But that was far from the truth, at least in my course and that may be a self-selection problem that many of the students who come to take my course tend to be people who want to work in the current capital market system. And so yes, many believe that the system has issues, but I think a majority of the students believe that the current rhetoric about how broken our system is, is just that: it's rhetoric and it's overplayed.

Brian Kenny: Well, we'll have to keep an eye on JUST Capital and see where this goes. Thank you both for joining me today.

Ethan Rouen: Thank you. This is great.

Charlie Wang: Thank you so much.

Brian Kenny: If you enjoy Cold Call, you should check out our other podcasts from Harvard Business School, including After Hours, SkyDeck, and Managing the Future of Work. Find them on Apple or wherever you listen. I'm your host, Brian Kenny, and you've been listening to Cold Call, an official podcast of Harvard Business School, brought to you by the HBR Presents Network.

 
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