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Dee Corrigan, A Blueprint for Better Business and Alex Edmans, London Business School

Last week, Blueprint hosted a webinar during which I spoke with Alex Edmans about the challenges businesses face thinking about purpose and responsibility in relation to real practical challenges and questions that have surfaced through Blueprint’s engagements with FTSE 100 companies. You can watch the webinar on demand – HERE

Our audience asked us wide-ranging and insightful questions and sadly we couldn’t get to so many on the night. This is the first in a series of posts Alex and I are working on together with the aim to answer them all over the next few weeks.

Audience question 1: One of the themes I recall from my time in the late 1990s doing a Masters in Finance at London Business School, where you teach, is the significance of (real) options. Two thoughts: firstly, given that most companies have more real options (such as investment projects) than they can realise, how can ‘purpose’ be deployed to help them decide which options to select to activate? Secondly, how could ‘purpose’ help a business decide which new real options (again, such as potential future projects) to try to create for itself for the future?

Alex Edmans (AE): Real options theory argues that, in a world of uncertainty, you should delay investment until the uncertainty is resolved – in other words, retain the “option” to invest later. But it defines the payoffs from investment in purely financial terms. For some investments, such as Vodafone launching M-Pesa in Kenya, or Merck developing Mectizan to cure river blindness throughout Africa, even if you waited several years, you still wouldn’t be able to justify the investment on financial grounds. Thus, given we do live in a world of uncertainty, real options theory would lead to firms postponing many critical investments almost indefinitely. Under purposeful business, you consider the social rather than financial returns to an investment. Even if the financial returns to curing river blindness are uncertain (because the African governments were unable to pay for the drug), the social benefits are immense, so a purposeful company undertakes that investment.

Dee Corrigan (DC): The deeper the understanding of what it means to be purpose-led across the leadership and board, the stronger the commitment is to invest in activities that support the company’s purpose, creating new possibilities even if the traditional financial-led business case is not clear-cut. A clearly articulated purpose can help stimulate innovation as well as judge whether an investment will further the purpose.

Audience question 2: When resource is limited, it can be relatively easy to evaluate financially-driven initiatives against one another. Would you have any advice on comparing, evaluating and prioritising purpose-driven initiatives?

AE: One way is to try to estimate the monetary value of purpose-driven initiatives. This post gives an example of how you can do this even for initiatives with purely social outcomes, such as programmes to reduce alcohol abuse and sexual assault. However, this won’t always be possible, and such calculations can sometimes require so many assumptions that they’re unreliable. Thus, Chapter 3 of Grow the Pie highlights three principles that a business leader can follow to evaluate such initiatives. One is the principle of multiplication – that the initiative should create more social value (note, not financial value) than its cost. The second is the principle of comparative advantage – that it should be an initiative that the company has particular expertise in addressing (such as Coca-Cola helping to transport medicines as discussed in the webinar). The third is the principle of materiality – that the initiative should affect stakeholder that are particularly material to its business. For example, an energy company decarbonising may consider the environment even more important than safeguarding jobs, and thus shut down a polluting plant.

DC: As I mentioned above a clearly articulated purpose can help judging investment decisions. An additional point which may be helpful in comparing, evaluating and prioritising initiatives is to consider engaging stakeholders in the decision-making process. How companies make decisions can often be as important as the decisions made. Being purpose-led invites organisations to think differently about their relationships with stakeholders. Recognising stakeholder as partners in the development of a company’s purpose-led strategy shifts the nature of the relationship from an extractive/contractual one to a generative relationship based on respect and dignity. I suggest reflecting on at what point and through what mechanisms you can enable people affected by your decisions to influence them. If people are engaged respectfully in the decision-making process, even if the outcome is not what they hoped, it may be accepted, supported and therefore more effective in the long-term. It is also an important signal, helping to reshape the nature of the relationships with business seeks to have with its stakeholders.

A clearly articulated purpose can also help navigate dialogue with stakeholders.

One final point is whilst it is necessary to assess the non-financial impacts a decision will have – both social and environmental – we do caution against the desire to try to measure all impact using the same monetary units, we outline the potential risks of doing this in the blog, the limits of putting numbers to things we care about.

Audience question 3: Corporate governance today seems to be about doing less bad / making incremental change. But the global challenges we face are requiring an absolute transformation of our companies: adaptation to climate change, stopping biodiversity loss and reshaping social distress. However, corp gov may have worked in the past, is it totally out of sync with where we need it to be?

Long term profit is almost an oxymoron today given that our time horizons are so short-term. The incentives we offer our managers are short-term, not long-term. Surely that tells us something?

AE: I agree with both points. On the first one, corporate governance is indeed focused on “do no harm” – ensure good risk management and avoid scandals. That’s obviously important, but it’s not enough. It should ensure that companies “actively do good”. Given the severity of the problems in the world today, it’s not enough for a company to not cheat on tax, not mistreat its workers, and not price-gouge its customers. Instead, it needs to ensure it uses the resources and expertise it’s blessed with to solve social problems. For example, in the pandemic, Mercedes is using its precision engineering expertise to make CPAP breathing machines, a less invasive alternative to ventilators.

Unfortunately, some advocates of responsible business have this “anti-growth” mindset, arguing that businesses shouldn’t grow too much otherwise they’ll exceed certain planetary boundaries. This leads to people thinking good corporate governance is about preserving the status quo. But, it has a narrow view of growth – being just about financial capital. When I speak about “growing the pie”, this involves growing social capital. Financial capital is only one part of it. Social capital also includes human capital – there are no planetary boundaries to treating employees better, providing them with meaningful work, and developing their skills. It includes natural capital – coming up with production techniques that use fewer resources, or use renewable rather than finite resources, eases rather than exacerbates planetary boundaries. It includes intellectual capital, and so on. Corporate governance is about growing these forms of capital.

I agree with the second point also. The pie only grows in the long-term. In the short-term, the fastest way to increase profits is to split the pie differently (e.g. cut wages, increase prices) rather than grow it. That’s why change needs to be systemic – it involves rewarding managers according to long-term value (see Chapter 5; a short summary is here) and investors evaluating companies according to long-term value.

DC: In a purpose-led business the role of the board changes (as we have set out here). They become the collective trustees of the purpose and see their role as long term stewards, accountable both to investors but also to wider society for the role the business plays in fulfilling its purpose including its social and environmental impact. We think as part of this greater diversity of Board membership is important. We also encourage leadership teams and boards to routinely listen and engage in a dialogue with a wide range of stakeholders, inviting and welcoming scrutiny of alignment to its purpose. More distant voices are often not so much ‘hard to reach’ as ‘seldom heard’. In governing a company how does the Board ensure that the voice and stake of future generations for example is effectively brought into the room?

Audience question 4: What, if any, corporate governance structures need to change in order to fertilise purpose-led companies?

AE:

  • Long-term pay, as per the above point
  • The board to take ownership of purpose. Many boards evaluate major decisions (e.g. capital expenditures, changes in strategy) with a purely financial analysis. They could require the executive team to explain how every major decision is consistent with the firm’s purpose in order to approve it.
  • Shareholders to take large stakes. Some so-called active funds are closet indexers, spread so thinly that they don’t have enough skin in the game in each company to look beyond financial value. It takes time and effort to analyse non-financial value, and only investors with skin in the game will have the incentives to do so.

However, it does not need – as some suggest – a change in the company’s articles of association to legally enshrine a purpose. First, I’ve consulted many senior lawyers (since law isn’t my expertise) who tell me that there’s nothing in the Companies Act which prevents executives from acting with purpose. Directors’ duties are to the success of the company, not just to shareholders, and in any case the Companies Act refers to the “benefit of its members” which can include non-financial benefits (as a shareholder, I care not only about my wealth in retirement but also the temperature of the planet). Second, in contrast to claims that it will provide legal clarity, legal experts argue the opposite. What does it mean to “consider stakeholder interests”? If an energy company shuts down a polluting plant, helping the environment but hurting workers, does this help stakeholders overall? If it doesn’t shut down the polluting plant, does that help stakeholders?

More importantly, the message that some convey, that “we can’t expect leaders to act purposefully unless we change the law” is a bad message, as it gives many executives a cop-out. They can think “since the law hasn’t changed, I’ll just focus on short-term profit”.

DC: It’s also worth reviewing how subcommittees of the board contribute to strategy development and value creation, and are not solely concerned with remuneration, risk and nomination (a legacy of the exclusive focus on shareholder returns).

Audience question 5: What are the more effective levers to encourage investors to prioritise longer term value and purpose? BlackRock’s announcement re sustainability seemed like a tipping point. If we could move the needle on investor motivation/intent, that would give powerful permission to CEOs and Boards to be more ambitious (as many would like) and innovative…

AE: Investors to take larger stakes, as per the prior response. Also, companies can get on the front foot and offer investors a “say-on-purpose”, as described in this article. This ensures that investors deeply scrutinise a company’s purpose, and will hopefully elevate the investor-company dialogue beyond purely financial factors.

DC: One lever on asset managers are the mandates set by pension funds and other asset owners. They are the trustees of their beneficiaries savings and investments and through the mandates they set, including the timescales they can influence what investments are made and over what period they are judged. The growth in ESG funds is a welcome response to this wider pressure. We also need the big asset managers running massive index funds to invest more in stewardship so there is better scrutiny of the companies in the indices they track. In the end this goes to the purpose of the investment industry itself and how it sees its role in society. There is good recent work by ShareAction and the 300 club on this.

Audience question 6: Can you share a bit on the relevance of externalities to growing the pie, and how pieconomics suggest companies account for the costs of their activities that don’t currently impact their P&L but significantly destroy common value?

AE: Absolutely – this is a very important point. The idea of “growing the pie” is that many things that a company does to create social value (grow the pie) ultimately increase long-term profit (shareholders’ slice of the pie). However, it would be too naïve and simplistic to argue that this is the case for every single decision. For example, the costs of global warming to society might be far greater than the ultimate cost to the polluting company – and if global warming hurts companies, it might hurt other companies than the polluter (e.g. real estate companies that own waterfront properties).

Most of my work (and Blueprint’s) emphasises how it should be companies and investors who take the lead in responsible business, since it’s simply good business. But, governments still have a role, because markets fail, and externalities are an example of market failure. Thus, governments should either outright ban activities which cause huge externalities (e.g. child labour) or tax them (e.g. carbon emissions). Other market failures which require government intervention include monopoly power, inequality (which can be addressed through taxes), information asymmetry (which can be addressed through mandatory disclosure), small business financing, and so on – the role for government is explained in Chapter 10.

DC: Excellent answer Alex. Nothing to add to that! Thank you for taking the time to respond to all these questions.

Thanks to everyone who attended and to our audience members who took time to share questions – if your question wasn’t answered this week we will respond soon!

Below are the questions that were asked and answered on the evening – you can watch the webinar on demand and hear Alex and Dee’s responses to these questions – HERE

  • What do you make of the latest discussions around Danone? Some are speculating it is a case study of a company that has either not manage to integrate it’s pursuit of purpose well enough with its financial performance, or hasn’t managed its shareholder expectations adequately.
  • Please can you talk about the different things companies need think about measuring (social capital, natural capital etc.) to help make purposeful decisions?
  • What do you think about the B Corp movement in the context of a journey towards being a purposeful company?
  • Some people will make the case that in order to protect the natural world we need to reduce consumption and so the pie might not get bigger though still needs to be more evenly allocated … your thoughts on this would be welcomed.
  • What responsibility do you think energy companies, transitioning away from oil and gas and towards renewable energy, have towards their employees? (particularly given that those oil and gas employees will find it hard to find work, give that their skills are in a profession that there is less demand for). Are generous redundancy terms really enough?
  • How have you seen companies which have recently decided to be “purpose driven” successfully deal with the challenge of actually taking key decisions according to their purpose rather that following the often decade long habits of financial based decisions?

Thank you David Nussbaum, Ben Pardy, Jyoti Banerjee, Kirsty Britz, Dominic Wilson, Tim Littlehales, Christine Dilvanis, Olly Holbourn, Jo Alexander, Mike Romig