Can private equity firms seize a leadership role in the rising movement toward stakeholder capitalism?

AJ Gonzalez | June 3, 2021

Private Equity Wire, 01/06/2021 – 4:44PM

By Kyle Burrell, US FSO Assurance Partner, Ernst & Young LLP – Over the years, private equity fund managers have bolstered their firms’ reputations as the asset class of choice for investors, building strong value for their portfolio companies and fuelling job growth across a wide swath of industries. This has also positioned private equity firms as key players in the corporate ecosystem, with a number of studies showing that companies backed by private equity funding created jobs at a faster pace than those that were not.

Now, as the US economy continues to rebound as the country emerges from the pandemic, it’s time for fund managers to look beyond economic growth as a success metric and join the rising tide of companies that are resetting priorities to focus on social and environmental issues.

Private equity managers need to do more than just cheer from the sidelines – they must  seize the opportunity to stake a leadership role in this rapidly growing movement. Larry Fink, Chief Executive Officer (CEO) of BlackRock, and Jamie Dimon, Chairman and CEO of JPMorgan Chase & Co., are a just two of the business executives who have issued statements supporting stakeholder capitalism and sustainable investing, encouraging companies to do more than just focus on profits.

In addition, as we noted in our 2021 Global Private Equity Survey, investors will increasingly be drawn to invest in funds focused on environmental, social and governance (ESG) issues. This trend will become even more prevalent as millennials and Generation Z professionals take on a larger role as investors. They increasingly view ESG considerations as key investment criteria.

Following the money

According to Morningstar, sustainable investment funds captured more than $51 billion in new net money in 2020, doubling the amount raised in 2019. The Forum for Sustainable and Responsible Investment issued a report claiming that assets that follow sustainable guidelines now represent a third of all professionally managed investments in the US, more than $17 trillion, a 42% increase from 2018.

As the momentum for sustainable investing gathers steam, fund managers should align themselves with this movement and advocate that their portfolio companies adopt stakeholder capitalism values that address looming threats to the planet and society, from climate change to rising inequality. This is hardly a radical agenda and the timing is critical, especially with respect to climate change. As Steve Varley, EY global vice chair – sustainability, has said, “Failure to arrest global warming would be an environmental, social and economic catastrophe as well as an existential threat to human wellbeing.”

To that end, private equity firms should focus on three areas that will help multinational and US companies strive to achieve a more equitable, environmentally sound future:

  1. Adopt common standards for measuring progress on ESG issues. While investors and activist groups are still debating the specifics, we are beginning to see a consensus form on a number of shared values:
    • Governance: Companies should align their strategies with an overarching purpose to solve problems for people and the planet.
    • Protect the planet: An increasing number of large companies are pledging to net-zero emission targets. Fund managers should insist that all portfolio companies make similar commitments.
    • Strive for social justice: Companies should adopt operating principles that pursue a broader ambition to respect health and safety, human rights, and provide decent working standards. They should also recognize the need to create a strong, inclusive and transformative economy.
  2. Hold portfolio companies accountable. If a company pursues policies that seek profits at the cost of sustainable principles, private equity firms should pressure the executives to either change the policies or replace those responsible for them.
  3. Identify and invest in innovative companies that are developing market-based solutions for addressing climate change and social justice. If the Biden Administration passes its infrastructure plan, there could be multiple opportunities for companies to participate in or lead green energy projects, broadband initiatives, and other developments that hold transformative potential for the US and the world. Even if those plans are scaled back, the market will continue to reward innovative companies that will drive positive change.

Walk the walk

With their unique positioning as incubators for many up-and-coming companies, private equity firms stand at a key inflection point in the broader effort to embed sustainable business practices into the corporate ecosystem.

By no means will this be an easy task. Fund managers will need to establish this type of governance into their DNA and collaborate with investors, portfolio companies, and each other to drive meaningful change and take actions that will persevere through the next short-term crisis or global recession. If private equity firms can join with others in the global business community to agree on a shared framework for sustainable capitalism, we are confident that the industry will have taken a huge step forward toward building a better working world.

The views expressed by the author are not necessarily those of Ernst & Young LLP or other members of the global EY organisation.

1 Money invested in ESG funds more than doubles in a year,” CNBC website,…, February 11, 2021.

2 Green wave drives ESG assets over USD17 trillion,” Investment News website,…, November 16, 2020.

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