The (Updated) Purpose of the U.S. Corporation

Encouraging broad economic goals vs. shareholder value is laudable and overdue — will it stick?

By Irving Wladawsky-Berger

In September of 1997, the Business Roundtable (BRT) — an association of CEOs of major U.S. companies— issued a Statement on Corporate Governance which argued that “the paramount duty of management and of boards of directors is to the corporation’s stockholders; the interests of other stakeholders are relevant as a derivative of the duty to stockholders.”

Last week, the BRT released an updated statement on the Purpose of a Corporation which moves away from its previous commitment to shareholder primacy to now emphasize a “Commitment to All Stakeholders” and to “An Economy that Serves All Americans.” This new statement, which was signed by almost 200 CEOs, now places shareholder interests on the same level as the interests of all its other stakeholders, including customers, employees, suppliers, and communities.

Getting the Message

The recent BRT statement has mostly positive coverage. “Top CEOs Say Companies Have Obligations to Society. Business Roundtable urges firms to take into account employees, customers and community,” said the WSJ in its article’s headline. Writing about the change, Fortune noted that over the past decade “Capitalism, at least the kind practiced by large global corporations, was under assault from all sides, and CEOs were getting the message loud and clear… Capitalism, it seemed, was desperately in need of a modifier.”

The only note of discord I came across was the response of the Council of Institutional Investors, which expressed concerns that the BRT statement “undercuts notions of managerial accountability to shareholders.”

I applaud the BRT statement. “This is great,” I thought when first reading it, followed by “ what took you so long?”

Given the suffering brought upon so many Americans by the 2008 global financial crisis — the worst since the Great Depression — restoring trust in business and in our capitalist economic system should have been a top priority for corporate leaders.

To help appreciate why it’s taken the BRT over a decade to affirm that companies have obligations to society, let’s take a look at the prevalent economic and political context of the past 50 years.

As a number of articles have pointed out, the notion that maximizing shareholder value should be the primary goal of corporate managers is relatively recent, an idea primarily formulated by academic economists about five decades ago, most notably those associated with the Chicago School of Economics. (Through much of the 1960s, I was a physics major at the University of Chicago.) In a 1970 article, The Social Responsibility of Business is to Increase its Profits, Chicago economist and Nobel Prize recipient Milton Friedman wrote:

Historical View

“In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”

Friedman believed that business concerns beyond making profit — such as “promoting desirable social ends,” or “providing employment, eliminating discrimination, avoiding pollution and whatever else” — amounted to “preaching pure and unadulterated socialism.”

It’s important to note that in the previous decades, from the 1930s to the 1970s, corporations, for the most part, were run for all stakeholders. It was a time when the interests of business and society were closely aligned, resulting in both high profits and decent livelihoods, making it possible for large portions of the US population to achieve a middle class life-style and aspire to what we think of as The American Way of Life. Keynesian economics, named for British economist John Maynard Keynes, was the standard economic model during this period. It was a pragmatic, mixed model of capitalism, based on a predominantly private sector economy but with an appropriate role for government, such as the New Deal during the Great Depression and the Internet Highway System and GI Bill in the post-WWII years.

Keynesian economics started to fall out of favor with the ascent of the Chicago School in the 1970s, whose views became highly influential over the next several decades, especially with former US president Ronald Reagan and Federal Reserve Chairman Alan Greenspan. Beyond the primacy of shareholder value, the Chicago School advocated a nearly universal trust in markets and a circumscribed role for government. Understandably, its influence waned considerably after the 2008 financial crisis.

Five Commitments

Let’s take a closer look at the BRT’s Statement on the Purpose of the Corporation , which is based on five fundamental commitments to all stakeholders:

• Delivering value to our customers. We will further the tradition of American companies leading the way in meeting or exceeding customer expectations.
• Investing in our employees. This starts with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
• Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other companies, large and small, that help us meet our missions.
• Supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.
• Generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders.

To me, this all harks back to the roots of free-market, free-trade capitalism as first articulated by Adam Smith, the 18th-Century Scottish economist and philosopher, in his two major works: The Wealth of Nations and The Theory of Moral Sentiments. Smith believed that in a free market, an individual pursuing his own self-interests tends to also promote the good of his community as a whole, and that the free market, while appearing chaotic and unrestrained, is actually guided to produce the right results by a so-called invisible hand. But, while believing that our actions are guided by self-interest, Smith also advocated that our actions should be guided by sympathy, the human ability to have strong feelings of concern for another person with no regard for financial returns, — seeing no contradiction between these two positions.

Let me conclude by borrowing Winston Churchill’s famous dictum about democracy: Capitalism is the worst form of economic system except for all those others that have been tried from time to time. But, as I recently wrote, free-market, free-trade capitalism is at a crossroads. A well-functioning capitalist economy requires trust and confidence in its various institutions, so that together, they can not only work more efficiently but also contribute to a more decent society.

While a prime responsibility of business leaders continues to be the viability and prosperity of their own companies and the generation of long-term value for their shareholders, they can no longer ignore the interests of customers, employees, suppliers, and communities.

As the Business Roundtable wrote in its recent statement, “Each of our stakeholders is essential… for the future success of our companies, our communities and our country.

Originally published at https://blog.irvingwb.com.