Who do businesses serve anyways?
A recent view of business in North America
If you went to business school in the last 50 years, you likely left with the impression that corporations exist to serve the shareholder (the people who own the shares of the company). For those of you who didn’t go to business school, you’ve probably heard this for years as well. After all, the shareholder “owns” the company, right? If you own the company, it should do what you want it to do. You’ve probably also been told that the best thing a company can do is make a profit; this is what shareholders want and this is what is best for society.
If this forms a good portion of how you see businesses, you have likely been influenced by a man named Milton Friedman. In 1970, he wrote an influential article in the New York Times entitled, “The Social Responsibility of Business Is to Increase Its Profits”. In it, he touts the responsibility of management to its “owners” and states unequivocally that the purpose of a business “is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to their basic rules of society, both those embodied in law and those embodied in ethical custom.”[1, p. 211] Mr. Friedman goes on to explain that shareholders are the owners of the company since they provide the money for the company itself.
This line of argument has underpinned the “trickle-down economics” idea. That is, if companies, and those who run them, focus solely on making money, this will benefit all in society. The better they do, the more that wealth and success will “trickle down” to the rest of us since more jobs will be created and we will all share in improved standards of living. On the surface, this sounds appealing. Those who can run companies efficiently and create more jobs in the economy should just focus on making more money so that this cycle continues and we all win.
Do trickle-down economics really benefit us all?
Unfortunately, simplistic arguments often fall flat in reality. Another key idea that goes along with this line of thinking is agency theory. Agency theory outlines that management in a corporation are actually agents working for the owners and, because people are selfish and will just do what is in their own self-interest (i.e. make more money for themselves), they must be monitored closely. Ironically, trickle-down economics fails to recognize that those in the decision-making position, those who create the jobs and run the companies, will also do what is in their own self-interest: take more money for themselves. The key flaw with “trickle-down economics” is assuming that those at the top will allow the money to trickle-down at all.
Inequality is rising
In fact, what we’ve seen since these ideas have taken hold is the opposite. The rich are getting richer and the poor are getting poorer. Instead of all of us being better off, this has had the unfortunate effect of making inequality worse.
Robert Reich, a professor at the University of California, Berkley, is an expert on inequality and has authored numerous books and articles on the subject. In his book Saving Capitalism: For the Many, Not the Few[2], he makes a number of excellent points. One of the most important is that power influences the distribution of wealth and income. An oft cited statistic is that 50 years ago CEOs made 20-30 times that of the average worker. Do you know what they make now? More than 300 times the average worker. Has their worth gone up over time in comparison to everyone else’s?
Reich also provides some interesting graphs to back up his claims. If wages are provided based on “worth” or some combination of skills and productivity, why did wages keep pace with productivity in the first part of the century and then suddenly stop? That’s right, wages increased in line with company productivity increases until about the 1970’s…just around the time that idea put forth by Milton Friedman started to take hold. Then, we see that wages got stuck despite continuing productivity increases. Where did the profit from the productivity increases go? Remember I said CEOs used to make 20 times the average worker and now make 300 times the average worker? That’s right, it went to the top.
But the shareholders own the company, and they decide what they want, right?
But, you might argue, shareholders are happy. They own the company so if they want to pay their CEOs 300 times what you or I make, they have the right to do that. Don’t they?
Dr. Lynn Stout is a professor of law at Cornell University, has also written extensively and is recognized as an expert in corporate law. In her book The Shareholder Value Myth, she debunks the idea that shareholders own the corporation. Shocking, right? After all, isn’t this what we’ve been taught for years? Two points she makes really stand out: 1) corporations are not required by law to maximize shareholder value (i.e. the value of the shares) and 2) shareholders do not own the company, they own rights that are attached to the shares.
Dr. Stout’s book is based in the U.S. so you might be tempted to think that what she is saying does not apply here. Wrong! The Supreme Court of Canada recently reaffirmed that the board of directors, the group of individuals charged with overseeing the company, have a primary responsibility to…wait for it…not the shareholders, but the corporation itself. The ruling went so far as to clearly advise boards that they should be taking other stakeholders into account. Stakeholders refer to any party who is affected by or affects the corporation and includes such groups as employees, communities, etc. Who knew?
Corporations are not owned by shareholders, “corporations are independent legal entities that own themselves”[3, p. 37]. What do shareholders own then? According to Dr. Stout, the answer is right in the title: shareholders own shares. What are shares then? Shares have limited rights as a result of a contract between the shareholder and the corporation itself.
This is no different than a bondholder who has a contract with the corporation that gives it limited rights or an employee who has a contract with a corporation and so on. The corporation exists independently of these parties and no individual party owns the corporation.
By the way, have you ever thought about who shareholders are anyways? If you think about it, they are you and me, your parents, your neighbours, your friends. Do you own investments? A mutual fund perhaps? Then you are a shareholder. What do you want from companies? Certainly, you want your investment to increase in value, but at what cost? Do you want a greater return in exchange for your friends and family making less money? What if you could make more money in exchange for more polluted air? Is that a sacrifice you would be willing to make? Does everyone around you feel the same?
What is the purpose of a company, then?
If companies aren’t here to maximize share value for the shareholders, what are they here to do? As Dr. Stout notes, if you asked managers this same question 50 years ago, their response likely would have included things like making money, being a good corporate citizen, providing good jobs, etc. In other words, serving a variety of stakeholders…not just shareholders.
Would it surprise you to know that there are many enterprising entrepreneurs who have found ways to create successful businesses that make money while treating people and the environment well?
Patagonia is a great example of a clothing company that is financially successful while also using environmentally friendly materials and providing a good work environment for its employees. Amazing, right? I’m sure you’ve heard of Etsy. It’s a large online marketplace for handcrafted and vintage goods. Patagonia and Etsy are B-Corps.
What are B Corps? These are companies that are publicly committed to social and environmental objectives as part of their very existence and corporate structure. Etsy is publicly traded by the way and doing well, its stock is up roughly 14% year over year. There are many more examples on our doorstep. Thousands of companies are starting every day that show that profit does not have to be sacrificed to treat the environment or people well, it can be done simultaneously.
In fact, Porter and Kramer at Harvard University have outlined how businesses can tap into new opportunities by thinking differently about creating value. In other words, by creating value for society and not just one group within it (shareholders) this can lead to new opportunities that a business would have missed otherwise. This creates a win-win situation for business and society.
What can we do?
What should we do? Banish inequality? No. As it turns out, we prefer inequality.
According to a recent study by researchers at Yale University, people prefer to live in a society where there is incentive to move up, to be rewarded. However, what really bothers people is unfairness within that inequality. For example, if you work hard you would expect to reap some benefits for your hard work as compared to someone else who didn’t work as hard, right? But what if your hard work was not recognized because of someone’s bias against your sex, gender, skin colour, or preferences? What if they simply had more power than you and withheld the benefits? That’s unfair.
If someone works 40 hours a week, perhaps holding down multiple jobs, would it be fair that that person be able to afford food, housing, perhaps even a treat or two once in a while? I would argue yes. And yet, according to those who examine living wages (the amount of money you actually need to live), this is not possible in many places. These are people who are working but cannot afford to actually live. Does that seem fair?
The free market can be changed
One of the most profound points Robert Reich makes in his book, is that the “free market” is not some naturally occurring phenomenon, it is designed and created and managed by us, by society. We make the rules. You can’t just buy and sell anything and everything. We decide as a society that, for example, the sale of human organs is not something we approve of ethically, therefore we have rules that prevent this.
The structure of our market is changeable. We can make things better, more fair. We provide the money to companies that make them profitable. If you are like me and want to do something to change the way companies behave, now is the time to act.
Spend your money with responsible companies. Invest in those behaving the way you would like them to behave. Become an activist. If you don’t like the way a company is acting, take a page out of the activist investing handbook: get together with others, buy stock, make your voice heard to force change on the company. Many investors are taking this approach.
If you are an entrepreneur, examine your business practices, make changes to the way you do business, fight for change. Contact your MP, fight for living wages. Change is possible and it is in our hands.
Considering society and the environment are good for business
I argue that the consideration of society and the environment is good for business in the long run. Businesses cannot survive without making money first and foremost. They must be profitable to live another day. But did you ever stop to think about how they make money? Companies use society’s resources to do this.
You and I, we work for corporations, we provide labour and time to help produce its products and services. Our environment’s resources, (water, trees, minerals, etc.) are used to make these products and services as well. Doesn’t it make sense for a company to take these societal and environmental resources into account when making decisions? After all, if the business really wants to be around for a while, it needs to take care of these resources if it wants to continue making money. Focusing on short-term strategies that generate additional profit and drive up stock prices at the expense of social and environmental resources harms not only the business itself, but the rest of us too and is not sustainable for the company long-term.
I’ve discussed that trickle-down economics doesn’t actually trickle down because those at the top have more power and, as we should expect, will keep more of the profits for themselves. I’ve also outlined that companies in Canada and the U.S. are not required by law to maximize shareholder value and that shareholders do not actually own the company.
We all have a stake in how companies perform and behave. We need to make our voices heard to ensure that all stakeholders are being considered in corporate decision-making so that we can all benefit from its success.
1. Friedman. (1970, September 13). The Social Responsibility of Business Is to Increase Its Profits. The New York Times.
2. Reich. (2015). Saving Capitalism: For the Many, Not the Few. New York: Alfred A. Knopf.
3. Stout. (2012). The shareholder value myth. San Francisco: Berrett-Koehler Publishers, Inc.
About the author
Leanne Keddie is a Concordia Public Scholar, PhD Candidate in Accountancy and also a Chartered Professional Accountant (CPA, CMA). She has a Bachelor's degree in Commerce from Mount Allison University and a Master of Business Administration from McMaster University. Her current research investigates why companies use sustainability goals in executive compensation packages, what kinds of firms use these and what impact these incentives have on a firm’s sustainability performance. She came to the PhD program with over ten years of work and teaching experience in accounting and finance.
This blog post first appeared on Concordia's Public Scholars website at https://www.concordia.ca/cunews/offices/vprgs/sgs/public-scholars/2017/08/29/Are-businesses-harming-you-or-helping-you.html