2019 Lane Reports

Is Shareholder Primacy Dead?

The Lane Report, September 2019
Tuesday, September 3, 2019 10:00 am
by Marc J. Lane

Is Shareholder Primacy Dead?

By Marc J. Lane

In a 1970 essay for The New York Times, economist Milton Friedman famously argued that a company has no "social responsibility" to the public or society; its only responsibility is to its shareholders, a view he justified by considering to whom, in his judgment, a company and its executives are accountable:

"In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires...the key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation...and his primary responsibility is to them."

Following that logic, Friedman concluded 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." And thus the theory of “shareholder primacy” was born.

Some, even today, insist that corporate directors have a legal duty to maximize corporate profits and “shareholder value” in the extreme, dodging ethical rules, polluting the environment and harming employees. They’re dead wrong. As the U.S. Supreme Court recently concluded: “Modern corporate law does not require for-profit corporations to pursue profit at the expense of everything else.”

Yet the corporate community has been of two minds. The Business Roundtable, an association of chief executive officers of many of America’s leading companies, issued a “Statement on Corporate Responsibility” in 1981 which recognized six constituencies – customers, employees, communities, society at large, suppliers, and shareholders – as forming the “web of complex, often competing relationships” within which corporations operate. It accepted the idea that “shareholders have a special relationship to the corporation,” but didn’t allow their interests to take priority over the others’:

“Balancing the shareholder’s expectations of maximum return against other priorities is one of the fundamental problems confronting corporate management. The shareholders must receive a good return but the legitimate concerns of other constituencies also must have appropriate attention. Striving to reach the appropriate balance, some leading managers have come to believe that the primary role of corporations is to help meet society’s legitimate needs for goods and services and to earn a reasonable return for the shareholders in the process. They are aware that this must be done in a socially acceptable manner. They believe that by giving enlightened consideration to balancing the legitimate claims of all its constituents, a corporation will best serve the interest of the shareholders.”

For the next decade, the Roundtable remained reluctant to place shareholders’ interests first, affirming in 1990 that “corporations are chartered to serve both their shareholders and society as a whole.”

But in 1997, it issued a new statement, altogether renouncing efforts to balance the interests of corporate constituents. The mission of business was redefined to drive financial returns to shareholders above all else. The Roundtable’s declaration echoed Milton Friedman’s decades-old thesis:

“In the Business Roundtable’s view, the paramount duty of management and of boards of directors is to the corporation’s stockholders; the interests of other stakeholders are relevant as a derivative of the duty to stockholders. The notion that the board must somehow balance the interests of stockholders against the interests of other stakeholders fundamentally misconstrues the role of directors.”

The consequences have been a fixation on short-term financial performance, an outsized focus on share price, and an unconscionably rapid increase in executives’ pay coupled with a drag on their capacity to build businesses for the long term, all to the detriment of a company’s diverse stakeholders.

On August 19 the Business Roundtable once again reversed course.

Progressive executives have long known that successfully growing corporations requires taking the concerns of all of their stakeholders into account. In a time of widening economic inequality and deepening distrust of business, the CEOs of Apple, IBM, Johnson & Johnson, JPMorgan Chase, and other Roundtable members have pledged to follow their lead by committing to deliver value to their customers, deal fairly and ethically with their suppliers, support the communities in which they work, and generate long-term value for their shareholders.

The Roundtable’s move reacts to a deepening distrust of business and a shift in public sentiment about the role of corporations in an increasingly unequal economy. It reflects the competition for next-generation talent that demands that their employers drive positive social change. And it acknowledges that the investment community justifiably links environmental, social and governance performance with value creation.

Kudos to the Business Roundtable’s members for abandoning their long-held view that shareholders’ interests should come first. Their words matter. But the Roundtable’s members haven’t committed to measure and disclose how, over time, their pledge actually affects their stakeholders. In the end, it’s their actions that will matter the most.


Marc J. Lane is a Chicago attorney and financial adviser and the vice chair of the Cook County Commission on Social Innovation.

Peterborough's problem was daunting: Sixty percent of prisoners serving short-term sentences historically had gone on to re-offend within a year after their release. But policymakers were confident that a solution was within their reach. They attracted private investment to pay experienced social service agencies to provide intensive, multidisciplinary support to short-term prisoners, preparing them to re-enter society and succeed outside the penal system. - See more at: http://www.chicagobusiness.com/article/20131007/OPINION/131009850/a-new-kind-of-futures-contract-for-illinois#sthash.ThgxeiFt.dpuf

The world's first social impact bond, or SIB, was introduced in 2010 to fund innovative social programs that realistically might reduce recidivism by ex-offenders in Peterborough, England, and, with it, the public costs of housing and feeding repeat offenders. Prudently building on the strengths of that initiative, Illinois Gov. Pat Quinn is rolling out SIBs to help solve some of the state's most vexing social problems.

A SIB isn't a traditional bond where investors are guaranteed a fixed return but a contract among a government agency that agrees to pay for improved social outcomes, a private financing intermediary and private investors. SIBs shift the risk of experimenting with promising but untested intervention strategies from government to private capital markets, with public funds expended only after targeted social benefits have been achieved.

Peterborough's problem was daunting: Sixty percent of prisoners serving short-term sentences historically had gone on to re-offend within a year after their release. But policymakers were confident that a solution was within their reach. They attracted private investment to pay experienced social service agencies to provide intensive, multidisciplinary support to short-term prisoners, preparing them to re-enter society and succeed outside the penal system.

The government decided which goals would be supported, but exactly how those goals would be achieved was left to the private sector. It was the investors, through a bond-issuing organization, who ultimately endorsed the allocation of investment proceeds — how much would be invested in job training, drug rehabilitation and other interventions.

If the Peterborough plan eventually shrinks recidivism rates by 7.5 percent or more, the government will repay the investors' capital and share the taxpayers' savings with them, delivering up to a 13 percent return. If the target isn't hit, the investment will have failed and the government will owe the investors nothing.

Illinois' SIB effort was spearheaded by the state's Task Force on Social Innovation, Entrepreneurship and Enterprise — the governor's think tank on social issues, which I am privileged to chair — with support from Harvard University's John F. Kennedy School of Government, the Rockefeller Foundation and the Aurora-based Dunham Fund. A request for information issued by the Office of Management and Budget on May 13 yielded responses from service providers eager not only to reduce recidivism here but also to create jobs, revitalize communities, improve public health outcomes, curb youth violence, cut high school dropout rates and alleviate poverty.

Now the governor has issued a request for proposals intended to spur better outcomes for Illinois' most at-risk youth — by increasing placement stability and reducing re-arrests for youth in the state's Department of Children and Family Services, and by improving educational achievement and living-wage employment opportunities justice-involved youth most likely to re-offend upon returning to their communities.

Kudos to Mr. Quinn for bringing SIBs to Illinois. May they soon start delivering on their promise.

- See more at: http://www.chicagobusiness.com/article/20131007/OPINION/131009850/a-new-kind-of-futures-contract-for-illinois#sthash.ThgxeiFt.dpuf
The world's first social impact bond, or SIB, was introduced in 2010 to fund innovative social programs that realistically might reduce recidivism by ex-offenders in Peterborough, England, and, with it, the public costs of housing and feeding repeat offenders. Prudently building on the strengths of that initiative, Illinois Gov. Pat Quinn is rolling out SIBs to help solve some of the state's most vexing social problems. - See more at: http://www.chicagobusiness.com/article/20131007/OPINION/131009850/a-new-kind-of-futures-contract-for-illinois#sthash.ThgxeiFt.dpu

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