Thanks to Paul Brest, Ronald Gilson, and Mark Wolfson for their article on investment and social value, because it opens up a renewed dialog about the state of impact investing—in both public and private markets.
The authors suggest that strong positive impact—what they call “social value creation”—is best accomplished through concessionary investments in private ventures where the market is not flowing capital freely to these companies. In fact, there is a broader market failure to consider.
Nearly a half-century ago, economist Milton Friedman wrote that the social responsibility of business is to increase profits as much as possible within the rules of the game. That still is regarded as the Holy Grail: Optimizing shareholder value, without regard for positive or negative social or environmental impact.
And therein lies the broader market failure. Delivering profits while creating negative externalities—like pollution in our air and water, or toxic pesticides and hormones in our food—produces social and environmental challenges that come with high costs. Someone is picking up the tab for these negative outcomes, and it is not the corporations that have created them. It is the corporations’ employees, their families, the community at large, and the environment.
That is why some of us are moving from the accepted paradigm of shareholder value and short-termism to a more farsighted vision seeking to create value not just for shareholders, but over the long term for customers, employees, communities, and other stakeholders.
This approach does not mean doing business without regard for profit. Far from it. Research from Oxford University, Morgan Stanley, and Harvard Business School shows that public company managers who engage in strong ESG (environmental, social and governance) practices keep pace with and, in many instances, financially outperform the traditional comparative universe. In a world where the majority (and for consumer-focused businesses, the vast majority) of market capitalization is driven by intangibles, it turns out that managing ESG risk and reward is just good business. The opposite is also true. Consider how the market punished Volkswagen and BP after their environmental issues came to light, not to mention their $15 billion and $20 billion settlements respectively.
Considering ESG as a source of investment alpha makes sense in our changing world—a world of population growth, food and water insecurity, education and public health challenges, climate change, drought, and other pressing social and environmental factors.
A new Holy Grail for business leaders involves pricing social and environmental risk and reward into the capital markets over time which would produce a paradigm shift to a more holistic view of long-term value creation. Impact investors believe this new paradigm would be more efficient and equitable than the current system of maximizing financial return without regard for social and environmental factors, and then redistributing value through domestic government programs, foreign aid, and philanthropy.
The authors state that “values alignment” through investment in and divestment from public companies is easier to achieve, though less impactful, than investing in the private markets. But the truth is that the global financial capital markets are more than $212 trillion, whereas private investment for impact is only about $77 billion worldwide. If we seek a more equitable allocation of value, the capital markets are a place to focus on.
We do agree that investors partnering with employees, consumers, pensioners, retirees, students, and other stakeholders may achieve amplified engagement with public company management and thereby compel greater change. In fact, as further generational wealth transfer unfolds, there will be an increasing demand for transparency, which means more informed investment and consumption decisions can be made. This is a golden opportunity for those of us who care deeply about impact and stakeholder value to encourage younger generations to expect more from corporations and the capital markets.
There is another market failure to look at when considering private investment in privately-held, market-rate impact ventures. Brest, Gilson, and Wolfson acknowledge that it is difficult to achieve what they call social value creation or impact additionality through such investments, in part because if these opportunities were veritably market-rate, non-impact investors would presumably be filling the gap. Indeed, there are increasing instances in which impact venture capitalists co-invest with traditional parties to gather more assets to scale impact-oriented private companies. But there are also many investment opportunities going underfunded or unfunded. Here, I’m thinking about women, minority, disabled, and other entrepreneurs with smart business ideas who experience greatly impeded access to traditional sources of capital. The authors may not consider these to be impact entrepreneurs per se, but at least a subset of them run ventures in which their products or services deliver positive impact. This market failure may in fact present opportunities for outsized returns.
According to the authors, the greatest and deepest impact may be achieved through the investment of concessionary capital into private ventures. It is true that there will always be a role for such private, patient capital that seeks to de-risk markets, sectors, geographies, and constituencies and pave the way for commercial capital. Matt Bannick, Paula Goldman, and the team at Omidyar Network have argued compellingly in their recent article in the winter 2017 issue of Stanford Social Innovation Review, “Across the Returns Continuum,” for a move toward investing across the returns spectrum for impact, and also point out that long-term concessionary capital may be distorting to markets. So while there are certainly instances when concessionary capital is required to be a catalyzing force, the goal is to validate, where appropriate, these markets to traditional sources of capital over time.
And that is the overriding argument: We as impact investors seek to solve market failures by taking a different approach to risk, reward and impact—an approach that Friedman would have dismissed. We may be considering extra-financial factors to make strong public market investments, or we may be funding a women entrepreneur or an emerging market start-up. Either way, the goal is the same: To validate markets and make them more perfect and inclusive over time.
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