Chapter 1 Article Measures of success must go beyond financial results By Michael Skapinker Financial Times; Mar 02, 2005 My column

last week suggesting we search for alternatives to shareholder value led one reader to accuse me of inciting lawbreaking. Did I not know that, in the US at least, directors had a legal duty to put shareholder returns above all other claims? The 1919 case of Dodge v Ford Motor Co, the reader said, put the matter clearly. Rejecting Henry Ford's desire to favour customers and employees over investors, the Michigan Supreme Court said companies existed to serve shareholders' interests. Directors could use their discretion over how to achieve that end - but that "does not extend to a change in the end itself". But, as I wrote on Monday in our weekly FT Business School briefing, subsequent cases have softened Dodge's edges, allowing boards to give consideration to the rights of employees and even the community in certain circumstances. As William Allen, then chancellor of the Delaware Court of Chancery, said in a brilliant lecture to the Cardozo School of Law in 1992, the argument about the purpose of companies has been around for more than a century.* Underlying the debate, he said, were "two quite different and inconsistent ways to conceptualise the public corporation". Prof Allen, who now teaches at New York University's Stern School of Business, called these two ideas "the property conception" and the "social entity conception". The first saw the company's aim as being to advance the financial interests of the owners. The second viewed the company as having "a duty of loyalty, in some sense, to all those interested in or affected by the corporation". For most of the century, these two ideas managed to rub along. Courts, managers and commentators reconciled them by arguing that looking after employees and the community was good for shareholders in the long run.

Happy staff would provide better service, a contented community would furnish loyal customers - and profits would rise, along with the share price and dividend payments. This is the argument underlying the current case for corporate social responsibility. There are times, however, when the inherent conflict between these two concepts bursts into the open. Prof Allen noted that takeovers often pitted shareholders, who benefited by selling their shares at a premium, against employees who stood to lose their jobs. Today, the availability of cheap labour in Asia, allied with consumer insistence on low prices, has brought the two concepts of the company into conflict once more. While good for shareholders, offshoring is disastrous for many existing employees. Who should prevail - shareholders or staff? Some argue that employee commitment is more important to companies than shareholder investment. Modern shareholders are vast institutional funds with no loyalty to the company. In an article published this month in Learning & Education journal (which I discussed last week), the late Sumantra Ghoshal of London Business School made the case for putting staff first. "Most shareholders can sell their stocks far more easily than most employees can find another job. In every substantive sense, employees of a company carry more risks than do the shareholders. Also, their contributions of knowledge, skills and entrepreneurship are typically more important than the contributions of capital by shareholders, a pure commodity that is perhaps in excess supply," Ghoshal wrote. There is much to this, but there are three reasons why we should not dismiss shareholders so easily. First, many people's hopes for a comfortable retirement depend on those faceless institutional investors. The beneficiaries of the institutional shareholders are often employees too, either of that company or another one. Second, with the collapse of trade unions, institutional investors are the only force able to stand up to overpowerful management. This is particularly true when shareholders act through representative associations. Witness the Association of British Insurers and the

National Association of Pension Funds' success in limiting departing UK executives' pay-offs to one year's salary. Third, share-price performance is a fair guide to corporate success - eventually. Shareholders often follow the herd. They can go collectively mad, as during the dotcom silliness. But the market cannot fool itself forever. Judged over five or 10 or 50 years, a successful company's worth will be recognised by the stock markets. The problem with shareholder value as currently understood is its obsession with the present: this quarter, this year, this Christmas's sales. It is the pressure for immediate results that pushes companies into unwise acquisitions and dubious accounting. There is only one proper measure of corporate success: remaining competitive and profitable over many years, through recession, technological change and political upheaval. Few companies achieve it. Those that do are alert to every change in their environment and know how to get the best out of their people. This does not mean employees never lose their jobs; sometimes it has to happen. But that means companies manage the move to lower-cost countries carefully, ensure customer service is not compromised and maintain the morale of staff who see their colleagues leave. Ghoshal said a new view of companies' role must begin in the business schools. It needs to begin with all of us. We must broaden what we measure and look beyond immediate financial results to whatever it is that will make companies succeed or fail some time from now. Here is a snippet to start with. A survey carried out for Proudfoot Consulting and published last week found that while UK banks were making record profits, only 12 per cent of customers thought their banks understood their needs. That should tell us more about the banks' longterm prospects than any analyst's note. © Financial Times

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