The headline on the cover of The Economist of 24-31 August 2019 queried: “What are companies for?”
In the story that followed, a variety of questions are posed, including whether it is the responsibility of big business to help fix economic and social problems such as inequality, sluggish growth and environmental degradation.
These questions are being posed in many forums and reflect a fundamental rethink on the purpose of companies. Two excellent books on the subject have recently been published: Rebecca Henderson’s Reimagining Capitalism: How Business Can Save the World and Alex Edmans’ Grow the Pie: How Great Companies Deliver Both Purpose and Profit.
Current thinking on the purpose of the company is a far cry from the traditional conventional wisdom, of which Milton Friedman (recipient of the Nobel Economics Prize 1976) was the champion. The ideology then was that the duty of managers of companies was to maximise profits for the benefit of shareholders. Put another way, the Chicago School stated that: “The business of business is business.”
As Henderson points out, managers were told that they had a moral duty to maximise profits – indeed that to do anything else was actively immoral – and CEOs’ pay was linked tightly to the value of the company’s stock.
Since then, inroads have been made to this doctrine. I would submit that these inroads have essentially occurred in three phases.
The first inroad to this thinking is reflected in the debate on creative capitalism, with the emphasis on corporate social responsibility.
On 24 January 2008 Bill Gates delivered remarks in Davos at the World Economic Forum in a presentation titled A New Approach to Capitalism. At the centre of that approach was so-called enlightened self-interest. The dominant theme was that philanthropic contributions by companies were often a mechanism for promoting and harnessing their self-interest. The purpose of companies remained profit-making, but in attaining that purpose, philanthropic contributions, also known as corporate social responsibility, would be beneficial to the objectives of the company.
Second, the next inroad occurred after the spate of high profile corporate failures due to massive frauds. Examples which immediately come to mind are the cases of Enron and WorldCom. This resulted in new thinking on governance, ethics and values.
Professor Lynn Sharp Paine of Harvard Business School examined the link between good governance and ethical culture on the one hand and superior financial performance on the other hand. In her famous book Value Shift: Why Companies Must Merge Social and Financial Imperatives to Achieve Superior Performance, Paine argues that there is a strong correlation between superior financial performance and good governance and a culture of high ethics and values. She argues that it is not enough for leading companies to create wealth and produce superior products and services. Companies are expected to behave responsibly, adhere to basic moral principles, and manage their own values and commitments.
Third, the next phase in the analysis of the company’s purpose reflects a dramatic change from the thinking of the Chicago School. Not only is it the subject of academic research but it is also being implemented by captains of industry.
An article in the Financial Times of 21 December 2019, headlined “Capitalism Shows Softer Side In Year Of Change”, contains this quote:
“Capitalism as we know it is dead, a new model of business is taking its place, driven by values, ethics, care of employees, concern for a multiplicity of stakeholders including, in particular, the prevention of environmental degradation.”
In August 2019 the Business Roundtable – an organisation composed of the chief executive officers of many of the largest and most powerful US corporations – released a statement redefining the purpose of the corporation: “To promote an economy that serves all Americans, for the benefit of all stakeholders, customers, employees, suppliers, communities and shareholders.” Added to this, Larry Fink, the chief executive of the world’s biggest asset manager, BlackRock, stated that he believes that, “We are on the edge of a reshaping of finance; no longer can the analysts focus only on financial metrics to that company; no longer can the portfolio manager focus solely on maximising total short-term return; no longer can the asset consultant focus solely on awarding mandates to those who have maximised such returns; no longer can pension funds turn a blind eye to which companies they are invested in; and certainly, no longer can chief executives focus on satisfying their direct shareholders by pointing to their rising share price.
“Paying lip service to sustainability will no longer be possible in the future. Pledging to integrate Environmental, Social and Governance factors into decision-making processes is but the baby-steps in what should be a fundamental re-assessment of purpose. An acknowledgement of previous shortcomings should go hand in hand with the renewed and transparent commitment to embrace this new finance paradigm that would be the beginning of sustainable investing.”
Henderson commences her book as follows:
“What is Capitalism?
“One of humanity’s greatest inventions, and the greatest source of property the world has ever seen?
“A menace on the verge of destroying the planet and destabilising society?
“Or some combination that needs to be reimagined?
“We need a systemic way to think through these questions.”
In answering these questions, Henderson provides powerful arguments that there is in fact no tension between profits and purpose. She submits that embracing pro-social goals for the firm – a pro-social purpose – is eminently profitable and legal. Commentators on Henderson’s book point out that a pro-social purpose is not only a moral imperative but also an extraordinary opportunity to drive growth and innovation in a competitive world.
The publishers of Henderson’s book point out that Henderson suggests that her view on the purpose of companies “has the potential to balance the power of the market with the power of democratic, accountable government and strong civil society – the only long-term solution to the problems we face”. DM
"Thou almost make me waver in my faith to hold opinion with Pythagoras" ~ Shakespeare, Merchant of Venice