Blog by Andrew Cave, Head of Governance and Sustainability, Baillie Gifford.
Building trust isn’t a communications exercise. It comes from having a clear corporate purpose, and consistent behaviours in the pursuit of that purpose (reliability, efficiency, honesty, etc). It is about culture, over compliance. Just like in our personal lives, we don’t trust statements of intent, we trust observed character.
What do we mean by corporate purpose? It certainly isn’t about chasing short-term numbers. Such financial navel gazing is invariably counter-productive and tends to be driven by inappropriate executive compensation targets, as a recent Economic Policy Institute report highlights. The debate around corporate purpose intensified in August after the US Business Roundtable published a new ‘statement of purpose’ (signed by over 180 corporations) which relegated shareholders to just one of several key stakeholders:
Since 1978, Business Roundtable has periodically issued Principles of Corporate Governance. Each version of the document issued since 1997 has endorsed principles of shareholder primacy – that corporations exist principally to serve shareholders. With today’s announcement, the new Statement supersedes previous statements and outlines a modern standard for corporate responsibility.
What should we make of this change in ‘tone from the top’? For some investors, the initial reaction might well echo that of the Council of Institutional Investors (CII):
The [Business Roundtable] statement undercuts notions of managerial accountability to shareholders….[a]ccountability to everyone means accountability to no one .
However, in many parts of the world, ‘stakeholder governance’ is business as usual. In Japan, which has long championed an approach to business that is less directly beholden to investors, executives might be wondering what all the fuss is about. German companies, with legally enshrined employee representation in their corporate governance, may also have wondered why it has taken so long for other regions to catch up. The new UK Corporate Governance Code also enshrines the importance of ‘corporate purpose’ and director accountability to the workforce.
In reality, the Business Roundtable statement is the final nail in the coffin of the dogma of relentless focus on profit as an end in itself. The best companies (and the ones that Baillie Gifford likes to invest in) understand that a focus on serving customers well and enduring business excellence is the surest way to sustainable profits.
Taking the long view, the last fifty years will be seen as the aberration. As Professor Colin Mayer’s excellent work has highlighted, corporations were originally set up to carry out a particular (socially useful) purpose, like building a bridge or importing goods. They have a different legal structure from owner-operated businesses, enjoy legal personage and can own property and intellectual capital. If run well, they enjoy a type of commercial immortality, whilst their shareholders enjoy limited liability. The idea that corporations could take this special ‘licence to operate’ and use it only for short term profit maximisation at all costs is out of step with history as well as the current zeitgeist.
Either way, society’s mood music has moved on, and across the political spectrum. The Business Roundtable, for whatever motives, has recognised this. Unfortunately, the CII’s counter-statement was somewhat misunderstood as the unreformed spirit of Friedmanism. The CII has long championed responsible investment, and is mostly comprised of public pension plans representing ordinary workers. The idea that they represent narrow capitalist interests is misguided (in full disclosure: we are an associate member).
We have sympathy with the CII’s concerns about less accountable corporations merely going through the motions of stakeholder-driven decision making. Too many companies have been principally run for the purpose of enriching executives in recent decades. CEO-to-average-worker pay ratios have spiraled accordingly, rising from around 30:1 in 1978 to closer to 300:1 today. Steven Clifford’s The CEO Pay Machine provides an excellent exposé of executive compensation practices. Collectively we need to push back hard against this – exceptional pay should be reserved for exceptional performance. For example, executive compensation targets which focus on earnings per share can be achieved by focusing on share buybacks rather than actual profit growth.
But to be clear, the corporate legal structure is not the problem. When the first joint stock corporation was listed in Amsterdam in 1602, it democratised capitalism, as ordinary burghers could for the first time invest alongside kings and nobility. Corporations are still widely owned by millions of savers through their pension plans, and they are almost uniquely capable of delivering the most complex of products at scale worldwide. They should be the most rational and enduring of all business structures, and held in the highest esteem. Tragically, because of market short-termism, weak governance, and too many examples of greed and misconduct, this could not be further from the truth today. This can of course change – if the ‘observed behaviours’ are right, trust will follow.
Baillie Gifford is very comfortable with the convergence towards a more balanced approach to corporate decision making to promote long-term value creation – our recently published Baillie Gifford Stewardship Principles cover all of these themes. However, we need more corporations to embody these principles, and governments to support and empower corporations to focus on clear purpose and good conduct as a necessary requirement for long – term value creation.
Platforms like the OECD’s Trust in Business Initiative are a great starting place for all stakeholders to catalyse change for the greater good of all. Despite all of the enthusiasm for social enterprise and other business ownership structures, corporations still completely dominate the global economy (the top 200 alone represent over 25% of global economic output). We are going to need the full commitment, resources and ingenuity of the corporate world if we are to address climate change and create the foundations for balanced, sustainable economic growth over the coming decades.
A special thank you to the children at the Royal School of Dunkeld in Scotland who I cited in my panel session at the OECD Trust in Business Forum in Paris. I asked two different classes (9-11 years old) a simple question, with no prior preparation: ‘What is the principal purpose of a business?’ A) to serve their customers really well B) to provide good jobs for their employees or C) to make profits for their owners. The children could only choose one option. The combined results from the 55 pupils were illuminating. Fully 51% choose ‘providing good jobs’, followed by 26% opting for ‘serving customers well’, with ‘profits for owners’ in last place. Thank you generation Z, your views have been noted!