by Filip Gregor
On February 11, 2014, Frank Bold (a purpose-driven law firm), the Cardiff Business School and Richard Howitt MEP, long-standing rapporteur of the European Parliament on corporate social responsibility (CSR), organized a conference in the European Parliament on the purpose of the corporation. The conference was the first major step in a project aspiring to re-open a public discussion on this topic. It attracted over 120 participants, including representatives from companies, investors, academia, NGOs, and policy makers.
The question of a corporation’s purpose has always been with us. It
is the basis from which everything else flows when we come to discuss
the corporation. Yet it is not something that most of us spend a lot of
time thinking about. We should.
The dominant paradigm of the last 30 years has been that the purpose
of the corporation is to maximize shareholder value, the presumption
being that society as well as investors would be better off as a result.
This presumption assumes that specific societal interests that may be
harmed by the pursuit of the maximization of shareholder value will be
protected by clear legislation. In other words, it is the role of the
legislature to address corporate externalities. Today, this theory is
firmly embedded in business thinking; it is the “state of the art”
taught at business and law schools around the world, and it provides a
theoretical basis for corporate governance regulation. For several
decades now we have been trying to align the interests of corporate
executives with those of shareholders or, perhaps more accurately,
financial markets.
One problem is that this model of corporate governance, in the words
of Professor Joel Bakan of the University of British Columbia, “compels
executives to prioritize the interests of their companies and
shareholders above all others and forbids them from being socially
responsible – at least genuinely so.” [Bakan, J. (2005). The Corporation.
London: Constable & Robinson, p 35.] A further problem is that we
seem to have largely forgotten the part of the model that expects
government to legislate to protect society from negative corporate
externalities.
This is particularly problematic in the area of business and human
rights. As explained by Professor John Ruggie during his mandate as the
UN Special Representative for Business and Human Rights, a root cause of
some of the most pervasive negative impacts arising from businesses’
operations is the governance gaps created by globalization – between
economic forces on the one hand and the capacity of societies to manage
them on the other. Following shareholder value maximization thinking, it
is perfectly acceptable for the managers of a corporation to create
“shared value” – as is proposed both by the work of Professor Michael
Porter and Mark Kramer and by the European Commission’s new policy on CSR – by
a measure such as improving safety in the workplace if it can be shown
that this will result in, say, litigation costs falling by more than the
cost of the safety improvements. This is because a benefit is being
delivered to society at the same time as the corporate bottom line is
being improved. However, this does not hold true in the situation where
the cost of the improvement is more than the saving. In that instance,
setting aside the question of reputational risk, maximizing shareholder
value, either in the short term or in the long term, requires that no
improvement be made.
The complex corporate structures and value chains that characterize
the organization of modern business in a globalized environment mean
that these problems often seem far away from corporate board rooms, both
literally and legally speaking. From this perspective, it is not very
surprising that in most sectors, business struggles to deal effectively
with the human rights impacts it generates. According to shareholder
value maximization thinking, managing human rights risks is not what
companies should be using their resources for in the first place. But at
the same time, it is perfectly logical for companies to lobby against
legislation that would set rules inconsistent with their business model.
As a result, we remain locked in a vicious cycle where the level of
governmental regulation ebbs and flows, often in proportion to the
number and intensity of corporate scandals that populate our televisions
and newspapers.
Yet one point came out very clearly from the European Parliament
conference: there is no overarching legal requirement for company
directors to blindly maximize shareholder value. This is consistent with
the conclusions of Prof. Ruggie’s Corporate Law Tools Project
carried out during his UN mandate, which found that corporate and
securities law principles in over 40 surveyed jurisdictions generally do
not explicitly prevent companies from seeking to respect human rights.
In other words, the understanding of shareholder value maximization
as an overriding element in corporate purpose is merely a social norm,
albeit a very powerful one. Cornell Law School Professor Lynn Stout, who
spoke at the conference, wrote in her award-winning book “The
Shareholder Value Myth” that not only is the business world
misunderstanding and misapplying the law that underpins shareholder
primacy, but that, as a concept, it “stands on the brink of intellectual
failure”. [Stout, L. (2012). The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations And The Public. San Francisco: Berret-Koehler Publishers, p 115. Stout summarizes her arguments in a shorter paper, available here.]
Indeed, while we have believed that the interests of corporate
managers need to be aligned with those of a model shareholder, financial
markets have become extremely short-term oriented. The risks this may
pose to market stability and to the economy at large were sufficiently
demonstrated by the financial crisis, but there is also an obvious
message for the business and human rights debate. As expressed by
Professor Simon Deakin from the University of Cambridge: “In systems
which treat the corporation as the shareholders’ private property, the
highest-valued companies will continue to be those which are most
effective in externalising the costs of their activities on to others.”
[Deakin, S. (2010). Corporate Governance and Financial Crisis in the Long Run.
Centre for Business Research, University of Cambridge, Working Paper No
417, p 19.] Participants at the conference reported that they were
surprised to learn that shareholders do not, in fact, own companies – a
point made by no less than four law professors on the day.
Recognition of these problems is not limited to academia – leading company voices are also calling attention to them. For example, Jack Welch, shareholder value maximization early adopter and former CEO of GE, commenting in the Financial Times (this article is not available online) on the 2008 financial crisis, has said that “strictly speaking, shareholder value is the dumbest idea in the world”, if it is understood, as he later explained, as a strategy rather than an outcome. Paul Polman, CEO of Unilever and a vocal critic of the “quarterly capitalism” that results from the shareholder value maximization drive, has put sustainability, demands of consumers and customers, and the needs of communities where Unilever operates ahead of a short-term focus on shareholders’ interests. It seems that this strategy is paying off as Unilever has performed strongly and delivered excellent returns to shareholders despite a challenging economic environment. At the conference, Susanne Stormer, Novo Nordisk’s Vice President for Corporate Sustainability, explained how sustainability and social responsibility is encoded in her company’s purpose and how this purpose is guarded by a foundation that controls minority shares vested with voting rights 10 times stronger than ordinary shares. The conference also heard that the business models of certain corporate forms, such as Cooperatives and Benefit (or “B”) Corporations, likewise have a purpose beyond mere profit maximization.
It is encouraging to see these and other companies trying to bring
business and society back together. They prove the possible. Investors
such as Calvert and Aviva are doing their share of this work by speaking
and acting on behalf of societal interests both in the market and in
public discussions. But it would be naïve to assume that the problem
will be solved by market dynamics alone, reliance on which largely
created the problem in the first place.
First, we need to recognize the importance of this debate. At present
there is no process for bringing the relevant actors together in a
meaningful way, so that the models that underlie thinking in this area
can be properly examined. The reason why reconsideration of these models
is needed is neatly captured by the man some describe as “the father of
corporate governance”, Bob Tricker. Tricker recently observed that we
still think about company law and corporate governance using a model of
the corporation as it existed in the 19th century. This, he says, “bears
about as much relationship to reality as a hang-glider does to a fleet
of jumbo-jets.” [Tricker, R. (2012). Corporate Governance: Principles, Policies, and Practices. Oxford University Press: Oxford, p 7.]
We need to start discussing and exploring how to adjust existing frameworks, regulations and incentives to allow corporate governance to better reflect the reality and fit the needs of the 21st century. This includes the question of business and human rights. The Purpose of the Corporation Project aims to create a safe and apolitical space for the relevant actors to engage in this discussion.
Filip Gregor is Head of the Responsible Companies Section at Frank Bold. He is an expert in the responsibilities of multinational corporations and has been extensively involved in litigation and public discussion in this area. He also sits on the Steering Group of the European Coalition for Corporate Justice.
The synopsis and program with
links to videos from the Purpose of the Corporation Conference are
available online. The Purpose of the Corporation Project has produced
succinct memoranda drawing on law, management studies, politics, and
accounting, which address the challenges of corporate governance, freely
available here. There is also a LinkedIn group “The Purpose of the Corporation.”