Posted on Nov 1, 2021, 7:30 a.m.
Is it possible to lead a large group on the path of sustainable development without upsetting the shareholders? When, on March 15, 2021, Emmanuel Faber was dismissed from his post as CEO of the Danone group, his ouster sounded like a sanction.
As soon as the press release was published, the business press recalled that for several years, this manager had oriented the group’s strategy towards greater sustainability and compliance with ESG criteria (environmental, social and governance). And this observation is made: the shareholders of a group are ready to move towards greater sustainability and the emphasis on ESG criteria… as long as this does not call into question the financial performance of the company! However, to put in place a policy aligned with the Sustainable Development Goals (SDGs), a company must necessarily commit money; which impacts its performance in the short term. Danone shareholders are therefore criticized, on the one hand, for not having had the patience to wait for the return on investment of a societal and environmental policy and, on the other hand, for not having been able to exceed the search for the only financial profitability.
A non-homogeneous group
It is important to avoid any confusion between the two activist funds , behind the ouster of Emmanuel Faber, and all of Danone’s shareholders. Investment funds are used to capitalizing on a rapid change and increasing the stock price of the company. They work in a short-term approach, which is not necessarily the case for other shareholders. The two activist funds held only a small part of Danone’s capital, less than 5% of the voting rights. They therefore had to either convince the other shareholders to obtain a majority at a general meeting, or contact the directors directly if they wished to avoid the complications of a motion to resign at a general meeting. They opted for the second option.
This episode in Danone’s life shows that shareholders do not form a homogeneous group. Large companies therefore have an interest in identifying the different categories of investors who participate in their capital. Some shareholders demand regular performance quarter after quarter, and are quick to sell their shares (“they vote with their feet”) as soon as the performance is no longer there. Others are prepared to wait patiently for the results of a longer-term strategy. There are also shareholders who seek to maximize their profits according to a risk-return ratio, while other investors wish to include a third environmental and societal dimension in their choices. It is this last category which then seeks to balance a risk-profitability-sustainability tripod.
Profitability, the criterion of differentiation
Let’s apply this tripod to Danone, Unilever and Nestlé. For risk, consider a classic measure of volatility in finance: the standard deviation of monthly returns for the shares of these three companies over five years. For profitability, note that Danone shares had only increased by 8% over the last five years, against 34% increase for Unilever and 58% for Nestlé (dividend included). Finally, let us take the MSCI ESG ratings as a criterion for the sustainability of the company. In terms of risk, the three companies are roughly at the same level: this is not too surprising, they operate in the same industry and on the same customer segments. Regarding the ESG rating, the differences are small: Danone is rated AAA, followed by Nestlé (AA) then by Unilever (A), i.e. the 3 highest levels of a scale that count 7. It is therefore on profitability that the major differences play out.
Shouldn’t we expect all three triangles to occupy roughly the same area? A company lagging behind in ESG might compensate for this with better profitability, while a company active in sustainable development might have lower profitability, but also reduced risk. The idea of the tripod is that of a compensation and a balance between the three criteria. In practice, Danone’s triangle is significantly smaller – on the surface – than that of Unilever and Nestlé.
Thus, despite better environmental performance and at an almost equal level of risk, Danone has a much lower profitability than the other two companies. Its sustainability axis does not provide additional information. Even in a classic risk-profitability pair, Danone generates much less profitability than its main competitors, at the same level of risk. Comparatively, Unilever has a lower ESG rating than Danone, but its triangle is more balanced. As for Nestlé, for a high level of profitability, the Swiss group has a lower level of risk than that of its competitors, and a very good ranking in terms of sustainability.
Priority to one of the three parameters
This approach not only makes it possible to better understand the choices of the different categories of shareholders, but also to dispel certain myths, such as the opposition between ESG concerns and shareholders’ demand for profitability. In Danone’s case, a strong commitment to sustainable development is no excuse for poor financial performance.
The risk-profitability-sustainability tripod can be applied to other sectors to map the different categories of shareholders and their concerns. If a company chooses to prioritize one of the three parameters, it will likely shift the balance of the risk-profitability-sustainability tripod against its main competitors, and therefore attract shareholders whose interests are most aligned with this new configuration.
Christophe Thibierge is professor of finance at ESCP Business School and co-founder of the Institute of Personality Sciences. His publications include numerous translations of American textbooks and original works (“Financial Analysis”, “Understanding All of Finance”).
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