Capitalisn’t: David versus Goliath

Jul 15, 2021

Sections Finance

In a major moment for what’s come to be called “shareholder capitalism,” activist hedge fund Engine No. 1 successfully claimed three seats on Exxon's board of directors this year. Its explicit mission is to force the energy goliath to turn away from carbon and toward more clean forms of energy. On this episode of the Capitalisn’t podcast, hosts Luigi Zingales and Bethany McLean speak with the founder of Engine No. 1, Chris James, about how the fund approached the proxy fight, his views on shareholder capitalism, and the future of activist hedge funds.

Chris James: When we did this campaign with the thought that we could actually win, we inspire other people to do the same thing. The idea that other people can find great directors, they have a great argument, and they put that in front of large shareholders and give them an opportunity to really effect change.

Bethany: I’m Bethany McLean

Phil Donahue: Did you ever have a moment of doubt about capitalism, and whether greed’s a good idea?

Luigi: And I’m Luigi Zingales.

Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.

Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.

Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed? 

Luigi: And, most importantly, what isn’t.

Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.

Bethany: I’ve long been interested in the question that if a company’s shareholders are its owners, then surely, they should be able to get that company to behave in ways that they like, whether we’re talking executive compensation or climate-change policies. But aside from some activist investors, who usually have very specific issues, shareholders often don’t do much with their considerable power. 

Regardless of the explanation, shareholder floppiness—Luigi, is there a better word?—is an issue for capitalism. Which is why we were so pleased to see the story of Chris James, a former hedge-fund manager himself, who has created a firm called Engine No. 1, which calls itself a socially responsible, activist hedge fund.

Speaker 8: It used to be that ESG meant screening out companies that don’t comply, but lately, activist investors are screening in companies that would be the antithesis of ESG, like big oil, and then pushing for changes. That’s what’s going on at Exxon right now. A new firm called Engine No. 1, led by an under-the-radar hedge-fund manager, Chris James, is running a proxy fight seeking to overhaul the business. 

Bethany: Chris’s partner, Charles Penner, picked Exxon, which has been struggling with losses as oil and gas prices plunge, along with a lack of strategy for renewables, as their first target. And they succeeded.

Speaker 9: Hedge Fund Engine No. 1 has gained a third seat on the ExxonMobil board of directors. The small fund campaigned on environmental concerns, ESG, of course, the idea that Exxon is simply not doing enough to address that in its business. 

Bethany: They were actually inspired by a paper of yours, Luigi.

Luigi: Yes, so they say. I’m flattered by that. 

Bethany: Tell us about it. Why?

Luigi: Since the 1970s, since the famous article by Milton Friedman, everybody thought that if you take the perspective of the shareholders, what you want to do is maximize shareholders’ value or the profits that the company generates. What we point out is that even if you take a perspective that shareholders should be first, or precisely because you take that perspective, you might want to consider the fact that there are some situations in which shareholders want something else. If I am a 100 percent owner of a company, I don’t necessarily maximize profits. I certainly want to have higher profits, but I want to also have happy employees, or I care about the local opera community, or something else. 

Now, Friedman points out, “Oh, you maximize profits, and then you distribute these profits as dividends. And then shareholders can do whatever with their money.” Now, we show that this idea of separation is true only if there are no synergies or benefits to do the two activities at the corporate level. So, if it comes to donating money to your alma mater, whether you donate $1 as a corporation, or you donate $1 as Bethany McLean, the dollar is still $1. It doesn’t make a difference. 

However, if it comes to, for example, pollution, if you maximize profits and pollute, and you, Bethany, care a lot about undoing that pollution, you probably would spend much more in undoing that pollution than they made in profits doing the pollution. At that point, we want to consider not just maximizing profits but maximizing your utility. And if you are a bit prosocial in your utility, there is something else other than money, there is also maybe the welfare of your community or of your country, or the environment, or whatever. 

In that situation, even if a company only cares about the shareholders, they need to ask the shareholders what they want to do. This might be different than pure maximization of profit. So, it’s a simple distinction, if you want, but enough to create a wedge between the mantra that you should only maximize value and a broader approach that shareholders also care about other things.

Bethany: Yeah, I do wonder, and let’s go talk to Chris, but I want to come back to this after our conversation with him. I do wonder how many companies are as flat-out stupid as Exxon. And it seems to me, from what you’re saying, maybe there are a fair number. But the CalPERS managing director for board governance and sustainability—and CalPERS ended up supporting Chris James—said the two key things that made a difference, the critical reason they were willing to support Chris James, were Exxon’s unwillingness to engage with shareholders—so, their no, no, no, no, no, hear no evil, see no evil, speak no evil—and also, the focus on future performance, the focus on money in the future. That this was, in the end, a financial issue. And so, those two things made me wonder how broadly applicable this strategy is. But let’s talk to Chris and come back to that.

Luigi: I have to admit that I screwed up during the Chris James interview, and a cable was not connected. So, we are going off our backup recording and not the higher-quality usual recording.

Bethany: And I’m always so happy to have somebody else screw up technology, because I’m usually the one who does it. So, all I have to say is, yay, Luigi, that’s awesome.

Luigi: I think it would be nice if you were to describe to us the Exxon story in your own words, because we know the story. But our listeners probably are not as familiar as they should be about this story.

Chris James: Yeah, the original idea around the ability to effect change with Exxon came from Charlie Penner. And Charlie had done a previous campaign with Apple. And I think we spent a lot of time walking through, how do you tie these impacts into economic outcomes? And we had kind of a mind meld over how that was actually going to be done. The framework which we developed, something we called the total-value framework.

If the company was able to change course and accept that the energy transition was going to take place, and then have board members who had experience with energy and creating value in the energy space, that message would resonate across all shareholders. Primarily because the company had refused to engage with virtually every shareholder, whether it was an active shareholder, whether it was an index fund, over the course of the previous decade. 

And even in the current leadership, there was very little dialogue between management and shareholders. And so, we felt that we could kind of harness that frustration with management’s unwillingness to engage with many shareholders. And the idea, which is just common sense, that an energy company should have people, at least some people, with some energy experience on the board. And this is a company that had no one with energy experience on the board. Which, in and of itself, tells you a lot about kind of the culture of the company. They didn’t really want to be questioned. 

We took the idea that shareholders were frustrated with the performance, the large index providers were frustrated with the lack of dialogue and acceptance that the world was changing, and harnessed this into a message where we didn’t talk about climate change as an ideological issue. We spoke about it consistently as an economic issue, because it is an economic issue over the course of time. And we were able to win three of the four board seats with the support of the three large index funds, support of ISS, support of Glass Lewis. 

And many active managers, and by far the majority of active managers with the top 15 shareholders, which was something no one thought was actually possible. But obviously, we thought it was possible, but I think we were the only people. We did a very simple Bayes probability model on what happens if you win two of the big three, what happens if you win three of the big three, and then we kind of would knock off the probability of each of the big active shareholders. And the fact was, if we won two of the big three, there was an 85 percent chance we’re going to win. And, by the way, no one for some reason did that calculation. 

Luigi: What is the strategy your fund is pursuing? And what is different vis-à-vis what other activists do? And what is new about it?

Chris James: Yeah, for the firm, we have several strategies. The concentrated equity fund is certainly one of the strategies. But the overall idea here has always been, across the firm, to effect systems change. And systems change takes multiple paths to actually do this, one of which is our ETF, one of which is our concentrated strategy. 

One is kind of the model which we call active ownership. Charlie Penner runs that, and he ran the Exxon campaign, the day to day, the hard grind, the letters, all of these components of the overall firm strategy. And then we have what we call the foundry, which is building companies from scratch, and private equity, all tied to the same simple idea, which is that the long-term value of companies is a function of the total impact that companies have on society in general. 

I don’t know if you’ve read this anywhere. But the initial inspiration for the firm and for the overall idea was partially done by the paper that you and Oliver did. And that basically became our investment framework, which we’ve kind of further developed into a very data-intensive framework, which really looks as best as we can at externalities, or impacts, and what effect they have on long-term value creation. So, multiple strategies.

Bethany: Does there have to be a component of value creation to this? In other words, if you think broadly about ESG goals, would you guys be interested in something that arguably was good for society but didn’t have a financial benefit as well? And I’m thinking about this through the lens of ExxonMobil, where you could argue that their strategy of fossil fuels, yes, bad for the environment, but also bad for where the world is going on a financial basis, given the move to renewables?

Chris James: Yeah, I don’t think you can unlink the two. We believe very strongly that many issues, and many reasons we have not seen change, is because the discussions have become ideological, and they’ve split across party lines, when the simple fact in front of them is that there is a linkage between long-term value creation and impacts. It’s not a coincidence that the big debate of the last 10 years among divestment or engagement has been around fossil-fuel companies.

And these companies, these stocks, have been horrible performers over the course of the past decade. I don’t think it’s just a coincidence. Yeah, I think the linkage, at least in our case, the linkage sits there for most companies. Certainly, where there’s transparency, and transparency is the vital part of this. Without the transparency into what impacts really have . . . And that’s what the data revolution, or the ESG revolution, as well, has really done, is just given us a lot better datasets on what impacts companies actually have on society at large.

Luigi: I’m certainly very flattered by the reference to my paper. But in our paper, we do point out also that there are tradeoffs. That sometimes you want to work for the environment at the cost of profits if this is important enough for the shareholders. Where do you see the tradeoff? Or do you see there is no tradeoff, it is all a win-win situation?

Chris James: Yeah, well, I think the tradeoff, which I think you pointed out in the paper, I think is around the short term. There are certainly tradeoffs over the short term. And there’s a J-curve associated with the companies when they actually realize what the impact is. I mean, 25 years ago, I mean, none of us really understood what the impact of climate change was actually going to be on society. And I think, over the short term, there are tradeoffs.

And the quicker companies actually realize what their impacts are, and then how that will affect the marketplace in which they play in, the sooner they actually understand that, the better off they’re going to be. We look at what we call internally the path of the impact, which is what happens when people realize that whatever this company is doing has a large negative impact. And we have regulation, governments get involved. We have consumers change behavior, early adopters. 

And this is, of course, like the people driving the Prius. And then you have innovation, and the innovation is to mitigate these impacts. And so, we kind of look at the intersection between innovation and impacts as the place where we think that we have the most ability to drive change, because just like we saw with the original clean-tech revolution, the idea was, how are we going to mitigate these impacts?

And then, once we started doing that, even though it took a large amount of pain over the short term, but over the long term, these companies are the ones that are driving the disintermediation that’s taking place in the energy markets. So, we do think that, yes, there are short-term tradeoffs, short-term investments, but we think over the long term that the impacts are, and how you mitigate those and the speed at which you do this and the speed at which you realize change. Or look at the energy industry. Look at Ørsted or Equinor versus Exxon, in particular, where Exxon has been the last person to actually talk about the desire for societies, what do they call it, the low-carbon solution business. This was the last oil company to do this. And look at the first ones, which are the Europeans, and they’ve been much more successful in the transition. Certainly, the first movers, which started almost 10 years ago.

Bethany: In a market that increasingly values the short term or always has valued the short term, how do you plan to mitigate that issue in your public-market funds, where you have a lot of pressure around short-term performance rather than just long-term performance? And, specifically, the energy industry, if you think back over the last 10, 15 years, there was, at least briefly, a reward for fracking and for incredible production driven by fracking. How do you mitigate that tradeoff between short and long term? The pressure from other investors?

Chris James: Yeah, I think that there’s a shift underway, and one of them has certainly been the fact that index investors, the big three, their time horizons, if you’re an index product, are virtually perpetual. And, as we’ve seen during the last proxy season, these companies have started to vote for not just our own directors, but within the proxy season were much more aggressive in voting for issues that they viewed as important to the long-term performance. 

So, yes, while on one end of the spectrum, you have short-term traders or you have the platforms, the Citadels, the Millenniums, which have a short duration, and then you have this move to the long-term index and the size of those, certainly within companies that are in the S&P 500 are definitely driving . . . It’s a very differentiated market. And there’s a gap there in the middle, which is no-man’s land, which you really don’t want to play in. 

But I do think the market is bifurcating between the very short term and very long term, and the very long term are growing faster. But for us, as a firm, it’s really having the right investors. If people think that we’re going to be able to effect change dramatically for large companies over three to six months, they’re going to be very, very disappointed. We think that change for a company, any large company, takes probably 7 to 10 years. And that’s certainly the expectation that we have. And we have to find investors that are aligned with those goals.

Bethany: Is it fair to say that index funds, instead of being a force for the status quo, are becoming a force for the greater good? Or is that too broad a simplification?

Chris James: I think it’s probably too broad right now, but they can be. The voting process in general, as we know, has . . . The fact that the ticker vote, which for our index fund was available, kind of tells you the level of prioritization that people put on what their own vote was. Which leads to an interesting dichotomy that has kind of existed, which is that many of the people that were talking about divesting last year, or in the previous years, are the same people who were also talking about making sure you get out and vote for the presidential election. 

And the idea that by divesting and giving up your vote, that is going to effect change, I think is an insane idea. So, I think that there is the possibility for index funds, in general, to be a positive force for good. There are some limitations, though, on what they can actually do, because they cannot be active in the same way that we can be active. You have to file a different regulatory filing, it causes an enormous amount of problems inside the company when you have a vote that exists across the whole firm. 

But, I mean, they’re clearly moving in the right direction. The pace of which is yet to be determined, but we certainly hope that people don’t lose faith in the capitalist system before we see these sorts of changes actually take place. And I think a big part of that change is going to have to be restoring some equilibrium between shareholders and management. And right now, that equilibrium is way out of whack, primarily because people haven’t really paid as much attention as they really should during the proxy season, or during voting, and realize the power that they ultimately have.

If you give your vote to a big institution, you kind of feel like they’re going to vote for a big institution. So, in many ways, I think people have become disillusioned. And what we want to do is bring visibility to the power of the shareholder, and especially the long-term shareholder. And, as we saw with Exxon, that is a powerful tool that people actually have to effect change. And we hope they use it.

Luigi: I love the emphasis on voting. As an Italian, I learned from history that not participating is very dangerous. During the rise of fascism, the opposition decided to leave parliament in protest. And, of course, Mussolini went ahead. And that was the biggest gift they could have given to him. Investing and not participating is not the right strategy. 

But, this said, I’m a little bit concerned about the incentives of the large index funds. I agree with you that the large index funds tend to have a longer, or should have a longer perspective, because they’re there for the long term. However, their managers are rewarded on short-term financial performance. So, how do you put the long-term objective into the manager that runs BlackRock or Vanguard or so on and so forth?

Chris James: I’m not sure I have a great answer to that. But what we have seen within the stewardship teams of these firms is we have seen them start to move in the right direction. I think it’s the pace. Are people going to be happy with the pace of change in large organizations? I think we’ll see next proxy season and the following proxy season. 

And hopefully what happens, and certainly one of our goals, is when we did this campaign with the thought that we could actually win, is that we inspire other people to do the same thing. The idea that other people can find great directors, they have a great argument, and they put that in front of large shareholders and give them an opportunity to really effect change. 

Again, they’re limited because they’re not going to . . . The big three are not going to propose their own slate of directors. Again, they can’t do that without becoming active. But other people can. While I don’t know, I certainly do hope that the win that we had with Exxon gets other people to look at other industries and other companies who have been recalcitrant on how much their impacts have affected shareholders and stakeholders, and put forth people that really want to effect change in multiple industries. That’s what we would like to say.

Luigi: Sorry, why isn’t the answer that as people get to know what these funds are doing, they might vote with their feet? BlackRock, until recently, has being very, especially Larry Fink, very active in words. But when it comes to votes, and the case of Exxon is a notable exception, but in the case of voting, the voting record of BlackRock was terrible on environmental issues. When you provide an alternative, an index fund that actually votes in the way people care, you’re going to get the same performance. If you have an index fund that is indexed to the S&P 500 but votes pro-environment, it will have exactly the same performance as the BlackRock 500, but your vote goes in the right direction. And so, that pressure might induce these guys to go in the right direction, as long as we investors, small investors, know that and vote with our feet.

Chris James: Yes, I mean, I think that the reason we are certainly offering an index fund is to try to capture people who believe that change needs to happen faster than it actually has been happening. And they have the ability to know, with a large degree of certainty, because of the transparency we were providing on how we’re going to vote, how we are going to try to effect change. 

But I also think, though, we can’t lose sight of what we have seen so far. And Exxon, when we started the campaign, was a 30-something-dollar stock. I mean, our cost basis is like $36. The stock is over $60. And there are 4 billion shares outstanding. So, think about the value that has been created for all index managers, because they think that maybe, with a few directors that have energy experience, they can improve the performance of a company. 

I do think that the idea that we can actually improve the index performance is kind of one of our core tenets. And there’s, of course, as a University of Chicago guy, I’m sure you may bring up the free-rider problem associated with that. But we’re willing to accept that, because we do think that this is an opportunity, because of the data, the ESG data revolution, to really take into account a better way for these companies to be run. 

I mean, there’s already been, I’ve been lucky enough to see how the investment banks are positioning themselves as potential advisors to many large companies. What ESG criteria are going to be important to shareholders, and how can they prevent an activist from coming with an ESG mandate to change out board members? And so, the fact that this is now going to be a discussion point, because of Exxon, it already means that we have sped up the pace of change dramatically from where we were before.

It is unclear exactly all the ways in which we’re going to potentially see the system change, but we know it’s moving in the right direction. And we know it’s going to move a lot faster because of the win that we saw with our three directors. 

Bethany: I know one issue that has frustrated investors for a long time is the lack of a link between executive compensation and performance. Is that an issue that you explicitly plan to take on? Or do you plan to take it on more indirectly?

Chris James: I do think that was an important part of our messaging, and one that we saw resonate extremely well with investors. And, certainly, when you have things like cut 401(k) matching programs for employees, and CEOs still get more shares than they had before when the stock is down a ton this linkage. And the “G” portion of this, which, frankly, I underestimated before getting into this campaign, I didn’t really understand to a full extent what role governance, which, obviously, compensation is a component of, could play. And shareholders’ inability to restore that equilibrium between themselves and management is directly tied to the governance component of this. 

And when you have a chairman and CEO combined, their ability to restrict data flow to boards and what boards actually end up knowing about the company is much smaller. And, therefore, there’s much less oversight when you have a chairman CEO. So, I do think that executive compensation as a component of this, it’s the one that really gets shareholders most bent out of shape when they see management teams make money while they’re losing money. So, that’s always going to be a tool, but it’s part of a broader governance issue that exists across . . . I mean, across US companies.

And I’ve read enough of your work around crony capitalism, and those components are certainly true in large companies in the US. And we certainly hope that changes, because if it doesn’t change, the direction that we’re going to go is completely the wrong direction. Which is towards a . . . Like we see today, the polling among millennials on why they think socialism is a good idea. Well, they think it’s a good idea because capitalism isn’t working for them and isn’t working the way it should. And a large part of that is because of this governance issue that exists in large companies right now.

Luigi: Yeah, I completely agree. And you pointed out, it’s a very important point that is often forgotten, is how much boards get served a prepared menu by the chairman CEO, and actually, on this dimension, the role that the media can play in informing board members of a different story. I’ve been on boards of large companies, and I found media reports very useful, because they give you an opportunity to ask a question inside a board that you would not have the possibility of asking. And once you ask the question, then you change . . . You turn the table, because you’re the one asking questions, not the one receiving the prepared information.

Chris James: This was a hallmark, by the way, and there were several . . . There was a lot of CEOs that I spoke to during the course of this process. And one told me the story of General Electric, and GE was the master of how to effectively punish the board members for asking any questions. And, over time, what they did is they created a system of so much actual paperwork over the board of day, day-and-a-half meeting, and so many things that they had to approve in a way that didn’t require debate, that that’s really all they had time for during the board meetings. 

And so, they would go there, there was a process, there was virtually no discussion about the business, there was a lot of actual formalities, and they left the board meeting knowing virtually no more about General Electric than they did before the board meeting. And I think many large companies have gone down the route of putting board members on the board who are not going to question management, are not going to push back. It’s not a secret that, in many cases, the chairman CEO picks the other board members. The nomination committee is very much tied to the chairman CEO. And so, therefore, they have all friendlies on the board. And then they put an enormous amount of paperwork in front of them over the course of the board meeting. And, guess what, there’s no real change. 

Luigi: Speaking of socialism, I always joke that board elections in the United States are the closest thing to a Soviet election in the Western world.

Chris James: Exactly. Oh, it’s 100 percent. That is completely true. And it’s not the right answer for anybody. It’s not the right answer for the system, it’s not the right answer for the companies. And the only reason you do that is you have a culture that is insular and one where you don’t like to be questioned. And that’s not going to get us to the best result. And I think we’ve seen this way too much recently among large companies, where they don’t have a board that’s really going to push back.

Bethany: It’s fascinating, given the trajectory of GE, that should be a warning sign to companies everywhere that this is not the right way to go. Last quick question for you. And I know you have to go, and it comes back to what we had talked about earlier. How much support do you think there is broadly among investors for issues that are purely ideological and that aren’t economic in the end?

Chris James: I don’t think there’s a lot of support for ideas that are only ideological, unless you can tie them back to economic outcomes. The shareholders vote, and the shareholders are going to vote what they think is in the best long-term interests of the company. But if you can’t link an ideological argument to an economic argument, then it’s probably not something that should be put to a vote anyway. So, I think that linkage, it occurs over the long term in many cases, and so therefore, you can do that, but I don’t think there’s . . . I personally don’t think there’s a way to effect change in the duration . . . It’s probably not the market’s job to do that. It’s probably government’s job to do that, if you can’t tie it to economic terms.

Luigi: That is great. Thank you very much for your time. And good luck with your strategy. We hope you succeed. 

Chris James: OK, thank you very much.

Luigi: I suspect that a lot of our listeners have no idea how board members are elected. And this is actually something extremely important and that receives very little attention, even among my colleague economists. And I think it receives very little attention, because it’s not a pleasant thing to actually advertise very much. You have the incumbents, a committee of the incumbents, make a proposal of who is going to be elected in the future. And this list goes up. And if there are nine seats on the board, there are nine people who are candidates. So, either you are elected, or you are elected. 

And, in fact, most of the time, even if you don’t get a plurality of the vote to be elected, you are co-opted by the board afterward. So, basically, it’s completely an incumbent decision to renew their friends on the board for the next time around. The interesting thing that Engine No. 1 did is to try to add new seats to the board and bring new people to the board. In order to do that, you have to mail your own proxy, you have to make your own campaign, you have to spend a lot of money. 

The interesting thing is this is the ultimate phenomenon we economists call the free-rider problem, because you spend your own money but to the benefit of all the shareholders. So, unless you have enough shares in the company and the company gets an important capital gain, you don’t recover your investment. Now, in this particular case, Chris James seems to have done well, because he collected enough shares of Exxon, and Exxon increased enough, that he more than paid for the $12.5 million that he spent to actually win these three seats on the board. But, in general, it’s not a profitable strategy.

Bethany: That makes a lot of sense to me. And I see why Chris James was so drawn to it, particularly with Exxon. Because part of his argument was not only that Exxon was losing a lot of money in traditional oil and gas, but that their lack of renewable strategy for the future was going to hurt the environment, but also hurt their chances of being profitable later on. Yes, these are broader societal issues, but issues that needed to be tackled at the corporate level for Exxon even to continue to be successful. Forget about even maximizing the success around the issue. It’s both.

Luigi: No, you’re absolutely right. The only difference is, because we are economists, we tend to put everything in terms of tradeoffs. So, shareholders might be willing to sacrifice some of their profits to have a better environment. Now, Chris James, who is a successful manager, is more in the business of a win-win solution. So, he points out that you can do both at the same time. And, if you can, kudos to him, that is great. 

OK, we have a more difficult world in which you have to trade one against the other. But I was discussing with my coauthor, Oliver Hart, what Chris said and how to interpret it in light of our model. I think that the simplest idea is Exxon was poorly managed. And you could have two kinds of takeovers, one that was maximizing profits and one that was maximizing something more than just the profits, like Chris James is doing. 

And it looks like Chris James’ strategy is also very effective from a marketing point of view, because I was reading that they had budgeted almost $30 million for the proxy fight, and they ended up spending only $12.5 million, which is a bargain. Not for you and me, Bethany, but for large investors, it’s a bargain. And part of it is actually, ironically, COVID, that you didn’t need to travel to talk to so many people. But the other, that’s my interpretation, is that this strategy makes it more appealing to a lot of people. It makes it more appealing, because people do care about things other than just profits.

Bethany: I’m not so sure about that. I thought after our conversation that the strategy was less revolutionary than it appeared on the surface. I thought that Chris was quite almost Friedman-esque in some of his final remarks, where he said that the business of the company is to make money. I don’t think he was driving a wedge between the idea of making money and the idea of doing something good for society. I think his point of view is that a lot of times those two things are aligned. And the issue in our capital markets is more one of timing, short term versus long term. 

And as long as you can convince investors to be sufficiently long-term-oriented, then the actions that Engine No. 1 wants to take will be in the long-term economic interests of those shareholders. But what I did not hear him say—in fact, I heard him say he would not do this—was take on ideological or social issues that didn’t have the potential to make money or prevent a company from losing money, either. So, even though what he’s doing is really, really interesting, and I applaud it, I think it is actually more Friedman-esque than less Friedman-esque, and I think it is less revolutionary than I had thought at first.

Luigi: I partially agree with you, and it is definitely the case that he wants to make money and that this is also a very good marketing strategy to raise money and make money. And this is not past him. But I think that one of the reasons why it is such a good strategy is because some investors actually do also care about the environment. Imagine that you can have two different investors running your money, and one can be an old Carl Icahn doing a takeover of Exxon and trying to restructure or to have Chris James.

I think Chris James looks more appealing today and is more likely to win a larger consensus by having that strategy. In fact, the crucial point is the reason why he was so successful is because the large index funds voted for him eventually. So, Vanguard, Fidelity, BlackRock, those guys count for a lot. And they are shaped by a very few people who make that decision. And whether it is simply the ISS and Glass Lewis of this world, the proxy-advisory firms, or they are the governance department of BlackRock, but a few people decide on the votes of millions of shareholders. And they count for a lot, and these people can be more easily won with a combination of make money and make good than just with either make money or make good.

Bethany: I think I’m still going to disagree with you a little bit. And I want to come back to the index-fund issue. But my point was not that this doesn’t have a lot of utility, that the Chris James model doesn’t have a lot of utility for climate change. I think it does. Because, arguably, you can make a very broad economic argument that if we don’t fix climate change, we’re all screwed, economically. I think what I heard Chris say, and my takeaway is that it is less broadly useful than I might have thought going into the conversation. 

In other words, climate change, you can make an argument, is an economic issue that is going to affect all of us.  For other social issues, the link to the economics of it are not as clear. And what I heard him say is that he would not be interested in those sorts of topics. So, this isn’t a mechanism for taking on social issues, as much as it is a mechanism for taking on social issues that also have broad and pretty obvious and pretty compelling, pretty broadly compelling, financial ramifications. And, in that sense, it’s a more limited strategy than I might have thought firsthand. 

But I totally agree with you about index funds. And I think that’s part and parcel of this conversation, which is, Larry Fink at BlackRock, for instance, has been very outspoken about the issue of climate change. And this played right into something that he already believed. But Chris himself was a little bit cynical about the idea that index funds were going to be forces for change rather than forces for the status quo. And so, I think he understands what he is up against there. That, in other words, the specific dynamics of the ExxonMobil situation may be hard to repeat.

Luigi: I completely agree. I think that he was very smart in packaging the entire thing together in the extreme case. Exxon’s board was particularly asleep at the wheel. But I think that what is important, once you see a phenomenon like Exxon, this will have a ripple effect on all the major corporate boards. Because the CEOs will start to panic. They are going to see how to prevent a future attack from Chris James. We’re going to see a lot of people at least paying lip service to the environment, et cetera, in order to block even that angle.

Bethany: Is that a good or a bad thing, if we see more people paying lip service to an idea more than more people actually doing something about it?

Luigi: We hope that there is something behind the lip service. This is what I think that, ideally, the press and academia should expose, if they pay lip service but with no substance.

Bethany: I thought Chris made a couple of other really good points that were surprising and interesting to me, too. And it might tie into this idea for you that boards are going to take a look at their own composition and their own activities and say, “Uh-oh.” But one idea was that on a lot of boards, you don’t have industry expertise. That on the ExxonMobil board, you didn’t have people with oil and gas experience. I have to admit, even after whatever it’s been, oh, dear God, a quarter-century of covering business. I hate to say that. It makes me sound old, I am old, whatever. 

I was still, I was totally shocked by that. I would have thought . . . I had never looked at it. But I would have thought at least half the people on that board had to come from the oil and gas industry. And I was stunned by that. I also thought the example he pulled forward about General Electric and the way the board was drowned in paper and drowned in paperwork in order to prevent them from even seeing substantive issues, let alone raising them, and that it was a deliberate strategy employed to keep the board sort of neutered. I thought that was a completely fascinating insight, too, and one that I had not thought about before. I actually always thought it was more social dynamics at the board of directors, either ignorance or social dynamics at the board of directors, that kept boards from raising issues that perhaps they should have. I had never thought it was actually a deliberate strategy by corporate management. I’m so naive. Were you surprised, too, or did you expect those things?

Luigi: No, having been on boards, I can say that I wasn’t surprised at all. I think there is an art of a good chairman to basically do it without giving the appearance of doing it. And I think if you are an inexperienced board member, you limit the amount of information that they give you on purpose, precisely because you want them to take responsibility for what they give you or not. Rather than covering with a lot of stuff. The other thing I learned is the paper you read first is the last one to arrive on your desk. The stuff they send you three weeks in advance, you know there is nothing in it. The stuff that arrives by email two hours before the board meeting, that’s where you have to pay all the attention, because that’s where the bodies are buried.

Bethany: OK, so here’s a question I was struggling with. As we talked about, I do think that oil and gas climate-change issues are absolutely right for Chris James’ strategy. And really, to be fair to him, if he does nothing other than tackle this issue, get companies to tackle it, that’s a lot. But can you think of anything else where the social goals and the long-term economic goals line up so clearly? I was trying to think of other social issues or other causes where there might be tight alignment between economic endpoints and the social goals. And I admit I was coming up a little short.

Luigi: Actually, I don’t think so. Think about social media, for example. If I interpret it correctly, Chris James’ strategy is to say, if you are doing something that society doesn’t like, eventually, you’re going to have the government after you, you’re going to have the consumer dissatisfied, you’re going to have the worker complaining. It’s not going to be a good business long term. That’s his proposition. I would like to see the numbers to trust that this is always the case or most of the time. I would like to believe so.

Certainly, in the very long term, it’s hard to imagine that this is a great strategy. In a sense, it is a broader version of . . . Have you heard this term of the Net Promoter Score? It is a marketing concept that people have used with a lot of success. It is the difference between the customers that really love you and the customers that hate you. And I think that industries that have a bad . . . Companies, particularly, but also industries, that have very low Net Promoter Scores are ripe for change. 

Comcast probably has a super negative Net Promoter Score, because nobody likes Comcast. And actually, I love that Matt Stoller said the worst sentence in the American language is, “I’m from Comcast, and I’m here to help.” That is an industry where people are upset and they find every way to bypass it. And, eventually, innovation will find a way to do it. Think about the cab industry. There was a lot of discontent about the way the medallion system was working. But, for whatever reason, it was very difficult to ever change. And then, you had the Uber revolution, with all the problems of Uber, but it massively impacted that industry. And, if you were the holder of a medallion, you took a big loss.

Bethany: That’s interesting. I think you or somebody out there should write a paper and see if there is a correlation between that and eventual economic decline, if one thing does lead to the other. And then, if it does lead to the other, if it is a predictor of eventual economic decline, then you could make the case to Chris James that his mandate should be even broader. Because these companies that are making enemies are eventually destined to fail. 

I’ve always believed that on some level, on a micro level. And what I mean by that is, when I think about companies I’ve covered that have been spectacular failures, from Enron to Fannie Mae, they were always companies that were making enemies, that were hated. And, when they got into trouble, no one came to their rescue. But that’s been my anecdotal, journalistic observation rather than anything more scientific. And I don’t know if it applies broadly to industries as a whole that are making enemies. 

I mean, for sure, that has not been true of big tech, until now. Big tech has been making enemies, I mean, at least . . . I don’t know, when do you trace it to? Do you trace it to the election of Donald Trump with Facebook? And certainly, if it is leading to enemies for Facebook, that is not showing up in their stock price. Although I guess that’s hard to measure, because you could say maybe their stock price would be even higher if it weren’t for some of the enemies that they’ve made. But it’s not showing up in their financial performance. And so, there is, for sure, a lag time in your proposition.

Luigi: That’s what makes it difficult to test. There is a lag time, and it’s not obvious how long this lag is. As Keynes said, in the long term, we are all dead. Eventually, I think all companies will be dead. So, it’s a bit tricky to test. However, I think that it’s interesting for the digital platforms, because I think they produced an enormous amount of consensus at the beginning. The Net Promoter Score was off the charts, and people loved Google. They also loved Facebook, but particularly Google. 

And part of it is because they were providing so much value to consumers. Regulators could not touch them. Even journalists could not touch them. I think things have changed. Certainly, they started to change with the election of Trump, even if what they have done is no worse or better than what they did when Obama was elected. It’s just that people did not like it.

Bethany: Maybe true. I always think whenever somebody says in the long term, we’ll all be dead, I always think of my sister’s variation on that, which always makes me laugh, which is, it’s all going to be fine in the end. And if it’s not fine, it’s not the end. I don’t know why that always makes me laugh. It’s probably not really funny. Anyway, so I was wondering, both . . . And back to this conversation about index funds, I thought there are limits that Chris is imposing on his own strategy in terms of the need for it to be economically viable as well as in the right interests of society. 

But I thought there are two limits that are going to get imposed on him externally. One is the issue of index funds. When will they put their foot down? When will they weigh in? And the other issue that I thought is going to be a big one for him, which we addressed a little bit, is the issue of timing. And you, I thought, asked him a really great question on that. But so many people, their compensation, and all aspects of this thing we call the market, is oriented toward the short term.

If you’re a portfolio manager, your compensation is oriented toward how your portfolio did over the last year. If you’re an investor, you care about how your portfolio did over the last year. And it’s artificial, and it’s stupid. But here we are. And some part of his strategy depends on getting people to give a damn about the long term again, and I think we’ve moved so far away from that I wonder, if it’s not a big, popular, major issue, like climate change, how much of a difference can you actually . . . How much movement can you actually get?

Luigi: I actually am a bit more optimistic than you are precisely coming from the index funds. Because, at the end of the day, if I invest in a S&P 500 index, I’m going to get the return of the S&P 500 index, at which point, I might be tempted to actually vote for things I care deeply about. So, if we open up a way for investors to communicate their preferences to institutional investors, institutional investors will be forced to communicate to companies, and that will have more of an impact than we expect. 

I think that the big risk that we saw—hugely under the Trump administration with Clayton at the SEC, we will see what Gensler does now—is that the regulators come in the picture to stop this process. Because corporate America does not want to be told what to do. They want to make sure that you give them your money, but you don’t give them your voice, because they like your money but don’t like your opinions. And the best way to do it is to block this system of proxy advisory, proxy voting, and all that stuff. And it’s very easy to have a couple of small rules that change the ability of all of us to express our opinion.

Bethany: That’s really interesting. Well, then, I guess maybe we should be grateful, I think, that Chris James is launching this in the Biden administration rather than in a Republican administration, which might have been more tempted to sneak little changes into some of the rules that would have made it much harder for this sort of tactic to succeed. But you can bet that in investment-banking boardrooms everywhere . . . Do you remember, back in the late 1980s, when the whole defensive takeovers, the greenmail thing, was a whole strategy that every investment bank had? You can bet they’re coming up with the Chris James strategy for how you prevent this from ever happening again, to implement at company after company, and the big law firms are all working on it. Any loophole that exists or doesn’t exist is getting closed.

Luigi: However, the fun part is they contribute to making Chris’s ultimate strategy more successful, because they go out scaring the hell out of the board members. That’s why they make money, they go out and say, “Oh, the world is ending, the world is ending. You need our advice on how to fight and how to prevent, how to do this, how to do that.” But, at least in part, that strategy must include doing something, for example, about climate change.

Bethany: I hope you’re right. I tend to be a little bit more cynical, but you know what, we shall see, and I certainly wish him the best of luck.