By Rick Alexander
Defending maneuvers to limit tax liability, Donald Trump cited “fiduciary” obligations to his businesses. While this excuse makes little sense for a family-held entity, public companies also cite fiduciary obligations as an excuse to avoid social responsibility. Many corporations make extraordinary efforts to reduce taxes, and appear unconcerned with paying their fair share of the price for a functioning government.
Outside the confines of a family business, Mr. Trump is right: Corporations maximize shareholder return, regardless of the burden on others. And that burden is a heavy one: Corporations control most of our financial capital, too often using it to drive climate change, increase inequality and risk our future. There is an urgent need to repair our broken system of capital allocation. The good news is that structures like benefit corporations can help us do so, but the clock is ticking.
Milton Friedman crystalized the “shareholders only” idea in the title of his 1970 article, “The Social Responsibility of Corporations is to Increase Profits.” On its face, this makes sense. If a 401(k) investor entrusts her retirement savings to an asset manager, shouldn’t the manager — and the executives of companies that the manager invests in — make sure her investments are delivering the best return possible? And won’t this lead to an “efficient” allocation of capital? Actually, no, and no.
Consider the run-up to the financial crisis: Banks sought profits for their shareholders, but created a financial crisis that cost trillions of dollars. However, most investors own many stocks, so these banks hurt their own investors by degrading the value of their portfolios, as well as reducing the quality of their lives. Similarly, lax emission controls may increase a corporation’s profit, but they decrease overall productivity in the economy by contributing to climate change. Because companies can retain benefits for shareholders while socializing losses, they are motivated to take actions with net negative values, inefficiently allocating capital, and collectively lowering returns for investors.
If blind pursuit of profit actually hurts investors, why does the Trump view of fiduciary duty survive? Two powerful but artificial constructs sustain it. The first is modern portfolio theory. MPT judges institutional investors (who control most of our financial capital) by whether they beat the market. This creates pursuit of individual company performance, even as it drives down the performance of the entire market.
The second artificial construct is shareholder primacy. This theory posits that corporations must deliver the best possible returns to shareholders, paying no regard to the effect on other assets the shareholders own or any other aspect of their lives. As a result, corporate executives make decisions oriented toward maximizing the return on their stock — even if those decisions harm other companies owned by their shareholders, and even if those decisions create instability in the world in which they live.
We must address this imbalance: NGOs and governments cannot repair the damage done by a system that encourages irresponsible behavior across the private sector. Investors must focus on the whole market, and we need to give corporations the tools to join with investors and act responsibly.
Such a tool now exists: benefit corporation governance. When a corporation becomes a benefit corporation, shareholder primacy is not an option; instead the company must account for the effects of its decisions on all stakeholders, as well as shareholders. Thirty states, including Delaware, now authorize benefit corporations. And legislation is moving forward internationally: Italy adopted a benefit corporation statute, and statutes are under consideration in a number of other countries. Traditional corporations can easily make the switch.
Benefit corporations dovetail with the movement to require corporations to act more sustainably. However, this movement treats the symptom (irresponsible behavior), not the root cause (focus on individual corporate financial performance). Proponents of corporate responsibility thus often emphasize only those “responsible” actions that benefit the corporation individually, by protecting reputation or decreasing costs. Enlightened self-interest is an excellent idea, but it is simply not enough. As long as investment managers focus on individual companies, corporate executives will “go low’ if it increases shareholder value. This means, among other things, avoiding fair taxes.
We deserve better. Thoughtful investors and benefit corporations can help shift the focus of our economy to creating durable, shared value that recognizes the external harms — and benefits — created by their operations.
Corporations enjoy great privileges, such as limited liability, as well as access to our courts and our transportation and communications systems. They also enjoy the privilege of access to our capital. We have every right to insist corporations use that capital in a manner that preserves our financial future, and the future of society and the planet we live on.
Image credit: Flickr/Charlie Phillips
Mr. Alexander is the Head of Legal Policy at B Lab, a non-profit organization that serves a global movement of people using business as a force for good.