Embed purpose into business so that it flourishes for the benefit of all

Article published by CITY AM on 27 February 2017

Written by Alex Edmans

Featuring: The Purposeful Company details reform in six interlocking areas to support the government’s mission and three hallmarks of approach.

UK business is at a critical juncture. Low investment and low productivity have been compounded by perceptions that their fruits are unequally shared.

The government’s recent green papers on corporate governance and industrial strategy signal a serious intent to address these problems by revitalising the productivity of business, reorienting its focus onto the long run, and ensuring that it “works for everyone, not just the privileged few”.

The Purposeful Company, established in 2015 to embed purpose into business, today releases a policy report that details reform in six interlocking areas to support the government’s mission. There are three hallmarks of our approach.

First, it is collaborative. Our interim report, published last May, suggested 21 areas for reform. We engaged in extensive consultation with leading executives, investors, policy-makers, and stakeholder representatives on the feasibility, the intended and unintended consequences, and their support for these areas. This led to us refining and deepening our proposals, indeed rejecting or de-emphasising some, to end up with our final six.

Second, it is rigorous. We have combined deep practitioner insight with large-scale academic evidence, on what has been tried and tested across industries and countries and over time. There is a huge range in the quality of academic evidence and it is almost always possible to find a study that supports a particular viewpoint.

Thus, we focus on the highest-quality evidence, published in the most rigorous peer-reviewed journals, and in many cases distinguishing causation from correlation. A consistent conclusion is that purposeful companies deliver superior long-run returns to all their stakeholders – there is no trade-off between purpose and profit. Thus, our reforms aim at growing the pie for the benefit of all stakeholders, rather than changing how a fixed pie is divided.

Third, it is broad. Change cannot be piecemeal, but must be system-wide, involving long-term thinking not only by executives, but also by the directors who evaluate them and the investors who appoint the directors. It involves not only changes in individual firms, but an overhauling of accounting principles and potentially company law.

Our first policy concerns company law and reporting. Directors should be required to report on how they fulfil their Section 172 obligations to “have regard to” other stakeholders. More radically, the articles of association could be amended to require companies to state precisely their purpose – an intrinsic reason for being that contrasts the extrinsic by-product of profits. The triennial assessment of boards under the UK Corporate Governance Code could be expanded to evaluate the delivery of this purpose.

Our second policy concerns accounting for purpose. Company reporting should be overhauled to properly value intangible assets. This in turn will both increase companies’ incentives to invest and transparency around the issues that matter to stakeholders. The Office of National Statistics should publish more disaggregated and more timely statistics on intangibles.

Our third policy concerns repurposing the investment industry, which is currently fragmented and focused on short-term returns. Asset managers should state and have certified their purpose, in particular how they promote the long-term interest of the companies they invest in and the savers they invest for. They should publish metrics on their stewardship activities and pay their fund managers according to long-term performance. In addition, sub-scale pension funds should be merged to create a stronger voice for stewardship.

Our fourth policy concerns blockholders (large shareholders). Due to their large stakes, blockholders have both the power and incentive to support purpose – to intervene in firms that are pursuing short-term profit, and to shield purposeful firms from the need to cater to the stock market.

However, the UK has fewer blockholders than almost every developed country. We propose relaxing disclosure requirements that deter the acquisition of large stakes. We also recommend facilitating collaboration between shareholders, such as the expansion of the Investor Forum, and the sharing of long-term information between firms and shareholders. We propose prohibiting shareholders from voting with borrowed stock, unless they have a large stake and thus are likely aligned with the firm’s long-term value.

Our fifth policy concerns finance for purpose. This aims to create a greater flow of equity investment towards purposeful companies. The default allocation for defined contribution funds could be changed to assign a given percentage to investment in purposeful companies. It could also involve the creation of crowdfunding models and digital platforms to support purposeful startups, and potentially also a UK Investment Fund.

Our final policy concerns executive remuneration. We should de-emphasise complex, opaque bonuses and long-term incentive plans and have greater focus on simple, transparent long-term equity (and perhaps also debt). Firms should increase the transparency of the link between pay and performance. The remit of the remuneration committee should be broadened to include accountability for pay fairness across the organisation. Firms should also release a Fair Pay Report on how they achieve this, engaging with employees in an appropriate way in the process.

We hope that this policy report represents a radical, practical, and coherent roadmap to allow purposeful companies to flourish, for the benefit of the UK and all its citizens.

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