Renewal

Repurposing business

Last Updated:
23.6.21
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Renewing the purpose of business

Businesses are fundamental to any economy. They come in all shapes and sizes, from sole traders to multinational giants. But in recent years there has been growing criticism, both of the way some businesses behave, and of how they are governed. Much of this has come from within the business community itself.

A key argument is that many large businesses have lost their sense of ‘purpose’. Increasingly focused on financial metrics of success, many are now seen as prioritising short-term returns above long-term investment, and the interests of their shareholders above those of their wider ‘stakeholders’, such as their workers and consumers.

Partly as a consequence, new models of business have become more prominent. These include companies committed to an explicit statement of purpose. New types of ‘stakeholder’ corporate governance and financial investing are on the agenda, along with new forms of ownership giving a greater stake to workers. In these and other ways, an increasing number of businesses are seeking to change their impact on society and the environment. But some critics have expressed doubt as to whether some of these initiatives are far-reaching enough.

Reforming corporate governance

Corporate governance in the UK and US is based on the principle of shareholder primacy. This means that the interests of shareholders take priority over those of other stakeholders in a firm, such as workers, suppliers or consumers. There is good evidence that this can encourage an excessive focus on short-term profitability, at the expense of long-term investment.

It is widely argued therefore that the Anglo- American model of corporate governance should better reflect the interests of a company’s stakeholders, not just its shareholders. Proposed reforms include giving firms an explicit duty to pursue long-term purpose or value creation, and to tie executive pay to a range of performance metrics rather than just a firm's profitability or share price.

A particular focus for reform is the make-up of company boards. Advocates of worker representation on company boards – which is commonplace in many European countries – argue that it would tend to strengthen investment, because workers have a longer-term interest in their companies than short-term shareholders. By fostering a culture of cooperation between managers and workers, it is said, it would also boost productivity. There are also widespread calls for mandatory improvement in the gender and ethnic diversity of company boards.

ESG: environmental, social and corporate governance principles

Over recent years there has been a huge increase in the number of companies and financial investors committing to ‘ESG’ principles, under which they aim to achieve not just profit and financial returns but better environmental and social impact and corporate governance. Globally, assets classed as ‘ESG’ were valued at over $30 trillion in 2018, an increase of a third on 2016.  ESG investment funds have consistently outperformed the average, and there is strong evidence that an attention to ESG can improve shareholder returns.

ESG principles commit companies and investors to assessing their performance through the ‘triple bottom line’ of ‘people, planet and profit’ (sometimes known as TBL or 3Ps). But there is no universal agreement on the specific standards of behaviour which define ESG, or the metrics which should be used to measure performance. With so many different criteria used by ESG investment funds, critics argue that too many allow for ‘greenwashing’ of companies with unsustainable and socially damaging impacts.

When the US Business Roundtable released a statement in 2019 arguing that US businesses should be committed to a broad range of stakeholders – including customers, employees, suppliers and communities as well as shareholders – this was widely interpreted as a significant shift in business philosophy. But others argued that ‘stakeholder capitalism’ in practice looked insufficiently different from shareholder capitalism. Activist investors, both corporate and individual, are increasingly seeking to hold businesses to account in order to raise ESG standards.

Regulating corporate behaviour

As multinational corporations throughout the world have grown over recent decades, they have developed complex supply chains. Globally traded commodities and goods may go through many stages of production in different countries before being made into the final products we buy. In this process it is easy for companies to profit from exploitative wages and conditions, forced labour and environmental harm, particularly in the global South where workers and local communities may have little bargaining power and enforcement is difficult.

Most of the initiatives designed to prevent abuses of this kind have been voluntary, where companies commit to codes of ‘corporate social responsibility’. But there is strong evidence to suggest that these are often ineffective. Companies are insufficiently motivated or incentivised to audit their supply chains properly.

One response has been the development of ‘worker driven social responsibility’, where trade unions and workers’ organisations agree higher standards with companies, and are able to enforce them. Another has been the development of ‘due diligence’ laws, by which multinationals are obliged under the law of their home states to audit their supply chains and ensure high standards, in areas such as labour conditions, human rights, environmental impacts and anti-corruption. The evidence suggests that a requirement to report on their supply chains is not enough; companies need to be criminally liable to ensure compliance.

Executive pay and pay ratios

One of the most persistent criticisms of corporate behaviour has been of the high levels of pay and share options by which company executives are often remunerated. Since 2000 the average earnings of workers in the UK have increased by about 3% a year, but the pay of FTSE 100 executives has grown by around 10% a year. The average FTSE 100 CEO is now paid 126 times as much as the average UK worker, compared to 58 times in 1999.

In principle executive pay should be based on company performance, but the evidence is that there is little or no relationship between them. Indeed, the widespread use of share option incentive schemes, in which executives are rewarded for increases in the value of company shares, has been criticised as an incentive for directors to focus on short term returns rather than long term investment. Various reforms to pay structures to incentivise long-term performance, and benefits to employees and other stakeholders, have been proposed.

Listed companies in the UK with over 250 employees are now required to report on the ‘pay ratios’ between their highest pay rates and their lowest and median pay. There are now calls for this to be extended to privately-owned companies, for more information to be disclosed about higher earners, and for the information to be better disseminated to company employees. Some have proposed a ‘maximum wage’, an upper limit on allowable executive pay, with the money saved redistributed to lower income workers in the company.

Widening business ownership

The ownership of UK firms is highly concentrated. Over the last fifty years there has been a dramatic decline in the proportion of shares held by ordinary individuals. Share ownership is dominated by institutional investors such as pension funds, asset managers (many now operating passive investment funds), and the wealthy, many based overseas. Since the 1980s successive governments have privatised previously public-owned industries such as rail, water and energy. Few workers hold shares in the firms in which they work and the UK cooperative sector is smaller than in many other countries.

In recent years there has been increasing interest in how ownership can be widened. One way is through public ownership, in which the state takes equity stakes in companies in major sectors, such as energy or rail. Another is by giving ownership stakes in companies to their workers. This can be done either through individual employee share ownership schemes, or through collective worker ownership funds which would both widen the distribution of profits and give workers a say in how businesses are run.  

Another route increasingly advocated would be through the creation of a national ‘citizen’s wealth fund’, which would build a portfolio of company shares and distribute a dividend to every citizen.

Cooperatives and social enterprise

The UK has a flourishing economy of cooperatives (companies owned by their workers or consumers) and other forms of social enterprise (non-profit-distributing businesses with social goals). Such businesses have a long history in the UK and around the world, their origins often in mutual self-help initiatives among working class and other marginalised communities. They are characterised by democratic ownership and governance, and often a social mission.

Mutual building societies – which borrowed money from members of a local community to lend to others for housebuilding and purchase – were once a pillar of the UK financial system, but most became commercial banks in the privatisations of the 1980s and 90s. Both in the UK and around the world credit unions have performed a similar role of mutual borrowing and lending within a local or occupational community. Today a new wave of mutual banks is emerging to fill a gap in finance for social good.

Worker-owned cooperatives continue to be the mainstay of the cooperative movement, with the Mondragon network in the Basque country of Spain the single largest group. In the UK John Lewis remains the most famous employee-owned business, though its governance structure is not fully democratic. The Cooperative Group and regional cooperative societies are consumer-owned mutuals. In recent decades  a vibrant movement of community enterprises has emerged: socially-owned businesses committed to advancing social and employment goals, often in low-income areas.

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