Food 4 Thought

As shareholder primacy gets dethroned, will executives lose focus?

Wouldn’t it be wonderful if we lived in a world where everything is not presented in simplistic polar oppositions? For example assuming that not prioritising shareholders implies prioritising the whole world, that all shareholders are the same and opposed to the sustainability world, that assessing financial impacts implies excluding sustainability impacts, and that the enterprise communicates through either a financial report or a sustainability report.

A decision last month by The Business Roundtable of the USA was followed by the usual array of responses reflecting extreme opposites. It among others illustrated the ongoing relevance of the AA1000 standard for stakeholder engagement, including its guidance on prioritising stakeholders. Consider the critical response by the American Council of Institutional Investors, who argued that the decision to drop the doctrine of shareholder primacy would lead to “accountability to no one”. It also criticised the listing by the Roundtable of five stakeholder groups, listing shareholders last and on top of it describing them not as “owners” but simply as “providers of capital”.

The statement by The Business Roundtable on the purpose of the corporation acknowledged that the duty of management and directors is not foremost to maximise shareholder value. The leadership needs to exercise accountability towards not only shareholders but all stakeholders. The almost 200 CEOs of the largest US corporations stated that business decision-making today should be guided by the undertaking to deliver value to all stakeholders.

Some praised the statement. It puts to end the doctrine of shareholder primacy as originated in the US since the 1930s and driven by the likes of Milton Friedman. It was never written into law, but found its way into common law through a series of court decisions. Today the view is, as The Wall Street Journal put it: “Move over shareholders. Top CEOs say companies have obligations to society”. From those who have worked in the environmental, social and governance (ESG) field since decades, there was also scepticism. Some saw it as another public relations statement in an Anglo-Saxon debate. Some noted that this is nothing radically new and that the five commitments in the Roundtable statement reflects corporate social responsibility as seen back in the 1990s.

In South Africa, a country that has been a central reference in the corporate social responsibility movement since the 1980s, the commitment to a stakeholder-inclusive approach is nothing new. This was among others reflected in the take-up by South African business of non-financial reporting and experimentation with integrated reporting over recent years. The approach is also engrained in the King Code that has steered corporate governance since the arrival of democracy in 1994. Making the case for a stakeholder-inclusive approach, the King Code puts all stakeholder types on an equal footing and notes that directors owe their duties to the company. Duty to the company is enshrined in the Companies Act. The company is represented by several interests, including those of diverse stakeholders.

The move away from prioritising shareholders and their returns was frowned upon by commentators on the Squawk Boxprogramme of CNBC television in the US. Running a profitable business is an essential component of contributing to the welfare of society.  Former Nasdaq CEO Robert Greifeld sought to put Milton Friedman in perspective, noting he said “you have to maximise profit within the confines of the law and the moral ethos of the time”. The debate illustrated the common error of framing the issue in terms of two simplistic opposites, i.e. making profit (thinking of shareholder return) versus doing the right ESG thing (thinking good of society), or the sequence within which these have to be done.

Who is that shareholder that the agent is accountable to? As the recent Steinhoff accounting scandal in South Africa and Germany illustrated, there are various layers of accountability at stake. It involves owners who may be pension-holding citizens, their institutional investor funds, the asset managers responsible for investment decisions, as well as a corporate governance structure that may involve a two-tier board structure as is practiced in for example Germany and The Netherlands. It can be argued that democratic or societal interest is represented in various ways, including the presence of independent or non-executive directors on either a unitary or two-tier board.

A separate issue is that of “profit maximisation”. Profit is probably the most abused term in debates on business performance. Any financial analyst knows that profit is only one of various key indicators. In the 1980s the father of shareholder value underlined that cash flows, and their sustainability in the longer term, is more important than profit. Alfred Rappaport insisted on the need to focus on longer-term value creation. He was highly critical of short-termism.

The intention was never to “maximise profit” at any cost. Yet as industrial disasters and accounting scandals have shown, many executives and managers have fallen into the trap of maximisation, growth at any cost and short-term targets. Here also lies an onus on those defining public morals, guarding accounting norms and shaping laws to keep abreast of an evolving global sustainability agenda. This includes standards setters, market regulators and those leading government, sharing a public duty to ensure proper standards, regulations and laws are effectively enforced. What society found acceptable twenty years ago may be unacceptable today.

We will not secure sustainability by simply saying all stakeholders are relevant, and shareholders are not the top priority. Stating all stakeholders are relevant implies the ability of decision-makers to prioritise different stakeholder groups and exchange information in a manner that speaks to the needs of different user groups. If the new doctrine is to be that of Capital Providers, Employees, Customers, Suppliers and Community or CPECSC primacy, then we need to take a closer look at the information needs and level of understanding of each of these groups, ones that are interested and affected in different ways. It also requires us to improve the education of our board members and investors, enabling them to ask the right questions.

The principle of stakeholder responsiveness (AA1000) also requires a new look at how corporate reporting meets the information needs of different stakeholder groups. The annual report was historically seen as the primary vehicle through which management and directors report to their principles. In our digital age, large and complex corporations have the ability to disclose their performance and value creation story in different ways, through different vehicles. Consider the annual report (AR) as a compliance document that speaks to regulators, the integrated report (IR) as a forward-looking communication that speaks to investors and employees, and sustainability reporting (SR) as a communication that goes into the details required by for example consumer groups and community organisations. And of course these different communications need to be aligned and not contradict one another. As the CEO of the Global Reporting Initiative (GRI) commented: “corporate (and investor) interests are served when companies consider, and meet, the needs of all stakeholders”.

The IR Framework of the International Integrated Reporting Council (IIRC) defines the target audience of the IR as “the providers of financial capital”. The South African IRC gives this a broader interpretation, encouraging reporting that engages all stakeholders. Experience to date shows the risk of reports that lack focus (in terms of target audience) and continue to display a fragmented approach. Integrated reporting needs to go beyond simply presenting financial and non-financial capitals side-by-side. If CPECSC primacy is to respect the interconnection between different capitals, then the integrated report has to show the ability to translate ESG performance into financial performance. Doing this with a longer-term and future stakeholder perspective is critical in maintaining the focus of executives and their ability to effectively engage the responsible investor.

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