Saturday, August 2, 2014

Incorporating Social Responsibilities: B Corporations

Since the 1970s, it has been standard to assume that corporations have only one responsibility—maximizing financial returns to shareholders.  This notion is so firmly imbedded in national discourse that it is assumed that this responsibility to investors is legally binding.  However, that may not be the case.

Lynn Stout argues that this interpretation is not based in law, but in what has become tradition.  In fact, the current tradition is quite different from what it was at the time corporations first became legal entities.  Stout’s arguments are presented in her short book The Shareholder Value Myth.  Her interpretation is discussed in The Legal Basis for Corporate Irresponsibility.

The most fundamental responsibility of a corporation is to obey the laws of the state in which it is formed and to obey the charter under which it is incorporated.  For reasons of flexibility, both laws and charters are kept vague.

Since the state agrees to allow the corporation to exist it is not too much of a stretch to assume that the state viewed the corporation as being of value to the state; and that a sort of partnership exists in which the state provides legal and physical protection for the corporation in return for some social benefit.  In this view, the state joins employees, creditors, and shareholders as stakeholders.

Stout provides a short history of how attitudes toward corporate responsibility have varied over the years.  She describes a long period in which the broader view of social responsibility described above contended with the more narrow interpretation giving dominance to shareholder value.  Surprisingly, she states that the former view was dominant until the 1970s.

She attributes the “rise of shareholder primacy” to a campaign by conservative economists who asserted that the proper role of a corporation should be based on economic principles.  Since economists tend to formulate economic principles that are consistent with their political views, their interpretation raised shareholders above all other stakeholders and recognized them as “owners” of the corporation.  Milton Friedman made the most effective public declaration on the matter when he claimed that the only social responsibility of a corporation was to increase its profits.

This assumption of shareholder supremacy is viewed as a source of a number of corporate governance issues.  The most serious involves the incentive to base decisions on short-term share price considerations rather than on the long-term health of the business.  Stout derived great pleasure from quoting Jack Welch, the respected former CEO of GE.

“Welch observed in a Financial Times interview about the 2008 financial crisis that ‘strictly speaking, shareholder value is the dumbest idea in the world’.”

The dumbness of the idea seems to have become more obvious as fewer traditional public corporations are being formed.  There is a preference shown for various types of partnerships and restricted shareholder models, presumably to avoid the pitfalls associated with shareholder supremacy.

Given this history, it is exciting to learn that the notion of corporations having a responsibility to society is making a comeback.  A number of states have created the option for companies to incorporate as Benefit corporations, or, more familiarly, as B corporations.  Wikipedia provides this description:

“A benefit corporation or B corporation is a corporate form available in certain US States, designed for for-profit entities that wish to consider society and the environment in addition to profit in their decision making process. Benefit corporations differ from traditional corporations in regards to their purpose, accountability and transparency. The purpose of a benefit corporation includes creating general public benefit, which is defined as a material positive impact on society and the environment. A benefit corporation’s directors operate the business with the same authority as in a traditional corporation, but where in a traditional corporation shareholders with proper standing judge the company's financial performance, here they judge qualitative performance based on the benefit corporation's stated goals. Shareholders in a benefit corporation determine if the benefit corporation has achieved a material positive impact. If a dispute occurs it is up to the courts to determine if the benefit corporation did achieve a material positive impact. Additionally, through the issuance of an annual benefit report to the public, consumers are provided information to determine if they agree or disagree with the benefit corporation’s methods of achieving a material positive impact on society and the environment.”

“The additional accountability provisions found in a benefit corporation require the director and officers to consider the impact of their decisions not only on shareholders but also on society and the environment. Benefit corporations also provide shareholders with a private right of action, called a benefit enforcement proceeding, that they can use to enforce the company’s mission when the business has failed to pursue or create general public benefit.”

A B corporation sets out to both make a profit and to perform some function of direct benefit to society.  Shareholder supremacy continues to reign, but the shareholders are now bound to insure that the company’s directors meet both fiscal and social responsibilities.  There even exists an organization that grades and ranks companies for their social contributions.  More can be learned here and here.

James Surowiecki discusses B corporations in an article in The New Yorker: Companies with Benefits.

“There are now more than a thousand B corps in the U.S., including Patagonia, Etsy, and Seventh Generation. And in the past four years twenty-seven states have passed laws allowing companies to incorporate themselves as ‘benefit corporations’….”

 Interestingly, he concludes that there are benefits to incorporating in this manner that go beyond the reward of having performed a beneficial service to society.  He uses the eyeglass-maker Warby Parker to illustrate his points.

“The company’s approach—selling stylish specs at affordable prices—seems obvious, but, in an industry where brand-name glasses cost two or three hundred dollars a pair, it counts as revolutionary. The company has a similarly unconventional approach to its corporate identity. Soon after starting Warby, the founders made it a ‘B corporation.’ B corporations are for-profit companies that pledge to achieve social goals as well as business ones….Warby’s production and distribution is carbon-neutral, and, for every pair of glasses it sells, it distributes another in the developing world, in partnership with a nonprofit called VisionSpring.”

What other benefits are obtained by a company like Warby Parker?

“Being a B corp also insulates a company against pressure from investors….Patagonia doesn’t need to worry about investors’ opposing its environmental work, because that work is simply part of the job. For similar reasons, benefit corporations are far less vulnerable to hostile takeovers. When Ben & Jerry’s was acquired by Unilever, in 2000, its founders didn’t want to sell, but they believed that fiduciary duty required them to. A benefit corporation would have had an easier time staying independent.”

“To a free-marketeer, a B corp is just a way to waste shareholder money on do-gooding whims. Yet Warby Parker has had no trouble raising money from investors. And Dave Gilboa, another Warby co-founder, told me that, at the operational level, having a social mission can offer distinct advantages. It’s an important way for a company to attract and retain talented employees. Survey data show that workers—especially young ones—want to work for socially conscious companies, and will take less compensation in exchange for a greater sense of purpose.”

Those who wish to provide a benefit to society can often deliver that benefit on a larger scale by operating in a for-profit mode than they could with a strictly non-profit approach.

Surowiecki reminds us that having profitable, socially conscious corporations is not exactly a revolutionary new concept.

“Yet the desire to balance profit and purpose is arguably a return to the model that many American companies once followed. Henry Ford declared that, instead of boosting dividends, he’d rather use the money to build better cars and pay better wages. And Johnson & Johnson’s credo, written in 1943, stated that the company’s ‘first responsibility’ was not to investors but to doctors, nurses, and patients.”

He finishes on this high note:

“The rise of B corps is a reminder that the idea that corporations should be only lean, mean, profit-maximizing machines isn’t dictated by the inherent nature of capitalism, let alone by human nature. As individuals, we try to make our work not just profitable but also meaningful. It may be time for more companies to do the same.”

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