Features Australia

Profits not passé

5 October 2019

9:00 AM

5 October 2019

9:00 AM

CEOs have wealth that far exceeds that of the average shareholder in their company, which they have every right to give away to benefit customers, employees, suppliers and communities, if that is their wont. Few do; giving away shareholders’ money is so much more appealing — perhaps because it confers a warm outer glow without any pesky personal sacrifice.

So, when 181 CEOs recently committed their companies to ‘deliver value’ to five stakeholders — customers, employees, suppliers, communities and shareholders — ‘for the future success of our companies, our communities and our country,’ it should ring alarm bells. Unfortunately, it was widely welcomed as signalling that profit should no longer be the sole aim of the corporation. Indeed, some took it as a declaration of independence that CEOs would no longer be responsible to their shareholders at all. Milton Friedman, with his quaint belief that ‘the social responsibility of business is to increase its profits,’ is passé.

‘Most meta-studies have found that companies with better environmental, social and governance records improved their financial performance,’ claims the Economist without citing any evidence to back up the assertion.

Executives often claim that corporate social responsibilities will redound to the long-term advantage of the company, implicitly endorsing the goal of maximizing the value of the company. This maintains the fiction that shareholders who care only about financial returns and shareholders who value non-financial goals, can both be faithfully served. However, unless shareholders approve a strategy that reduces the value of the company in pursuit of moral virtue, such a path steals from shareholders whose only interest is financial, and from shareholders who value corporate do-gooding too.

Shareholders can express their disapproval by selling their shares, or by voting at the AGM against relevant resolutions, especially on remuneration. But if the executive takes actions that more than offset the financial losses imposed by the company’s corporate social responsibility frolics, shareholders motivated solely by financial objectives might, quite rationally, support the board and the executive, despite the company’s costly pursuit of moral vanity.

Indeed, even if directors promise some overall financial harm, they may still win the votes of shareholders who care only about financial returns ,because directors enjoy an element of market power: they are costly to replace, and their insider knowledge gives them an advantage over outsiders. And since, unlike CEOs, directors infrequently get to bargain for their salary, their potential value to shareholders may exceed their remuneration. Thus, directors might pursue social goals rather than profit and still be re-elected, especially in Australia, which is unlike the US,  where the market for executives is ‘thicker’, corporate takeovers easier and performance monitoring more intense.

The ACCC’s Rod Sims has been a rare advocate of leaving social goals to governments ,arguing that ‘we don’t want companies to get confused, so I think their duty should be just to the long-term interests of shareholders.’ He rightly points out that in broadening board responsibilities, companies would ‘lose the power of what companies bring to society, and they bring a lot’. Sims, like Friedman, is concerned with how a ‘principal’ (the shareholders as employer) can best structure a contract or arrangement to induce the ‘agent’ (the directors as employees) to pursue the goals of the principal. The first desideratum is a clear line of responsibility: a company that answers to everyone, answers to no one. The second is a clear, measurable objective. Although Sims nominates the long-term interests of shareholders as the sole goal, this is too general: if shareholders want the company to pursue multiple interests, it’s impossible to judge whether the situation has improved overall if it has worsened on some criteria and improved elsewhere, unless we can ‘add up’ the disparate results into a single criterion. Directors can weaken shareholders’ control by making it harder to monitor performance, which is what the inclusion of non-profit objectives will most likely do.

Friedman nominates ‘profits’ as ‘generally’ being the objective of shareholders but as a sophisticated thinker, Friedman surely meant ‘profit’ to stand for ‘the long-term financial interests of the owners’, which is best judged by the company’s value. The market price reflects how much shareholders value being part-owners of the company, including shareholders who value the company for its CSR actions, other than or in addition to the profits and dividends generated.

If the pursuit of CSR is expected to decrease the value of the company, directors should convince the required ‘super-majority’ of 75 per cent of shareholders to support an appropriate change in the company’s constitution. The company would then share some characteristics of ‘benefit’ corporations that pursue profit, not as a goal in itself, but as a means of financing charitable works. Those who approve of the company forgoing profit would buy its shares while shareholders more interested in financial returns would sell and the share price would rise or fall in accordance with their wishes.

To forgo profits does, however, make a company more vulnerable to a hostile takeover. Private equity firms, seeing profit potential, might offer a premium over the market price which would be attractive to the many shareholders interested in financial returns as well as in CSR. The new, profit-seeking owners would ‘deliver value’ to customers, employees, suppliers and communities, but only to the extent that this boosts profits. Paradoxically, then, the pursuit of profit-reducing CSR may result in a takeover by owners who treat CSR as an instrument, and not as a good in itself, and consequently reduce the amount of CSR undertaken by the corporation. This might lead to agitation for legislation mandating profit-reducing CSR; or requiring that boards include directors answerable—somehow—to customers, employees, suppliers and community, but not to shareholders.

Absent such legislation, directors and CEOs would be wise to heed Friedman (however unfashionable it might now be) when he said, ‘there is one and only one social responsibility of business: to use its resources and engage in activities designed to increase its profits so long as it stays in the rules of the game, which is to say, engages in open and free competition, without deception or fraud.’ Anything else is malfeasance, for which, sooner or later, they will, hopefully, be held accountable.

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