ESG: Ripe for Abuse

Exxon Mobil plant (WSJ photo)

If you have not been keeping up with the latest corporate trends, dear reader, you may not know the letters "ESG" (environmental, social, and governance). Proponents say that ESG measures the degree to which companies subscribe to the values of a significant sub-set of the investing public, i.e., those for whom environmental, social, and/or governance issues are important.

Critics argue that this is another attempt to bend corporations to the will of activists who have not achieved their objectives through the political and legal systems.

What are the details of ESG reporting? Investopedia: [bold added]

Environmental criteria may include a company’s energy use, waste, pollution, natural resource conservation, and treatment of animals. The criteria can also be used in evaluating any environmental risks a company might face and how the company is managing those risks. For example, are there issues related to its ownership of contaminated land, its disposal of hazardous waste, its management of toxic emissions, or its compliance with government environmental regulations?

Social criteria look at the company’s business relationships. Does it work with suppliers that hold the same values as it claims to hold? Does the company donate a percentage of its profits to the local community or encourage employees to perform volunteer work there? Do the company’s working conditions show a high regard for its employees’ health and safety? Are other stakeholders’ interests taken into account?

With regard to governance, investors may want to know that a company uses accurate and transparent accounting methods, and that stockholders are given an opportunity to vote on important issues. They may also want assurances that companies avoid conflicts of interest in their choice of board members, don't use political contributions to obtain unduly favorable treatment and, of course, don't engage in illegal practices.

In the opinion of your humble blogger, ESG is ripe for confusion, if not abuse:
1) Who decides what the measurements are, and who measures them?
2) The three categories have only a tangential relationship: dividing the CEO and the Board Chairman into two separate positions (good governance) has little to do with water usage (environmental impact).
3) Once a business starts measuring the data, activists will never be satisfied, because, for example, carbon emissions and plastics usage can not be reduced to zero.
4) In the age of social media, companies will make themselves even more vulnerable to judgment-by-bullhorn. There is enough headline risk already.
5) ESG disclosures will be expensive, because it's unlikely that a business will have in-house expertise on all the topics. Small businesses will be especially affected.

Nevertheless, not paying attention to ESG makes it more likely that a company's stock price will suffer:

while companies that don’t disclose environmental and social data may not always lose investors, they are more often being passed over by new investors, in favor of firms with better disclosure practices, ESG investors say.

pressure on companies for nonfinancial disclosure is growing. A group of 88 investors with nearly $10 trillion in assets, including HSBC Global Asset Management and the Washington State Investment Board, sent standardized environmental disclosure forms—requesting information related to issues such as carbon dioxide emissions, use of fresh water and deforestation—to many of the world’s biggest companies in February and followed up with officials of companies that hadn’t responded by June. Another group, the Workforce Disclosure Initiative, a coalition of investors with more than $13 trillion in assets under management, sent a letter to 750 companies in July asking for more information on how they manage their staff and workers in supply chains; 90 companies have provided the requested information.

I'll believe that the ESG movement is little more than a front for anti-capitalists when the same reporting is demanded of government agencies, some of which affect our lives more than any single company.

Corporate Tax Reform: A Big Deal

"President Donald Trump signed a sweeping tax overhaul bill into law in the Oval Office on Friday morning."

As Joe Biden said on an open mic in 2010 vis-a-vis the just-signed Affordable Care Act, “This is a big f—ing deal”. (BTW, Mike Pence said the 2017 Tax Cuts and Jobs Act was "a pivotal moment in the life of our nation.")

The media probably is making the right call with regard to its audience by devoting most of the ink to the effects on individuals. However, don't confuse minimal attention with unimportance; the changes to business are also sweeping and will result in a lot of overtime in the next few months for finance staffs.

Not only will tax reform trigger major changes to strategic--not just financial--plans, but it will also affect earnings for the current year (the deferred income tax liability is based on future taxable income paid at a 35% rate, and the change to 21% will result in a significant income pickup to accounting earnings in 2017).

In addition to the rate change, the following is a "big [insert-appropriate-adjective] deal" for corporations.

"The act repealed the corporate AMT [alternative minimum tax]."

Capital equipment may now be expensed under loosened "bonus depreciation" rules. Also, the bonus/expensing applies to used, not just new equipment.

Net operating losses may no longer be carried back and the use of NOLs is limited to 80% of current year income (this is a reduction in corporate tax benefits).

Repatriation of overseas earnings. The bad news is that corporations must increase their 2017 income by the amount of post-1986 un-repatriated earnings (for tax purposes, not accounting); the good news is that it will be taxed at 15.5% (cash assets) or 8% (non-cash assets), instead of 35%. After 2017 the U.S.-tax motivation to keep monies overseas will be greatly diminished.

Big money's at stake, decisions have to be made quickly because they affect 2017 earnings, and the rules are complicated. It almost makes me want to get back into the game.

Tax and Spend

Federal taxes and receipts have grown ten-fold since the
mid-1970's per the Office of Management and Budget

In last month's State of the Union address the President called for the taxing of educational savings accounts (529 plans) (withdrawals exceeding invested amounts would be taxed as ordinary income). The resulting protests from many quarters, including his own party, forced him to back off.

Now the President is calling for the current U.S. taxation of foreign subsidiaries of U.S. companies. These subsidiaries generally do not pay U.S. taxes until the profits are sent back to the U.S. parent.

There are policy arguments for and against the President's position, but the larger picture is:

a) For the past 40 years Federal spending has ratcheted up inexorably, regardless of which party controls the White House;

b) Under President Obama estimated 2015 Federal tax receipts of $3.1 trillion will be 50% higher than 2009 (give him credit for an improving economy).

c) These historically high receipts still are not enough to fund the President's vision of government.

d) If this corporate-tax increase fails (or even if it's partially enacted), look for the President to submit other revenue proposals. Whatever tax increase Congress agrees to, it won't be enough.

[Update - 2/13/2015: First Time Ever: Federal Tax Revenues Top $1 Trillion Thru January; Gov't Still Runs $194B Deficit.]