Yesterday's Company?

02 Sep 2010 – Geoff Lye

Over 15 years ago I sat on a UK inquiry into the role of business (Tomorrow’s Company Inquiry). It concluded among other things that the traditional argument against corporate social and environmental responsibility – namely, that it would be in breach of a board’s fiduciary duty to its shareholders – was a flawed assumption. While precise legal requirements vary across the globe, company directors need – and have the right – to recognise the role and interests of other stakeholders. The Inquiry coined the concept of the ‘inclusive company’ and made a compelling case that to be competitive in the 21st-century companies should balance short-term profitability with a more informed assessment of how shareholders’ needs could be best served by seeking the wider views of stakeholders; and by judging shareholder value within a longer-term timeframe than the quarterly earnings cycle.

So it is depressing to read another article – in the Wall Street Journal, no less – which argues “the idea that companies have a responsibility to act in the public interest and will profit from doing so is fundamentally flawed.” Indeed, the author, Professor Aneel Karnani of University of Michigan’s Ross School of Business proposes that an attempt to simultaneously deliver both societal and shareholder value is “a potentially dangerous one”. He chooses to ignore the huge risks to shareholder value in maximising profit with no regard for the massive shifts in societal expectations of business in a globalised and privatised world. Our Changing Landscape of Liability report offered evidence-based insights into the risks of a compliance based business model and the risks to goodwill (the highest component of share value) if a company breaches societal values and expectations.

Far from Karnani’s claim that “in most cases, doing what’s best for society means sacrificing profits,” the opposite is surely true. Shareholder value is not simply a function of profitability. Why has Big Pharma radically altered its approach to patent protection and introduced differential pricing over recent years? It has nothing to do with short-term profitability and everything to do with its long-term “licence to operate and innovate”. Its position on generic drugs (particularly for HIV/Aids) exposed a fault line in its business model. Does elimination of generic drugs to protect IP not lead to the death of those who cannot then afford to be treated? Outcome: dead potential customers and protected IP. Very few businesses make money from dead customers. Similar examples can be found across all sectors. Oil companies are beginning to see that their assets (hydrocarbon reserves – the essence of today’s share value) may not be as safe as they assumed. Oil sands derived fuels could face the same fate as GMOs – fully legal but increasingly unacceptable to society. ‘Stranded assets’ are another huge threat to the oil sector’s balance sheets (Shell’s Nigerian reserves and, very probably, BP’s deepwater reserves are early examples).

The oil industry offers another insight into Karnani’s narrow perspective. How can he explain that a dollar of profit is valued differently according to which company is delivering that profit? Paradoxically, in the oil industry, ExxonMobil’s profits are (at least for the moment) valued more highly than its competitors’. I would suggest that this is because that company is more efficient in its operations and risk management than its competitors; while the huge climate change liability risks it is building are barely on investors’ radar screens. The point, however, is that share values are not simply a reflection of profitability but of the ability of a company to manage the complexity of risks and shifting societal expectations robustly: engaging sustainability challenges is now acknowledged by all progressive business leaders as a strategic issue. They also recognise that corporate responsibility investments – which may have been inappropriate in 1970 when Milton Friedman railed against them – are essential for protecting and enhancing shareholder value.

I am sure that Professor Karnani is well respected. It is all the more surprising, therefore, that he appears to be out of touch with rapidly changing societal values – and how that is reflected in corporate engagement with the sustainability agenda.