Are companies and their boards succumbing to short-term pressures from shareholders?
That’s the concern of Larry Fink, CEO of Blackrock, the world’s largest fund manager with $4 trillion in assets under management. Fink personally wrote to all CEOs in the S&P 500 index last spring to warn them about trying to return money to investors through so-called “shareholder-friendly” steps like increasing dividends and buying back stock. Fink believes pressure from activist investors is harming long-term shareholder value, despite stock price increases that often follow.
The pressures today have never been greater on chief executives and boards to produce short-term results and maximize shareholder value. The paradox of these pressures is that they may actually destroy long-term shareholder value if they force executives to cut R&D, capital spending, new ventures and expansion in emerging markets, thus constraining future growth potential.
What is missing in the faux debate about “shareholders versus stakeholders” is a deeper understanding of how shareholder value is created. It is not just by cutting costs, as steadily declining revenues spell doom as they did for Sears and Kodak. Rather sustainable shareholder value – which I believe should be the goal of every company – comes from serving society through great products and services that in turn meet customer needs and create profitability, cash flow for ongoing investments and shareholder value. As Infosys Founder Narayana Murthy argued, “You cannot sustain long-term shareholder value without creating sustainable value for your customers.”
The responsibility of corporate leaders is to achieve their short-term objectives while investing for future growth. It is not an either-or trade off. But those who make their quarterly numbers by cutting future investments or financial engineering are headed for trouble. Investors can always sell their stock before the long-term consequences are apparent, but corporate leaders are responsible for ensuring their firm’s viability for the long-term.
Look at what happened to General Motors under former CEO Rick Waggoner and his predecessors, who consistently opted for short-term profits over product improvements and quality. Over forty years GM’s U.S. market share eroded from 52% to 18%, and the firm wound up in bankruptcy when the global recession hit in late 2008. Contrast that with Ford’s Alan Mulally who borrowed $23.5 billion in 2006 to invest in retooling Ford’s entire product line and had sufficient reserves to withstand the 2008-09 market downturn — consequently, Ford continues to thrive.
In recent years short-term traders and hedge funds have steadily gained power. These active investors, earning high fees and taking 20% of gains, have had a powerful impact on capitalism. For the past five years, however, they have struggled to justify their high fees because they have been unable to consistently outperform index funds, so increasingly they focus on driving short-term gains rather than investing for long-term returns.
These trends are raising questions about the ultimate purpose of business: is it solely to meet shareholders’ near-term expectations or do companies have larger obligations to serve society and all their stakeholders, including shareholders?
Public companies get significant privileges as limited liability corporations because they are chartered to serve society. If they do not honor their obligations to individual countries, they may be forced to depart, or have their freedom constrained by laws like Dodd-Frank imposed on financial institutions. Unfortunately, current pressures in the financial system may be forcing companies to view themselves as extractors instead of beneficiaries of society.
As my HBS colleague Michael Porter argued in his 2011 HBR article, “Creating Shared Value,” when businesses focus on both societal benefit and economic profit, they do the most good through the business model itself. General Electric’s Eco-Imagination line, for example, develops energy efficient products like traditional light bulbs that are growing rapidly and have positive externalities in saving energy.
Instead of including society as one of its many stakeholders, World Economic Forum President Klaus Schwab argues that companies should view themselves as stakeholders in society. When the world we live in improves — education expands, violence decreases, or global warming slows – everyone wins, especially shareholders. Walmart, for example, cut greenhouse gas emissions in 2009 by reducing packaging and decreasing truck routes by 100 million miles, and it saved $200 million.
As Porter observed, “The new thinking reveals that congruence between societal progress and productivity in the value chain is far greater than traditionally believed. Few companies have reaped the full productivity benefits in areas such as health, safety, environmental performance.”
A pioneer in the sustainability movement, Unilever CEO Paul Polman summed up this new mission of business, “It’s not enough anymore to say you contribute to a better world. Instead of thinking how you can use society to be successful, you have to start thinking how you can contribute to society and the environment to be successful.” Polman concluded by saying, “Unilever’s purpose is having a sustainable business model that is put at the service of the greater good. It is as simple as that.”
What if all companies reframed their purpose along these lines? Think of the impact that global companies and local enterprises could have on addressing the world’s most pressing problems.
This article was originally published 9/22/15 on HuffingtonPost.com.