The New Corporate Governance: Corporate Purpose and Corporate Leadership
It was almost half a century ago that Milton Friedman pronounced, in a famous article in the New York Times Magazine, that a corporate executive is an agent of the shareholders, that “his primary responsibility is to them,” and that therefore “there is one and only one social responsibility of business - to use its resources and engage in activities designed to increase its profits.” And it has now been a decade since the financial crisis, a decade that has in many ways seen deep economic and social turmoil beneath a veneer of economic growth. That turmoil, stirred by recognition of deepening inequalities, has ignited a re-evaluation of the role of business in our society, a re-evaluation that has involved academics, advocates, protesters and politicians and has now risen to the highest reaches of the capital markets. The very foundations of corporate governance are changing.
What the financial crisis and its aftermath have revealed is that corporate governance is not a rarefied philosophy of the ivory tower or the private dealings of the proverbial smoke-filled room. It affects, and is for, everyone. In that light, the direction of the discourse, and statements from highly influential CEOs, judges, politicians and others, indicate that the fundamental principle of governance is shifting from Friedman’s “shareholder primacy”, where the benefit of the corporate endeavour is aimed exclusively at the shareholders, towards one of “corporate purpose”, where all efforts are aimed at achieving what the corporation was formed to achieve.
The simple idea behind “corporate purpose” is that corporations are formed to solve real problems and fulfill real people’s desires in a profitable way. If they solve those problems or fulfill those desires properly, the shareholders will benefit, because the company will profit, but so will the customers, the workers and the communities in which they operate. If a mousetrap maker makes really good mousetraps, customers will buy them, workers will be employed to make them and shareholders will participate in the profits. The purpose of the mousetrap company is not to make money; it is to make really good mousetraps. Profit is but one by-product of the corporation’s pursuit of its purpose.
This is a fundamentally different premise on which to ground a philosophy of governance than Friedman’s “shareholder primacy” model. It envisages the corporation, and more importantly “business” writ large, as a fundamental and wholly integrated element of our society. Businesses do not exist and operate in a silo, separated from our other political and social institutions; the people that participate in and are affected by every corporate enterprise are the very same people who work, vote, pay tax, go to school, drink water and breathe air. The doctrine of corporate purpose recognizes the integration of businesses with the rest of a civilized and functioning society. It recognizes that if every individual corporation pursues its purpose with a long-term view, business as a whole will thrive and society as a whole will prosper.
It is important to understand that “purpose” does not create distinct “social responsibilities”; rather it creates an aim of generating sustainable profits by virtue of achieving some other desirable outcome. In that sense, it is more expansive and flexible than the old doctrine of “corporate social responsibility” (of which Friedman was critical). While corporate social responsibility would require companies to form ancillary purposes that are “socially responsible” (and the legal source of such a requirement has never been perfectly clear), a corporate purpose is the very raison d’etre of the company, the pith of the entire endeavour.
It is on this landscape that Larry Fink’s annual letter to CEOs has become a recurring landmark. Mr. Fink, the influential CEO of BlackRock Inc., has embraced a model of governance that believes in the long-term financial benefits of considering and caring for corporate constituencies beyond the shareholders. In particular, his 2018 letter appeared to espouse a more sophisticated and nuanced understanding of “purpose” - which Mr. Fink called “social purpose” - as the foundation of good governance. In that letter, he wrote: “Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”
Whether every valid corporate purpose could properly be called a “social purpose” is unclear, and the distinction is unnecessary. The word “social” implies a limited subset of purposes and can engage questions of morality that are unhelpful and irrelevant. Each business is born to fulfill a need: a better way to connect advertisers with consumers; a better way to rent a vacation home; a better mousetrap. If the business idea can generate sustainable profits over the long term - meaning that people think the good or service actually benefits them - then it does have a social purpose in this broad sense.
Allowing a different definition of “social purpose” brings the old doctrine of “corporate social responsibility” back in through the side door, but with an element of paternalistic moralism. It implies that there are moral aims that CEOs and boards are bound to cause their businesses to pursue that may not relate directly to the more specific corporate purpose that is the object of their legal duty. And by extension, it implies that CEOs must not only be leaders of their businesses, but leaders in society’s other realms. Mr. Fink tells CEOs in his 2019 letter that “the world needs your leadership… at a time of great political and economic disruption, your leadership is indispensable.”
What Mr. Fink is saying is that in a time of political dysfunction and social volatility, people are looking to corporations to fill the void of leadership and cohesion. If this is true, it should be resisted, not encouraged. There is something a little sinister about the thought of corporations gaining more and more influence over citizens in a fraught political climate. The human beings who CEOs and directors must consider in pursuing their corporate purpose are multifaceted beings: investors, customers, workers, community members; but more fundamentally, they are citizens, and in that capacity they ought to be beyond the corporation’s grasp. Corporate purpose understands that distinction.
Capitalism at a Crossroads
What we, as a society, need in this difficult time is not more influence over our social and political decisions by corporations, whose legal incentives cannot be to act for a society broadly, in a direct sense, and not more leadership from corporate CEOs beyond the leadership of their own firms. Rather, what we need is for all of our fundamental institutions, including corporations, to be governed more wisely, with a longer term view that by its very definition will promote fairness across all sectors.
Shareholder primacy is fading from relevance, and it will be replaced by a new principle. This element of capitalism is at a crossroads, and we all have a stake in what that new principle will be. Accepting the doctrine of corporate purpose at the root of corporate law and corporate culture is more likely than the other options on offer to promote a prosperity that is long-term, inclusive and widespread. And conveniently, it requires no change in the law. It simply requires corporate leaders to develop a better understanding of their duties and goals. To paraphrase Friedman, and to alter his pronouncement to one that fits our time and our law, a corporate executive’s primary responsibility is to his or her corporation; and there is one and only one social responsibility of a corporation - to use its resources and engage in activities designed to pursue its corporate purpose.