The business case for purpose-driven strategy
As a lawyer, my legal training has continuously reinforced the perspective that companies are owned and controlled by shareholders and their primary purpose is shareholder value maximisation (SVM). In the UK (where I am qualified), statutes are structured to ensure that corporations work in the interests of shareholders and there are several examples of case law where shareholder primacy is articulated.
However, on a closer look we see that the law affords more flexibility to directors than is immediately apparent. Directors are subject to a fiduciary duty to act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. But how do we define success? Whilst success will generally mean a long-term increase in value, fundamentally, it is up to each director to decide, in good faith, whether it is appropriate for the company to take a particular course of action.
There is also a flaw in the view that shareholders “own” companies. A company is a legal entity in its own right and, therefore, by its nature cannot be owned. Shareholders, instead, own shares which represent a contract between the shareholder and the company giving them limited rights under limited circumstances. In this sense, shareholders are no different from other stakeholders, such as employees.
There is therefore a disconnect between how the law requires directors to behave and the teachings conveyed to lawyers and law students. Whilst the law does not mandate shareholder primacy, the SPN widely exists amongst legal practitioners and scholars as a normative goal.
Companies subscribing to the shareholder-centric model adopt a range of internal governance rules and structures with the primary goal of maximising shareholder wealth, such as remuneration packages linked to financial performance, allocation of resources and decision-making powers,
However, the shareholder-centric model fails to take into account that shareholders have different needs and interests. As a result, managers are incentivised to prioritise short-term earnings over long-term performance. Decisions not to invest in the future of the company and, potentially, engage in socially irresponsible behaviour (and reap the financial benefits of doing so), ultimately harms shareholders along with its other stakeholders.
There is a lack of reliable empirical evidence demonstrating the connection between shareholder-centric governance practices and corporate performance. Given the collective shift to shareholder-orientated governance structure over the past two decades you would be forgiven for assuming that average investor returns would have increased. But this has not been the case; instead we have witnessed a chain of corporate scandals and disasters, from Enron and Worldcom in the early 2000s, the financial crisis in 2008 and recently the P&O Ferry layoffs.
It is clear that the shareholder-centric model is inconsistent with corporate law, misstates the economic structure of companies and lacks persuasive empirical support, so it is therefore time for companies to pursue a purpose other than SVM.
When we look at the role of purpose within organisations, a study published by Harvard Business Review found when companies have a clearly articulated purpose which is widely understood, they have better growth as compared with companies which have not developed or leveraged their purpose. Specifically, 52% of purpose-driven companies experienced over 10% growth compared with 42% of non-purpose-driven companies. Purpose-driven companies benefitted from greater global expansion (66% compared with 48%), more product launches (56% compared with 33%) and success in major transformation efforts (52% compared with 16%). These findings are supported by other findings that organisations with midlevel employees with strong beliefs in the purpose of their employer, and the clarity in the path toward that purpose, experience better financial performance.
With such a compelling business case for purpose, we are witnessing the emergence of hybrid organisations which blur the boundary between social and environmental missions, whilst generating income to accomplish their mission.
According to Malnight et al (2019), there are two ways to formulate a purpose-driven strategy: (i) redefine the playing field; or (ii)reshape the value proposition. Mars Petcare is an example of a company which has successfully used its purpose to propel its expansion in the broader field of pet health because it ensured that every move it made was aligned with the same core purpose: “a better world for pets”.
When faced with diminishing margins, companies should look at how they can improve their value proposition by innovating products, services, or business models. Whilst this can be done by either adopting a transaction or purpose-driven approach, Malnight et al (2019) show that adopting a purpose-driven approach “facilitates growth in new ecosystems, allows companies to broaden their mission, create aholistic value proposition, and deliver lifetime benefits to customers”.
In order to implement a sustainability-driven business model, leaders need to make purpose central to their strategy. The two best tactics for doing that are “to transform the leadership agenda and to disseminate purpose throughout the organisation” (Malnight et al, 2019). This is clearly easier said than done though, and whilst there is much to be learned from the companies that are doing it well, my own experience has shown just how challenging it is to implement this in practice. We can also see from the experience of the ex-CEO of Danone, Faber, who was ousted by activist shareholders for promoting stakeholder capitalism and centering core business units around ESG, that the business case for purpose-driven strategy is not universally accepted.
Research carried out by the EY Beacon Institute (2019) found ten ways purpose can be turned into strategy. For me, the most powerful is using your purpose as a decision-making filter: “Purpose can and should be a reason to say “no” to something, but it’s rarely the only reason to say “yes””. In order to be successful, every key decision made by a purpose-driven organisation needs to assess each decision through the lens of its purpose; this is something which I consciously implement in my own business and believe it to be extremely powerful.
As we see how corporate governance can be used to reinforce the SPN, it can equally be used to reinforce the role of purpose within an organisation. Instead of creating incentive schemes designed to reward short-term profitability, they can instead be designed to reward the behaviours that are aligned to the organisation’s purpose. B-Corp certification, or similar initiatives, can be helpful to use as a guiding coalition to structure internal governance rules, and we are seeing more and more organisations choosing this path.
Purpose creates a sense of meaning, inspiring employees and unlocking discretionary efforts to transform and grow. It has the power to transform an organisation, but it must be articulated, activated, and embedded to have impact.