The profitability of trust

The effects of the most devastating financial crisis in decades have begun to fade. But debate about the fundamentals of the global economy is far from over. Indeed, there has been a new wave of heated discussion about whether companies should put profits or the common good first.

Milton Friedman, a leading proponent of the profit-oriented approach to corporate management, famously declared that “the business of business is business.” Indeed, from this standpoint, there is no contradiction between profit maximization and the common good. The pursuit of profit itself is a socially beneficial goal.

A conceptual basis for the opposing perspective, to which I adhere, lies in the Harvard economist Michael Porter’s theory of shared value creation. In fact, my own publications promote the stakeholder concept as the framework for a modern understanding of socially responsible corporate management.

The theoretical debate could continue indefinitely. But, in terms of practical company management, such ideological polarization is not particularly useful. If managers had to choose between fulfilling the expectations of shareholders and meeting their social and ethical responsibilities, their companies would probably collapse.

Instead, successful managers recognize that any company is both an economic and social entity, and thus that no stakeholder can be neglected. As I wrote more than four decades ago, a company, “like an organism…depends on several arteries,” all of which it must nurture if it hopes to survive and grow.

That sounds straightforward. But it can be very difficult when the demands of, say, the company’s shareholders conflict with the interests of its employees, customers, or local communities. The good news is that, in any such conflict, there is one clear, unifying goal: ensuring the company’s long-term success.

This requires, first and foremost, that the company is profitable. But profitability should not be an end in itself; it is a tool to help managers determine the most effective use of their resources and gauge the company’s competitiveness and vitality. So instead of just paying out dividends, companies should use their profits to bolster their long-term viability.

Profitability, growth, and safeguards against existential risks are crucial to strengthening a company’s long-term prospects. But if these three factors constitute a company’s “hard power,” firms also need “soft power”: public trust and acceptance, won by fulfilling a company’s social responsibility. Only when a company has gained the public’s confidence – its “license to operate” – can its management create long-term value for all stakeholders, including shareholders.

In short, the real conflict is not between profit maximization and social responsibility, but rather between short- and long-term thinking. This, in a sense, is an easier conflict to resolve. After all, a short-sighted approach not only undermines companies’ prospects; it also threatens the entire economy. Indeed, managers’ irresponsible focus on advancing shareholders’ immediate interests, thereby maximizing their own bonuses, contributed significantly to bringing the global financial system to the brink of collapse in 2008.

In order to enable a company’s management to accommodate the long-term interests of all stakeholders, corporate decision-making must account for the four prerequisites of a company’s survival: profitability, growth, risk protection, and public trust. Given that satisfying one of these prerequisites often comes at the cost of the others, such a system would entail continuous adjustment and compromise.

We are emerging from a period when companies, under pressure to meet shareholder expectations, favored profitability and growth, even if it meant taking undue risks and losing public confidence. Companies now need to work on minimizing risk and building trust by meeting the legitimate expectations of all their stakeholders, including reducing their activities’ adverse impact on the environment and creating high-quality employment opportunities.

But corporate social responsibility is not limited to how a company does business. Firms should use their core competencies to help find solutions to today’s most pressing social problems. In other words, beyond serving its own stakeholders, a company should accept its own role as a stakeholder in our collective future – a sort of quid pro quo for its license to operate.

Fortunately, companies are increasingly acting with a sense of social responsibility. By working with governments, international organizations, and civil society, companies are addressing major challenges like social integration, and creating the necessary systems to provide education and health care to those who need it most. These companies are implementing the stakeholder concept on a micro and macro level, answering to the demands of their employees, customers, and communities, and thus strengthening their brands.

In doing so, such companies offer a powerful response to the question of what their role in society should be. More important, they are showing the rest of the corporate sector that the business of advancing the common good is a worthy one.

This article is published in collaboration with Project Syndicate.

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Author: Professor Klaus Schwab is Founder and Executive Chairman of the World Economic Forum. 

Image: A man walks past buildings at the central business district of Singapore February 14, 2007. REUTERS/Nicky Loh