Shareholders Or Shared Value?

David Garnett

“Shareholder value should be a result not an objective.”

Until recently there was a generally held belief that company executives have an over-riding duty to maximise shareholder value. This idea became entrenched in business attitudes in the last quarter of the twentieth century. It is still continually referred to as a sort of ‘moral responsibility’. These persistent references act as a barrier to the introduction of socially orientated business cultures. Where did this idea come from?

No popular idea ever has a single origin. But the idea that the sole purpose of a firm is to make money for its shareholders was given prominence in an article by the influential monetarist economist Milton Friedman in the New York Times on September 13, 1970.

Friedman’s article was uncompromising. It argued that any business executives who pursued a goal other than making money were “unwitting pup¬pets of the intellectual forces that have been undermining the basis of a free society these past decades.” They were, he argued, guilty of “analytical looseness and lack of rigour.” Ironically, the article made a series of loose assertions, some of which might be regarded as more hysterical than analytical. Friedman suggested that investing in non-proprietary interests (such as community projects) should be regarded as undemocratic. Executives with wider community commitments, he argued, had become “unelected government officials” who were illegally taxing employers and customers. The article began with the bold assertion that “in a free-enterprise, private-property sys¬tem,” it is a self-evident truth requiring no justification, that “a corporate executive is an employee of the owners of the business,” namely the shareholders. How did the Nobel-prize winner arrive at these conclusions?

Friedman was making the classic mistake of which we are all guilty at various times. He addressed a debateable proposition that is founded on contested concepts, through the distorting lens of his own presuppositions and then presented his views as ‘common sense’.

His argument gathered support from a number of business academics and in 1976 an even more influential article reinforcing his argument was published in the Journal of Financial Economics by professors Michael Jensen and William Meckling of the Simon School of Business at the University of Rochester. The article entitled ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’ become one of the most widely cited academic business articles of all time.

After 1975 this notion of the executive function became embedded in the general business discourse and commentators continually restated Friedman’s ‘self-evident truth’ that business leaders have a legal obligation to give the enhancement of shareholder value a top priority. This was despite the fact that anyone with even the most basic understanding of corporate law knows that business executives are not employed by the shareholders but by the firm (that has a legal identity all of its own).

In order to make their point, advocates of the Friedman line have been forced to argue that the firm’s legal identity is a “legal fiction” and that executives have a direct and over-riding re¬sponsibility to their “employers.” i.e. the shareholders. “That responsi¬bility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while con¬forming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”

The 1976 article went so far as to propose that, to ensure that executive interests were fully aligned with those of shareholders, they should be made major shareholders themselves and be given bonuses that are related to share values. By the early years of the twenty-first century, in certain corporate sectors, the ‘compensation and bonus culture’ had become so embedded that institutional remuneration practices were shifting away from executive salary enhancements being regarded as motivational drivers relating to performance outcomes to being individual entitlements that should be awarded irrespective of performance. Arguably it is this shift in emphasis that brought the whole question of executive roles and rewards into the public domain.

Following the financial crisis of the early years of the twenty-first century, the governments of many developed economies introduced austerity measures that affected the standards of living of their poorer citizens. At the same time, vast sums of public money were used to underpin large banking and other financial institutions whose policies were implicated in the crisis. The fact that these institutions were still paying large bonuses to their top executives became a topic of discussion in the popular media and academic commentators began to question the established consensus about the role of executives. Indeed, there opened up a wider debate about the very function of corporate institutions in the twenty-first century.

Much of the criticism emanated from the Harvard Business School that had spent a number of years investigating the characteristics and policies of successful companies. In the 2012 March issue of the Harvard Business Review, Professor Mihir Desai argued that the compensation culture operating in American businesses was no longer fit for purpose and was actually damaging the competitiveness of the US economy. In his recent book Fixing the Game, Roger Martin, Dean of the Rotman School of Management at the University of Toronto, went further by pointing out that maximising shareholder value is actually a bad way to run a business.

In the summer of 2015 The Bank of England’s chief economist Andy Haldane gave an interview on television in which he argued the need to start a discussion about how companies run themselves. He stated that companies risk “eating themselves” as shareholders and management were gripped by a self-regarding mindset of short-termism in which the short-term monetary interests of current shareholders and executives are given preference over the wider and longer-term interests of the company.

Martin argues that it represents a naive and wrongheaded coupling of the “real” market (the business of designing and making products and delivering services) with the “expectations” market (the business of trading stocks, options and complex derivatives). The point is that success in the ‘real’ market involves long-term strategic thinking and planning followed by capital investment in real economic value while the ‘stock’ market focuses on short-term fluctuations in monetary values. Much of today’s established business theory and practice encourages and rewards unstable, short-term monetary expectations rather than real long-term economic growth. As the eighteenth century moral philosopher, Adam Smith, (“father of economics”) put it over 230 years ago, “Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer.”

Steve Denning has made the point (Forbes Leadership, February 22 2012) that we can no longer simply embrace the “greed is good” philosophy of Michael Douglas’s character in the 1987 film Wall Street. Indeed the fact that this ironic film was produced at all indicated that by the 1980s there was a significant change of mood about business attitudes in society at large. This change in mood provides an opportunity to create a different type of business culture that is fit for purpose in the 21st century.

I wish to argue that housing associations are well positioned to take the lead in this way of thinking.

What Is ‘Shared Value’?

“We believe that the idea of shared value will give rise to the next major transformation of business thinking.”
(The Harvard Business School)

In its simplest formation ‘shared value philosophy’ can be thought of as a rational belief that the long-term success of any company depends on the health and wellbeing of its employees, customers, and the communities in which it operates. According to the Harvard Business School, shared value is the ‘big idea’ for business success in the twenty-first century. It advocates corporate policies and practices that enhance the competitive advantage and profitability of a company whilst simultaneously advancing social and economic conditions in the communities in which it operates.

The shared value approach is based on research findings that indicate that profit-seeking companies have much to gain by embracing more than simply shareholder interests. It also indicates that social enterprises, such as housing associations, can embrace shared value philosophy in ways that that provide coherence and meaning to their changing role in modern society.

A number of highly successful profit-orientated companies such as GE, Google, IBM, Intel, Johnson & Johnson, Nestlé, Unilever, and Wal-Mart have recently modified their business models in ways that incorporate a shared value approach to their operations. Because the shared value business mind-set involves adopting policies that appreciate the existence of a key relationship between society and corporate performance, it has a particular applicability for organisations operating in the not-for-profit and voluntary sectors of the economy. In Britain, a number of housing associations have taken the lead and embraced the idea of shared value as a way of strengthening their identities and clarifying their roles as modern social businesses.

Shared value is not so much a new idea as the latest manifestation of a long-standing concern to develop an appropriate relationship between business and society: that is, a relationship that takes account of more than crude market forces. As well as Christian principles, the paternalistic benevolence of nineteenth century industrial philanthropists such as George Peabody, Titus Salt and George and Richard Cadbury reflected an underlying commitment to ethical capitalism. Among other things, progressive entrepreneurs pointed to the tangible benefits to the firm of sharing the rewards of business output with the workforce – an idea that was famously demonstrated by Robert Owen’s application of the notion of ‘the economy of high wages’. By the middle of the twentieth century economists had incorporated a theory of ‘commercial self interest’ into the analysis of why monopoly power should be controlled. This idea was succinctly summarised by John Hick’s often quoted observation that “The best of all monopoly profits is a quiet life.” (Professor Sir John Hicks 1935).

Shared Value is not the same thing as Corporate Social Responsibility
By the last quarter of the twentieth century, a number of firms were declaring a commitment to ‘corporate social responsibility’ (CSR). This can be thought of as an approach to business that actively seeks to make a positive contribution to society. In practice the term can refer to a wide range of actions that companies may take, from donating to charity to reducing carbon emissions. The Harvard Business School approach argues for the efficacy of instigating more fundamental changes in business thinking and suggests that in the political and commercial climate following the financial crisis of the late 1980s, successful companies need to review their relationships with society in a more fundamental way. The criticism of CSR is that it does not represent a full cultural commitment to being a valued part of society but rather it maintains an “old-fashioned” (and increasingly inappropriate) view of nineteenth and twentieth century benevolent capitalism. Social organisations and government entities often see success solely in terms of the external (e.g. community) benefits achieved or the money expended. By failing to embed the creation of social value into the business plan, the advocates of shared value argue that the ‘good works’ of the corporately responsible firm are little more than ‘bolt-ons’ to their traditional ways of working.

The concept of shared value involves the declaration of a social dividend as an integral part of an organisation’s business practices. This approach moves away from a business model in which the firm donates a small proportion of its distributable profits to ‘good causes’, to one in which proper recognition is given to the fact that the firm is part of the community in which it operates. By engaging directly with wider concerns, the organisation strengthens its position in the community and this in turn enhances its competitiveness and creates a variety of productivity benefits.

Fig.1 ‘Shared Value’: An Emerging Idea

Its advocates make the point that shared value is not the same thing as corporate social responsibility (CSR), philanthropy, or even sustainability: it is, they suggest, a new business model appropriate for the demands of the twenty-first century. They see it as a radical development of the preceding models of ethical capitalism and argue that it more fully meets the challenges of our times.

Fig.2 An Emerging Business Model

In recent years, business policies have been regarded by many as a major cause of current social, environmental, and economic problems. Some companies are perceived to be prospering at the expense of the wider community. There is even a danger that the more business has begun to embrace corporate responsibility, the more it has been blamed for society’s failures. The legitimacy of business practices is being challenged and the respect for areas of business such as banking and financial services has fallen to levels not seen in recent history. Land and landed property are key elements in the stock of social assets of every community and we need to recognise that land-use professionals are not immune from these contemporary criticisms of business behaviour.

The diminished trust in business has led political leaders to introduce regulatory arrangements that could undermine the flexibility and freedom of business decision-making and thereby inhibit economic growth and innovation. The proponents of shared value suggest that much of the problem lies with companies themselves, which they see as being locked into business models that are no longer adequate to the needs and expectations of modern society. The adoption of a shared value model provides an opportunity for an organisation to contribute to the wellbeing of society whilst stealing a march on its competitors.

DJG September 2015

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