ESG, “Wokism,” and Corporate Finance Theory–Oh My!

One can essentially sum up corporate finance theory with a simple statement: the corporate objective is shareholder wealth maximization (Belghitar, Clark, & Kassimatis, 2019). However, companies must consider many, sometimes seemingly unrelated or irrelevant, factors to achieve this objective. For example, Brigham and Ehrhardt (2016) identified nine integral traits to the success and longevity of a corporation such as Apple, Disney, or Amazon.

They are innovation, quality of management, long-term investment value, social responsibility, personnel management, quality of products and services, fiscal reliability, application of corporate assets, and efficacy in doing business globally (Brigham & Ehrhardt, 2016). However, these factors lie in a delicate balance. For example, if corporate leadership and board members concentrate too heavily on individual traits without deference to or at the expense of others. In that case, the company could incur significant losses, including the faith of its shareholders.

In recent years, social responsibility, personnel management, and the application of assets have been the focal point of many contentious political and social debates and harmed the respective shareholders’ investments. Examples are Twitter’s proven political bias, Disney’s support of issues that do not resonate with numerous consumers, and Netflix similarly producing content that is only marketable to a small audience. As a result, these companies have recently seen their valuation drop significantly to the consternation of their shareholders.

Additionally, corporate scandals and misconduct like the one with the Weinstein Company have devalued those companies at the expense of the shareholders (An & Xu, 2020). Finally, data breaches and similar cyber intrusions shake the public and investor trust in an organization driving business and capital away and into competing firms (Ashraf 2022). If one discounts the individual bad actors involved in scandals or sources of cyber events, there is an explanation for some of the other corporate leadership follies.

For a company to survive and stay relevant, it must change with the times and provide products and services it believes consumers will want not just now but in the future also. Traditionally, corporate leadership made these decisions based on market research using random controlled testing (RCT). However, these firms’ decision-makers seemingly change their policies and operations based on observational data of perceived public interests but may not reflect the actual markets.

This pragmatic approach is to accommodate better the exponentially increasing trends relying on environmental, social, and governance (ESG) practices (Madden, 2021). But unfortunately, ESG priorities are ideologically divisive and largely irrelevant outside Western liberal democracies. This component is where a form of corporate governance becomes a factor in influencing social norms and culture globally. Corporations have exploited developing states to conform to their interests for monetary gain or societal change, even hiring private military and security companies to decide conflicts (Venter, 2006).

Typically, it is far more passive and benign than the Executive Outcomes example. Still, the global marketing of McDonald’s and Coca-Cola, social media applications, and international distribution of entertainment mediums have impacted societal norms worldwide. However, there have been some benefits to global markets. For example, companies in economically weaker or developing states have been able to improve transparency and auditing practices with the help of outside corporate governance, especially in the financial industries (Arslan & Alqatan 2020).

In closing, much of corporate finance theory revolves around maximizing profits for the company and the shareholders to whom they are accountable. Therefore, their operations have to be innovative, provide quality and relevant products and services, and ensure the quality of their leadership, the management of their employees, the long-term value and reliability of their firm, and their social responsibilities. Unfortunately, the latter has dominated corporate objectives recently, to the detriment of those companies and their investors. As ESG and corporate governance practices become more prolific than in decades past, the social responsibility of these companies should be to return the balance to the nine traits outlined above and be less focused on social issues that will ultimately hurt their bottom line.

References:

Arslan, M., & Alqatan, A. (2020). Role of institutions in shaping corporate governance system: evidence from emerging economy. Heliyon, 6(3). https://doi.org/10.1016/j.heliyon.2020.e03520

An, J., & Xu, J. (2020). International spillovers of corporate scandal: evidence from the Harvey Weinstein event. The European Journal of Finance, 27(11). https://doi.org/10.1080/1351847X.2021.1906729

Ashraf, M. (2022). The Role of Peer Events in Corporate Governance: Evidence from Data Breaches. Accounting Review, 97(2), 1–24. https://doi-org.ezproxy1.apus.edu/10.2308/TAR-2019-1033

Belghitar, Y., Clark, E., & Kassimatis, K. (2019). A measure of total firm performance: New insights for the corporate objective. Annals of Operations Research, 281(1-2), 121-141. doi:https://doi.org/10.1007/s10479-018-2983-z

Brigham, E. F., & Ehrhardt, M. C. (2016). Ch1: An overview of financial management and the financial environment, in Financial Management: Theory & Practice (15th Edition). Cengage Learning US.

Madden, B. J. (2021). The Pragmatic Theory of the Firm. Journal of Applied Corporate Finance, 33(1), 98–110. https://doi-org.ezproxy1.apus.edu/10.1111/jacf.12448

Venter, A. J. (2006). War dog: Fighting other people’s wars: The modern mercenary in combat. Lancer Publishers.

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Ben Varlese is a former U.S. Army Mountain Infantry Platoon Sergeant and served in domestic and overseas roles from 2001-2018, including, from 2003-2005, as a sniper section leader. Besides his military service, Ben worked on the U.S. Ambassador to Iraq’s protective security detail in various roles, and since 2018, he has also provided security consulting services for public and private sectors, including tactical training, physical and information security, executive protection, protective intelligence, risk management, insider threat mitigation, and anti-terrorism. He earned a B.A. and an M.A. in Intelligence Studies from American Military University, a graduate certificate in Cyber Security from Colorado State University, and is currently in his second year of AMU’s Doctorate of Global Security program.

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