What if the Board Members of ChatGPT-Maker OpenAI were right?

In the aftermath of Sam Altman's firing (as a Board Member and CEO) and subsequent return (at least as CEO for now), a closer examination of OpenAI's governance structure gives rise to some intriguing insights. Many commentators were swift to dismiss the not-for-profit model at the helm, deeming it inadequate for a tech powerhouse like ChatGPT-maker OpenAI, especially given its growing commercial ties with Microsoft. At Valoris Stewardship Catalysts, it is our business to examine different governance models, with a particular focus on how for-profit organizations incorporate sustainability into their decision-making. We believe it is important in the aftermath of the OpenAI kerfuffle to reaffirm the continued relevance of the not-for-profit model and point out some of the advantages of not-for-profit leadership that should not be discarded solely on basis of one high-profile, albeit flashy, example.

While acknowledging the governance challenges inherent in not-for-profits, such as the potential for cooptation of board members because of a lack of accountability to shareowners, there is an important aspect that critics these days often overlook—the underlying commitment to mission. Not-for-profit ownership of a commercial enterprise inherently embraces a mission-driven ethos, empowering companies to prioritize long-term goals and societal impact over short-term profits. For Mozilla (also a not-for-profit corporation overseeing a for-profit subsidiary), for example, this translates into ensuring an open and accessible internet to all.

In our previous roles within development finance institutions, we grappled with the governance challenges of microfinance entities, many of which started as NGOs and later encountered difficulties in maintaining their mission integrity as they subsequently transformed into fully-fledged commercial banks. A notable instance of this mission drift phenomenon occurred in the early 2000s with a microfinance institution in Lima, Peru, exemplified by its establishment of a branch in the city's most upscale shopping center.

So, you might wonder, if not-for-profits can have certain advantages in terms of long-term direction and purpose because of their governance set-up, why did OpenAI experience a seemingly disastrous outcome? While the exact reasons behind some board members' decision to terminate Sam Altman still remain unclear, it is likely they perceived a threat to the overall mission of OpenAI and the benefits of its AI technology. The lack of transparent communication may have been intentional, possibly for legal reasons or to not ruin Mr. Altman's career entirely. It would be hasty to assert that the board entirely mismanaged the process without a fuller understanding of the circumstances.

One failure in securing the mission in this case may be OpenAI’s overly broad definition of the mission itself (i.e., "save humanity from the downsides of AI"). How does a board member operationalize their duty to such a vague, if laudable, mission? What sort of accountability can there be without a more defined set of core stakeholder groups. Not-for-profit boards, like any other, are at the end of the day not immune to the risk of mission drift. As a result, we do not recommend adopting a not-for-profit governance model for for-profit entities. Instead, firms that initially began with that model may choose to sustain it, ensuring a clearly defined and manageable mission and stakeholders that keep the board accountable.

 

 

Disclaimer: The author of this blog and his firm maintain a neutral stance in the ongoing debate over the dismissal of Altman from OpenAI's Board. This piece is intended solely to express the author’s thoughts on the not-for-profit governance model implemented at OpenAI and many other organizations.

Why the Economist is wrong about ESG

Why the Economist is wrong about ESG…

Last week the Economist issued a special report about ESG[1] with the overall conclusion that “ESG has too often been neither a good measurement tool nor an effective risk management one.” Based on this and other sweeping statements, the series of articles recommends to not only “simply” focus on the E, but further narrow the scope of the “E” to ‘emissions only’ and jettison all other ESG related topics.

The report exclusively focuses on public markets. We concur with much of the underlying analysis:

  • The three letters do indeed “lump together a dizzying array of objectives that very rarely lead to one outcome”; not even within the category of the ‘E’;
  • There is at least sometimes a trade-off between doing good and doing well but the investment industry is not always straight about this and its real incentives; and finally
  • The rating issue: various scoring systems have different underlying policies, which lead to inconsistencies and gaming approaches such as summarized in the joke (or conventional wisdom) that if as an (investee) company you are not happy with your ESG score, just change the service provider.

 

 

Only a couple of weeks back we addressed several aspects of the above shortcomings in our initial blog post: “Investors are growing increasingly uncomfortable with the ESG label[2]. The drastic conclusion of the Economist’s special report, namely, to focus only on emissions going forward and drop the rest, justifies revisiting what is important about ESG.

 

Let’s indeed first remind ourselves that the conceptualization of ESG — the lumping together of Environmental, Social and Governance considerations in the evaluation of businesses — mainly originated with the investment community. Investors know that good governance is positively associated with company performance and investment returns, especially in the long term. Investors have likewise come to understand that environmental and social factors may present businesses with severe, often catastrophic, risks. Even if these risks were not always properly assessed as part of due diligence and post-investment stewardship, they are nevertheless real or, in investor lingo, ‘material’ and the fact that there are many (and more than in the past) and that their materiality may be dynamic does not justify the conclusion to just focus on one singled-out aspect going forward.

 

The rationale for bundling together E, S and G has perhaps never been very apparent to the people who run companies. From the perspective of company managers, the term ‘sustainability’ may be more useful to describe an entire approach to running a business to make it more likely to survive and prosper in the long run. Yet, within the broad topic areas of ESG—and on the Venn diagram with sustainability—lie many, long-recognized top-level responsibilities such as CEO succession and compensation, compliance with environmental and safety regulations and supply chain management, with challenges around labor, waste minimization and management, and the sourcing of scarce resources. Ignoring these risks was and will continue to be the kind of failure that could even support a liability claim in some jurisdictions.[3]

 

Considering the Economist special report’s main conclusion to focus on emissions only in light of the above indicates to us that a pure counting of carbon emissions at the cost of disregard of all other climate and ESG related issues – whether under such arguably problematic label or otherwise — risks creating perverse incentives. For example, a bank may drop portfolio companies because of their carbon footprint without feeling the need to engage with them regarding transition pathways, bringing them too early at the brink of loss of access to capital (and potential bankruptcy), ultimately contributing to destroying jobs. Job losses in turn will increase political opposition.  In the European Union, the concerns facing workers in fossil fuel industries for example needed to be addressed by the Just Transition mechanism in the European Green Deal.  All in all, the focus on carbon emissions only may lead to unwanted consequences that actually impede decarbonization, thereby bringing us to exactly the opposite of what most would consider a Just Transition.[4]

 

In the final article of the special report, the authors offer more realistic recommendations such as i) to focus disclosure on risks material to the industry at company level and ii) to customize investment product offerings to be better tailored to investor constituencies around the ‘E’, ‘S’ or the ‘G’ but to no longer cluster them together at investor level.

 

As concerns the first recommendation, and given the variety of topics linked to ESG, creating more focus through a materiality lens is never a bad idea, but the outcome of that focus may still mean in some cases that a company is confronted with a variety of climate, environmental, social and governance challenges all at the same time while in other cases it may allow for it to prioritize physical climate risks only or deal with the emissions in the supply chain first and foremost. Therefore, a narrower focus, such as just on emissions may not easily solve questions of prioritization and still leave the investor and the company with a high number of different ESG related challenges.

 

Regarding the second recommendation, we have always advocated the importance of unbundling ESG scores and thoughtful and judicious consideration of individual scores for ‘E’, ‘S’ and ‘G’. Overall, trying to develop approaches and methodologies for assessing each of the E, S and G components—adjusted for materiality and harmonized—is the better way forward than engaging in discussions trying to discredit the whole concept of ESG and limiting it to narrow elements.

 

We believe there are still promising possibilities for better ESG integration at investor level beyond what the Economist refers to as “a marketing hype and PR spin” if public market investors move beyond clustering portfolios around ESG scoring providers to performing their own meaningful analysis of ESG. ESG integration can be more sophisticated than just the blind use of ratings. Here, a lot could be learned from private markets where PE investors and development finance institutions in emerging markets involve specialists in the due diligence based on a well-defined investment policy and process description to thoroughly assess the material ESG risks with all its investments.  This somewhat opposite approach to simply purchasing data and ratings also triggers its own challenges, but there is a middle ground that has not been fully explored by the industry, namely, to use the data of (maybe even more than) one service provider, but ultimately arrive at the investor’s  own informed analysis of what ESG-related risks are most material to the investment.

The subject matters bundled under ESG are indeed many and not all may be relevant to all companies at a specific point in time.  The fact that they are many though is testimony to the complex times we are living in. The temptation to focus on just one or some of them is understandable, but naïve. This approach ignores inconvenient but unavoidable interdependencies. The complexity of our world can sometimes surpass our mental capacities and our emotional bandwidth[5]. This cognitive impact may explain the Economist’s rather radical suggestion to limit the ‘E’ to emissions and get rid of the rest, but this is neither a realistic scenario nor a practical solution for the existing shortcomings of ESG.

 

[1] ESG: Three letters that won’t save the planet | Jul 23rd 2022 | The Economist

[2] Investors are growing increasingly uncomfortable with ESG label (valoriscatalysts.com)

[3] See for example A Board’s Guide to Oversight of ESG (harvard.edu)

[4] See for example https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3962238.

[5] See in Kegan/Lahey, Immunity to Change: How to Overcome It and Unlock the Potential in Yourself and Your Organization (Leadership for the Common Good) (2009).

 

Martin Steindl is Managing Director at Valoris Stewardship Catalysts          
Learn more about Valoris at 
www.valoriscatalysts.com.

 

To comment on the blog post, please use this Link

 
 
For additional information, please contact: 
Mike Lubrano at +1 (301) 335-5238 (USA) and Martin Steindl at +43 650 911-8768 (Europe),
E-mail: This email address is being protected from spambots. You need JavaScript enabled to view it..
 

 

Meet the founders:

 
Mike Lubrano, Managing Director
Over the past two decades, Mike has worked with scores of investors to integrate the consideration of ESG factors in their investment process and with company boards of directors to improve corporate governance, sustainability practices and transparency. He holds degrees from Harvard College (AB), Princeton University (MPA) and New York University School of Law (JD). He is co-author of ICGN’s Governance, Stewardship and Sustainability, published in June 2021.

Mariangeles Camargo, Managing Director
Mariangeles has worked with financial institutions for almost two decades helping improve environmental and social performance, comply with regulatory requirements and respond to increasing expectations of stakeholders, including capital providers. She has extensive expertise in the development of green financial products. She holds a Master of Science in Finance from Bentley College, in Massachusetts, USA.

Martin Steindl, Managing Director
Martin brings over twenty years of experience leading initiatives and teams in FMO, the Dutch development bank, and IFC that helped streamline environmental, social and governance risk management processes when investing in financial institutions and private equity funds in emerging markets. Martin holds a PhD degree from the University of Vienna and Georgia State University and an MBA degree from the HEC School of Management in Paris.

Davit Karapetyan, Managing Director
Davit has more than 20 years experience designing ESG methodologies, tools and internal policies and procedures for institutional investors to apply in their investment and portfolio operations.
He helped develop International Finance Corporation’s (IFC) corporate governance methodology, which is today widely used by many other development finance institutions (DFI) as well as private asset managers and private equity funds that are DFI investees. Davit’s work includes crafting tailored ESG policies and procedures for a variety of investors to  integrate corporate governance and governance of sustainability analysis in investment and portfolio operations, sharevoting and nominee directorships. Davit has a Ph.D. in Law and is fluent in English and Russian.

 

About Valoris Stewardship Catalysts

A unique advisory services firm that helps investors and portfolio companies improve corporate governance, investor stewardship and sustainability performance in their operations. Valoris was founded by experienced practitioners in the fields of corporate governance, stewardship and environmental and social sustainability. Valoris serves institutional investors, impact funds, development finance institutions, financial institutions and their portfolio companies. Headquartered in Washington D.C. (USA) and Vienna (Austria), Valoris operates worldwide. www.valoriscatalysts.com

Investors are growing increasingly uncomfortable with ESG label

Ron Lieber recently interviewed two high-profile investors in the ESG space, Amy Domini of Domini Impact Investors and Rachel Robasciotti of Adasini Social Capital, for his Your Money column in the New York Times. His opening query to each was “What’s the most accurate definition of ESG today, and how has it changed?” Perhaps surprisingly, perhaps not, both Ms. Domini and Ms. Robasciotti deliberately ducked the question. Ms. Domini preferred instead to describe her own approach as “ethical investing” and lamented losing vocabulary battles over the course of her long career. Ms. Robasciotti responded by calling her firm’s approach “social justice investing”, and like Ms. Domini avoided directly responding to Mr. Lieber’s question of what, exactly, ESG investing really means. Frankly, I don’t blame them.
 
A well-known corporate governance leader once described ESG to me as an unstable molecule. What holds it together? Why should investors talk about bundling assessment of environmental, social and governance? Are these even coherent categories? Is ESG simply a term to organize consideration of non-traditional factors? Do investors and companies look at ESG the same way? What’s objective and what’s subjective in each category? Can anyone at investors or companies be an expert in all three? And who decides what’s important, what’s nice to have and what’s a distraction?
 
 
Corporate governance professionals have always found the term ESG problematic and fraught.
 
 
Corporate governance professionals have always found the term ESG problematic and fraught. From a corporate governance perspective, environmental and social considerations are objects of governance. Effective corporate governance is the sine qua non of effective long-term management of any enterprise. Senior executives, board members and investors all play a direct role in governance – company oversight, strategic direction, risk management, the control environment and transparency. It is within the framework of corporate governance that these actors – the people with the greatest interest in and power over the direction of the company – ensure that due attention is paid to all internal and external factors material to the operation of the enterprise, whether organized along the lines of environmental and social categories, or otherwise.
The foregoing is not intended in any way to belittle the importance of careful attention to environmental and social factors in the operation of companies or the management of investment portfolios. Just the contrary. The climate crisis in particular has made company managers, board members and investment professionals increasingly aware of how complex such issues are, how well-tailored investors’ and companies’ approaches need to be, and how much they necessarily rely on outside expertise and advice. Plenty of executives and investors are governance literate; none can be fully ESG competent. The field, if it really exists at all, is simply too broad for a priesthood.
 
 
The climate crisis in particular has made company managers, board members and investment professionals increasingly aware of how complex such issues are, how well-tailored investors’ and companies’ approaches need to be, and how much they necessarily rely on outside expertise and advice.
 
 
So let’s go back to Mr. Lieber’s question, what does it mean to be an ESG investor? If it means that the investor considers certain non-traditional factors pigeonholed under one or more of the three categories, doesn’t that cover pretty much any active portfolio? Since at least the revolutions of 1848, investors have understood that how companies treat their workers is something worth looking at. Regulatory risk is a relevant factor in the valuation process for most industries – environmental and social regulation is ubiquitous. And what about passive portfolios with exclusion lists? Don’t they qualify? If so, then the term is so inclusive as to cease to be a meaningful differentiator. And saying that being an ESG investor means having a systematic process of evaluating ESG factors merely begs the question – what counts as a systematic process? How does the investor demonstrate how investment decisions are different because of its application?

If investors can’t help squirming when asked to define it, maybe it is time to scrap ESG, even as an umbrella term. Instead of using overbroad, misunderstood or vague labels, institutional investors should be speaking to their clients in terms of the specific factors they think are relevant, the information they collect and analyze, the science behind their methodologies and the results (financial and non-financial) they believe these generate. This would likely accelerate the emergence of categories more useful than a generic “ESG investing” label. Hopefully, these categories will be ones that investors will be comfortable using in front of journalists (and the investors’ clients).

There are instances when we at Valoris find ourselves still using the term ESG investing for lack of a better alternative. But we do so in the full knowledge that it is an imprecise term, susceptible to accidental and intentional misuse. Wherever we can, we will endeavor to employ more precise terminology, providing explicit reference to context and purpose, in order to contribute to clearer expression and understanding of what enlightened investors are actually doing or should be doing.

Mike Lubrano is Managing Director at Valoris Stewardship Catalysts          
Learn more about Valoris at www.valoriscatalysts.com.

 

To comment on the blog post, please use this Link

 
 
For additional information, please contact: 
Mike Lubrano at +1 (301) 335-5238 (USA) and Martin Steindl at +43 650 911-8768 (Europe),
E-mail: This email address is being protected from spambots. You need JavaScript enabled to view it..
 

 

Meet the founders:

 
Mike Lubrano, Managing Director
Over the past two decades, Mike has worked with scores of investors to integrate the consideration of ESG factors in their investment process and with company boards of directors to improve corporate governance, sustainability practices and transparency. He holds degrees from Harvard College (AB), Princeton University (MPA) and New York University School of Law (JD). He is co-author of ICGN’s Governance, Stewardship and Sustainability, published in June 2021.

Mariangeles Camargo, Managing Director
Mariangeles has worked with financial institutions for almost two decades helping improve environmental and social performance, comply with regulatory requirements and respond to increasing expectations of stakeholders, including capital providers. She has extensive expertise in the development of green financial products. She holds a Master of Science in Finance from Bentley College, in Massachusetts, USA.

Martin Steindl, Managing Director
Martin brings over twenty years of experience leading initiatives and teams in FMO, the Dutch development bank, and IFC that helped streamline environmental, social and governance risk management processes when investing in financial institutions and private equity funds in emerging markets. Martin holds a PhD degree from the University of Vienna and Georgia State University and an MBA degree from the HEC School of Management in Paris.

Davit Karapetyan, Managing Director
Davit has more than 20 years experience designing ESG methodologies, tools and internal policies and procedures for institutional investors to apply in their investment and portfolio operations.
He helped develop International Finance Corporation’s (IFC) corporate governance methodology, which is today widely used by many other development finance institutions (DFI) as well as private asset managers and private equity funds that are DFI investees. Davit’s work includes crafting tailored ESG policies and procedures for a variety of investors to  integrate corporate governance and governance of sustainability analysis in investment and portfolio operations, sharevoting and nominee directorships. Davit has a Ph.D. in Law and is fluent in English and Russian.

 

About Valoris Stewardship Catalysts

A unique advisory services firm that helps investors and portfolio companies improve corporate governance, investor stewardship and sustainability performance in their operations. Valoris was founded by experienced practitioners in the fields of corporate governance, stewardship and environmental and social sustainability. Valoris serves institutional investors, impact funds, development finance institutions, financial institutions and their portfolio companies. Headquartered in Washington D.C. (USA) and Vienna (Austria), Valoris operates worldwide. www.valoriscatalysts.com