The Case Against Stakeholder Capitalism

Episode 107 of the Investopedia Express with Caleb Silver (October 11, 2022)

Welcome back, and welcome aboard. We're in another one of those good news equals bad news moments in the markets and the economy when the good news in the labor market is bad news for equity investors. After U.S. equity markets rallied more than 5% to start the week and the month of October last Monday and Tuesday, investors backed away from buying mid-week as more tough talk from the Fed dampened hopes of a pivot on interest rates. Friday's jobs report for the month of September all but confirm those dashed hopes, as U.S. employers added 263,000 jobs to their payrolls and the unemployment rate ticked down to 3.5%. Wage growth ticked slightly higher and has risen 5% on an annual basis. The Federal Reserve wants to cool wage inflation along with every other inflation that remains sticky high.

So, the thinking goes, the Fed will stay the course and raise the Fed funds rate a couple more times at its next two meetings this year. We don't have to guess or hope it changes its mind. Various Fed presidents were out on the speaking circuit last week, all but promising a 75 basis point hike, followed by a 50 basis point hike in December. No pivot there. As soon as investors wrap their minds around that Friday morning, they sold, and they sold hard, wiping $930 billion in market cap off the stock market in a single day. Still, through it all, U.S. equity markets actually ended the week higher. The first positive week for stocks in seven. It may not have felt that way, but the numbers don't lie. The Dow rose 2% for the week while the S&P 500 added 1.5% percent and the Nasdaq posted a 0.7% gain. Volatility, which had been at a simmer through the sell-off in September, has been boiling over in the past couple of weeks. The S&P 500 has moved at least 1% in 11 of the past 14 trading days, the most volatile 14-day surge since April of 2020, according to Dow Jones Market data, which leads us to our Big Three for the week. 

Number one: What's the fair value for the S&P 500? First of all, what is fair value anyway? Fair value, basically, is the sale price agreed upon by a willing buyer and a willing seller. The fair value of a stock, ETF, or index is determined by market participants who are looking at the price of a security compared to its future earnings. That's the forward price-to-earnings ratio that is used to value a company's share price or the price of an index like the S&P 500. Currently, fair value for the S&P 500 is around 14 times forward earnings per share, which translates to a price for the index of around $3,300. The S&P 500 closed a week just above $3,600, actually trading slightly higher than what would be considered fair value. The question big investors are asking is whether that is still too optimistic, given what they believe is likely to happen with interest rates.

Number two: Let's dig a little deeper into earnings estimates, since that will be a dominant theme in the coming weeks. Analysts are forecasting 2.4% earnings growth in the third quarter for S&P 500 companies. That's according to FactSet. The few companies in the S&P 500 that have already pre-released their results have reported earnings that are in aggregate only 0.4% higher than a year earlier. That's pretty weak. Most of the companies have seen their share prices fall in the days surrounding those reports, so the bad news is not being taken well at all. Leading up to the end of the third quarter, analysts have trimmed their forecasts for S&P 500 third quarter earnings by 6.8%. That's the largest cut to estimates during the reporting period since the second quarter of 2020, according to FactSet. They also have dialed back their projections for the fourth quarter and the full year 2023.

Number three: Hiring and consumer spending have been surprisingly resilient all year, despite persistently high inflation. We know consumer spending in the U.S. inched up in August, even though inflation was still stuck above 8%. Wages have grown at a 5% annual rate, which is not keeping up with inflation. So, where is all that spending power coming from, especially with the stock market in a tailspin? Turns out we're saving less, a lot less. The U.S. personal savings rate is at its lowest level since 2008. We're also borrowing more as consumer credit is increasing at the fastest pace since 2011. That combination heading into a potential recession is not the recipe for success, especially with interest rates on the rise. As the Federal Reserve raises the federal funds rate, that pushes up the prime rate for banks, which pushes up APRs on credit cards. The average APR for a credit card is about 18.5 %. Consumer spending, my friends, is 70% of U.S. GDP. If consumers pull back, watch out. 

Meet Vivek Ramaswamy


World War Zero

Vivek Ramaswamy is the co-founder and executive chairman of Strive Asset Management. He previously founded and served as the CEO of Roivant Sciences, in addition to leading the largest biotech IPOs of 2015 and 2016. Mr. Ramaswamy is the New York Times bestselling author of Woke, Inc. and the recently released Nation of Victims. He has also authored articles and op-eds for The Wall Street Journal, The New York Times, and Harvard Business Review and regularly appears on national television networks, including CNBC, Fox Business, and The Fox News Channel.

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You may have heard the phrase "stakeholder capitalism" over the past few years. It's become a popular catchphrase among CEOs, including Larry Fink and Jamie Dimon; it's been embraced by business groups like the Business Roundtable; and it's been used to create thousands of financial products for investors of all sizes. Stakeholder capitalism refers—or at least used to refer—to the idea that companies should serve not just their shareholders but also other societal interests, which include suppliers, consumers, their employees, and the planet overall. But there's also been a growing backlash against the term and what it represents. One of the most outspoken critics on stakeholder capitalism and its cousin ESG (environmental, societal, and governance concerns) is Vivek Ramaswamy. He's the founder and executive chairman of Strive Asset Management and also the author of Woke Inc., a 2021 book, and the forthcoming book, Nation of Victims: Identity Politics, The Death of Merit, and the Path Back to Excellence. And he's our special guest this week on the Investopedia Express. Thanks so much for being with us."

Vivek: "Glad to be here. And I'm happy to report that actually Nation of Victims is now officially out. So that is the sequel to Woke Inc. And so, thank you for having me. It's actually just came off the book launch."

Caleb: "I've had the pleasure of reading an early edition of it, so thanks for sending it. And folks, we'll link to those books in the show notes. So, you're certainly not the only person who takes issue with stakeholder capitalism and its cousins, but you chose to write a book about it, now a sequel, and become very public with your criticism. You are a successful CEO, you're a big philanthropist. You've done very well, Vivek, by most measures. Why devote your energy to this subject? Why are you so passionate about it?"

Vivek: "It's a good question. I mean, I started on this journey in early 2020 when I wrote my first editorial in The Wall Street Journal, the first of many that followed. So, this is about a little over two and a half years ago at this point. And I felt like there was something incomplete in the debate where there was a legitimate viewpoint that companies ought to be responsible for more than just making products and services for profit. And Milton Friedman had always said the social purpose of a corporation is to pursue profit, and that's what makes companies more effective, is if they're focused exclusively on making widgets. But to me, it felt like there was something incomplete about that defense of the classical shareholder model."

"And so, Milton Friedman's long dead and gone and I felt some sense of obligation to pick up where he left off, to get to the other half of the story that he never touched. And the other half of the story that he never touched was that this wasn't just about defending the integrity of capitalism. It was equally about defending the integrity of democracy. And that's actually what bothered me the most. This has since entered the public discourse, but when I first started writing about this in early 2020, this was a head turner of a view. No one was thinking about it this way. So, I felt compelled to make the contribution to the dialog to say, 'You know what, the problem with stakeholder capitalism isn't just that it distracts companies from being less profitable. It is that it signals to citizens that your voice on political questions doesn't matter.' What it says is, instead, 'We settle our most important political and normative differences through the corporate boardroom, through the use of economic force, through use of economic power, where everyone's voice and vote is adjusted upward or downward by the number of dollars they control in the marketplace. And to me, that that's not the American vision."

"For better or worse, the American way departed from the Old World European model, which said, 'You know what, church leaders and business leaders get together and decide what's right for the rest of society at large.' No, that is not the American way. The American way is, for better or for worse, we the people, as co-equal citizens, settle the answers to our most important political questions. Be that how we fight climate change, or how you address historical racial injustice—every person's voice and vote ought to count equally. And I grew concerned that this trend of stakeholder capitalism was sucking the lifeblood, the air, out of what it meant to be a citizen in a democracy. And so, I don't know what made me so passionate about it. I don't know. It just seems like an issue that I care about. It turns out I care about democracy, and that's what sent me on the journey that I've been on for the last couple of years."

Caleb: "Well, if you read Woke Inc. like I read it, you understand where a lot of that comes from. Your family comes from India. You learned a lot through traveling there with your family over time. But you've also come to America. You've grown up in America, in Ohio of all places, and done very well there. But you write in Woke Inc. and I thought, 'This is pretty powerful.' There's a new invisible force at work in the highest ranks of corporate America, one far more nefarious. It's defining scam of our time, one that robs you of not only your money but your voice and your identity. You spoke to that a little bit earlier, but what brings you to that overall conclusion? Because I think a lot of folks might say, 'I'm free to believe what I want, even though I know that the places I spend my money believe a certain thing and want us to believe a certain thing.' But what brings you to the conclusion that made you write that?"

Vivek: "I think a lot of citizens... I mean, take where I live in central Ohio today. In a 50 mile radius of where I live, it's a pretty good cross section of the country. It's one of the reasons I love living in Ohio as opposed to the years that I spent in Manhattan, which as much as I enjoyed it, it was a bit of an echo chamber. I think that if you take that cross section of people across the country, or across 50 miles of where I live, there's a sense that something is amiss. The sense that something is amiss is that my voice no longer matters. My voice is no longer relevant. The world that I travel in as my country feels like I'm traveling in a foreign land. It's foreign because my voice is irrelevant to shaping the norms that govern the place where I live. And where does that come from? I think it comes from a sense of fear, a sense of fear created... Let's say you're working at a company. The idea that expressing your viewpoint freely may be used as a basis for terminating your job or for being denied a promotion. I think that sense of the everyday citizen's voice mattering in a body politic, that is what we lose when we hand over the power to... not just determine what products rise to the top."

"And by the way, I'm a big believer in American capitalism. I don't think that everyone has an equal say in determining whether it's this phone in my hand or a different phone in someone else's hand that rises to the top of the products that get sold at a store. That's a $1, one vote system, as it should be. But the right way to address climate change, the right way to address historical injustice, racial- or gender-driven injustice... These are fundamental political questions where Larry Fink's voice, as the CEO of BlackRock, might matter on which stocks rise to the top and which ones don't. But it ought not matter with the respect to which ideas rise to the top of the marketplace of ideas in a democratic society."

"And so, I think that it's this idea... It's a heist. I think it's the heist of our time where, when managing other people's money, the things you stole (and I use that word intentionally) as an ESG-promoting asset manager was also their voice and their vote that they never intended to give to you. I think it's the largest scale form of (and I don't say this lightly) financial fraud, at least the largest scale financial breach, fiduciary breach of duty in the 21st century. It was hiding in plain sight. No one stepped up to the plate to address it. And I thought the least I could do was to share my perspectives on the pages of The Wall Street Journal, in the form of a book, in the form of writing and speaking about it. When I didn't see much progress being made in terms of institutions changing their behavior in response to that (a little bit, but not a lot), I said, 'Look, we got to actually just do this through the market,' which is what led me more recently to found Strive."

Caleb: "I want to get into Strive in a few minutes, but I also want to come back to this notion of the corporations and corporate CEOs stepping into what may have seemed like a moral vacuum. A lot of this stuff has been bubbling up over the past few years. There was a pandemic. There was racial issues, racial injustices. There was George Floyd, a number of other incidents like that across the country that brought a lot of this to the surface and brought a lot of companies off the sidelines and their CEOs into the mainstream, where maybe they felt like there was an absence of leadership, whether that was political or through communities or through family, that they felt like they had to speak up. Am I hearing you saying that it wasn't about their conscience, it was about what was best for their company and what they wanted the people who follow their companies and shop with them to believe. Why do you think that this happened?"

Vivek: "So, I think that there's no one answer, to overgeneralize, and that's why it takes a book to explain. I think there are some cases in which it was in the best financial interests of the company to signal something that they or their executives absolutely did not believe. So, that's the case of what I sometimes jokingly call 'blowing woke smoke' to be able to deflect accountability from the issues you'd rather not be addressing. If you're Coca-Cola, you'd rather teach your employees how to be less white (their words, not mine) or to pontificate about a voting law in Georgia, then you would talk about your own products' impact on the nationwide epidemic of diabetes and obesity, by the way, including in the Black community that you profess to care so much about. So, in some cases it's a deflection move."

"I think in other cases, it is actually not in the financial best interests of a company, but they're forced to adopt that behavior by large asset managers like BlackRock and Vanguard because it's in their financial best interests to be able to aggregate assets from pension funds like New York and California to agree to then foist those policies on the companies, even if they're not in the best interests of the companies themselves. So, in some cases, it's imposed by financial institutions on the companies when it serves the financial institution, even when it doesn't actually serve the company. And then in other cases, I think you have executives who say that, 'You know what, you only live once, and I'm going to impose my views on everybody else. And these are my views and I authentically hold them, even if it is going to hurt the company's interests.' And that's a principle agent problem of a different kind."

"So, I think that there's no one-size-fits-all answer, it's a complicated phenomenon. Different cases have different forces at work. But at the end of the day, all of them, I think, represent a threat to democracy because they involve an empowered market actor making a political or social judgment, but without the backstop of political accountability on which our system is built."

Caleb: "You kind of experienced maybe the flip side of this as the CEO of your biotech company when a lot of these racial incidents were coming up over the past few years. And you didn't necessarily address it head on, although you address that you got some backlash from that from your staffers, from your employees. Talk about that experience. How did that shape your thinking around this?"

Vivek: "It's a good question. I mean, it was a big part of the experience I talk about in the book. Look, I think that there's... The first thing that I reflect on as a CEO and as a leader is that a lot of times when your younger employees are clamoring for you to make a statement or adopt a social or public position, it comes from in many cases, and in this case, an earnest place, a good place different than the cynical motivations of the BlackRocks of the world that are imposing this in a top-down manner. Oftentimes, young people, it comes from a good place, wanting to do their part to make the world better. And I think that that's important to acknowledge in the response so we don't hammer out the good impulse underlying it, even though it may be misguided in the end."

"And I think the job of leaders is to fill what I see as a generational hunger for purpose and meaning and identity, a black hole of purpose in the heart of the generation, millennials and Gen Z included. They're hungry for a purpose, hungry for a cause but used to have that cause or purpose filled by things like faith or patriotism or hard work as those things have receded in modern life. That, I think, creates a situation where they start to fill that void by looking to fill it with fast food instead. You know, go into Ben and Jerry's and ordering a cup of ice cream with some social justice sprinkles on top. They think that fills their moral hunger, but you don't satisfy a moral hunger with fast food."

"And what can a CEO do? A CEO is not in a position to revive patriotism or national identity or family. I don't propose that they try. But I think a CEO can fill that void with a strong sense of corporate purpose, to actually remind their employees about the importance of the work that they do. Maybe it's being an entertainment company. Maybe it's being a biotech company that makes medicines that save people's lives. Maybe it is through becoming a technology company that makes people more effectively able to live their lives. Whatever it is, there's a presumption in favor of a company that's able to sell a product that people want to pay for because generally people want to pay for something that has value to them. That means that there's likely... not always, but likely a really worthy mission at the heart of that."

"And I think that sometimes CEOs who feel pressured, as I did even at times—I mean, this is a reflection on my own failures as as a leader in some ways—is that many CEOs, many of us who might find us in a position of responding to the calls to fulfill a social purpose that's different from the purpose of the company might mean that we weren't even doing a good enough job of articulating our own company's and institution's purpose, and that could actually fill that millennial, Gen Z hunger for a cause more effectively than just waving like a flag in whatever direction the wind blows on a given day, which is like the equivalent of fast food, to satisfy a much deeper hunger."

Caleb: "I want to pull another quote from the book. I think you're an excellent writer and some of these things you just put in such interesting context. But you write here, 'The real problem with stakeholder capitalism isn't that it's inefficient. The deeper threat is this: It's the Goldman Rule in action. The guys with the gold get to make the rules, not just market rules, but moral rules too.' You, Vivek, you were referring to Goldman Sachs, of course, the giant legendary investment firm where you worked for a few years. Are things like pushing for more diverse workforces, broadening suppliers, protecting the environment... Are these things that just bankers with fleece vests want, or is this something that you think a lot of people want but shouldn't be pushed from a corporation out into its customers and its shareholders?"

Vivek: "I mean, it was a few months that I worked at Goldman as a summer internship. I ended up working at a hedge fund after I graduated for a few years thereafter. But it was an edifying few months. And the Goldman Rule, as I said, it was the guy who had the gold gets to make the rules. You know, that's not the way democracy is supposed to work. Do the fleece-vested bankers actually want it? No, actually, it's funny because most of them didn't want it. Most of them could care less. Most of them want they want their year-end bonus and are going to be able to say or do whatever it takes to get that year-end bonus."

"But I think that the reality... And by the way, I don't think there's anything wrong with that. I don't think that someone needs to apologize for wanting to make money, especially if they're working in the financial services industry. Presumably you went into that because you care about managing and making money. So, I think that this apologist culture to cover up for that sin when it wasn't a sin at all, but you're trying to cover it up, is itself fake and creates a new sin of dishonesty in its wake. That being said, I think that there are people out there who authentically want, with their own money, to advance an environmental or social or cultural agenda. It's a free country. They ought to be free to do that."

"But I think what's happened right now is large financial institutions have captured the money of everyday citizens who don't want to advance those agendas and are still using them to advance those agendas. I think BlackRock is an epitome of this example of which. California and New York might have said you need to adopt environmental and social standards, modern diversity, equity inclusion standards in the Paris Climate Accords, and net zero pledges by 2050. Great. Do that for clients who demanded, but you can't vote everyone else's shares or advocate on behalf of everyone else to do the same thing."

"That's actually what's happened, and I think that breeds a sense of mistrust. I think it stifles open public discourse and debate about these issues. And I think that that's something that leaves everyone worse off in the end, whether or not you're a proponent of an environmental or anti-climate change or anti-racist agenda, you don't want to win that debate by force, or at least you shouldn't want to win that debate by force. You should want to win it on the merits of the ideas themselves because that's what's going to give you lasting victory in a way that matters in a society of co-equal citizens, rather than using economic force to foist your ideas on to people who are never persuaded by them in the first place. I think we need more persuasion. That's what we need our country. We need more authentic persuasion as a way to win people over rather than the use of economic force."

Caleb: "Sounds like the title of a new book, potentially. Let's see if you have time for that. But let's talk about ESG. We've been dancing around it and talking about it a little bit, but this is a way that the financial industry has basically productized a lot of this. We know that assets under management in ESG-related investments are up to something like $11 trillion and growing every year, every year. But it has become the subject of a lot of criticism, a lot of companies being accused of greenwashing. We know the SEC is looking into it. We have folks like Tariq Fancy, who I had on to my other podcast, The Green Investor, talking about what a sham it is. Why do you think that it is such a poisonous part of what's going on in this industry?"

Vivek: "I think Tariq is focused on the narrow issue of greenwashing, which is to say that any ESG fund that claims to do a certain thing may not even be doing that thing, and even if it did do that thing, it's not going to move the needle very much. And that's one set of issues. I'm focused on the converse issue, which is what I call green smuggling, which is actually taking all of the funds that weren't described as ESG funds, but in fact are using ESG-linked voting principles and voting guidelines to advocate for policies that people who invested in those funds didn't actually expect or know they were subsidizing. And it turns out that's even a much bigger-scale problem."

"I think the problem at the root of the ESG movement is it's irreducibly vague. It's vague on purpose. The definition of what counts as ESG changes on a given day. A couple of years ago, it was being against oil and gas until Russia invades Ukraine, in which case, 'Eh, we're not really against oil and gas anymore because gas prices are higher and we might need to invest in production some more.' That's a year-to-year change. Investing in weapons manufacturers. 'Oh, well, that's not ESG. Eh, unless you're actually selling weapons to Ukraine, in which case it might be ESG.' Nuclear energy. 'Eh, systematic exclusion from the Vanguard ESG funds if you're a nuclear energy producer. But wait a minute. Actually, maybe nuclear energy is ESG friendly because it's carbon neutral.' The definitions change by the day. It's purposefully vague. That's not by accident, it's by design because it further empowers the people who get to design and define the three letter acronyms in the first place."

Caleb: "Let's talk about how you invest. Furthermore, you have an asset management firm, Strive Asset Management. I don't want to get too much into what's in there, but how do you direct investors' money? What is the philosophy and the ethos behind Strive, and what is your take on investing to maximize shareholder return?"

Vivek: "So Strive was formed... I mean, I co-founded the company to fill what I saw as a gap in the marketplace created in the wake of the ESG movement. And what we wanted to offer was not an anti-ESG voice, but a pro-excellence voice. A voice that stands for a different view. A voice and a mandate to corporate America to focus exclusively on delivering excellent products and services to their customers and maximize shareholder value that way, rather than focusing on anyone else's social or cultural or political agenda. And as simple as that might sound, in today's environment that ends up being a very contrarian message. Leave politics to the politicians and tell companies to focus on products and services for their customers. It's that simple, and that was the mantra of Strive. 'Invest in Excellence,' advocate not for stakeholder capitalism, but excellence capitalism."

"And you know what, for the people out there... you asked about this earlier too. Are there people out there who want with their own money to advance an environmental agenda or a worthy social agenda or political agenda with their money? It's a free country, and they're free to do that. And Strive would probably not be a good home for their capital. I think that's one of the things that more asset managers need to do. They need to be transparent about the fact that there are certain customers or clients whose interests... you can't be a good fiduciary to everybody, you can't be a good fiduciary to them either. And so I think that in a society of mutual respect, they deserve a fiduciary who looks after their interests if they want to advance an environmental or social agenda. But conversely, if somebody wants to exclusively, with their money, tell companies to focus on products and services for profit without apologizing for it, maximize shareholder value that way, that's the kind of client for whose business Strive wants to compete."

Caleb: "Well, Vivek, you know we are Investopedia, a site built on our terms, on our dictionary. We like to ask our guests for their favorite investing term. I have a feeling I know what your favorite investing term is not, but I would love to know what it is. What is that term that just means so much to you that so special to you as an investor, as a CEO, as someone who has grown up in this industry, which term really speaks to your heart?"

Vivek: "I'd say Alpha. Alpha is a term that speaks to me because it means it's doing something distinctive. You're doing something that achieves a unit of extra outperformance as a consequence of ingenuity, generally human ingenuity. Maybe these days it can be algorithmic ingenuity too. But the use of ingenuity to create something that did not otherwise exist, which is outperformance relative to the herd. That's the term that if you put me on the spot means something to me."

Caleb: "That's a great term. We love that term. Well, it's been really interesting talking to you. Folks, we are going to link to your social media platforms, to Strive Asset Management, and some of the articles that you've written, and also to your books because they are fascinating. So good to talk to you. Vivek Ramaswamy, so good to have you on the Investopedia Express. Thanks for your time." 

Vivek: "Thank you. Good talking to you."

Term of the Week: Credit Default Swaps (CDS)

It's terminology time. Time for us to get smart with the investing term we need to know this week. And this week's term comes to us from Mahmoud, who hit us up on Instagram. Mahmoud suggests credit default swaps this week, and we like that term given all the action in the credit default swaps under Credit Suisse last week. According to Investopedia, a credit default swap, or a CDS as we call them, is a financial derivative that allows an investor to swap or offset their credit risk with that of another investor. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse them if the borrower defaults. Most CDS contracts are maintained via an ongoing premium payment similar to the regular premiums due on an insurance policy. A lender who is worried about a borrower defaulting on a loan often uses a credit default swap to offset or swap that risk.

It's basically insurance against default. And if you're old enough to remember the great financial crisis in 2009, credit default swaps were at the heart of it. They were highly used during that time to reduce the risks of investing in mortgage-backed securities and fixed-income products. But when the bottom fell out of the mortgage market, premiums on credit default swaps spiked, prompting defaults and a liquidity crisis for the ages. Cut to last week, and the price of credit default swaps for Credit Suisse jumped dramatically as there were rumblings about the bank's solvency as it undergoes a restructuring. The stock nosedived as the price of those credit default swaps soared, but by the end of the week, those reversed as the company announced that it would be buying back $3.3 billion of its own debt. We haven't seen reader interest in credit default swaps like that in a while, and they don't bring back great memories, but it's an important product to understand and a good term for our investing vocabularies. Great suggestion, Mahmoud. We're sending you a pair of Investopedia's finest socks.

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