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Better business

Tue, 25th Sep 2012

How do we get more responsible, ethical business? In order to answer that, we have to ask ourselves why we have so much unethical, or to be more accurate, a-ethical business (as by and large we do), in the first place.

The answer is very simple: that’s the way it has been designed. People seem constantly surprised by the fact that business can and does behave badly, but they shouldn’t be. I'll spell it out: business is an amoral, ethics-free zone because that’s what it’s been set up to be.

Generations of managers have learned at business school, from consultants, their peers and the business press that:

  • Shareholders own companies
  • The exclusive job of managers is to to make as much money as possible for shareholders
  • The business of business is business; its purpose is to make profits, and provided it does it legally, that’s the only obligation it owes to society
  • The way to get managers to do this is to heap them with equity-based incentives, so they act in the interests of shareholders.

Actually, all these propositions are false. Shareholders don’t own companies – they own shares which give them certain rights, a very different thing. In law, diirectors have to have regard for shareholders, as they do for employees and customers, but their direct fiduciary duty is to the company itself, for the benefit of all its members over time. As for purpose, Dave Packard, one of the founders of HP (who must be writhing in his grave at the moment), put it like this: the purpose of management is not profit, it’s profit that makes the proper ends and aims of management possible. And all the evidence is that incentives simply teach people to take their eye off the job and pay attention to incentives: except for the very simplest and most direct tasks (which emphatically does not include running a company) incentives are more likely to do harm than good, by wrecking teamwork and cooperation, for example.

Nonetheless, this is what managers have absorbed with their mother's milk, and it's no surprise that many of them behave accordingly.

So in survey after survey, managers say that despite the talk of ethics and corporate social responsibility, they would engage in dodgy practices if it benefited shareholders, because that's what their pay structures encourage them to do. So even when behaviour isn’t illegal or criminally reckless, as much of the behaviour of the banks clearly was, it’s often irresponsible to the point of endangering sustainability.

To take a small example from retail (for which thanks to that wise observer, John Carlisle): in 1990s the farm gate price of potatoes was 9p a kilo and the retail price 30p; a mark-up of already more than 200 per cent. Ten years later the shop price per kilo had gone up to 47p, which the farm gate price at 9p hadn't budged. The mark-up was no 425 per cent: not a penny of the extra profit had gone to the farmers. That's not fair profit: that's predatory rent-seeking.

Or Apple, a company which gets so much right for customers. How could Apple be caught out imposing indefensible conditions on subcontractors building $600 iPhones on which it makes a 70 per cent marging? Because its managers believe, or at least act on, the myths that I listed a few moments ago, in particular the imperative to maximise returns to shareholders. Prominent among whom, of course are Apple’s own managers. When he became CEO last year, Tim Cook was awarded nearly$400m-worth of stock options to vest over the next 10 years, and last time I looked they were worth more than double that. That’s a pretty strong incentive to go on screwing your suppliers, whatever the ethics might look like.

The Apple example of course illustrates exactly how and why executive pay keeps on going up and up as it does. It’s an integral part of the same nonchalantly ethics-free dynamic, which has a massive weight of vested interest in theory and practice behind it, not least among the top-level managers who stand to gain from it above all.

Given all this, the surprise is not that much business should display so little concern with ethics, but that there is any that is ethical at all. We should be even more grateful for such stand-outs than we are.

So how do we level the playing field?

The first thing is that we need some politicians brave enough not just to talk vaguely about responsible capitalism but to recognise that this is a crisis, more particularly a crisis of what has been the engine of capitalism up to now, the public limited company; and that since the mess we're in is squarely man made, the result of faulty design, it shouldn't be beyond the wit of man to put it right by designing a better system.

This isn’t chiefly a matter of regulation or law change: you can’t regulate to make people better. If you could, Sarbanes-Oxley would have prevented the financial crash. Instead, as John Kay says, we need simple structures that foster resilience. It’s not just the banks – in obsession with economic ‘efficiency’ we have allowed far too many companies of all kinds to grow too big – too big to manage, too big to fail and too powerful for the good of the rest of us. So competition policy should be reframed in the light of sustainability concerns, and that probably means breaking up some of the larger concentrations of corporate power, again, not just the banks. Will Hutton's Ownership Commission has argued that instead of the current overreliance on the public limited company, we should encourage a plethora of other corporate forms – mutuals, cooperatives and social enterprise, for example, and that's an important part of the equation. We could make a start on diversification, as suggested by Oxford's professor of global economic governance, Ngaire Woods, by reincorporating the investment banks with unlimited liability – which is not as far-fetched as it sounds, since as partnerships that's how most of them effectively operating until as late as the 1990s. Seriously, why not?

But the biggest change has to be internal. This goes far beyond the figleaf of corporate social responsibility. Business needs to acknowledge, explicitly and directly, what is abundantly clear to everyone else: that it can only prosper in the long term if it simultaneously pays attention to the interests of customers employees, shareholders and the communities it is embedded in. That needs to be written into the corporate governance codes, which ironically, and with the most earnest of intentions, have congealed into the bastions of the current corporate social irresponsibility.

But I sense the grain of an opportunity here. Interestingly, there is no empirical evidence that current governance ‘best practice’ – independent boards, splitting chairman and chief executive roles, aligning management with shareholder interests – has any beneficial effect on performance. In fact, the whole enterprise of making business morals-free doesn’t even benefit shareholders in whose name the privilege is claimed. Over the last 30 years, companies have done less welly by shareholders than they did in the previous period when shareholders weren’t put first in the same way. Ethics-lite shareholder capitalism fails even in its own terms.

That means that for once we’re in that rare situation where we have nothing to lose and everything to gain by doing the right thing.  So who's up for it?


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User comments

Donal Carroll :: 25th Sep 12
Brilliant thought-grenade to throw into so-called 'markets' which continually try to hide the scar tissue of their preparation. Great thought-leadership piece which political parties shd be basing polices on. Why aren't you writing for a quality Sunday! When can I buy you a drink!
Joel :: 9th Oct 12
I agree with your diagnosis of the problem in that as Paul Batalden says, "Every system is perfectly designed to get the results it gets." I suggest considering introducing the requirement for democracy into the equation for businesses and for government; see Susan Rosenthal's work: http://bit.ly/A2VOeJ and/or Anthony Arblaster's "Concepts in the Social Sciences - Democracy (3rd ed). http://bit.ly/dypjJd
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