One of the key topics being discussed in management circles is Corporate Purpose. Yet for all the praise of stakeholder engagement, a recent study by the Economist shows there is a disconnect between much of corporate America’s communication and their actions.
“Last year 184 of America’s mightiest bosses vowed to manage their firms in the interest not just of company owners but also of other stakeholders — from employees to the environment. (…) However, as new research from Harvard Law School suggests, many firms are only paying lip-service to the fashion for purpose.”
For the better part of 2019, I spent my time building and managing a balanced scorecard for a Canadian Crown Corporation and certified B-Corp, with the goal of promoting better stakeholder engagement. Over the same period the framework was implemented the organization saw a 3% growth of clients served and an additional $1.5B in dollars committed to the entrepreneurial ecosystem. My time advising on this governance activity, leads me to believe stakeholder management is perhaps the single biggest driver that will allow leaders to quickly move the needle and start growing through the current environment.
Leaders can look to the recent past for why investing in stakeholders is so important. In the financial crisis of 1914, the Ford Motor Company introduced the world to the Model T. Henry Ford made an announcement that he would pay his workers the unheard-of wage of $5 a day. As the case study will show, Ford believed that higher wages were not only a social benefit but good business too.
“There is one rule for the industrialist and that is: make the best quality goods possible at the lowest cost possible, paying the highest wages possible.” — Henry Ford
Ford created a little bit of a self-fulfilling prophecy by introducing higher wages. With higher pay, his workers could earn enough to buy his goods thus securing the business. As a result of Ford’s economics, America enjoyed its best period of growth from 1945 to 1973. However, by 1980 corporate profit was not translating into widespread economic prosperity.
To understand why we need to review Agency Theory, developed by finance professor Michael Jensen and Dean William Meckling from the University of Rochester, Simon School of Business in 1976. The pair published a paper entitled “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure”. It would go on to be the single most frequently cited article in business academia and forms the prevailing theory of the role of the firm and proper compensation in our society today. They argued the way to spur executive performance was to make pay significantly dependent on the performance of the company in the expectations market (also called the stock market). After 1976, executive compensation became increasingly stock based, so that when executives produced a stock price increase in the expectations market, their compensation rose dramatically.
As a result, the allocation of corporate profits to stock buybacks over the last 50 years deserves our attention. “Consider the 449 companies in the S&P 500 index that were publicly listed from 2003 through 2012. During that period those companies used 54% of their earnings — a total of $2.4 trillion — to buy back their own stock, almost all through purchases on the open market. Dividends absorbed an additional 37% of their earnings. That left very little for investments in productive capabilities or higher incomes for employees”.
The second item that deserves our attention is the changing role of the CEO from the fallout of the Enron scandal. As a result, CEO focus increased in monitoring financial reporting and internal controls. “Under the Sarbanes-Oxley Act CEO’s cannot claim that they didn’t know what was going on in the lower levels of their firms”. James Brickley, governance teacher at the University of Rochester’s Simon School of Business, was an expert witness for the defense in the Enron litigation. Brickley warned that renewed focus on monitoring means CEOs would be spending less time on other activities geared to growing their businesses.
Companies that are able to focus efforts on their stakeholders can outpace the long-term growth of their rivals. From my experience, implementing a balanced scorecard will allow leaders more control over their environment and activities, and allow them to create the environment to satisfy growth.
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