A New and Legal Orthodox Wisdom
Unilever’s Paul Polman must be a Chief Executive in a million. Or more. In his interview with Guardian Sustainable Business, Polman calls on business leaders, politicians and NGOs to recognise they cannot deal with the world’s environmental and social challenges by pursuit of Milton Friedman’s target of maximising shareholder wealth. Polman names a few other companies who are moving in that same direction, and suggests their numbers are growing. But it is a drop in the ocean.
“Why,” he asks, “would you invest in a company which is out of synch with the needs of society, that does not take its social compliance in its supply chain seriously, that does not think about the costs of externalities, or of its negative impacts on society?”
Sadly, the answer is simple and obvious: to make a quick buck. Friedman said that corporate officials had no other social responsibility than to make as much money as possible for shareholders, and that is what the business schools and university departments have been teaching ever since. So that is how the world now works. The world – business leaders, politicians, academics, and even the people in the street – have come to believe that it is the legal duty of those who run businesses to maximise the wealth of shareholders, and to hell with everything else. But it is simply not the case. We should not need heroic figures like Paul Polman to change the world. It should simply be a matter of compliance with the law.
J K Galbraith used the term “institutional truth” to describe the sort of lie which people have to internalise in order to progress within their relevant institution. For business leaders, politicians and management academics, ‘shareholder primacy’ has been their institutional truth. And it has become a deep cultural belief in the non-totalitarian world, which the vast majority appear to have internalised. It is high time the truth was out.
Friedman’s justification of his position was the false assertion that: ‘a corporate executive is an employee of the owners of the business (ie the shareholders) … the manager is the agent of the individuals who own the corporation.’ But, as every employee in the land knows, their contract of employment is with the company, not the shareholders. Company directors have no direct contract with shareholders. Their duties are to serve the best interests of the company. Their service agreements normally make it clear that the agreement may be immediately terminated should the director act in any way against the company’s best interest.
A standard legal text explains the position as follows: ‘since the artificial entity which is the company can only act by and through human beings, it is clear that the company must be treated as a principal or as a master, and those through whom it acts (ie management) as agents or servants..’ Thus the law clearly invalidates the Friedman argument. However, economists developed what they referred to as ‘agency theory’ which holds that a company is a ‘legal fiction’. That being the case, they could reassert the argument that directors are directly linked to shareholders as their agents. However, it is only a theory. And easily disproved: the truth is that the company is a legal fact – that is its whole point.
Since 1844, successive UK Companies Acts have specified the legal duties of directors as focusing on their company’s long term viability, but also include their duty to have regard to the interests of employees and other stakeholders such as the local community and the environment.
Nevertheless, the ‘institutional truth’ of shareholder primacy still dominates, as exampled in Kraft’s takeover of the highly successful Cadbury business. When the Cadbury directors agreed and recommended its takeover, their service contracts were not terminated and they were not sued for dereliction of their legal duty as agents of the company. Instead they were paid huge bonuses for their betrayal.
Much of the totally unsustainable impoverishment faced today springs from that one simple untruth: the reckless depletion of finite resources, pollution of atmosphere and oceans, predatory activity of an unregulated financial sector, and the destruction of the real economy which provides real jobs as well as paying for education, health, defence and social security. All this destruction on the altar of shareholder wealth maximisation, is mirrored by the excessive bonuses and executive remuneration that are part of the daily news. No wonder, in his BBC ‘lecture’, Barclays CEO Bob Diamond lovingly claimed Milton Friedman to be his ‘favourite economist’!
It is to be hoped that more will follow Polman’s bold lead away from short term shareholder gain towards long term sustainability. But many firms are not strong enough to swim against the tide. Friedman’s agency lie has to be exposed and demolished. And Polman’s alternative enabled to become the new orthodox wisdom.