Mobile Nav
Shift

Paradigm Shift: It's Time to Speak about the Purpose of the Corporation

A critical look at the role of companies in society, and the concept of shareholder value.

March 2014 | 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."

Close Overlay