A recent announcement by nearly 200 CEOs that corporations should serve more than the bottom line may be great public relations, but don’t hold your breath waiting for big changes in the way corporate America operates.
For four decades the popular conception is that a corporation exists to maximize returns to shareholders. This conceit is the work of economists. Milton Friedman, who was awarded the Nobel Prize in Economics in 1976, made the case in a famous 1970 New York Times Magazine article that the social responsibility of business is to increase profits. It laid the intellectual foundations for the shareholder value revolution of the 1980s.
As he put it “there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits.” His former students popularized the idea that the great challenge of corporate governance is getting executives (agents) to act in the interest of the shareholders (principals).
This view caught on and became conventional wisdom, as universally accepted as the idea that the sun revolves around the earth once was. Over time the U.S. stock market has focused strongly on corporations’ quarterly earnings to the point that a penny up or down from expected earnings per share can cause the stock price to fluctuate.
This has created a number of potential problems. For starters the short-term focus of the stock market dictates a short-term approach by management, at the expense of long-term shareholder value. For example, management might decide to shower cash on shareholders and not invest in research and development on projects that would only pay off down the road. Also, market pressures could tempt managers to cheat or manage earnings to meet investor expectations, especially since the compensation of CEOs and other executives is linked to stock performance.
This August, nearly 200 chief executives of major American corporations including Apple, Amazon, General Motors, and Walmart – all members of the powerful U.S. Business Roundtable – announced that corporations should no longer just maximize profits for shareholders but also benefit other stakeholders including employees, customers, and citizens.
Is this all just rosy rhetoric or a real change in mission? Will these corporations who are people, really nice people, now use house money to support expansive social goals that are irrelevant to maximizing shareholder returns? This rhetoric about the purpose of a corporation won’t even rise to the level of the inconsequential unless executives address basic questions.
Will they argue for changes in how they are paid, how corporations are taxed and regulated and focus instead on the long-term health of their companies? What metrics will these executives use to measure stakeholder returns? How will corporations pivot away from the needs of activist short-term investors? How will they balance the needs of multiple stakeholders to create value for all these shared interests? How will executives resolve stakeholder conflicts? What tradeoffs have to be made? There are more unasked and unanswered questions than positions in the Kama Sutra.
New York Times Columnist Farhad Manjoo believes the new mission statement is all foam and no beer. He cynically says these CEOs want you to know how much they care, but they will continue to eat your lunch while virtue signaling. Many others are quite skeptical that corporations will change the way they behave.
Former General Electric CEO Jack Welch said in a 2009 interview with the Financial Times that: “On the face of it, shareholder value is the dumbest idea in the world.” This comment may be the height of irony given that when he ran GE, the firm consistently met or beat analysts’ quarterly earnings forecasts.
One thing is for certain. The time is long overdue to shift the focus of corporations away from maximizing shareholder value and stock-based executive compensation. But don’t hold your breath. This is like asking business executives to perform surgery on themselves.