Here's how boards can balance profit and social purpose
By Thomas A. Cole
It is hard to read any newspaper these days without running across at least one article, column or editorial debating socialism vs. capitalism.
Trends in income and wealth inequality, and the “financial fragility” of the middle class, give rise to questions about whether our economic system is in need of some sort of adjustment.
Attention to this question is enhanced by the relatively new Securities & Exchange Commission disclosure requirements relating to “pay ratio” — the comparison of CEO compensation to the compensation of the median employee.
Second, the debate gets a boost in volume in the lead-up to an election year when two prominent Democrats are self-described “democratic socialists,” and Republicans latch onto that label to hyperbolically warn the electorate of a slide into Venezuelan chaos. And one U.S. presidential aspirant (John Hickenlooper) has declared that he is “running to save capitalism” from attacks by both the left and the right.
It is quite interesting that no one from the left seems all that bothered by the incomes and wealth of sports figures, actors, super-models, rock stars or best-selling authors despite the fact that corporate executives and entrepreneurs can make a much greater contribution to the common good, by creating jobs and innovative products and services.
It is equally interesting that no one on the right seems to attack free public education, municipal-owned public utilities, fire and police protection or even the concept of collective risk sharing through insurance as socialist.
(Related article: The Character of the Corporation series - Balancing profit and social purpose.)
Another element of this debate is the false framing of the issues. No one is really advocating what might be called “socialism” — which Webster’s defines as “collective or governmental ownership of the means of production and the distribution of goods” or “the stage of society in Marxist theory transitional between capitalism and communism.”
No one is calling for a free market system with little or no government regulation.
Even Warren Buffett, who calls himself a “card-carrying capitalist” says “Capitalism does involve regulation [and] involves taking care of people left behind.”
The polls that purport to indicate that young people prefer socialism to capitalism have been interpreted, wisely, by Barton Swain as “enthusiasm for racial diversity, state-sponsored compassion and bohemian idealism, [not an] economic doctrine [but] a cultural attitude.”
Capitalism has appropriately been given a full-throated defense by JPMorgan Chase CEO Jamie Dimon as “the most successful economic system the world has ever seen, [which] has helped lift billions out of poverty, has helped enhance the health, wealth and education of people around the world, [and] enables competition, innovation and choice”.
Nevertheless, even he says the system is “frayed,” a more restrained position than hedge-fund billionaire Ray Dalio who repeatedly says capitalism is “broken.” (Incidentally, Dalio made $2 billion in 2018, up from $1.3 billion in 2017.)
So, what should be done?
One proposal comes from U.S. Sen. Elizabeth Warren: Put employees on corporate boards and require boards and managements to consider the interest of all stakeholders, not just shareholders. Such an approach would create enormous difficulties for effective decision-making.
But it is also seems to be based upon a misunderstanding of two critical issues:
1. It is incorrectly assumed that the focus of corporate governance on responsibilities to shareholders leaves out-in-the-cold all of the other stakeholders (that is, employees, creditors, suppliers, customers and communities at large). It is true that directors and officers owe generalized fiduciary duties only to the shareholders and that those duties require actions be taken that will ultimately maximize value for the shareholders. It is not true, however, that there are no duties to the other stakeholders. Those duties are numerous and can be found in specific laws and regulations and in contracts.
Take employees as one example. Corporations owe their employees duties under, among other things, OSHA, WARN, ERISA, ADA, ADEA, EEOC, FLSA, NLRA, something like 40 whistleblower anti-retaliation provisions, collective bargaining agreements, employment agreements and state law limitations on non-competition agreements. Similar lists can be generated for the remaining other stakeholders.
Other than disclosure requirements under the securities laws, the shareholders — who only receive value on a residual basis, after all of the obligations to the other stakeholders have been satisfied – do not have the benefit of specific laws, regulations and contracts.
It is also not true that directors and officers cannot take actions that benefit the other stakeholders. They can, so long as such actions can be justified as ultimately beneficial to the shareholders.
2. There seems to be a lack of appreciation about how beneficial the focus on shareholder value maximization is to a very broad swath of the population. The benefits do not inure only to those households that own publicly trade equities (directly or through index funds and pension benefits) — although there certainly is a significant number of such households.
Less directly, for example, university students and their parents, recipients of grants from foundations and those served by other nonprofits all benefit from the investment returns achieved by the endowments of such enterprises. And those endowments were built up by donations from capitalists derived from their investments.
Another proposal is to increase taxes on income and wealth for purposes of a redistribution to those “left behind.” A problem with this approach is a lack of trust or confidence that moneys taken in by the government would actually be made available to those in need rather than wasted on, say, a border wall. Without adequate assurances along those lines (likely an impossibility), many would prefer to see the tax laws en-courage private philanthropy that targets those in need.
There is also the philosophical issue of whether the goal is equality of income or equality of opportunity. While proposals for guaranteed minimum incomes are intriguing, more conventional approaches — such as retraining workers who are left behind by technology that benefits most Americans through better quality and cheaper goods and services may be preferable.
Also, more useful than redistribution would be for government to do a better job in attacking causes of poverty — mass incarceration, opioid addiction, gun violence and failing schools.
Another approach is corporate social responsibility, meaning doing more for the other stakeholders than the minimum required by law and contract. Corporate social responsibility (CSR), also known these days as environmental, social & governance (ESG) issues, can include paying more than the minimum wage even when not required by a tight labor market, with the thought that a family with one or two full time workers should be able to live above the poverty line. It can also include pursuing environmentally sustainable production methods, engaging in corporate philanthropy that enhances equal opportunity, adopting robust diversity and inclusion programs and establishing pipeline and retraining programs to help those whose livelihood is challenged by technological advances.
CSR and ESG are sometimes maligned as a cosmetic attempt to “soften” capitalism, nevertheless:
- Corporate boards should not dismiss the social responsibility movement as a fad, a waste of shareholder value or an inappropriate focus on the other stakeholders. In the right context, it provides long term benefits to shareholders. Consider, for example, positive investor, consumer and employee reactions, as well as enhanced goodwill upon which to draw in the event of a crisis adversely impacting the corporate reputation. A decision about whether or not, how and how much to engage in social responsibility should be made as part of overall corporate strategy.
- Customers and employees should reward companies that engage in socially conscious issues that they believe in. For example, if someone is appalled by gun violence, the customer should shop at Dick’s instead of its competitors that continue to sell guns. If an employee is proud of the employer’s position on such social matters, say so, especially to prospective future co-workers!
- Institutional and other investors that believe in, and loudly advocate for, CSR should be supportive of like-minded boards and managements, especially in a proxy contest mounted by a financial activist. Those investors should also ask themselves whether it is right if they are, at the same time, shareholders in companies whose core products and services are fundamentally detrimental to societal wellbeing.
There may be other approaches to addressing the shortcomings of our capitalist system, but for now balancing profits and social purpose, when coupled with sensible regulation, seems to be the best approach on both a micro and macro level. And it is in keeping with what the members of the next generation (who naively say they favor socialism) actually want and would support.
Thomas A. Cole is a Chicago corporate lawyer. He teaches the seminar on corporate governance at the University of Chicago Law School and is the author of “CEO Leadership: Navigating the New Era in Corporate Governance” to be published in November by the University of Chicago Press.