In the first of a new editorial series, Link, AIQ brings together people from across Aviva Investors to debate topical themes. Mirza Baig and Stephanie Niven consider whether CEO claims about running businesses for multiple stakeholders rather than shareholders alone is a grand idea or just plain grandstanding.

16 minute read

Corporations have no higher purpose than maximizing profits for their shareholders
Milton Friedman

For almost six decades, the concept of shareholder primacy went largely unchallenged after economist Milton Friedman argued “corporations have no higher purpose than maximizing profits for their shareholders”. More recently, however, Friedman’s ideas, which first appeared in his 1962 book, Capitalism and Freedom, have lost their lustre. A new corporate model, built around multi-stakeholder engagement, has been touted as the way forward.

Companies themselves appear to be major advocates of this new approach, with chief executives taking every opportunity to talk up their corporate purpose and ‘longstanding commitment’ to a host of worthy causes, from diversity to sustainability.

CEOs committed to lead their companies for the benefit of all stakeholders – customers, employees, suppliers, communities and shareholders

These days, it’s hard to find a company CEO that isn’t a proponent: in August 2019, the Business Roundtable – an association of CEOs from many of America’s largest companies – issued a new ‘Statement on the Purpose of a Corporation’.1 The statement was signed by 181 CEOs, who committed to “lead their companies for the benefit of all stakeholders – customers, employees, suppliers, communities and shareholders”. Jamie Dimon, chairman and CEO of JP Morgan, a former chairman of the Business Roundtable, proclaimed: “These modernised principles reflect the business community’s unwavering commitment to continue to push for an economy that serves all Americans.”

It all sounds quite noble, but when the most prominent capitalists in the world’s biggest economy attempted to tug at the heartstrings, there were inevitably going to be cynics lining up to call their bluff.

Wrong for companies to impose their views of doing good on society
Warren Buffett

Few will be surprised Senator Elizabeth Warren is among them. Warren, currently vying for the Democratic nomination in the 2020 US presidential election, told CNBC in December: “If Jamie Dimon thinks it’s a good idea for giant corporations like J.P. Morgan Chase to have multiple obligations, he and I agree. Then let’s make that the law.”2 Warren Buffett was of the same opinion, telling the Financial Times it was “wrong for companies to impose their views of doing good on society”, adding that “the government has to play the part of modifying a market system”.3

The ire of the Business Roundtable’s critics has been further fuelled by the association’s efforts to limit the influence of proxy advisers, who some would argue provide a vital role in protecting investors’ interests against powerful corporate executives.4

To unpick the substance from the spin, the AIQ editorial team brought together Mirza Baig, Aviva Investors’ global head of corporate governance, and Stephanie Niven, global equities portfolio manager, to give their perspectives on corporate purpose and whether the age of shareholder primacy is coming to an end.

AIQ: Why do corporations exist? Is the pursuit of returns for shareholders above all else really so bad?

SN: There is an argument to say the purpose of a corporation is to make profit. Companies that can’t do that go out of business, which also explains why capitalism drives growth and living standards up over time.

The main asset of any corporation is its people

I have issues with that theory. The main asset of any corporation – although this may change – is its people. If people aren’t objects, is the full-blown pursuit of profit morally unacceptable? I think it is; it creates a moral dilemma. Economics is all about models, real life isn’t. You need to adapt some form of multi-stakeholder approach into the way we think about the purpose of a corporation. 

At the same time, there is a disconnect between the flexibility of shareholders and the flexibility of stakeholders. Shareholders are the owners of businesses; CEOs are the agents of businesses; but shareholders have an immediate and instant flexibility to move ownership of a company. All other stakeholders – the towns in which businesses are based, employees – are indefinitely wed towards that corporation. Trying to marry those two things is difficult.

Ultimately people are only incentivised by what they are paid

Adding further complexity is the fact executive management teams are appointed by shareholders, not stakeholders. Their incentive packages generally depend on total shareholder return (TSR). CEOs want to keep their jobs, but unless incentives are changed and more stakeholders are part of that appointment process, why would they change what they do when their incentives are so heavily driven by TSR? Big corporations can say the right things and form roundtables, but ultimately people are only incentivised by what they are paid.

 What is good for the share price in the short term isn’t necessarily good for the long-term sustainability of a business

The reduction in holding periods of shareholders is also relevant. What is good for the share price in the short term isn’t necessarily good for the long-term sustainability of a business. For example, CEOs are under increasing pressure to cut headcount – that’s not necessarily the right thing to do over a ten-year period. We have to look at how the short-termism of shareholders impacts the sustainability of the business and on employees and communities.

AIQ: Mirza, what are your thoughts?

MB: There was a lot of fuss about the Business Roundtable statement. It was significant because for the last 40 years, the Roundtable has been publishing governance principles that made it very clear the purpose of a corporation was to maximise shareholder returns; full stop. This is why the August announcement was quite a big shift, at least in terms of messaging.

The area that caused quite a bit of debate was why shareholders were last on that list

There was nothing surprising in the stakeholders selected: customers, employees, suppliers, communities and investors. The area that caused quite a bit of debate was why shareholders were last on that list.

From our perspective, all the Business Roundtable did was make a statement of fact:  that the success of a business depends on the ecosystem in which it operates. That ecosystem includes customers, employees, suppliers; there is no business without those relationships. However, investors and companies have known this for quite some time and the statement didn’t commit, in any practical way, to how the dynamics of those relationships will change.

Nor is the debate unique to the US. In Europe, the UK corporate governance code that was issued in 2018 and came into force this year states clearly the role of the board in determining corporate purpose, values, and how all that fits into strategy. In France, we had the PACTE law that came into force earlier this year – again, that law talks about encouraging companies to change their articles to include social objectives within their corporate purpose. And the German corporate governance code has been updated to emphasise the important role of stakeholders.

SN: Why are we seeing momentum behind this shift – at least in the narrative – now?

MB: There are a few reasons. There has been an erosion of public trust in business and some of that is down to executive pay. You’re never far away from a headline looking at percentages and ratios of executive pay to that of the average employee. The situation is even more acute in the US. As companies are managing their business for the imminent downturn, whether that’s a recession or a slowdown, the go-to executive decision is headcount cuts. That just accentuates the issue as management often get bonuses for delivering on those headcount reductions, which grates the public even more.

We have seen a focus on the lack of inclusive growth and on drops in productivity

Over the last decade, we have also seen a focus on the lack of inclusive growth and on drops in productivity. The big hope for productivity growth is artificial intelligence and automation. The problem is that, according to some projections, between 40 and 50 per cent of all jobs will become redundant as a result. Now that doesn’t mean you’ll have a net drop in employment of 50 per cent, as new jobs will be created through automation. But they will be different jobs; there will be more tech jobs and fewer manual jobs, which again will create further triggers of economic exclusion for large swathes of society.

The plight of the 99 per cent – rising living costs and falling real income – has helped fuel populism. The Trump mantra has quickly spread across Europe as the underlying social issues are the same.

You need a social purpose, you need stakeholders to be part of the decision-making process

Look at the PACTE law. It was about: ‘How do we improve productivity, allocate capital for growth among French companies, to improve employment opportunities in France.’ To achieve that, you need a social purpose, you need stakeholders to be part of the decision-making process.

There is a reason why we’re seeing calls for renationalisation, employees on boards, transfer of equity to employees. All these issues are fundamentally linked.

Stephanie mentioned short-termism versus long-termism. Over the long term there should be no conflict whatsoever between the interests of stakeholders and shareholders. In fact, companies that understand the positive impact each of those stakeholder dynamics has should develop a strategy, a code of conduct, a culture and a set of values that aligns those interests and creates a business that generates value across the chain for all stakeholders. It is in the short term that conflict will exist. This is the battle that needs to happen and be overcome.

AIQ: How will that battle play out?

MB: It is not one group of stakeholders versus another; it is long-term stakeholders versus short-term stakeholders. In the US, I don’t think the long-term/short-term battle has been had and, as a result, I am not convinced the Business Roundtable statement will translate into significant changes in how businesses are run. This is about business conduct and what it means in practise for a company to talk about its employees being its most important asset.

Nike is an interesting case study of a business with a strong purpose and identity

How do you translate those principles into actual business decision making? Nike is an interesting case study of a business with a strong purpose and identity – based on uniting the world in sport. Its decision to support black players in the NFL therefore made absolute sense. There may have been some short-term blowback on sales in the US, but over the long-term it should strengthen the global appeal of the brand and is one of the reasons why its biggest growth market is in Asia.

AIQ: How much of a responsibility is it for shareholders to push for these broader changes?

SN: It is absolutely their responsibility. First and foremost, if we were to start again and remuneration committees were charged with designing an incentive structure for management based upon what they deemed to be the success or failure of a business, incentives would look very different.

MB: Shareholders were the cause of a lot of these issues, so they absolutely have a responsibility to be part of the solution. Shareholders appoint and remove directors, and approve pay arrangements. Enlightened shareholders have the power and responsibility to engage with remuneration committees to change how and how much executives are paid. But the process will be iterative.

If a company came out now and said: ‘OK, forget earnings targets, forget return on capital capital…we are going to pay management on the results of an employee survey’, it would probably get voted down. It is too far a jump for the entire shareholder community.

Improving stakeholder relationships to strengthen a business is more difficult to measure and hold management accountable for

Historically, focusing purely on shareholder returns created transparent, simple performance metrics. To judge the CEO, you look at what the share price has done and how they have improved basic underlying metrics – earnings, margins, gearing and so on. On the other hand, improving stakeholder relationships to strengthen a business is more difficult to measure and hold management accountable for.

Beyond pay, in terms of our own engagement with company boards, one of our key asks is for them to be more decisive in holding management accountable for poor performance. But to define ‘underperforming’, you need to define success, you need to define objectives. In turn, this means we need to create a more holistic matrix of performance measurement that has a much greater weighting towards longer-term metrics and broader stakeholder considerations.

SN: I don’t see any change unless you change how people are paid. People act on incentives.

MB: It’s the short-term reality of business. The question is to what extent do you value those wider relationships? That is the point investors have to get across. Now we are saying if they want to be successful, they need to value those relationship more. And they need to make business decisions based upon it not being a zero-sum game.

SN: Previously there was an expectation or hope that, with the rights of stakeholders enshrined in law, some of the corporate governance issues we talked about – legal restrictions that prevent pollution or whatnot – would be addressed. But governments can’t regulate to include all stakeholders. There needs to be something beyond that.

AIQ: Why is regulation not the answer?

SN: The bigger corporations become, the more complex regulation has to be. The Dodd-Frank Act ran to over 2000 pages. You need to be huge to even incorporate those sorts of complex rules into your business. Barriers to entry are rife and that is something large corporations can exploit. I don’t think it can be regulation-led. I don’t think that will work.

AIQ: Should there be a limit on what CEOs should get paid relative to the average worker? 

MB: I think we will move to a point where there will be a limit, but I don't think it's going to be a fixed ratio, because ratios vary by sector. However, we must get to a point where we look at the numbers. The interesting thing is that investors have been talking about alignment with shareholder returns for years. We've looked at structure of pay, we got into heated debates about detailed metrics, but outside of investment firms, in the real world nobody cares about alignment and structure – they merely care about the headline figure.

Remuneration committees are going to have to start thinking about 'how much is too much?' in absolute terms

Up until January, the Business Roundtable was chaired by Jamie Dimon. The reality is that few people care what value JPMorgan has created in the last five years under his leadership: they’re just going to look at his pay and see $20 million. People are not going pay attention to what he is saying because of that number. The longer that continues, remuneration committees are going to have to start thinking about 'how much is too much?' in absolute terms.

SN: Why should you pay people on things they can't control? My view is that we should pay CEOs over the things they can control: they can control relationships with employees, and they can control relationships with clients. They can't control share prices. And they can't control the oil price in the case of Shell. There needs to be more accountability within pay. 

AIQ: You both support the multi-stakeholder model. Outside of governments, shareholders have the most clout: do asset managers need to take more responsibility?

SN: Clearly, we work at an active asset manager, but I have a strong belief active is the way to invest responsibly. Active investors can get in and out of shares and respond to bad decisions. Passive holders can't. What I would like to see is the expectations around how asset managers engage with companies feeding into investment management agreements and ultimately how fund managers think more widely about stakeholders. The longer investors are in my fund, the longer term I can be.

AIQ: Isn’t there a need for more collective action? There are cases when a group of shareholders act in a coordinated way, on climate change for example, but what about doing that on issues such as remuneration?

MB: You can't deal with one issue in isolation. We have talked about executive pay and why it is based on short-term factors. It is because boards and companies are judged on short-term performance by shareholders. And shareholders are concerned about short-term performance because that is how their funds are assessed. Why are their funds assessed like that? Because these are the mandates given by asset owners and consultants. You can't just change executive pay on its own.

The first thing Paul Polman did after taking over at Unilever was remove quarterly guidance. He told the market: ‘If you're a short-term shareholder, I have no interest in talking to you’. He instituted a new corporate purpose, created something called 'Sustainable Living Plan' and he built a business designed for the long term. But it wasn't immediately rewarded by markets.

Even when you get companies and CEOs trying to do the right thing, the entire incentive structure in the market has to change to support it

When you look at the fundamentals now, the fastest growing parts of the business are connected to that sustainable strategy. It is a story that worked from a business sense, but not from a capital market sense. When shareholders were evaluating his pay, they were still looking at things from a six-month or 12-month perspective. Even when you get companies and CEOs trying to do the right thing, including changing pay structures, the entire incentive structure in the market has to change to support it. 

There are regulations like the European Union’s Shareholder Rights Directive, which was designed to promote long-termism from institutional investors through to managers through to companies. It talked about asset managers being incentivised over the long term. If you've got an asset owner with liabilities over twenty years, how does that affect your equity strategies, how does that affect your allocation to managers? How are you rewarding them, and how does that feed through to stewardship?

I think the intention behind the Directive is absolute right – effectively seeking to build long-termism throughout the investment value chain. But we have to wait and see how this will translate in practice.

AIQ: Shareholders are also motivated by financial incentives – how do you change shareholders when they act on what they can see?

SN: How do you change human psychology? There needs to be a shift in what we do, to say: “Let’s just not compensate people on their one-year performance”. As a portfolio manager, I need to be able to back one company over another because I think will be in a better position and have done more of the right things over the next ten years. That might not pay off in the next 18 months, but I shouldn’t lose my job over that.

It’s challenging – everyone’s involved in this conversation and until humans can live with uncertainty and be more long term in their outlook, I don’t see a clear answer.

AIQ: Stephanie, you mentioned a lack of competition. Is that at the root of public antipathy towards companies? Tech companies would seem a good example – we have near monopolies, whose share prices have skyrocketed, but without reflecting any real economic contribution. It hardly helps resolve the erosion of public trust.

SN: I wholeheartedly agree with the premise things are being made worse by a lack of competition, particularly in the US and in the tech and finance sectors. Technology has increased dispersion and the competitive advantage. The haves and have nots have bifurcated.  

Regulation is not necessarily the answer

I go back to my earlier point about regulation not necessarily being the answer. If you look at banking post the financial crisis, the regulations are stricter but the barriers the entry are higher than they’ve ever been. In technology, the introduction of GDPR in Europe has only further entrenched the competitive advantage of the big tech firms. That’s why this goes beyond rules and regulations. Until we as investors and society hold these businesses more accountable, there are big problems ahead. Free markets just don’t operate the way they used to.

AIQ: We’ve talked about the need for shareholders to play their part. A recent example of that not occurring happened in California – after a law came in requiring companies to treat contract workers as employees, share prices of Californian companies fell.

MB: Again, it comes down to that long-term/short-term tension. A multi-stakeholder model can only exist within a long-term investment framework. If we continue to look through a short-term prism, nothing will change.

Structural issues across labour markets are often a key inhabitant to inclusive growth

Structural issues across labour markets are often a key inhabitant to inclusive growth. One of Prime Minister Abe’s structural reforms in Japan was employment regulation. Historically in Japan you had a job for life and as a result of that no companies were giving permanent roles any more to the younger generation. They had no flexibility. You had similar issues in France, which is why there was a push towards part-time employment. And in the UK, you’ve got the rise of the gig economy.

Labour markets are fundamentally shifting away from permanency and traditional forms of security. As a result, you are effectively institutionalising job insecurity for an entire generation of people. And that feeds into social exclusion. You cannot get on the property ladder without having some sort of job security. Something needs to be done, otherwise populist sentiment, and the political and economic instability it fuels, will continue unabated.

Companies may be less reliant on employees than 50 years ago, but you cannot run a business with an algorithm

Companies operate within an ecosystem. Yes, they may be less reliant on employees than 50 years ago, but you cannot run a business with an algorithm. Unless companies and governments work together to address this, you will have chaos. Investors need to accept that regardless of near-term headwinds for profitability, it is necessary to rebase views on the fair distribution of economic value.

AIQ: Is there an effective model anywhere?

MB: Ironically, family-run businesses that are insulated from short-term market dynamics tend to be ones that have longer-term capex strategies and pay their employees more. They tend not to do well in the short term as governance professionals tend to say: “Look, they’ve got too much control, excessive voting rights”. At the same time though, they have more stability.

Japan is also an interesting case. I remember visiting companies ten to 15 years ago and it was almost impossible to get shareholder primacy on the agenda. The perception was that they didn’t care about us, it was all about employees, customers and suppliers. As a result, the return on equity was negligible and there was a big focus on improving the quality of products, even if they had absolutely no return prospects. If you were an employee, you would stay forever, even if you had completely redundant skills.

We need to find a hybrid model that values employees, customers and other stakeholders, while ensuring businesses remain profitable and sustainable

Given the poor performance of Japan Inc. since the turn of the century, clearly the model wasn’t working. However, the answer is not to shift completely in the other direction. Instead, we need to find a hybrid model that values employees, customers and other stakeholders, while ensuring businesses remain profitable and sustainable. You need to take the positive attributes of different markets and corporate models and try to mesh them together.

AIQ: Beyond standard financial metrics, what other measures are you looking at that better reflect a multi-stakeholder approach?

SN: One metric we look at is net promoter score, which is a measure of how companies are seen by customers. In truth, we have only really begun to take more of an interest in this over the last 18-24 months, but it is something companies are starting to talk more about.

As companies outline a broader strategy, they need metrics connected to that strategy. If it was about customer retention, we would look at net promoter scores; if the objective is about securing a sustainable supply chain, we would look at other metrics to support that.

Rather than being prescriptive, we need to be able to see the narrative arc

Rather than being prescriptive, we need to be able to see the narrative arc; from a company talking about corporate purpose and about a long-term strategy, that’s not three years but five to ten to 15 years, depending on the sector. We then need to see how that translates into goals, into a plan, into the decisions they make and then into indicators of success and failure. What we then want to see is how that subsequently translates back into pay. Incentives are almost the last component.

AIQ: Final question. How do you see this evolving in the next five to ten years?

MB: I think you will see other stakeholders on the board, starting with employees, having a more direct impact on how businesses are run and how they allocate capital and determine success.

When deciding on a capital strategy, companies must consider what that means for the environment and the local community

The UK Companies Act already states companies’ board of directors need to take account of external stakeholders when making business decisions. Now the Corporate Governance Code requires them to disclose how they are doing that. So, when deciding on a capital strategy, they must consider what that means for the environment and the local community. The more accountability there is on these issues, the more holistic decision-making will become.

SN: I think we will see changes, but they’ll be slow. We still see CEOs paid on adjusted earnings per share growth; in other words, incentivising poor acquisitions. That has been obvious for 20 years and is not a good use of anyone’s capital, yet people are still paid on it. I suspect we’ll hear more noise, but not much in the way of change.

AIQ: Thank you both for your time.

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