Responsible Capitalism and Climate Change: Does Business Ownership Matter?

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‘Utility’ companies provide essential services – water, gas, electricity, telecoms, rail transport, and arguably retail banking – to the public. In the UK, most utilities have been privatised. But a debate remains about whether government control would be more appropriate, particularly of water (as it is in Scotland) with its vital role in public health and the environment, including flooding and sewage discharges. 

Sir Dieter Helm, a University of Oxford professor, has argued that ownership structures should not matter as long as competition in service provision is assured and cross shareholdings by ‘alternative’ (such as private equity and hedge funds) and ‘institutional’ (pension and insurance funds and other fund managers, such as BlackRock) investors are prevented from re-asserting oligopolistic control through their substantial combined share ownership. To assure competition in utility service provision (including water), Helm advocates adopting an approach similar to that applied to the railways, where potential suppliers submit tenders.  

The recent failure of two prominent railway line suppliers, East Coast and Southeastern, whose operations were taken over by the state, points to weaknesses in the approach. Essentially bidders are tempted to underestimate costs and do not build enough resilience into their bids. This is a wider issue with public-private partnerships, as now acknowledged by HM Treasury and illustrated by the Carillion debacle. The need to ‘insure’ against unforeseen, but not unforeseeable, events was also recently illustrated by the smaller gas suppliers that went bust as wholesale gas supplies rose in the second half of 2021. 

In sum, oligopolistic supply, perhaps with a competitive fringe, is likely to persist in utility markets (including banking). The problem is particularly acute in the water industry where the water companies have regional monopolies over river-water catchment areas and so a national network allowing customers to ‘switch’ suppliers does not exist. 

Encouraging firms to be more responsible

Many utility companies have substantial foreign ownership and also large investments from private equity and infrastructural funds, such as Macquarie based in Australia. Prior to the Glasgow COP26 meetings, financial companies (including institutional investors and banks) and non-financial companies were progressively being encouraged to develop a broader ‘stakeholder’ perspective, becoming responsible and purpose-led. Investors and businesses would consider ESG (environmental, social and governance) factors, rather than focussing on short-term profit maximisation. 

Now at COP26, non-financial companies are being urged, in particular, to take account of their direct (through production) and indirect (through their supply chains and the consumption of their products) carbon emissions and ultimately to ‘pay’ a fair price for the public goods provided by nature in order to restrict global warming to safe levels. Through the stewardship of their investments, financial firms are in turn being urged to promote responsible business activity – with many of them agreeing.

However, also at COP26, Larry Fink, the CEO of BlackRock, warned that whilst public shareholder-owned companies were coming on board, a significantly growing proportion of shareholding was by private equity (PE) investors. These tend to promote maximisation of shareholder returns rather than pursuit of ESG or ‘net zero’ targets, and are relatively free of regulatory restraints and stewardship pressures. They also often load their ‘portfolio’ companies with debt (bonds and non-bank loans) and so market discipline is more keenly felt through bond markets. Hence, it is not just the non- participation of Russia and China, and others, in the agreed targets to reduce methane emissions and curb the use of coal in electricity power generation, but also the non-participation of PE funds (PEFs) that should be a cause for concern.

Should the freedom of private equity be curbed?

Hedge funds (HFs) are another important class of alternative investors. Not to be confused with climate activists, shareholder activism led by hedge funds involves buying or borrowing shares in public shareholder-owned companies in order to try to force changes in management, strategy or structure to boost the value of their shareholdings. On the positive side, a hedge fund recently forced ExxonMobile to drop its opposition to developing green energy projects and adopting a net zero target. In contrast, another HF is pressing Shell to separate off its green energy business to prevent cross-subsidising it with its oil revenues. 

Like PEFs, HFs generally have little time for public interest or purpose-led business orientation. Unilever, a renowned purpose-led company, was famously pressed to separate its ‘soap’ business from its ‘food’ business some years ago, as explained in a recently published book – Net Positive: How Courageous Companies Thrive by Giving More Than They Take  co-authored by its former CEO Paul Polman. It is now coming under pressure from activist investors to do so again. Similarly, Emmanuel Faber, the CEO of Danone (which is an ‘Entreprise à Mission’, the French equivalent of a B-Corp), was forced out by activist investors earlier this year for not paying enough attention to cost efficiency and short-term profitability. 

In the interests of developing a more responsible capitalism, should the freedom of HFs to disrupt long-termist responsible business strategies be curbed? As divestment by institutional investors from coal and oil miners progresses, there is a distinct possibility that private equity may fill the vacuum and so – as Fink implies – the playing field between public and private equity needs to be levelled to underpin responsible capitalism in order to avoid a climate change Armageddon.

By Professor Andy Mullineux
Lloyds Banking Group Centre for Responsible Business, Emeritus Professor of Financial Economics