Businesses and companies play a central role in our lives. We work for them, purchase their products and services, and invest our money in them. They influence our quality of life, standard of living, and life expectancy. They shape our ideas and beliefs through their power over the media, culture, the sciences, and politics. They hold title to a majority of humankind’s wealth. They are the movers and shakers.
What is all this vast power used for? The common notion is that a company has a single raison d’être — maximizing profits for its shareholders. This explains the excitement generated by the historic statement in August by the members of the Business Roundtable — the CEOs of more than a hundred leading US companies — in which they proposed a new goal for their companies: promoting the interests of all those with a stake in the firm, including workers, creditors, the state, and the public at large.
The economist Milton Friedman, justified the accepted approach of focusing on shareholders, noting that their interest in ensuring that the company is run in optimal fashion exceeds that of all other parties. Since they are entitled to receive whatever remains in the company’s treasury after it has paid off all its obligations to the rest of the world, it is reasonable to assume that shareholders will aspire to increase the size of the corporate pie — to the benefit of all.
But this assumption is mistaken: the shareholders’ interests are not identical with those of the company itself and those of other parties. As a matter of course, public shareholders are attracted to risk. It is in their interest to encourage the company to make high-risk business decisions, because if the bet pays off, their residual claim (the shares) will increase in value; and if the bet goes sour, their loss will be limited — no greater than the size of their investment in the specific company (limited liability). For those with a diversified investment portfolio, the damage will be moderate.
The average investment horizon of public shareholders is relatively short. Managers, apprehensive about a hostile takeover that would leave them out of a job, are pushed to focus on maintaining share value, even at the expense of the company’s long-term interests. This management philosophy led corporations to subordinate their overall interest to the immediate satisfaction of their shareholders and is the underlying factor in the Great Recession of 2008, which wiped out an astronomical amount of economic value. Banks and insurance companies faded away like soap bubbles, because they had taken extreme risks that may have made sense for investors, but were catastrophic for the companies themselves, their employees, their creditors, and the global economy.
In its dramatic statement, the Business Roundtable proposes a new approach, but which does not deviate from the capitalist paradigm. Profit remains the ultimate objective, but the focus should be on profit for all those with a stake in a company, and not just its shareholders. The entrepreneurial spirit with its love of risk, typical of shareholders, is important and not to be denied. Investors’ interest in the share price and their expectation of a healthy dividend payout are an important growth engine for the economy as a whole. At the same time however, a more conservative approach, one that is wary of extreme risk and makes growth and long-term corporate survival the key considerations, is also important. There are great advantages to a management method that is not frenetic and does not lead managers to sacrifice the future for the present.
If corporations are run on behalf of all their stakeholders, the conflict of interest that plagues them would be lessened, the cost of supervising their officers and managers would be reduced, and their operating costs would be lowered. Such a change would induce companies to take a more balanced level of risk and make labor relations less confrontational, because the companies would take their employees’ interests into account. The change would also permit—even require—managers to weigh the broader implications of their decisions on the social and economic environment in which they operate, in keeping with the company’s long-term good.
In Israel there is a strong statutory basis for implementing the American CEOs’ new vision. Section 11 of the Corporations’ Law allows companies, when operating to make a profit, to take into consideration, “inter alia, the interests of their creditors, employees, and the public at large.” Interpretation of this section is a complex matter for professionals, but it is clear that it provides the basis for the implementation in Israel of a capitalist system, in the spirit of the recent announcement by the Business Roundtable in the United States.
The article was published at the Times of Israel.