13/04/2017
Given the magnitude of insolvencies, M&A activity, mass layoffs and flat increments the age old shareholders vs stakeholders discussion, that is, the question of the real objective of a firm, is surfacing again. Is it profit maximization or shareholder value maximization as the dominant theme appears to suggest? Is it stakeholder value that holds primacy? Is there space for another model in this discussion?
Jack Welch of GE famously called shareholder maximization "the dumbest idea in the world". Xaviier Huillard called it "totally idiotic". Alibaba's Jack Ma said that "customers are number one, employees are number two and shareholders are number three". John Mackey of Whole Foods condemns businesses that "view their purpose as profit maximization and treat all participants in the system as means to that end". Joining voice was Salesforce Marc Benioff who said that this still-pervasive business theory is "wrong", that it is also about improving the state of the world and driving stakeholder value.
It implies, that there is growing recognition of the fact that businesses need to shift from creating shareholder value to stakeholder value. Corporate management is not just accountable to shareholders, it should seek to protect and serve the interests of all stakeholders - customers, employees, partners, suppliers, citizens, government, the environment and any other entity impacted by its operations.
However, both these governance models are weak. The former is unachievable given the management's control, power and relationship to constituents other than shareholders. Similarly, given the fact that shareholders provide the capital required to keep the company going, the sustained application of the stakeholder model is precluded.
Yet, all significant activity requires an objective, and the work of a company is no different. A company is an entity whose defining characteristic is the attainment of a specific goal or purpose, but the problem is that there is little agreement on what that goal or purpose should be. Yet every organization attempting to accomplish something has to ask and answer the question: What are we trying to accomplish?
The ascertainment of the objective is critical for a number of reasons, not the least because it underpins
the kind of corporate governance model, what responsibilities are imposed on directors and helps assess whether directors have done what they should have done.
The third model - the entity maximization and sustainability model (EMS) - postulates that the goal of a company is to maximize the company's total wealth and, importantly, at the same time to ensure that the operation of the company is sustained.
The modern firm is a complex undertaking that consists of intertwined human and economic relationships and far more complex than that posited by the traditional shareholder model. The third model therefore suggests that there is renewed focus on the company as an entity or enterprise, that is the company is an institution in its own right. This entity exists separately from those who invest in it, and continues to exist notwithstanding changes in the identity of the investors.
if the entity's interests are to be maximized for the long term - this might entail making less profit one year compared with a previous one, but still maximizing the entity for the future. It changes the perspective of its managers and calls for a new type of sustainable leadership - one that focuses on not just the firms longer term interests, but also that of its environment and of the society in which it exists and operates.
This vision for the long-term and the maximizing of entity wealth means giving up on actions such as trimming labour costs, scrimping on health and safety matters, delaying payment of creditors and embracing risky ventures just to increase revenue growth. Directors will not be moved to act in order to justify a higher share price, or to cook the books, acquire unprofitable assets or firms, or undertake investment projects with negative NPVs. It permits managers to invest more in R&D, the training of employees, and to make investments in the local and broader community because it intends to be located there in the long haul. The creation of value will no longer mean that managers have to succumb to the vagaries of the movements in a firm's value from day to day.
