Investing in Capricious Morality
The Morning Call examines the next step in politicized investing
Last week, you may recall, we discussed a Bloomberg column by Saijel Kishan that detailed the next evolutionary step in ESG investing. We mentioned it then because it demonstrated one of the fundamental flaws of the entire ESG/applied business ethics movement, its reliance on the “myth” of Milton Friedman to enable the creation of its own moral universe. Today – as promised/threatened – we want to revisit the column for a couple of reasons. First, it details the aforementioned evolution, which is important in its own right. And second, it demonstrates in as clear and potent a way as possible just why this moral universe is destined to fail and why its founders’ efforts will end in far greater misery than any of us can possibly imagine.
If that sounds like hyperbole…well…unfortunately, it’s not. As we’ve noted more times than we can count, creating a moral code out of whole cloth is kind of a difficult thing to do. More often than not, since the mid-18th century, the efforts that have been made to this end have resulted in death, destruction, and then collapse – followed, in turn, by new efforts, entirely ignorant of the causes of the previous failures and yet confident that their mistakes will not be repeated. Western history since the Enlightenment can be described as a series of attempts to create a new moral code to impose on the universe in the wake of the intentional destruction of the pre-modern, pre-Enlightenment code that had provided moral guidance for some 2000 years prior. These attempts inevitably fail, however, because the moral ideas they favor are based on capricious principles and the subjective notion of “reason,” loosely defined, and because their initiators know precious little about morality in the first place. As the inimitable Alastair MacIntyre put it:
Imagine that the natural sciences were to suffer the effects of a catastrophe. A series of environmental disasters are blamed by the general public on the scientists. Widespread riots occur, laboratories are burnt down, physicists are lynched, books and instruments are destroyed. Finally, a Know-Nothing political movement takes power and successfully abolishes science teaching in schools and universities, imprisoning and executing the remaining scientists. Later still there is a reaction against this destructive movement and enlightened people seek to revive science, although they have largely forgotten what it was. But all that they possess are fragments: a knowledge of experiments detached from any knowledge of the theoretical context which gave them significance; parts of theories unrelated either to the other bits and pieces of theory which they possess or to experiment; instruments whose use has been forgotten; half-chapters from books, single pages from articles, not always fully legible because torn and charred. Nonetheless, all these fragments are reembodied in a set of practices which go under the revived names of physics, chemistry and biology. Adults argue with each other about the respective merits of relativity theory, evolutionary theory and phlogiston theory, although they possess only very partial knowledge of each. Children learn by heart the surviving portions of the periodic table and recite as incantations some of the theorems of Euclid. Nobody, or almost nobody, realizes that what they are doing is not natural science in any proper sense at all. For everything that they do and say conforms to certain canons of consistency and coherence and those contexts which would be needed to make sense of what they are doing have been lost, perhaps irretrievably.
In such a culture, men would use expressions such as ‘neutrino’, ‘mass’, ‘specific gravity’, ‘atomic weight’ in systematic and often interrelated ways which would resemble in lesser or greater degrees the ways in which such expressions had been used in earlier times before scientific knowledge had been so largely lost. But many of the beliefs presupposed by the use of these expressions would have been lost and there would appear to be an element of arbitrariness and even of choice in their application which would appear very surprising to us. What would appear to be rival and competing premises for which no further argument could be given would abound. Subjectivist theories of science would appear and would be criticized by those who held that the notion of truth embodied in what they took to be science was incompatible with subjectivism….
The hypothesis which I wish to advance is that in the actual world which we inhabit the language of morality is in the same state of grave disorder as the language of natural science in the imaginary world which I described. What we possess, if this view is true, are the fragments of a conceptual scheme, parts which now lack those contexts from which their significance derived. We possess indeed simulacra of morality, we continue to use many of the key expressions. But we have — very largely, if not entirely — lost our comprehension, both theoretical and practical, of morality.
In the world of business, corporate, and investor ethics, Milton Friedman’s model of shareholder primacy represents the old moral order. Indeed, it’s EXPLICITLY biblical in nature. His basic premise – if one takes resources from another, then his principal responsibility is to shepherd those resources wisely—is, as we have noted elsewhere, simply the Parable of the Talents restated. HOW a manager stewards the investment capital he is provided and HOW he manages the company and HOW he grows the “talents” with which he is entrusted are questions Friedman leaves unanswered. All that really matters is that talents are managed effectively, productively, and in accordance with the “basic rules of the society, both those embodied in law and those embodied in ethical custom.”
The stakeholder model of corporate behavior started life as a means to accomplish those Friedmanite ends. By the early 1980s, however, it had developed – largely because of the work of Edward Freeman, who is now a professor of Business Management and Ethics at the Darden School of Business at the University of Virginia – into a full-blown moral code intended to supplant the old order and to caricature Friedman as the symbol of that order. Over the course of the four decades since, various iterations of the pragmatic/stakeholder moral order have come and gone. They appear, are embraced, grow obsolete, and are then discarded, with extreme prejudice. Freeman’s moral code is based on the principles of philosophical pragmatism. The moral code that dominates the corporate world today is loosely correlated with pragmatism but emphasizes contemporary principles like “sustainability” and “social justice.” These are subjective values that have no basis in reality (literally) and will, therefore, be overthrown themselves in favor of other, more contemporary values.
Consider, for example, the NEW ethical investment model created by Harvard’s George Serafeim, who is the subject of the Saijel Kishan column. Serafeim’s model is exquisite. It is everything a post-Enlightenment moral model should be. It is rational. It is mathematically complex and seemingly scientific. It is empathetic and “other-oriented.” And it is junk. Kishan describes it as follows:
George Serafeim wants to revolutionize the way businesses calculate their success.
Profit and loss aren’t enough, says the Harvard Business School professor. Serafeim aims to do what no one has done before: Put a dollar value on the impact of products and operations on people and the planet, then add or subtract it from companies’ bottom lines….
Serafeim’s research throws out the playbook of measuring business performance primarily by shareholder value, which was popularized last century by Nobel Prize-winning economist Milton Friedman. Besides providing an antidote to “good washing” -- corporate happy talk without follow-up -- his work comes as companies increasingly search for ways to help boost a society that, despite its wealth, suffers from woes that include racism, a widening chasm between rich and poor, and deepening damage to nature. The coronavirus pandemic has made that quest more urgent.
Life lesson #1: Anytime someone is described as having “thrown out the playbook,” that means that he/she is a radical moralist concerned principally with the accumulation of power and the advancement of his/her own moral ends. Jussayin’.
Serafeim is well-known in the world of environmental, social and corporate governance investing -- in his words, he was “doing ESG before it was cool.” Growing up in Greece and observing problems in its government sparked his fascination with measuring performance.
His analysis goes beyond the established work on measuring greenhouse gases or using carbon pricing. Keeping in line with the adage, “what gets measured, gets managed,” Serafeim’s goal is to value intangible, non-financial factors. By tapping machine-learning technology, Serafeim and his team evaluate products and services on factors that include how accessible and affordable they are, their health and safety, and the ability to recycle them.
This means charging credit-card companies for the medical costs of depression connected to indebtedness, debiting airlines for the human toll of flight cancellations and making food producers accountable for health issues related to obesity. Their calculations also credit automakers for the safety of their vehicles and companies that hire in areas of high joblessness.
On employment, the team assesses issues such as the quality of wages paid, the number of Black women in high-salary positions and the impacts of sexual harassment.
There are several things worth noting about Serafeim’s model/analysis. First, it is, as we said, absolutely perfect. He uses complicated technology to provide a veneer of rationality. He assigns “values” to otherwise “intangible factors.” He “taps machine learning technology” to “evaluate products and services.” He calculates and “assesses” issues that allow him to quantify the “quality” of things like wages. Lots of numbers, figures, models, and calculations – all in the service of proving things that are utter bulls**t.
The factors Serafeim, et al. have decided to evaluate are PURELY capricious. They are arbitrary, based on nothing more than the researchers’ “feelings” about what matters and what doesn’t. There is no reason whatsoever to presuppose that accessibility or recyclability are universally applicable moral considerations. There is no demonstrated connection between flight cancellations and human well-being. There is no reason to believe that companies with more black women in higher-wage positions perform better or are more ethically or that such figures are based on anything other than randomness and luck. Finally, in any legitimate moral universe, there should be a point at which individuals bear responsibility for their own decisions – in this case, regarding debt and food consumption. Should companies be punished for providing customers what they want?
The whole thing is nuts, in that it hinges on values that the god-men of Serafeim’s research group deem valuable, based exclusively on their own preferences.
The second thing worth noting is that the variables Serafeim introduces here are EXPLICITLY NON-FINANCIAL. Throughout the short history of the ESG movement, its advocates have always insisted that their proposals would result not in losses or slower gains, but, over the longer event-horizon, GREATER gains. This is, in fact, the entire premise on which the sustainability movement is based: “Ignoring environmental impacts is bad business and focusing on sustainability will yield greater profits over the longer term.“ Now, there are countless reasons to be dubious of these claims, but, at the very least, they represent a symbolic nod to the ideas that businesses should still make money and that managers (corporate and asset) still have a fiduciary responsibility to their clients. The sustainability complex has even created a standards board designed to quantify and thus to “prove” their fiduciary pronouncements valid (SASB). But Serafeim? He doesn’t give a damn. His metrics are unrelated to anything even resembling fiduciary duties. Kishan admits as much in his profile, without ever realizing just how radical the sentiments are: “Keeping shareholders happy has long been the primary goal and focus of decision making for companies, and it remains to be seen whether Serafeim’s work can be a part of altering that.”
Finally, the most telling thing about all of this is that George Serafeim’s model represents a significant departure from the current ESG model, the morality of which he implies is now passe:
Serafeim, 38, plans for his work to culminate in a set of impact-weighted financial accounts. The metrics can aid in investment decision-making, help design tax incentives, be a factor in credit ratings or even assist companies in raising money….
His analysis goes beyond the established work on measuring greenhouse gases or using carbon pricing. Keeping in line with the adage, “what gets measured, gets managed,” Serafeim’s goal is to value intangible, non-financial factors.
The revolution always eats its own. And Larry Fink and BlackRock, the vanguards (sorry) of the new corporate morality, will not be merely discarded; they will be guillotined by the likes of Serafeim, who will judge Fink’s revolutionary fervor insufficient. And then, in time, Serafeim too will be guillotined, as his moral pronouncements replaced by others, more radical and still further removed from petty matters like “financial performance.”
Looking back, Fink, Serafeim, and others will wonder how it all got so far out of control. All they wanted to do, after all, was make things better for everyone, but then…things…just…spiraled on them.
Who could ever have seen it coming?