shared value – Vogel Wakefield

Occupy London protestors at St Paul's Cathedral. — Occupy London protestors at St Paul’s Cathedral.

The idea that business should create social value, not just shareholder value, is fast becoming the common sense of our time. One could interpret this as a delayed corrective to the crisis in capitalism brought about by the credit crunch. But there was no inevitability about it. Even at the start of the year, when Michael Porter published his Harvard Business Review article on creating shared value, his argument was greeted with scepticism as much as agreement.

Since then, we’ve had the Arab Spring, public disgust with the press brought about by the phone hacking scandal and now the Leveson hearings, riots in England over the summer, the Occupy protests, and the looming threat of financial and social collapse in the euro zone. These events have given voice to public unease with corporate elites who seem out of control and political elites who have no answers to our current predicament.

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Our influences

Public value in a commercial space

By Mark Wakefield

The public valuing the public space at Primrose Hill

Last week we learnt that, despite “Project Merlin”, bank lending to small and medium sized enterprises fell short of expectations by some £2bn in the first quarter of this year, only adding to fears that we are set for a sluggish recovery. This together with the news that the Chief Executives of both Barclays and HSBC have been awarded £9m in pay apiece will have done little to assuage public anger over bankers’ behaviour. What is so strange in all this is that the banks are apparently oblivious both to the public mood and to what seems to be the makings of an emerging consensus amongst politicians and policy makers that business must urgently rediscover its social purpose. Suffice it to say that when as luminous a business luminary as Harvard Business School’s Michael Porter argues that capitalism is facing a crisis of legitimacy you know that something is up.

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Ideas

More to business than shareholder value

By Martin Vogel

Andrew Hill writes in the FT about the way opinion is turning against the idea that businesses should focus primarily on maximising shareholder value.

He is reviewing a book by a Canadian academic, Roger Martin, which appears to be a polemic against linking CEO pay to company share price. But it’s interesting also for the background on how the tide has turned on the shareholder value movement:

Prof Martin’s central concern is that the pursuit of shareholder value “simply fails as a unifying theory to produce value in business”

Given that even Jack Welch, the high priest of shareholder value creation while chief executive of General Electric, has since dismissed its strategic primacy as “the dumbest idea in the world”, this argument sounds a little out of date. But Prof Martin is right that the theory continues to distort corporate strategy and that chief executives need to step off the consensus earnings treadmill. “I do think there’s room for leaders to lead, not to be led by the nose-ring by analysts,” he told me recently.

The idea that companies’ principal aim should be to maximise profits for owners came from Michael Jensen and William Meckling’s 1976 paper on the “principal-agent problem”, caused by chief executives allegedly enriching themselves at shareholders’ expense. But Prof Martin’s own research has shown that in the 20 years before 1980, when the shareholder value movement took root, CEO compensation per dollar of income earned at the biggest US companies actually fell. Between 1980 and 1990, it doubled and between 1990 and 2000, when Mr Welch and others were in their pomp, it quadrupled. Returns for shareholders, meanwhile, were better before 1980.

Hill highlights some interesting recommendations from Martin on improving the role of directors:

Recast board directors (who are as susceptible to the principal-agent problem as chief executives) as public servants. Encourage companies to rebuild the civil foundations of business for the mutual benefit of society. Readjust priorities to focus on customers over shareholders.

Cynics may roll their eyes at such prescriptions. But one of the insidious effects of the quest to hit quarterly targets is that it distances executives from the real reasons they are in business. In Prof Martin’s words, it makes them “indifferent to their communities”.