Moving Beyond Shareholder Primacy: Can Mammoth Corporations Like ExxonMobil Benefit Everyone?

Frederick Alexander is Head of Legal Policy at B Lab. This post is based on a B Lab publication authored by Mr. Alexander.

The New York Times recently took issue with Rex Tillerson, the President-elect’s nominee for Secretary of State, and the current CEO of ExxonMobil. Why? “Tillerson Put Company’s Needs Over U.S. Interests,” accused the front page headline. The article details how the company puts shareholders’ interests before the interests of the United States and of impoverished citizens of countries around the world.

In response, a company spokesman insisted that all laws were followed, and that “‘[a]bsent a law prohibiting something, we evaluate it on a business case basis.’” As one oil business journalist puts it in the article: “‘They are really all about business and doing what is best for shareholders.’” Thus, as long as a decision improves return to shareholders, its effect on citizens, workers, communities or the environment just doesn’t rank.

Unfortunately, this idea—evaluate the “business” case, without regard to collateral damage, permeates the global capital system. Corporations are fueled by financial capital, which ultimately comes from our bank accounts, pension plans, insurance premiums and mutual funds, and from foundations and endowments created for public benefit—in other words, our money. And yet when that capital is invested in companies that ignore societal and environmental costs, we all suffer: Corporations use our savings to drive climate change, increase political instability, and risk our future in myriad ways.

The good news is that structures like “benefit corporations” can help us repair our broken system of capital allocation—but the clock is ticking.

Milton Friedman crystalized the “shareholders first” idea in the title of his 1970 article, “The Social Responsibility of Corporations Is to Increase Its Profits.” This simple concept is appealing. If a pension investor entrusts her retirement savings to an asset manager, shouldn’t the manager, and the executives of companies that the manager invests in, ensure that her investments deliver the best return possible for her retirement? And won’t this lead to an “efficient” allocation of capital? Actually, “no” and “no.”

Consider the run-up to the financial crisis: Banks sought profits for shareholders, but created a financial crisis that cost trillions of dollars. Because most investors owned many stocks, these banks hurt their own investors, by degrading the value of their portfolios, not to mention reducing the quality of their lives by driving the world economy into recession. Similarly, ExxonMobil’s practices may increase profits, but decrease economic productivity through environmental degradation and political instability. In other words, companies can retain benefits for shareholders while socializing losses to other stakeholders, and this encourages investments that actually are very inefficient overall.

If blind pursuit of profit actually hurts investors, why does the ExxonMobil view of fiduciary duty survive? Two powerful but artificial constructs sustain it. The first is “Modern Portfolio Theory.” MPT has taken over the asset-management industry, and measures institutional investors by whether they “beat the market.” This creates pursuit of superior relative company performance, even as it drives down the performance of the entire market.

The second artificial construct is “shareholder primacy.” This theory posits that corporations should deliver the best returns they can to shareholders, without regard to the effect on any other asset the shareholders own, or any other aspect of their lives. Guided by shareholder primacy, current legal and financial systems encourage corporate executives to maximize the return on their stock, regardless of harm to other companies owned by their shareholders, or of damage to the world in which those shareholders live.

This system is not tenable. Investors and executives must broaden their vision. This is not a novel idea: During the post-war era of rapid economic growth, and before the ascendancy of Friedman’s ideas, corporations were viewed as having broad responsibility. Indeed, in 1951, the chairman of Standard Oil—the predecessor of ExxonMobil—described the executive’s job as balancing the interests of all stakeholders: “The job of management is to maintain an equitable and working balance among the claims of various directly affected interest groups … stockholders, employees, customers and the public at large.” Quite a contrast.

We need to give corporations tools to climb out of the morass of shareholder primacy, and get back to viewing themselves as institutions with ethical obligations. One such tool was recently created in a number of jurisdictions: the benefit corporation. Shareholder primacy is not an option for a benefit corporation; it is legally required to account for the effects of its decisions on all stakeholders. Thirty states (including Delaware) have authorized benefit corporations, and legislation is moving forward internationally—a statute has been adopted in Italy, legislation has been introduced in Columbia and Argentina, and is being considered in a number of other countries. Traditional corporations can easily make the switch, and responsible investors should be encouraging them to do so.

Benefit corporations dovetail with the movement to require corporations to act more sustainably. However, the sustainability movement often treats the symptom (irresponsible behavior), not the root cause—the focus on individual corporate financial performance. Proponents of corporate responsibility often emphasize “responsible” actions that increase share value, by protecting reputation or decreasing costs. Enlightened self-interest is an excellent idea, but it is not enough. As long as investment managers and corporate executives are rewarded for maximizing the share value of individual companies, they will have incentives to impose costs and risks on everyone else.

We deserve better. Thoughtful investors and benefit corporations can help shift the focus of our economy to creating durable, shared value that recognizes the external harms—and benefits—created by business. Corporations enjoy great privileges, including limited liability and access to our courts and our transportation and communications systems. They also enjoy the privilege of access to our capital. We have every right to insist that corporations use that capital in a manner that preserves our financial future, and the future of society and the planet we live on.

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