Institutional EYE

Commentary on Corporate Governance Issues

Roll over Friedman, corporates will now start to care

November 4, 2019

 

Twenty-two years after first committing itself to Milton Friedman’s mantra that the principal objective of a business enterprise is to generate economic returns to its owners, the US Business Roundtable has now given corporations a new purpose. In a statement in August, the Roundtable stated that purpose of the corporation is no longer maximizing returns to shareholders, rather it is a commitment to all shareholders. This puts shareholders at par with employees, customers, suppliers and communities in which businesses operate. It is useful to remember this is how it was till the Business Roundtable exhorted corporates to embrace the profit motive.

 

The US Business Roundtable has an oversized influence on US businesses – close to 200 US CEO’s from Jamie Dimon at JP Morgan to Tim Cook at Apple as members, and therefore on companies across the globe. This statement has the potential to upend the roles and responsibilities of the board and what roles corporates see for themselves. Issues that are placed on the board agenda and the basis of decision making, is all set to change. Will the duty of care be revisited? Will the Revlon Rules be jettisoned, and the board charged with preserving the company, post its sale and not just selling it to the highest bidder? It’s too early to say but change you can expect.

 

 

It is probably just a coincidence, but still noteworthy, that just around the time the Business Roundtable first painted shareholders sitting at the high table, the UN adopted its Millennial Development Goals, which in 2015 gave way to Sustainable Development Goals. These asked that the corporate sector walk lockstep with governments and broaden their agenda by focussing on hunger, health, gender, sustainability and thirteen other goals. Clearly, the pressure to redefine the purpose of a corporation began almost as soon as it was first enunciated.

 

In parallel, capitalism too tried to soften itself around the edge, and there was talk of shared value capitalism, conscious capitalism, share value capitalism or development with a human face.  And with this, the shift to corporates larger role in society.

 

How might the firms change? Clearly, how they report on their activities will change. The thrust towards integrated reporting is the first step towards this. And as firms change their time horizon, investors need to do so too They will need shift focus away from quarterly results, but the need to look beyond numbers is critical for the long-term. Finally, regulations need to recognize this change. Interestingly, the Companies Act 2013 spoke of a stakeholder engagement committee, rather than a shareholder grievance committee, but the committee is floundering to find a meaningful role for itself.

 

This shift from shareholder to stakeholder is easier said than done. A recent survey by Stanford Business School of the CEOs and CFOs of S&P 1500 companies, finds just 5% saying that stakeholders are more important than shareholders. The rest believe shareholder interests are significantly more important (23%), only slightly more (32%), or equally important (40%). Opinion was even divided on who or what the company needs to focus on – community, employees, trade unions etc. 

 

This last is an area where one of the few criticisms has come from. The powerful US based Council of Institutional Investors has said that accountability to everyone means accountability to no one. Cynically one can argue that this clamour is because hitting financial numbers is far more difficult than replacing plastic bottles with glass ones. This is what will trouble academia – maximizing many functions rarely has an elegant solution; something needs to be prioritized. And if its not profit, then CEO’s will game the system.

 

Repurposing is not about variables. It is a recognition that the role of the corporation is more than just about sustainable production - ensuring that the area around the factory has emissions well within standards, water is cleaned before it is discharged, raw materials used are biodegradable. That suppliers and employees are respected and rightfully rewarded. It is about companies taking into account the social order in which they operate. 

 

A modified version of this comment appeared in Business Standard on 25 Oct 2019, under the title “Corporates 2.0: Profit with a purpose

 

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