Corporate Stakeholders, Corporate Valuation, and ESG

Abstract

In an article published in 1987, we explained how corporate stakeholders, including customers, employees, suppliers, and distributors, influence financial policy and corporate behavior and why corporations have an incentive to treat these non-investor stakeholders fairly. At the heart of this explanation is the recognition that there are two fundamentally different classes of claims on a corporation. The first and most familiar are explicit contractual claims. These include employment contracts, bond indentures, product warranties, and the like. The second are implicit claims. Examples include fair treatment of employees, promise of continuing service to customers, and honest dealing with suppliers and distributors. Corporate stakeholders, all of whom have business relationships with the companies whose implicit claims they hold, value these implicit claims and are therefore prepared to pay for them. Corporate value is created by selling these implicit claims for more than it costs to honor them. More recently, a new class of non-investor stakeholders has arisen, related to Environmental, Social, and Governance (ESG) issues, but with no business relationships with the companies they are making demands on. Although many ESG advocates stress their role in creating shareholder value, they provide no explanation for how this value creation occurs. In this paper, we show that implicit claims provide a critical link that ties non-investor stakeholders and ESG to shareholder value. We show why many of the demands placed on corporations by ESG advocates, in the name of corporate social responsibility, interfere with the sale of implicit claims to corporate stakeholders and may thereby destroy shareholder value.