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8/29/2020 Larry Fink's 2019 Letter to CEOs | BlackRock

https://www.blackrock.com/corporate/investor-relations/2019-larry-fink-ceo-letter 1/4

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Purpose & Prot

Dear CEO,

Each year, I write to the companies in which BlackRock invests on behalf of our clients, the majority of whom have decades-long horizons and are planning for retirement. As a duciary to these clients, who are the owners of your company, we advocate for practices that we believe will drive sustainable, long-term growth and protability. As we enter 2019, commitment to a long-term approach is more important than ever – the global landscape is increasingly fragile and, as a result, susceptible to short-term behavior by corporations and governments alike.

Market uncertainty is pervasive, and condence is deteriorating. Many see increased risk of a cyclical downturn. Around the world, frustration with years of stagnant wages, the effect of technology on jobs, and uncertainty about the future have fueled popular anger, nationalism, and xenophobia. In response, some of the world’s leading democracies have descended into wrenching political dysfunction, which has exacerbated, rather than quelled, this public frustration. Trust in multilateralism and ofcial institutions is crumbling.

Unnerved by fundamental economic changes and the failure of government to provide lasting solutions, society is increasingly looking to companies, both public and private, to address pressing social and economic issues. These issues range from protecting the environment to retirement to gender and racial inequality, among others. Fueled in part by social media, public pressures on corporations build faster and reach further than ever before. In addition to these pressures, companies must navigate the complexities of a late-cycle nancial environment – including increased volatility – which can create incentives to maximize short-term returns at the expense of long-term growth.

Purpose and Prot: An Inextricable Link I wrote last year that every company needs a framework to navigate this difcult landscape, and that it must begin with a clear embodiment of your company’s purpose in your business model and corporate strategy. Purpose is not a mere tagline or marketing campaign; it is a company’s fundamental reason for being – what it does every day to create value for its stakeholders. Purpose is not the sole pursuit of prots but the animating force for achieving them.

Prots are in no way inconsistent with purpose – in fact, prots and purpose are inextricably linked. Prots are essential if a company is to effectively serve all of its stakeholders over time – not only shareholders, but also employees, customers, and communities. Similarly, when a company truly understands and expresses its purpose, it functions with the focus and strategic discipline that drive long-term protability. Purpose unies management, employees, and communities. It drives ethical behavior and creates an essential check on actions that go against the best interests of stakeholders. Purpose guides culture, provides a framework for consistent decision-making, and, ultimately, helps sustain long-term nancial returns for the shareholders of your company.

The World Needs Your Leadership As a CEO myself, I feel rsthand the pressures companies face in today’s polarized environment and the challenges of navigating them. Stakeholders are pushing companies to wade into sensitive social and political issues – especially as they see governments failing to do so effectively. As CEOs, we don’t always get it right. And what is appropriate for one company may not be for another.

One thing, however, is certain: the world needs your leadership. As divisions continue to deepen, companies must demonstrate their commitment to the countries, regions, and communities where they operate, particularly on issues central to the world’s future prosperity.

About Us Newsroom Insights Investor Relations Sustainability Careers 

8/29/2020 Larry Fink's 2019 Letter to CEOs | BlackRock

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Companies cannot solve every issue of public importance, but there are many – from retirement to infrastructure to preparing workers for the jobs of the future – that cannot be solved without corporate leadership.

Retirement, in particular, is an area where companies must reestablish their traditional leadership role. For much of the 20 Century, it was an element of the social compact in many countries that employers had a responsibility to help workers navigate retirement. In some countries, particularly the United States, the shift to dened contribution plans changed the structure of that responsibility, leaving too many workers unprepared. And nearly all countries are confronting greater longevity and how to pay for it. This lack of preparedness for retirement is fueling enormous anxiety and fear, undermining productivity in the workplace and amplifying populism in the political sphere.

In response, companies must embrace a greater responsibility to help workers navigate retirement, lending their expertise and capacity for innovation to solve this immense global challenge. In doing so, companies will create not just a more stable and engaged workforce, but also a more economically secure population in the places where they operate.

A New Generation’s Focus on Purpose Companies that fulll their purpose and responsibilities to stakeholders reap rewards over the long-term. Companies that ignore them stumble and fail. This dynamic is becoming increasingly apparent as the public holds companies to more exacting standards. And it will continue to accelerate as millennials – who today represent 35 percent of the workforce – express new expectations of the companies they work for, buy from, and invest in.

Attracting and retaining the best talent increasingly requires a clear expression of purpose. With unemployment improving across the globe, workers, not just shareholders, can and will have a greater say in dening a company’s purpose, priorities, and even the specics of its business. Over the past year, we have seen some of the world’s most skilled employees stage walkouts and participate in contentious town halls, expressing their perspective on the importance of corporate purpose. This phenomenon will only grow as millennials and even younger generations occupy increasingly senior positions in business. In a recent survey by Deloitte, millennial workers were asked what the primary purpose of businesses should be – 63 percent more of them said “improving society” than said “generating prot.”

In the years to come, the sentiments of these generations will drive not only their decisions as employees but also as investors, with the world undergoing the largest transfer of wealth in history: $24 trillion from baby boomers to millennials. As wealth shifts and investing preferences change, environmental, social, and governance issues will be increasingly material to corporate valuations. This is one of the reasons why BlackRock devotes considerable resources to improving the data and analytics for measuring these factors, integrates them across our entire investment platform, and engages with the companies in which we invest on behalf of our clients to better understand your approach to them.

BlackRock’s Engagement in 2019 BlackRock’s Investment Stewardship engagement priorities for 2019 are: governance, including your company’s approach to board diversity; corporate strategy and capital allocation; compensation that promotes long-termism; environmental risks and opportunities; and human capital management. These priorities reect our commitment to engaging around issues that inuence a company’s prospects not over the next quarter, but over the long horizons that our clients are planning for.

In these engagements, we do not focus on your day-to-day operations, but instead seek to understand your strategy for achieving long-term growth. And as I said last year, for engagements to be productive, they cannot occur only during proxy season when the discussion is about an up-or-down vote on proxy proposals. The best outcomes come from a robust, year-round dialogue.

We recognize that companies must often make difcult decisions in the service of larger strategic objectives – for example, whether to pursue certain business lines or markets as stakeholder expectations evolve, or, at times, whether the shape of the company’s workforce needs to change. BlackRock itself, after several years of growing our workforce by 7 percent annually, recently made reductions in order to enable reinvestment in talent and growth over the long term. Clarity of purpose helps companies more effectively make these strategic pivots in the service of long-run goals.

Over the past year, our Investment Stewardship team has begun to speak to companies about corporate purpose and how it aligns with culture and corporate strategy, and we have been encouraged by the commitment of companies to engaging with us on this issue. We have no intention of telling companies what their purpose should be – that is the role of your management team and your board of directors. Rather, we


8/29/2020 Larry Fink's 2019 Letter to CEOs | BlackRock

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seek to understand how a company’s purpose informs its strategy and culture to underpin sustainable nancial performance. Details on our approach to engaging on these issues can be found at BlackRock.com/purpose.

I remain optimistic about the world’s future and the prospects for investors and companies taking a long-term approach. Our clients depend on that patient approach in order to achieve their most important nancial goals. And in turn, the world depends on you to embrace and advocate for a long-term approach in business. At a time of great political and economic disruption, your leadership is indispensable.


Larry Fink Chairman and Chief Executive Ofcer

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The New Story of Business: Towards a More Responsible




Business is undergoing a conceptual revolution. Since the Global Financial Crisis there are many new ideas and pro- posals to make capitalism more responsible. The purpose of this paper is to identify key flaws in the “old story” of capitalism. Six principles are explained that taken together form the basis for a new story of business, one of responsible capitalism.


The last 40 years have seen great changes in our understand-ing of business. In our lifetime, we have seen a remarkablepace of globalization. We have seen revolutionary informa- tion technology. We have seen nothing less than a fundamental shift in the story of business. In this talk I will try to explicate what I believe is a conceptual revolution in business, and in particular, I

R. Edward Freeman is University Professor and Olsson Professor of Business Administration, the Darden School, University of Virginia, Charlottesville, VA. E-mail: [email protected] ginia.edu; redwardfreeman.com.

Editor’s Note: A public lecture by R. Edward Freeman, Verizon Visiting Professor of Business Ethics, Bentley University.

VC 2017 W. Michael Hoffman Center for Business Ethics at Bentley University. Published by Wiley Periodicals, Inc., 350 Main Street, Malden, MA 02148, USA, and 9600 Garsington Road, Oxford OX4 2DQ, UK.

Business and Society Review 122:3 449–465


will try to explain this “new story of business” in terms of a few fun- damental principles or ideas.

While the roots of this revolution are easily traceable back to the 1980s or even earlier, they are most clearly seen in the responses to the Global Financial Crisis (GFC) of 2008. Since that time, we have seen an explosion of ideas of how to make businesses more responsible for the consequences of their actions.

For instance, many companies have taken a renewed interest in corporate social responsibility and sustainability. In addition, we have seen a renewed emphasis on the idea of Conscious Capitalism as John Mackey and Raj Sisodia have argued that companies that follow the tenets of conscious capitalism will outperform those that do not. Michael Porter and a colleague have suggested that compa- nies focus on “shared value” where economic value and social value are seen as going hand in hand. Nestle has been the show pony for this idea. Just Capital is an NGO that is committed to rating com- panies on widely accepted standards of justice. Bill Gates has sug- gested Creative Capitalism, whereby companies forego profits for the sake of public welfare. Senator Mark Warner of Virginia has suggested that it is time for new metrics, especially around the wel- fare of workers and has hailed a move to Capitalism 2.0.

Meanwhile, the idea of social entrepreneurship has taken off with many millennials beginning to start businesses that address social problems. NGOs such as the Acumen Fund, Kiva, Kickstar- ter, and countless others have been started to provide capital for small and very small businesses and entrepreneurs who are socie- tal change agents. Even on Wall Street, we see an increase in the movement toward what is variously called, “patient capital,” “impact investing,” “responsible investing,” and other terms.

Business pundits have gotten into the act, decrying a lack of ethics that they claim brought about the GFC. Robert Reich has argued that ethics and profits have to go together. Agency Theorist pioneer Michael Jensen has suggested that integrity is an important element in a successful business. The Aspen Program in Business and Society has led various conversations about new business mod- els, new governance models, and a variety of other related ideas.

At two recent meetings at the White House in 2016 sponsored by the Obama Administration’s Department of Labor, 75 people from these organizations and movements gathered to discuss common- alities and whether or not there needed to be one brand that


identifies this new story of business that is emerging. While such a brand may someday emerge, or perhaps it already has, for my pur- poses I want to focus on the underlying ideas and principles that are inspiring all of this activity. Whichever brand or brands that ultimately become the rallying cry on which this conceptual revolu- tion will be based. The brand will have to be based on a sense of purpose and ethics that is as central to the new narrative as profit is to the old one. It will have to address how companies can simul- taneously create value for all of its key stakeholders. The brand will have to take sustainability and the physical limits of business very seriously. And, it will have to recognize that people are complex and that they can and do collaborate with others to create value. I will set these ideas out more carefully in a later section. For now, let’s turn to the dominant narrative or the “old story of business,” and see why it is no longer applicable for the twenty-first century.


While all of these conversations and new business models are going on, we still see many executives and academics who are strongly committed to the idea that the main goal of any business is to make as much money as possible for its shareholders. This view was artic- ulated best by Milton Friedman in a 1970 New York Times article in which he stated that the only responsibility of the executives is to make as much money as possible for shareholders. While Friedman’s view is more nuanced and is often misinterpreted, the shareholder primacy idea has a real grip on both executives and academics. This dominant narrative of what we might call the old story of business is deeply rooted in business cultures around the world. Oftentimes, it is appealed to as a way of justifying almost any action that seems to harm groups other than shareholders. Consequently, especially since the GFC, there’s a real struggle going on around the issue of the ethics of capitalism. Let’s be a little more precise here. We can talk about this old story of business in terms of five claims.

The first is that business is primarily about making money and profits for shareholders. Business on this view is the physics of money, and the language of money and profits is seen by many to be the main metaphor in talking about business. Often these theorists talk as if money is the only thing that matters, and the vocabulary of


finance and accounting are the only vocabularies that tell us how to build a great business. More precisely, business is seen as a collec- tion of economic transactions that can be fully understood using economic models and concepts. Modern economics has built some really powerful models, from general equilibrium to modern econo- metrics, and indeed they are useful for understanding how markets work. The problem is that they are not the only way to understand business, and they can be misleading as the GFC taught us.

The second claim is that the only constituency that matters is shareholders. Friedman’s claim is that the only social responsibility of an executive is to make as much money as possible for sharehold- ers. Even though Friedman was careful to also say that such a claim was subject to ethical rules and law—this part of the claim often gets left out. So, executives and pundits sometimes argue that what- ever is not illegal is permissible in the name of shareholder value.

The third claim is often implicit. It is that we live in a world of fairly limitless physical resources, or that market forces will always determine which resources are economically feasible to use. We need markets for natural resources such as air, water, and carbon emissions, not regulation.

The fourth claim, that we see played out in the popular press all the time, is about what motivates business people. In keeping with the idea that business is about the physics of money there is a wide- spread idea that given the opportunity business people will cut cor- ners, lie, and cheat. People, on this view, are completely self- interested. They will work for others, only if they are incentivized to do so with either a threat of punishment or a promise of rewards.

The fifth claim summarizes the first four and says that business and capitalism work because people and companies are self- interested, competitive, and greedy. The greatest good emerges as if by an invisible hand. Usually homage is paid to a brief passage in Adam Smith about the butcher and baker.


Profits Are not the Purpose of Business

While there has been much criticism of this so-called neo-classical view of the firm, for our purposes I want to focus on three main


flaws that make it easier to see why the old story is no longer appropriate. The first flaw is the idea that business is the physics of money and that profits are and should be the purpose of any business.

While there are many businesses that have come to see making money for their “owners” as the main purpose of their business, most of these businesses didn’t start out this way. Most entrepre- neurs start their companies because, in John Mackey’s words, “they are on fire about their business idea.” No matter whether it was Steve Jobs and Bill Gates on fire about the desktop computing revolution and starting Apple and Microsoft, Mackey himself, on fire about bringing healthy food to people through what became Whole Foods Market, or my son, Ben, on fire about bringing the great rhythm and blues sound of Motown and Stax into the twenty-first century with Red Goat Records, none of these entre- preneurs started the business with the purpose of making as much money as they could.

Now, of course, money and profits are important. They must exist for a business to live. Demonizing profits, as many pundits have done, is just a shortsighted, ideological mistake. Likewise, to claim that the purpose of a business is to make profits for owners is a similar and often ideological mistake.

I need to make red blood cells to live. However, it does not follow, without a lot of argument that I simple cannot imagine, that the purpose of my life is to make red blood cells. Even if I have fallen on unhealthy times, and I have to actually concentrate on making red blood cells, for instance by paying a lot of attention to the iron in my diet, it still does not follow that the purpose of life is to make red blood cells (or to breathe, or to drink water, etc.).

Likewise, sometimes businesses fall on hard times. A competi- tor disrupts the industry, or mistakes have been made, or the world simply changed. In all of these cases, a business might have to focus fairly clearly on generating profits to stay alive, but it would be a mistake to claim that profits were the purpose of the business.

Former CEO of GE, Jack Welch, business guru, Simon Sinek, and many others have claimed that it is best to see profits as an outcome. And, I will add it is an outcome of purpose and how value gets created for stakeholders. More on that idea later.


Business Ethics Is Not a Contradiction

When I tell people that I teach business ethics you know what hap- pens. Either they have to manage not to laugh, or they say “business ethics” I thought that was a contradiction. The idea that business and ethics do not go together has long been a part of the dominant story of business. After all, if business is just about money, shareholders, and profits, there’s not much room for ethics to be a central part of it. The way I like to put it is that of the phrase “business ethics,” we only really misunderstand two of the words.

First, let’s talk about business. The old story of business says to us that business is about competing, making money, and doing whatever you can get away with. The idea that business people are not trustworthy is in many cultures around the world. A recent study found that only 19% of people around the world actually trust business executives of large companies. Now, every business person that’s here today knows that business is not just about making money. But even if that’s all you want to do, how are you going to do it? You would better have some products and services that customers want to buy. You need suppliers who are commit- ted to making you better by improving your business with their products and services. You need employees who are not there just for the paycheck but are there to make your business better— employees who are engaged in their jobs. You need them not to be unengaged or actively engaged, as many studies have found is the case in a lot of businesses. And, you need to be a good citizen in the community. If you are not a good citizen in the community, communities will pass restrictive laws or ordinances to prevent your business from operating well there. If you do these things, if you have great products and services for customers, if your suppli- ers want to make you better, if you have employees who are engaged, and if you are a community builder, then if you put those things together the right way, profits will emerge. Again, this is the idea that profits are an outcome. So business, far from being just about the money, is about creating value for stakeholders.

Now, let’s talk about ethics. Many people think that ethics is about things you talk about only on Sunday. It’s about angels and organ music or very serious things talked about in hushed tones. While religion is important in ethics, I want to urge you to think


about it more broadly. Ethics is really the most practical thing around. Ethics is about how I live my life and how living my life affects how you live your life. Ethics is always personal; it’s about what I want and how I’m going to live. And, it’s always interpersonal. It’s about how we are going to live together. Many people have the idea that ethics is about rules chipped into stone, rules that never change and rules that are fairly inflexible. But sometimes these “rules” can conflict and sometimes they need to change or be inter- preted in different ways as we invent new technologies or discover other previously hidden features of a situation. Ethics is, in my view, a conversation about how we are going to live together. It is a conver- sation that substitutes reason, dialogue, and talking together for vio- lence. It’s easy to see in many places in the world where the conversation has broken down. Violence is not a good answer. Now, many people would argue that ethics is personal. I get to decide what my ethics are. I have to look myself in the mirror. I have to live with myself. And that’s true, you do have to live with yourself. But all of us have to live with you too. And that gives us some right to join in the dialogue and conversation about how we are all going to live and thrive together. From the time when we lived in caves, we have always had conversation about what behavior is appropriate and what behavior is inappropriate in a community. We have had con- versations about what are some good ideas—some good rules of thumb—to keep the order in society and to allow all of us to flourish. This is ethics at its best. Over time, we have grown quite good at ethi- cal reasoning. But at the same time, we have many challenges to our ethics in society today primarily because of technological change and the emergence of new societies to do things differently and new cases of a kind that we just have not thought of before.

For instance, I learned ethics at my grandmother’s knee in the 1950s in Georgia, but we did not have any conversations about intellectual-property that could be digitally reproduced for no cost. We did not have any conversation about end-of-life technology that could prolong life at a great cost. We did not have any conversa- tions about abortion or things like file-sharing and Napster or what’s appropriate on Facebook and Twitter. Those things simply did not exist. Now, one thing you can say is know your ethics and your values and you will not have to have much of a conversation. The problem with this is that it is very hard to do in today’s world. Human beings are very good at fooling themselves and saying one


thing and doing something else. We need each other in this conver- sation about how we are going to live together.

What does all this have to do with business? If you ask people around the world to write down their three most important values that they would like to teach their children, or their three most important ethical principles, they all pretty much actually write the same thing. There is some version of respect, honesty and integrity, caring and love, and responsibility. Of course, what it means to show respect in Jakarta is very different than what it means in Charlottesville, so there is always a cultural context. But, it is diffi- cult to imagine doing business without these values. Try to think what it would be like to do business always with people you did not respect, or on whose honesty you could not rely on, or who did not care about others. It would be impossible.

Adam Smith knew how important ethics was to business. Indeed, in The Theory of Moral Sentiments and in The Wealth of Nations, Smith makes it clear that without a sense of justice, mar- kets just will not work very well at all. Thinking that business ethics is a contradiction is a deep flaw in the dominant narrative of business.

People Are Complicated

There is ample scientific evidence that human beings are not the rational economic beings that much of our economic and business theory assumes. We are not always driven by extrinsic if-then rewards. We want to be engaged in doing something that has meaning and purpose. Some like Daniel Pink, have argued that we understand human motivation in terms of three ideas: Mastery, the sheer joy we take out of getting better at something; Autonomy, the freedom to live our own lives to try new things; and Purpose, the idea that we stand for something greater than just ourselves and our self-interest. By thinking about mastery, autonomy, and purpose we get a much more realistic view of what motivates peo- ple in business. The old story’s insistence on human beings being motivated primarily by money is really not appropriate in the twenty-first century if it ever was appropriate. Certainly, the new generation that we call Millennials want to do something that has meaning, that has purpose, that is not just making money.


Psychologist, Harry Levinson, used to hang out at the Harvard Business School. He was kind of a crusty old guy and would often ask executives what was the main way people are motivated inside corpora- tions. Most executives would say to him rewards and punishments or carrots and sticks. Levinson would draw on the board a carrot at one end and a stick at the other. In the middle, he would put a question mark. He would ask what animal do you imagine between the carrot and the stick? Most people would say a jackass. So, Levinson coined the idea that he called the great jackass fallacy. It goes like this: maybe. . . just maybe, human beings are slightly more complex than jackasses. Maybe they have social, spiritual, sexual, political, ethical lives as well as economic lives. But it’s even a little more difficult than that. If you treat people like jackasses, they begin to act like jackasses. They nose around for the carrots and they try to avoid getting the stick. Think of all of the productivity that gets left on the table, and, indeed, think of all of the human misery that results from treating people like jackasses. Human beings are more complex than the dominant story would have us believe. We will say more about this as we move to thinking about the principles that underlie this new story of business.

There are at least three flaws in the current story of business. First, the purpose of a business is not only to make money. Sec- ond, business and ethics need to go hand in hand. And, third, human beings are complicated. The time has passed for these flaws. The new story of business that is being built by thousands of entrepreneurs and executives around the world eschews these flaws and takes a different approach. Let’s turn to understanding the ideas that are behind the new narrative.


I have identified at least six new ideas that undergird the new story of business that is emerging. They are: (1) The unit of analysis is stakeholder relationships; (2) stakeholders are interdependent; (3) tradeoffs are managerial failures of creative imagination; (4) pur- pose, values, and ethics must be embedded in organizations; (5) business exists in the physical world; and (6) people are compli- cated. Let’s look at each in turn and see how they are connected with each other and this new story.


The Unit of Analysis Is Stakeholder Relationships

One of the cornerstone ideas behind the new story of business that is emerging is the importance of looking beyond shareholders to a broader group of stakeholders. As we saw earlier, creating value for stakeholders is something that every successful busi- ness has actually done. As we become more aware of this fact, we can build into our business models more nuanced ways to create value.

The key difference is that in a relationship there is a presump- tion that the relationship will continue over time, other things being equal. Businesses need relationships with their stakeholders so that each has some attachment to the other. You want custom- ers to have some degree of loyalty. You want employees to give you the benefit of the doubt, and you want shareholders who will stick by you when things are tough. Seeing these relationships through the lens of “discrete transactions unrelated to each other” does not build loyalty. In fact, it encourages exit when things get tough. Building loyalty with stakeholders mitigates the risks of difficult times.

Company X had built a relationship with a stakeholder group that often criticized the company. The stakeholder was targeting X with a campaign and called to tell them. The executive at Com- pany X asked for help in solving the problem that the campaign was about, and the company and stakeholder were able to intro- duce an innovative program that went a long way toward solving the problem. All of this happened because there was a relational mind set.

Of course, relationships are two-way streets. Companies have to stand by their suppliers and their employees when times are tough for them. And, they have to share in the rewards of success, in a broad manner, not just in terms of rewarding senior management. Whole Foods Market uses gain-sharing to reward the employees who work to bring things in under budget. They also give most of the stock options to non-top management employees.

Stakeholders Are Interdependent

It has often been said that the key insight of stakeholder theory is that there are groups that are important other than shareholders.


And, while this is one insight that the theory has brought to man- agement thinkers, another is more important. It is that stake- holder interests have a certain interdependence. And, when management can capture this interdependence and push it for- ward, great results are likely to occur. Wal-Mart was for many years a poster child for this interdependence. By negotiating tough deals with suppliers, Wal-Mart could offer customers every- day low prices, and even though the margins were thin for suppli- ers, there was a great deal of volume that could lead to profitability. Employees were better off since there were more cus- tomers coming to take advantage of the everyday low prices, and the stock price saw a steady increase. Unfortunately, Wal-Mart paid little attention to communities as stakeholders, focusing on citizens as customers. Many outside groups began to be formed and Wal-Mart was blamed for many social ills. Today, Wal-Mart is working hard to repair its relationships with communities and to integrate ideas that make communities better off into the rest of its business model. The progress that has been made with sus- tainability is but one of several examples where Wal-Mart has taken a leadership role.

Even the companies who do CSR and who have adopted Michael Porter’s view of shared value have begun to see stakeholders as interdependent. For a long time, CSR was seen as something of a public relations move, unconnected to the main business model. More recently, we have begun to see how CSR can be connected to the basics of what a company knows how to do. Nestle has pio- neered this idea with shared value, as it has sought to introduce the creation of social value all the way down its economic value chain.

Trade-offs Are Managerial Failures of Creative Imagination

Economists love trade-offs. In fact, one of the hallmarks of modern economics is that one can always calculate trade-offs. I have become increasingly skeptical of trade-off thinking. In fact, I believe that the drive to collaborate and avoid trade-off thinking is far more powerful. When we see the task of the executive as getting stakeholder interests all going in the same direction over time, trade-offs will disappear. Of course, sometimes they have to be


made, because we cannot imagine an alternative, but when we make a trade-off we need to immediately begin the process of mak- ing the trade-off better for both sides.

I have often told the story of a large chemical company who decided to commit to being more sustainable and cleaner. The CEO announced a large and lofty sustainability goal and proceeds around to the divisions and plant sites to let them know that he was very serious about this. There were interim goals and plans in a very businesslike approach. In one facility, as he told the story to a symposium at Dartmouth in the 1990s, the engineers came up to him and said, “Sorry but we can’t meet these interim goals. This process is too dirty, this equipment is too old, and we can’t meet the first target.” The CEO said that they were serious about this program and so they would have to close the plant. What I under- stood from that was that he was willing to make a trade-off, envi- ronment or community on the one hand versus employees on the other. The CEO’s trade-off was that the environment was a serious issue and it was going to be the winner. So, he told the engineers to prepare to close the plant. A few weeks later the engineers came back and said that a miracle had occurred. They figured out how to do it. When the CEO asked what it would cost, the engineers actually were embarrassed to say that the new method would save money.

When trade-off thinking becomes unacceptable we kick into gear the only infinite resource we really have, which is our creative imagination. The use of the creative imagination is radically underutilized in most companies today. Trade-offs are easy. In the new story of business with the stakeholder mindset, trade-offs become managerial failures. As more and more companies are thinking about the new story of business, they are discovering ways to satisfy multiple stakeholders. Simultaneously, this is one of the key ideas in the new story.

What this means is that conflict, often avoided in many compa- nies, is precisely the place where value creation can take place. When there’s conflict among stakeholders, where there’s conflict among core values, where there is conflict among competitors or products this is exactly the place where we can reimagine that con- flict and create more value. We have to come to see conflict as a good thing. Recall the story above about company X who had con- flict with the stakeholder group but kept up the relationship


because that stakeholder group could help them figure out how to solve a problem. A lot of value was created.

Purpose, Values, and Ethics Must Be Embedded in the Organization

One of the great things about business as an institution is that many different purposes are possible. Novo Nordisk wants to rid the world of diabetes. Whole Foods Market wants to help people be healthier with better choices for food. Tastings, a small restaurant in my hometown, wants to bring the joy of good French country cooking to its customers. The founders of Relish MBA want to make it easier for companies and MBA students to find a good match. The only limit to the purpose of a business is our imagina- tion. Of course, purposes do not have to be all good. We have plenty of examples from human history about organizations that were of high purpose, but whose purpose was morally evil. A sense of values and ethics has to go alongside purpose. There are many organizations in the pantheon of new story organizations who are addressing precisely this issue. Just Capital is rating organizations based on a notion of “Justice.” However, it shakes out, we can no longer make the mistake that the pursuit of profits is the sole pur- pose of business. Real purpose inspires both employees and other stakeholders who come to share that purpose. And, this new story of business is an inspirational story.

Businesses Exist in the Physical World

While many who write about sustainability and the environment sound a caution about the physical limits of the world, I want to suggest that this is only part of the story. We do need to come to see business as embodied in the world, and hence, there are con- straints imposed by the physical world. However, we also need to see business as capable of transforming those constraints into new opportunities. We have seen this time and again as companies such as 3M figure out how to turn waste streams into products and services. Obviously, we need to tackle climate change, but see- ing it as giving us limits to growth is forgetting the creative imagi- nation that has solved so many of our problems in the past. Adopting some kind of green values, and integrating respect for the


environment into our purpose and values, can be a powerful elixir for creativity.

People Are Complicated

I do not want to repeat the arguments I gave earlier about the flaws in the old story. Rather, I want to suggest that there is a much more inspirational view of human beings that is emerging. People are using business models and ideas to attack age old problems of poverty, education, disease, and more participation in society. Often these problems are attacked by these “new story companies” in conjunction with NGOs, governments, and other private organi- zations. We have seen a wave of “social entrepreneurs” and “impact investing” where the explicit idea is to use business to make society better and to solve social problems. I believe that we are fast craft- ing a new idea about what it is to be human. Let me illustrate.

What is this smartphone, really? The way I see it, it’s some bits of sand and metal, some vocabularies that we have invented to solve problems, and the fact that we can work together collabora- tively to achieve things that no one of us can achieve alone. In short, I see the world not as a world of scarcity, but as one of abun- dance. We have an almost infinite capacity to invent ways to solve our problems, whether we take on poverty, space travel, climate change, or understanding the rules of cricket. But, we are not in it alone. We invent mutually beneficial vocabularies with others to solve our problems. And, this is true whether we are scientists or politicians. We are surely more than narrow economic creatures, and in fact, capitalism works just because of this complex human dimension.


If we are to move our system to a more responsible capitalism, we need a few more ideas that will transcend these particular ones aimed at creating and sustaining a successful business. First of all, we need some broadly defined principles of responsibility throughout our society. Responsibility is an idea that comes with the more libertarian idea of freedom that underpins market sys- tems. We need to see people and companies as responsible for the


effects of their actions on others. That is the moral cornerstone of the stakeholder idea. Unless we are willing to take responsibility and to be willing to justify our actions to our fellow humans, our society will not continue to flourish.

The second idea is that we need to continue to see business as a voluntary enterprise. No one is forced to do business with anyone else. This idea of choice as applied to multiple stakeholders is cen- tral in creating a system of business that works for everyone. Com- petition should celebrate the choice that customers have. Restricting that choice artificially through institutions like crony capitalism should have strong sanctions.

Finally, we need a new idea of the role of government. While we have clear theories about how government plays its role as both regulator and redistributor, there is another role that is often over- looked. Government can be a facilitator of value creation. It does this via infrastructure and other programs such as enforcing civil rights, and ensuring that crony capitalism does not take hold. We have only begun to explore this idea of government as facilitator of value creation, so stay tuned.


Let me wrap up by taking these ideas down to an extremely practi- cal level. There are at least five ways to begin to practice this more responsible capitalism in your businesses.

First, you can rediscover your purpose and the values that go with it. No less a company than Unilever has begun this process, and while it takes time, the payoffs are large. Employees become inspired, and the innovative ideas begin to flow. How do you redis- cover your purpose? Well, the first thing to do is to have a look at history. What are the founders’ stories that are told in the com- pany? Why do people actually show up for work? What really helps them when they are at their best? It takes a concerted effort if a company has lost its way, but it is an exciting process to rediscover the purpose of an organization. Values go along with purpose and are often seen as the “How” we are going to realize the purpose.

Second, you can perform a systems/process check on the pur- pose and values. Purpose and values live in the systems and pro- cesses of an organization. Talk is cheap. The first places to look are


the HR and expense reimbursement systems. Think about an orga- nization that trumpeted its respect for employees but required them to get a receipt for a $2 toll on the Mass Pike, a task that is mostly dangerous if not impossible. Or consider an organization who is very proud of its stand on values, yet waits 60 days to reim- burse employees, and pays suppliers in even later terms.

Third, you can begin live conversations about the purpose and values. Small groups of employees can help to clarify what values are actually in force at the company, and there are known techni- ques for creating a conversation about these values, such as which ones are we really serious about, and which ones are we just giving lip service to. Some companies have begun to encourage meetings where employees bring “values vignettes,” or sticky problems, to groups of peers to try and get insights. Based on Johnson and Johnson’s original “challenge meetings” discussions of these vignettes helps to clarify what the true meaning and intention of often quite general values statements are.

Fourth, you can be a community builder. There are many ways to help build the communities in which you operate. Giving employees time off to volunteer, hiring some of the least well-off members of a community and giving them training, and donating to charities, are all viable strategies. However, figuring out what you know how to do, can be used to build community, brings the power of the business model to bear on tough problems. We are beginning to see more and more companies working with stake- holder groups in the nonbusiness sector to jointly tackle societal issues. Such multi-sector collaborations are one of the best ways to build community.

Finally, you can communicate how your organization makes the world a better place. We need business organizations to inspire us. We need business to become an institution of hope. We need busi- ness executive to try and remake their organizations to be places we want our children to live in. Asking anything else is to set the bar too low.


The ideas in this paper have been partially developed in a number of places, especially Freeman, Martin, and Parmar (2007); Freeman,


Parmar, and Martin (2016); Freeman and Ginena (2015); and, Free- man (2017, forthcoming).

I am grateful to editors and co-authors for their permission to more carefully develop these ideas here for a public audience. This paper will be a part of a forthcoming book, tentatively titled The New Story of Business: Responsible Capitalism, co-authored with Bidhan Par- mar and Kirsten Martin, in 2018.


Freeman, R. E. 2017. “Five challenges to stakeholder theory: A report on research in progress,” in D. Wasieleski and J. Weber, eds., Stakeholder Management, Business and Society 360 Series. Emerald Publishing (forthcoming).

Freeman, R. E., and Ginena, K. 2015. “Rethinking the purpose of the cor- poration: Challenges from stakeholder theory,” Notizie di Politeia 31(117): 9–18.

Freeman, R. E., Harrison, J., Wicks, A., Parmar, B., and de Colle, S. 2010. Stakeholder Theory: The State of the Art. Cambridge: Cambridge University Press.

Freeman, R. E., Martin, K., and Parmar, B. 2006. “Ethics and capitalism,” in M. Epstein and K. Hanson, eds., The Accountable Corporation, Vol 2: Business Ethics. Westport, CT: Praeger, pp. 193–208.

Freeman, R. E., Martin, K., and Parmar, B. 2007. “Stakeholder capital- ism,” Journal of Business Ethics 74: 303–314.

Freeman, R. E., Parmar, B., and Martin, K. 2016. “Responsible capital- ism: Business for the 21st century,” in D. Barton, D. Horvath, and M. Kipping, eds., Re-Imagining Capitalism. Oxford: Oxford University Press, pp. 135–144.

Friedman, M. 1970. “The social responsibility of business is to increase its profits,” New York Times Magazine 13: 32–33.


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The Problem of Corporate Purpose


The Problem of Corporate Purpose Lynn A. Stout

hat is the purpose of the modern public corporation? Most people today would say corporations have but one proper purpose: maximizing their shareholders’ wealth as measured by stock price. Other goals--serving

customers, building great products, providing good jobs—are viewed as legitimate business ends only to the extent they increase “shareholder value.” This view prevails in large part because it’s what is taught in our nation’s classrooms. According to a recent Brookings study of the curricula of top law and business schools, professional school courses emphasize maximizing corporate profits and shareholder value as the proper purpose of business corporations. As a result, “students believe the primary purpose of the corporation is to maximize shareholder value, and they believe this is how current corporate leaders behave when they are making business decisions.” 1 In my book The Shareholder Value Myth, I demonstrate how this “shareholder primacy” theory can be hazardous to the health of investors, companies, and the public alike.2 Shareholder value ideology in fact is a relatively new development in the business culture. It is not supported by the traditional rules of American corporate law; is not consistent with the real economic structure of business corporations; and is not supported by the bulk of the empirical evidence on what makes corporations and economies work. Indeed, there is good reason to suspect that focusing on “shareholder value” may in fact be a mistake for most business firms. This is because there is no single shareholder value—different shareholders have different needs and interests depending on their investing time frame, degrees of diversification and interests in other assets, and perspectives on corporate ethics and social responsibility. Shareholder value ideology focuses on the interests of only a narrow subgroup of shareholders, those who are most short-sighted, opportunistic, willing to impose external costs, and indifferent to ethics and others’ welfare. As a result shareholder value thinking can lead managers to focus myopically on short-term earnings reports at the expense of long-term performance; discourage investment


Number 48 June 2012

Lynn A. Stout is the Distinguished Professor of Corporate and Business Law, the first endowed professorship in the Clarke Business Law Institute at Cornell School of Law.

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and innovation; harm employees, customers, and communities; and lure companies into reckless and socially irresponsible behaviors. This ultimately harms most shareholders themselves—along with employees, customers, and communities.

Where Did Shareholder Value Thinking Come From?

The public company as we know it today came to prominence at the turn of the 20th century. Before then, most corporations were “closely held” companies whose stock was held by a single controlling shareholder or group of shareholders who were intimately involved in the company’s affairs. The question of corporate purpose wasn’t really on the table, because the company’s purpose was whatever its controlling shareholder or shareholders wanted it to be. Some controlling shareholders might care only about profits, but others worried about the welfare of their employees, consumers, and communities, and about the growth and health of the business itself.

By the early 1900s, however, a new type of corporation began to cast a growing shadow over the economic landscape. The new “public” companies sold stock to hundreds or even hundreds of thousands of small investors who had no interest in being involved in the company’s daily affairs. Control and authority in firms like American Telephone and Telegraph (AT&T), General Electric (GE), and the Radio Company of America (RCA) rested not in controlling shareholders’ hands, but in boards of directors who hired full-time executives to run their companies.3

Who or what should these professional corporate managers serve? Almost from its inception, the public corporation inspired impassioned debate over what its purpose ought to be. Some observers thought that (as we teach today) the corporation’s only goal should be maximizing its shareholders’ wealth. This “shareholder primacy” view was countered, however, by a “managerialist” philosophy that taught that corporations should be professionally managed to serve not just shareholders, but also employees, customers, and the broader society. By mid-century, the managerialist view clearly dominated.4 Fifty years ago, if had you asked a director or executive what the purpose of the corporation was, he was likely to answer that the firm had many purposes: to produce satisfactory returns for investors, but also to provide good jobs to employees, make reliable products for consumers, and to be a good corporate citizen.

All this changed in the 1970s with rise of the Chicago School of free- market economists. According to prominent members of the Chicago School, economic analysis revealed the proper purpose of the public corporation clearly, and that purpose was to make money for its dispersed shareholder “owners.” If corporate managers pursued any goal other than maximizing shareholder value, they were misbehaving corporate “agents” imposing inefficient “agency costs” on both shareholders and society.5 An increase in share price was viewed as proof of greater economic efficiency.

Almost from its inception, the public corporation inspired impassioned debate over what its purpose ought to be.

The Problem of Corporate Purpose 3

The Chicago School’s approach proved irresistibly attractive to a number of groups for a number of reasons. To tenure-seeking law professors, the Chicago School’s application of economic theory to corporate law lent an attractive patina of scientific purity to the messy business of corporate law. The idea that business performance could be measured through the single metric of share price enticed a generation of economists and business school professors to produce innumerable empirical studies testing the relationship between share price and variables like board structure, capitalization, mergers, state of incorporation, and so forth, in the quest to uncover the secret to “good corporate governance.” To the popular press and the business media, shareholder primacy provided an easy sound-bite explanation of the firm and, better yet, an obvious villain for every disaster and scandal: wayward corporate “agents” taking advantage of their “shareholder principals.’”

Finally, lawmakers, consultants, and would-be reformers now had a simple prescription for every corporate ill. The prescription had three ingredients: (1) give shareholders more power, (1) give boards of directors less power, and (3) “incentivize” executives and directors by tying their pay to share price. According to the dogma of shareholder value, this medicine could be given to any suffering company and better performance was sure to follow.

The Chicago School’s theories began to influence actual corporate practice. During the 1990s, the Securities Exchange Commission (SEC) adopted a number of individually-modest but collectively-significant rule changes designed to encourage boards to pay closer attention to shareholder demands. Meanwhile, activist shareholders and would-be reformers pushed for changes in corporations’ internal governance structures, especially the elimination of “staggered” boards that made hostile takeovers more difficult, in order to “unlock shareholder value.” Finally, shareholder value thinking came to appeal to executives through the direct route of self-interest. In 1993, Congress amended the tax code to encourage corporations to tie the bulk of their executive’s compensation to stock price as a means of “tying pay to performance.” Equity- based compensation rose from an average of zero percent of the median executive’s pay at Fortune 500 firms in the 1980s, to account for 60% of the median pay in 2001.6

Time to Question Shareholder Primacy By the close of the millennium, most scholars, regulators and businesspeople had come to accept without question that shareholders “owned” public corporations and that the proper purpose of the corporation was to maximize its shareholders’ wealth. Shareholder primacy had become dogma, a belief system that was seldom questioned, rarely justified, and so commonplace most of its followers could not even recall where they had first learned of it.

The Problem of Corporate Purpose 4

Today questions seemed called for. The dogma of shareholder primacy predicts that Corporate America’s mass embrace of shareholder value thinking over the past two decades should have greatly improved the business sector’s performance. This prediction plainly has not been borne out. For most of the twentieth century, American public corporations were the engine of a thriving economic system that worked to benefit investors, employees, and the broader society. But in recent years our business sector has stumbled. We have suffered a daisy chain of costly corporate scandals and disasters, from massive frauds at Enron, HealthSouth, and Worldcom in the early 2000s, to the near-collapse of the financial sector in 2008, to the BP Gulf oil spill disaster in 2010, to the Walmart bribery scandal unfolding today. The number of U.S. public companies is decreasing, from 8,823 in 1997 to only 5,401 in 2009.7 Shareholder returns have been disappointing at best— the past ten years are now known as “the lost decade” for investors.

We have been dosing our public corporations with the medicine of shareholder value thinking for at least two decades now. The patient seems, if anything, to be getting worse. And with good reason. Closer inspection reveals that the idea that public corporations are run well when they are run to maximize share price is a myth, and a dangerous myth at that.

How Shareholder Value Thinking Gets the Law Wrong One of the most striking symptoms of how shareholder primacy thinking dominates contemporary discussions of corporations is the way it has become routine for journalists, economists, and business experts to claim as undisputed fact that U.S. corporate law requires directors of public companies to try to maximize shareholder wealth. As one editor of Business Ethics put it, “courts continue to insist that maximizing returns to shareholders is the sole aim of the corporation. And directors who fail to do so can be sued.”8

This common and widespread perception lacks any solid basis in actual corporate law. The corporate code of Delaware, where the majority of Fortune 500 businesses are incorporated, states that corporations can be formed for any lawful purpose.9 Similarly, the typical public company charter broadly defines the company’s purpose as “anything lawful.” (Although it is perfectly possible for a corporate charter to state that the company’s purpose is to maximize shareholder value, virtually no public company charter does so.) This leaves advocates of shareholder primacy in something of a bind. Where, exactly, can the supposed legal requirement that directors maximize shareholder value be found?

When pressed, shareholder primacy advocates typically cite the nearly century-old case Dodge v. Ford, in which the Michigan Supreme Court famously observed that “a business corporation is organized and carried on primarily for the profit of the shareholders. The powers of the directors are to be employed for that end.”10 This remark, however, was what lawyers call “mere dicta,” an

Shareholder returns have been disappointing at best— the past ten years are now known as “the lost decade” for investors.

The Problem of Corporate Purpose 5

offhand remark that was not needed for the court to reach its desired result in the case, and that does not create binding precedent. More importantly, modern courts—especially Delaware courts—simply do not follow this element of Dodge v. Ford. To the contrary, thanks to a vital legal doctrine known as the business judgment rule, directors of public companies enjoy virtually unfettered legal discretion to determine the corporation’s goals.

In brief, the business judgment rule holds that so long as a board of directors is not tainted by personal conflicts of interest and makes a reasonable effort to become informed, courts will not second-guess the board’s decisions about what is best for the company—even when those decisions predictably reduce profits or share price. Consider the recent Delaware case of Air Products, Inc. v. Airgas, Inc.11 Air Products wanted to acquire Airgas, whose stock had been trading in the $40s and $50s, at a price of $70 per share. Airgas’ board refused Air Products’ amorous advances, even though many Airgas shareholders supported the sale as a way to make a quick profit. The Delaware Court supported the Airgas boards’ decision to reject the offer, stating that the board “was not under any per se duty to maximize shareholder value in the short term.”12 As Airgas and many other cases show, disinterested and informed directors are free to reduce profits and share price today when they claim to believe this will help the corporation in “the long run.” They are also free to decide what is in the corporation’s “long run” interests.

How Shareholder Value Thinking Gets the Economics Wrong

Even if the law does not require directors to maximize shareholder value, it is of course still possible to argue it ought to. In other words, shareholder primacy can be defended not as a legal requirement, but as a superior philosophy for managing corporations to ensure they contribute the most to the economy and to our society. Many advocates of shareholder value maximization do indeed seem to believe this rule ensures corporations provide the maximum possible benefits to society: an increase in share price is viewed as tantamount to an increase in overall economic efficiency. This belief, in turn, seems based not on experience or hard evidence but on the seductive appeal of a theory, the principal-agent model of the corporation.

The principal-agent model is associated with a 1976 article published in the Journal of Financial Economics by business school dean William Meckling and finance theorist Michael Jensen. 13 This article, titled “The Theory of the Firm,” explored in economic terms the problem that arises when the owner of a business (the so-called principal) hires an employee (the agent) to run the firm on the owner’s behalf. Because the agent does all the work while the principal gets all the profit, we can expect the agent to shirk or even steal at the principal’s expense. Thus undesirable “agency costs” are created when ownership is separated from control.

Jensen and Meckling’s article--the most frequently-cited article in

The Problem of Corporate Purpose 6

business academia today14—assumed without discussion the “principals” in public corporations were the shareholders, and directors were the shareholders’ “agents.” Yet Jensen and Meckling were economists, not lawyers, and this assumption (as we shall see below) fundamentally mistakes the real economic and legal relationships among shareholders, executives, creditors, and directors in public corporations. Nevertheless, the principal-agent model was eagerly embraced by a generation of academics in law, business, and economics as a simple way of understanding the complex reality of public corporations. Among other advantages, it gave a clear answer to the murky question of corporate purpose, because it taught that the best way to maximize the total value of the company was to focus on maximizing share price, which represented the shareholders’ interest as the firm’s supposed “residual claimant.”

There is one serious problem with this analysis, however. Put bluntly, the principal-agent model is wrong. Not wrong in a normative sense; there’s nothing objectionable about a principal hiring an agent. But it’s clearly incorrect, as a descriptive matter, to say the principal-agent model captures the reality of modern public corporations with thousands of shareholders, scores of executives, and a dozen or more directors.

This becomes readily apparent if we consider the three factual claims that lie at the heart of the principal-agent model. The first incorrect factual claim is that shareholders “own” corporations. As a legal matter, shareholders do not own corporations. Corporations are independent legal entities that own themselves, holding property in their own names, entering their own contracts, and committing their own torts. What do shareholders own? The label “shareholder” gives the answer. Shareholders own shares of stock, and shares in turn are contracts between the shareholder and the corporation that give shareholders limited rights under limited circumstances. (Owning shares in Ford doesn’t entitle you to help yourself to the car in the Ford showroom). In a legal sense, stockholders are no different from bondholders, suppliers, and employees. All have contractual relationships with the corporate entity. None “owns” the company itself.

The second mistaken factual claim underlying the principal-agent model is that shareholders are the sole residual claimants in corporations. Corporate “stakeholders” like employees, customers, and creditors are assumed to receive only the benefits their formal contracts and the law entitle them to (fixed salaries, interest, and so forth), while shareholders supposedly get all profits left over after the firm has met those fixed obligations. Again, this assumption is patently incorrect. The only time shareholders are treated anything like residual claimants is when a company falls into bankruptcy. In operating firms, shareholders only get money when the directors decide the shareholders should get money, which the board can arrange either by declaring a dividend (a decision entirely in the board’s discretion) or by choosing to limit expenses so the company builds up accounting profits and “retained earnings.” (If a company is minting cash, its directors have the option of allowing accounting profits to

But it’s clearly incorrect, as a descriptive matter, to say the principal- agent model captures the reality of modern public corporations with thousands of shareholders, scores of executives, and a dozen or more directors.

The Problem of Corporate Purpose 7

increase, but they could also raise executives’ salaries, improve customer service, increase employee benefits, or make corporate charitable contributions.) The corporation is its own residual claimant, and its board of directors decides which groups get what share of the corporation’s residual.

Finally, the third fundamental but mistaken belief associated with the principal-agent model is that shareholders and directors are just that—principals and agents. Again, this premise is wrong. The hallmark of an agency relationship is that the principal retains the right to control the agent’s behavior. Yet one of the most fundamental rules of corporate law is that corporations are controlled by boards of directors, not by shareholders. Although in theory shareholders have the right to elect and remove directors, in practice the costs of mounting a proxy battle combined with dispersed shareholders’ “rational apathy” raises near-insurmountable obstacles to organized shareholder action in most public firms.15 Thanks to the business judgment rule, shareholders also can’t successfully sue directors who place stakeholders’ or society’s interests above the shareholders’ own. Finally, while the ability to sell her shareholdings sometimes can protect a disgruntled individual investor who wants to express her unhappiness with a board by “voting with her feet,” when disappointed shareholders in public companies sell en masse, they drive down share price, making selling a Pyrrhic solution.

The economic structure of public corporations insulates boards of directors from dispersed shareholders’ command and control in ways that make it impossible to fit the square peg of the public corporation into the round hole of the principal-agent model. Of course, one could always argue that shareholder powerlessness is exactly the problem that needs to be remedied, and that corporations would work better if shareholders acted more like principals and if directors acted more like shareholders’ agents, Yet this argument leaves shareholder primacy dogma at its most vulnerable. If changing corporate governance rules to make boards more shareholder-oriented really improves corporate performance, we should see evidence of this in the business world. That evidence is notably missing.

How Shareholder Value Thinking Gets the Evidence Wrong Over the past two decades, legal and economic scholars have generated dozens of empirical studies testing the statistical relationship between various measures of corporate performance and supposedly shareholder-friendly elements of corporate governance like director independence, a single share class, or the absence of staggered boards and poison pills. These tests have produced mostly confusion. For example, one recent paper surveyed the results of nearly a dozen empirical studies of what happens when companies use dual share classes to reduce or eliminate public shareholders’ voting rights, a governance structure the principal-agent model predicts should harm corporate performance by increasing agency costs. The survey concluded that some studies found no effect

If changing corporate governance rules to make boards more shareholder- oriented really improves corporate performance, we should see evidence of this in the business world.

The Problem of Corporate Purpose 8

on performance, some found a mild negative effect, and some a mild positive effect. At least one study found that dual share classes greatly improved performance—exactly the opposite of what shareholder primacy advocates would predict.16

This lack of empirical support for the supposed superiority of the shareholder-oriented model has captured at least some scholarly attention. (Roberta Romano of Yale Law School has famously called some shareholder- oriented governance reforms “quack corporate governance.”)17 But the evidence in support of shareholder primacy is even weaker than it appears. This is because most empirical studies focus only on how giving shareholders greater power effects economic performance at the level of the individual company, typically measured over a few days or at most a year or two. These studies may be looking in the wrong place, for the wrong time period. It is not only possible, but probable, that raising the share price of individual firms relative to the rest of the market in the short run reduces aggregate shareholder wealth over time.

To understand this counterintuitive idea, imagine trying to empirically test the best method for catching fish. On first inspection, one reasonable method would be to study the individual fishermen who fish in a particular lake, comparing their techniques with the amount of fish they catch. You might find that fishermen who use worms as bait get more fish than those who use minnows, and conclude fishing with worms is more efficient.

But what if some fishermen start using dynamite in the lake, and simply gather up all the dead fish that float to the surface after the blast? Your statistical test would show that individuals who fish with dynamite catch far more fish than those who use either worms or minnows, and also show that fishermen who switch from baited hooks to dynamite see an initial dramatic improvement in their fishing “performance.” But as many real-world cases illustrate, communities that fish with dynamite see long-run declines in the size of the average haul, and eventually total collapse of the fish population.

Fishing with dynamite is a good strategy for an individual fisherman, for a while. But in the long run, it is very bad for fishermen collectively. There is reason to suspect the same can be said for shareholders, when corporations are driven to “maximize shareholder value.”

There is No Single “Shareholder Value”

To understand how encouraging corporate directors to maximize shareholder value can hurt shareholders themselves, we must begin by recognizing that “shareholder” is a fictional noun. The principal-agent model presumes shares in public companies are held by homogeneous entities that care only about the firm’s share price. Yet no such homogenous entities exist.

When we think of shareholders, we are really thinking of human beings,

This means the idea of a single “shareholder value” is intellectually incoherent, because different shareholders value different things.

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who typically own shares either directly or through pension and mutual funds. Human beings inevitably have many different values and interests.18 For example, some want to hold their shares for only a short time, and care only about tomorrow’s stock price. Others may be investing for retirement or to pay a child’s college tuition, and care about long-term returns. (The old “efficient markets” idea that stocks prices perfectly measure future returns has been discredited.)19 Some want their firms to make informal commitments that build employee and customer loyalty that will pay off in the future; others who plan to sell soon want firms to opportunistically renege on such commitments. Some hold widely diversified portfolios and worry about how the corporation’s behavior affects the value of their other assets and interests; others are relatively undiversified and unconcerned. Finally, some shareholders may care only about their own material wealth. But many and possibly most are “prosocial,” and prefer their companies not earn profits by harming third parties or breaking the law.20

This means the idea of a single “shareholder value” is intellectually incoherent, because different shareholders value different things. It also means that business strategies designed to raise share price help some shareholders primarily by hurting others.

Suppose, for example, Anne and Betty each own shares in Apple corporation. Anne is an asocial hedge fund manager who seeks only to “buy low and sell high,” who takes positions in only two or three companies at a time, and who churns her investment portfolio two or three times annually. Betty is a prosocial, diversified, buy-and-hold investor saving toward her retirement, who works as an elementary school teacher in California .

Anne wants her Apple investment to generate immediate profits in the form of dividends or quick stock appreciation. She has incentive to pressure Apple’s board to pay out all its cash in the form of dividends instead of retaining earnings to reinvest in innovative future products that the stock market can’t easily value today—even though retaining earnings might increase Betty’s future returns. Anne also wants Apple to reduce its expenditures on customer support and product quality. In the long run, this will likely hurt employee and customer loyalty and Apple sales, but Anne expects to have sold her Apple shares and moved on to her next investment long before these long-run harms are reflected in Betty’s stock price. Anne also wants Apple to outsource as many jobs as possible to areas of the world where labor is cheap and taxes are low, even though cutting Apple’s employment rolls and tax payments in California may harm California’s public education system (and Betty’s job). Finally, Anne is happy when Apple violates labor laws to make a few more pennies of profit on each iPad it sells. Prosocial Betty is not.

Clearly, Anne’s and Betty’s interests and values are different. Unfortunately, the idea that Apple’s directors should only focus on raising Apple’s stock price resolves these differences and conflicts of interest by simply assuming--without evidence or justification--that Anne’s interests must always

The Problem of Corporate Purpose 10

trump Betty’s. And Anne is perfectly happy to fish with dynamite, because she gets all the benefits of short-term strategies that (perhaps temporarily) bump up Apple’s share price, while Betty bears the costs. Privileging Anne’s interests over Betty’s creates a kind of investing “Tragedy of the Commons.” Individual investors do best by pursuing short-term, opportunistic, external-cost-generating corporate strategies, but investors as a group suffer over time when all pursue this strategy.

Revisiting the Idea of Corporate Purpose To avoid the trap of shareholder value thinking, it is essential to recognize that even if shareholders are the only participants in corporations whom we care about, it is still unwise to reduce shareholders’ interests to the single metric of today’s share price. The idea that one can “maximize” shareholder value rests on an impossible abstraction of the shareholder as a Platonic entity that cares only about the market price of a single corporation’s equity. This reduces shareholders to their lowest possible common human denominator: short- sighted, opportunistic and untrustworthy, happy to impose external costs that reduce the value of other assets, and psychopathically indifferent to the welfare of other people, future generations, and the planet. Such a single-dimensioned conception of the shareholder is not only unrealistic, but dysfunctional.

Advocates for shareholder value thinking sometimes argue that without a single, objective metric to judge how well directors and executives are running firms, these corporate “agents” will run amok. 21 This argument ignores the obvious human capacity to balance, albeit imperfectly, competing interests and responsibilities. Parents with more than one child routinely balance the interests of competing siblings (not to mention balancing their children’s welfare against their own), just as judges routinely balance justice against judicial efficiency and professors balance teaching against research and scholarship. The fact that balancing interests is sometimes difficult does not mean it cannot be done. Indeed, decently satisfying several sometimes-competing objectives, rather than trying to “maximize” one, is the rule and not the exception in human affairs. Although we should not expect directors to do a perfect job of balancing the competing interests of different shareholders, there is no reason to think they can’t do it well enough that shareholder interest-balancing is preferable to serving only the interests of the most short-sighted, opportunistic, undiversified, and unethical shareholders.

Accepting directors’ obligation and authority to mediate between different shareholder interests, and abandoning the quixotic and ultimately self- defeating idea that corporate success can and should be measured by a single objective metric, allows us to understand a host of otherwise-puzzling realities of corporate law and practice. Perhaps the most obvious is how the U.S. public corporation managed to thrive for most of the twentieth century. Thanks to dispersed shareholders’ rational apathy and the business judgment rule,

Indeed, decently satisfying several sometimes- competing objectives, rather than trying to “maximize” one, is the rule and not the exception in human affairs.

The Problem of Corporate Purpose 11

directors of public companies who avoided personal conflicts of interest enjoyed virtually unfettered discretion to set corporate policy, even over some shareholders’ vocal objections. This undoubtably increased “agency costs,” but it did not stop public corporations from producing excellent results for investors, employees, and communities. More recently, as shareholder value thinking has gained traction, boards have lost some of their ability to resist shareholder demands. Perhaps in consequence, aggregate shareholder returns have eroded and the numbers of public companies have been declining.

That possibility carries at least two important implications. The first is that policymakers and would-be reformers should stop reflexively responding to every business crisis or scandal by trying make managers pay more attention to “shareholder value.” For over two decades, the Congress, the SEC, and various policy entrepreneurs have successfully pushed through a number of individually modest but collectively significant regulations designed to make managers focus more on increasing shareholder wealth as typically measured by stock price . These supposed reforms have done nothing to improve investor returns or shareholder satisfaction. Similarly, there is no reason to think that promoting “shareholder democracy” through rules like the SEC’s controversial proxy access proposal22 will serve shareholders’ collective welfare. Such regulatory changes may provide an immediate windfall to certain types of shareholders (for example, undiversified hedge funds that want to pressure boards to do share repurchases or asset sales). But they may ultimately work against the interest of shareholders as a whole.

The second and more important lesson is that investors and business leaders need to liberate themselves from the tyranny of shareholder value thinking. While regulatory shifts have helped to move Corporate America closer to the shareholder value ideal, a far more important factor has been the business world’s own intellectual embrace of shareholder primacy. In the interest of maximizing shareholder value, corporate directors have voluntarily de-staggered boards, adopted stock-based compensation schemes, outsourced jobs, and cut back on research and development to meet quarterly earnings estimates. In the interest of shareholder value, pension and mutual funds have joined with hedge funds to pressure boards to “unlock value” through repurchases and asset sales, while turning a blind eye to questions of corporate responsibility and ethics. This has happened not because of regulatory requirements, but because investors and managers alike have come to accept shareholder value thinking as a necessary evil in the world.

John Maynard Keynes famously said that “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”

Shareholder value ideology shows all the signs of a defunct economists’ idea. It is inconsistent with corporate law; misstates the economic structure of

The Problem of Corporate Purpose 12

public companies; and lacks persuasive empirical support. Not only does shareholder value ideology fail on inductive grounds, it is riddled with deductive flaws as well, especially its premise that the only shareholder whose values should count is the shareholder who is myopic, untrustworthy, self- destructive, and without a social conscience.

Nevertheless, as described in the Brookings study, shareholder primacy continues to be taught in our nation’s law schools, business schools, and economics departments. Meanwhile, firms run according to the mantra of shareholder value cut safety corners (BP), outsource jobs and exploit workers (Apple), and indulge in criminal misbehavior (Walmart). If we want our corporations to perform better for investors and the rest of us as well, we need to re-visit the wisdom of shareholder value thinking.

The Problem of Corporate Purpose 13

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The views expressed in this piece are those of the authors and should not be attributed to the staff, officers or trustees of the Brookings Institution.

Governance Studies The Brookings Institution 1775 Massachusetts Ave., NW Washington, DC 20036 Tel: 202.797.6090 Fax: 202.797.6144 www.brookings.edu/governance.aspx Editor Christine Jacobs Production & Layout Stephanie C. Dahle Susan Schipper

The Problem of Corporate Purpose 14

Endnotes 1 Darrell West, The Purpose of the Corporation in Business and Law School Curricula (Brookings, July 18, 2011) www.brookings.edu/- /media/Files/re/papers/2011/0719_corporation_west/0719_corporations_west.pdf., 17-18. 2 Lynn Stout, The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public (San Francisco: Berrett-Koehler Publishers, 2012). 3 Adolf Berle and Gardiner Means, The Modern Corporation and Private Property (New Brunswick, U.S.A. and London: Transaction Publishers, 1991, originally published 1932). 4 Adolf A. Berle, The 20th Century Capitalist Revolution (New York: Harcourt, Brace, 1954) 169. 5 Michael C. Jensen and William H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Vol. 3, No. 4 Journal of Financial Economics (October, 1976) 305. 6 Brian J. Hall, “Six Challenges in Designing Equity-Based Pay,” 15 Accenture Journal of Applied Corporate Finance (2003) 23, cited in Jill E. Fisch, “Measuring Efficiency in Corporate Law: The Role of Shareholder Primacy,” 21 Journal of Corporation Law 639 n.5 (Spring 2006). 7 David Weild and Edward Kim, “A Wake-Up Call for America,” Grant Thornton Capital Market Series (November 2009) 1. 8 Marjorie Kelly, The Divine Right of Capital: Dethroning the Corporate Aristocracy (San Francisco: Berrett-Koehler Publishers, 2001, 2003) 54. 9 Delaware General Corporation Law, Section 102 (2011). 10 Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919). 11 Air Products and Chemicals, Inc. v. Airgas Inc., Civ. 5249-CC, 5256-CC (Del. Ch., Feb. 15, 2011). 12 Id. 92, citing Paramount Communications Inc. v. Time, Inc., 571 A.2d 1140, 1150 (Del. 1990). 13 Jensen and Meckling, supra. 14 Roger Martin, Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL (Boston, Massachusetts: Harvard Business Review Press, 2011) 11. 15 Lucian A. Bebchuk, “The Myth of the Shareholder Franchise,” 73 Virginia Law Review 675 (2007). 16 Renee Adams and Daniel Ferreira, “One Share-One Vote: The Empirical Evidence,” 12 Review of Finance 51 (2008). 17 Roberta Romano, “The Sarbanes Oxley Act and the Makings of Quack Corporate Governance,” Vol. 114 Yale Law Journal 114 (2005). 18 Iman Anabtawi, “Some Skepticism About Increasing Shareholder Power,” 53 University of California Los Angeles Law Review 561 (2006). 19 Lynn A Stout, “The Mechanisms of Market Inefficiency: An Introduction to the New Finance,” 23 Journal of Corporation Law 635 (2003); John Quiggen, Zombie Economics: How Dead Ideas Still Walk Among Us (Princeton, New Jersey and London: Princeton University, 2010). 20 Lynn Stout, Cultivating Conscience: How Good Laws Make Good People (Princeton and Oxford: Princeton University Press, 2011) 98. 21 Michael C. Jensen, “Value Maximization, Stakeholder Theory, and the Corporate Objective Function,” Vol. 12 Business Ethics Quarterly (April, 2002) 238. 22 Business Roundtable et al. v. Securities Exchange Commission, No. 10-1305 (D.C. Cir., July 22, 2011).

  • The Problem of Corporate Purpose
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