181 CEOs take on Milton Friedman

When 181 US chief executives, organised by the Business Roundtable, issued a “collective statement on the purpose of the corporation” it caused fury among some investors and economists; joy among some activists; cynicism among other activists; and, horror among conservative commentators.

The problem was that for the critics – since 1962 Milton Friedman’s book Capitalism and Freedom argued among other things now in the dustbin of history that the sole obligation of companies was to maximise shareholder value – it had provided a convenient justification for the wave of neo-liberal policies implemented by Thatcher, Reagan and Australian governments which have resulted in the mess we are now in.

With all due respect to the committee that awarded Friedman the Nobel Prize in Economics his claim on shareholder value was nonsense then; nonsense historically (as evidenced by the 19th century British Quaker industrialists); and, nonsense in the context of Adam Smith’s philosophy. Needless to say the 181 chief executives’ commitment is also seen as nonsense by many on the left who accuse them of hypocrisy – an appealing argument given the disparity between the remuneration of the CEO’s who have signed up and that of their workers.

The story about the 181 CEOs is best told by the FT’s Gillian Tett (7/8 September 2019) in the article Does Capitalism Need Saving From Itself which  points out that by 2000 academics, investment companies, lawyers and chief executives were declaring that that the shareholder maximisation model was triumphant – despite a series of doubting voices including that of the now 88 year old Marty Lipton’s 40 odd year career to persuade investors and companies to “stop focussing on short-term shareholder returns and instead chase long-term value for ‘stakeholders’ such as employees, clients and communities.”

Ironically, GE’s Jack Welch (who was no stranger to smoothing earnings and promoting steady growth in shareholder value) said around the same time that pursuing shareholder value as a strategy was “the dumbest idea ever” – by the way just as Cheney, Rumsfeld, Bush, Howard and Blair were pursuing one of the dumbest Gulf policies of all time. It might be about to be replicated with Iran.

The underlying argument about shareholder value was that it benefitted the whole community. But as demonstrated by recent corporate tax cuts in the US and Australia the end result is share buybacks and increased dividends rather than new investment; ceilings on pay increases; cuts to workforces; and spiralling CEO pay.

The other problem is that markets tend to be irrational. There are many examples of this in terms of market booms and busts throughout history, but perhaps the best simple example in recent times as to how dumb major investors can be was when the Cameron Government put a tax on sugar. UK share market traders immediately pushed the price of Tate and Lyell shares down. Yet Tate and Lyell had sold its sugar business in 2010 and was no longer one of the world’s major sugar operations.

The most profound rejection of the shareholder value thesis came in one sentence: the quickest way to destroy shareholder value is to ignore stakeholders. Who said it first is unclear but it has been evident in many case studies over the years. A variation is that the quickest way to destroy shareholder value is to ignore the values of shareholders.

Indeed, while economists, investors and politicians were mouthing the Friedman mantra some businesses and academics were developing quite sophisticated approaches to stakeholder theory.

Modern stakeholder theory stems from work by R. Edward Freeman (Strategic Management: A stakeholder approach) as far back as 1984. In essence his view was that stakeholder theory is about identifying the groups who are stakeholders in a corporation and who need to be managed to ensure the licence to operate is constantly renewed. The licence to operate is really about the fact that companies, and most organisations, ultimately can only exist with the consent of the community. Sovereign risk is one problem (much exaggerated and misused as the term is) but loss of community consent can be just as destructive. A point the mining industry needs to consider in its campaigns – for instance the Minerals Council of Australia rather silly 2016 coal campaign “the amazing little black rock.” Arguably it was successful in persuading some voters in northern Queensland but it has had little impact on bankers and investment managers.

Since 1984 almost all companies and organisations have compiled longer and longer lists of stakeholders ranging across investors, employees, suppliers, customers, governments, trade unions, community groups, NGOs, and so on. Eventually the lists become so large as to be almost unmanageable – raising the possibility a stakeholder you may not have even thought of could have profound impact on shareholder value.

Without mentioning the company name (as it is a former client) one company exemplifies how businesses dig down into stakeholder issues by segmenting stakeholders into categories as to whether stakeholders had a direct interest in your business (employees for instance); whether they were potential allies (trade unions and business associations); whether they were hard-core opponents (the health thought police or Greenpeace); whether they are independent monitors (Human Rights Watch or Transparency International); or, whether they are uninvolved (which is the category the general public is normally in until an issue blows up). There are also some questions in this context for NGOs – mainly how close is too close?

Another significant indicator of how important stakeholders are is the emphasis many companies put on ‘reputation’. Reputation is a seductive concept because it conveys much more than the concepts of brands and image. Indeed, it is based on the reality that reputation is conferred on you by others while brands are something you create yourself.

Ultimately though, reputation stems from your own behaviours and your own cultures – things which can be rather more important than how large the latest dividend was. Tony Jaques the Australian issues management scholar discusses this in detail in his latest newsletter – Joan Jett Was Wrong.

While the argument about shareholder value has been convenient for those who Thomas Piketty demonstrated have benefitted most, it has never been the sole driver of business strategies. On the other hand many of those (for instance banks bailed out after the GFC) signing the collective statement have done well in terms of shareholder value at the expense of the stakeholders they claimed were important.