CHAPTER ONE

Rethinking Risk

RULE #1
Reputation, Trust, and Other Intangibles Drive Business Value

To create a fairer economy, one where prosperity is more broadly shared and is therefore more sustainable, we need to reinvigorate a serious discussion about the nature and origin of value.
—MARIANA MAZZUCATO, THE VALUE OF EVERYTHING

ON A WARM SEPTEMBER AFTERNOON under a brilliant blue sky, a group of finance scholars were fighting to hear one another over the sound of the Roaring Fork River where it winds through the campus of Aspen Institute in Colorado. It was 2010. The meltdown in the financial markets—from the failures of Bear Stearns and Lehman Brothers to the bailout of major banks—was still reverberating on Wall Street, but especially on Main Street where the value of homes plummeted and the real effects were still felt a decade later.

The purpose of the gathering was to consider what role the finance academy might have played in the turmoil that roiled the markets and defined the early days of a new presidency. Nineteen faculty members drawn from influential business schools—Stanford, NYU, Wharton, the University of Chicago, and Darden at the University of Virginia among them—had accepted our invitation to dialogue. What had we learned—and what were the consequences for how finance is taught?

David Blood had left a leadership position in asset management at Goldman Sachs in 2005 to start a new company called Generation Investment Management. David waved his hand at the rushing stream that tumbled 15 feet below on its journey to the Colorado River and asked the scholars a provocative question: “How do you put a price on the fish?” One of the scholars took the bait: “You can’t,” he said definitively. It was clear from his quick dismissal of the idea that he thought, “What’s more, you shouldn’t.”

Trying to value the fish in the stream—or the water we drink and the air we breathe—is an abstraction. Yet as we pull back from the river and consider the consequences of an ecosystem at risk, it becomes more than an academic exercise on a warm afternoon in the Rockies. As we consider the livelihoods of communities and quality of life for future generations, we experience challenging questions and very real costs, albeit largely unmeasurable by the traditional tools of finance.

Economists and their colleagues in finance use the label externality for a cost imposed on a third party who isn’t part of the transaction. In business terms, this might mean the cost of a decision made inside the gate on the community that resides outside the gate—for example, the unintended consequence of a product with observable social ramifications, such as the public health costs of alcohol abuse or soda consumption; or how work, structured for maximum efficiency, affects home life or commitment to education. Externalities, by and large, are viewed as a distraction by managers committed to profits and growth.

Social and environmental impacts of business decisions sit outside the frame of financial analysis—until they don’t. When we step away from the classroom and observe the world that students enter upon graduation, the need for change in how we invest and how we measure value becomes clear.

Risk analysis is bending to embrace the full life cycle of products. It connects us with the effects of business decisions over time—and is widening in scope to include perspectives of those who help create the product or who feel its effects downstream. Both shape our definitions of value.

These ideas are hardly new. The contemporary framework of the circular economy, given visibility by the Ellen MacArthur Foundation and a score of aligned thinkers, has traditional roots; it is part of a conversation about value creation and what to measure and how to measure it that has been evolving since the time of Adam Smith. The idea of thinking in systems echoes a core principle of the Iroquois Confederacy formed by five Native American tribes over 500 years ago. The name of the eco-friendly consumer products company Seventh Generation recalls the Native American ideal of considering the impact of decisions today on generations far into the future. The thesis behind David Blood’s successful investment company Generation Investment Management draws from the same philosophy, translating business norms and impact on living systems into investment theory and analysis.

Lorraine Smith, a creative thinker and gifted adviser to our work at the Aspen Institute, weaves together the worlds of business and finance to put nature at the center of the bull’s-eye. Maybe because of her Canadian roots, she gets away with questions like “What if the Colorado River were the board of directors—what if the fish owned the business?”

Welcome to the front lines of business, where the game of finance is changing in real time.

Teachers and scholars in management schools are insulated from the pace and chaos of markets and business decision-making. Their job is to observe, interpret the data, and build knowledge, which requires some distance from the day-to-day. In their search for clear decision rules for managers and investors working across a range of industries, they employ both large data sets and case studies.

The tension between theory and practice can be a healthy one. The principal ideas and analytical frameworks that are taught in finance classrooms—and shape the attitudes and frameworks in professional domains like consulting and finance—may lag behind what’s current today, the thinking goes, but they stand the test of time.

But what do financial analysts and scholars in finance do when the key assets of the enterprise are unmeasurable?

The simple frameworks that dominated business classrooms in the decades leading up to the turmoil of 2008 were the last gasp of a world ring-fenced by rules about capital formation and valuation. They fail to make the most obvious connections between the real long-term health of the underlying corporation and that of the society and natural systems on which the enterprise depends.

A WAKE-UP CALL IN FINANCE

An early-warning signal of the need for fundamental change emerged early in 2007, in a boom market, before the 2008 collapse. Texas Power & Light, then known as TXU, was one of the most profitable utilities in the country, its growth and prosperity a mirror of the economy of Texas. When the influential private equity firm Kohlberg Kravis Roberts & Co. and its partners, Texas Pacific Group and Goldman Sachs, prepared to take the publicly listed company private, they offered a window into the failure of the old rules of valuation. TXU became a Yale School of Management case study of the need for risk assessment to adjust to new realities and the influence of new voices equipped to go head-to-head with Wall Street.

The deal was ultimately consummated at a valuation of $44 billion—the largest leveraged buyout recorded at the time. Valuations are part art, part mathematics. They are derived from estimates of the market value of current assets of the company plus projections of future asset values, profits, and cash flows—all of which must be stress tested against the competitive environment and future risks to the business model, then discounted back to the value in today’s dollars. Citibank, Morgan Stanley, JPMorgan, and others led the placement, and virtually every asset manager and investor of scale on Wall Street, and, by extension, every pension fund in the country, contributed capital—hungry for high-yielding junk bonds at a time of relatively low interest rates.

But that’s only part of the story. At the most crucial moment, with the required capital fully subscribed and syndicated and the fees all but booked, the architects of the transaction returned to the drawing board—forced by a network of environmental activists to reexamine assumptions about the future of coal in the state of Texas.

In time, a more environmentally friendly deal went forward, but the wall that insulates the valuation and investment game on Wall Street from the real consequences of investment decisions had begun to crumble. Assumptions about business in the volatile energy sector have continued to morph. We have come to understand brand and business risk in new ways.

We are no longer taken by surprise when B-to-C brands are hijacked by dogged activists determined to make the real costs of operations and the so-called externalities material. What was once outside the scope of the interests of profit-seeking investors blurs the lines between tangible and intangible; the contributors to real value are being redefined, and the central theorem of value is being shaped by critical thinking about the material relationships between and among firm value, human systems, and the biosphere. The simplicity of the single-objective function of maximum profit is no longer deemed superior—or useful.

Within five years after the deal closed, TXU was in shambles and headed toward bankruptcy; the expected cash flow needed to retire massive levels of debt had been undermined by the shift from coal to cheap natural gas. Along the way, TXU was renamed Energy Future Holdings, perhaps in the hope of a better future, and the game started anew.

Welcome to Finance 2020, where pension funds, state controllers, institutional investors, and even the investors’ investment bankers have begun to redefine real value and seek a more complex—and useful—understanding of risk.

SIGNS OF CHANGE IN ASSET MANAGEMENT

Thomas Kamei, an investor focused on the Internet sector for Morgan Stanley Investment Management’s Counterpoint Global fund, is a member of the Aspen Institute’s First Movers Fellowship class of 2015. First Movers meet in cohorts of 21 fellows per class to hone skills and build their know-how about creating change from within companies. The fellows are drawn from every corner of the business world—from heavy equipment manufacturers to consumer products, finance to retail. They are selected for their commitment to the complex task of aligning business decisions with the long-term health of society—a complicated endeavor that depends on new business models and metrics.

Thomas was born to investment. At age 10, he began an annual pilgrimage with his mother to sit at the feet of the Oracle of Omaha, Warren Buffett. In 2019, he and his colleagues at Morgan Stanley Investment Management began to test a model for assessing risk that Thomas started working on during his fellowship year. The model offers a clear-eyed view of both risk and rewards when the rules no longer support walls between business and society. Long-term investing demanded a fresh approach, and Thomas was offered the chance to experiment.

The fund that employs Thomas Kamei seeks superior long-term returns for patient investors. Counterpoint Global is designed to identify and invest in undervalued stocks for the long term. Counterpoint is one of the most successful long-only funds in the market, and Thomas’s job was to study companies and understand risks and opportunities now and into the future in order to pick stocks that have a long-term competitive advantage.

With a doggedness that is both admirable and the key to systemic change, Thomas has helped widen the lens at Counterpoint Global to consider material, yet difficult-to-measure, disruptions from unusual places. In one example, Thomas and his colleagues aligned with Lonely Whale, an NGO working on eliminating plastics in oceans, to engage Starbucks on the use of plastic straws. Thomas considered Starbucks’s iconic green straw for frozen drinks a “gateway plastic”—not by any measure the key to protecting ocean ecology yet an obvious target for campaigners seeking massive change in norms around producer responsibility. Following a series of conversations in 2018 highlighting the material risks of inaction around plastic waste, CEO Howard Schultz responded to the call from his early and important investor Counterpoint Global and put a process in motion to eliminate the straw. By the end of 2019, Pepsi and Coke had announced the decision to drop out of the Plastics Industry Association and to double down on investment in alternatives to plastics in packaging.

As Morgan Stanley’s Counterpoint Global fund began to test Thomas’s framework, it became not only an analytical tool but also a guide to engagement with company management. The framework features a dashboard of data and a series of questions designed to unlock the attitudes, embedded incentives, and mindset of the target enterprise.

The quantitative measures on the analyst’s dashboard help provide insight into a company’s alignment with long-term value creation. The methodology that Thomas scoped out and continues to develop employs questions to take the measure of leadership and commitment—what Thomas calls agency. Do the executives have the bearing and aligned incentives to take a long-term view? Is the culture equipped to understand the collision of changing expectations among investors and the shifts in social norms and environmental trends that are on the horizon—and that could rebound to the firm? Is management awake to the opportunity that the trends present, as well as the risk?

This kind of thoughtful analysis requires more than a simple spreadsheet.

Thomas and his colleagues at Counterpoint Global are dealing in real time with the limitations of the decision rules taught in finance classrooms everywhere. The discounted cash flow (DCF) model has glaring shortcomings.

First, DCF fails to capture material, but hard-to-measure, risks— such as a sudden shift in consumer attitudes toward plastic bottles or consumption of meat, or a sustained drought deep in the supply chain, or a potential strike or employee protest. In fact, material risks—the kind that blow a hole in the spreadsheet—may not show up at all. And the disruptions that do show up may require such a long-term view—from the impact of climate change to trends in labor markets and debates about a livable wage—as to disappear through deep discounting of future costs.

And second, the future opportunity embedded in risks may be hidden from the business managers buried in the need to report in 90-day increments to conventional analysts who consider “long term” to be three to five years, or even one year—far less than a normal business cycle. The fact that most asset managers are on a yearly bonus cycle based on recent stock performance compounds the problem.

The kind of analysis and direct engagement that Thomas and his colleagues employ works best with a highly curated portfolio of dozens of companies. It’s kind of like hand-to-hand combat: you can look the target in the eye and assess their readiness for battle. Risk management at an index fund with thousands of stocks in the portfolio, or a large mutual fund with hundreds of investments, requires a different approach.

For example, BlackRock, with $7 trillion in assets under management, is the largest investor in the world and a significant force in both public and private markets. When the CEO of BlackRock speaks out, he is heard in the C-suite of every publicly traded company. Larry Fink’s annual letter to CEOs in 2020 cited the Sustainability Accounting Standards Board (SASB) as a useful, comprehensive reporting framework. SASB experienced a fivefold increase in the number of daily downloads in the two weeks following the publication of Larry’s letter. And even more important for SASB is that the new visitors to their site included more business managers inside corporate accounting, risk management, and the legal department.

Yet, managing to the rapidly changing expectations of the ultimate investor is nothing if not complex. So-called ESG investing—short for environment, social, and governance investment objectives— embraces a crazy quilt of issues du jour. Managers of ESG funds, like all asset managers, compete for clientele and are measured by growth in assets under management. The competitive environment produces a confusing array of individual funds marketed as gun-free or pro-diversity to attract investors who want to match their values and pocketbook—but without sacrificing returns or the safety of holding a truly broad index of stocks, like the S&P 500.

The growing array of investment products may be a positive trend and signaling device to corporations—but it can also be confusing, or not what it appears to be. Matt Levine, the voice behind the popular and often hilarious Bloomberg column “Money Stuff,” calls the natural desire of ESG fund managers to exclude as few stocks as possible “grading on the curve.”

If ESG investments are designed to keep investors happy—i.e., take a stand without incurring much risk—can they actually drive behavior change in companies? How does an asset manager assess worker-friendliness or compare the track records of different companies on human rights deep in supply chains? What measures of carbon output work best across multiple industries without losing the plot? And which is more important as an investment strategy: modest but measurable change across Pepsi’s massive supply chain, or supporting a start-up or small private company with superior standards?

Setting the rules of engagement in the C-suite is a complicated endeavor. The backward-looking metrics and algorithms behind the marketing of eco- or worker-friendly portfolios fail to capture the complexity of managing sensibly with the goal of real, long-term value creation.

What is required now to keep pace with public expectations for risk assessment and valuation in a changing world?

In September 2019, on the stage of Fortune’s Global Sustainability Forum in Yunnan, China, Dutch designer Daan Roosegaarde had this to say about the planetary limits we face, which have seized the attention of both individual investors and those who manage their money:

Don’t be afraid, be curious. I don’t believe in utopia, I believe in protopia: designing prototypes for solutions that create a better world and that can be realized. As humans, we learn, we fail, and we evolve. Stop whining and worrying. We need to fix it.¹

Today, a robust industry of committed analysts and consultants is trying to do just that, inspired by the pioneering work of architect Bill McDonough; Arie de Geus of Royal Dutch Shell; Paul Hawken, founder of Smith & Hawken; Marjorie Kelly, author of Owning Our Future; and others who design business models that work with natural systems and hold out regeneration of life-sustaining natural systems as the goal.

Sustainability experts work with business executives to understand, and price, the real costs of industrial processes—and to execute the changes needed to establish a new baseline for corporate performance. The first step is what one innovative business association, Future-Fit, calls “break even” goals. But companies able to capture both the best talent and the best press today go further; they move beyond a do-no-harm mindset.

Leading companies design products and industrial processes within the limits of natural resources. Levi Strauss’s founding story began in the Gold Rush. It links innovative design with community values and continues to draw talent committed to both high labor standards and resource conservation. Bart Sights is one of five Aspen First Mover Fellows who hail from Levi Strauss. Bart grew up in the textiles business in Henderson, Kentucky, where his family’s denim operation had Levi Strauss as a customer. When denim production moved offshore, Levi Strauss recruited Bart to support their manufacturing operations, first in Turkey and then at the San Francisco headquarters, where Bart runs the company’s Eureka Innovation Lab. In his fellowship year, Bart tested the use of lasers to replace chemicals in the production of “distressed” jeans. The process has raised the bar in the textile industry and continues Levi Strauss’s tradition of incorporating environmental values in design.

Dow Chemical’s decade-long partnership with the Nature Conservancy brought the engineers in close collaboration with the environmentalists to restore the wetlands downstream from Dow’s facilities. Microsoft’s commitment announced in early 2020 to recapture by 2050 all of the carbon released directly by the company and its electricity usage since it was founded will require technology not yet fully at scale. A $1 billion Climate Innovation Fund established by the company will become a resource for others; it recognizes that to solve our planet’s carbon issues will require technology that does not yet exist.

How do these companies capture the benefit of these innovations? Surveys that measure employee engagement or consumer attitudes, such as net promoter scores, help inform business decisions, but the benefit to the company may not be tangible enough to show up in ticks in the stock price or in profitability today. After all, the primary motivation for discrete investments by these companies—Levi Strauss, Dow Chemical, and Microsoft—is aimed at the health of the ecosystem—not the business bottom line. These executives are acting on instinct; they believe in a tangible payback if they do the right thing today. The idea that externalities may simply be ignored in asset allocation and investment is getting harder to fathom.

Chris McKnett of Wells Fargo and Ashley Schulten of BlackRock are also Aspen Fellows. Chris has built a career in finance around making “ESG values” tangible. In a compelling TED Talk, he translates these ideals as a matter of risk— and opportunity.² He gives voice to the “woke” asset managers, like Ashley, who value ecologically sound products and more resilient business models. Ashley leads the coordination of ESG integration, climate risk evaluation, and sustainable investing for BlackRock’s fixed income division, where she explores innovative approaches to understanding business risks of climate change. She uses climate models to reveal physical, as well as socioeconomic, impacts and a user-friendly interface to map these impacts against financial asset valuations.

Ashley wants investors to connect the dots between a changing climate and management reality; for example, if company assets are likely to flood, do financial models capture the risk? By helping institutions—pensions, endowments, and mutual funds—manage long-term risk, she links investment to business decisions and makes the executive’s job easier, not harder. In turn, Ashley’s work is aligned with the almost infinite time horizons of the vast majority of individual savers and equity investors—those saving long term for college or retirement.

Ashley, Thomas, Chris, and their peers throughout the finance industry defy conventional ways of assessing risk. They also stand against short-term market pressures from investors who have little interest in the longer-term prospects of the enterprise but who influence norms and decision rules in both public and private markets.

Take, for example, the world of private equity, an elite and fast-growing corner of investment where “qualified” investors—high net worth individuals and institutions—seek higher yields beyond the intense scrutiny and regulation of the public markets.

Private equity firms like KKR and Texas Pacific Group, the partners in the TXU deal, have a modest investment horizon for the companies they acquire, typically five to seven years, long enough to upgrade technology and make other changes in strategy and management with an eye to greater efficiency, productivity, and return on investment (ROI). Greater productivity typically requires selling off parts of the business and reducing head count. Most private equity deals carry heavy debt loads to finance the purchase and subsequent investments. The financial gains are captured when the company is sold back to the public market or to another private investor at a higher valuation.

Critics like economist Mariana Mazzucato turn our assumptions about what is productive upside down. In her book The Value of Everything: Making and Taking in the Global Economy, Mazzucato revives an old conversation about what constitutes productive work—a debate that threads the entire history of economic thought. Productivity is a measure of output. It was once tied to land and then, in the industrial age, to labor itself. For Adam Smith and those who followed, the activities that help facilitate commerce were considered outside the productive boundary. Activities like finance and investment, and in fact the entire mercantile sector of buying and selling of goods, were not measured as part of the economic output of the country.

Today, productivity has a very different spin. Private equity firms have both admirers and detractors, but both acknowledge that these investment funds measure economic productivity principally through the lens of returns to investors. In recent years, the stories of private investors preying on Main Street to identify the next target and extract profits have become part of the narrative about where the profession of finance has failed us. Examples also originate in the public capital markets where corporate raiders, today’s “activist” investors, demand a seat on the board to oversee goals that are short term in nature, to institute measures that “release value”—i.e., raise the stock price for short-term investors. Research calculates the cost of hedge fund activism on long-term stock value—but, more important, for other stakeholders who bear the real costs over time.³

Senator Tammy Baldwin, Democrat of Wisconsin, made a case example out of a paper mill forced to capitulate to a private takeover:

Wausau Paper in Wisconsin . . . had a 100-year history of making paper in Wisconsin. When a wolf pack seized control, they forced out the company’s executives and sold several mills—causing one Wisconsin town to declare bankruptcy. The hedge funds demanded that Wausau abandon investments in future growth and instead borrow to buy back shares and boost stock prices. This example is tragic, but not unique; there were 348 activist campaigns in 2014.

The number has risen annually by 60 percent since 2010.⁴

The case of Wausau Paper is compelling but complicated. The paper industry is built on a business model of extraction of natural resources—and the purpose of the buyout had nothing to do with enhancing the health and well-being of the people or the ecosystem that sustains life. None of the players who had built or supported the enterprise—neither the employees, nor the towns, nor the local businesses—enjoyed any of the upside of the transaction.

Stories like these may have cost former Massachusetts governor Mitt Romney, who entered politics after a career at Bain Capital, his bid for the presidency in 2012. When Deval Patrick, also a former governor of Massachusetts, threw his hat in the ring for president in 2019, he resigned from his post at Bain and removed the company from his campaign bio.

The tide may have begun to turn, even in the less-than-transparent world of private equity, as wealth concentration escalates and firms have been forced to reckon with new rules of finance—i.e., embedding environmental costs of doing business and balancing returns to investors with jobs and returns to workers. The investment firm Apollo signaled a desire to change the conversation when it rescued Hostess and its iconic brands out of bankruptcy, and then began to experiment with employee profit-sharing as a pathway to better relations with workers and, yes, higher productivity. Leading firms like KKR and Carlyle now employ ESG specialists to alert analysts to the human and environmental costs of business as usual. The conversation in private equity firms has begun to widen from risk mitigation to value creation: by focusing on intangible values, can the firm create a better opportunity and return for the investors, the portfolio company, and society?

Marty Lipton is a founder of the law firm Wachtell, Lipton, Rosen & Katz and inventor of the “poison pill” to thwart unfriendly takeovers. In the article “Takeover Bids in the Target’s Boardroom,” published in the Business Lawyer in 1979, Marty asks if “the long-term interests of the nation’s corporate system and economy should be jeopardized in order to benefit speculators interested not in the vitality and continued existence of the business enterprise in which they have bought shares, but only in a quick profit on the sale of those shares.”⁵

Beginning in the 1980s and intensifying since, the world of finance in both public and private capital markets has confounded our view of what constitutes good business management. From outside the finance industry, the different kinds of investments tend to confuse more than clarify objectives. What are the goals of the business, and are they aligned or at odds with the goals of different kinds of investors?

Roger Martin is a well-known business strategist and former dean of the Rotman School of Business at the University of Toronto. Martin accepted an invitation to join an Aspen Institute dialogue convened at the close of the go-go stock market years of the 1990s. The design of the meeting enabled the participants to dive into the murky area of the changing role of corporations in society to better understand what is needed to withstand race-to-the bottom market pressures. How might we support the kinds of decisions that create real value for the business and society?

Roger Martin writes about this challenge. In his book Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL, he distinguishes between two kinds of market activity. The real market includes everything needed to create the goods and services to serve the customer—i.e., R&D, sourcing, manufacturing and production, marketing, and all the labor and infrastructure to support business activity. The expectations market is about investing in and betting on the future value of shares of stock—shares that are initially issued to raise cash to support the company’s growth but continue to circulate in a secondary market with only an indirect connection to the company. Today’s stock price is influenced by myriad events and macroeconomic trends that may have little to do with the fundamentals of the business itself.

To bring home the point, Martin uses the analogy of American football, in which the real market and the expectations market are kept separate. Players on the football field—and the coaching staff and managers and anyone who can influence the game—are prohibited from betting on the outcome of the game.⁶

In US public companies, managers are expected to tend to both— the market strategy and execution on the one hand, but also the stock price. As we will see in chapter 7, the design of pay compounds the lack of clarity between these aims and resulting tensions between executives rewarded mostly for increases in the stock price and the workers seeking higher pay, benefits, and financial security.

CHANGE IN THE C-SUITE: WHAT MATTERS MOST?

As COVID-19 wreaked havoc in communities and the national and global economy imploded in the early spring of 2020, Eric Motley, an Aspen Institute colleague, wrote an email to the staff of the Institute about the dilemma of decision-making and how abstract ideas and tradeoffs had materialized in this moment—had become “current, real, and disturbing.”⁷

Eric quotes Mortimer Adler, an educator and philosopher from the University of Chicago and architect of the Aspen Seminar in the 1950s—still a core offering of the Aspen Institute today. In How to Read a Book, Adler wrote, “The essence of tragedy is time, or rather the lack of it. There is no problem in any Greek tragedy that could not have been solved if there had been enough time, but there is never enough. Decisions, choices have to be made in a moment.”⁸

Eric ends his message building on the ideas of Jim O’Toole, whose contemporary and powerful contributions to the Aspen Seminar are explored in his book The Executive’s Compass.⁹ Eric writes,

At best those decision-points are informed by a moral compass, our own internal sense of right and wrong, shaped and sharpened by education and experience. Nonetheless our moral framework, inherent in its very formation, is both complex and often contradictory. At the very intersection of society lies both a tragic and ironic sense of history . . . and both the collision of values and the dialectical dilemma of liberty, equality, efficiency, community. And I would add, equity.

As the pandemic crisis unfolded in spring 2020, the question of equity reentered the American conversation. Like other qualities of business culture, equity is hard to measure; it depends on what lens you apply, whose needs you consider. Equity matters little in the pricing of assets, and until recently, equity, or fairness, has not been much of a factor in the allocation of pay and rewards. As a value of business culture, equity has an intangible quality to it—yet the absence of equity is deeply felt and is now at the center of discourse in the public square, and within organizations of all kinds.

At this writing, Amazon warehouse and Instacart delivery workers are on the front lines of a massive shift in buying habits under restrictions on public assembly. As jobs melted away under stay-at-home orders, it took courage for these employees providing essential services to protest their working conditions and a lack of protocols to protect worker health. As with the courageous nurses and orderlies caring for patients in hospitals and nursing homes, for the laborers behind commerce, it is a matter of life and death.

In a scene that recalls labor protests of yore, a growing number of workers have found their voice for the first time in a generation. The question of equity is back on the table. Where and how it will be applied is too early to tell.

In this moment, executives are again asked to do more—to move beyond markets to a new way of thinking and assessing value that is critical to both stability and growth. Tierney Remick, who co-chairs the CEO search practice at Korn Ferry and is a member of the advisory board of the Aspen Institute Business and Society Program, says highly effective CEOs are both strong commercial leaders and courageous social architects.

CEOs today require different skills and new ways of managing. They are whiplashed by rapid shifts in the expectations communicated by their own employees and the fast-paced changes at the intersection of business disruption, evolution in technology, and societal expectations. When the response led by the executive is authentic—i.e., when it lives up to its promises—it affects business operations as well as firm reputation. It can be the very key to understanding and building long-term value. Authenticity is evident in the actions of effective leaders but is difficult to measure—and cannot be discounted.

Roy Vagelos was CEO of Merck in the 1980s. His closest advisers cautioned against his decision to produce and distribute the drug Mectizan, a cure for a disease known as river blindness, whose victims had no means to pay for the drug. Merck led on private investment in a public good, and Vagelos demonstrated a keen understanding of long-term value creation. We will explore the connections between corporate purpose and his decision in the next chapter.

Doug McMillon, CEO of Walmart, was called to act in the wake of mass shootings in Walmart stores in 2019—one outside of El Paso, and the other south of Memphis in the town of Southaven, Mississippi. In the space of a week, 24 customers and staff were killed. After a period of consultation, McMillon announced that all Walmart stores everywhere would stop selling handguns and ammo, including ammunition for military-style weapons. His decision departed from earlier policy, and in the times and social mosaic of the United States, the implications for the business were uncertain. He had listened to his employees.

With a nod to Theodore Roosevelt, who became president in 1901 after the assassination of William McKinley at a time of growing tension between capital and labor, participants in an Aspen dialogue began to refer to this realm of thinking and acting as market civitas. President Roosevelt’s battle with the railroads and monopolists had multiple objectives—a “square deal” for citizens, and a different kind of consciousness and civic engagement, not unlike the need for managers to consider a company’s social and environmental values and impacts today.

Market civitas, in the new millennium, requires business to lend its considerable weight to the health of the commons: to critical infrastructure, an educated labor force, and equal access for all to public goods. Market civitas requires wise use of consumer data, mitigation of a warming climate, and the end of commodification of nature and our separation from it. To make real progress, business leaders need to lean on their trade associations to advance supportive public policy, including a price on carbon and a fair tax system for future collective benefit.

But market civitas also requires private investment of time and money. An airline invests in technology to reduce carbon emissions; a tech company transforms the rules on data privacy; a clothing manufacturer redefines global protocols for contract labor. As we will explore more fully in chapter 6, sometimes market civitas means engaging in complicated coalitions of change agents and competitors. As Amazon found out when it gave up on its national bid for a second headquarters city, market civitas means taking public benefit as seriously as private benefit.

Market civitas is about both utilizing business soft power and deploying business capacity with wisdom and with respect for the institutions that uphold democracy and community.

The PR firm Edelman produces an annual survey called the Trust Barometer to capture public opinion about institutions: government, business, media, and civil society organizations. In May 2020, as the COVID-19 surge commanded headlines and boardrooms, Edelman did a refresh of the 2020 Trust Barometer released in January; it found an anxious public with renewed trust in government, but also heightened expectations that business could put “people before profits.” The interest in business is anchored to perception about business capability—i.e., problem-solving capacity and an ability to put people to work. When government fails us, it is unrealistic to wait—the public wants action now.

Both COVID-19 and the climate crisis put a spotlight on the intersection of the health of business and the health of the society. For the public’s confidence in business to be borne out requires business acumen coupled with emotional intelligence and a keen understanding of the complex interplay of democracy and free markets—of culture and commerce.

THE CHALLENGE FOR FINANCE SCHOLARS WHEN THE KEY ASSETS ARE INTANGIBLE

Finance faculty who teach valuation and investment as a math problem—take the future projected value of hard assets and revenues and discount it against an implied rate of return to determine the value today—are teaching only one tool in a much more complex tool kit required to succeed as a chief executive today, or even as the CFO. Many MBAs in elite schools end up in professions that advise business. They need much more than the decision rules built on classical economic thinking. These students want to make a real difference in how the executive acts.

A business is nothing without a workforce that believes in the product or standing in the community that governs access to tangible assets—clean water, infrastructure, minerals. A business that adds value across the key relationships upon which it depends is an enterprise or brand worth working for and investing in. It is much, much more than a piece of real estate.

As finance faculty wrestle with demands for change in their discipline—what counts the most and what can be discounted—they are swimming in the wake that still swirls around Milton Friedman.

At the end of the 2010 meeting of finance faculty in Aspen mentioned at the beginning of the chapter, a seasoned scholar and teacher at one of the most highly regarded business schools in the country offered up this thought as a place to restart the conversation: “Over the course of a career, my students rotate through jobs on Wall Street, but also through the Treasury Department. I need them to understand the balancing act between private inurement and public benefit. What do I teach in cases where there is misalignment between private gain and public welfare?”

The same can be said of business managers whose license to operate is on the line.

Finance scholars are tough nuts to crack, but real change is occurring in business schools, and within the proximity of the core finance classroom. Michael Porter and George Serafeim from Harvard Business School, and their colleague Mark Kramer, wrote in Institutional Investor about the state of finance in 2019 and its aims:

We believe that the most fundamental purpose of investors is to allocate capital to those businesses that can use it well in meeting society’s most important needs at a profit. Without the effective investment of capital in the real economy, society cannot prosper. But we live in a world today where investors are profiting while much of society is struggling. This disconnect is a threat not only to the legitimacy of capital markets, but also to the future of capitalism itself.¹⁰

If you scan the dozens of faculty members who have won one of Aspen’s Ideas Worth Teaching Awards, very few are in finance. There are courses that have examined exemplary uses of finance and financial tools, such as microcredit, and courses that look at ethical dilemmas in finance or even the failure of the finance system. But the fundamentals of how finance is taught, or might be taught differently today, still seem off-limits or very complicated to unwind.

Anat Admati is on the faculty at Stanford’s Graduate School of Business, where she is a professor of finance and economics. After a number of years of exploring different disciplines as a lens on the near-failure of the financial system in 2008, she began to experiment with a course called Finance and Society, which she describes this way in the syllabus:

This interdisciplinary course will discuss the role of the financial system within the broader economy and the interactions between the financial system and the rest of society. . . . [It will] cover the basic economic principles essential for understanding the role of finance in the economy, and discuss policy issues around financial regulation.

She tackles the financial system, from microfinance to global megabanks and the role of regulation—why needed and how executed. She covers the domain of fiduciary duty, when you are responsible for “other people’s money” and the governance issues that result; and she examines what she terms the “politics of banking and finance.”

Anat is comfortable in an interdisciplinary environment and encourages students from law and policy to come mix it up with the students at the business school. She recently launched the school’s Corporations and Society Initiative to bring the dialogue into the open.

She is eager to explore the disconnect at the heart of the financial meltdown and described her reason for creating the new initiative for a Stanford GSB publication:

Financial firms can do all the things that we tell them to do to maximize shareholder value and yet still mess up everything—make reckless mortgage loans, bundle and sell them around the world, and create a fragile system that takes down the global economy when homeowners start defaulting. . . . How can that be? How is that tolerated?

It turns out the rules were bad, and our assumptions about markets were wrong. Worse, as I looked more closely, I encountered false or misleading claims that seemed to support and enable the system. Our teachings and research assume or suggest that if corporations maximize shareholder value or stock price, that’s good for society. But it turns out you can do considerable harm as you chase these targets.¹¹

Anat’s curiosity about what went wrong led her into other fields— the social sciences and law—to understand, as Thomas Berry says, the Old Story and the need for a new one: “I started getting a better understanding and insight in ways that I would not get from the standard models in economics and finance. And I began to question a lot of our basic assumptions.”

She mused about a Capitalism 3.0 course that might build a bridge between observing what’s wrong and teaching finance differently, and said she was inspired by the vision of Arjay Miller, who served as Stanford GSB dean from 1969 to 1979. Miller created the public management program that first began to host teaching and scholarship on questions of business accountability and, today, the content about social enterprises and nonprofits that deploy capital to good ends.

It’s a start.

Rebecca Henderson teaches strategy to MBAs at the Harvard Business School. She was recently appointed course head for a required leadership curriculum, the seeds of which began as an elective called Reimagining Capitalism. Her teaching earned an Ideas Worth Teaching Award from the Aspen Institute, and in 2020, she published a book with the same title: Reimagining Capitalism in a World on Fire.

The first year, 28 students showed up. The course created significant buzz, and the next year nearly 400 students applied to take it—nearly half of the entire second-year class. The success of the course is testament to a hunger for knowledge about what capitalism can and should deliver—and for know-how about managing between the health of the enterprise and the health of the society on which the enterprise depends.

Rebecca uses a classic 2×2 matrix to lay out the contemporary challenge of managers: the tension between decisions that work best for “me, now” versus the long-term and future needs of “the other.” That quadrant labeled “the other” captures complicated questions like business dependency on the host community, complexity in the supply chain, and the costs of resource use on generations in the future. The manager’s need to balance multiple perspectives and the dynamic effects of business decisions today is clear and compelling. It is also real to the students who are entering business at a time of remarkable complexity.

This change in business teaching mirrors the changes in investment, where asset managers consider criteria relevant to the needs and hopes of a new generation of investors, for whom the importance of a healthy stream can no longer be ignored.

To rewrite the rules of and connect these dots within business begins with a deceptively simple question: What is the purpose of the enterprise?

The purpose of the corporation is not a slogan; it is the key to unlocking the value of intangible assets—to developing and sustaining the trust of consumers, investors, and employees themselves. And as the next chapter makes clear, the purpose of the enterprise is best understood, and fully revealed, through the actions of management.

 OLD RULE 
Shareholder value or profit maximization is the organizing principle of the corporation.

A single objective function—profit—is easy to measure and enables comparisons across divisions or firms. Shareholder value and its corollary, profit maximization, are the keys to accountability.