Corporate success lies at the heart of directors’ duties in many corporate laws, but few of those laws define success.  As a result, there is growing confusion and concern about the objective of the firm.

Some scholars argue that it is about maximizing profit, others about the long-term value of the corporation.  Increasingly, there has been a focus on the long-run sustainability of the firm and the environment in which it operates.  One view is that firms should be promoting the welfare and not just the financial wealth of their shareholders, while another is that they should enhance the wellbeing of their stakeholders more broadly defined.

The agenda over the last 60 years has been dominated by Milton Friedman’s assertion that there is only one social responsibility of business: to increase profits while acting within the rules of the game.  Anything else, he believed, would involve businesspeople in political judgments for which they had no authority or accountability.

However, that has not stopped businesses becoming increasingly embroiled in political controversies.  Never has there been a greater need to bring clarity to what is meant by the success or interest of the corporation.

In a new article and book, I argue that profits, the fuel that powers capitalism, are at the heart of the problem.  Without profits, there is no capital in capitalism.  But we are misconceiving the nature of profits.

Profit derives from the Latin proficere and profectus, to advance and progress.   That is precisely from where a profit should come in contributing to the success of the corporation. It frequently does, but too often it also comes from advantage and regress.  Profit should be earned without inflicting harm on others.  Companies should incur the costs of ensuring that they do not cause harm to others and, where they do, rectify the damage and clean up the mess they have created.  They should in other words, incur the “true costs” of avoiding negative impacts as well as producing positive outputs.  They should “profit without harm” and earn “just or fair” profits from value creation, not value transfer at the expense of others.

This is profoundly different from corporate social responsibility (CSR) and environmental, social, and governance (ESG), which seek to impose additional requirements on companies to act responsibly and respect the interests of the environment and society.  Instead, it suggests a need to align the fundamental driver of business – profit – with the avoidance of detriments to others.  It does not seek to impose additional expectations or obligations on companies.  It does not require companies to promote other stakeholder interests.   It simply says do not profit at others’ expense.

It is such a minimal restriction on companies that most people would be surprised that it could be otherwise.  Of course, businesses should not be profiting at our expense as customers, employees, communities, or the natural world.  We are understandably outraged when we discover that they have been doing anything different, for example during the global financial crisis of 2008.  However, if companies do not profit at the expense of others, they should not be restricted in how they conduct their businesses and earn profits or be expected to undertake activities that are not profitable.

On the contrary, we want many flowers to bloom.  We want businesses to be free to choose whatever activities they deem to be profitable and, as Milton Friedman suggested increase their profits, so long as they are not profiting from harm.   At the heart of this is the purpose of business and the notion of success in corporate law.  The purpose of business is indeed to profit but to recognize that profit derives from a more fundamental objective, namely, to solve rather than create problems for others.  Provided that business profits from producing solutions not problems for people and planet then any purpose is welfare enhancing.

To date we have thought that alignment between earning profits and solving rather than creating problems comes from markets and competition.  Any misalignment between the two reflects “externalities” resulting from market failures, requiring regulation and taxation.  But this is a confusion of cause and effect.

Markets fail because profit and problem solving are not aligned, and public policies to promote markets and competition fail for the same reason.  Competition fails because good firms that profit without harm cannot compete against bad firms that do not.  Far from promoting a “run to the top” of good firms driving out bad, competition creates a “run to the bottom,” a Gresham Law, of bad firms driving out good.  And regulation fails because bad firms seek to avoid it and turn it to a competitive advantage by raising the costs of good firms that abide by it.

We will not solve the failures so long as we treat them as externalities instead of recognizing them for what they are: misconceived notions of profit that are intrinsic to the driver of business and capitalism.  Instead of resorting to the sticking plaster of competition policy, regulation, taxation, or even worse CSR and ESG, we need to address this at its core – the meaning of “success” in corporate law.

The notion of success in corporate law derives from corporate purpose – the reason why a business is created, why it exists, and its fundamental reason for being.  Success reflects advancement of the corporate purpose – a process of progress towards achievement of the purpose.  It is the overarching framework within which the strategy of a business resides.

The problems that businesses are there to solve are the objectives around which their strategies are formulated – the resources that are required, the procedures that need to be implemented, the incentives that should be provided, and the measures that demonstrate progress towards their attainment. But equally, success derives from avoiding and resolving the creation of problems, and strategy determines the resources, procedures, incentives, and measures required to achieve that as well.

The role of corporate law is to define the duties of directors as ensuring that success of corporations derives from solving not creating problems for others.  It comes from wealth creation not wealth diversion or transfer from others.  This is a matter of honesty and integrity.  In declaring the financial statements of a company “true and fair,” the directors have a duty to act with honesty and integrity in stating that, to the best of their knowledge and understanding, they reflect its true costs and therefore fair and just profits.

The importance of this is not only to encourage firms to take their environmental, human, and social responsibilities seriously but more significantly to focus on finding value enhancing ways of solving problems.  It therefore creates an alignment of interests between businesses and investors in profit and those of their customers, employees, communities, and environment in problem solving without problem creation.

My book describes how this relates to existing corporate laws around the world, and the forms of ownership, governance, leadership, measurement, reporting, and financing that are required to achieve it.  In the process, a natural partnership develops between the public sector in promoting the public interest and the private sector in earning a profit.

This post comes to us from Colin Mayer, emeritus professor of management studies at the University of Oxford’s Said Business School and visiting professor at the university’s Smith School of Enterprise and the Environment. It is based on his recent article, “Success, Law and ESG,” available here, and his book, Capitalism and Crises: How to Fix Them, Oxford University Press, available here.