Alex Edmans, Professor of Finance at London Business School, explains why purpose and profit don’t have to be mutually exclusive
Purpose is the corporate buzzword of today, with politicians, the public and even investors calling on companies to serve wider society. But purpose is also controversial. Critics label it ‘woke’ and a distraction from the primary responsibility of business, which they view as delivering shareholder returns. They stress how shareholders aren’t nameless, faceless capitalists but include pension funds, insurance companies and ordinary citizens, and so shareholder returns are important. Accordingly, politicians in the US are seeking to ban state pension funds from pursuing environmental, social and governance (ESG) strategies. Both purpose and ESG have become politically charged, with champions on the left and opponents on the right.
This controversy is based on the pie-splitting mentality. Opponents of purpose assume that the value that a company creates is a fixed pie. The only way to increase the slice enjoyed by society is to reduce the slice that goes to business – investing in ESG initiatives, donating profits to charity, and paying furloughed workers all hit the bottom line. If the pie is fixed, companies have to choose between serving shareholders or society – you can turn right or turn left, but not both.
This controversy isn’t just confined to 2023; the battle between business and society has been around for decades. In the mid-19th century, Karl Marx wrote about the struggle between capital and labour. Since then, we’ve seen a pendulum swing back and forth between business and society. Think of the late 19th century robber barons who created giant monopolies such as Standard Oil; policymakers responded by breaking some up. Or the peak of trade unions in the 1970s, followed by legislation that caused their decline. Or the rise of big banks in the early 20th century, which culminated in the 1929 financial crisis and their regulation by the Glass-Steagall Act – itself partially reversed since the 1980s, contributing to another crisis in 2007. Unless we can come up with another way, this movie will keep on being replayed.
But the good news is that there is another way.
By applying a radically different approach to business, companies can create both profit for investors and value for society. The pie-growing mentality stresses that the pie is not fixed. By investing in stakeholders, a company doesn’t reduce investors’ slice of the pie, as assumed by some CEOs – it grows the pie, ultimately benefiting investors. A company may improve working conditions out of genuine concern for its employees, yet these employees become more motivated and productive. A company may develop a new drug to solve a public health crisis, without considering whether those affected are able to pay for it, yet end up successfully commercialising it.
Importantly, the idea that both business and society can simultaneously benefit is not wishful thinking, but backed up by rigorous evidence, which I lay out in a recent book, Grow the Pie: How Great Companies Deliver Both Purpose and Profit. For example, one of my own studies shows that companies with high employee satisfaction outperformed their peers by 2.3–3.8% per year over a 28-year period. That’s 89–184% compounded. I do further tests that suggest it’s employee satisfaction that leads to good performance, rather than the reverse. Other studies find that customer satisfaction, environmental stewardship and sustainability policies are also associated with higher stock returns.
How does a company put this into practice and actually ‘grow the pie’? The starting point is to define its purpose – why it exists, its reason for being and the role that it plays in the world. Many companies have broad purpose statements, such as ‘To serve customers, colleagues, suppliers, the environment and communities while generating returns to investors’, because they sound inspiring. But a purpose that’s all things to all people offers little practical guidance because it sweeps the reality of trade-offs under the carpet. Leaders need to make tough decisions that benefit some stakeholders at the expense of others. Closing a polluting plant helps the environment but hurts employees. A focused purpose statement highlights which stakeholders are first among equals to guide such a trade-off.
All this means that purpose is not black or white; both the left and the right are more correct than their detractors claim and more wrong than they’d like to admit. Purpose is not ‘woke’ but makes good business sense – a company with a clear purpose will make more long-term investments than one based on profit – and ultimately become more profitable as a result. But purpose does not involve shooting for all 17 Sustainable Development Goals, because trying to achieve everything may lead to it achieving nothing. In 2023 the world faces many serious challenges, but several of them are best dealt with by government or other companies. A company’s purpose is to address the societal problems that it is best placed to solve – by doing so, it not only serves society, but also its shareholders.
Alex is a speaker at the IFoA’s Presidential Speaker Series webinar about the power of purposeful business on 20 April. Learn more and book at the power of purposeful business.
