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This month, August 2019, the Business Roundtable issued a new overall statement of purpose for a corporation, signed by the CEOs of almost 200 of the largest US corporations. This is a big deal because the previous 1997 statement from this same group had created a major problem by elevating shareholder value as the prime purpose of business. The new statement broadens the corporate commitment to all stakeholders, including customers, employees, suppliers, local communities, and shareholders in order to set an improved tone for business activities going forward.
Let me include the statement here, it’s not long.
Business Roundtable Statement on the purpose of a corporation
Americans deserve an economy that allows each person to succeed through hard work and creativity and to lead a life of meaning and dignity. We believe the free-market system is the best means of generating good jobs, a strong and sustainable economy, innovation, a healthy environment and economic opportunity for all.
Businesses play a vital role in the economy by creating jobs, fostering innovation and providing essential goods and services. Businesses make and sell consumer products; manufacture equipment and vehicles; support the national defense; grow and produce food; provide health care; generate and deliver energy; and offer financial, communications and other services that underpin economic growth.
While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders. We commit to:
– Delivering value to our customers. We will further the tradition of American companies leading the way in meeting or exceeding customer expectations.
– Investing in our employees. This starts with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
– Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other companies, large and small, that help us meet our missions.
– Supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.
– Generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders.
Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities, and our country.
[Issued August 19, 2019, by the Business Roundtable and signed by almost 200 CEOs]
Significance. Stephen Pearlstein, writing in the Washington Post this month, notes that “what most distinguishes America’s brand of capitalism is the widely held belief that the first duty of every business is to maximize value for shareholders. The benign version of this credo is that there is no way to deliver maximum value to shareholders over the long term without also satisfying the needs of customers, employees and the society at large. But in its more corrosive application — the one that is inculcated in business schools, enforced by corporate lawyers and demanded by activist investors and Wall Street analysts — maximizing shareholder value has meant doing whatever is necessary to boost the share price this quarter and the next.” Over the years, this approach has justified corporate efforts that have mislead or defrauded customers, squeezed workers & suppliers, reduced or avoid taxes, but showered stock options on executives. It has been the ruthlessness, the greed and inequality that most people find distasteful in American capitalism, and such attitudes are rooted in the persistent notion that maximizing shareholder value is what business is all about.
Which is why the new statement by the Business Roundtable disavowing shareholder primacy is important. Pearlstein further notes that “in the Roundtable’s new formulation of corporate purpose, delivering value to customers, investing in employees, dealing fairly and honestly with suppliers, supporting communities and protecting the environment all have equal billing with generating long-term value for shareholders.” The statement rejects the whole idea of “maximizing” the value benefiting one stakeholder over all the others. Instead, it calls for balance and compromise in serving all company stakeholders.
Despite the upbeat statement from the Business Roundtable, a blanket statement of purpose for all corporations remains contested territory. Reaction from opposing quarters was swift, as the Council of Institutional Investors expressed concern that the statement undercut managerial accountability to shareholders because of their ownership rights within the corporation (Bertsch, 2019).
Let me stop here and note that, as has been mentioned before on this podcast, shareholders do not own a public corporation. Shareholders only have a claim to some of the residual assets of the company via stock ownership. The related argument for shareholder primacy (among all stakeholders) also falls apart when the following is considered: 1) shareholders do not have the right of control over corporation assets; the Board of Directors has that right. Similarly, 2) shareholders do not have the right to help themselves to a firm’s earnings; they only receive dividends when the Board of Directors sees fit. The claim that shareholders own the corporation is empirically incorrect from both a legal and an economic perspective (Stout, 2002). No-one owns a public company; it owns itself. As the British say, it’s like the river Thames, nobody owns it (Kay, 2015).
Yet it was the political and economic landscape of the 1980s that enshrined shareholder value maximization as the main purpose of a corporation. The decades-long influence of that narrative cannot be easily put aside. To review how we got here, the period after World War II until the late 1970s was characterized by a “retain-and-reinvest” approach to resource allocation by major U.S. corporations. During this period corporations tended to retain earnings and reinvest them to increase the corporation’s capabilities. This served to benefit the employees who had helped improve firm competitiveness and provided workers with higher incomes and greater job security. It also gradually increased shareholder value as firms grew. The “retain-and-invest” pattern gave way in the late-1970s to a “downsize-and-distribute” regime where corporate efficiency became an overriding goal, justifying layoffs, asset sales, and other cost reduction approaches, followed by the distribution of freed-up cash to financial interests, particularly shareholders (Lazonick, 2014). The downsize-and-distribute approach tended to strip value from a firm and contributed to employment instability and income inequality inside the firm because the firm’s ability to be productive in the future was weakened. During the “retain and invest” regime, workers were relatively happy because they felt that their organization was keeping their interests in mind. With the advent of “downsize and distribute,” however, stresses built up around the social contract between management and workers (Chandler, 2017).
There was likely more than one cause for the adoption of the downsize-and-distribute regime during the 1980s. Not insignificant was the corporate raider model first employed by activists such as Carl Icahn, who employed asset-stripping techniques in the 1985 hostile takeover of TWA. One example was that in 1991 Icahn sold TWA’s prized London routes to American Airlines for $ 445 million. Icahn later took TWA private and made a personal profit of $ 469 million while leaving TWA with debt of $ 540 million (Grant, 2006). Partly in response to these techniques, management of some publicly traded corporations adopted countermeasures designed to make corporate raids and hostile takeovers less attractive, including legal poison pills, C-suite golden parachutes, and debt level increases on the balance sheet. Even after such measures, however, activist investors or hedge funds could buy as little as 10% of the stock of a public company to argue for a seat on the board and pressure management to increase returns to shareholders. While hedge funds have claimed that their efforts create a more efficient industrial structure and a better allocation of capital overall, it is doubtful that history will be kind to the downsize-and-distribute regime, since it strips away assets and hampers a firm’s ability to produce in the future.
Another trend associated with the practice of shareholder value maximization has been the widespread increase in executive compensation, largely influenced by the popularity of agency theory — championed by Milton Friedman and the Chicago School of Economics. Agency theory holds that C-suite executives are agents of the owners and need to be heavily incentivized to be sure that their interests are aligned with those of the owners (who are equated with the shareholders). Over the years, friendly boards have increased CEO compensation to extraordinary levels (tens of millions of dollars) by benchmarking with other firms that were doing the same (Whoriskey, 2011) . Starting with the 1980s, recent decades have seen a meteoric rise in executive compensation in the USA relative to the average worker’s wage. This is an example of the perverse incentives that operate under agency theory, due to the elevation of the inappropriate goal of shareholder value maximization. Milton Friedman’s view that the sole social responsibility of the firm was to maximize profits (Friedman, 1970)—leaving ethical questions to individuals and governments—became dominant in both finance and law by the 1980s. It also provided the intellectual foundation for the “shareholder value” revolution.
A prominent view during the period was that the invisible hand of the market remained a dominant force in the economy. Conservatives, such as Friedman (and Alan Greenspan at the US Federal Reserve after 1987), argued that the market could be relied upon to regulate the economy and that government intervention is unnecessary and undesirable. In their view, government was the problem and needed to get out of the way. While it has often been taken for granted that an organization’s purpose is to produce economic value, and although economic value can often add to social value, sometimes it does not. According to Mary Ann Glenn (2016) of the Academy of Management, this disjunction raises the question of meaningfulness, which can be viewed as an organization’s expression of purpose, values, or worth. It should involve a sense of significance that goes beyond material success or profitability by highlighting how an organization expects to play a larger and more positive role in the world (AOM, 2015)
No matter which theory of business purpose you ascribe to, we all can agree that corporations have a central role in modern life. They offer goods and services. They are places to work. They are force multipliers, allowing individuals to achieve purposes much larger than they could accomplish by themselves. The best corporations help add meaning to our lives. Truly great ones occupy an important niche in their environment and act in ways that benefit the common good. That’s why the revised statement of purpose for corporations issued by the Business Roundtable represents a more hopeful note on what they can become.
References:
Bertsch, Ken. 2019. “Council of Institutional Investors Responds to Business Roundtable Statement on Corporate Purpose.” Council of Institutional Investors, Washington, DC. August 19.
“Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans'”. www.businessroundtable.org. Retrieved 2019-08-19.
Chandler, Charles G. 2017. Become Truly Great: Serve the Common Good through Management by Positive Organizational Effectiveness. Powell, OH (USA): Author Academy Elite.
Friedman, Milton. 1970. “The Social Responsibility of Business is to Increase Its Profits.” New York Times Magazine, September 13.
Glynn, Mary Ann. 2016. “Making Organizations Meaningful – Academy of Management Annual Meeting 2016.” AOM.org.
Grant, E. X. 2006. “TWA — The Death of a Legend.” St. Louis Magazine, July 28, online ed.
Kay, J. 2015. “Shareholders think they own the company — they are wrong.” Financial Times, November 10, online ed.
Lazonick, W. 2014. “Profits Without Prosperity.” Harvard Business Review, September 2014, online ed.
Pearlstein, Stephen. 2019. “Top CEOs are reclaiming legitimacy by advancing a vision of what’s good for America.” Washington Post. August 19 (online edition).
Stout, Lynn A. 2002. “Bad and Not-so-Bad Arguments for Shareholder Primacy.” Southern California Law Review 75: 1189-1209.
Whoriskey, P. 2011. “Cozy relationships and ‘peer benchmarking’ send CEO pay soaring.” Washington Post, October 3.