The mantra of profit maximization is slowly losing its grip.

While the falsehood that fiduciary duty means solely making money for shareholders is being chipped away, many business leaders still cling on to this behaviour.

hanging precaiously

The world of business appears to be so powerful and robust from the outside but look up close and it is brittle and full of fear.

Anxiety among top executives about losing their lavish bonuses and the status and lifestyle that comes with it, leads to the most perverse behaviour. Ignoring the damaging impacts on both society and the environment keeps things nice and simple in the same way as keeping away from the great unwashed by living behind high walls and security cameras.

While the concept and practice of sustainability has been slowly chipping away at the falsehood that fiduciary duty is solely to make money for shareholders by bringing business back into relationship with the real world, it is extraordinary how many executives still cling to behaviour that may well in the future be considered criminal.

I was reminded of this listening to John Kay, one of the UK’s leading economists, give a strongly worded condemnation of shareholder primacy, arguing profit maximization is a “crass description” of the purpose of a company.

it is extraordinary how many executives still cling to behaviour that may well in the future be considered criminal.

“Making a profit is no more the purpose of business as breathing is the purpose of living,” said Kay, who chaired the government review of UK equity markets and long-term decision making (pdf). “Why should I allow organizations that believe in profits above all else to exist in modern society? There is no good answer to that question.”

Kay says the constant repetition of the slogan of profits maximization “undermines the legitimacy of business, which will destroy the ability even to achieve this particular objective.”

He insists there is nothing in the law to suggest business should put its shareholders ahead of all other stakeholders. Rather, the law says the duty of directors is to promote the success of the company and Kay says that this can be achieved only by seeing the multi-dimensional nature of business.

“One day the scales fell from my eyes when I realized that companies don’t maximize anything,” he said.

Kay insists it is a legal fiction that companies can be seen purely in the economists’ sense of a nexus of contracts to be used to make agreements, full of people who find it convenient to come together every day. Instead, he says companies have a corporate personality and express “the kind of personal characteristics we attribute to individuals. A corporation only adds value because it is more than the sum of its parts.

“A firm is a construct that has purposes not to maximize but of having a balance of objectives and goals and has obligations to customers, suppliers, society as a whole, and the environment.”

there continues to be a “queasiness” in the corporate sector about NOT putting shareholder value at the centre of all they do

James Macpherson, co-head of UK equities at the world’s largest asset manager Blackrock, admits there continues to be a “queasiness” in the corporate sector about not putting shareholder value at the centre of all they do and says this is partly because such a single-minded approach unifies business culture.

But he says analysis demonstrates this approach destroys shareholder value over the longer term: “There is an enormous noise around short term financial metrics,” he say, “but taking a longer term view we can make a lot more money for our clients.”

Despite this view, Macpherson is himself a cog in the system that drives short-termism and admits his pay and bonus package is based on beating the stockmarket. Kay says this makes him part of the problem as the deeper truth is that what his clients should really want is to secure good pensions for its members.

“We have set up a dysfunctional system where you have a goal short term that is not consistent with the long term purpose of the investors,” he said.

Paul Polman, CEO of Unilever, is one business leader prepared to call out that the emperor has no clothes. He gives the example of a recent college graduate who was interviewing with an established law firm and was shocked when they told him that while they were not doing anything illegal, their activities might be seen as immoral. The firm’s justification for its behaviour – it’s “worth it as it made a lot of money” – would ring true in the corridors of finance institutions as well as many other companies.

Polman says: “Clearly we are not getting it right if we only focus on financial returns and don’t include broader factors that value environmental and social progress… When people in companies are disconnected from serving citizens and accountability and transparency is lacking we seem to revert too often to self service as Libor and mortgage manipulation issues have shown, amongst others.”

Many academics such as Lynn Stout of Cornell Law School have persuasively debunked any legal or fiduciary duty to maximize shareholder value but then wonder why these intellectual arguments don’t make much impression.

The reason is simple. Executives have no choice but to cut themselves off from their own humanity when they choose to pay the lowest wages possible, destroy ecosystems and damage community cohesion.

The only reason this ruinous idea of running a business is allowed to continue is because enough executives still collude with each other to justify it and society has not yet called their bluff.

This article was originally published on the Guardian website
Jo Confino is an executive editor of the Guardian and chairman and editorial director of Guardian Sustainable Business. He also advises Guardian News & Media and Guardian Media Group on their sustainability strategies.

4 Responses

  1. Michael Yates

    Although I’m all for sustainable business practices and social responsibility, I’m pretty sure this will be a convenient excuse used to cover stagnating profits which until now have been hidden with massive stock buybacks and non-GAAP reporting.
    Truth is, corporations have watched profits and revenues slide for years now, and it has nothing to do with the implementation of ethical or environmental practices.

    • Brad Zarnett

      Hi Michael, thanks for sharing your thoughts. I see things a little differently…what’s important is that regardless of how a sector is performing, companies that incorporate a more sustainable approach to their business will ultimately outperform competitors who sit on the sidelines and don’t do the heavy lifting in the realm of learning to approach business in a more sustainable way. Here’s a few examples:

  2. Neda Nordin

    I think the problem lies in lack of knowledge and guts of CEOs. If there were proactive consultants who would prove the long-term monetary benefit for the company of the TRUE CSR as incorporated in their business model, and show good examples, there we more chances for shared value creation.

    Another problem is the lack of customers/society pressure – much discussed topic… But also related to education and awareness on what IS “true” CSR. My understanding is that true CSR is about integration, innovation and collaboration in creating shared value, and thus should benefit the business and society.

    • Brad Zarnett

      Hi Neda, thanks for raising some great points. I agree with all of your thoughts regarding the slow adoption of companies behaving more sustainably and I would add one more…the system itself. Unfortunately Capitalism, that way it is practiced, places almost no value on our air, water, biodiversity, labour exploitation and the list goes on. We need better metrics to reward companies who internalize these issues as part of their business strategy.