California, ethics and business purpose

For more than 90 years the mythical notion of shareholder primacy in US corporate purpose has dominated debate about why companies exist.

In the case of Dodge vs. Ford in 1919: “the Michigan Supreme Court held that Henry Ford owed a duty to the shareholders of the Ford Motor Company to operate his business to profit his shareholders, rather than the community as a whole or employees”.

This was taken up by many, to demonstrate that the duty of corporate management is to provide profits to shareholders. This paradigm, encouraged the “Chicago school” of Economists (such as Milton Friedman) has dominated MBA and business education programmes ever since.

Yet Dodge vs. Ford has never been the final word on the topic.

Here’s a well-written and compelling academic article on why teaching Dodge vs. Ford is so misleading when it comes to corporate purpose.

For example in another ‘test’ case, Shlensky v. Wrigley in 1968, Shlensky, “a shareholder in The Chicago National League Ball Club, brought a derivative suit against the company’s directors and majority shareholder and President, Phillip K. Wrigley, charging that Wrigley did not exercise reasonable care in his failure to schedule night games, which, according to the plaintiff, resulted in the company suffering economic losses. The plaintiffs suit was dismissed”.

The court ruling was that: “Courts will not step in and interfere with honest business judgment of the directors unless there is a showing of fraud, illegality or conflict of interest.”

And according to Lynn Stout in the Virginia Law & Business Review: “Judges routinely refuse to impose any legal obligation on corporate directors to maximize shareholder wealth.”

Despite this, the primacy of shareholder value has persisted. No doubt it has done some good in keeping managers focused and companies on the ball. But it has had serious side effects, as any reader of this blog (particularly if you have got this far in the post!), will know.

Now though, the debate about corporate purpose may get a further airing due to a proposed bill in California’s State Senate.

The Corporate Flexibility Act of 2011 would mean that:

“Any company establishing in California will be permitted to negotiate to include a social and environmental mission that is given equal weight, perhaps even greater weight, than profits,”

This bill, should it pass (and it well might) will be no panacea for the problem of corporate bottom line focus.

Large companies will struggle re-enact themselves under its breadth. I’d guess that most will just ignore it. Systems long since set up cannot change fast, as we know.

But at least the bill may help defuse the myth that the purpose of a corporation, particularly a big firm, is only to make short term returns for shareholders.

The Japanese have long understood this, as have companies such as Unilever in Europe.

(See Akio Toyoda‘s recent comments and shake-up of how Toyota looks at growth for details)

Chinese, Indian and Brazilian firms also get this, indeed most of them always did.

Breaking the tautology of Dodge vs. Ford is still a taboo in large American companies, (Coke’s European head re-enforced that in a recent London interview) but perhaps shifts like those underway in Californian corporate law, and perceptions of it, may help persuade more and more US companies that next quarter’s shareholder returns are no longer what it is all about.

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