Rather than maximising profits through reducing any value distributed to other stakeholders, can companies take an approach that grows the overall value of the enterprise, for the gain of all? Elias Papaioannou, Professor of Economics at London Business School and Co-Academic Director of the Wheeler Institute for Business and Development was joined in conversation with Alex Edmans, Professor of Finance at London Business School and Academic Director of the Centre for Corporate Governance and author of ‘Grow the Pie: How Great Companies Deliver Both Purpose and Profit’ to discuss how corporate responsibility is fundamental to the success of a business.
- In order to increase value, firms should take responsible action that benefits all stakeholders, growing the overall ‘pie’ rather than focussing on returns to shareholders;
- An intrinsic desire to solve social problems can lead to solutions that can be monetised, or encourage employees to become more engaged, increasing the value of the organisation;
- Responsible firms have to go further than ‘doing no harm’, it is not enough to just pay a fair wage, reduce pollution and pay taxes, firms have to proactively remedy social problems;
- Measuring inequality through the disparity in CEO pay to the average worker is a pie-splitting mentality, CEOs should be rewarded for innovation, solving social problems and growing the firm;
- During the crisis firms should not take short-term measures to cut costs through reducing their workforce, they need to take an approach that shares the consequences of the downturn;
- Firms should also investigate how they can solve social problems during the pandemic by redeploying their expertise and innovating, which will ultimately help them to ‘grow their pie’.
Shareholders benefit when a company takes care of all stakeholders
According to Edmans, the traditional view of finance is that the value that a company creates is given by a fixed pie. The firm can distribute that value either to investors in the form of profits, or society, in the form of wages to workers, taxes to government or stewardship of the environment. In this case, the role of a business is considered to be profit maximisation, which is achieved by reducing the ‘slices’ of value given to everybody else. However, Edmans’ book suggests that if companies invest in society, through paying workers more than the minimum and investing in reducing your carbon footprint, profits to shareholders are not reduced; instead, this ‘grows the pie’, with the result that shareholders are better off. Edmans therefore believes that it is in a company’s interests to take responsibility seriously as it is fundamental to the success of a business.
There are long-run returns for investing across a company’s ecosystem
‘Grow the Pie’ argues that companies should make decisions based on an intrinsic desire to solve social problems, even if there’s not a clear route to profit. That is because, unexpectedly, those solutions and social problems might end up being monetized or leading to greater employee engagement which will be of benefit eventually, even if profits were not the primary motivation for those actions.
Edmans differentiates between Corporate Social Responsibility (CSR) and ‘growing the pie’. Paying fair wages, not polluting the environment and paying taxes are CSR activities that ‘do no harm’; ‘growing the pie’ goes further through actively doing good by solving social problems. He cites the example of Vodafone, who released a tax transparency report to show how much tax they were paying worldwide. This action is about CSR – not doing harm by avoiding taxes – rather than doing good. A more pie-growing action was Vodafone developing a mobile money service in Kenya which provided financial inclusion to hundreds of thousands of Kenyans, lifting 200,000 households out of poverty as a consequence. This venture did not seek to make profits but solved the issue of financial inclusion. Ultimately Vodafone was able to monetise their investment, so it ended up being profitable as well as serving society.
Fair pay means if the company is successful, the CEO gets rewarded
The public debate on inequality, according to Edmans, tends to focus on the wrong issues, such as the pay ratio between the CEO and an average worker. Edmans believes this analysis is framed through a ‘pie splitting’ mind-set: the CEO’s high pay is at the cost of all other employees. Instead, Edmans encourages us to ask whether high CEO pay is as a by-product of making the company more successful. Using Disney CEO Bob Iger as a reference, Edmans explains that his $66m in pay did not extract value from other employees; it was because since he joined the company the stock price had increased by 600% and he had created around 70,000 jobs. Edmans thinks CEOs should be judged on actively creating value through innovation and solving social problems, not the pay ratio.
Going above and beyond to treat your workers pays off with long term returns
How firms treat their workers is an important aspect for Edmans; while companies influence many stakeholders, such as the environment, suppliers and customers, workers are important because they are material to all firms – companies are human organisations. Edmans’ research shows that companies that treat their workers better, do better themselves. This becomes an even more essential principle during a crisis, such as during the COVID-19 pandemic. Companies that try and minimise losses to workers often do better in the long term. Edmans refers to the example set by the manufacturer Barry-Wehmiller during the last crisis. In order to save $10 million, they could have fired a proportion of the workforce. Instead, everyone in the organisation shared the load equally, taking unpaid leave. This meant everyone kept their job and the firm ended up saving $20 million, as well as taking the opportunity to retrain many of its staff so they were productive while not at work.
Firms should try and share the consequences of the downturn equally rather than singling out employees to cut costs
Edmans thinks that in the long run, firms that focus their thinking on how the consequences of the financial downturn can be shared throughout the company during the pandemic will be those that are successful. The burden cannot be left for all the workers at the bottom of the organisation. Not every company will be able to protect all of its workers as a result of COVID-19 – some will have to downsize – but they should focus on easing the burden on displaced workers as well as innovating to solve social problems. While the crisis is a massive negative shock, a silver lining that has emerged might lead to companies using their resources to innovate, such as all of the firms that have moved into making personal protective equipment or hand sanitizer alongside their core products.
Elias Papaioannou’s conversation with Alex Edmans is part of the Wheeler Institute’s COVID-19 series – bringing together the expertise and experience of our extended community to understand, illuminate and offer solutions to the challenges created by COVID-19. Our differentiating factor is the role of business in addressing these challenges, with a focus on the implications and actions for those in developing countries.
This is ‘part two’ of two conversations with Professor Edmans; for ‘part one’, focussing on how companies should use their comparative advantage to serve society, click here. If you’re interested in following the Wheeler Institute COVID-19 series, check out our previous episode below.
Elias Papaioannou is academic director of the Wheeler Institute for Business and Development and professor of economics at London Business School, focusing on international finance, political economy, applied econometrics and growth and development.
Alex Edmans is Professor of Finance at London Business School and Academic Director of the Centre for Corporate Governance. He has published in the American Economic Review, Journal of Finance, Journal of Financial Economics, Review of Financial Studies, and Journal of Economic Literature. He is Managing Editor of the Review of Finance, Associate Editor of the Journal of Financial Economics, a Research Fellow of the Centre for Economic Policy Research, and a Fellow of the European Corporate Governance Institute.