Mutuality and morality in business

Colin Mayer

Peter Moores Professor of Management Studies at Saïd Business School, University of Oxford

A most remarkable institution

This article is about the most remarkable institution in our lives. I am not talking about the state, religion or universities. I am talking about an institution that clothes, feeds and houses us, employs us and invests our savings. It is the source of economic prosperity and the growth of nations around the world. It is a much-neglected institution because, at the same time, it has been the source of terrible depravation, poverty and environmental degradation.

Failure of the conventional view of the corporation

Underlying the corporation is a belief that it exists to serve the interests of one particular group in society – its shareholders – and its executives owe its shareholders a fiduciary responsibility to uphold their interests and maximise the value of the firm. This view of the corporation is widely held but is incorrect. The corporation does not exist simply to further the interests of its shareholders. It exists to do things, to make goods and services that benefit us as customers and communities. The corporation is exceptionally well placed to do that because it can balance the commitments it gives to different parties with the control that it exerts over them. It is an Alice in Wonderland, but over time it has become a Dracula in Transylvania and the reason for that is it has been hijacked by one particular interest group in society – its shareholders, and in particular very short-term shareholders.

Why is this happening?

70 years ago, the average holding period of shares on stock exchanges around the world was eight years. 30 years ago, it was four years. Today it is a matter of months, weeks, days, hours, seconds or, in the case of high frequency trading, nanoseconds. The consequences of this for our financial, economic and environmental systems have been devastating because, in the pursuit of short-term shareholder gains, corporations have been willing to sacrifice our interests as creditors, employees, communities and, above all, future generations.

What should be done about it?

In seeking to address the problem we should be clear about what we want our corporations to do. We want them to promote our long-term well-being as customers, communities and employees as well as creditors and shareholders. Critical to this is the ownership of corporations.

Currently some of the most successful nations are the Nordic countries, such as Denmark, Norway and Sweden. One of the distinguishing characteristics of these economies is the nature of their corporations and the fact that control of them frequently resides in families who hold the firms through many generations, such as the Wallenbergs in Sweden.

As a consequence, while in UK and US firms the audit, appointment and remuneration committees report to their boards of directors, in Nordic corporations they also report to the shareholders. That means that not only is control in the hands of owners interested in the corporations’ long-term prosperity but there is also better governance by informed shareholders who have an interest in monitoring their performance.

Corporate Values

Engaged long-term ownership is the first requirement to address the failings of corporations but it is not sufficient. Corporations also need to expound their values and principles much more clearly and precisely than at present. In a survey of middle management undertaken in France, Germany, Japan, the UK and US, respondents were asked whether they thought their companies were being run just in the interests of their shareholders or also for their wider stakeholders. 70 per cent of the middle management of the UK and US firms said that they thought that their firms were run just for their shareholders while 20 per cent of the French and German firms gave that response and just three per cent of Japanese firms.

And these differences matter. The middle management were also asked whether in the event of their company getting into financial difficulty they thought that it would cut employment or its dividends. 90 per cent of the UK and US firms said that they thought that their company would cut employment, compared with 40 per cent of the French and German firms and just three per cent of the Japanese firms.

Credible Commitments

Shareholder-oriented firms do not have to be exclusively focused on their shareholder interests but if they are to uphold our wider interests with conviction and go beyond the empty rhetoric of ‘Corporate Social Responsibility’ then three criteria need to be satisfied. First, the values of the firm need to be clearly articulated. In whose interests is it being run? Does it exist to further the interests of just short-term shareholders or those of other stakeholders as well and, if so, what precisely are the purposes of the firm?

Second, the values that the firm attributes to the human capital of employees, the social capital of customers and communities, and the natural capital of future generations need to be carefully measured and reported in corporate balance sheets and income statements along- side existing financial information. Third, someone needs to be responsible for promoting the different forms of capital and ensuring they are properly protected and enhanced. That responsibility should start at the top with the board of directors and should then permeate throughout the organisation.

Some of the most successful corporations in the world display these characteristics: Bertelsmann, the media company; Robert Bosch, the automotive supply company; Carlsberg, the brewery; Tata, the Indian conglomerate; Velux, the window manufacturers. All of these firms have one thing in common: they are all owned by industrial foundations. These foundations donate a majority of their corporations’ profits to charities, but it is not their philanthropic nature that is their most important feature. More significantly, it is the directors of the foundations who are responsible for up- holding the values of their corporations and bearing responsibility if they fail to do so.

Trust firms and mutuality in business

This combination of long-term ownership, clearly articulated values and an independent board of directors responsible for upholding corporate values gives rise to what I term ‘trust firms’ – firms that we can trust to protect our interests as customers, communities and employees, as well as creditors and shareholders. These three features are the basis of the principle of mutuality in business by which the rewards of the corporation are appropriately shared amongst those who contribute to it.

“Restoring trust in corporations is probably the most important issue of this decade because without it economic systems will go on failing, financial systems will repeatedly collapse and the environment will continue to degrade”

Mutuality is not only a fairer way of sharing the benefits of business but also of enhancing financial returns. In a comparison that was recently undertaken of 90 ‘high sustain- ability’ and 90 ‘low sustainability’ firms, it was found that $1 invested in the shares of the high sustainability firms in 1992 was worth $23 in 2010, while it was worth just $15 in the low sustainability firms – a 50 per cent difference. What distinguished the first group of firms from the second was a stronger emphasis on high sustainability policies, a greater focus on long-term performance and a clear alignment of the incentives of executives with measures of sustainability.

Moral firms

Ultimately, the goal should be to establish corporations as moral entities. The notion of a moral, commercially-oriented organisation might sound like an oxymoron but it is not because corporations are exceptionally powerful instruments for upholding commitments. Two corporations that illustrate this particularly well are Lehman Brothers and Barclays Bank – not their current or recent manifestations but their 19th and 17th Century versions respectively. Mayer Lehman, the founder of Lehman Brothers, took his children every weekend to the Mount Sinai hospital in New York to show them the plight of the poorer members of New York society. John Freame, the founder of Barclays Bank in 1692, wrote Scripture Instruction, a text that was used for more than 100 years in Quaker schools. These banks, which were established by founders with strong ethical principles, have over time come to be owned and controlled by shareholders and executives who are interested in one thing and one thing alone – making money.

Restoring trust in corporations is probably the most important issue of this decade because without it economic systems will go on failing, financial systems will repeatedly collapse and the environment will continue to degrade.

With it, we can achieve higher levels of economic prosperity and social wellbeing than have been possible to date. Because ultimately, a moral corporation is a commercially successful corporation and the competitiveness of nations depends on the moral fibre of their corporations.