governance – The Sense of Fairness blog

A merchant ship, carrying a mix of cargo on behalf of different business concerns, gets caught in a storm. It’s a bad one, and the ship, and all hands, are at risk. The captain must act. To save the crew, ship, and the bulk of its cargo, the captain orders that some cargo be thrown overboard. The ship becomes more manoeuvrable, and less low in the water, and it is saved. The storm passes, and it continues to its port, off-loading the remaining cargo at profit.

What happens to the merchant whose cargo was thrown into the waters to save the rest and the ship? Its loss has enabled the saving of the rest, and the profits that come from the (at least partially) successful voyage?

Since antiquity, the answer to this question has been the same, so it doesn’t matter if our ship is a Roman corbita, Portuguese carrack, Dutch fluyt, English tea clipper or a vessel today. The so-called ‘rule of general averages’ is applied, and the merchants that benefit from the success of the voyage need to share profits to make the cargo-loser whole. And by ‘whole’ that means the value of the goods at the destination, not on embarkation, i.e. giving the benefit of the successful voyage that their loss enabled.

The core of this rule is equity, or fairness: the voyage is a shared endeavour and the jeopardy is a shared one. Informally, it becomes a partnership where risks need to be shared fairly – though the sense of partnership is only triggered if the captain needs to take such a drastic decision. By granting the captain full discretion, the merchants allow him or her to take the decisions that give the voyage the best chance of overall success, and enable him or her to exercise professional judgement to deliver that result.

A fascinating academic article draws an analogy between this granting of discretion to someone who can exercise professional judgement over the success of an operation to the role of the board of directors and management of a company, and an analogy between the rule of general averages and the governance need to exercise judgement over how the fruits of business success are shared among the stakeholders who share in that endeavour. Called, perhaps inevitably, Captains of industry? Value allocation and the partnering eﬀect of managerial discretion, the article suggests that corporate law could benefit from more of a similar sense of equity (or fairness). Company directors have fiduciary duties to promote the success of the company (the English law formulation is acknowledged in most markets, and, as I explain in my forthcoming book, was a proper understanding of US law too). This implies a need to seek a fair balance of the interests of stakeholders, as that is what will promote long-term business success. The analogy comes largely in thinking through the equitable sharing of that success. The paper doesn’t argue that the general averages model should be adopted, but rather shows that it is a helpful reframing allowing us to see more clearly how modern corporations are often run. Essentially, it points out that modern management and boards often display a failure to be fair.

For the academics, the first benefit of the analogy is in thinking about any particular sacrifices that stakeholders may make which operate to the benefit of the company. This, they suggest, might give rise to a similar sense of quasi-partnership that the captain’s cargo sacrifice triggers in general averages. The example given is staff undertaking specialist training that is relevant only to that particular business, but it is also relevant to consider any time that workers spend that exceeds the expectations of their job description. Certainly, workers who do work beyond their contract (which is many) tend to feel that they have some right to better reward or treatment over time as a result of such actions. As the academics say: “the rule of general averages makes us realize that some stakeholders can be affected by decisions taken for collective purposes, without being considered as general averages. It thus questions whether these impacts are treated in a fair way.”

The core of the argument is that at least some stakeholders should be seen as corporate partners in the business endeavour, and that their interests need to be fairly considered and balanced alongside shareholder interests in setting strategy and delivering operationally. Thus: “our analogy calls for a solidarity rule to share the impacts of managerial decisions on ‘partnered stakeholders.’ In practice, this rule would require ex ante that any strategy designed by corporate leaders must achieve a balance between employees and shareholders. Management should also be required to report on how they integrate fairness into their strategic thinking.” One specific example that the authors posit is that workers laid off to preserve the company through difficult times might be given a financial instrument that enabled them to participate in the upside should the company not only recover but prosper in the future.

That discussion reads (to this reader at least) as though the authors are going a little further than their own strictures about the limits to the value of the general averages analogy that they themselves set – but it is all the more thought-provoking as a result.

There may well be aspects of this work that we should jettison, but it does seem to me that the overall cargo offered by the article’s thinking could be valuable if safely brought to harbour. Its active consideration of fairness is clearly attractive for this blog, but also the emphasis on businesses as effectively partnerships between stakeholders – certainly when they are successful this is how the best companies feel – and the need for boards to find a fair balance between the interests of different stakeholders are all elements that chime with earlier posts and with a sensible understanding of where long-term business success lies.

Captains of industry? Value allocation and the partnering eﬀect of managerial discretion, Segrestin Blanche, Armand Hatchuel, Ken Starkey, 2020. Management & Organizational History, 15:4

Inequality is getting in the way of delivering value through corporate purpose statements. It’s an unusual form of inequality – inequality of inspiration, perhaps due to cynicism that arises from unfair treatment of the workforce.

The debate on the value of company purpose statements goes on. Fans of the approach believe it offers companies a route to providing a clear message to their investors and to their workforce about what the company stands for and is seeking to deliver, serving as a rallying point to shape their interactions. For those unpersuaded, corporate purpose looks like more of a fad, a set of at-best fine words that make no difference to how the company has always operated.

Such cynicism is perhaps encouraged by the poor quality of so many corporate purposes. One thing I am repeatedly struck by when reading the shortlisted annual reports of companies considered for the IR Society awards is that even at these companies with apparently exemplary reporting, several have weak or meaningless purposes. Many are so abstract as to be empty fluff while others are strikingly mundane or focus on financials. Few actually strike the right balance of providing a rallying point for shareholders and employees and assisting their decision-making, including notably assisting decisions about what the company, and individual employees, should not do. These are central elements of what an effective purpose should be.

Recent analysis suggests that this failure to inspire employees may mean corporate purpose fails to deliver on its potential.

The debates on purpose were opened up again at a conference late last year entitled Modern Capitalism and Corporate Purpose, hosted by Copenhagen Business School and organised alongside the ever-excellent European Corporate Governance Institute (ECGI). ECGI recently published a user-friendly summary ably written by my friend George Dallas. One of the key speakers at the conference was Claudine Gartenberg, assistant professor of management at the University of Pennsylvania’s much admired Wharton School. Dallas reports her being still more dismissive than I am about many existing corporate purpose statements, calling them both “twaddle” and “word salads of nothing”.

Gartenberg discussed the key results of a recent study into purpose at both public and private companies. This found that employees of public companies have a lower sense of purpose than those of private companies, and the difference is driven by more junior employees (ie middle managers, professional salaried staff and hourly workers rather than those at the executive level). And, as the chart shows, this situation of what she calls ‘purpose inequality’ is reflected in a rapid deterioration in the sense of purpose as you go down the seniority grades in these organisations:

In an earlier paper, Corporate Purpose and Financial Performance, Gartenberg showed that it is clarity of purpose in the middle ranks of an organisation that can lead to company outperformance. That has to make sense: clarity of purpose can assist with board decision-making (perhaps particularly about activities that the company as a whole should not be doing), but really the value of purpose lies in its providing inspirational rallying power for employees, and helping them in their day-to-day decision-making. Where corporate purpose statements fail to inspire employees they will not convince others and will be only so much ‘twaddle’.

The fact that the evidence on purpose inequality indicates that there is not just a step-change in faith in corporate purpose below the executive level, but a steady deterioration as the study considered more junior members of the workforce, is suggestive that in part staff consider their own treatment when thinking about the corporate purpose. A company that isn’t fair to its own workers isn’t likely to inspire them to believe that it is animated in all its actions by a higher purpose – meaning that it is much less likely to achieve its purposeful aims.

A similar finding in a different industry with different ownership structures strongly suggests that this finding of detrimental effects from limited faith among the broader workforce in purported purposes can be seen as potentially broadly generalisable. This evidence is from the legal profession, and comes from work by LexSolutions and the Law Firm Maturity Index. This shows a sharp disconnect between the faith in a law firm’s stated purpose as seen through the eyes of its leadership (partners, directors or board members) and of its broader staff base (professional lawyers below partner level, generally referred to as associates) – and an apparent correlation between this and these individuals’ sense of wellbeing.

As their article on these findings indicates:

“This suggests a causal connection between the reality of a firm’s purpose and the health of its people…Low levels of wellbeing that arise from primarily pursuing a financial purpose may eventually lead to burnout or staff turnover.” [my emphasis]

Gartenberg’s evidence regarding the differences in employee attitudes in private companies in comparison with public ones (and ones with high levels of private equity ownership) is also telling. It suggests that generally employees are less persuaded that purpose is meaningful in the latter organisations, perhaps as they suspect that the profit motive will always be allowed to override all other considerations. Thomas Thune Andersen, chair of Denmark’s energy business Orsted, which has transitioned into renewables, who also spoke at the conference, tended to agree with this. He clearly felt that the support of the government as a majority shareholder had enabled Orsted to deliver on its purpose. Andersen was cynical about the short-termism of mainstream institutional investors.

If owners tend to be driven by things other than corporate purpose, and are not keen to encourage companies to establish purposes and be driven by them, then it is not surprising that the workforce will doubt the sincerity with which the company operates. Of course there are many investors that do have some confidence in the power of purpose and its value for long-term shareholders as well as stakeholders. But it seems that their voices are overwhelmed by a broader market of institutions that are less convinced – at least in the US, where Gartenberg’s work was carried out.

Purpose won’t deliver on its potential positive effects unless it is believed in by those within the company. But purpose inequality won’t be overcome by fiat, but persuasion, and demonstration in practice. In order to deliver, corporate purposes need not only to be better written and more meaningful statements of intent, but that intent needs to be followed through by boards and management in their treatment of staff, and also supported by investors in the business. Failures to deliver on either or both of these elements may serve to explain why there isn’t stronger evidence of the value of corporate purpose.

That redoubles the challenge for boards: live the purpose, demonstrably to your workforce, and reinforce it to your investors too. As I’ve suggested in previous blogs on this topic, there is an opportunity for companies through their actions to influence their shareholder base, discourage those shorter-term voices and encourage the longer-term institutions that will provide more reliable and consistent support. Boards should rise to that challenge, minimise purpose inequality and awaken the opportunities offered by meaningful corporate purposes.

Summary Report: Modern Capitalism & Corporate Purpose, ECGI, December 2023

Corporate Purpose in Public and Private Firms, Claudine Gartenberg, George Serafeim, Management Science Vol 69 No 9, September 2023

Corporate Purpose and Financial Performance, Claudine Gartenberg, Andrea Prat, George Serafeim, Organization Science Vol 30 No 1, January 2019

LexSolutions

Lessons from the Law Firm Maturity Index, Manu Kanwar, Stuart Woollard, Legal Business World, No 1, 2024

Tag: governance

Captains of industry

Operating on purpose – hampered by inequality