Address to the School of Business, Oslo University, Oslo, Norway
April 29, 2015
What is the purpose of a society, or a nation? And what is the purpose of a business firm? Depending upon how you answer these questions, you may come to very different conclusions about what is the proper relationship between the two.
For instance, a free market capitalist might argue that the economy should be treated as a separate sphere. It is essentially a marketplace where organized business firms endeavor to satisfy consumer “tastes and preferences.” Furthermore, this objective can be pursued more effectively if the “private sector” is unfettered and subject only to the “invisible hand” of market dynamics – demand and supply. Therefore, the state should play only a supporting role — ensuring the “common defense” and law and order, including especially the protection of property rights.
This utopian model is, of course, widely disputed. Historically (especially during the era of absolute monarchs who claimed a “divine right”), organized business firms in Europe were chartered under the authority of the ruler and were charged with serving various purposes for the state in return for limited liability. There was no question about who was ultimately in charge.
As the industrial revolution was gathering steam (both literally and figuratively) during the nineteenth century, the British and Americans led the way in dropping the “public purpose” requirement and allowed companies to be established with an open-ended mandate to engage in business for their own, self-defined purposes and without an explicit regard for the public interest. Today this model is the rule in the United States and Britain (and elsewhere). Of course, there are also many state-owned businesses as well — as is the case in Norway and especially in China (a legacy of the Communist pattern of state ownership).
In time, the decoupling of public corporations from public purposes led to the self-serving theory (inspired by economists Michael Jensen and William Meckling and promoted especially by Milton Friedman at the University of Chicago) that the central purpose of a public firm is to “maximize shareholder value.” Because the shareholders are the “owners”, so it was said, their interests should take precedence over any others.
For several decades during the latter part of the twentieth century, shareholder capitalism seemed to be the predominant view in Western economic theory, as well as in business (and legal) circles, certainly in the U.S. and England. Over time, this theory incited some colossal business failures, including Enron, WorldCom, Arthur Anderson and, most famously, Lehman Brothers — which triggered the global financial meltdown in 2008.
A thoughtful “Schumpeter” column in the Economist recently pointed out that the shareholder ownership model is actually “the dumbest idea ever,” as the former CEO of G.E., Jack Welch, bluntly expressed it. In fact, public companies are distinct “legal persons” and shareholders typically have only limited rights and entitlements, while most managers and directors have wide “business discretion,” the authority to pursue the best interests of their firms.
The collapse of Lehman Brothers was an extreme case of shareholder capitalism gone wrong, but it highlighted a growing concern that the self-defined interests of the business sector can be seriously at odds with the common good, or the public interest, in the current era of climate change, environmental destruction, and an ever-increasing inequality of income and wealth. Indeed, the shareholder model has played a major role in the decline of the middle class in America over the past 30 years.
This has led to new thinking, such as the Corporate Social Responsibility Movement and Michael Porter and Mark Kramer’s “shared value” capitalism. More recently, a global commission convened by the Center for American Progress and headed by former U.S. Treasury Secretary Larry Summers and Britain’s prominent Labour MP Ed Balls, has called for a broad range of economic reform measures under the heading of “inclusive capitalism.”
It has also become the practice among some liberal companies in recent years to include explicit public purposes in their charters and in their business dealings, from Fair Trade policies toward suppliers to profit sharing programs with employees, local sourcing of materials, and (more than ever) volunteer community service work.
In the United States, the most common public companies, known as C-corporations, are only required to operate according to the laws and regulations imposed by the state. But there is also a relatively new category of so-called B-corporations that explicitly seek to provide public benefits. Many B-corporations serve what has been called a “triple bottom line” – meaning “people, profits, and planet.” (As of 2014, there were some 500 B-corporations in the United States and 27 states had enacted laws to recognize this model.)
The progressive British journalist and author Will Hutton, in a new book, argues that all companies should be required to specify their purposes in a way that is related to some broad public purpose or societal need. The conservative response has been that, in a rapidly changing and highly competitive global economy, a company must be free to pursue its interests as it sees fit; its overarching purpose should continue to be “open-ended.”
I have a different, middle-ground response to this disagreement I have a different, middle-ground response to this disagreement, one that derives from an evolutionary and biological perspective. It is developed at length in my 2011 book, The Fair Society: The Science of Human Nature and the Pursuit of Social Justice.
To a biologist, survival and reproduction is the basic, continuing, inescapable problem for all living organisms, including humankind. Life is fundamentally a “survival enterprise,” and an organized, interdependent society – whether it is in leafcutter ants or humans — is quintessentially a “collective survival enterprise.” (I hasten to add that this characterization is not simply a loose analogy. It is a homology. It forces us to recognize the underlying biological imperatives in human existence and it defines the unavoidable priorities for any society.)
For the human species, the survival enterprise entails no less than fourteen categories of “basic needs” – essential requisites for survival and reproduction over time. Furthermore, we spend most of our daily lives involved in activities that are either directly or indirectly related to satisfying these needs, including (not least) earning an income.
The fourteen basic needs categories are listed in the diagram that I brought with me today and there is a chapter devoted to this subject in my book. These needs have been extensively documented at my research institute. I won’t take the time to go through them here, but you can see that they encompass a very broad range of economic activities. (I might just add that there is a brand new Social Progress Index – developed by a group of private organizations and individuals – that encompasses most of these basic needs – but not all. It will be able to provide ongoing international comparisons with an array of more concrete, targeted measures than in the U.N.’s Human Development Index.)
Accordingly, the fundamental purpose of an economy is to provide for our basic needs (along with various discretionary “wants”), and the interests of the economic sector must be subordinate to the overriding obligation of a democratic state to further the collective survival enterprise. The state has a fiduciary responsibility for the “common good” of all its citizens – the “public interest.” The state is also empowered to exercise this role through the doctrine of the “public trust,” which is a well established legal principle but has been used very inconsistently in practice. (I have written a short paper that briefly recounts the history of this important concept, if anyone is interested.)
I also define the “common good” in terms of a very specific, biologically grounded model of a “Fair Society.” A Fair Society is one that adheres to three distinct social justice principles that must be bundled together and balanced. These three principles are:
(1) EQUALITY: Goods and services must be distributed to everyone according to their basic needs (this must take priority);
(2) EQUITY: Surpluses beyond the provisioning of our basic needs must be distributed according to “merit”;
(3) RECIPROCITY: In return, each of us is obligated to contribute to the “collective survival enterprise” proportionately in accordance with our ability.
I cannot take the time to elaborate on this framework here. It is discussed at length in my book. Suffice it to say that this framework is also aligned with the emergent interdisciplinary science of human nature. It defines the basic elements of what could be called a “biosocial contract” for any given society.
These three fairness principles provide concrete, measurable criteria for assessing the common good, and they establish a biologically-based normative framework for evaluating the conduct and contributions of both the public sector and private sector business firms. This framework does not dictate how private companies should pursue their interests, but it does limit and constrain their actions. They must be consistent with the fundamental purpose of the collective survival enterprise.
How can this vision of a biosocial contract be implemented in practice? Can a Fair Society be achieved and sustained? Thomas Piketty warns us in Capital in the Twenty-First Century that the odds are against it, and the global statistics on poverty and the concentration of wealth are daunting. In my book I emphasize that a truly fair society (according to these criteria) is relatively rare and fragile.
A comparison between America in the 1950s and today provides an example of how easily a once fair society can be dismantled, and the ascendancy of shareholder capitalism in the U.S. has had a lot to do with it. Shareholder capitalism is fundamentally unfair in that it elevates the interests of shareholders over all the other interests in a society; it provides a license to be exploitative. In game theory terminology, it legitimizes a zero-sum relationship rather than a win-win relationship.
I believe democratic governments can and do play an important role in counterbalancing this ideology (in various ways), and the “public trust” doctrine can enhance their authority to do so. But much more could be achieved by moving toward what is known as “stakeholder capitalism.” Stakeholder capitalism is hardly a new idea, but I view it in a somewhat different way. I see it as a tool for pursuing the objective of a Fair Society.
The concept of a “stakeholder” refers to anyone who has a material interest in a given business organization — in other words, when there is a relationship that entails costs and benefits for each of the participants. It means that the actions of a business firm are likely to have an impact on the participant’s interests – for better or worse. For any large corporation in a modern complex society, the list of potential stakeholders is likely to be quite long. It might include management, various categories of workers, subcontractors, many suppliers (including transportation, energy, communications and internet services), customers, local communities, government (or the “state”), financiers, and, of course, the shareholders.
Accordingly, stakeholder capitalism, as I see it, must include structural arrangements (either formal or informal) that empower and advance the interests of all the various stakeholders, as appropriate. This could encompass many specific mechanisms: membership on the board of directors by worker and community representatives, Fair Trade policies for suppliers, mechanisms for responding more effectively to customer feedback and complaints, a cooperative ongoing dialogue with suppliers, a cooperative relationship with labor unions, and (especially in America), a greater willingness to accept legitimate government regulation and oversight when the public interest is at stake.
The ideal outcome for the stakeholder model, as I envision it, is to enhance a company’s performance and its value by aligning the interests of the various stakeholders, rather than creating obstacles and roadblocks that might harm the company and reduce its value. This is easier said than done, of course, but the principles of compromise and mutual sacrifices where needed can achieve a great deal. Indeed, a formal model (and analysis) developed by Franklin Allen and his colleagues in 2009 showed that such an alignment of interests may be attainable – depending on the circumstances — and can lead to higher overall efficiency and value for a firm. Their model was supported by a number of empirical examples, most notably in Germany, Japan, Austria, Luxembourg, and in some Nordic countries.
Stakeholder capitalism as espoused by the philosopher/economist Edward Freeman and others has a strong moral cast to it. It is oriented especially toward giving workers and others a “voice” in the management of a company. Stakeholder capitalism within the Fair Society model would have a more practical objective. It would be oriented to achieving a proper balance between the three basic social justice principles — equality, equity, and reciprocity — for the many different stakeholder interests. There are no simple formulas for how to do so. It will always require a case-by-case approach and the spirit of compromise. But the Fair Society model clearly defines the overall goal for any given business firm. It is to provide fair deal for all of the stakeholders. (For instance, it would preclude sending profits offshore to avoid taxes, or paying poverty wages, or paying executive compensation at levels that amount to legalized looting.)
However, stakeholder capitalism also requires a favorable business environment, where “private equity firms” (corporate raiders) cannot prey on any firm that does not maximize shareholder value. When all of the competitors in a given market are free to adhere to the stakeholder capitalism model, then there is, in effect, a “level playing field” as the saying goes. No company is seriously disadvantaged by being fair to its various stakeholders.
This was the case in America in the 1950s and something similar seems to have been the case with the Corporate Assembly model in Norway, although I understand that (unfortunately) this is now changing.
But in the context of a global economy where corporate predators and sometimes ruthless and exploitative competitors may act with complete disregard for fairness, the playing field may be steeply tilted. Franklin Allen and his colleagues, in their analysis, concluded that in some circumstances business firms that utilize the stakeholder model may prevail over those that utilize the shareholder model, but this is far from being the general rule. In the longer run, it is possible to envision a global economic “playing field” in which stakeholder capitalism is the rule and is enforced by international trade agreements and various regulatory constraints. But such a global Fair Society is still far in the future.
In the meantime, there is also the promising idea of “shared value capitalism.” In their path breaking 2011 Harvard Business Review article, “Creating Shared Value,” Michael Porter and Mark Kramer propose a new strategic vision for the corporate business world that is addressed the growing dissatisfaction with “shareholder capitalism” and its failure to respond to the major social and environmental problems of our time.
Rather than simply redistributing existing value, as is the case with such “Corporate Social Responsibility” measures as Fair Trade agreements with suppliers, shared value capitalism is focused on finding new ways to solve societal problems that will also increase value (or grow the pie), so that both society and private business firms can benefit (in other words, win-win solutions).
Specifically, it involves finding and exploiting novel opportunities for investment and value/profit growth. The authors cite three distinct ways for doing so: (1) re-conceiving product lines and markets; (2) redefining and improving the value chain; and (3) building mutually-supportive industry clusters and networks. A number of relevant examples are cited by the authors, from Nestlé’s investments in improvements in cocoa and coffee bean growing to Wal-Mart’s reductions in packaging and transportation costs and Coca-Cola’s reduction in water usage.
There is a great deal of merit in this new vision, and the very term “shared value” implies that others will benefit as well as the business firm. The problem is that this is only an aspiration not a requirement. There is no certainty that such sharing will occur, much less that it will be done in a way that is fair to other stakeholders. Because the institutional and economic forces associated with shareholder capitalism still predominate, the pressure for public companies to retain all of the benefits achieved by any new profit stream or cost reduction are formidable, unless they are associated with B-corporations that pursue explicit public purposes. Ancillary benefits for the environment, or for a local community, are laudable, but they are not the same as sharing increased bottom-line benefits with workers, or suppliers. In fact, Shared Value Capitalism does not directly confront the extreme world-wide mal-distribution of income and wealth — a serious problem that has been exacerbated by the shareholder model of capitalism.
Wal-Mart, which was cited by Porter and Kramer as an example of how reducing your ecological footprint can also be profitable, inadvertently provided a perfect illustration of this shortcoming. Wal-Mart is today the largest employer in the United States, with some 1.3 million workers. About one-third of these are part-time workers, and Wal-Mart has for many years paid them only a poverty-level minimum wage, currently $7.25 per hour (unless it is required by local or state laws to pay more). Even full time workers average about $9 per hour, still below the poverty line for a family of four in the U.S. Moreover, Wal-Mart’s policy of part-time employment for many of its workers enables the company to avoid paying fringe benefits (such as health insurance and unemployment insurance). Part-time worker’s schedules are also irregular, so that it is difficult for them to fill the income gap with other work. Nor do taxpayer subsidies in the form of food stamps, Medicaid and low-income tax credits compensate for this income shortfall. Meanwhile, the Wal-Mart family is reputed to be the richest in the world, with an estimated total fortune of about $85 billion.
Porter and Kramer cite Wal-Mart as an example of shared value capitalism because of the reported $200 million that the company was able to save in 2009 (and going forward) by reducing its packaging requirements and rerouting its trucks to save some one million miles annually. Too be sure, all this reduced Wal-Mart’s ecological footprint. However, none of the cost savings were shared with the workers.
It is clear that shared value capitalism, while certainly a worthy idea, is not sufficient without the stakeholder empowerment associated with the idea of stakeholder capitalism, where the influence of managers and shareholders in determining how the value pie is divided must be shared with the other stakeholders in an equitable way. Both of these models have something to offer in dealing with the deep challenges faced by the global community. I would argue that neither one alone is sufficient to address our collective malaise.
There will very likely be some difficult challenges ahead for a society like Norway, which practices what other countries only preach. If so, compromises may be necessary, but the guiding rule should be a fair sharing of the necessary sacrifices while adhering to the principles of a Fair Society – basic needs take priority. If this can be achieved, Norway will continue to be a model for us all.
 Michael Jensen and William Meckling, “Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure.” Journal of Financial Economics 3(4): 305-360, 1976
 An excellent general overview can be found in Gavin Kelly et al., eds. Stakeholder Capitalism. New York: St. Martin’s Press 1997.
 In fact, the spirit of stakeholder capitalism long predates the term. Back in the 1950s, most American business firms endorsed a model of capitalism that was synonymous. For instance, the Chairman of Standard Oil of New Jersey, Frank Abrams, asserted that “The job of management is to maintain an equitable and working balance among the claims of the various interested groups…stockholders, employees, customers, and the public at large.”
 Franklin Allen, Elena Carletti, and Robert Marquez, “Stakeholder Capitalism, Corporate Governance, and Firm Value.” (September 2009). http://fic.wharton.upenn.edu/fic/papers/09/0928.pdf.
 See especially R. Edward Freeman, Strategic Management: A Stakeholder Approach. Boston: Pitman 1984.
65] Government mandates, such as minimum wage legislation and regulations governing working hours, sick leave, etc., or the legal protections afforded by B-corporation status, also have the effect of leveling the playing field. Even Walmart, a firm that is notorious for paying poverty wages, must pay higher wages in jurisdictions that require it.
 Wal-Mart recently announced that it was raising its minimum part-time wage to $9 per hour this year and $10 next year. However, social justice probably had nothing to do with the decision. A combination of a tightening labor market with wages increasing elsewhere, Wal-Mart worker strikes, low worker morale, customer boycotts, and flat or declining sales receipts at Wal-Mart stores were more likely causes.