Being good or not being bad: what should we expect from business?

9 April 2019

By John Dudding

10 minute read

In this blog John Dudding looks at why we need to revisit the fundamental economic philosophy of business to shape ideas on the role of business in delivering inclusive growth.

There is an ongoing discontent with business. Policy circles opine about the ills of shareholder value maximisation; politicians rile against takeovers; everyone looks to Germany; and the general public continue to worry about executive pay and corporate tax avoidance.

Yet this discontent has not manifested a clear policy agenda on the role of business in the UK. Over recent decades, debate narrowed from challenging fundamental economic theses to challenging particular practices of profit-seeking companies (executive pay, takeovers, high-frequency trading) or particular industries (generally natural monopolies such as rail) rather than challenging the purpose of the company itself. Only more recently, and at the fringes of the symptom-based discussion, has this purpose begun to be questioned through proposals to change to company law concerning the duties of directors, or the independent action of firms to become social enterprises.

Whilst this focus on symptoms does have a pragmatism needed for short-term improvements, it also reflects a lack of vision and failure to address the fundamental question: what should we expect from business? What is business there for? Should it be primarily seeking profit or the interests of society, or what mixture of the two? Should business have ethical codes or should it obey laws and customs solely to avoid punishment and increase sales? Without clarity on what a business should be doing, we can’t expect business to achieve it, and we can’t expect the public to endorse it.

Friedman

Without a compelling 21st century narrative, the debate appears still centred around the ideas of Milton Friedman, whether in support or in antithesis. Friedman may be remembered for his confrontational, free-market bombast: his most famous 1970 article stated anyone espousing corporate social responsibility (CSR) is “preaching pure and unadulterated socialism” and “unwitting puppets … undermining the basis of a free society”. But whilst the language is dated, from a time when planned economies were both reality and geopolitical threat, the argument within it has been more persistent. He argues that in an economic system built around the idea of property, the ultimate duty of a company (i.e. of its directors) is to the owners. In the case of public corporation, this is the shareholders. And the manifestation of this duty is making profit – where there are numerous shareholders they are unlikely to hold a consistent view on social objectives. It is then up to the owners to decide what to do with this profit, philanthropic or not. Any philanthropic activity that detracts from this profit-making is in effect taking money from someone: from consumers through higher prices, from employees through lower wages, or from shareholders through lower profits. This would be without their consent, to satisfy the moral feelings of the directors.

Economic philosophy v. management handbook

Recent trends in the CSR landscape have abetted our failure to address underlying questions on the role of business. Good CSR has begun to be seen by directors and investors not as a cost to business but as in the financial interests of shareholders: Danone, often cited as a leading business example through their movement to become a B Corp, openly state that this move will be financially beneficial. Whilst the action may be socially beneficial, this justification suggests their ultimate motive is still shareholder value. So this new wave of CSR is not challenging the underlying economic philosophy that shareholders should come first, it is presenting a management handbook as to how to promote those shareholder interests.

The same thing could be said about the rise of ESG investment (assessing investment candidates on Environmental, Sustainability and Governance criteria). Whilst this started with the treatment of these three criteria as an end – investors valuing them as an inherent goal – its expansion was the result of investors seeing the criteria as a means to achieving financial return: a good ESG record is seen as inherently beneficial risk management (i.e. avoiding costly scandal) and also an effective indicator of a profitable company.

It is undoubtedly helpful to achieving socially beneficial outcomes that some of these have been associated with profitability. However, focusing on this relationship implicitly endorses a Friedmanesque position: by using profitability as a justification for socially-beneficial behaviour, it is acknowledging profitability as the company’s chief objective. It is placing the burden on consumers and investors to change company behaviour, and it is not offering a solution for the many situations where the pursuit of profitability still conflicts with socially desirable outcomes.

Stakeholder management

Recent attempts to engage with what business should do, and to challenge Friedman have come through stakeholder theory. This was originally presented as management guidance: managers needed to understand the concerns of stakeholders (employees, customers, suppliers, lenders and society) so that they supported the firm’s objectives, as this support was necessary for the long term success of the company. It did not offer a new definition of what that success meant. However, more recently there have been suggestions (including the 2017 Labour Manifesto) that something similar is written into company law – that company directors’ duty should not only be to shareholders but also wider stakeholders. This interpretation is much more radical as it moves beyond how to achieve business success, and into to the fundamental question of what the success of business is, of what business should do.

The problem with this move at first appears definitional: who are the stakeholders and what does considering their interest mean? If a company emits CO2, this affects the entire world through climate change. How does a director weigh up the competing claims? The business can surely not treat all interests equally, not even national governments aspire to do this (not for global stakeholders), but if shareholders’ interests come first are we moving forward at all? Is this just a definitional problem or does it reflect incompatibility with our broader economic system?

Unique placement and negative framing

An alternative critique of Friedman is to consider the unique placement of a company: Friedman suggests that potential philanthropy of a company is more appropriately channelled through individual shareholders. But sometimes companies are uniquely placed to perform good. This can conceivably include positive acts: a large employer in a town may be the only institution with the capacity to support a local sports club. But it is much more obvious when the action is negatively framed: a company is uniquely placed to stop itself doing bad. Whereas individual shareholders of XYZ Corporation could donate towards an ocean clean-up programme, only XYZ Corporation can ensure it doesn’t shift profit to a tax haven; only XYZ Corporation can ensure it doesn’t exploit its vulnerable customers or employees; and only XYZ Corporation can prevent itself lobbying for societally detrimental policy.

This negative duty is, in fact, in line with the letter of Friedman, if not the tone. His headline “there is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits” is caveated with “so long as it stays within the rules of the game” or, elsewhere, “while conforming to their basic rules of the society, both those embodied in law and those embodied in ethical custom”. The extent of these customs could hugely alter the implications of the philosophy – is tax avoidance or lobbying for societally detrimental policy within ethical custom? But for the followers of Friedman it has remained a superficial caveat. Paying it more attention – that is looking at what these customs are and how they’re changing – may be an option for developing a broadly-accepted answer to what we expect from business.

Where next?

Since Friedman’s 1970 article we’ve had a narrowing of the political debate. There has also been a change in perceptions amongst investors and directors that that socially beneficial behaviour can be profitable, not a cost. Whilst helpful in motivating more positive business behaviour, it has also confused the issue of what firms should be doing through conflating means and end.

We are left with the ongoing need to set a clear expectation of the role of a company so that we can propose policy that reflects it. This applies not only to policy that aims to influence corporate behaviour, but also that which relies on it. If we expect business to primarily pursue profit, government should better channel that to society’s interests through tax and regulation. If we expect business to pursue society’s interest itself, we’d need a different framework.

This leaves outstanding questions to resolve: once we have established what we expect of business, both the principle and the detail, we then need to work out how to enact this through legislative or cultural change, and then ensure our wider economic approach is fastened around the correct mast. CPP will be looking this year at a range of ways business can help or hinder inclusive growth and what we can do about it. Watch this space.