PERSPECTIVES ON GOVERNANCE, STEWARDSHIP AND THE PURPOSES OF BUSINESS

Business and society

In our introduction to the book, 'Having Their Cake' we said:

• There is such a thing as Society.
• The economy is an integral part of a society.
• The main goal of a society should be to strive to ensure the greatest well-being of all its members.

The performance of a society as a whole and each of its constituent parts, including its economic component, should therefore be judged by the degree to which it contributes to the overall well being of its members.

If any element - political, military, economic - is manifestly serving only the interests of a small part of society, or damaging its overall interests, then action should be taken to modify or regulate what it does so that its contribution to the whole can be positive.

The same applies to the so-called "global economy". If the functioning of the global financial system is manifestly damaging the interests of 'global society' (and it may well be - think about the possible relationships between regional wealth and poverty, instability of governments, violence and international terrorism), then its activities need to be re-aligned with those interests. That is a major purpose of international co-operation.

To allow the self-interest of a nation or group of individuals to be separated from the interests of society will more likely than not create corruption and distortions in the effective use of resources for the benefit of society as a whole.

Equally, to argue that the interests of individuals are more important than those of the society of which they are a member is likely to result in significant distortions in the effective use of resources and also behaviours by some individuals which will seriously damage the overall interest.

It seems to us that the above propositions are not at all incompatible with a strong belief in capitalism.

Governance and the purposes of business

Charles Handy, in his excellent article, What's a Business For in the 'Harvard Business Review of December 2002, wrote:

Capitalist fundamentalism may have lost its sheen (following corporate and financial scandals), but the urgent need now is to retain the energy produced by the old model while remedying its flaws.

Corporate governance will now surely be taken more seriously by all concerned, and watchdogs appointed. But these will be plasters on an open sore. They will not cure the disease that lies at the core of the business culture.
We cannot escape the fundamental question, what is a business for? The answer once seemed clear, but no longer. The terms of business have changed. Ownership has been replaced by investment, and a company's assets are increasingly found in its people, not its buildings and machinery.
In the light of this transformation, we need to rethink our assumptions about the purpose of business. And as we do so, we need to ask whether there are things that (UK and American) business can learn from Europe, just as there have been valuable lessons that the Europeans have learned from the dynamism of the Americans.

Both sides of the Atlantic would agree that there is, first, a clear and important need to meet the needs of a company's theoretical owners: the shareholders. It would, however, be more accurate to call most of them investors, perhaps even gamblers. They have none of the pride or responsibility of ownership and are, if the truth be told, only there for the money.

......to turn shareholders' needs into a purpose is to be guilty of a logical confusion, to mistake a necessary condition for a sufficient one. We need to eat to live, food is a necessary condition for life. But if we lived mainly to eat, making food a sufficient or sole purpose of life, we would become gross.
The purpose of a business, in other words, is not to make a profit, full stop. It is to make a profit so that the business can do something more or better. That 'something' becomes the real justification for the business. Owners know this. Investors needn't care.

An investors' view

In October 2000 Hermes Pensions Management, one of the larger UK pensions investors, produced a statement of Principles designed to make clear their views on what they expect from companies when investing. They accompanied the Principles by stating clearly some fundamental convictions that drove their thinking:

1. It is axiomatic that the Primary Goal of a UK-listed company is to be run in the long-term interests of its shareholders......Central to this goal is the need to create a financial surplus. (authors' emphasis)
2. That financial surplus is achieved by having a competitive advantage.
3. That companies should behave ethically.

They then nod briefly to acknowledge the fact that they are not actually the real shareholders; (Throughout this document reference to Hermes as the shareholder is in recognition of Hermes as the agent for the owners)".

The Ten Hermes Principles.

Principle 1: "Companies should seek an honest, open dialogue with shareholders. They should clearly communicate the plans they are pursuing and the likely financial and wider consequences of those plans. Ideally, goals, plans and progress should be discussed in the annual report and accounts".

Principle 2: "Companies should have appropriate measures and systems in place to ensure that they know which activities and competencies contribute most to maximising shareholder value".

Principle 3: "Companies should ensure all investment plans have been honestly and critically tested in terms of their ability to deliver long term shareholder value".

Principle 4: "Companies should allocate capital for investment by seeking fully and creatively to explore opportunities for growth within their core businesses rather than seeking unrelated diversification. This is particularly true when considering acquisitive growth".

Principle 5: "Companies should have performance evaluation and incentive systems designed cost-effectively to incentivise managers to deliver long-term shareholder value".

Principle 6: "Companies should have an efficient capital structure which will minimise the long-term cost of capital".

Principle 7: "Companies should have and should continue to develop coherent strategies for each business unit. These should ideally be expressed in terms of market prospects and of the competitive advantage the business has in terms of exploring these prospects. The company should understand the factors which drive market growth, and the particular strengths which underpin its competitive position".

Principle 8: "Companies should be able to explain why they are the 'best parent' of the businesses they run. Where they are not the best parent they should be developing plans to resolve the issue".

Principle 9: "Companies should manage effectively relationships with their employees, suppliers and customers and with others who have a legitimate interest in the companies activities. Companies should behave ethically and have regard for the environment and society as a whole".

Principle 10: "Companies should support voluntary and statutory measures which minimise the externalisation of costs to the detriment of society at large" (God knows what this means!).

From the Combined Code on Corporate Governance:

Whilst recognizing that directors are appointed by shareholders who are the owners of companies, it is important that those concerned with the evaluation of governance should do so with common sense in order to promote partnership and trust, based on mutual understanding. They should pay due regard to companies' individual circumstances and bear in mind in particular the size and complexity of the company and the nature of the risks and challenges it faces.
Whilst shareholders have every right to challenge companies' explanations if they are unconvincing, they should not be evaluated in a mechanistic way and departures from the Code should not automatically be treated as breaches.

Changing attitudes of top managers

It is possible to detect subtle changes happening in the attitudes of top managers even in the 1980's.

For example, from the chairman's statement of Redland plc, 1983;
On behalf of the shareholders, of whose loyalty we are always mindful, I wish to express to my board colleagues and to my fellow employees, great appreciation for the way in which we work happily and productively together in building a fine and progressive enterprise. This chairman seems to be identifying himself closely with the shareholders.

In the 1990's, many companies sought to align their causes with those of 'the Shareholders' through the introduction of a plethora of Shareholder Value-related financial measures and incentive plans. Much of this was also accompanied by rhetoric that followed a line that the governing, or over-riding objective of the enterprise is to 'Maximise the wealth of shareholders'.

A 1993 quote from William Smithburg, CEO of the Quaker Company describes the changes: EVA (Economic Value Added) makes managers act like shareholders. It's the true corporate faith for the 1990's.

Coca Cola, an enthusiastic proponent of EVA, described its mission simply: Ours is a mission with one simple goal- to create greater value for our share owners. That is the main purpose of the Coca Cola Company.

The debate is not new....

Let us leave the final words with Lord Eustace Percy. In 1944, he said,

Here is the most urgent challenge to political invention ever offered to statesman or jurist. The human association which in fact produces and distributes wealth, the association of workmen, managers, technicians, and directors, is not an association recognised by law.

The association which the law does recognise - the association of shareholders, creditors and directors - is incapable of production or distribution and is not expected by the law to perform these functions.

We have to give law to the real association and to withdraw meaningless privileges from the imaginary one.

We hope readers can detect that there are quite fundamental differences between contemporary conventional wisdom about the fundamental purposes of business and the main accountabilities of directors - and the views of those who are prepared to challenge the status quo.

These differences are not trivial - they represent a fundamental divergence that is of fundamental importance to our society - about the purposes of private enterprise and for what and to whom business leaders should be accountable. This should be the real nub of any serious discussion on Governance.

We will, over time, explore these issues, examining different philosophies and looking at experiences from outside the UK and from the social purpose sectors.