The Business of Business is Creating Value (Which Leads to Profits)
What do Bechtel Group, American Express, Chubb, Target, Carlyle Group, JPMorgan and Tishman Speyer have in common? Their CEOs were just six of the nearly 200 executives who signed the Business Roundtable’s new “Statement on the Purpose of the Corporation,” taking out a full two-page ad in the Wall Street Journal on August 19 to explain the need to move on from the idea that “corporations exist principally to serve their shareholders.”
As a customer or an employee of a company, we have all at one time or another experienced the challenge of feeling that the company is putting profits before customer experience or employee benefits or the community. We have wondered, How can they make a good profit if they produce an inferior product that I will never again buy, or drive away good employees or anger the community into lawsuits? Yet, we have heard a philosophy, first articulated by economist Milton Friedman, that “the business of business is profits,” and then, as articulated by Jensen and Meckling, that shareholders are owners of the corporation and their needs come first (even if they have no responsibility for the actions the corporation takes to maximize profits and stock price).
In business schools, in the investor community and in corporate management, this dominant definition of the purpose of the corporation over the last 50 years has often led to a focus on extracting value rather than creating value. In practice, this has translated into maximizing short-term profits and boosting stock price, often at the expense of stakeholders other than shareholders.
Ultimately, however, shareholders also lose. In 2017, HBR devoted most of an issue to researchers who argued that agency theory has been detrimental to the health of organizations and data that showed that companies with a long-term focus outperformed short-term oriented companies on every financial measure.
In addition, external factors such as climate change, automation, the opioid crisis, immigration and diversity and inclusion concerns are intensifying societal expectations of corporate leaders, and investors are increasingly focused on the financial risks and opportunities that these sorts of ESG issues create. One study of 2,300 companies found those performing well on material ESG issues have a 6 percent outperformance on stock price. Companies with low performance on both material and immaterial ESG issues underperform the market by -2.9 percent.
So, back to the new and improved Business Roundtable Statement. The CEOs committed to:
- Delivering Value to Our Customers,
- Investing in Our Employees,
- Dealing Fairly and Ethically with Our Suppliers,
- Supporting the Communities in Which We Work, and
- Generating Long-Term Value for Shareholders, who Provide the Capital that Allows Companies to Invest, Grow and Innovate.
In other words, the focus is now ostensibly on creating value for all stakeholders in a sustainable way. Indeed, our own research at NYU Stern’s Center for Sustainable Business has found a significant return on sustainability investment (ROSI). Managing for multiple stakeholders and related environmental and social issues leads to innovation, operational efficiency, lower risk, employee retention and other benefits that translate into improved corporate financials. We found that McDonald’s sourcing sustainably produced beef in Brazil through partnering fairly and ethically with their suppliers led to a 2.3x increase in productivity and a 6.8x increase in profitability for ranchers. In turn, this leads to better quality beef and lower operational and reputational risk for the McDonald’s supply chain. In the automotive sector, we found that recycling paint and solvents led to lower costs (less paint and no waste disposal cost) as well as additional revenue (selling leftover recycled product), with significant benefits for the bottom line.
A statement of purpose is just that, a statement. Translating statement into action has begun, with CEOs such as Larry Fink of BlackRock, Tom Wilson of Allstate and Doug McMillon of Walmart beginning to transform their companies to deliver on value creation for all their stakeholders. How will we know if this commitment is real? Look for lower executive compensation tied to ESG and financial performance, far fewer share buybacks, better pay, benefits and working conditions for employees, sustainability embedded into company strategy rather than a siloed CSR exercise, diverse board members with substantive ESG credentials and aggressive sustainability targets supported by stakeholders and third party assessment and reporting. I could go on, but you get the idea.
But it is a long road from here to there, with skeptics along the spectrum. Senator Elizabeth Warren responded by saying, “These big corporations can start following through on their words by paying workers more instead of spending billions on buybacks.” And the Council for Institutional Investors issued a statement saying, “If ‘stakeholder governance’ and ‘sustainability’ become hiding places for poor management, or for stalling needed change, the economy more generally will lose out.”
For my money, stakeholder governance means that the company is paying attention to its customer and employee needs and sustainability means tackling issues that create risk for its business such as climate change. What could be better management than that?