In August 2019, nearly 200 chief executives from some of the world’s largest companies put a stake in the ground and redefined the role of a corporation and its responsibilities to society.
Or did they?
Members of the Business Roundtable, a prestigious group that includes the heads of Apple, GM, Walmart, and BlackRock, recently updated their statement on the purpose of a corporation. Most notably, while previous statements argued that corporations exist primarily to serve their shareholders, this version acknowledged that “too often hard work is not rewarded” and explicitly clarified companies’ commitment to other stakeholders such as customers, employees, suppliers, and communities.
The CEOs’ statement attracted widespread attention and responses ranging from optimism and relief to skepticism and displeasure. Most of all, it raised a lot of questions. Why did the Roundtable choose this moment to make their announcement? Is the common refrain of “maximizing shareholder value” really a thing of the past? What might change—if anything? And how do we know whether any changes will be for the best?
Kellogg Insight sat down with several Kellogg faculty members to discuss. Carola Frydman, Ravi Jagannathan, Bob Korajczyk, and José Liberti are professors of finance, and Aaron Yoon is an assistant professor of accounting and information management.
The resulting conversation was edited for length and clarity.
José Liberti: I find the statement absurd—a way for the CEOs to appear on radio and TV.
There are a lot of misconceptions about maximizing shareholder value, even among economists. But talk to a legal scholar or a corporate lawyer: a CEO or board is not legally obliged to maximize shareholder value. They need to maximize the value of the corporation and act in its best interest. Only when there is a change in legal control, such as a merger or imminent hostile takeover, do they have to maximize shareholder value.
Just to be very clear: modern corporate law does not require profits at the expense of everything else, and maximizing profits or shareholder value is not the same thing as serving shareholders’ best interest.
Ravi Jagannathan: Maximizing the long-term value of the firm involves doing lots of things. You have to keep your customers happy, because customers have to voluntarily come and buy your goods. If you don’t keep your employees happy, they will leave. And if you don’t keep your community happy, then tomorrow lots of regulations are going to come down the road and your profits will suffer.
Robert Korajczyk: I think that well-run businesses, in competitive industries, understand this. This quote from Southwest Airlines’ Herb Kelleher illustrates the point: “The business schools used to pose it as a conundrum. They would say, ‘Well, who comes first? Your employees, your shareholders, or your customers?’ But it’s not a conundrum. Your employees come first. And if you treat your employees right, guess what? Your customers come back, and that makes your shareholders happy. Start with employees and the rest follows from that.” Costco is a great example.
“Firms function in a free-market economy; that doesn’t mean they function in a jungle.” - Ravi Jagannathan
Liberti: Yes. If a firm maximizes profits by doing crappy things, it can harm shareholders.
The concept of “maximum shareholder value” also assumes that one single shareholder value exists! But there are different shareholders and they hold different values. Some are short-term investors, some are activists, some are passive investors, some are long-term investors.
The directors can already decide how to best serve the corporation and its shareholders. These CEOs are not creating a new definition of corporation or focusing on something else. I think they are just saying what any layman in the street wants to hear.
Jagannathan: So you have to ask yourself, why, at this particular time, has this letter come about? The CEOs are trying to reduce economy-wide risk.
Firm value depends what happens in the future, and today the global economy has a huge amount of risk. Go ahead and look at government bond interest rates in Western countries and Japan. Many of them are below zero. That suggests a flight to safety, and investors are willing to accept less in the future than what they are giving up now.
While individual firms’ managers cannot reduce economy-wide risk, collectively they may be able to do so. This would have two benefits: it would increase expected future cash flows, and at the same time it would reduce the risk premium for bearing that risk—thereby increasing the discounted present value of those expected future cash flows. This would increase the value of all of the firms. (So the issuance of the letter is consistent with maximizing firm value!)
A number of events have contributed to a heightened global risk. The easy answer is to attribute it all to the trade war. The supply chains in China that firms have created for over 20 years are not easy to replace within a short time. But I view the trade war as a symptom, not the disease itself. If it’s not Trump’s trade war today, it will be something else tomorrow. Globalization that followed the fall of the Soviet Union has created immense changes in the world economic order. China is now the second largest economy, but their economic system is different from the one Western countries and Japan are used to, and the adjustment process needs time and will not be without costs. The wealth and income disparities within Western countries have become very large, as pointed out by Thomas Piketty in his bestseller Capital in the Twenty-First Century, and that is creating social unrest.
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Carola Frydman: But it’s not only global risk. The threat of domestic regulation is also becoming stronger.
For more than 30 years, the enforcement of antitrust regulation in the U.S. has not been particularly strong. In the last couple of years, many voices—within politics, the public, and also academics—have started to call for stronger antitrust, arguing that companies like Amazon and Facebook should be broken up.
Why is this happening now? In recent decades, many industries have seen an increase in market concentration. Some link this to the decoupling between workers’ wages and their productivity. In the past, wages and productivity used to track one to one, but measured productivity has increased more rapidly than wages since the 1980s. It is unclear whether breaking up large corporations would improve the bargaining power of workers or reduce income inequality, but it would quite likely have a large cost for firms and shareholders.
Another important issue is that the level of political polarization in the U.S. is quite high. In this environment, a change in government could quickly shift the equilibrium from one that is favorable for firms and shareholders (with low corporate taxes, for example) to one that entails much higher costs. Senators Chuck Schumer and Bernie Sanders had a recent proposal to outlaw buybacks unless firms show they are sufficiently investing in workers or communities, for instance.
I think one factor motivating CEOs is to try to preempt regulations with high potential costs to firms from being enacted.
Jagannathan: Yes. The way of doing business in the past is highly threatened. These CEOs are trying to sooth passions and convince people they are aware of the problems. They are trying to make people feel more comfortable, and if they are successful, that will be good for them.
Frydman: I also think the statement is responding to a generational change in preferences. Young people, who are becoming these firms’ new employees and customers, are paying attention to the environment and how companies are sourcing certain materials.
Aaron Yoon: That’s right. Before, let’s say, 20 years ago, if a company invested in environmental, social, and governance (ESG) criteria, there might have been a lot of criticism about those investments destroying shareholder value. I think there’s less criticism now.
Both in academia and in practice, the long debate has been whether ESG investments ever really enhance firm value, or do firms engage in ESG for signaling or marketing or branding purposes? Some academic research finds that firms that make material ESG investments (investments that are related to their core industry practice) exhibit better stock returns. There are many fund managers that are now using this materiality concept when analyzing and quantifying firms’ ESG investments when they make investment decisions.
“I think if there was an attempt for real change, then the way to do it would be to do it with this type of concerted effort.” - Carola Frydman
Korajczyk: Some management teams do confuse short-run profits or, more likely, short-run executive compensation with long-run shareholder-value maximization. This leads them to act as if the firm is like the splitting of a fixed pie—if one party gets more, others get less. In reality the well-run firm is a bigger pie and allows all stake holders to benefit.
Liberti: Here’s an angle: Many of the companies whose CEOs signed the statement have a dispersed shareholder base formed by institutional investors. The Vanguards, BlackRocks, JPMorgan Asset Managements, and Fidelities of the world (among others) own north of 70% of the shares of companies in the S&P 500 index. These institutional investors are the companies’ main partners, whom the CEOs need to make happy by providing dividends or capital gains. Will this have an implication for the portfolio-management business? How are institutional investors going to do their homework in terms of deciding whether a firm will provide a return to shareholders?
Jagannathan: This statement was signed by the CEO of BlackRock. And BlackRock is not really the final owner: individuals are. BlackRock acts as an agent for those who invest in their ETFs, and those investors are the owners.
Yoon: So maybe it’s the other way around. My impression in talking to the investment community is that they feel like they have to incorporate ESG—they are feeling pressure from the folks who contribute to them. Yes, BlackRock gets money from individual investors, but also big pension funds like Norges and CalPERS, some of which are trying to induce their investment managers to take some type of stakeholder approach.
Jagannathan: But I don’t see anything wrong in an approach that maximizes shareholder value. Mobile phones and smartphones have changed the lives of people around the world for the better. Smartphones are one of the most important innovations in the past twenty years. They started with Steve Jobs and Apple and were driven by a profit motive!
Frydman: Markets are not always a panacea, and regulation is not perfect either. We live in this delicate balance where rules, regulations, and institutions have to be reassessed and evolve as the economy evolves.
Jagannathan: Firms function in a free-market economy; that doesn’t mean they function in a jungle. Firms are subject to the laws and rules of society, and those will change over time, along with changes taking place in society. There will be a lag, but then the laws and rules do catch up.
Some of the CEOs’ posturing here is to say, “You don’t have to change many of the laws. We are responsible people. We will do it ourselves.”
And I am not a big believer in that. I think we do need rules and regulations to have a good society, and they are there for good reasons. But the way that people enact rules and regulations is by consensus and voting. We have a democratic system; there are lot of ways for people to express their views about what is good and bad for them. I don’t trust CEOs of companies to know what the consensus is when people have different views. Even when they know, in the presence of externalities (like, for example, carbon emissions), individual firms may not have the right incentives for doing what is good for society. Higher emissions from any one firm do not really matter. But when the higher emissions add up across firms, this can be very bad for the society.
Further, there’s no way to even measure whether they’ve done well along that dimension. If you say, “I’m going to do good,” you better come up with metrics, and those are not yet in place.
Yoon: Yes, but there’s a tremendous amount of movement from companies and even stock exchanges on implementing new standards. So if you look at South Africa, for example, they mandate a certain type of ESG disclosures in addition to their annual report. And there’s thousands of companies globally that produce some type of ESG-related report in addition to their annual report to the SEC. So there are more companies doing this.
I thought it was very interesting for the Business Roundtable to come out and say they have to make a big shift. They’ve already been doing a lot of things like charitable donations and investing in ESG. I think they’re just shifting the tone on everything that they’ve been doing in the past 10, 15 years—likely as a way to manage the global and political risks we discussed earlier—and trying to get these donations and investments acknowledged.
Frydman: The announcement has been received with a heavy dose of skepticism. My worry is that this will put pressure on the CEOs to focus on actions that will have an immediate impact that is easily measurable. And these actions may not be what is best in the long run or for all stakeholders.
I will say this: I think if there was an attempt for real change, then the way to do it would be to do it with this type of concerted effort. Because even if a firm’s investors were to question these actions or their cost to them, the management could say, “Well, but everyone else is doing it, therefore we must do it too.” So if you’re going to do it, this is the way in which you shift the equilibrium in a more sustainable way.
Do they do it or not? We’re going to have to wait and see.
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