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2.3 Corporate Purpose: A Societal Perspective

One reason that U.S. governance law is sometimes indeterminate is that the enormous differences between the two legal views described above reflect a broader, philosophical debate on the role and purpose of corporations in society. Indeed, opposing views on the purpose and accountability of the corporation—shareholders versus stakeholders, or private (property) versus public (social and political entity) conceptions of the corporation—have been part of the governance debate for well over 100 years.See, for example, Bradley, Schipani, Sundaram, and Walsh (1999), pp. 9– 86; and Matheson and Olson (1992), pp. 1313–1391.

Shareholder capitalismAn economic system of capitalism that holds that a company is the private property of its owners., until recently prevalent mainly in the United States and the United Kingdom, holds that a company is the private property of its owners. From a legal perspective, the Anglo-American corporation is essentially a capital market institution, primarily accountable to shareholders, charged with creating wealth by exploiting market opportunities. Stakeholder capitalismAn economic system of capitalism that holds that companies balance the interests of shareholders with those of other stakeholders, primarily employees but also suppliers, distributors, customers, and the community at large. This system holds the view that companies have a broader obligation than shareholder capitalism., on the other hand, embodies a more organic view of the corporation in which companies have broader obligations that balance the interests of shareholders with those of other stakeholders, notably employees but also including suppliers, distributors, customers, and the community at large. Under this set of beliefs, the corporation is seen as an institution with a continuing purpose, and therefore, with a life of its own. Shareholders and wealth creation for owners do not dictate its priorities. Rather, a deep concern for employees, suppliers, and customers, and implicitly for its own continued existence, defines the corporate mission.

As noted in Chapter 1 "Corporate Governance: Linking Corporations and Society", stakeholder capitalism can take different forms, reflecting the degree of commitment to different stakeholders. Germany’s legal system, for example, makes it clear that firms do not have a sole duty to pursue the interests of shareholders. Under Germany’s system of codetermination, employees and shareholders in large companies hold an equal number of seats on the companies’ supervisory boards, and the interests of both parties must be taken into account in decision making. In Denmark, employees in firms with more than 35 workers elect one third of the firm’s board members, with a minimum of 2. In Sweden, companies with more than 25 employees must have 2 labor representatives appointed to the board. These employee board members have all the rights and duties of other board members.

The situation differs somewhat in France. French firms with more than 50 workers have employee representatives at board meetings, but they do not have the right to vote. More conventional codetermination systems exist for former public-sector French firms that have been privatized; these systems can be introduced voluntarily by companies. In Finland, companies can also voluntarily adopt employee representatives on the board. Across the European Union (EU) as a whole, another type of worker participation in decision making is the works council, a group that has a say in such issues as layoffs and plant closures. A corporation with at least 1,000 employees, of which there are 150 or more in at least two EU countries, must have a “European Works Council.”

The situation in Japanese firms also differs from that of the United States and the United Kingdom. Japanese executives do not have a fiduciary responsibility to stockholders, but they can be liable for gross negligence in performing their duties. At the same time, it is accepted practice in Japan that managers align their priorities with the interests of a variety of stakeholders. For example, a recent survey revealed that if Japanese executives feel that the company is going through a tough period financially, keeping their employees on the job is much more important than maintaining dividends to shareholders. Specifically, only 3% of Japanese managers said companies should maintain dividend payments to stockholders under such circumstances. This compares with 41% in Germany, 40% in France, and 89% in both the United States and the United Kingdom.

In the United States, these issues also continue to be debated. Some time ago Reason magazine featured a spirited debate among the late Milton Friedman, former senior research fellow at the Hoover Institution and Paul Snowden Russell Distinguished Service Professor of Economics at the University of Chicago; John Mackey, founder and CEO of Whole Foods Market; and others, on the purpose of the corporation.Reason (2005, October). Friedman, a Nobel laureate in economics and the author of a famous 1970 New York Times Magazine article titled “The Social Responsibility of Business Is to Increase Its Profits,” had no patience with capitalists who claimed,

Business is not concerned “merely” with profit but also with promoting desirable “social” ends; that business has a “social conscience” and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers.Friedman (1970).

He wrote that such people are “preaching pure and unadulterated socialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.”Friedman (1970).

Mackey disagreed vehemently with Friedman. A self-described ardent libertarian who likes to quote Ludwig von Mises on Austrian economics and Abraham Maslow on humanistic psychology, and is a student of astrology, Mackey believes Friedman’s view of business is too narrow and underestimates the humanitarian potential of capitalism. Selected portions of this debate are reprinted below, beginning with Mackey’s passionate, personal vision of the social responsibility of business.

In 1970 Milton Friedman wrote that “there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” That’s the orthodox view among free market economists: that the only social responsibility a law-abiding business has is to maximize profits for the shareholders.

I strongly disagree. I’m a businessman and a free market libertarian, but I believe that the enlightened corporation should try to create value for all of its constituencies. From an investor’s perspective, the purpose of the business is to maximize profits. But that’s not the purpose for other stakeholders—for customers, employees, suppliers, and the community. Each of those groups will define the purpose of the business in terms of its own needs and desires, and each perspective is valid and legitimate.

Mackey continues,

We have not achieved our tremendous increase in shareholder value by making shareholder value the primary purpose of our business … the most successful businesses put the customer first, ahead of the investors. In the profit-centered business, customer happiness is merely a means to an end: maximizing profits. In the customer-centered business, customer happiness is an end in itself, and will be pursued with greater interest, passion, and empathy than the profit-centered business is capable of.

Not surprisingly, Friedman respected Whole Foods’ success but took issue with its business philosophy:

Maximizing profits is an end from the private point of view; it is a means from the social point of view. A system based on private property and free markets is a sophisticated means of enabling people to cooperate in their economic activities without compulsion; it enables separated knowledge to assure that each resource is used for its most valued use, and is combined with other resources in the most efficient way.

Mackey replied,

While Friedman believes that taking care of customers, employees, and business philanthropy are means to the end of increasing investor profits, I take the exact opposite view: Making high profits is the means to the end of fulfilling Whole Foods’ core business mission. We want to improve the health and well-being of everyone on the planet through higher-quality foods and better nutrition, and we can’t fulfill this mission unless we are highly profitable. High profits are necessary to fuel our growth across the United States and the world. Just as people cannot live without eating, so a business cannot live without profits. But most people don’t live to eat, and neither must a business live just to make profits.

Mackey’s logic was perhaps most effectively first articulated by Peter Drucker in 1974 in his famous book Management: Tasks, Responsibilities and Practices:

The purpose of a business is not to make a profit. Profit is a necessity and a social responsibility. A business, regardless of the economic and legal arrangements of society, must produce enough profit to cover the risks of committing today’s economic resources to the uncertainties of the future; to produce the capital for the jobs of tomorrow; and to pay for all the non-economic needs and satisfactions of society from defense and the administration of justice to the schools and the hospitals, and from the museums to the boy scouts. But profit is not the purpose of business. Rather a business exists and gets paid for its economic contribution. Its purpose is to create a customer.Drucker (1974), p. 67.

This discussion raises questions that transcend the legal debate on fiduciary obligations. It asks us to consider questions, such as, What does society want from corporations? What are the moral obligations and responsibilities of business? Who has the right to make such decisions in a public company? Is shareholder wealth maximization the right objective? And what obligations does a company have to other stakeholders, such as employees or suppliers, and the community at large? And are these objectives necessarily in conflict with each other? If so, how should trade-offs be made? What is more, the discussion suggests that to be consistent and effective, directors and boards should have ready answers to many, if not all, of the questions and know where they agree or disagree. As we shall see, regrettably, this is not true. Not only has the United States, as a society, changed its perspective on this issue several times, but also, today, the majority of directors remain confused, sometimes intimidated, by the law and often unwilling or unable to debate these issues openly.