We are witnessing a continuing debate as to whether a corporation is solely responsible to its shareholders to maximize profit or whether it carries a broader responsibility, not only to its shareholders to provide an acceptable, competitive profit return, but also to its employees, its consumers and the communities in which it lives.
This question has been argued from almost time immemorial and continues to be argued today, including under new vocabulary: the pursuit of “socially responsible capitalism” and “inclusive capitalism.”
I believe we risk complicating an issue which, at least for me, in its essence, is quite simple.
Certainly, a corporation has the responsibility to provide a fair, competitive economic return to its shareholders as produced through the value of its stock (influenced mightily by its profit) and by its dividends (also enormously influenced by its profit). It has the responsibility to do this over time.
It also has the foundational responsibility to better serve its consumers, for without consumer satisfaction flowing from the purchase of its product or service, a corporation will not exist let alone thrive. A corporation also has the responsibility to provide its employees, who make the corporation go, a sustainable financial existence and an environment which nourishes their growth. Finally, a corporation has a responsibility to contribute to the community in which it lives and in countless ways it depends.
Now you can try to have it both ways. You can postulate that the asserted singular mandate of maximizing profit for the long-term depends on honoring these responsibilities to other stakeholders. You could go on to say that, only to the extent that honoring these other responsibilities maximizes the long-term profit is it appropriate to bring energy against them.
While seemingly convenient, I regard this as a cop-out. Specifically, I would argue that maximizing profitability is not the right goal, per se. Maximizing profitability could lead one to cut corners in the sustainability effort for a company, or cut corners in the benefits being provided to its employees, or cut corners in terms of philanthropic support for needy people in the community in which the company resides.
The notion that corporations should devote themselves to maximizing profits is often taken to be one of the bedrock principles of corporate law and governance, especially since Milton Friedman’s famous article in 1970 which asserted just that.
In the history of corporations, however, business corporations were much different. As Blackstone wrote in his Commentaries, corporations could only be formed if they served public purposes. Today that rule no longer applies. Legally, modern business corporations are considered private entities that need not serve any explicitly public objective. Indeed, corporate officers who fail to focus on the profitability of the business for the long term would be a breach of their fiduciary responsibilities. And properly so.
I recently came across a fascinating historical case bearing on this in Adam Winkler's fine book, "We the Corporations". It occurred in 1916 as Henry Ford was sued by two business partners, James and Horace Dodge. The Dodge brothers, who built Ford’s engines and owned 10% of Ford Motor Company stock, had been made immensely wealthy from their relationship with the company; their $10,000 investment netted them more than $32 million. Yet, the brothers were unhappy that Ford refused to maximize profits even more. They saw him running the company in ways designed to benefit employees and the larger community instead of solely its stockholders.
In 1914, for example, Ford announced that he would begin paying workers $5 a day, double their previous wages. Every year the company lowered the price of cars even as significant improvements were introduced and inventory sold out. Ford had decided the stockholders were earning enough, explaining that he did “not believe that we should make such an awful profit on our cars.”
In 1916, Ford announced that his company would not distribute a special dividend to stockholders despite having on hand an extraordinary surplus of $60 million. Ford justified this decision as necessary to avoid “the discharge of a large number of employees in case there should be a sudden depression of business,” something he felt possible following the end of World War I.
The Dodge brothers condemned Ford for not running the company “as a business institution.” Helping employees and the largely public goals were “worthy of themselves but not within the scope of an ordinary business corporation.” They agreed.
During the trial, the outspoken Ford insisted that his company had the right to make business decisions in the interest of the public even if stockholders had to sacrifice. The Ford Motor Company was organized “to do as much good as we can, everywhere for everybody concerned,” Ford testified and only “incidentally to make money.” “My ambition,” Ford said, is to “spread the benefits for this industrial system to the greatest possible number, to help them build up their lives and their homes.”
Citing Ford’s testimony, the Michigan Supreme Court ruled against Ford and his public spirited view of the corporation. While corporations might lawfully make “an incidental humanitarian expenditure of corporate funds,” the court held they could not commit to a “general purpose and plan to benefit mankind at the expense” of stockholders.
Ford could have claimed that his corporation would benefit in the long run from his policies, as he should have and as executives often do today when pressed to defend socially responsible policies. But Ford stubbornly refused on principle.
“A business corporation is organized and carried on primarily for the profit of the stockholders,” the court explained. “The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself.”
There we are, facing the question, “What is the end we seek?”
I believe the corporation must fulfill its responsibilities to its shareholders and its other stakeholders, all in the context of maximizing the sustained, healthy life of the firm. Yes, shareholders have every right to expect a fair competitive rate of return in their investment. But they should also expect the corporation to be a responsible citizen in its relationships with its employees, the community and the consumers it serves.
I don’t find it surprising that surveys of long-term financial performance show a consistent, even if not perfect, correlation between companies that deliver the best financial returns and those which rank highest in social responsibility.
As Roberto Goizueta, the brilliant former CEO of the Coca-Cola Company once said, “While we were once perceived as simply providing services, selling products and employing people, business now shares in much of the responsibilities for our global quality of life.”
Or, even more directly, as John Smale, former CEO of Procter & Gamble, wrote:
“It isn’t enough to stay in business and be profitable. We believe we have a responsibility to society to use our resources—money, people, and energy—to the long-term benefit of society, as well as the company.”
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