Five levers of change to reform business for the 21st century
There are a range of possible tools and levers available to business leaders and governments to promote change. Here we consider five: ownership, corporate governance, regulation, taxation, and investment. But this list is not exhaustive; for example, incentives and measurement are frequently mentioned as critical determinants of behaviour. [1] However, the five levers lay the foundations for a more precise and detailed consideration of policy for the next phase of our research.
1. Ensuring owners play their part
Our research suggests that ownership is at the heart of the failure of the conventional framework to depict the public corporation correctly.[2] As mentioned above, it ascribes rights to shareholders equivalent to the property rights of owners. But shareholders are not necessarily owners and in many cases make no pretence to be so. In particular, the conventional view does not ascribe corporate purpose to shareholders beyond their own financial interests. In other words, it does not attribute a responsibility beyond the achievement of shareholder value.
In contrast ownership in the context of purposeful corporations is intimately associated with defining and delivering corporate purpose. It does not automatically attribute property rights to shareholders but recognises that different owners might be best suited to the achievement of different firms’ purposes. It points to the desirability of diversity of ownership. In some companies it might be associated with financial institutions, in others with families and foundations and in others with employees. In all cases someone should be responsible for the corporate purpose. The “best owner” is not necessarily the creator of the greatest shareholder value but the most enlightened and visionary deliverer of corporate purposes.[3]
Ownership in many countries has changed significantly since the 1950s.[4] There has been a shift from individual and retail ownership to institutional ownership; growing concentration of ownership in professional asset managers; declines in publicly listed companies; globalisation of finance; and a change from active to passive investment strategies by institutional investors. Each of these has had profound influences on the nature of corporate purposes. However, research will be needed to establish the precise form of that relation and public policy should recognise the importance of it.
2. Improving corporate governance frameworks
To date, corporate governance — the allocation of decision-making power and influence within the corporation — has been associated with aligning the interests of management with shareholders and promoting shareholder value. Our research suggests that it should instead be recognised as a key tool in delivering corporate purposes.
Achieving this will require significant changes to existing corporate governance arrangements. The new Corporate Governance Code in the UK has gone further in this direction than any previous attempt to date.[5] Principle B of the Code states that: “the board should establish the company’s purpose, values and strategy, and satisfy itself that these and its culture are aligned. All directors must act with integrity, lead by example and promote the desired culture.” Companies that do not comply with the provisions of the Code will be required to explain why they do not do so.
Other recent proposals go further than this in prescribing the types of governance arrangements companies should adopt. In the United States, Senator Elizabeth Warren has proposed an Accountable Capitalism Act setting out a co-determination approach to corporate governance.[6] It takes the view that the relentless maximisation of shareholder value is the root cause of many economic and governance problems. However, it also recognises the risk of co-determination degrading the economic performance of some companies, so only the largest are targeted by the proposed legislation. Similarly in the UK, the Labour Party is proposing a combination of employee ownership and employee board representation in larger companies.[7]
Whether change needs to be mandated, as suggested by Elizabeth Warren and the UK Labour Party proposals, or encouraged, as under the Corporate Governance Code, depends on the extent to which it is accompanied by supportive purposeful ownership as described in the previous section. Without owners who effectively promote purposeful governance and protect management from corporate raiders that equate purpose with profits, then governance codes on their own are unlikely to be adequate.
Failures of corporate governance in part result from the flawed composition of corporate boards.[8] Independent directors may be insufficiently informed and committed to serve as credible monitors of management’s strategy and operational performance, and the concept of board-monitoring may not be suited to corporations whose projects and business strategy are difficult for equity markets to evaluate. Addressing this requires the identification of new measures of corporate performance that extend beyond financial returns and relate to human, social and natural capital as well as financial capital.
Even if ownership and governance are aligned then companies cannot on their own insure their stakeholders against the systemic risks of technological changes and globalisation to which they are being increasingly subject.[9] This may require governments to bear some of the risks of, for example, the consequential reskilling needs of employees. We return to partnerships between public and private sectors below when we consider reframing investment around corporate purposes.
3. Making regulation work
Globalisation, digitalisation and rapid technological innovation have enabled unprecedented mobility for key corporate functions and assets, including intellectual property rights, administration centres, production and sales.[10] However, the analysis conducted for our research shows that the speed and reach of that capability is posing major questions for current models of regulation and taxation.[11]
How can regulators and lawmakers resist intellectual and regulatory capture through open lobbying and more subtle forms of influence? How can states maintain corporate tax revenues in the face of fiscal arbitrage and tax competition? How can regulators clamp down on profit-shifting and strategic transfer pricing? [12]
These questions fuel doubts about the trustworthiness, transparency and accountability of both corporations and governments. The lag between technological changes that result in disruptive business models, and the corresponding regulations and institutional changes that are needed to maintain public confidence has increased. [13] One way to address this is through ‘forward compliance’[14] — a dynamic response where corporations are expected to deliver conduct ‘consistent with anticipated regulatory requirements’, shifting supervisory onus from regulators to firms themselves.
As outlined in our research, many companies incorporate and promote social responsibility in their corporate purposes and at the very least appreciate the need to ‘do no harm’. There is a large array of codes of conduct, standards and guidelines available to support such objectives. However, alignment of corporate with public purposes needs to be made explicit in the case of corporations that perform social and public functions, such as utilities and corporations with significant market power. In these cases, regulation should require companies to incorporate their licences to operate in their charters and articles of association, thereby imposing fiduciary responsibilities on directors to uphold their public as well as private purposes.
4. Reforming corporate taxation
Globalisation has proven highly rewarding for an increasingly concentrated pool of corporate owners, but it has also alienated and displaced other interests.[15] It has raised incomes in low-income countries but concentrated wealth in high-income countries. In the UK and US, corporate tax rates declined from around 40% in 1980 to 25% by 2015.[16] Erosion of corporate tax has created opportunities for those with higher personal income tax rates to use corporations as vehicles for deferral of taxes.[17]
Corporate taxation is in need of urgent reform and several alternatives have been considered. One involves shifting both corporate and personal taxes from a focus on production to consumption; another is to move personal taxation to an accrual basis. There are limitations to both. A third approach is to consider how corporations can be encouraged to promote a more socially responsive agenda that includes a willingness to pay a “fair share” of taxes as part of their corporate purposes.[18]
5. Reframing investment around a corporation’s purposes
The relationship between socially responsible business practices and financial performance has been the active subject of research.[19] In early studies, results were mixed: socially responsible practices did not necessarily correlate with financial performance and in some cases detracted from it. More recent studies suggest that corporations that embed environmental, social and governance values perform better than other firms and are less prone to failure.
Private capital markets are often thought to suffer from short-termism in the allocation of financial resources for investment. The short payback periods that financial markets require of corporate investment constrain the projects that the private sector can support, necessitating the participation of the public sector in large-scale, long-term investments, such as infrastructure projects.
The relative merit of private and public sector ownership and investment has been lent particular significance by the success of the Chinese economy, and the poor record of investment by some privatised corporations in the west.[20] In some cases, this is raising the prospect of renationalisation of previously privatised entities and contracted out activities.
It is in precisely where private corporations deliver public services that corporate purposes should be aligned with public purposes. As described above, this can be achieved through incorporating licence to operate conditions in companies’ charters and articles of association, thereby imposing a fiduciary duty on directors of corporations to uphold their public as well as private purposes.
Together reform of ownership, governance, regulation, taxation and investment offer the prospect of establishing the purposes, trustworthiness and cultures that are needed of 21st century corporations.
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[1] Hsieh, N., Meyer, M., Rodin, D. and Van’t Klooster, J. (2018) The Social Purpose of Corporations: A Literature Review and Research Agenda. British Academy (FOTC Paper 2) and Gordon, J. (2018) Is Corporate Governance a First Order Cause of the Current Malaise? British Academy (FOTC Paper 6) and Buckley, Peter. (2018) Can Corporations contribute directly to society or only through regulated behaviour? British Academy (FOTC Paper 13)
[2] This section primarily references Villalonga, B. (2018) The Impact of Ownership on Building Sustainable and Responsible Business. British Academy (FOTC Paper 12). Any assertions or findings presented which are more specific are referenced separately.
[3] Villalonga, B. (2018) The Impact of Ownership on Building Sustainable and Responsible Business. British Academy (FOTC Paper 12)
[4] Gordon, J. (2018) Is Corporate Governance a First Order Cause of the Current Malaise? British Academy (FOTC Paper 6)
[5] Financial Reporting Council (2018), The UK Corporate Governance Code, July.
[6] See https://www.warren.senate.gov/imo/media/doc/Accountable%20Capitalism%20Act.pdf
[7] See speech by John McDonnall (24 September 2018), Shadow Chancellor, proposing an “Inclusive Ownership Fund”
[8] Gordon, J. (2018) Is Corporate Governance a First Order Cause of the Current Malaise? British Academy (FOTC Paper 6)
[9] Gordon, J. (2018) Is Corporate Governance a First Order Cause of the Current Malaise? British Academy (FOTC Paper 6)
[10] Birkinshaw, J. (2018) How is Technological Change Affecting the Nature of the Corporation? British Academy (FOTC Paper 8)
[11] This section primarily references Armour, J., Enriques, L., Ezrachi, A., Vella, A. (2018) Regulation and Law: The Role of Corporate, Competition and Tax Law. British Academy. (FOTC Paper 10). Any assertions or findings presented which are more specific are referenced separately.
[13] Birkinshaw, J. (2018) How is Technological Change Affecting the Nature of the Corporation? British Academy (FOTC Paper 8)
[14] Armour, J., Enriques, L., Ezrachi, A., Vella, A. (2018) Regulation and Law: The Role of Corporate, Competition and Tax Law. British Academy. (FOTC Paper 10)
[15] A number of papers within the programme comment on this general trend: Armour, J., Enriques, L., Ezrachi, A., Vella, A. (2018) Regulation and Law: The Role of Corporate, Competition and Tax Law. British Academy. (FOTC Paper 10), Gordon, J. (2018) Is Corporate Governance a First Order Cause of the Current Malaise? British Academy (FOTC Paper 6) and
[16] Desai, M., Dharmapala, D. (2018) Revisiting the Uneasy Case for Corporate Taxation in an Uneasy World. British Academy (FOTC Paper 9), based on World Revenue Longitudinal Dataset (WoRLD), available at: http://data.imf.org/revenues
[17] This section primarily references Desai, M., Dharmapala, D. (2018) Revisiting the Uneasy Case for Corporate Taxation in an Uneasy World. British Academy (FOTC Paper 9). Any assertions or findings presented which are more specific are referenced separately.
[18] Buckley, P. (2018) Can Corporations contribute directly to society or only through regulated behaviour? British Academy (FOTC Paper 13)
[19] Villalonga, B. (2018) The Impact of Ownership on Building Sustainable and Responsible Business. British Academy (FOTC Paper 12)
[20] Offer, A. (2018) Patient and impatient capital: time horizons as market boundaries. British Academy. (FOTC Paper 11)
