Banks should serve stakeholders not just shareholders

HARRISONYOUNG,NON-EXECUTIVEBANKINGDIRECTOR&AUTHOR

Banksoccupyacentralpositioninsocietyandtheeconomy.

Peoplehavepassionateopinionsaboutthem– somearguablymisguided,somethoughtfulandchallenging.

Ihopetodothreethingsherethatmightenhancepublicdebate.

Iwanttocreateaconceptualframeworkandvocabularyfortalkingaboutenterprise

1.

Iwishtosuggestthatabankboard’sobjectiveisbestdescribedasabalancedresponsetostakeholderclaims– asopposed,thatis,to maximizingthewealthofoneclassofstakeholders

2.

Iwillbrieflydiscussthematterofworthycausesclamoringforboardattention.Mypersonalview

isthattheycannotbewhollydismissed.

3.

WhatamItryingtoaccomplish?

Brain-stretching

Inote

1.Thechallengesfacingtraditionalcorporations

2.Idescribeotherorganizational

forms

3.Ihighlightthevalue-allocationdecisionsboardsmustmake,notbecauseIfavor

movingbusinessintosomenewconstruct,orexpectparliamentstoaltercorporationsacts,buttoencouragedirectorstothinkabouttheirjobdescription– includingthe

unwrittenparts.

Someofwhatfollowsisintentionallyprovocative.

Thetimescallforunconventionalthinking.

Therehavebeenacoupleofelectoralsurprisesrecently.“Left”and“right”nolongerhavestablemeanings.Communityexpectationsarechanging.

Executivesineverysectoroftheeconomyperceivearisingtideofdistrust.Itmaymakesensetore-examinehowbusinessexplainsitselftoaskepticalpublic,andseeifwebelievewhatwe’resaying.

Model &Vocabulary

Abankisanenterprise.Thetaskofeveryenterpriseistooffergoodsandservicesatprices

thatexceedtheaggregatecostoftheiringredientsbutarenohigherthanthoseof

alternativeproviders.Doingthatcreatesvalue.

The proof is that you have customers.

Some- ingredientsaretangibleandobvious:bricksto

buildahouse,claytomakebricks,menandmachinestodiguptheclay.Someareintangible:energytobakethebricks,theskillsthatoperatorsofmachinesacquire,thetransportationofthebrickstomarket.

Iliketousetheword,“enterprise,”forvaluecreation– boththeactivityandentitiesthatengageinit– becauseitisneutralastodistributionandstructure.Thepurpose ofanenterpriseisvaluecreation,fullstop.

.

Anenterprisecantakeamultitude of

organizationalforms.

Howthevalueanenterprisecreatesissharedamongthepartiesatinterestisafunctionofhistoryandnegotiation.

“History”isshorthandforpoliticalarrangementsandresourceendowments– inotherwords,luck.Negotiationsareconductedinaccordancewithamixtureofwrittenandunwrittenrulesregardingprocessandentitlementthatwemightthinkofasavirtualconstitution.Everyconstitutionissubjecttoamendment.

“Stakeholders”isanothernameforpartiesatinterest.

Thetermcoversanyonewhoreceivessomeoftherevenueandotherbenefitsanenterprisegenerates,orsuffersfromcollateraldamagetheenterpriseinflicts– e.g.,bypolluting.

Shareholdersarestakeholders,ofcourse,butsoarecustomers, creditors, employees, executives, directors, suppliers, the government invariouscapacitiesandthecommunity.By

echoingtheword,“shareholders,”theword,“stakeholders,”quietlyassertsthatallthesepeoplehaveaformofownershiprights.

Freedomtopollute,sinceImentionedpollution,isasortofnegativeingredient.

Addingittothemiximposesacostonthecommunity.Itmayalsoincreasetheprofitshareholdersenjoy– forexamplebecausetheyarefreenottotreattheirwastewaterbeforereleasingitintotheriver.

Every kind of freedom can be viewed as an ownership right.Somefreedomsturnouttobevalue-enhancingandsomedonot.

Bankshavealotofstakeholdersandtheymakealotofnoise.Idon’tknowwhetherthatshouldberegardedaspartofthebusinessmodel,butitisdefinitelyanimportantfactaboutbanks.Itisoneofthethingsthatmakesbankinghard.

How Business Explains Itself

ThetraditionalapologiabeginswithAdamSmith’s“invisiblehand”– thenotionthathonestpursuitofself-interesttakesaneconomytoanequilibriumstatethatmaximizestotalwelfare.

Thisisactuallyonlytrueforagiveninitialallocationofresources.Grosslyunequaldistributionsofwealthmeanlesstotalwelfare,andtheremedyismorelikelytobesoughtinpoliticsthaninclassicaleconomics– aswehavelatelyseen.Butnevermind.Competitionistheheroofthestoryandbusinesspeopleloveretellingit.

Believingineconomicsandacquaintedwithcorporatelaw,directorsofpubliccompanieswilloftentellyou– orsomewill– that their job is maximizing shareholder wealth,with

broaderoutcomesbeingthemarket’saffair.

TheymayevenassertthatthePURPOSE ofthecompanyonwhoseboardtheyserveis“tomakeaprofit.“

This wins business little support.

Self-interestmaybeconstructivefromamacro-economicperspective,asAdamSmithtellsus,butit’sunattractiveatapersonallevel.Arobustdefenseofprofit-seekingremindspeopleofhowhandsomelycorporateleadersarepaid.Morefundamentally,thisisthewrongwaytothinkaboutprofit.Anditdoesn’tdescribewhatcompaniesactuallydo.

I’ll start with profit.

Oneoftheingredientsanenterpriserequiresinordertodelivergoodsandservicesistheuseovertimeofacertainamountoffinancialcapital.Suppliersofcapitalmustbeadequatelycompensated– asmustemployeesandexecutivesassuppliersoftheirtimeandtalent– ortheywillnotparticipateintheproject.Profithastocoverthecostofemployingthatcapital,whichmaybethoughtofasinvisiblerent.

Ifprofitconsistentlyexceedsthatrent,thevalueofowningtheenterprise– i.e.,theshareprice– willgoup.Ifwhatbusinesspeoplemeanwhentheysaythattheirpurposeistomaximizeshareholderwealthisthattheirroleistomarshalingredientssoastoachievethatresult,Ihavenoargument.

Butthatwayofputtingitcanalienatetheirfellowcitizens,anditgivesthewrongmessagetodirectors,executivesandimpressionableadolescents.AsthemanagementguruPeterDruckerputityearsago,profit is a means, not an end.Theendtofocuson,andtalkabout,isvalue

creation.

Regardingwhatcompaniesandtheboardsthatguidethemactuallydo– asopposed,thatis,tosingle-mindedlychasingprofits– letmedrawapictureofrealityasIseeit.

Manycommunitiespasslawstolimitpollution.Alogical corollary totheassertionthataboard’sonly responsibilityismaximizingshareholdervaluewouldbeanobligationtoopposeorlegallycircumventthoselaws.Theoddacademicorjournalisticprovocateurmayarguethatsuchanobligationexists,butpractical business executives donot.

Justforstarters,theyknowthatpublicoppositioncouldentailbrand damage,andthatevenquietfoot-draggingwouldmeansignificantlegalexpensesandthepossibilityoffines.

Dependingonwhatdamagetheeffluentdoesorisallegedtodo,howmuchtreatingitisprojectedtocost,ahostoftechnicaldetailregardingthoseissues,howimportantacleanriverseemstobetothegeneralpopulation,ajudgmentabouthowaggressiveenvironmentalactivistsandrelevantgovernmentagencieswillbe,andtheirpersonalvalues,directorsmaysupport,attempttoclarify,improveorfrustratesuchlegislation.

Anyonewhohasbeenacompanydirectororservedonthegoverningcouncilofaschoolorcharityknowswhatthediscussionwillbelike.Boardsworkhardtogetahandleonthefacts,payattentiontocommunityexpectations,andtrytocomparecostsandbenefitssomeofwhichareimpossibletoquantify.Intheend,partofwhattheydoismake moral choices.Theycallthem“businessdecisions.”

Youcanbeacynicifyouwant,butdirectorswanttodotherightthing.Figuringoutwhattherightthingiscanbequitedifficult.

Shared value - AHarvardBusinessSchoolprofessorandamanagementconsultanthavepublishedacoupleofarticlespromotingastrategytheycall“sharedvalue,”whichmakesdoingtherightthingsomewhateasier.

Theirideaisthatcorporationsshouldpursueinitiativesthatbenefitthecommunitiestheyoperatein– withoutworryingtoomuchaboutimmediate returnstotheirshareholders.

Examplesincludefacilitatingtheemergenceofacluster of associated local businesses,orreducingtheamountofenergy-consumingtransportationandpackagingintheirsupplychain.Conceivingtheseasbusiness initiativesratherthancharityisthefirststepinmakingtheflowofbenefitssustainable.

PorterandKramerseethisasanewformofcapitalism.Ifitis,I think I like it.

Anumberofmajorcompanies haveembracedtheconcept.Agroupofacademicshaveattackedit.Thereisa“SharedValueProject”inseveralcountries,includingAustralia.Thequestionofpurposeisoccupyingsomeverygoodminds.

Tobeclear,mypointisnotthatdirectorsoughttoconsidertheinterestsofallstakeholders,butthattheyalready do.

Ipersonallybelievethatcompanies have obligations to stakeholders other than shareholders.Ibelievebankshave

obligationsthatgobeyondthoseofordinarycompanies.Reasonablepeoplecandebatethosepropositions.Boardsbehaveasiftheyaretrue.That’sthewaythesystemworks.

The righthome

Somepeople,observingthatbanksgrantoptionstotherestoftheeconomy,concludethatabsorbingriskisbanking’spurpose.That’sadangerousview.Banks accept risk in order to provide the services they do,buttheyshouldnotseekriskthewaygeneral

insurancecompaniesdo.

Theyshouldstrivetominimizetheriskstheyhavetotake.Iregardthatasfundamentalbankerwisdom.

Iknowthatsomepeoplebelieveabankcantakeanyriskitwants,solongasthepriceisappropriate.Withinthenormalrangeofloantransactions,yes,alittlemoreriskandalittlemoreinterestgohandinhand.Butadequatecompensationforalotmoreriskrequiresabigdiscountfrompar.

Making– ormorelikely,buying– averyriskyloanisaformofequityinvesting. Different skills are required.Averydifferentbalancesheetisrequired.

Untilsuchtimeastheborrowerrepays,youcanhavebigargumentsaboutvaluationwithyouraccountantsandregulators,whichisdifficultforbanks.Youaretalkingabouta

differentbusinessmodel.Youwanttobeahedgefund.

Enterprise needs the right home.Theremustbeacongenialorganizationororganizationalconstructforvaluecreationtohappenin.Itsconstitutionshouldbeconsistentwiththecharacteroftheenterprise.Therighthomeisoftenacorporation,butthatisn’ttheonlypossibility.

Formuchofthe19th Century,mostEnglishbanksweresmallpartnerships,whichmadebankerscautiousbyincreasingtheirpersonalrisk.Thisworkedwhentheirbusinesswasseasonallendingagainstinventoryandreceivables– andentirelydomestic.Itdidn’tworkaswellforinternationalbusiness,whichiswhyoverseasbanksandtradingenterpriseswereamongthefirsttobegiventheprivilegeofincorporation.

Othervenuesinwhichvaluecanbecreatedinclude(withoutlimitation)ajointventure,acharitablefoundation,agovernmentagency,auniversity,apoliticalpartyandameeting.Notallofthesearebusinesses,orevenorganizations.That’swhyIusetheawkwardphrase,“organizationalconstruct.”

Acorporationhasdistinctadvantagesasahomeforenterprise,startingwiththefactthatweknowhowitworks.Ithasaconstitutionthatiswritten.Well,mostlywritten.Ithastransferableandthereforepermanentcapital,limitedliabilityfortheowners,andarelativelycleardecision-makingprocess.

Largepubliccorporationsalsohavelimitations.Quotedsharesmakefocuson current shareholderwealthinevitable– whichcangivecompaniesashort-termbiasthatputsmanyvaluecreationopportunitiesoutofreach.Transferablesharesmakeiteasyforinstitutionalownerstoselliftheysenseproblems,ratherthanstickingaroundandexercisingstewardship.

Otherorganizationalformshavetheirownstrengthsandweaknesses.Membersofaprivatepartnershipworrymoreaboutpersonalriskandreputationthanshareholdersofpubliccompaniesdo.Illiquidpartnershipinterestspromotelong-termthinking,whichinprincipleoughttobevalue-enhancing.

Ontheotherhand,themutualtrustandoversightapartnershiprequiresaredifficulttosustainaboveacertainsize,andtheentitylacksfinancialflexibility.Itsdividendpolicyisthepartners’retirementschedule.Itsconstitutionisaformofmusicalchairs.Thepartnersleadingasuccessfulfirmwillalwaysbeinapositiontoenrichthemselvesbygoingpublic– indoingsodisappointingtheexpectationsofyoungerpartnersandaspiringassociates.Thiscanmakesuchafirmunstable.Individualsmanagingsuccessfulprivatepartnershipsaddressthisissuebydescribingthemselvesas“custodiansofthefranchise.”

Institutionsthatpoolanddeployacommunity’sresourcesaresometimesseentodobetterwithout shareholders.Manysavingsinstitutionsandlifeinsurancecompaniesusedtobemutualentities.Withnoshareholderstochallengethechiefexecutive,however,sometookegregiousrisks.

Othersbecamehopelesslybureaucratic.Amanwhoknewtheinstitutionwelloncetoldmethatthethen-mutualMetropolitanLifeInsuranceCompanywas“owned”byitsownlawdepartment.MostmutualorganizationsintheU.S.andU.K.havebeenconvertedtonormalcorporations.

Learningfrom China

ThecorporationsactsofAnglo-Saxoncountriesareprettystrictaboutownershiprights.Theworldisnot.Thatbeingthecase,lookingatthingsexclusivelythroughaWesternlegallensdistortsreality.IlearnedthatlessontwentyyearsagoinChina,whereIhelpedestablishthecountry’sfirstinvestmentbankingfirm,ChinaInternationalCapitalCorporation(“CICC”).

IassumedbeforeIarrivedinBeijingthatmuchofCICC’sworkwouldberestructuringstate-ownedenterprises(“SOEs”).

SowhenIhaddinnerwithaviceministerofplanning,Iaskedhimwhatthehardestpartofrestructuringwas.Heansweredimmediately:“Findingtheowner.”HewentontoexplainthatownershipmeantinfluenceonoperationsandaccesstosomeofthevalueanSOEgenerated.Thatdidn’thavetoinvolvecommonshares.Intheabstract,andasagoodCommunist,heregarded“thepeople”astheowners.Buthehadtoidentifytheonestotalkto.

Commonsharesdohavetheiruses.CICC’smainworkturnedouttobetakingSOEspublic,whichcreatedownersintheconventionalsense,andgaveeveryoneaninterestinfacilitatingthechangesthatmadeaninitialpublicoffering(“IPO”)possible.SOEshadtobe“corporatized.”PrivilegesenjoyedbyindividualsandcommunitiesassociatedwiththeSOEhadtobecoveredbycontracts.

Newshareshadtobesold,sotherestructuredSOEhadtobeprofitable.Itwasassumedthepricewould“pop”upwardthedayofthelaunch,sothenewshareshadtobeallocated.Allthisinvolvedpoliticaldecisions,whichforeignbankerscouldnotadviseon.Butwatchingtheprocessgavemeanewunderstandingofanenterpriseasanarenainwhichstakeholderscontend,andanappreciationofthedifficultyandimportanceofabalancedresponsetotheirclaimsonvalue.

Iexpectarangeofreactionstotheaccountofownershipinthelastfewparagraphs.Agenerationafterthebirthof“capitalismwithChinesecharacteristics,”afewreadersmaystillbeoutragedbycommunism.Otherswilllaughandpointtomystoryasevidencethat“eventheCommunists”seethemeritsofunambiguousownership.Mostwillinsistthatdirectorsofcorporationshaveaclearandsimpledutyandcannotstartrewritingthelaw.

Alltheseviewsareunderstandable.Notallofthemarevalid.Full-onsocialismhasbeenafailuremostplacesitwastried,andI’mnotendorsingit.Privatepropertyisthehookintheceilingthatthetinklingchandelierofenterprisehangsfrom– withself-interestintheroleofgravity– butmutualityexistsinmanyforms.Anddirectorsdonothavesimplejobs.

Competingmetaphors

Thelawtreatscorporations(includingbanks)as sentient beings empowered to pursue their own self-interest providedtheyobeywhateverrulessocietyhasmadeforthem.

Theirself-interestisidenticalwithshareholders’interest.Whatinterestsshareholdersisprimarilydividendsandpriceappreciation.Thearenainwhichcorporationsseekprofitis“themarketplace.”Good outcomes are the product of competitionamongcorporations,asperAdamSmith.Itisnotthatcomplicated.

Exceptthatitis.Youcanalsoregardacorporation,andespeciallya bank, as a parliament of stakeholders,aninternalmarketplace,aclearinghouseforstakeholderinterests.Employeeswanthighersalaries;shareholderswanttocontrolcosts.

Politicianswanttheeasycredittheybelievewillrevivetheeconomyandgetthemre-elected;prudentialsupervisorsarerisk-averse.

Environmentalactivistswantbanks tostopfinancingcoalcompanies;managementwantstorespectlong-standingrelationships.Abankchiefexecutivetriestodeliverforshareholdersbutencountersastreamofdistractions.Eventuallyhecomestounderstandthatcopingwith“distractions”ispartofhisjob.Heisanswerabletoeveryone.Theoutcomehemustdeliverisbalance.

Marketsandintelligentmarketparticipantsaregoodatfindingthepointofbalanceinacomplexsituation– anactivityeconomistscall“price discovery,”politicianscall“consensus-building”andinvestmentbankerscall“deal-making.”

Boardsperformasimilarfunction.Theyrepresentshareholders,tobesure,andfavorthemwhentheycan,butinsidetheboardroom,directorsarearbitratorsasmuchasadvocates.Smartboardstrytounderstandthemoralforceofstakeholderclaimsandanticipateshiftsincommunityexpectations.

Implicitintheuncomplicated,sentient-beingviewofcorporateentitiesisanassumption thatthepricesofmostingredientsaresetby“themarket.”Thechallengeistocombinethemefficientlyandmarkettheresultingproductsskillfully.

Competitionisexternal.Banksarecross-subsidymachines,however,sothereisalsointernalcontentionamongstakeholderswhowantoutcomesforwhichthereisnomarket.Adirectorofabankcanseeherselfasazoo-keeperwhocaresforthesentientbeingorasspeakeroftheparliament.Ithinksheisboth.

“License to operate”isacurrentlypopularnameforthemixtureoflegalauthorizationandpublictrustbanksmustmaintaintobeinbusiness.(Allmajorpubliccompaniesneedsomeformofsuchalicense.)

Abank’slicensecomeswithfiduciaryobligationstoshareholdersasagroup,butalsotounsophisticatedretailcustomerswhobuyproductstheywillneverfullyunderstand,andtothecommunityatlarge,whichwantsfinancialstability.“Maximizingshareholderwealth”isatbestapartialjobdescription.

Thelicensealreadyrequiresabankchiefexecutive,asprimeministerofhis/herenterprise,tosubmittoquestiontimeonaregularbasis.Theevolutionarypathbanksareonwillmaketheparliament-of-stakeholdersmetaphorincreasinglyappropriate.

Historically,bankshavepresentedthemselves,andthoughtaboutthemselves,assafelysituatedbehindthickwalls.Morerecently,theirboundaries have grown porous.

Examplesofthisphenomenonincludethemigrationofdatatothecloudjustasthevalueofdataisbeingrecognized;thepropensityofyoungpeopletovieweveryjobasagig,givingbanksaworkforceofstrangers;andthegrowthofcyber-terrorism,whichmakessharedinterestinprotectingfinancialinfrastructureoutweighcompetitiveinstincts.

Ifyoucarrythesetrendstotheirlogicalconclusions,thedistinctionbetween“internal”and“external”becomesquitefuzzy.Mutualitygrows.Everyoneiseveryoneelse’stakeholder.Ambitiousbusinesspeoplemayobjecttothis“vegetariancapitalism,”asitmightbecalled,butforthevulnerable,politicalcreaturesthatbankshavealwaysbeen,“servingstakeholders”istherightmotto.

HoldthosethoughtswhileIdescribeanenterprisethatwasn’tanorganization,andintroduce(ifyouhaven’theardofit)theconceptofamixedgame.Asithappens,thisstorycomesfromtheworldofbankregulation,butthere’snomessageinthat.

A Game of Breakfast

WhenanAmericanbankexhaustsitscapital,itissupposedtobeclosedbyitsprudentialsupervisor– theOfficeoftheComptrolleroftheCurrency(“OCC”)ifit‘sanationalbank,otherwisebythestatebankingcommissionthatcharteredit.Whenabankisclosed,theFederalDepositInsuranceCorporation(“FDIC”)automaticallybecomesthereceiver.From1991to1994,IranthedivisionofresolutionsattheFDIC.

Ourjobwastopersuadeanotherbanktoassumethedepositsofafailingbankandtopurchaseasmanyofitsassetsaspossible.Ittooksixweeksto

arrangeeven the simplest resolution,andfourorfivemonthsincomplexcases.

Ifthebankinquestionwasstate-chartered,theFedoftengotinvolved,andif,assometimeshappened,abankexperiencedliquiditypressureasitwaitedtobeputoutofitsmisery,theFedalonecouldprovidesupport.

Anyonewhohaseverworkedinabureaucracyknowsthatoverlappingpowersandinterconnectedresponsibilitiesofthissortcanresultinfrictionandturfwars.Thatsimplywasn’tacceptablein1991and1992.Fourorfivebankswerefailingeveryweek.Abungledtransactionhadthepotentialtostartacascadeofbankruns.Preventingpaniccreatedvalueforthewholecountry– nottomentionpreservingregulatoryreputations.

Thesolution,inventedbymypredecessor,was a weekly breakfast,attendedbytwo

orthreeseniorcivilservantsfromeachagency.MostbanksareclosedonFridayafternoons,sothebreakfastwasonFridaymorningtopermitlast-minuteupdates.

TheOCCwasalwaysthehost– Ineverfoundoutwhy– buttheyneverclaimeditwas“their”meeting.The“constitution”wasentirelyunwrittenandtherewereonlytworules:nosurprisesandnofeuds.Youwereexpectedtotellyourcolleagueswhatyouwereplanning,andmentionanylurkingpolicyissues.Andifyouwereangryaboutsomethingthathadhappenedduringtheweek,youhadtoputitonthetableFriday.

Youmightnotcallthatweeklybreakfastanenterprise.Officially,itdidn’tevenexist.Notexistingwascrucialtoitssuccess.Butitprovidedahomeforthevaluecreationofsmoothresolutions,anenterpriseinwhicheachoftheattendeeshadastake.Ithelpedtomaketheresolutionprocessa“cooperationgame,”inwhichnoneofthethreefederalagenciessoughttolookbetterthantheircousins.

Theoppositeofacooperationgameisthe“zero-sum game,” in which every gain is a loss toanotherplayer.Inbetweenare“mixedgames,”the

objectofwhichistoagreeonadivisionofvaluewithoutdestroyingtoomuchofitnegotiating.

Lengthy negotiations erode value because they distract management from productive activities.

Morefundamentally,gettingtheotherplayersinamixedgametoagreetoaparticulardivisionofwhateverprizeyouarefightingoverrequiresyoutoconvincethemofyoursincerity inmakinga“final”offeror“drawingalineinthesand.”Todothat,youmustdemonstrateawillingnesstosustainlossesiftheofferisrejectedorthelineiscrossed.Anexamplewouldbeacompanythatabruptlycutspricesandincreasesitsadvertisingspendtoprovetoaninterloperthatitwilldefenditsmarketshare“atallcosts.”

Competitionwiththeothercompaniesinamarketcanbeazero-sumgameandbegoodfortheeconomy.Competitionlawputslimitsoncooperation.Ontheotherhand,stakeholdersofthesameenterprise“ought”tobeplayingacooperationgame.Lifeteachesusnottoexpectthat.Mostlyweplaymixedgames.

Inbetweenalargepubliccorporationandaweeklyget-together,thereisawiderangeoforganizationalformsandconstructs.Theconceptofamixedgamehelpsusunderstandmanyofthem.

Out-sourcingisagoodexample.Bankshavedonealotofit– andsomearebeginningtowishtheyhadn’t.Thevendorhasaninterestinminimizingthecostoffulfillinghiscontractualobligations.Thepurchaserofserviceswillhaveputservicestandardsintothecontract,andwillholdthevendortothem.

Butif,astheyearspass,thevendorfindshecannotmakeaprofitwithoutcuttingcorners,heislikelytoconcludethatcuttingcornersis“fair.”Maintenancewillgetdeferred.Staffqualitywilldecline.Evenwithcontractualinspectionrightsandremediationmechanisms,thepurchaserislikelytosuffer.Theagreementbetweenthepartieswillhavetoberestructured.Signinganout-sourcingcontractamountstocreatingajointventure.Ajointventureisanagreementtoplayamixedgameforanindefiniteperiod.

Worthy Causes and Complex Risk Decisions

Amongthestakeholdersboardsmustrespondtotodayareadvocates ofvariouscauses.

Theymaybeshareholderswhocaremoreaboutsomeaspectofcorporateconduct– thecompany’scarbonfootprint,forexample– thantheydoaboutthedividend.Theymaybecommunityleaderswhowanttoseetheirtribeorgenderbetterrepresentedinseniormanagement.

Manyexecutivesandnon-executivedirectorsbelievestronglythatburdeningcorporationswithsocialobjectivesisinappropriate,nomatterhowworthythoseobjectivesmightbe.Itwillmaketheenterpriseinefficient,theyargue.Doingmorethanthelawrequiresmaysoundvirtuousbutitisnotwhattheothershareholderssignedupfor.Andtobehonest,moderatingclimatechangeisnotourcorecompetence.

Otherscontendthatlargepubliccorporationsareamongsociety’smostimportantinstitutions.Theirlicensetooperatecreatesanobligationtohelpsolvesociety’sproblems.Thereisnoreasontheyshouldn’tbeconscripted,justasindividuals

areintimeofwar.Globalwarmingisanexistentialcrisis,afterall.

Therearetwoargumentsgoingonhere.Onehastodowithcapability,theotherwithduty.Theanswertothefirstiseasy.

Tothosewhoseethestatement,“Weserveshareholders,”asanadequate descriptionofwhatboardsdoandarecapableof,myfirst

responseistoask,“Which shareholders?” Thechoiceofacorporatestrategyisalsoadecisionaboutriskappetite,andappetitesvary.

Someshareholderswantreliabledividends.Somewantgrowthandpriceappreciation,evenatthecostofincreasedvolatility.Shareholdersmayalsobesortedintogroupsbyreferencetotheirtimehorizonsandtaxpositions.Somewantaquickprofit.Thosewhowouldfacesignificantcapitalgainstaxesiftheysoldwanttocollectdividendsforever.

Ifboardscanmakechoicesaboutwhichshareholderstosatisfyandwhichtodisappoint,banksclearlyhavethecapacitytoallocatevalueamongstakeholdergroups.Theydoitallthetime,infact.

Whenacentralbanklowersitsbenchmarkinterestrate,bankshavetodecidehowmuchbenefittoconferonborrowersbydroppingloanrates,howmuchtoclawbackfromdepositorsbyloweringdepositrates– andwhetherintheprocesstowidenthespread,whichwouldbenefitshareholders.Thesearequestionsofstrategybutalsoofpolitics.

Orconsidertheprocessofrecruitinganewchiefexecutive.

There’sanegotiationaboutherpay.Andthere’samarketfortalentthatcanbecitedtojustifytheoutcome.Headhunterswillgiveyoucompensationfiguresdisclosedbyothercompanies.

Butthereisanallocationdecisionburiedinthisprocess.Theboardhastodecidewhatmanagerialskillsandrecordofpastsuccessthenextchiefexecutivehastohave,whatpartofthemarketfortalentthatmeansthecompanyisin,whatshareofthevaluethecompanycreatesinthenextfewyearswillgotothechiefexecutiveascompensationratherthantotheshareholdersasprofit.

Whenevercurrentvalueisallocatedawayfromshareholders,whethertocustomersorexecutivesorenvironmentalprotection,thedecisionislikelytobedescribedasbeing“intheshareholders’long-runbestinterest”orasrepresenting“enlightenedself-interest.”

Atbestthesearestatementsofintent.Thefutureisprofoundlyuncertain.Long-runbestinterestisharder to calculate thanwepretend.Judgmentisrequired.

Well-constructedboardsaregoodatmakingdecisionsthatcallforjudgment.Onemightalmostsaythat’swhatthey’refor.These“complexriskdecisions,”togivethemaname,involveapples-and-orangessituationswherefinancialorlegalanalysesarenotsufficient.Science,ethics,reputation,brand,staffmorale,politicalreactionandchangingindustrystructuremayalsobeconsiderations.

Definingacompany’sstrategyisacomplexriskdecision.Choosingorfiringachiefexecutiveisacomplexriskdecision.Thequestionsadvocatesofcausesraisearesimilar.

Theyneedtobeconsideredfrommultipleperspectives.Onadistribution-neutralbasis,whatvaluecanbecreated– forthebankanditscommunity?Whatorganizationalarrangementsarelikelytomaximizethatvalue?Howcantheallocationofburdenandrewardbesquaredwithrelevantstakeholders?Whatisfair?

Thebestboardslistentoexpertsifsuchexist,butknowtheycan’tout-sourceresponsibilityforimportantchoices.Theybringtothesedecisionsdiversityofexperienceoutsidetheboardroom,themutualrespectthatcomesfromwrestlingwithdifficultquestionsinsidetheboardroom,abitofdistancefromtheproblemandwithluck,collectivewisdom.That’smyanswerregardingcapability.

Butshould boardsengageinthesedebates?Mypersonalviewisacautious“yes.”Toreinforceanearlier

observation,largepubliccorporationsarethemostimportantinstitutionsinmodernsociety.Theirlicensetooperatemakesthemapublicresource.

Ifthereissignificantinterestinanissue,boardsmightchoosetoinvestigateit,commissioningmanagementandoutsideexpertstohelpasnecessary.Ifdirectorshaveconviction,theymightspeakout,andencouragetheirpeerstojointheconversation.

Iacceptthattherecouldbecoststospeakingout.Aboardshouldprobablyrationtheoccasionsonwhichitdoesso.Butthisisarolelargepubliccompaniesareunderincreasingpressuretoplay.Therewillprobablybecoststoshirking.

Summary

Everyenterpriseisajointventureamongitsstakeholders.Theycometogethertocreatevaluebutfightoveritsdistribution.Theyaresimultaneouslyalliesandopponents.The work of a board involves satisfying, and by definition therefore disappointing,all

stakeholderstosomedegree.It’spoliticalwork.Wemightcallit“honoring”claims.

Honoring begins with listening.

Acompany– oranindustry,orbusinessingeneral–mustconvinceeveryclassofstakeholderthatitunderstandstheirfrustrations,thatitknowswhattheywantandknowswhythey’reangry.Thismaysoundambitious,butitismoreachievablethanconvincingpeopleofyourvirtue.

Ifitcanfindtherightvoice,businessmightspeakpubliclyabouttheethicaldilemmasitwrestleswith.Manybusinesspeoplewillrecoilfromthissuggestion,fearingtheywilllosecontroloftheconversation.Butwhosayswehavecontrol?

I’llendwithsomethingquirkyandhopefullythereforememorable.Ireadanarticlenearlyfortyyearsago– I’vesavediteversince– thatdescribesa(presumablyimaginary)gamecalled“Chinesebaseball.”ItdiffersfromtheAmericanversioninonlyonerespect.Whenevertheballisinplay,anyplayermaymovethebases.ThismakesChinesebaseballmorelikelifethanmostgamesare.

Theauthorcallsthegamean“art.”Herecommendsthatplayers,“Actfromaninstantaneousapprehensionofthetotality”–advicemakingthepointthatweallhavemorecapacitytoimagineandshapethefuturethanwesometimesadmit.

“We serve shareholders” is akin to “I was just following orders” – a dumbing down of the job, and an abdication of responsibility.

Banksareservantsofthewholecommunity.Thereisnoescapingtheattendantcomplexity.Butyoucanfindthepointofbalanceifyouwantto.Anditispossibletocultivategoodjudgment.Honoringthelegitimateclaimsofallstakeholdersiscommonsense. Itiswhatboardsdo.Itiswhattheyoughttodo.