One of the problems of capitalism (at least I see it as a problem) is that its only fiduciary duty is to the shareholders. In other words, its business practices have to have the prime purpose of maximizing the returns to its investors, consistent with the existing laws. This makes sense, in a narrow way. After all, the shareholders are the ones who provide the money and in any large public company, they will constitute a varied group that has diverse interests. The only thing that they can be guaranteed to have in common is the desire for a good return on their investments.
But this leaves the issue of ethics in a twilight zone. Does the company have an obligation to maximize profits at all costs? What if it means squeezing workers with low wages and awful conditions? What if it means polluting the environment? What if it means shutting down a production facility in one town and moving it to another town or state or even country, devastating the economy of the community that was abandoned?
At present, the main requirement is that a company comply with existing laws. But there is no uniformity in the regulatory structures across the globe or even within countries and that can lead to a race to the bottom as companies seek communities that have the least regulations while countries compete to provide low-cost workers. This leads to the kinds of abuses as seen in the case with the company Foxconn in China, supplier of electronics products to companies like Apple.
This narrow focus on maximizing profits leaves very little room for corporations to act ethically if such ethical behavior increases the cost of doing business. Even if the company’s president and board would like the company’s actions to benefit the workers, community, and the environment, if those actions cannot be shown to benefit the company in tangible and intangible ways or are not required by law, they run the risk of violating their fiduciary responsibilities and could be sued by shareholders.
As Jamie Raskin writes:
When America began, the states chartered corporations for public purposes, like building bridges. They could earn profits, but their legitimacy flowed from their delegated mission.
Today, corporations are chartered without any public purposes at all. They are legally bound to pursue a single private purpose: profit maximization. Thus, far from advancing the common good, many for-profit corporations have come to defy the law, corrupt the officials charged with enforcing it and inflict harm on the public with impunity. The consequences are visible in the wreckage left by BP, Massey Energy, Enron, AIG, Lehman Brothers, Blackwater and Exxon Mobil, to name a few recent wrongdoers. Profits rule; anything goes.
This is why complaints that governments are crushing the private sector by over-regulating them, and that if left to themselves they would be better able to do the right thing, ring hollow. Governments must impose requirements on business entities to do the right thing.
Hence I was interested in the idea of the ‘benefit corporation’, a relatively new form of legal entity that allows companies to give social and environmental goals equal weight with making profits.
California has passed a law enabling the creation of such entities becoming the seventh state to do so, following Vermont and Maryland in 2010, and New York, New Jersey, Virginia and Hawaii in 2011. About 100 companies have so far become benefit corporations, most of them privately held. The outdoor clothing company Patagonia is one of dozen companies that have chosen to do so in California as a result of the new law there.
Raskin explains why this gives companies greater freedom.
The new laws permit companies to join the profit motive with the purpose of making a “positive impact on society and the environment.” In their articles of incorporation, Benefit Corporations declare their public missions—things like bringing a local river back to life, providing affordable housing, facilitating animal adoptions or promoting adult literacy.
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But why would public-spirited corporations embrace these exacting duties when they can simply roam free and do a little bit of altruistic good on the side? For one thing, Benefit Corporations can’t be held liable by courts for failing to place profits over everything else. This is an important shift in law. The fear of shareholder litigation has driven many public-spirited businesses, most famously Ben & Jerry’s, to take the high bid rather than the high road in a corporate takeover fight.
I am not of the business world and thus don’t know what the downsides of benefit corporations are or whether this model can be scaled up to larger and more companies. Clearly it will result in lower profits and thus lower returns to shareholders. Its success would require the existence of large numbers of shareholders who want their money to do good for others as well as for them.
You’ve pretty much nailed the primary problem with corporations today.
The single consistent part of my MBA education was this -- As an executive in a corporation, your one primary duty is to profit to the shareholder. All other considerations are secondary. My MBA is from a respectable institution (William & Mary), so the education is pretty mainstream.
The only exception to this rule is to consider long-term impacts so that short-term gains don’t lead to much larger long-term losses.
I still remember many students in one of my classes where the instructor put out this simple question: “You contract to deliver 1,000 widgets. Why do you actually deliver the widgets?”
Most people (and most of the students) answered because they signed the contract. The professor corrected them by stating that you only deliver the widgets if there is a net profit. If there are losses, then you don’t deliver the widgets. Of course, there are considerations for legal impacts, long-term potential sales losses, etc. But you don’t automatically deliver the widgets just because you have that contract.
I remember another class where the professor had the scenario of opening a restaurant, and, the next day after installing the cooking equipment you find out that new equipment will save you money and cover the cost of the new equipment within 6 months. Some students say you shouldn’t get the new equipment due to things like wasteful and sunk costs, but the professor corrected them stating that sunk costs are irrelevant and wastefulness should only be accounted for by figuring in disposal costs.
This should tell you what the true answers are to the questions in the 2nd paragraph above. Of course it is profits at all costs including squeezing workers as much as possible with zero consideration for local communities (except where sufficient goodwill can be had). Donations to the community are done for 2 reasons only…tax benefits and PR. Individually, there are far more C-level executives making big bucks like Steve Jobs (who contributed nothing to his local community) than like Bill Gates.
Welcome to the true world of capitalism.
Good to hear that benefit corporations are taking off, but I suspect those will be niche corporations only since there is less profit involved.
One interesting concept in Charles Stross’s ‘Rule 34’ was the idea that companies in the future will be held to universally adopted ethical standards. In the world of the novel, this was a response to the malfeasance of investment banks which causes the recession. As part of this, companies undero regular ‘ethics audits’ where everything they do, even down to patterns of interaction among employees, is reviewed for any suggestion of burgeoning unethical behavior. I’m not sure how well it would work in real life, but it was an interesting concept.
As for benefit corporations, it is an interesting idea, but I wonder if there are enough people willing to put their principles above their bank accounts to make it work.
In the sci-fi book Market Forces, Richard Morgan uses the idea of conflict investment as a plot tool. In short, investors back one side in a conflict (like a civil war) not due to some idea of right or wrong, but rather what profits are to be made.
When I told a friend about this book several years ago, he smiled and said, “What a great idea.” Of course, he is a pure capitalist.
One possible way to counteract your last statement, that the success would hinge on a large number of shareholders who want to do good as well as make profits:
Governments (in other words, public funds) monetarily reward benefit corporations who meet their ethical, social, or environmental goals. The governments could establish individual benchmarks for each benefit corporation; in this way, the profits that are lost to meeting these ethical/social goals are supplemented by public money. This would more allow benefit corporations to compete with profit-only corporations for shareholders who don’t care so much about the social impacts, but do care about seeing a financial return.
Governments already interfere in the market through regulations. This would only be another way: by promoting benefit corporations over profit corporations, for once.
“Welcome to the true world of capitalism.”
Yeah, this is a brief summary of why I facepalm every time I hear a conservative say the problem is “crony” capitalism — their ideal vision of capitalism isn’t realistic.
If CEOs and shareholders were made legally accountable for the actions of the companies they own and run, there would be fewer problems.
1) Make shareholders cover the losses and pay the debts. And I don’t mean the current shareholders, I mean those who owned the shares when the actions and decisions were taken.
2) Make them legally culpable. Would any company build a poorly designed and unsafe operation in poor countries if its Union Carbide CEOs had gotten life sentences for the 2000 deaths they caused?
It could be as simple as changing the convention for how a simple balance sheet is prepared.
The current convention, just to pick one example, essentially registers employee income as a cost, which when deducted, reveals the value of the shareholders’ equity.
A simple (but revolutionary) change in the structure of the balance sheet could render the shareholders’ income as a cost, which, when deducted would reveal the value of the employees’ equity.
Sometimes it’s a matter of thinking laterally. Why shouldn’t we be able to change who the main stakeholder in a balance sheet will be? For the record, I think it’s obvious from consequential damage to date, that, as a society, we’ve made the wrong choice in making the shareholder the main stakeholder.