This article first appeared in the Financial Post.
By Jerome Gessaroli, July 20, 2022
As society grapples with economic challenges, climate issues and divisive social justice matters, there is discussion in some quarters about whether corporations should continue their long-standing focus on simply maximizing shareholder wealth over a wider set of objectives.
The very word “corporate” evokes emotional reactions. Critics claim that prioritizing shareholder wealth requires short-term decision making that undermines other important longer-term investments. They also mistakenly believe shareholder priorities are met by sacrificing the needs of other groups with a stake in the company.
In recent years, some observers have begun calling for an alternative philosophy in corporate governance — one that rejects prioritizing profits.
Rather than simply benefiting shareholders who provide the risk capital, this perspective broadens the corporation’s purpose — to include not only wealth-focused shareholders in corporate decisions, but all constituencies with an interest or stake in the company, including employees, creditors, customers, government, the community, and the environment.
Advocates of this alternative approach say changes such as those implemented in 2019 to the Canadian Business Corporations Act — expanding which groups directors can consider when determining a corporation’s best interest — might be a good first step, but more must still be done.
However, attempts to prioritize a variety of interests on par with maximizing wealth will likely result in serious unforeseen consequences. This debate becomes even more relevant given the OECD’s forecast placing Canada last among 40 industrialized countries in per capita GDP growth. (GDP growth and wealth creation are closely related.) The debate may seem abstract, but its economic consequences are real.
Changing the governance framework of corporations carries very real dangers. Every day, companies make decisions that affect production costs, consumer prices, the returns investors receive, and whether capital is used productively. The secondary impacts are no less important, including affecting profits, which determine how much tax governments receive. Corporate purpose affects job creation, salaries, economic growth, and overall living standards. It is the basis for Adam Smith’s famous “invisible hand” concept of business benefitting society.
Importantly, despite what critics might say, there is certainly no conclusive evidence that corporations which prioritize shareholders and profit systematically suffer from short-term decisions. If a corporation’s purpose is to maximize its value, managers must make appropriate short-term and long-term decisions. Indeed, three-quarters of a company’s stock price is based on its expected financial performance (as measured by cash flow) five or more years in the future. So, if investors don’t believe a company is making suitable long-term decisions, its current stock price will suffer.
We also cannot disregard that competition and the voluntary nature of contracts force businesses to co-operate with various other stakeholders, even if the company’s goal is to maximize shareholder wealth. Suppliers must receive a sufficient return, or they’ll deal elsewhere. Employees must receive competitive wages, or they’ll find alternative employment. And customers won’t buy a company’s product unless it is priced competitively, is of sufficient quality, and provides useful benefits.
The pandemic revealed the importance that investors place in long-term thinking. For instance, Cineplex Inc. (movie theatres) and Carnival Corporation (cruise ships) were hit hard during the pandemic. Cineplex lost 80 per cent of its 2020 revenue, posting a loss of over $600 million. Despite these numbers, the company found investors willing to put $300 million of new capital into the firm. Carnival actually shut down in 2020, reporting $10 billion (U.S.) in losses, yet still sold $19 billion (U.S.) in new securities to investors. In each case, company and investors were thinking long-term to a post-COVID future when normal operations can resume.
Mountain resort operator Vail Resorts recently reported quarterly earnings and revenue that came in $50 million below forecast, yet its stock rose by over $7, or three per cent. If investors had reacted to the short-term earnings news, the stock would have fallen. Instead, when Vail announced a dividend increase, which is a positive signal about the company’s longer-term prospects, its stock price rose.
With concerns such as climate change, amending corporate purpose isn’t necessary to change behaviour. Governments need to ensure that costs for carbon or pollution are paid by the emitting businesses, so companies have incentives to make more green investments. Maximizing shareholder returns requires a corporation to consider environmental stakeholder interests.
The bottom line: There’s powerful evidence and history that corporations which prioritize shareholders and profits not only thrive, but contribute to the greater good. Replacing shareholder primacy will undermine market discipline that forces managers to act competitively and use corporate resources efficiently — the very elements that create wealth, GDP growth, and a flourishing society.
Jerome Gessaroli teaches in the School of Business at the British Columbia Institute of Technology and is a visiting fellow at the Macdonald-Laurier Institute.