Season 2 Episode 3: Tom Gosling Edited Transcript

Conversation on Climate season 2 episode 3 – ESG, Climate, and Responsible Stewardship with Tom Gosling – Edited transcript 

We were delighted to have the brilliant Tom Gosling join us for this insightful conversation. Tom’s career has been nothing short of extraordinary, resembling the growth of a flower or the burst of a firework. Starting with a strong foundation during his 24-25 year tenure at PWN (PriceWaterhouseCoopers), his journey has now evolved into a mesmerising array of lights and colors, branching out in multiple directions. In this interview, Tom sheds light on the background of his unique portfolio career, sharing fascinating insights into the path that led him to his current endeavours.

Section One: Tom’s portfolio career

Chris: Tom Gosling, thank you so much for coming in to have a conversation with us. Brilliant to have you. Your career to date has been unusual, it’s been interesting path. The image that comes to mind is of a flower or a firework. We’ve got this strong stem; and then at some point 24-25 years into a career at PWN (PriceWaterhouseCoopers), it explodes into lights and colours in lots of different directions. Could you explain a little bit of the background to this portfolio career? 

Tom: That’s a very poetic description of it. I can tell you Chris, it feels much more prosaic from my side of the fence. I had a great time at PWC, and never had a reason to leave for most of my professional career there. I had 24 years in the firm.

But from the point I became a partner there in my mid-thirties, I’d always had a plan to be in a position to do something completely different when I got to 50. And that was something my wife and I discussed, and there were several motivations for that. One was just personal: life can’t be all about work, and I’d seen people spat out an exhausted husk at 60, wondering where to go next.

But also professionally, I just wanted the freedom to be able to explore a number of different professional dimensions as well. And the way I see my life now is integrating a greater focus on family, friends, personal occupations. Also, a greater variety of professional pastimes as well. 

I had a great time at PWC, but I have to say I’ve also had a new lease of life since moving into this new phase. 

Chris: in your portfolio career, you’ve got a lot of very different interests and a lot of different positions. Is there one unifying theme that holds it all together? 

Tom: I’m not sure there’s one unifying theme. I guess there are a few things that are consistent because I suppose most of what I do falls into a couple of buckets. I do some personal coaching work. I also do some consulting work still. And then I have my academic interests. Common themes across all of those are that I still    to feel I’m having an impact in some way, shape or form. I don’t want to just sit in the room talking to myself. Communication is a big part of what I enjoy doing.

And most of what I do, as well as touching on aspects of public policy which I’ve always been very interested in,  still has a crunchy, analytical angle. There’s a geek in me that loves to get into the spreadsheet and figure out what’s going on.

Chris: At some point along your journey you got bitten by the climate bug, by ESG. You decided this would be a focus of yours. Could you talk a little bit about how you came to climate? 

Tom: It’s an interesting one. Grom the mid-nineties really, as the whole debate on climate change was gaining increasing prominence, I was always aware of it and always somewhat considerate of how I sought to live my life. But candidly the real acceleration of what I was doing came through two directions. 

One was professional. Towards the end of my time at PWC, I was increasingly getting involved in questions of investor stewardship, corporate governance, the purpose of the corporation. That inevitably linked onto ESG issues. But there was also a personal aspect to it as well. It must have been 2018, 2019 when we had all of the Etinction Rebellion protests going on here. For me, this is an interesting case study in what activism can do. Extinction Rebellion was going on. We had the Friday School Strikes, my daughters were freaking out about climate change and I reflected a little bit around what I was doing. Was there a way to get a greater sense of agency in this, rather than just throw my hands up and grinding my teeth and saying how terrible the whole thing is?

The personal and professional really came together about four or five years ago to make climate a much bigger part of what I did. 

Section Two: lessons from middle-class decarbonisation 

Chris: Focusing on the personal for a little while: you’ve been documenting and undergoing a family journey towards pretty ambitious decarbonization goals. Would you like to talk to us about that?

Tom: Yes. About that same time I came across a pledge on a UN website which suggested that signatories do a few things. From my recollection, first you were meant to calculate your carbon footprint. You were then meant to set a timeframe over which you would make a target reduction. And I think they were suggesting 50% over 10 years. I can’t quite remember. And then you were also meant to communicate about what you were doing.

I thought, this ticks a few boxes for me and it’ll be fun to start a blog on what I’m doing. And I actually sat a slightly more ambitious target, which was to reduce our carbon footprint by 50% over seven years – which is getting alarmingly close now we’re approaching it.

I started writing this blog about it, which has actually opened up a whole new part of my life and some fascinating conversations. And what was really notable was when I wrote the first edition, I was really overwhelmed by the feedback that I got from people within PWC who really valued seeing someone senior in the firm openly grappling with these issues. 

I’ve learned an enormous amount through the process. And are we on track for it? I’m not quite sure we’ll quite get there. It’s a little bit more difficult in a couple of areas than I thought, but I think we’ll be somewhere between a third and 40%. And who knows, we might sneak over the line. 

Chris: And buy-in from everybody was unconditional, for that problem? 

Tom: This is one of the things that is a little bit challenging about it because as a family, you’ve got to do stuff as a family. And we’re all complicated. People talk about the young wanting more action on climate change; but in my experience, kids are quite capable of holding two completely contradictory notions in their heads at the same time without apparently noticing the conflict. That has required certain compromises, candidly; because I’m not going to be an authoritarian and say we’re never going to get on a plane again, or anything like that. I’d lose the audience at that point. 

That’s one of the realities that you have to deal with right from the beginning, The reason I called my series, ‘a middle class approach to decarbonization,’ is simply because I’m not going to go and live in a log cabin in the forest eating berries. I’m going to live an affluent western lifestyle. And actually I thought, we need different voices in this debate. The contribution I can make is for other people who want to do something, but also aren’t going to go and live in the forest. What are some of the things that you might usefully do?

That was always the perspective that I was going to take, rather than a particularly hair-shirted perspective. 

Chris: What was the biggest lesson that you’ve come away with? If you could share one pearl.

Tom: there are so many different things. But one of them is that I do think we slightly overcomplicate some of this stuff. I went through a huge effort to calculate my carbon footprint, but I’m not sure I really needed to, and I’m not sure anybody does need to. When it comes down to it, if you live an affluent western lifestyle, there are probably four or five things that you can do that you have personal agency over. 

They are: how you heat your home; how you get around the place, whether internationally or locally; what you eat; and the type of consumption you undertake. I think we can do more to focus on those actions rather than asking people to calculate a carbon footprint, which to 99% of the population is abstract and irrelevant.

In fact, I’m slightly surprised that we don’t have more public messaging on this. I know governments really don’t like nanny state-ism; but actually, very consistently across the world when people are surveyed, they say, ‘I’m taking personal action on climate change.’ And then the follow up question is: what are you doing? And they say, ‘I recycle.’ Ugh. And recycling is not a bad thing to do – we should all be recycling, but it’s irrelevant when it comes to climate change. So there’s clearly this   massive gap in understanding about what you need to do. Particularly for moderately well off people in Western countries, it’s pretty clear what we’ve got to do. So let’s simplify the messaging around that. 

Chris: People have too much forgiveness in saying: I recycle, therefore I can fly in Europe. No, really it’s not quite the same. 

Tom: If I can sneak in a second lesson: I grew up a Catholic, so I’m used to the idea of penance. So I entered this in the spirit of, I’m going to have to take my medicine. I’m going to have to sacrifice.

But actually there’s a lot of stuff that you can do around climate change that not only is not negative, but is actually life enhancing. This is going to be very much a rich world perspective on this problem, so I need to caveat that: but people who buy an electric card don’t go back, right? They just think it’s better. I’ve just installed a heat pump – it’s great. It heats a house in a much nicer, gentler way. If you eat a more plant-based diet it’s cheaper. You feel better, it’s healthier. If you focus your consumption on experiences rather than stuff, all of the research evidence shows that makes you happier.

So actually, there’s quite a lot that is very aligned with just living life in a better, more fulfilling, cleaner way. Again, I think that’s something we could make a little bit more of. This isn’t about denying you and stopping you from doing things you want to do. There’s going to be a little bit of that undoubtedly, but actually there’s a lot of this stuff that’s when we get there, is better.

Chris: Taking these personal learnings from your experiences of decarbonization, has that influenced how you feel about the way society at large looks at these issues, around governments and corporations? One example might be that the whole carbon footprint idea that we were talking about, is a construct from British Petroleum. It was an idea of trying to deflect responsibility onto individuals. 

Tom: Yes, so I think my view has developed on this over time. What’s absolutely clear is that individuals can’t solve this by themselves.  I think it’s wrong to entirely put the emphasis on individuals. That is part of the reason why I haven’t taken an excessively hair-shirt approach to this, because we have to solve the systemic issues.

On the other hand, I think the idea that governments have got to solve this so let’s just wait for governments to act, is for the birds as well. That’s not how politics works. So I think that individuals, the corporate and finance sector, and governments all have a role to play.

I’ve certainly found that individual action and talking about individual action helps to create the circumstances in which climate is politically salient. Corporate action enables governments to see how this can be done without it being too costly, that they’re not going to face massive backlash from the corporate community which is very influential in policy-making. That creates the conditions in which government can act. So I think all of this has to go together. None of us can just point the finger and say, you’ve got to do it. 

Chris: You suggest there that an individual has influence in all these places. You can vote for the politicians, you can spend with the companies you feel aligned with. You have some powers. 

Tom: I do think the political saliency is particularly important. If you listen to Chris Stark, the CEO of the Climate Change Committee in the UK, I think are doing really great work in this area. When asked what’s the most important thing that individuals can do, he says: talk about it. Talk about what you’re doing. Talk about it and from this, little ripples flow out. 

That’s been one of the really rewarding experiences from communicating about this –I’ve discovered all of these connections. People who dropped me a note saying: I’m just doing a home renovation, and I’m really glad I read your blog, because I’m now putting in underfloor heating and a heat pump. As part of my renovation, my local MP tabled a couple of parliamentary questions on the back of some of the planning difficulties I had around my heat pump. She got the brush off from the department; but all of these things keep it salient. 

Take the UK as an example; we’re quite likely to have a change of government in 18 months time. It’s not certain, but if we don’t have a change in government, we are going to have the existing government with a renewed mandate. Any new government has enough political capital to do two or three things. What we need to make sure is that action on climate change is one of those two or three things that they feel emboldened to do something about in the first 18 months, before it’s just all gone to hell in a handcart for them. So this point of political salience is, I think is really critical. 

Section Three: CEO pay: myth and reality 

Chris: Moving on to your core professional expertise, which is executive pay: the general critique of the area is that top corporate executives are overpaid and performance is not affected by overpaying. What are the main myths that you see surrounding this area? 

Tom: There are a lot of misunderstandings about executive pay. I focus on what I think is probably the key one, which is this idea that levels of executive pay are just outrageous and completely unjustifiable. This is a difficult one because they’re definitely high, right? CEOs get paid an awful lot of money. But actually when you really look at it, CEO pay is pretty readily explicable by a number of economic forces that we’ve seen over the last three decades. 

Typical CEO pay has gone up around six fold in real terms since the early 1980s. That’s compared with typical worker pay increases of no more than two times in real terms. That is often taken as   face value evidence for the fact that the whole thing’s a racket. But the thing that’s often missed in that debate is that the value of our largest companies has also gone up around sixfold in real terms over that period. You might say: why does that affect anything? Just because the company’s bigger, it doesn’t necessarily make it any more difficult to do the job. And that’s true, but when you look at pay in scarce skill, and high stakes occupations, all of the evidence shows it does broadly scale with the size of the organization and the stakes.

A couple of examples of that. I generally avoid sporting analogies when it comes to CEO pay, but in this regard they’re quite helpful. So if you compare Christiano Ronaldo and George Best, both the greatest footballers of their generation, Christiano Ronaldo’s peak contract at Real Madrid was a massive multiple of George Best’s peak contract at Manchester United.

Is it because Ronaldo was a better player? He probably worked a little bit harder than George Best, but the key reason for that is that the Real Madrid franchise was just so much more valuable than a Manchester United franchise was back then, because of the globalization of sports rights. Paying that little bit more for a slightly better player became much more important, and so we saw this explosion in sports wages. It’s the same in golf tournaments: the prize money for the top few golf players has stretched enormously from the distribution lower down the spectrum. So when you get these very   scarce skill, high value occupations, you tend to find an economic consequence of that is that the pay rates scale with the size of the company.

The reason I think this is really important is not to say that these levels of pay are okay. It is for us to focus on the right causes for that. Because I think there’s been far too much emphasis placed on this idea that it’s a market failure. The response to that ‘market failure’ has been to give shareholders more and more powers over CEO pay, and to have more and more disclosure about CEO pay. That has had some impact on CEO pay structures, but it’s had basically no impact on CEO pay levels at all. 

Really, the key drivers around rising pay levels have been that we’ve allowed reduced competition, we’ve allowed agglomeration and the generation of these huge mega-corporations. Reducing marginal tax rates have also certainly played a role. If we want to reverse that, we need to look at some of these root causes and have a different set of policies, whereas actually I think politicians have just tried to shove it off to shareholders. 

For me that’s one of the key myths: that this is just an unjustifiable explosion in wages. Actually it’s exactly what you’d expect from an economic point of view, given what has happened to the structure of corporations. That’s not particularly to defend the outcome – people have different views on the outcome – but if you don’t diagnose the problem correctly, you’ll come up with the wrong treatments for it.

Section Four: what is a responsible business anyway?

Chris: One of the treatments that you’ve written quite a lot about is the whole concept of responsible stewardship. Would you care to define that and talk about it?

Tom: Responsible stewardship is a really interesting concept. There’s this massive debate at the moment about what responsible business is, and what responsible stewardship is. The way I view it is as follows: I think that we have to remember that corporations exist by virtue of rights that have been endowed on them by society. Things like limited liability, the rule of law, these are the things that enable corporations to flourish. And the general purpose corporation that can do what it likes, and in its corporate form has delivered enormous benefits to society. But I think we must never forget that the purpose of all of this is to produce societal benefits, and therefore I think it’s very reasonable for society to place expectations on corporations about how they behave and operate.

 Having said all of that, I’m a little bit nervous about this idea that corporations should be running around solving all of society’s problems. I don’t think that’s realistic. I don’t think they have the skills or legitimacy to do that. So for me, responsible stewardship is very much about pursuing the goal of creating long-term value through the provision of great products and services to the world; but doing that subject to, the norms and expectations of society that go beyond statement of the law. And that set of expectations does evolve over time, and I think we’re clearly in a period of time when notions of fairness – of the distributions of spoils and so on – have become very germane. Any board, any investor thinking about discharging their duties needs to have those considerations in mind as they go about their work, rather than just simply saying: that’s down to the government to solve, we’re just going to focus on our business of making money. It is tricky because we need to think about and define the boundaries of that, which is why I think that for the corporate sector on the whole, this does need to be in the service of the unifying, long term goal of creating value. But it’s creating value subjects to the norms and societal expectations of the day. 

Chris: It’s interesting you frame it that way, that the long-term goal of corporations is to create value. It may be argued that there is no such thing as a long-term goal for a corporation; what management are very much focused on is the next quarterly performance. How does that issue of short-termism bump into the issue of responsibility? 

Tom: Clearly there is a tension in human existence. Evolution didn’t really prepare us terribly well for thinking beyond the annual cycle of survival. We know that there are benefits in lengthening our time horizon beyond that; actually, sometimes I think it’s amazing how long-term we are, given how we evolved and what we grew up to deal with. But I think there are a couple of important points to make around long-termism, without denying that it can be a problem (and it can be a problem in pay systems as well, which we will come back to).

Firstly: I’m not a shareholder value extremist or anything, but shareholder value is inherently a long-term concept because the value of companies on stock markets relies on their enduring ability to create cash flows that are valued many years into the future. And although, in that valuation calculation, anything beyond 50 years out doesn’t really figure, things beyond 10 years out, really do. That’s why we see the enormous valuations put on technology companies that aren’t making any money today. In fact, if anything, some of these long-term factors have become more important and we see an increasing amount of the value of companies being in excess of the value of their current tangible assets created today. So sometimes I think we panic a little bit about stock market’s being incredibly short term. 

The other thing that it’s really important is that we can confuse short-termism and agility. In a world that’s changing really rapidly, there aren’t that many environments where it makes sense to take a massive bet on something that’s going to happen in 20 years, and make 20 years of losses waiting to get there. Sometimes, the world changes so fast that there is value in agility and in having options. And I think we also have to be realistic about where, in those circumstances, those really long-term bets are value-creating and can sensibly be made. Those are probably going to be in ownership structures that support such bets, right? It might be a dominant family owner, or a large private owner who really deeply understands the business. That’s probably not going to be the type of business that’s appropriate for dispersed ownership in public markets. 

Sometimes I think we need to be realistic about what type of investments public markets are ever going to make, given that they only have a somewhat superficial knowledge of the companies that they invest in. Are they really going to trust that this very long term, loss-making investment is going to pay off? Sometimes they’ll be able to judge that, sometimes not. So that’s just a couple of perspectives on the issue. Sometimes I think we’re a little bit harsh on public markets in relation to this charge of short-termism. My take on it is that more of the problems around short-termism arise from how companies respond to some of those signals, as opposed to the market structure itself. 

Section Five: are ESG bonuses a good idea

Chris: Another interesting development in this whole space has been the link between ESG and incentivization. We can bring the two together and try to put non-financial criteria to executive bonuses. What trends have you seen in that area?

Tom: It’s exploding, right? Virtually all companies are now incorporating ESG goals in some way, shape or form into pay, which is up from really a small minority just five years ago when it was really limited to the most exposed sectors – extractive industries who had their community health and safety metrics. You can argue about whether they were effective or not, but they were one of the industries where ESG geometrics were very early in plans based around community impacts. Pretty much everybody’s got them now. They’re on a whole range of metrics. Climate is obviously a popular one. Diversity is another popular one. There are various metrics that you could call ESG that have been there for a long time, around employee health and safety and employee wellbeing. But it’s certainly something that is becoming almost a universal practice today. 

Chris: It’d be interesting to get your take because I’ve seen it argued both ways: that the reason is because ESG drives long-term value, and you need to be sustainable to get those long-term cash flows; or I’ve also seen it seen to argued the other way, that companies wouldn’t be doing this otherwise, so therefore we need force them. What’s the reality? 

Tom: You’re right, there is this split view on it. Personally, I think that the only realistic view for including ESG targets in pay is the first explanation, which is that we have a time horizon issue. We have these factors that are important to long term value creation in the company, which given that incentives are so short term will be ignored if we rely on profit based incentives. Therefore we need to include these ESG metrics as a counterbalance.

The reason why I don’t think the second view is valid is that I think this idea that we can somehow use a component of pay to get these nasty CEOs to do stuff that they wouldn’t otherwise do, to the benefit of society, is just unrealistic. I, I think it portrays a misunderstanding about how pay is set in companies. CEOs largely run companies. They set the strategy of the company, the board then endorses the strategy of the company and then they set pay metrics that are aligned with the strategy. That’s actually one of the problems behind ESG metrics in pay, because they’re generally targets that companies fully expect to meet anyway, which is why they pay out higher level than other metrics. But I’m not quite sure what the mechanism would be for superimposing over that. Targets that somehow went against strategy? Even if you could do that, even if you had some   central body for climate change targets that forced every company to have a climate target that was aligned with science-based targets, the reality is that the executives are still going to do what is in the long-term interests of shareholders. So if that’s disconnected, if we have an externality (as we do with climate) where there’s a disconnect between what is even good for long-term value versus what’s good for society, a small component of pay isn’t going to correct for that. It’s just not going to work. So I think we have to say that the best and only rationale for including ESG targets in pay is this   time horizons issue, and I think there’s some merit in that. 

Chris: One of the major issues there though is that the targets, by and large, are 80% to 90% met. How challenging are they really? How do you go about fixing that? 

Tom: That’s the big problem I think. ou can put pay targets in three buckets. The totally objective, completely un-gameable targets, like relative total shareholder return – where you compare your total shareholder return against a peer group of companies. There’s really nothing you can do to influence or game that. 

Then you then have financial targets: return on capital, earnings per share etc., where although actually management can have quite a lot of influence over those targets in the short term by decisions that they make around cutting R&D, or what they do about accruals, there is at least strong external investor understanding of those metrics, and norms and benchmarks and ideas about how tough they should be.

And then you get this set of strategic goals that ESG falls into, where there’s enormous information asymmetry between executives and their board – let alone boards and investors. Which means that actually external observers don’t really know how tough they are. And what you see consistently in the data is that as you go through those spectrum of measures, payout rates go up.

with my old firm PWC, we recently completed a study on climate targets in large European companies. Half of these are paying out at a hundred percent of the maximum. On average, they’re paying out at nearly 90% of the maximum. All of the oil majors have paid out on their climate transition targets at over 90% of the maximum. So good news, Chris, we don’t need to worry about climate change. It’s all sorted.

How can we overcome that? I think the circumstances in which you can overcome that are relatively limited, but I think they are: where you have an ESG issue that’s clearly first amongst equals; where there’s some measure of an external standard or acceptance or benchmark about what good looks like; and where you have a knowledgeable anchor investor with a big stake who can apply that external scrutiny.

I fear that we’re just getting junk metrics put into plans. And the horse is bolting on this. We somehow need to make these targets better, but I would’ve preferred that we had gradually evolved and expanded the practice from a core of companies where we could do it really well. Because we have the opportunity here for a classic executive pay own goal, where in three years time we found out we’ve had more pay, but not more ESG. And that just undermines credibility in the whole executive pay setting system yet again.

Section Six: the philosophy of fair pay

Chris: Fair enough. A really interesting area that you’ve done quite a lot of work on, back in your time in PWC, is distributive justice. Pay is clearly an issue of justice. It’s about fairness, about distribution, about equality. What does distributed justice teach us about executive pay, and what tools does it offer?

Tom: What’s really interesting about that work on distributive justice is that it makes you realize that we all talk about the importance of fairness, but we all mean completely different things by it. There are various different ways you can think about fairness. You can think about fairness in terms of economic efficiency. You can think of fairness in terms of equality of opportunity – once you’ve got equality opportunity, everything’s fair. You can think of fairness of outcomes, in terms of just desserts for effort and skills. Or you can think about it in terms of, minimum standards for everybody, in terms of liveability of pay. Or you can think about it as equality. 

These different definitions are held by different people as being important to different degrees. What’s fascinating is that people’s notions of fairness are an amalgam of all of these. That’s what this study showed. We analysed people responses to structured economic trade off questions, as well as some more qualitative questions, and we understood where people sat on these different axes of   dimensions of fairness. People fall into different buckets.

So what does that mean for organizations? One of the findings of that piece of research work that we did, which was with Sandy Pepper and Judy Gore of London School of Economics – who are a former colleague of mine at PWC and an academic philosopher –one of the things that we found was that interestingly, people do expect their organizations to apply principles of distributed justice.

You might think that people view their organizations as purely economic entities. It should be driven entirely by economic efficiency, and they might view society as doing the job of dealing with fairness. But actually, they don’t. They view fairness as being relevant to organizations. What that suggests is that organizations probably need to have a point of view on this question; but importantly, they can’t assume that all of their people are going to think the same way. Different organizations are likely to have different dominant views on this question amongst their people.

If you look at some of the US tech organizations, for example, they’ve taken very market driven approaches to pay, where everybody’s paid differently according to their market value. That’s an economic efficiency view of fairness. But we also have cooperatives that pay people in a very equal way, who have a very different principle of fairness. And I think it’s one of the things that organizations can think about as they’re setting their pay policies. 

We did work with some clients off the back of that, that led them to developing what they called Fair Pay Charters where actually they just try to articulate what they meant by fairness, and sometimes that’s about what you do about pay at the top. So there’s a very small number of organizations that actually set limits around pay at the top relative to wider workforce pay. But actually more often it leads to considerations about what you do about pay at the bottom. So a common outcome from work on these Fair Pay Charters is organizations feeling that they needed to get an understanding of what living wages were throughout their population across the world, and redirect budget resources to make sure that everybody was paid at least a living wage.

In other organizations it meant creating equality around benefit provision across the workforce. Why should the CEO also get a more valuable pension? It doesn’t make sense; they’re already paid more. So I think it can be a helpful lens for helping organizations understand the extent to which the way they’re operating pay throughout the organization is congruent with the culture and values that they have.

Section Seven: rethinking Friedman and democracy

Chris: We’re very much in the world of Milton Friedman, and shareholder primacy now. You had a really interesting discussion with Alex Edmond – who will be on the podcast in a couple of weeks –about where Friedman’s thinking is in relation to this whole idea of shareholder activism; what we should hold onto and learn from, and what needs to be left behind. Could you elaborate on that? 

Tom: I think there are a couple of things about what Friedman said that are worth unpicking. People tend to stop halfway through his famous sentence, right? Where he said that the purpose of the organization is to maximize profits. But he had a second part of that sentence, which is: …subject to constraints imposed by society as embodied in law and prevailing ethical custom. I think Friedman didn’t reject the idea that there are ways of behaving that are accepted and normal that actually companies need to respect them, even if it might not be profit maximizing to do so. I think he’s that he’s often misquoted in that regard. 

The other point is that he was operating in a time when companies seemed to be expected to, or wanted to, take on more and more in terms of social obligations. And that wasn’t just through charitable giving, that was through the way in which the administration at the time in the US was wanting them to participate in income’s policies and various other social dimensions. And I think he was, making the point that corporate directors are not particularly well placed to undertake those societal trade offs. 

That there are prevailing ethical norms and standards that evolve over time, and that companies need to reflect and build into how they create value and they shouldn’t just blindly follow profits – I think that’s a very valuable insight of his that’s often ignored, but that should be retained. And I also think that when people talk about failing trust in capitalism, is polo neck wearing Davos-men making all the decisions really what they had in mind as a solution? I don’t think so. This idea that corporate boards should be cautious about straying into the political arena is also valid. 

But I think there’s an aspect in which the world’s also moved on. Friedman had this presumption of a government that was competent, and state capacity that was competent to deal with the big pervading issues of the day. Therefore this idea that it was a job of government to get on with certain functions remained valid. And there was a different balance of power between governments and corporates at that time as well; not just with reference to the size of corporations, but the extent to which they’re embedded into the fabric of everyday life through globalization etc..

So I think that, in important aspects, we are in a slightly different world today. One of the things in this whole debate around what companies and investors should be doing that’s it’s really important to come back to, is that one of the ethical norms that we need to be trying to establish now is that the private sector needs to support the continuation of democratic capitalism and the institutions that enable that.

Democratic capitalism is not a state of nature. It exists because of institutions and frameworks that we’ve put in place. It’s a phenomenally successful system, but there are clearly issues now that are of a scale that they are challenging some aspects of that. And I think that where we need to move beyond Friedman is thinking about the role that the corporation has in sustaining that system, rather than just viewing the system as exogenous and something the corporation only exists within. It also has agency in enabling the system to develop in productive ways. 

Again, where things are different now compared with Friedman’s day is that I think he assumed that there was this competent government with state capacity that could deal with some of these externalities that business might create. We’re in a different world now: by virtue of the systemic nature of some of those issues such as climate change. because of the increased size and influence of corporations; and the extent to which they’re embedded in our everyday lives through globalization. We’re in a place now where governments are increasingly challenged to take the sole initiative on these issues. 

What I’d like to see, building and developing on his idea of acting in accord with prevailing ethical custom, is us develop this prevailing ethical custom that democratic capitalism matters. It’s a system that is not a state of nature; it requires nurture and support, and our whole way of life depends upon it. And the corporate sector has agency in nurturing and nourishing those institutions as opposed to on occasions undermining them. Candidly – and I think this is where we need to build on Friedman – because of the nature of issues like climate change and biodiversity loss, corporations and investors need to lean in, in a way that enables governments to act rather than just treating government regulation as an exogenous factor. They’re regulation takers; but they can also have influence on regulation making as well.

Chris: Do you think that democratic capitalism is fit for the purpose of solving these massive global issues such as climate change? 

Tom: It’s the old Churchill maximum: it’s the worst solution, other than every other one that’s been tried from time to time. I’m definitely not in the mind to throw out democratic capitalism, because if you look at any of the alternatives you shudder. We have to make it work, but that does imply a slightly different role and attitude from the corporate sector.

Section Eight: fiduciary duty and climate goals

Chris: The last issue I’d like to dig into before we wrap up is the whole idea of fiduciary duty. Which is    by nature is a double-edged sword; you’ve got your short term duties to be maximizing income for your investors right now, versus the long term of all of those cash flows put together being the actual value of the company.

There’s an interesting dynamic, an interesting tension between those. A nice way of talking about it might be to dig into the Glasgow Financial Alliance for Net Zero (GFANZ) which came out of COP 26 and Mark Carney’s initiative. You’ve been quite critical of GFANZ, and I think it’s a good way of getting to the complexities of this issue. 

Tom: The first thing I want to say is that I actually think that initiatives like GFANZ, and the Net Zero Asset Managers Initiative which sits underneath it are really important initiatives. If we go back to what we’ve been talking about around the role of investors in helping support democratic capitalism and creating space for companies to innovate, I think these groupings are really important. The bit that I’ve been a challenging is the extent to which the goal of 1.5 degrees with limited or no overshoot has been embedded into those commitments in quite a granular way. 

Let’s keep it simple and focus on asset managers, who are generally managing other people’s money, whether it’s your client, the asset owner, or your beneficiary like the pensions fund member. You have to be managing the money in their interests. So the big question is whether managing that money to deliver a 1.5 degree outcome is necessarily and automatically in that client’s interests.

And one of the things around fiduciary duty that has evolved is if you look around the world, fiduciary duty is generally pretty tightly aligned to maximizing returns for the client or investor, for the simple reason that’s an objective that you can pretty much establish that everybody agrees on. Whereas for other non-financial objectives, it’s much more difficult to assume that people agree on them, so those objectives would generally have to be explicitly built into investment contracts and mandates. In the absence of that explicit inclusion of a 1.5 degree goal, can we just assume that’s the right goal for everybody? Even if we take a long-term investor, say a 30 year old who’s going to retire in 35 years time and live for another 35 years? 

The point is that it’s not easy to say, because financial markets do a very different job from the   political and economic modelling that enables us to decide where we want to go on an issue like climate change. For example, the decision that 1.5 C is the right goal – and by the way, 1.5 C with limited or no overshoot actually goes beyond even the stretch goal in the Paris commitment, but let’s put that to one side for a minute – that 1.5 C with limited or no overshoot goal takes into account the needs of vulnerable people in developing nations. It treats people equally around the world. It treats future generations who have not yet been born equivalently to today’s generations, so you tend to use low discount rates for that decision making. It also takes into account non-financial welfare benefits such as health benefits, and not just cash flow benefits.

Financial markets do none of those things. Financial markets are skewed towards financially material actors in the developed world. They’re focused on cash flows and what affects cash flows, not on non-financial impacts. And for a case study in that, look at markets’ reactions to Covid. There was an immediate fall, but then they bounced back immediately despite the fact that there were millions of people sick all around the world as a result of Covid. Furthermore, financial market discount rates are set by the market to intermediate between the current and future consumption of people who are generally alive today. So we should not expect the optimizing outcome for financial markets to be the same as the optimizing outcome when we look at things from a political economy perspective. 

I would love it to be different; but if it was different, we wouldn’t have a problem. We wouldn’t have an externality and the market would already be solving all of this stuff. The fact is we have this big disconnect, which is that what maximizes financial returns (even over the really long term) is very different from what may be ideal from a socioeconomic point of view. And so investors have to be concerned about those financial returns, not the social and economic outcomes.

Even a climate aware investor, for example, needs to ride two horses: on the one hand thinking about how they can influence the world to be where they want it to be; whilst also investing for the world as it actually is. To give a very tangible example, if you were really investing for 1.5 C, we need to electrify pretty much everything right now. So you would be investing in massive renewable energy capacity, massive electrification of home heating, cars, and so on. But if governments don’t follow through and create the grid infrastructure to make all of that work, you’re going to have a whole bunch of stranded assets If you if you take that view on a 1.5 C world. So stranded assets cut both ways. 

Investors need to have an eye to where the world is actually going, which unfortunately is not 1.5 C. I think that’s now a low probability. Mark Jacobson can produce a spreadsheet that shows how it’s going to happen, but that’s a spreadsheet, right? There is not, in my view, a viable sociopolitical pathway to that. And so investors need to recognize their role in this. 

My criticism of GFANZ has simply been that the embedding of that 1.5 C with limited or no overshoot target in quite a granular way into the commitments, is doing a couple of things. It’s creating a structural incentive for asset managers to undertake superficial 1.5 degree alignment activity. It’s creating an open goal for people who are saying to them, we didn’t sign up to this goal; because it goes beyond even what is in the stretch goal of the Paris Agreement. On the other hand, it’s opening the industry up to greenwashing accusations because, if you look at what they’re actually doing, they’re not investing in a way that’s bringing about a 1.5 C world.

So I think the initiatives are really important, but they’ve allowed themselves to get distracted by focusing on what is an increasingly unattainable goal in a way that is now not just a rallying cry, but actually becoming problematic for the initiative. 

Section Nine: how to make an ESG career shift 

Chris: This has been a brilliant conversation and we’ve covered an awful lot. Is there something else that you’re working on now that you might want to mention? What’s exciting you now?

Tom: The next one I’m interested in is diversity and inclusion. I’ve done a little bit on that in the past and I think it’s a very important issue. Again, in some ways analogous to the climate situation, we’ve had a very big focus on some quite superficial measures of diversity – board diversity or representational diversity. I don’t think we’ve focused enough on the flip side of inclusion: what it really means to make life for underrepresented groups sustainable when they come into a system that’s been largely created and run by and for white men over several decades. I think there are some, really hard, under-asked questions in there about what effective action on diversity and inclusion means, and what the research evidence really has to tell us on that. 

Again, one of my motivating principles in life at the moment is that academia has an enormous amount to bring to practice and to policy, but there’s often too much of a gap between the two. A lot of what I do is try and create a bridge. 

Chris: I look forward to that with great interest. Last words: we generally ask our guests to give a piece of advice. In this case, if anybody who’s watching or listening is considering a portfolio career particularly people who’ve got an interest in climate or ESG – what advice would you give them? 

Tom: It depends where you are. If you are already in a job it’s about looking for the opportunities adjacent to what you are doing today that enables you to craft your role. People quite often come to me and say, I want to get into ESG and I want to completely change career. That, frankly, is often pretty difficult to do. But there’s often a surprising amount you can do, in using your discretionary effort to turn your existing role and job towards your new areas of interest. 

The other thing is to just create some small experiments and networks. Get involved in some industry projects around climate or ESG, attend some conferences, build some networks with some academic institutions. I spent many years of shoe leather building connections with people, and surprising stuff comes out of that. Start talking about what you are doing and your interests. Use LinkedIn to talk about your interest and connect with people that way. I think there is a whole thing around experimentalism, but also an element of incrementalism; don’t necessarily look for that big bang change that’s going to solve all of the problems. Think about how you can take continuous steps forward all of the time to develop your interest, connections and work areas.

Chris: Thank you so much Tom, I’ve really enjoyed it. 

Tom: It’s been a great pleasure, thank you very much. 


If you found this transcript interesting, you may want to watch the full conversation of episode 3, season 2 of the Conversations on Climate Podcast. For all other episodes of the Conversations on Climate podcast go to our podcast page.