By Paige Morrow
The future of sustainable development is being shaped by events such as the U.N. Forum on Business and Human Rights held earlier this month in Geneva, the Climate Change Conference in December, and the adoption of the Sustainable Development Goals in September. Considering that many corporations have greater turnover than the GDP of several countries and that 500 transnational corporations control roughly 80 percent of world trade, it is clear that we need business on board. The way these corporations are governed is essential for either positive or negative change of the system as a whole, depending on the chosen stewardship, which takes us to the central question: What is the purpose of the corporation?
A corporation may decide to maximize profits and share price it is a permitted objective, but not one that is required by law. The purpose of a corporation is instead whatever its founders wish it to be, as long as it is legal. Thus, it might be to make innovative products, develop cutting edge technology, build a spaceship or create the next penicillin. The law has left a vacuum allowing companies to decide what their purpose should be. Unfortunately, the current model of corporate governance is based on the popular conception that the sole or primary purpose of the corporation is to maximize its value for shareholders.
The often myopic focus on share price is driven by a business culture that is based on this misunderstanding of the legal obligations of directors and a corporate governance system that empowers shortterm oriented shareholders and facilitates the demands of capital markets. This approach has resulted in decision making within companies that focuses on quarterly earnings and creates perverse incentives that encourage problematic practices such as stock buybacks. This way of doing business is also implicated in a range of unintended social, human rights, and environmental consequences. It compels companies to externalize as many costs as they can get away with (e.g. companies’ carbon footprints and supply chains issues). It is also a driving force behind growing inequality (e.g. the pay gap between average workers and bonusdriven top management compensation, the race to the bottom in the cost of labour, and the reallocation of resources to shareholders).
Not surprisingly, the focus on maximizing shareholder value ultimately undermines the viability of companies in the longterm as they are not reinvesting their returns into R&D, human capital, addressing systemic risks and exploiting strategic opportunities. The maximizing shareholder value imperative drives spending of corporate resources and time of top management on strategies such as buying other companies, paying out dividends to shareholders and buying back shares.
Furthermore, according to an article published in the Harvard Business Review by William Lazonick, professor of economics at UMass Lowell, the focus on short-term returns has resulted in a shift from “value creation” to “value extraction," contributing to “employment instability and income inequality."Corporate governance must evolve into a model that balances the interests of investors, workers, consumers, communities, and the environment, allowing businesses to thrive while contributing to broader sustainability. For this to happen, it is essential that we shift the policy discussion from a singleminded focus on shareholders to a more holistic understanding of their role in the firm.
Image credit: Flickr/Corey Leopold
Paige Morrow is head of Brussels Operations at Frank Bold, a purpose-driven law firm. The firm leads the Purpose of the Corporation Project, which invites businesses, academics, policymakers, and civil society to debate the future of publicly traded companies. Connect with us on @purposeofcorp or on our Linkedin Group.