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.
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Hi Gordon
Great article, and great to be in contact through Facebook. I’d be really interested in your views on co-operatives and trading charities that appear to get it right. I think this further substantiates your view that the appeasement of shareholders is a trunk road to economic failure.
Phil G
Phil,
Nice to make contact. I did a book titled “The Road to Co-operation: escaping the bottom line” (just published) which heartily supports co-operatives etc, taking the general line that co-operation is a matter of shades of grey and can take many forms which might merely involve some stakeholders (eg employees) in critical decision making or extend to full on co-ownership and all stages between the two. Any form of co-operation is preferable to the current position while any increase in co-operation is desirable so that in my view co-owning and involvement of all stakeholders in critical / strategic decisions would be the ideal. The book is described in a separate page on the blog site.
Gordon,
I’d like to pick up on your point about being compliant with law. As I’d related in a previous response, it was in a seminal paper that P-CED founder Terry Hallman reasoned that within current law, a business need not comply with the assumption that a business must maximise shareholder return. He makes the point again in our 2006 paper, describing a ‘Marshall Plan’ for Ukraine:
“An inherent assumption about capitalism is that profit is defined only in terms of monetary gain. This assumption is virtually unquestioned in most of the world. However, it is not a valid assumption. Business enterprise, capitalism, must be measured in terms of monetary profit. That rule is not arguable. A business enterprise must make monetary profit, or it will merely cease to exist. That is an absolute requirement. But it does not follow that this must necessarily be the final bottom line and the sole aim of the enterprise. How this profit is used is another question. It is commonly assumed that profit will enrich enterprise owners and investors, which in turn gives them incentive to participate financially in the enterprise to start with.
That, however, is not the only possible outcome for use of profits. Profits can be directly applied to help resolve a broad range of social problems: poverty relief, improving childcare, seeding scientific research for nationwide economic advancement, improving communications infrastructure and accessibility, for examples – the target objectives of this particular project plan. The same financial discipline required of any conventional for-profit business can be applied to projects with the primary aim of improving socioeconomic conditions. Profitability provides money needed to be self-sustaining for the purpose of achieving social and economic objectives such as benefit of a nation’s poorest, neediest people. In which case, the enterprise is a social enterprise. ”
The primary focus of this plan are thousands of disenfranchised children which he had drawn attention to in his provocative article ‘Death Camps, For Children’.
Our action as a business was not constrained by UK charity laws, which prohibit lobbying and complied with Ukraine’s written constitution. Specifically articles 26 and 52 of the Rights, Freedoms and Duties section, which oblige a foreign resident to act where the vulnerable are being harmed.
Seeking support from other US and UK organisations cut little ice. Sab Miller was one example I recall, who actually responded with a ‘do something later’ whereas most disregarded us. Notably this included the British Ukrainian Society in which a number of our politicians were involved.
Paul Polman’s stance is radical in the corporate world, but much of the pledge is saying ‘we will be’ in contradiction of Henry Ford’s assertion that ‘you can’t build a reputation on what you are going top do’.
We clearly are a very small business and yet, have been the change. It is an inconvenient truth for the Guardian’s, who resist all efforts I make to introduce this on their sponsored hubs.
It is inordinately difficult for a small business like ours to gain media attention and to add to this, we were experiencing a smear campaign, orchestrated by those who were in denial over children in ‘Death Camps’.
if media such as the Guardian take such a stance with all those who follow this new orthodoxy, filtered on the basis of business turnover rather than social impact, it is very difficult to see how others will be able to follow. In the past I’ve pointed out to Jo Confino that one of the Guardian Media Group companies has disregarded our invoice for services for 4 years. This surely should be their first social responsibility, to ensure the suppliers of their businesses are paid.
One of the activities it was not safe to write about until Terry’s death was his contribution to a proposal which led to a joint production initiative for medical isotopes, in Kharkiv where Russia had once developed the H bomb.
http://economics4humanity.wordpress.com/2012/05/22/swords-to-plougshares/
Gordon,
I hope you don’t mind if I respond to Phil above.
It was our perception that the cooperative movement had a very suitable model for the ‘profit for purpose’ business model we prescribed. It is known as a Community Benefit Society and was described in the business plan we created in 2004.
One of the first to be approached with this plan for investment funding were ICOF who responded saying that community broadband projects were being limited to bona fide coops and we were registered as a guarantee company, a route we took on the advice of ICOFs outgoing finance director at that time.
http://economics4humanity.wordpress.com/2012/05/28/capitalism-is-an-insufficient-economic-model/
In 2005, I expressed my concerns about lack of social finance, writing to Baroness Thornton a Labour Cooperative member at the House of Lords, who was then chair of the Social Enterprise Coalition. She never replied.