December 9, 2023

Rui Soares is an investment professional for FAM Frankfurt Asset Management, an independent investment firm.

Olaf Scholz, the German Chancellor, has said that a return to any kind of a normal relationship with “Putin’s aggressive, imperialist Russia” would be “inconceivable”. In other words: no regime change in Russia, no return to the German-Russia partnership.

What about the business world? What will western private companies that had operated in Russia before the invasion of Ukraine do once the war is over?

Let’s try a hypothetical: you run a company whose revenue is growing 5-10 per cent a year. Russia previously accounted for 5 per cent of revenue. Vladimir Putin’s invasion has ended with a settlement mediated by the USA and the European Union that gives security guarantees for Ukraine. Putin has taken over the Donbas region, a land bridge to Crimea, and remains firmly in power. He is Russia’s stronger-than-ever strong man.

Your company suspended activities in Russia when war began. Will you reopen the Russian business now?

Some would argue that shareholder value maximisation (ie profit maximisation) is a company’s only goal. Therefore, a reopening of the Russian business is mandatory. It’s the only decision fully compliant with the mandate shareholders entrusted in the board.

For followers of Milton Friedman this may indeed seem a convincing and definitive argument. Then again, it’s not. Even if one accepts Friedman’s view that shareholder value maximisation is the only goal, there is a question left open: maximising value on what time horizon?

If the horizon is six months, reopening the Russian business may make sense. If it’s ten years the case becomes more difficult, because ESG is not a quarterly concern.

How will you deal with the potential bad publicity and lobbying by competitors whose corporate footprints are less problematic? How will you deal with social media shitstorms? How will you attract a new generation of talented employees? And how many of your current talented employees will leave you at the first opportunity? Which insurance company in the ESG age will still want, and be able, to deal with you? What banks will provide you with financing? What investment funds will be willing to hold your bonds and equity? What will be the impact of a tarnished reputation for social responsibility on revenue outside Russia? How much will your brand be damaged?

The loses resulting from not reopening the Russian business can be offset within one year as the company grows 5-10 per cent annually on a global basis and Russia would account for only 5 per cent of the firm’s revenue. Why would you risk losing multiples of that in revenue outside Russia and handicap your long-term global growth prospects? The simple answer is: you will not.

We know there is a time inconsistency in optimal decision making. Whatever goal you want to achieve and objective you want to maximise, the best short-term decision isn’t often the best long-term one. This applies to all domains of human endeavour, including politics, corporate life, and shareholder value maximisation.

ESG forcibly aligns shareholder value principles with long-term strategic thinking and goal setting. It lengthens the time horizon over which shareholder value should be maximised. It should therefore contribute to a more long-term efficient allocation of resources in the economy (you could call this sustainability). For all its flaws — and there are many in the way it is being implemented — ESG is a welcome correction to financial markets traditional modus operandi.

Russia accounts for less than 10 per cent of revenue for the vast majority of the foreign companies that were active inside its borders, which in turn is equivalent to a year or two of their normal global revenue growth. It is surely fair to assume that without regime change the overwhelming majority of western companies will not return to Russia after the end of the Ukraine war, independently of official western political and economic sanctions being formally lifted or not. Putin’s Russia will become a pariah state.

Vladimir Putin might be ESG’s biggest incidental victim. If so, Milton Friedman would be pleased.

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