As traditional expectations of corporations are tested, corporate purpose and the role of shareholders are challenging the future of capitalism. David Walker writes.
Almost 50 years ago (September 1970), American economist Milton Friedman famously put the case for a constrained view of the purpose of the corporation. In a New York Times Magazine article — The Social Responsibility of Business is to Increase its Profits — Friedman wrote that corporate executives have a direct responsibility to their employers, the business owners — that is, the shareholders. That meant executives should “conduct the business in accordance with [the owners’] desires, which generally will be to make as much money as possible while conforming to their basic rules of the society, both those embodied in law and those embodied in ethical custom”. For example, he wrote, if a corporate CEO wants to help a worthy cause, he should use his own money, not that of his shareholders.
The economist’s view was so influential, particularly in the US, that it became known as the Friedman Doctrine. Yet recently, particularly since the 2008 global financial crisis (GFC), the position, also known as shareholder primacy, has been increasingly subjected to criticism in its country of origin. The opposing view — that companies should consider “stakeholders”, as they were dubbed in 1984 by another business thinker, Edward Freeman — has now become mainstream in American business. The Washington DC-based Business Roundtable, which counts as members the CEOs of major US corporations, made headlines earlier this year when it revised its longstanding Statement on the Purpose of a Corporation. It moved the roundtable away from Friedman’s constrained, shareholders-first view by declaring: “We share a fundamental commitment to all of our stakeholders”.
The Business Roundtable statement may have little formal effect, but flags growing concern at the top of many businesses across the developed world about what voters expect of them. Signatories included Amazon’s Jeff Bezos, BlackRock’s Larry Fink, JPMorgan’s Jamie Dimon and Fox Corporation’s Lachlan Murdoch. The Council of Institutional Investors and other investor bodies expressed concern over this statement, stating it undercuts the notions of managerial accountability to shareholders.
The greatest problems of all in doing well by doing good are... inside the corporation itself.
While the debate in the US impacts Australia, particularly because many of the signatories helm companies with operations here, it is important to note that directors’ duties differ between the US and Australia, and the two systems should not be conflated. It is a widely accepted view that the current formulation of the Corporations Act 2001 (Cth), which requires directors to act in the best interests of the company, allows consideration of stakeholders, including customers and employees, beyond shareholders. The issue was expressly examined in the banking Royal Commission, with Commissioner Hayne emphasising that acting in the best interests of the corporation demands consideration of more than the financial returns to shareholders. With regard to customer interests, Hayne remarked companies are not faced with a binary choice between the interests of shareholders and those of customers. Over time, he argued, the interests of different stakeholders will converge.
As part of the Forward Governance Agenda consultation, the AICD explored how directors are interpreting the best interest duty in practice. Nearly half of members responding to the consultation said they balanced the interests of shareholders and stakeholders, while another 32 per cent consider stakeholder impacts as relevant to the interests of shareholders as a whole (this latter formulation being the more generally accepted understanding of the legislative duty). Notably, 16 per cent of respondents consider the interests of shareholders as a whole.
There is some evidence the community would like business to go further. For example, the 2018 Committee for Economic Development of Australia (CEDA) Company Pulse report found 72 per cent of Australians believe business should place equal importance on economic, environmental and social performance.
A new framework?
Further out on the spectrum stands Colin Mayer CBE, a corporate revolutionary with a classic management academic’s resume, who recently spoke at the Supreme Court of NSW Corporate and Commercial Law conference in Sydney on 29 October (see full report, p40). Mayer has been a Harkness Fellow at Harvard University and a Houblon-Norman Fellow at the Bank of England. Now he’s the Peter Moores Professor of Management Studies at Oxford’s Saïd Business School — and the best-known and most ambitious voice calling for transformation of corporate purpose.
Mayer has set his ideas out both in a report for the British Academy, a humanities group, and in a book, Prosperity: Better Business Makes the Greater Good. He would move far away from the Milton Friedman concept of the corporation, which he calls “no longer tenable as a framework for business in the 21st century”. Mayer worries that inequality, environmental damage and mistrust of business are all a result of over-concentration on profit.
He would rebuild the corporation around the idea of “corporate purpose” — the reason a corporation is created and exists, what it seeks to do, and what it aspires to become. That corporate purpose would include not just profit, but also public purposes that relate to societal goals.
Mayer wants “profitable solutions to the problems of people and planet”, but is adamant the route to profit has to change dramatically using the following levers:
- Shareholders don’t act as owners in any meaningful sense, he argues, and their influence on company decisions should be tied to support corporate purposes as well as their rights to derive financial benefit.
- Corporate governance, instead of aligning the interests of management with shareholders, should be legally required to aim at achieving the implementation of corporate purposes.
- Regulation, together with competition, no longer moves fast enough to keep the interests of businesses and society aligned, so companies must be encouraged to incorporate public purposes in their corporate purposes.
- Corporate taxation currently allows too much tax to be earned in low-tax jurisdictions, and interest payments on debt should no longer be tax-deductible.
- Investment plans must incorporate public purposes because privatisations, public-private partnerships and other such arrangements have failed.
- New measures of corporate performance are needed to show a company’s effect on human, social and natural capital.
There is a broader conversation going on. In the US, Elizabeth Warren, a leading Democrat candidate for the presidency, has to proposed her Accountable Capitalism Act, which would require corporations with revenues above US$1b to comply with a federal charter making executives accountable for their decisions. The charter could be revoked for “repeated and egregious illegal conduct”. These corporations would need to have employees select 40 per cent of their directors, and both directors and officers would be subject to stock sale restrictions. Warren draws a parallel with existing “benefit corporations”, which can balance the interests of all stakeholders.
Purpose in practice
Searching questions have been asked about the workability of the Mayer model. Australian economist Nicholas Gruen is disappointed with the alternatives being offered to traditional corporate governance arrangements by thinkers such as Mayer. “There’s nothing wrong with the sentiments,” he explains, but finds the sentiments rarely able to be translated into actionable principles. “It’s really surprising to me how poorly articulated this is,” he says. In her address to the Supreme Court of NSW Corporate and Commercial Law conference, Commonwealth Bank of Australia (CBA) chair Catherine Livingstone AO FAICD endorses the importance of the concept of a corporation’s purpose, but calls the proposal to regulate it by law “problematical”.
Statements of purpose have been used by corporations in Australia for some time, Livingstone noted. Increasingly, they reference stakeholders other than shareholders, she says, citing as an example CBA’s stated purpose “to improve the financial wellbeing of customers and communities”. Such statements, in Livingstone’s view, guide “the evolution of strategy, priorities and decision-making, and send a signal as to the intent, nature and commitment of the corporation.
Regulating purpose will likely lead to a number of unintended consequences, according to Livingstone, including constraining “directors from taking difficult decisions, for fear of straying from their now legally defined purpose” and “a shift away from the corporate structure as a preferred vehicle for capital”.
Elizabeth Bryan AM FAICD also recently talked about the benefits of companies themselves defining corporate purpose. The Insurance Australia Group (IAG) chair told the 2019 Stockbrokers and Financial Advisers Association (SFAA) conference that the company’s stated purpose — “making your world a safer place” — had allowed it to expand its offering and raise profits at the same time, by letting the company think about services that stop insured risks materialising. “Returns on mitigation money are much higher than returns on remediation money,” says Bryan. “If we can do things for you before something nasty happens, then you are happy and better off, and we are happy and better off.”
Gruen notes such win-wins are hard to identify and achieve. Bryan stresses, each one depends on having a clearly defined purpose “very tightly linked with your business model”. If it is not, she told the SFAA, “it becomes a form of philanthropy. Then you get down to having really hard conversations with your shareholders. There’s no way you can reconcile shareholder return requirements and a weak version of something that is a disguised bit of philanthropy.”
Frequently the message is little more than that you must apply ethical considerations. Who decides on those... and on how they resolve the problem confronting the board?
Bryan says that intangible assets “have become much more important than they used to be” and this makes trust vital to maximising long-term corporate value. “You can’t really, in the interest of the shareholders... trash the trust of society, the trust and allegiance of your customers, [or] your brand.”
The Mayer proposal would pose middle managers with a huge new challenge, which Mayer himself admits. “The greatest problems of all in doing well by doing good are... inside the corporation itself,” he says. Managers “unfamiliar with the processes required to promote people and planet as well as profits” are unlikely to be supportive. The net effect would be to give not just boards, but an army of corporate managers a challenging task. They would have to manage “capitals” they cannot measure and trade them off against profits, guided by their company’s corporate purpose.
Mayer’s insistence that companies must start measuring not just financial capital, but human, social and natural capital, would also be very difficult in practice. Luigi Zingales, a professor at the University of Chicago Booth School of Business, points out these capitals are very real and important. But most economists agree this supposedly central measurement task is, right now, impossible even at a national level. We simply lack the statistical tools to do it.
Zingales, with co-author, Oliver Hart, a Nobel laureate in economics, has his own suggestion. They argue a company’s prime objective should not be shareholder value, but shareholder welfare. They see welfare as a broader term; one that can include non-monetary benefits ranging from individual freedom to environmental protection.
A former president of the American Finance Association, Zingales is no revolutionary. He agrees with Friedman that CEOs have no right to simply spend shareholders’ cash on good deeds. But he also sees tougher cases that Friedman never considered.
Take Google’s Dragonfly project, designed to deliver a censored search engine to the Chinese audience as an alternative to the more heavily censored Baidu search facility. Many Google employees opposed Dragonfly on the grounds the company was accommodating an authoritarian state. No private philanthropic alternative was available here; Google simply had to decide which way to move. It ultimately cancelled the project — an astonishing withdrawal from the world’s second-largest market, and one that may cruel its future in China. It may be the most costly corporate move in history triggered by ethical concerns. Zingales argues that in such cases, companies should ask two questions. The first is whether profitability itself compels an action. Had Google not cancelled Dragonfly, for instance, it might have faced an even more damaging exodus of coders and managers. If that was so, its CEO was right to act.
But if Google would have profited from Dragonfly, Zingales argues, then the shareholders, not the CEO, needed to decide whether to pass up that profit. In contrast to traditional understandings of the role of the board and shareholders, Zingales says, the board should “ask the shareholders what to do”. That, of course, would mean more shareholder votes. Zingales believes its effect would be to involve large shareholding funds more deeply in some company decisions. Meanwhile, more individual investors would choose their funds on the basis of the funds’ ethical preferences.
The Google example illustrates the difficulty of asserting that companies must act ethically without practical guidance on how and who decides the ethical framework. Sydney barrister and leading corporations law expert Dr Robert Austin emphasised this point at the Supreme Court of NSW conference. “Frequently, the message [to directors] is little more than that you must apply ‘ethical considerations’,” says Austin. “But who decides on those ethical considerations and on how they resolve the problem confronting the board? Replacing the maxim ‘behave ethically’ with the idea that corporations should adopt and be held to their corporate purpose will be a step forward, but only if corporate purpose is expressed in practical terms providing real guidance.”
Friedman himself acknowledged the importance of the profit motive being constrained by ethics. It may be that nothing in corporate purpose, culture or trust necessarily collides even with Friedman’s view of the world, let alone the outlook of Zingales and other corporate philosophers. University of Illinois at Chicago economist Deirdre McCloskey, a liberal admirer of Friedman, argues most people forget the rider he put on his famous 1970 quote — the rider that subjects corporate conduct to the constraints of “law and... ethical custom”.
So even according to Friedman’s worldview, corporations and their boards need to understand the ethical customs of their times. In an era with new ethical boundaries and heightened ethical sensitivities, directors face two new challenges. First, their job now requires much more awareness of the social context in which their companies operate. Second, they need to make a greater number of difficult calls between raw profit and corporate reputation.
To Bryan, that makes the director’s role more interesting. It is, she says, “a much more sophisticated job to get right than an argument that simply leaves you maximising shareholder returns.” The task of reconciling competing interests, even with shareholder returns first among them is, in contrast, “a very nuanced, skilled, experienced job”.
“What people are saying is: ‘Is the corporate governance community up to it?’ Well, it has to get up to speed if it’s not up to it.”
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