Why do businesses exist? To earn profits, or to serve a purpose? For shareholders, or for society, customers, employees, or the environment?
The conventional view is exclusively to earn profit. In 1970, Milton Friedman famously wrote that “the social responsibility of business is to increase its profits.” This view isn’t as hard-hearted as it may sound. Friedman argued that a company can only increase its profits by taking other stakeholders into account — producing high-quality products, treating its employees fairly and having a good environmental reputation. Under this view, firms should just focus on profits, and everything else will fall into place. Consideration other stakeholders beyond the profit implication is at the expense of shareholders: a dollar spent on improving working conditions is a dollar that cannot be paid as dividends.
However, the Corporate Social Responsibility (CSR) view argues that Friedman’s hypothesis only holds in theory. In practice, it’s extremely difficult to quantify the profit implications of most socially-responsible actions. A company could decide whether to grant an employee compassionate leave by trying to calculate the potential loss in morale and productivity if the leave was withheld. But there’s no way you can put a number on that! The CSR approach would be to grant the leave simply because it’s the right thing to do – because the goal of the company isn’t only to maximize profits, but to treat stakeholders with compassion. Treating employees fairly will eventually manifest in greater staff retention and future productivity. However, these long-run effects are difficult to quantify, so a company focused exclusively on profits will not invest in its stakeholders.
Which view holds in the real world? Well, for that, you have to look at the data. I shared the results of a study using 26 years of data in a recent TEDx talk titled “The Social Responsibility of Business.” Here is a bullet-point summary:
– I give examples of real-life companies (Marks & Spencer, Merck, Costco, Unilever) that successfully implement responsible practices – and are profitable as a by-product.
– One concern might be that the above are hand-picked examples. I then present the results of a rigorous study, suggesting that employee well-being (a dimension of social responsibility) leads to superior stock returns. The 100 Best Companies to Work For in America beat their peers by 2-3% *per year* over a 26-year period from 1984-2009.
– How do we know that this outperformance is due to employee well-being, rather than some other factor? I control for the performance of the industry the Best Companies are in, for recent performance, size, valuation ratios, dividends, risk, outliers, and a whole host of other characteristics.
– I also conduct analyses to suggest that it’s causation, not correlation, of employee well-being that leads to good performance, rather than good performance allowing a company to spend on employee well-being.
– Even though the identity of the Best Companies is public information, I show that it takes the market 4-5 *years* before it fully incorporates this information. The stock market is good at valuing tangible assets, such as profits and dividends, but very slow at valuing intangibles — not just employee well-being, but also innovative capability, customer loyalty, and environmental sustainability.
– Since the market does not take intangibles (such as CSR) into account, investors can earn profits by using these measures. Even investors who do not care at all about social responsibility, but just wish to maximize returns, should pay attention to these measures. Examples include Calvert, Asset4, Trucost, and Sustainalytics.
– I emphasize how social responsibility is not immediately appreciated by the stock market and — like any long-run investment — takes many years to pay off. Thus, investors should not evaluate companies according to whether they meet quarterly earnings targets, but instead take a long-term view.
In short, there is no trade-off between profit and purpose. Caring about society is not at the expense of profit, it supports profit. To reach the land of profit, follow the road of purpose.
The full talk can be seen below:
Article first published on the Huffington Post
Alex Edmans twitter account: @aedmans
Alex Edmans is a Professor of Finance at London Business School. He was educated at Oxford (BA) and MIT (PhD, Fulbright Scholar) and then joined Wharton, where he won 14 teaching awards in six years and was granted tenure. Alex’s research interests are in corporate finance, behavioural finance, and corporate social responsibility. He has presented to the Bank of England, Federal Reserve, Goldman Sachs, IMF, McKinsey, Morgan Stanley, and SEC, and been live-interviewed by Bloomberg, BBC, CNBC, CNN, ESPN, Fox, and Sky. Alex co-led a session on behavioural economics at the World Economic Forum in Davos and gave a TEDx talk on “The Social Responsibility of Business” (http://bit.ly/csrtedx). He runs a blog, “Access to Finance” (www.alexedmans.blogspot.com), that makes complex finance topics accessible to a general audience. His twitter account is: @aedmans