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On Boards Forum

Time To Start Walking the Talk With Social Contracts, Value Schemes and Social Contract Accounting.

Photo by Matus Karahuta

As I reported in my previous article, the Financial Reporting Council recently published the findings of its early assessment of 82 entities representing the early adopters of the UK Corporate Governance Code 2018 guidance. I suggested the findings were “shocking, but not surprising”.

Here is one example. Principle B of the 2018 Code states, ‘the board should establish the company’s purpose, values, and strategy, and satisfy itself that these and its culture are aligned’. The review found, “There was a tendency to conflate mission and vision with purpose; normally, mission and vision rely on a company’s purpose to provide the reasons behind their goals. Too many companies substituted what appeared to be a slogan or marketing line for their purpose or restricted it to achieving shareholder returns and profit”. The report adds, “This approach is not acceptable for the 2018 Code. Reporting in these ways suggests that many companies have not fully considered purpose and its importance in relation to culture and strategy, nor have they sufficiently considered the views of stakeholders in their purpose statements”.

This is shocking but not surprising because of the evidence I presented in the article, Board & CEO: The Blind Leading the Blind Into a Decade of Radical Change. The first item of evidence was the McKinsey research I have often quoted. It found that a mere 34% of the 772 directors surveyed agreed that the boards on which they served fully comprehended their companies’ strategies. Only 22% said their boards were completely aware of how their firms created value, and just 16% claimed that their boards had a strong understanding of the dynamics of their firms’ industries.

The second piece of evidence I cited was research by Donald Sull of MIT and his co-authors which found “No One Knows Your Strategy Not Even Your Top Leaders”. They discovered, “only 28% of executives and middle managers responsible for executing strategy could list three of their company’s strategic priorities”. They also found, half of the top team in one company, typical of those they surveyed, were “completely out of touch”. Three of the top team members could list only one of the company’s strategic priorities, and two executives did not get a single objective correct — despite having five tries. Between them, “these C-suite members listed a total of eight additional priorities that were not among the company’s official objectives”.

Taken together, this evidence suggests the board and the C-Suite are as clueless as each other and the only conclusion that can be drawn is that any vision, mission or purpose statements they might publish would be totally worthless. Any strategy they might claim to have would also be equally worthless.

Having said all that, I am no fan of vision, mission and purpose statements. It is important that companies have a vision, mission and purpose, but I see little value in them being stated in annual reports. More meaningful to investors and all other stakeholders would be an explicit social contract that has been informed by consideration of these factors, explaining how they will be translated into policies, a strategy and plans — “walking the talk”. Then linked to appropriate key performance indicators to enable Social Contract Accounting, which supplements, but is linked to, the financial accounts. Consider this example of a Social Contract:

We believe our first responsibility is to the patients, doctors and nurses, to mothers and fathers and all others who use our products and services. In meeting their needs everything we do must be of high quality. We must constantly strive to provide value, reduce our costs and maintain reasonable prices. Customers’ orders must be serviced promptly and accurately. Our business partners must have an opportunity to make a fair profit.

We are responsible to our employees who work with us throughout the world. We must provide an inclusive work environment where each person must be considered as an individual. We must respect their diversity and dignity and recognize their merit. They must have a sense of security, fulfillment and purpose in their jobs. Compensation must be fair and adequate and working conditions clean, orderly and safe. We must support the health and well-being of our employees and help them fulfill their family and other personal responsibilities. Employees must feel free to make suggestions and complaints. There must be equal opportunity for employment, development and advancement for those qualified. We must provide highly capable leaders and their actions must be just and ethical.

We are responsible to the communities in which we live and work and to the world community as well. We must help people be healthier by supporting better access and care in more places around the world. We must be good citizens — support good works and charities, better health and education, and bear our fair share of taxes. We must maintain in good order the property we are privileged to use, protecting the environment and natural resources.

Our final responsibility is to our stockholders. Business must make a sound profit. We must experiment with new ideas. Research must be carried on, innovative programs developed, investments made for the future and mistakes paid for. New equipment must be purchased, new facilities provided and new products launched. Reserves must be created to provide for adverse times. When we operate according to these principles, the stockholders should realize a fair return.

This example incorporates vision, mission, purpose and values. And a mix of financial and non-financial KPIs can easily be associated with it so performance can be properly measured. The statement also refers to its responsibilities to all stakeholders. Interestingly stockholders are listed as the firm’s “final responsibility”, and they are only offered a “fair return” and only after provisions have been made that will generate long-term value. Despite this, as of 2019, the firm had delivered increased dividends to its shareholders every year for 57years one of only 29 companies on the S&P 500 to have ever done so. Here is a graphic image of how the company performed over the first 53 of those years. And the trajectory continues despite the unforgivable and costly mistakes the firm has made in recent years.

Some readers have already guessed that the business I have been referring to is Johnson and Johnson. And the statement I referred to as an example of a social contract was written in 1943 by the CEO of Johnson & Johnson at that time. It is referred to as the ‘J&J Credo’.

In my view, the credo can be regarded as an early prototype for what I call a corporate social contract. It would make clear what value the business creates, who for and how — the three key questions of any good strategy. And the strategic plan based on this could provide anyone interested in the future value creation potential of the firm to make better assessments and more sound judgements. If linked to financial and non-financial metrics used in Social Contract Accounting, I believe investors and other stakeholders would have all the information they need to know if they want to invest in, buy from, work for and sell to such a company. They would be in no doubt about the mission, vision, purpose of the business and they would be able to hold its leaders to account for their performance.

As I have argued before the only purpose of any organisation is to create value and for the business model to be sustainable it must understand what value it creates to satisfy all stakeholders over a reasonable period of time. Only by meeting needs and wants does it create any value. It must understand and satisfy or exceed the needs and wants of customers, employees, suppliers, distributors, society and any other legitimate stakeholder. And a smart company will see the value in treating them as partners in the co-creation of value, contributing to the sustainable prosperity of all.

These principles are incorporated in the concept of Valueism — business focused on value-creation. And each business can begin to design a social contract by first producing a Value Scheme — the business’s unique design by which is able to create value for all stakeholders, sustainably and profitably. Consideration of the values, vision, mission, purpose etc will be part of the process. But these considerations should not become meaningless rhetoric. They should be implicit in the contract as they are in the J&J Credo, then embedded in the policies, decisions, practices and behaviours of the business.

Johnson & Johnson’s recent troubles indicate hope problems occur when they are not constantly reinforced, which may explain why the company has also published a code of conduct. The document introducing the code of conduct describes the credo as the compass and the code as the road map — a foundation for the company’s policies, procedures and guidelines, all of which provide additional guidance on expected behaviours.

For a further introduction to Valueism and Social Contract Accounting read the article I wrote for London School of Economics (LSE).

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