It Takes A Village To Change The Purpose Of A Corporation

If you took comfort in the Business Roundtable’s “Statement of the Purpose of a Corporation” released in August 2019 that companies operating in the U.S. would be easily empowered to significantly re-orient their focus toward maximizing the long run net benefits that inures to enterprises’ shareholders and to society more broadly, you would be wise to be patient.  

With the continued reluctance of independent U.S. government regulators to alter long-ingrained misdirected requirements pertaining to corporate governance practices, the unprecedented rupture in the U.S. economy’s terrain engendered by the Covid19 pandemic, and the highly erratic and statist economic policy actions of a President, it is clear the alteration of American businesses’ aspirations, no matter how well-intentioned they may be, cannot be fulfilled in a vacuum. 

To borrow from an African proverb made familiar to U.S. audiences by the title of one of Hillary Clinton’s book, ‘it takes a village’ for companies to be enabled to fundamentally re-orient their objectives. 

In other words, all corporations, whether in the U.S. or elsewhere, strive to fulfill their objectives as they function within their operational ecosystems—environments comprised of varied interest groups, or what we corporate governance experts refer to as “stakeholders,” who are driven to follow their own dictates.  

A corporation’s stakeholders constitute a disparate group of different but not always mutually exclusive elements, such as a company’s owners (or shareholders), management, board of directors, workers, customers, suppliers, regulators and policymakers, investment activists and NGOs. And if one thinks in the broadest terms, a company’s competitors also are stakeholders.

Unless and until the system of incentives and disincentives emanating from these constituents of the ecosystem change, it is hard to imagine corporate conduct will be fundamentally modified.  In a word, a “supportive environment”—however one wishes to define it—is necessary.

Here are three key elements, including those that have come to the fore during the period since the Business Roundtable Statement was published, that are shaping the stance of today’s corporate ecosystem in the U.S. and which will affect the prospects for achieving the envisioned reform of American companies.

Regulation’s Impact On U.S. Corporate Short-Termism 

One cannot overstate the importance of transparency and the regular disclosure of public companies’ financial performance to sound corporate governance and compliance practices, as I have done several times in this space. While there have been some legislative actions taken by the Congress in recent years to water down, or even to rescind such requirements, especially those enshrined in the Dodd-Frank Act of 2010, the U.S. regime for corporate financial disclosure is strong compared to counterpart countries.

In one dimension, however, current U.S. corporate financial disclosure regulation creates strong disincentives for companies’ management teams and boards from adopting a longer-term perspective that could sustain strong company economic performance beneficial not only to shareholders but also to vast portions of companies’ overall stakeholders. That is the Securities and Exchange Commission’s (SEC’s) requirements for such disclosures every quarter.

The result is stock market analysts and investor groups, including shareholder activists, form judgments about how public U.S. companies are performing on a quarter by quarter basis. In turn, the impact on the attention span of C-suites and boardrooms to broader matters concerning companies’ health is palpable. Every quarter companies issue artfully worded press releases as to whether or not their financial performance met consensus estimates made by stock analysts. It is almost a full-time job for corporate media officers.

The fact is three-months is an extraordinarily—make that “an excessively”—short period to meaningfully assess the results of changes in corporate policies, management moves, the introduction of new products and services and so on. It certainly does not create the most inviting environment for experimentation and innovation within a company. Yet those are the attributes that have made American companies the envy of the world.

Historically that is.

The present day is a different matter. An increasing portion of the world’s advanced democratic economies, including a swath of Americans themselves, are concerned that the globe’s erstwhile innovation pace-setting firms are less and less those headquartered in the U.S.

Without making a definitive judgment about that hypothesis, it is worth noting that by comparison with the frequency protocols for financial reporting required of public companies domiciled in other economic democracies, the U.S. is a significant outlier.

In 2013, the EU issued a directive allowing for semiannual reporting and making quarterly reporting optional for companies in its 28 member states. Semiannual reporting is also the norm for Australia and New Zealand. Currently, other than the U.S., other major economic democracies that currently abide by quarterly reporting include: Canada, Mexico, Japan, and South Korea.

To President Trump’s credit, in 2018 he asked the SEC to consider changing its reporting requirements for U.S. public companies to a semiannual basis. In 2019, however, the SEC demurred doing so based on comments it received from the public.

Paradoxically, while major players in the investment community such as Berkshire Hathaway’s Warren Buffet, BlackRock’s Larry Fink and JP Morgan’s Jamie Diamond all supported making the change, smaller investors were less in favor of doing so, arguing less frequent reporting would intensify market volatility and reduce transparency.

The strongest proponents for maintaining quarterly reporting were the large accounting firms. They are not public companies, and dare I say they have a self-interest in having a steady stream of auditing assignments. (For full disclosure earlier in my career I worked at one of the Big Four, though in the management consulting side of the business as I am not an auditor.)

How Salient Are Workers As Stakeholders?

If there is one set of stakeholders front and center to the fulfillment of a corporation’s purpose it is the firm’s workers. When business conditions soften, however, they are usually the ones bearing the brunt. This is certainly the case with the dramatic upheaval in the U.S. economy due to the Covid19 pandemic—both the plummeting of aggregate economic activity and the need to reconfigure the workplace to meet the health imperatives for social distancing.

On the first score, the evidence of massive employee layoffs by some of America’s largest—and most globally well-known—public corporations has been regularly filling the business headlines.

Not surprisingly, given the downdraft in travel due to the pandemic, workers in that sector have been the major casualties. As a whole, the biggest airlines are estimated to have laid off, furloughed for the long run, or cut wages of more than 60,000 of their employees. Hospitality and entertainment firms have taken steps of similar magnitudes. While generally not as sweeping, analogous measures have been instituted by firms in sectors as disparate as consumer goods, food, electronics, industrial products and software.

There are two important questions.

First, how have the other stakeholders in such firms fared? For the three major U.S. air carriers, stock prices have fallen around 50% since the start of the year. For the shareholders who are not employees of these firms that is not good news; but it is even worse for airline workers laid off who are also shareholders. Importantly, airline share values throughout the crisis have not risen because the travel business has rebounded significantly; rather stock prices have tended to increase when federal bailout funds have become available.

But in some of the other sectors where large layoffs have occurred, for example in software, such decisions have been taken even in the face of share prices hitting record levels. The asymmetric impacts among a corporation’s stakeholders from changes in macroeconomic business conditions are, of course, not unique to the Covid19 crisis.

This points to the second question: As painful as the layoffs and furloughs are likely to be, are the sharper deleterious effects emanating from the pandemic on workers compared to other stakeholders part and parcel of usual cyclical economic disruptions and thus workers should expect a traditional rebound? 

Here, I think, there is evidence the pandemic will engender secular economic scaring among some of the workforce.

There are several reasons to expect this. There is always some degree of “stickiness” in rehiring as an economic recovery from a sharp fall takes hold, in part driven by the time it takes companies to rebuild their confidence in improving business conditions. In addition, however, recessions often provide companies new opportunities to implement changes in worker rolls that have been previously contemplated but not acted on.

Nonetheless, there are also unique deleterious economic effects stemming from this pandemic. As long as there is a requirement for social distancing, absent enlargement of workspaces, which will require additional capital invested, the volume of workers that can be safely employed in a given company may well be reduced. Of course, this need may be mitigated to the extent employees are able to work from home and be as productive as otherwise (an open question as many employees and business have discovered since the onset of the crisis).

More fundamentally, perhaps, coupled with the underlying trend toward digitalization of certain industries, social distancing imperatives will likely accelerate embedding artificial intelligence and robotics into traditionally manual work processes.     

How Does A Statist Government Fit Into U.S. Corporate Purpose?

The framers of the BRT Statement surely know their ability to achieve the “Purpose” they articulate is conditioned by U.S. public policy. The Statement however assumes only implicitly that government actions will be supportive of the broad public interest of the U.S., not only in preserving the country’s national security but also in maintaining a competitive marketplace, one free from cronyism.

This is important because as lofty as the framers’ aspirations may be, one cannot get around the fact that corporations ultimately are driven by commercial imperatives. Moreover, these imperatives are certainly influenced by policy incentives generated by government.  If this were true, it would be naïve not to recognize there are risks that government actions may well stymy meeting the Statement’s objectives.

Unfortunately, some of the policies pursued by the Trump Administration regarding China-U.S. national security, investment and trade matters have veered in this direction. Most visibly, of course, is the current ByteDance-TikTok case. But there have been others, such as Washington’s Phase1 trade deal with Beijing. Well-known U.S. public companies have been involved in these.

Mind you, I am not casting aspersions at these corporations. Not at all. Rather it is important to recognize companies do not operate in a policy vacuum. Significantly, not only is the modern U.S. corporation affected by government actions, but they also expend significant efforts to try to shape public policy in ways that further their objectives.

The question thus arises how should American companies respond if Washington takes decisions that run counter to the purpose of the corporation? We saw in the aftermath of the violence in Charlottesville in 2017 they can play a productive role—or at least distance themselves from government conduct that runs counter to their values.      

This is pertinent with regard to the current administration’s dealing with China.

The heart of Mr. Trump’s Phase1 trade agreement with China is a series of transactions negotiated state-to-state. It is not a market-oriented trade agreement; there are simply purchase commitments made by Beijing with Washington irrespective of any changes in prices that always occur—rather significantly—in markets for the commodities in question.

Nor is Beijing required to implement any serious reforms of the functioning of its economy to ease U.S. and other foreign firms’ abilities to operate in China. Its sole purpose is to reduce the bilateral U.S. merchandise trade with China—a fetish of President’s Trump. That is an objective devoid of any economic significance in and of itself.

If anything, the Phase1 agreement signals Mr. Trump wants the U.S. to be more like China than the reverse. Indeed, he has said he envies Xi Jinping’s command of China’s economy.

The saga involving Mr. Trump’s demands for a divestiture of TikTok from ByteDance to U.S. companies conveys the same values of cronyism and a disdain for arms-length transactions consummated between American companies. In fact, Mr. Trump has been micro managing the contours of the deal and publically conveying which U.S. firms he would favor closing it. Moreover, he has gone even further demanding the parties to the transaction cough up a “finders’ fee” to the U.S. Treasury, which White House lawyers have opined is illegal.

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One is forced to wonder as the leader of the U.S. carries out such conduct where exactly does the purpose of today’s American corporation fit in.