The arbitrary case for responsible capitalism

Few topics are more widely debated today than the concept of ‘responsible’ capitalism. But what does ‘responsible’ really mean? Definitions can vary but in principle, one could argue that the common thread of various theories that support such a ‘new’ notion of capitalism is the need, in the perpetual balance between shareholderism and stakeholderism, to tilt decidedly towards the latter.

And that is in stark opposition to the ‘classic’ shareholder value theory, which assumes that a company’s ultimate goal is to maximize returns for shareholders irrespective of the needs of all other parties impacted by the company’s activity, namely stakeholders. It is, of course, inevitable to refer to Milton Friedman’s most famous article and his quote that the social responsibility of a company is to increase its profits, as it is precisely that assumption that is now widely and indeed rather fiercely disputed. Well, let me state that whilst remaining sensitive to the contrarian arguments, I stubbornly remain a devoted follower of Mr Friedman’s theory. Simply, he is often misquoted, as the entire sentence specifies that in pursuing profit maximization a company should ‘stay within the rules of the game and operate without deception or fraud’ and that critical half of the sentence is often forgotten. In other words, Mr Friedman clarifies that a company should limit the production of negative externalities entailed by its activities to the extent allowed by the imperative rule. To make a very sensitive example in times when, quite rightly, concerns about the environment are overwhelming, a company should be able to pollute only to within the limits foreseen by the norm, which borrowing from Jean-Jacques Rousseau supposedly embodies the social contract on which a society is founded. The underlying principle is that a company’s production is useful for the community (otherwise its activity should be banned altogether) and therefore its negative consequences, provided they are confined within certain limits, are beneficial enough to be tolerated.

It is paramount to differentiate between where the production of such positive externalities has a favourable impact on the business, and where it is only beneficial for society as a whole but does not entail any positive consequences for the bottom line.

In straight opposition to such a theory, supporters of the notion of responsible capitalism argue that a company should not only commit not to exceeding the level of negative externalities allowed by the imperative rule, but should voluntarily engage to produce positive externalities, whose beneficiaries are, the stakeholders in the widest possible meaning of the term.

Here, a very important distinction, often overlooked, must be made. It is paramount to differentiate between where the production of such positive externalities has a favourable impact on the business, and where it is only beneficial for society but does not entail any positive consequences for the bottom line. In the first case, creating positive externalities, or at least leading customers to believe that is the case, becomes a competitive advantage, or at least might avoid a competitive disadvantage – meaning that should such positive externalities not be produced, the company’s P&L would in the short, medium or long term, suffer. If that is the case, the quest for being a good corporate citizen is perfectly compatible with Mr Friedman’s theory. But what is relevant here is a situation where positive externalities are produced on a purely voluntary basis and have, or at least potentially have, a negative impact on the bottom line.

Who should ultimately decide to trade the value created for shareholders for incremental benefits in favour of stakeholders?

In such a case, also from a theoretical standpoint, things get substantially more complex: Who should ultimately decide to trade the value created for shareholders for incremental benefits in favour of stakeholders? Assuming shareholders operate in their capacity of homines oeconomici, one should presume they would refrain from willingly curbing their financial benefits. However, most of the time they are not even in the position to make such a choice, as they have delegated it to their agent (i.e., management). Therefore, would it be sensible to argue that management’s choice to allocate more value to stakeholders depriving the shareholders could be considered arbitrary?

It seems indeed a very illogical conclusion. And yet many brilliant minds (Colin Mayer of Oxford University being the most prominent) simply refuse to offer a convincing answer to such an irresolvable dilemma and fiercely support the notion of responsible capitalism. One should therefore ask why such an apparently illogical position has been so widely and, allow me, rather blindly embraced?

Irrespective of the different industries (manufacturing, financial, etc.), in the appropriation of the added value which is created, capital looks like an expanding behemoth that dwarfs all other production factors.

I believe two factors play a role in that respect. One is the constantly decreasing trust that people have for the legal system. Capitalism has become more complex than it originally was, and it is more and more difficult for governments to provide coherent rules. In which case, I very much doubt that the solution is to abdicate and defer the issue to private companies, but rather to try to master the additional complexity and produce a well thought-out and articulated system of rules. The second is that capital is eating an ever-increasing portion of the cake represented by the added value of organizations. Irrespective of the different industries (manufacturing, financial, etc.), in the appropriation of the added value which is created, capital looks like an expanding behemoth that dwarfs all other production factors. This explains widening wealth distribution, with capitalists owning an ever-larger share to the detriment of labour and other actors (including communities as taxes are in rather a steep decline trajectory when observed over a long enough period). Other causes include the secular trend of lowering interest rates that has benefitted capital much more than labour, the winner-takes-all model of many new industries that rewards capital immensely once a sustainable competitive advantage has been established, and more. Furthermore, the absence of a robust theoretical framework that allows workers to ask for more, after the demise of Marxism, has weakened trade unions enormously. 

But again, assuming wealth distribution inequality is an issue, an assumption to which I subscribe wholeheartedly, is pushing companies to create less shareholder value the right approach?
Food for thought, to say the least.

Luca Garavoglia is Chairman of Davide Campari-Milano S.p.A., parent company of the Campari Group. Davide Campari-Milano S.p.A is an Institutional member of ECGI.

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