Revue Européenne du Droit
The Power of Purposeful Business
Issue #4
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Issue #4

Authors

Alex Edmans

Revue européenne du droit, Summer 2022, n°4

Even before COVID-19 devastated the world, capitalism was already in crisis.  The 2007 financial crisis cost 9 million Americans their jobs and 10 million their homes.  Although the economy recovered, the gains largely went to bosses and shareholders, while worker wages stagnated. In 2019, the world’s 22 richest men enjoyed more wealth than all the women in Africa.  This inequality will only increase due to the coronavirus pandemic. While 100 million people are being plunged into extreme poverty, the wealth of tech billionaires is skyrocketing. 

Corporations aren’t just passive beneficiaries from global trends – they actively contribute to them. To squeeze out every last dollar of profit, many pay their employees as little as possible and work them to the bone, flouting health and safety regulations. Every day, 7,500 citizens around the world die from work-related diseases and accidents.  A company’s impact is so far-reaching that it can harm people who aren’t even its customers or employees. In June 2020, US power supplier PG&E pled guilty to 84 manslaughter charges stemming from California wildfires caused by its faulty equipment.

The damage isn’t just to people, but to the planet too. In 2010, the explosion of BP’s Deepwater Horizon drilling rig saw 4.9 million barrels of oil spill into the sea, threatening eight US national parks, endangering 400 species and spoiling 1,000 miles of coastline. Five years later, Volkswagen admitted installing a ‘defeat device’ in its cars, which cheated emissions tests and contributed to 1,200 deaths in Europe alone.  In May 2020, mining company Rio Tinto detonated Juukan Gorge in Australia, a sacred site for the indigenous Puutu Kunti Kurrama and Pinikura people, which had been continuously occupied by humans for 46,000 years. Over and above these individual cases, the environmental costs created by business are estimated at $4.7 trillion per year. 

Citizens are fighting back. On 15 April 2019, the activist group Extinction Rebellion organised demonstrations in 80 cities across 33 countries, blockading roads, bridges and buildings in protest at climate change. Myriad other responses include Occupy movements, Brexit, the election of populist leaders, restrictions on trade and immigration and revolts on CEO pay. But while the precise reaction varies, the sentiment’s the same. ‘They’ are benefiting at the expense of ‘us’.

In turn, companies were responding – or at least are appearing to.  Sustainability has become the corporate buzzword of the day.  It was the theme of the 2020 World Economic Forum in Davos. In August 2019, the Business Roundtable, a group of influential US CEOs, radically redefined its statement of the ‘purpose of a corporation’ to include stakeholders, rather than just shareholders. In June 2020, Danone was the first French company to become a ‘société à mission’, writing its purpose into its corporate bylaws. 

But it wasn’t clear whether these leaders genuinely meant what they said. Critics argue that Davos is more about appearing to do good than actually doing good. Sceptics claim that the Business Roundtable statement was a public relations exercise to stave off regulation. Indeed, several signatories shed thousands of workers in the coronavirus pandemic, at the same time as paying huge dividends to investors. A few months after becoming a société à mission, Danone announced 2,000 job cuts. Critics argued that Danone’s focus on purpose was an attempt to mask its poor performance – its stock price was flat over CEO Emmanuel Faber’s 6.5-year tenure, compared to a 50% rise for its competitor Nestlé and the broader CAC-40. 

Why is it that some leaders may not do as they say?  Why do they reduce sustainability to an ancillary activity to be buried in a ‘Corporate Social Responsibility’ department rather than part of the core business?  Because many fear that sustainability is at the expense of profits.  Traditional management thinking is that the value created by a company is represented by a pie, which is fixed in size.  So any slice of the pie given to society means a smaller slice for shareholders.  A CEO’s goal, therefore, is to squeeze as much as possible out others, by holding down wages, price-gouging customers, and paying scant attention to the environment.  This pie-splitting mentality would argue that you should practice sustainability to the minimum possible, and reduce it to PR initiatives that cost little but create much fanfare.

And the pie-splitting mentality is also practiced by many advocates of business reform.  If the pie is fixed, the only way to increase the share that goes to society is to straitjacket business with heavy regulation so that it doesn’t make too much profit. 

Under the pie-splitting mentality, business and society are enemies.  And the battle they’ve been fighting has been around for centuries.  In the mid-19th century, Karl Marx wrote about the struggle between capital and labour.  Since then, we’ve seen a pendulum swing back and forth between business and society.  Think of the late 19th century robber barons who created giant monopolies such as Standard Oil; policymakers responded by breaking some up.  Or the peak of trade unions in the 1970s, followed by legislation that caused their decline.  Or the rise of big banks in the early 20th century which culminated in the 1929 financial crisis and their regulation by the Glass-Steagall Act – itself partially reversed since the 1980s, contributing to another crisis in 2007.  Unless we can come up with another way, this movie will keep on being replayed.

But the good news is that there is another way.  

By applying a radically different approach to business, companies can create both profit for investors and value for society.  The pie-growing mentality stresses that the pie is not fixed.  By investing in stakeholders, a company doesn’t reduce investors’ slice of the pie, as assumed by some CEOs – it grows the pie, ultimately benefiting investors.  A company may improve working conditions out of genuine concern for its employees, yet these employees become more motivated and productive.  A company may develop a new drug to solve a public health crisis, without considering whether those affected are able to pay for it, yet end up successfully commercialising it.  A company may reduce its emissions far beyond the level that would lead to a fine, due to its sense of responsibility to the environment, yet benefit because customers, employees, and investors are attracted to a firm with such values.

Under the pie-growing mentality, a company’s primary goal is to serve society rather than generate profits.  Surprisingly, this approach typically ends up more profitable than if profits were the end goal.  That’s because it enables many investments to be made that end up delivering substantial long-term payoffs.  It’s important to acknowledge that a profit-focused company will still invest in stakeholders – but only if it calculates that such an investment will increase profits by more than the cost of the investment.  Indeed, comparing costs and benefits is how finance textbooks argue companies should decide whether or not to take an investment.  

But real life isn’t a finance textbook.  In practice, it’s very difficult to calculate the future payoff of an investment.  In the past, this was easier when investments were in tangible assets – if you build a new factory, you can estimate how many new widgets the factory will produce and how much you can sell them for.  Most of the value of a 21st century firm comes from intangible assets, such as brand and corporate culture.  If a company improves working conditions, it’s impossible to estimate how much more productive workers will be, and how much higher profit this greater productivity will translate into.  The same is true for the reputational benefits of a superior environmental record.  A company that’s free from the shackles of having to justify every investment by a calculation will invest more and may ultimately become more profitable.  

This new approach to business is the subject of my recent book, ‘Grow the Pie: How Great Companies Deliver Both Purpose and Profit.’ 1   I wrote this book out of concern for the polarisation between business and society that the world finds itself in.  In the face of this conflict, this is a fundamentally optimistic book.  Yet this optimism is not based on blind hope, but on rigorous evidence that this approach to business works – across industries and for all stakeholders – and an actionable framework to turn it into reality. 

Let’s indeed turn to the evidence.  The idea that both business and society can benefit might seem to be a too-good-to-be-true pipedream.  However, rigorous evidence suggests that companies that treat their stakeholders well deliver superior long-term returns to investors.  For example, one of my own studies, shows that companies with high employee satisfaction outperformed their peers by 2.3-3.8% per year over a 28-year period 2 .  That’s 89-184% compounded.  I do further tests suggest that it’s employee satisfaction that leads to good performance, rather than the reverse.  Other studies find that customer satisfaction 3 , environmental stewardship 4 , and sustainability policies 5 are also associated with higher stock returns.  

So creating value for stakeholders isn’t just a worthy ideal – it’s good business sense.  When I speak to practitioners on the importance of purpose, I’m introduced as a Professor of Finance and the audience often thinks they’ve misheard.  The finance department is frequently the enemy of purposeful business, believing that it’s simply a distraction from creating profits.  This might be true in the short-term, but the long-term evidence shows that any finance department with this mindset is failing at its job.  The positive relationship with long-term returns also means that it’s in companies’ own interest to transform the way they do business and take very seriously their impact on society.  In fact, it’s urgent that they do.  Otherwise, anti-business regulations will be passed, and customers and workers will switch to competitors whose values they share.  Serving society isn’t an optional extra to be confined to a CSR department, but should be fundamental to how a business is run.  

A Shift In Thinking

The pie-growing mentality shifts our thinking on some of the most controversial aspects of business.  First, it transforms what leaders’ and enterprises’ responsibilities are, and how what society should hold them accountable for.  We often ‘name and shame’ companies who engage in errors of commission – actions seen as pie-splitting, such as making what we see as too much profit.  But high profits may be a by-product of serving society.  Instead, we should hold businesses accountable for errors of omission – spurning opportunities to grow the pie through inaction.   For example, Kodak failed to invest in digital cameras and ultimately went bankrupt.  Yet it’s rarely seen as a corporate governance failure because investors didn’t profit – but that’s of no consolation to the 150,000 workers were made redundant.  An irresponsible company is one that shrinks the pie or fails to grow it, harming everyone.  

Second, the pie-growing mentality changes our view on how to reform executive pay.  The level of CEO pay is perhaps the single most-cited piece of evidence that business is out of touch with society.  In the US, the average S&P 500 CEO earned $14.8 million in 2019, 264 times the average employee.  The idea is that, if the CEO wasn’t so greedy, her pay could be redistributed to her colleagues or invested.  But that’s the pie-splitting mentality.  The amount that can be reallocated through redistributing the pie is tiny.  The median equity value in the S&P 500 is $24 billion.  $14.8 million is only 0.06% of the pie – far smaller than the 2.3-3.8% that can be created by growing the pie through improving employee satisfaction.

Moreover, just like high profits, high pay could be a by-product of creating value.  It’s fair for CEOs to be paid like owners – to own a long-term share in her business, so that she’s on the hook if it underperforms.  But the flip side is that, if she grows the long-term stock price, she’ll automatically be rewarded as her shares will be worth more.  For example, Disney’s Bob Iger was criticised for earning $66 million, but the market value of Disney had risen by 578% in his four years at the helm, and 70,000 jobs had been created.  So we shouldn’t criticise high CEO pay without first asking whether it results from pie-growing or pie-splitting.

And that’s where there is indeed major room for reform.  Some CEOs aren’t paid like long-term owners.  They’re instead given bonuses based on short-term targets – and so it’s indeed possible for them to earn millions by exploiting workers and customers.  So the solution isn’t so much to change the level of pay, even though this might win the most headlines, but its structure – to move away from short-term targets and pay the CEO with shares that she can’t sell for (say) 5-7 years.  Giving her long-term incentives rewards her for pie-growing and discourages pie-splitting. Indeed, research shows that short-term incentives lead to CEOs cutting investment to meet quarterly earnings targets 6 , while long-term incentives are associated with not only higher financial performance, but superior innovation and stakeholder welfare 7 . Importantly, both papers document causation, not just correlation. 

Importantly, the CEO should continue to hold her shares after retirement, to ensure that her horizon extends beyond her tenure.  And shares should be awarded to all employees, to ensure that everyone benefits from pie-growth.  If the company does well, it’s not just due to the CEO. Giving shares to colleagues treats them as partners in the enterprise, rather than hired labourers. 

Third, the pie-growing mentality shifts our thinking on investors.  Investors are often viewed as nameless, faceless capitalists who extract profits at the expense of society.  One book claimed that ‘Shareholder activists … are more like terrorists who manage through fear and strip the company of its underlying crucial assets, … extracting cash out of everything that would otherwise generate long-term value’ 8 , and politicians in both the UK and US have made proposals to restrict investor rights.  But such views aren’t backed up by the evidence.  Rigorous studies show that, while shareholder activism does indeed increase profits, this doesn’t arise from pie-splitting but pie-growing – improved productivity and innovation, which in turn benefits society 9 .  

Investors are not ‘them’; they are ‘us’.  As mentioned earlier, they include ordinary citizens saving for retirement, or mutual funds or pension funds investing on their behalf.  Policies that suppress investors will not only make companies less purposeful and less productive, but also harm citizens.  Investors aren’t the enemy, but allies in growing the pie.  Any serious proposal to reform business should place investor engagement front and centre.  

Putting It Into Practice

So how does a company actually ‘grow the pie’?  The starting point is to define its purpose – why it exists, its reason for being, and the role that it plays in the world.  A purpose might be to develop medicines that transform citizens’ health; to provide an efficient rail network that connects people with their jobs, family and friends; or to manufacture toys that entertain and educate children.  

Importantly, a company’s purpose cannot be to earn profits – instead, profits are a by-product of serving a purpose.  This is similar to how a citizen’s vocation is not to earn a salary; instead, he earns a salary by choosing a career he enjoys and thus flourishes in.  Equally importantly, a purpose should be focused.   Many companies have broad purpose statements, such as ‘to serve customers, colleagues, suppliers, the environment, and communities while generating returns to investors,’ because it sounds inspiring to be able to serve everyone.  But a purpose that tries to be all things to all people offers little practical guidance because it sweeps the harsh reality of trade-offs under the carpet.  Leaders need to make tough decisions that benefit some stakeholders at the expense of others.  

In November 2016, French electricity firm Engie announced the closure of its Hazelwood power station in the Latrobe Valley of Victoria, Australia. This decision caused 450 Engie employees and 300 contractors to lose their jobs. Customers also suffered – since Hazelwood provided a fifth of Victoria’s electricity-generation capacity, average household bills rose by 16% over the next year.  But Engie took the decision because, earlier that year, it had announced a transformation plan to prioritise the environment. As then-CEO Isabelle Kocher said: ‘We want to focus our investments solely on generating low carbon energy . . . we are redesigning our entire portfolio.’ Hazelwood was the most polluting plant in Australia, responsible for 3% of its greenhouse gas emissions, and one of the most polluting plants in the world. In 2005, the World Wide Fund for Nature had named it the least carbon-efficient power station in the OECD.  

Having a focused purpose statement guided Engie on this tough decision. Because its purpose ranked the environment as even more important than employees and customers, it knew what it had to do. It first chose to close down the plant, and then sought to mitigate the job losses by finding jobs for its employees at nearby companies. 

And evidence highlights the criticality of focus.  Companies that do well on ESG (environmental, social, and governance) dimensions across the board don’t beat the market.  But those that do well on only dimensions material to their business – and scale back on others – do significantly outperform 10 .  The book introduces three principles (the principle of multiplication, the principle of comparative advantage, and the principle of materiality) to provide practical guidance on which investments in stakeholders a company should make, and when it should show restraint.  This balance is critical.  Some leaders misinterpret the call to ‘serve society’ as an imperative to invest as much as possible, and many politicians advocate such behaviour.  But there are many cautionary tales of companies imploding through overinvestment, Daewoo being a particularly prominent one.  

Of course, purpose must go beyond a mere statement and must be put into practice.  The book discusses five tools through which a company can do so – aligning its strategy, operating model, culture, reporting, and governance.  It also stresses the role of investors in stewarding a company’s purpose – holding CEOs to account for embedding it throughout the organisation, and providing an independent sounding board on long-term issues.  I provide a practical guide for how investors can undertake stewardship effectively, and how the relationships between different players in the investment industry – asset managers, asset owners, investment consultants, and proxy advisors – can be reformed from the transactional to the trusted, in turn providing the long-term context necessary for stewardship to thrive.  

And citizens have a major part to play too.  The popular narrative is that corporations are so large that citizens are powerless to shape them.  But I stress how citizens – in their roles as employees, customers, and investors – enjoy agency: their capacity to act independently and influence their environment, rather than being acted upon.  One source of agency is the power to put their time and money into companies that reflect what they would like to see in the world, and walk away from others.  Customer boycotts for allegedly non-purposeful behaviour are arguably more powerful than ever before due to social media, as shown by the #boycottvolkswagen and #DeleteUber campaigns.  In the modern firm, human (rather than physical) capital is more important than ever before, and departures of key employees severely damage a company’s competitiveness.  

A second source of agency is the power to shape companies they do choose to be members of.  Every night, Abdul Durrant worked hard to clean the London offices of HSBC, including that of chair Sir John Bond.  But he struggled to support his five children on his low wages.  So Abdul attended HSBC’s AGM and addressed Sir John, saying ‘I am here on behalf of all the contract staff at HSBC and the families of East London. We receive £5 per hour – a whole £5 per hour! – no pension, and a measly sick pay scheme. In our struggles our children go to school without adequate lunch. We are unable to provide necessary books for their education. School outings in particular they miss out on.’  Moved by this plea, Sir John gave HSBC’s cleaners a 28% pay rise.  This shows the power of a single employee to change the wage policy of a large multinational.  

Purpose in the Pandemic

The importance of viewing purpose as growing the pie, rather than splitting it differently, is particularly critical in the pandemic.  Some companies have indeed been able to serve society by splitting the pie in the pandemic. For example, Unilever donated €100 million of food and sanitiser to local communities and safeguarded the jobs of its 155,000 workers – including contractors, such as cleaners and catering staff.

Such actions are highly laudable and should never be downplayed. But the problem with viewing responsibility as only about splitting the pie is that many companies don’t have pie to share, particularly in a pandemic. What if you’re not in the food and sanitiser industry and don’t have relevant products to donate? What if you’re a small enterprise that doesn’t have millions lying around? 

The value of thinking about responsibility as pie-growing is that it unlocks the potential for all companies to play their part. Unlike splitting the pie, growing the pie often doesn’t cost a huge amount of money – what it requires is the mindset to create value for society. A responsible leader asks herself ‘What’s in my hand?’ What resources and expertise does my company have, and how can I deploy them innovatively to serve society?

Such a mindset can inspire some great ideas. LVMH’s luxury perfumes were indeed a luxury in a pandemic. But what’s in its hand is a production facility that uses alcohol, which it redeployed to manufacture hand sanitiser. Many of JetBlue’s planes were grounded as passenger numbers plummeted. So it partnered with charities such as the Red Cross and Médecins Sans Frontières to use these planes to transport medical professionals, devices and supplies to where they’re most needed. 

And thinking of responsibility as growing the pie is particularly relevant for small businesses, who don’t have pie to give. Take Barry’s, the boutique fitness studio. What’s in its hand is fitness expertise, which it used to offer free livestreamed workouts – particularly valuable when citizens are locked down at home. Now it might seem not particularly innovative for a fitness studio to provide fitness classes, albeit online. The real creativity was in how it redeployed its office and desk workers. Some of them also had jobs as actors; since acting can be volatile, they also worked for Barry’s to provide a stable income. If you’re an actor, what’s in your hand is that you’re entertaining. How does that help in a crisis? Barry’s launched a ‘Barry’s Cares’ programme, which included their staff reading stories and providing entertainment to children over Zoom – taking the load off working parents whose kids were at home due to school closures.

Citizens practised the pie-growing mindset in the pandemic too. For some, what’s in their hand was time – by doing grocery shopping for their vulnerable neighbours. For others, it was money. One friend advance-purchased 100 coffees from his local coffee shop, supplying them with a liquidity lifeline. For others still it was words, which are often seen as vacuous compared to ‘hard’ actions or financial contributions. But telephoning someone who is self-isolating alone, or giving a sincere thank you to an overworked delivery driver, can make a big difference.  

These inspiring examples give us hope even in bleak times. If there’s any silver lining to the crisis, it’s that it will permanently lead to a shift in thinking about what responsible business entails – from splitting the pie by spending money to growing the pie by innovatively using what’s in our hand. The latter can be practised by companies both large and small, in bad times as well as good, and by citizens and junior employees not just senior executives.

A Collaborative Effort

So it’s not business or society – it’s and.  This observation gives us great hope, but also great responsibility.  Not only can all stakeholders benefit from a growing pie, but it’s also their duty to work together to grow the pie.  When they do so, bound by a common purpose and focused on the long-term, they create shared value in a way that enlarges the slices of everyone – shareholders, workers, customers, suppliers, the environment, communities, and taxpayers.  Evidence suggests that visionary leaders can transform a company, growing the pie for the benefit of all.  Engaged shareholders can intervene in a failing firm, growing the pie for the benefit of all.  A motivated workforce can innovate from the bottom up, growing the pie for the benefit of all.  

Importantly, an approach to business driven by purpose typically ends up more profitable in the long-term than an attempt to maximise shareholder value.  So it’s one that leaders should voluntarily embrace, even in the absence of public mistrust or threats of regulation.  Creating social value is neither defensive nor simply ‘worthy’ – it’s good business.  The highest-quality evidence, not wishful thinking, reaches this conclusion: To reach the land of profit, follow the road of purpose.  

Notes

  1. Edmans, Alex (2020): Grow the Pie: How Great Companies Deliver Both Purpose and Profit. Cambridge University Press. 
  2. Edmans, Alex (2011): ‘Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices.’ Journal of Financial Economics 101, 621-640; Edmans, Alex (2012): ‘The Link Between Job Satisfaction and Firm Value, With Implications for Corporate Social Responsibility.’ Academy of Management Perspectives 26, 1-19.
  3. Fornell, Claes, Sunil Mithas, Forrest V. Morgeson III and M.S. Krishnan (2006): ‘Customer Satisfaction and Stock Prices: High Returns, Low Risk.’ Journal of Marketing 70, 3-14.     
  4. Derwall, Jeroen, Nadja Guenster, Rob Bauer and Kees Koedijk (2005): ‘The Eco-Efficiency Premium Puzzle.’ Financial Analysts Journal 61, 51-63.
  5. Eccles, Robert, Ioannis Ioannou and George Serafeim (2014): ‘The Impact of Corporate Sustainability on Organizational Processes and Performance’ Management Science 60, 2835–2857.
  6.  Edmans, Alex, Vivian W. Fang and Katharina Lewellen (2017): ‘Equity Vesting and Investment.’ Review of Financial Studies 30, 2229-2271.
  7. Flammer, Caroline and Pratima Bansal (2017): ‘Does Long-Term Orientation Create Value? Evidence from a Regression Discontinuity.’ Strategic Management Journal 38, 1827-1847.
  8. Georgescu, Peter (2017), Capitalists, Arise!: End Economic Inequality, Grow the Middle Class, Heal the Nation, Berrett-Koehler Publishers, 118.
  9. Brav, Alon, Wei Jiang, Frank Partnoy and Randall Thomas (2008) ‘Hedge Fund Activism, Corporate Governance, and Firm Performance.’ Journal of Finance 63, 1729-1775. Brav, Alon, Wei Jiang and Hyunseob Kim (2015): ‘The Real Effects of Hedge Fund Activism: Productivity, Asset Allocation, and Labor Outcomes’ Review of Financial Studies 28, 2723–2769. Brav, Alon, Wei Jiang, Song Ma and Xuan Tian (2018): ‘How Does Hedge Fund Activism Reshape Corporate Innovation?’ Journal of Financial Economics 130, 237–264.
  10. Khan, Mozaffar, George Serafeim, and Aaron Yoon (2016): ‘Corporate Sustainability: First Evidence on Materiality.’ The Accounting Review 91, 1697-1724.
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