Tim Weinhold
Adam Smith probably tops history’s list of influential teachers with the most followers who largely misunderstood their teacher’s message. As we all know, Smith is widely viewed as the father of capitalism, based on his 1776 book, The Wealth of Nations. Smith and his book remain hugely influential to this day.
His principal thesis was that individuals – and enterprises and countries – should focus their productive activities on that which they do best, and then, via a free market, trade their specialised outputs for the goods and services produced by others. He argued that this combination of specialised production, with supply-and-demand-based free-market trading, most efficiently allocates productive resources and, as a result, maximises overall wealth creation. As well, it (generally) maximises utility for all participants; that is, everyone is better off.
Smith’s core contention, therefore, is that the market’s ‘invisible hand’ transforms self-interested production and trading behaviours into outcomes of maximum economic and social benefit. This has provided the foundational rationale for business and free markets – in other words for capitalism itself – ever since. Much of this is summed up in the book’s most famous sentence: ‘It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own self-interest.’
Arguably no other single sentence has ever been so thoroughly misunderstood, by so many people, to such disastrous effect. In fact this misunderstanding goes to the heart of why so many are now so critical of contemporary capitalism. More specifically, it explains why the rewards of late-twentieth and twenty-first-century capitalism have flowed increasingly to the wealthy, while the fortunes of much of the (Western) middle class, working class and poor have deteriorated.
The misunderstanding arises from a failure to recognise that, morally and practically, there are two very different kinds of self-interested behaviour. One occurs when an individual – or enterprise – acts for their own benefit at the expense of someone else. We generally describe such behaviour as selfish and predatory. Fortunately, there is a quite different sort of self-interested behaviour – where someone achieves a favourable outcome for themselves and for the other individual(s) affected by their action.
Though both behaviours are self-interested, their effects are poles apart. The first unilaterally imposes costs on someone else, making them worse off; that is, they are harmed. The second, by contrast, benefits not only the one taking action but the other party as well.
It is not surprising, then, that from our toddler years on we experience being on the receiving end of these two behaviours very differently. Reflect back, for example, on your own toddlerhood. Suppose you had been playing with a favourite toy and your older sibling came by and snatched it away saying, ‘I want to play with this now!’ Not very hard to recall how you felt, right? A terrible injustice has been perpetrated! Call in the authorities (Mom or Dad)! Such a grave wrong, such a violation of all that is just and proper, must be put right – NOW!
Suppose, though, that your sibling had said, ‘I’d like to play with your toy now, so how about if I let you play with my super-duper new toy?’ Provided that the new toy in question really was super-duper, you probably would have been quite happy to accede. In both cases, the result for your sibling was the same – they got to play with the toy they wanted. But the respective outcomes for you are quite distinct: in one scenario you were disadvantaged (harmed); in the other you were made better off (helped).
If even a toddler instinctively understands the watershed difference between these two versions of self-interest, why, we might ask, has it proved so difficult for adults – specifically economists, business people, business academics, political commentators and the like – similarly to understand that difference when it comes to the way business, and capitalism, are meant to work?
Yet a great many of Adam Smith’s devotees find themselves unable to grasp that distinction. Over and over they evidence a belief that, effectively, Smith’s most famous sentence reads, ‘It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their selfishness.’ They believe that Smith was claiming for free markets and capitalism something quite extraordinary: that they magically transmute the lead of selfishness and exploitation into the gold of maximised benefit for individuals and society. This is nonsense and delusion.
And yet we find the Harvard economist Edward L. Glaeser declaring in The New York Times:
Two hundred and thirty years ago, Adam Smith made the case for selfishness when he wrote that ‘it is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own self-interest.’[1]
Or we read comments like this one, attributed to one of the two most influential economists of the twentieth century, John Maynard Keynes: ‘Capitalism is the extraordinary belief that the nastiest of men for the nastiest of motives will somehow work for the benefit of all.’[2] Keynes may simply have been paraphrasing an earlier quotation from a close colleague, E. A. G. Robinson, who wrote in his book Monopoly: ‘The great merit of the capitalist system, it has been said, is that it succeeds in using the nastiest motives of nasty people for the ultimate benefit of society.’[3]
Of course, no one has done more to associate capitalism with selfishness – and its close corollary, greed – than Ayn Rand. Then again, in her full-on defence of selfishness and greed, maybe she meant something different from what we imagine. Rand acknowledged, for instance, in the introduction to her book The Virtue of Selfishness, that she was using the term ‘selfishness’ to mean, more precisely, ‘concern with one’s own interests’.[4] Hmmm.
Along similar lines, consider this defence of greed from the other most influential economist of the twentieth century, Milton Friedman:
Well first of all, tell me: Is there some society you know that doesn’t run on greed? You think Russia doesn’t run on greed? You think China doesn’t run on greed? What is greed? Of course, none of us are greedy, it’s only the other fellow who’s greedy. The world runs on individuals pursuing their separate interests … there is no alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by the free-enterprise system.[5]
If smart, prominent commentators like these are going to treat ‘selfishness’ and ‘greed’ as synonyms for ‘self-interest’, no wonder so many devotees imagine Adam Smith claimed the market’s beneficent hand turns selfishness and greed into social and economic blessing. This has done great harm. In particular it has caused a great many business people to believe that selfish, exploitative behaviour, though toxic in every other arena of life, is somehow magically beneficial when practised in business.
But failing to distinguish the words ‘selfishness’ and ‘greed’ from ‘self-interest’, as sloppy and unhelpful as that may be, is not our real problem. Rather, the words themselves focus our attention in the wrong direction – towards the character and motivation of the actor. As a result, they keep us from recognising what truly differentiates good from bad and moral from immoral behaviour.
Let’s revisit for a moment our hypothetical scenario from your toddlerhood. When your sibling wanted your toy, your response had nothing to do with his or her motivations or character. If your sibling’s behaviour injured you – made you worse off – then you knew you had been mistreated and a wrong perpetrated. Period. If, instead, their action left you better off, you were happy to approve their behaviour – whether or not they were motivated by self-interest, selfishness or greed.
You knew your sibling’s conduct was wrong, or not, entirely based on the effect it imposed on you. Which means that, even as a toddler, you were thinking clearly as to what actually differentiates behaviours that are good from bad, right from wrong, moral from immoral; and that you were already thinking clearly about how we should assess good versus bad business conduct, and the difference between moral versus immoral versions of capitalism.
Of course, there’s more here than the justice instincts of toddlers. Throughout human history – across religions, across civilisations, even now in our post-religious Western secularism – one principle has always provided the bedrock foundation for human morality: the golden rule – ‘Treat others as you yourself wish to be treated’; or in its alternative rendering – ‘Love your neighbour as yourself.’ Notably, this cornerstone moral principle zeroes in on our actions – how we actually treat others – not our motivations.
Just as notably, the golden rule envisages a behavioural landscape comprised of not two but three impact categories – two of which meet the golden rule test. One such behaviour/outcome occurs when an individual – or enterprise – chooses to do good for someone else to their own detriment. We typically refer to such behaviour as altruism or selflessness. More precisely, though, we can label this ‘lose–win’ behaviour. The one taking action is disadvantaged for the sake of benefiting another.
Most of us have a tenuous relationship with selflessness. We acknowledge its moral attractiveness yet practise it infrequently. There are exceptions, of course. Many parents exhibit a great deal of lose–win behaviour towards their children. Good soldiers in combat may do so as well. And good spouses. Nevertheless, selflessness seems more the province of saints like Mother Teresa than us ordinary mortals. Across the landscape of human behaviour it is decidedly more the exception than the rule.
Fortunately there is another behaviour/outcome that also fulfils the golden rule. Win–win behaviour, as noted earlier, occurs when someone’s conduct brings about a beneficial outcome for themselves and for the other individual(s) affected by their action. Such behaviour is almost always motivated by self-interest. Yet it entirely meets the ‘Love your neighbour as yourself’ moral test.
Selflessness, therefore, is not the only way to keep the golden rule. Self-interested actions also meet the test for good and moral behaviour — provided they don’t come at the expense of others. It’s only when self-interest crosses over from win–win behaviour into win–lose territory that it violates the golden rule and becomes what most of us call selfishness (Ayn Rand and certain economists notwithstanding). A simple summary diagram should prove helpful (see Figure 1).
A great deal of what passes for moral commentary, at least as it relates to business and economics, assumes the important moral watershed is between selflessness and selfishness (or self-interest) – as if the foundational injunction is to ‘Love others rather (or more) than yourself.’ This both misunderstands the golden rule and misses the moral divide of real consequence.[6]
In fact the line of first-order significance is that between win–win mutuality and win–lose selfishness. It is here that we find the precise divide between what is moral and immoral, the exact boundary between right and wrong. It is also the difference between good and bad outcomes or, more broadly, between blessing and blight. More prosaically it is the difference between the merchant who makes money by providing a beneficial product and the mugger who takes money at knifepoint – or the loan shark (or payday loan company) who does so via extortionate interest. One practises a morally commendable self-interest, while the others’ behaviour is morally reprehensible.
As a moral philosopher, Adam Smith understood this distinction clearly, even if many of his followers do not. In his book The Big Three in Economics: Adam Smith, Karl Marx, and John Maynard Keynes, the prolific economics author Mark Skousen describes Smith’s fundamentally moral understanding of self-interest:
Smith recognized that people are motivated by self-interest. It is natural to look out for one’s self and one’s family above all interests, and to reject this would be to deny human nature. Yet at the same time, Smith did not condone greed or selfishness. For Adam Smith, greed and selfishness are vices.[7]
Skousen elaborates Smith’s morally circumscribed view of self-interest in a piece for the Foundation for Economic Education:
[Smith] wrote eloquently of the public benefits of pursuing one’s private self-interest, but he was no apologist for unbridled greed. Smith disapproved of private gain if it meant defrauding or deceiving someone in business. To quote Smith: ‘But man has almost constant occasion for the help of his brethren … He will be more likely to prevail if he can interest their self-love in his favour … Give me that which I want, and you shall have this which you want, is the meaning of every such offer.’ In other words, all legitimate exchanges must benefit both the buyer and the seller, not one at the expense of the other.
Smith’s model of natural liberty reflects this essential attribute: ‘Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men.’[8]
All of which makes especially compelling Smith’s pithy, emphatic statement of what we might call the ‘foundational justice dictate’ in his earlier (1759) masterwork, The Theory of Moral Sentiments: ‘There can be no proper motive for hurting our neighbour.’[9] It would be hard to misinterpret that.
The bottom line is this: Adam Smith, the father and foremost apologist for self-interested capitalism, nevertheless saw a bold bright line between actions that benefit both us and our neighbour versus those that help us but harm our neighbour. He recognised that a self-interested win–win mutuality was essential to business success and the creation of wealth, yet never countenanced win–lose selfishness and predation. He knew that taking advantage of others for one’s own benefit is both deplorable and dangerous. Smith understood clearly (along with virtually every other moral thinker throughout history) that such predatory behaviour undermines the very foundation of human society – and deserves to be roundly condemned by all.
This is consequential for three key reasons:
During the middle portion of the twentieth century, American business was the envy of the world. American corporations were the pre-eminent global leaders in virtually every industry. And the prevailing view among CEOs and business academics was that the purpose of a corporation was to create value for several different constituencies, more or less in this rank order: customers, employees, host communities, society and shareholders. In practice this meant companies generally aimed at win–win outcomes vis-à-vis their various stakeholders.
But starting in the 1970s, American business embraced an entirely different conception, a view that the pre-eminent purpose of a corporation is to maximise the wealth of its owners.[10] This view, labelled ‘shareholder value maximisation’ (SVM), has been the prevailing consensus ever since.
This watershed reconception of business purpose was first advanced by Milton Friedman in his famous 1970 opinion piece in The New York Times Magazine entitled, ‘The Social Responsibility of Business is to Increase its Profits’.[11] Then in 1976 two business academics, Michael Jensen and William Meckling, published ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’.[12] This hugely influential article argued for giving CEOs substantial grants of stock, or stock options, to better ensure their energies were pointedly focused on behalf of shareholders.
But it was in the 1980s when business people themselves embraced in a big way this new understanding of corporate purpose. They were especially influenced by Jack Welch’s 1981 speech, ‘Growing Fast in a Slow Economy’, in which he made clear that, henceforth, General Electric’s primary objective would be to return maximum value to shareholders.[13] This conception of corporate purpose has reigned supreme in America ever since. (It got considerable, but less, traction in other English-speaking countries, and relatively little in Europe.)
In practice, SVM has translated into a rigorous focus on maximising short-term profits. But maximising one outcome necessarily means sacrificing others. So when profits conflict with creating value for customers (or with the good of employees, suppliers, host communities or even society as a whole), SVM dictates that profits prevail.
In fact this understates the distorting effect of SVM. Once corporate purpose is defined in terms of immediate maximised wealth for shareholders, the priority job of senior management becomes channelling every dollar possible away from employees, suppliers, communities, society, even away from research and development for future growth – all for the sake of a fattened bottom line this quarter or next. SVM represents, therefore, a giant turn towards selfishness, towards advantaging business owners – senior management owners in particular – at the expense of everyone else.[14] Consequently a great many businesses have moved squarely into the win–lose, plunder and predation end of the moral landscape.
The effects have been severe. Rather than a last resort, layoffs are now a go-to choice to boost near-term profits. Pension plans have all but disappeared. For many retail workers, so too have predictable hours and incomes. More and more health care cost has been pushed from employers to employees. At a more foundational level, the ‘gig economy’ threatens to undo the entire landscape of worker protections, blithely turning employees into contractors with virtually no rights or security. And maybe most significantly, the share of economic output flowing to profits (shareholders) is at an all-time high, while the proportion flowing to workers has never been smaller (see Figure 2).[15]
Of course, corporate win–lose predations are hardly restricted to employees. Anti-customer corporate scandals – GM’s ignition switch, VW’s emissions cheating, Wells Fargo’s bogus accounts, Wall Street’s seemingly endless stream of malfeasance – have become commonplace. So has corporate tax avoidance, including through domicile inversions and aggressive use of tax havens.
And what about unilaterally pushing business costs onto taxpayers? As a rather notable instance, American taxpayers spend in the vicinity of $8 billion a year providing poverty assistance benefits to Walmart workers[16] – despite the company topping the 2016 Fortune Global 500 with revenues of $482 billion. And, of course, there’s this egregious example of misbehaviour: less than a decade ago the greed and recklessness of our largest financial institutions came within a hairsbreadth of taking the entire global economy over the cliff.
No wonder the ranks of capitalism’s critics continue to swell, as does the vehemence of their critiques. No wonder more young people now say they prefer socialism to capitalism (43 per cent to 32 per cent).[17] No wonder the communications group Edelman reported recently that the credibility of corporate CEOs has fallen ‘off a cliff’, dropping 12 points in just the past year.[18]
There is a better way. Business, practised wisely and well, is an extraordinarily powerful means for human betterment. Business fulfils this high calling by creating value for its stakeholders in two particular and important ways. First and foremost, business solves human problems. In fact it solves an especially large and important set of human problems: the material challenges of human existence.
Virtually every product and service offered by business is meant to meet a material human need.[19] In some cases business products may represent novel and dramatic new solutions to those needs (breakthroughs), as happened with the invention of automobiles, personal computers and mobile phones. In other cases the solutions may be more modest: a less expensive option for air travel, a more comfortable mattress or a non-polluting laundry detergent. All of which makes business, quite literally, a solutions machine targeted at humankind’s material welfare.
But business creates an entirely different type of value as well. When a business sells its products for more than their cost of production, it creates profit – and thereby enlarges human wealth. Provided this wealth is broadly deployed rather than narrowly hoarded, business both solves human problems and creates the economic provision that makes those solutions affordable and accessible.
Both forms of value creation are extraordinarily important. As Eric Beinhocker and Nick Hanauer note in their compelling article, ‘Capitalism Redefined’: ‘Ultimately, the measure of a society’s wealth is the range of human problems that it has found a way to solve and how available it has made those solutions to its citizens.’[20] It is no overstatement, therefore, to say that business provides the material foundation for human flourishing.
Or, more precisely, business is capable of providing the material foundation for human flourishing. It delivers these great benefits when, and to the degree that, it engages in win–win behaviour. Period. But win–lose behaviour is an entirely different matter. When business selfishly and narrow-mindedly pursues profits at the expense of stakeholders, then it becomes something altogether disparate. Rather than a means of value creation, it becomes a mechanism for value extraction – in other words, for plunder and stealing. That version of business – based on the intrinsically selfish ideology of shareholder value maximisation – rightly deserves the ire and condemnation increasingly directed against it.
The Business 360 Framework[21] provides a helpful analytical tool by which to understand and apply all this in practice, as shown in Figure 3. The top-left part of this figure identifies the crucial difference between win–win behaviour that creates value for stakeholders, versus win–lose behaviour that extracts value, and provides a +100 to -100 reference scale. The top-right part lays the basis for applying this create-versus-extract value assessment to each of a company’s primary stakeholders. The bottom-left and bottom-right parts show, in turn, two sample 360 Impact Maps that might result from such an analysis. We might label these particular assessments ‘Business for blessing’ (bottom-left) and ‘Profits by plunder’ (bottom-right). More simply, let’s just call them examples of good business versus bad business.
Is good business too much to ask? Hardly. First off, it’s the way business was characteristically practised until recently, including during its (American) mid-twentieth-century heyday. Second, it asks business to forsake neither self-interest nor the pursuit of profit. It simply requires that business not pursue self-interest and profit in ways that harm others. How is that unreasonable? (And what argument would business make as to why it should be allowed to inflict harm on others?)
More importantly, win–win behaviour is in the best interest of business. Treating others the way we want to be treated is the only behaviour that really works. It’s the behaviour that creates trust and fosters relationship. These are the essential building blocks of sustainable business success – trust and relationship with customers, with employees, with suppliers and so on. In fact without trust and relationship, business grinds to a halt.
It’s not surprising, then, that the empirical evidence for golden-rule behaviour in business is compelling. In The Ultimate Question, first published in 2006, Fred Reichheld introduced the powerful new business metric Net Promoter Score (NPS). Superficially, NPS measures how well or poorly a company satisfies its customers. But according to Reichheld, what NPS really measures is golden-rule behaviour. In turn, Reichheld marshals compelling data demonstrating that companies with superior NPS scores have substantially higher rates of profitability and growth than their competitors.
Similarly, in her 2013 book The Good Jobs Strategy, Zeynep Ton, one of the foremost retail operations experts, makes a powerful empirical case that – even in the extremely price-sensitive arena of low-cost retail – the most successful companies are the ones that pay and treat their workers well. Specifically, she found that these ‘good jobs’ companies were anywhere from 50 to 300 per cent better than their competitors at bottom-line performance metrics such as inventory turns, sales per employee and sales per square foot.
Let’s complement this with some anecdotal evidence:
Isadore Sharp, founder and chairman of the Four Seasons hotel group: ‘Our success all boils down to following the golden rule.’
Colleen Barrett, retired president of Southwest Airlines: ‘Practising the golden rule is integral to everything we do.’
Andy Taylor, CEO of Enterprise: ‘golden rule behaviour is the basis for loyalty. And loyalty is the key to profitable growth.’[22]
John Bogle, founder and former CEO, Vanguard Group: ‘You [only need] one rule … “Do unto others as you would have them do unto you.”‘[23]
The ‘golden rule’ is called that for a reason. Throughout human history it has been the gold standard for good behaviour. And for prudent behaviour. Profiting at the expense of others may work in the short term but not in the long. The merchant who delivers good value can expect to operate indefinitely; not so the knife-wielding mugger. Or as Jim Collins says in his seminal book Built to Last: ‘You can cheat your way to seeming greatness for five or ten years, but not for fifty or one hundred years.’[24]
It’s high time, therefore, for American public company CEOs to give up their profits-by-plunder myopia; high time to forsake win–lose value extraction and recommit to win–win value creation for all stakeholders. It’s how capitalism was always meant to work – for everyone.
[1] Edward L. Glaeser, ‘Can Business Do Well and Do Good?’, The New York Times, 6 January 2009; emphasis added.
[2] From Quote Investigator: Exploring the Origins of Quotations, http://quoteinvestigator.com/2011/02/23/capitalism-motives.
[3] From Quote Investigator: Exploring the Origins of Quotations, http://quoteinvestigator.com/2011/02/23/capitalism-motives.
[4] https://en.wikipedia.org/wiki/The_Virtue_of_Selfishness.
[5] Transcript of Milton Friedman interview quoted in ‘Donald Trump Says Greed Is Good’, by Aaron Sandler, The Daily Wire website.
[6] Which is not to say the divide between selflessness and self-interest is unimportant. It has considerable significance related to one’s character growth and spiritual development. But as regards outcomes, and the difference between right and wrong, moral and immoral, the dividing line of real consequence is between win–win mutuality and win–lose selfishness and predation.
[7] Mark Skousen, The Big Three in Economics: Adam Smith, Karl Marx, and John Maynard Keynes, Armonk, NY and London: M. E. Sharpe, 2007, p. 29.
[8] Mark Skousen, ‘Is Greed Good?’, Foundation for Economic Education, 1 May 2001; emphases in first paragraph added; emphasis in second paragraph original.
[9] Adam Smith, The Theory of Moral Sentiments, II.ii.2.
[10] In her excellent book The Shareholder Value Myth, the respected Cornell Law School professor Lynn Stout makes a convincing case that neither shareholders nor anyone else are the legal owners of corporations. That said, whatever their precise legal status, in the shareholder-centric version of business embraced in the USA since the 1980s, shareholders are clearly the effective and beneficial owners of public corporations – Lynn Stout, The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public, San Francisco, CA: Berrett-Koehler, 2012.
[11] Reprinted in Walther Ch. Zimmerli, Markus Holzinger and Klaus Richter (eds), Corporate Ethics and Corporate Governance, Heidelberg: Springer, 2010, pp. 173–8.
[12] Michael C. Jensen and William H. Meckling, ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’, Journal of Financial Economics 3:4, 1976, pp. 305–60.
[13] John F. Welch, ‘Growing Fast in a Slow Economy’, speech to financial community representatives, Hotel Pierre, New York, 8 December 1981.
[14] In fact it disadvantages long-term shareholders as well. A major study from the Harvard Business School, ‘Competitiveness at a Crossroads’, February 2013, comes to the blunt assessment that American business is losing the ability to compete in the global marketplace. Much of this is driven by companies’ squeezing research and development budgets to maximise short-term profits and fund dividend payments and stock buybacks.
[15] This chart comes from Andrew Smithers, economist and founder of Smithers & Co. Until recently he also wrote a recurring column for the Financial Times. The chart can be found at www.pbs.org/newshour/making-sense/merle-hazard. To be clear, SVM has not been the only driver of the disproportionate flow of business rewards towards owners and away from workers during the last few decades. Globalisation and automation have also had significant effect. Without the embrace of SVM, however, business would have looked for ways to mitigate the anti-worker effects of these other factors. Instead, SVM justified a wholesale embrace of any measures that fattened profits at the expense of workers and/or other stakeholders.
[16] ‘The Low-Wage Drag on Our Economy: Wal-Mart’s Low Wages and their Effect on Taxpayers and Economic Growth’, a report from the Democratic Staff of the US House Committee on Education and the Workforce, May 2013.
[17] Catherine Rampell, ‘Millennials Have a Higher Opinion of Socialism than of Capitalism’, The Washington Post, 5 February 2016.
[18] 2017 Edelman Trust Barometer: Global Annual Survey, 15 January 2017, www.edelman.com/trust2017.
[19] That said, it should be acknowledged that some businesses meet ‘needs’ that many may judge to be illegitimate – such as pornography or gambling.
[20] Nick Hanauer and Eric Beinhocker, ‘Capitalism Redefined’, Evonomics, 30 September 2015 – http://evonomics.com/redefining-capitalism-eric-beinhocker-nick-hanauer; originally published in Democracy: A Journal of Ideas, 31, Winter 2014 – http://democracyjournal.org/magazine/31/capitalism-redefined/?page=all.
[21] Developed by Eventide Asset Management, LLC as a guiding framework for ‘better investing for a better world’.
[22] All three quotations are from Fred Reichheld with Rob Markey, The Ultimate Question 2.0: How Net Promoter Companies Thrive in a Customer-Driven World, Boston, MA: Harvard Business School Publishing, 2011.
[23] John C. Bogle, ‘What I’ve Learned in a Half Century in Business – Twelve Rules For Building A Great Work Force’, 23 April 2003, www.vanguard.com/bogle_site/sp20030423.html.
[24] James C. Collins and Jerry I. Portas, Built to Last: Successful Habits of Visionary Companies, New York: HarperBusiness, 1994, p. xi.
An interesting example of market transformation can be seen in the growth of worldwide spending on beauty products, which reached $440bn in 2024. There are various trends (or pressures) at work, with men now feeling freer to spend on beauty products and demand growing among young people, who are purchasing such products at much earlier ages than their grandparents. Social media has played a significant role: as influencers share their beauty regimes, the online space is becoming the biggest shop window for the beauty industry. Additionally, there has been a shift in the marketing and consumption of beauty products, as consumers have become increasingly interested in the ingredients of the products that they buy and their supposed effects. In consequence, packaging is now plainer and bears something of the ‘laboratory look’.
Naturally there are concerns about trends among young people. With reports that beauty products are now being bought by children as young as eight, there has been alarm at the loss or increasing sexualisation of childhood, as well as concern about the damage that certain products can do to children’s skin. In consequence, there have been calls for regulation. It is normal to seek restriction or regulation of products that are deemed harmful, as witnessed in relation to tobacco, for instance, and more recently in connection with tobacco alternatives, such as of vapes and nicotine pouches. In connection with the beauty industry, one might wonder whether (or hope that) a ban on social media accounts for under-sixteens, as implemented in Australia and currently under consideration in the UK, will have an effect. Regulation in one sphere might affect associated behaviour in another. If young children are heavily invested in ‘beauty’ in an unprecedented manner – to the point of talking about anti-ageing products before they reach their teens – and social media influencers are in part responsible for driving such an interest, then restrictions on social media access could go some way towards addressing the problem. However, it is important to consider whether regulation is the answer.
The thought of the sociologist Max Weber (1864-1920) perhaps offers one means of shedding light on the issue. Weber described the phenomenon of ‘disenchantment’ and its effects on society. With the advance of reason and scientific principles, it becomes increasingly difficult to believe in spirits, gods or supernatural forces, with the result that the influence of religion and superstition is diminished. As the world becomes demystified and science is able to explain everything in rational terms, the world loses its mystery and appears mechanised and predictable. However, science cannot adequately fill the void created by the ousting of religion and people are no longer able to find the kind of meaning once provided by the values grounded in traditional beliefs; moral questions can be articulated and analysed, but not satisfactorily answered.
Some have questioned Weber’s account of the disenchantment of society, while others have proposed the possibility of re-enchantment: meaning and value – if they have indeed been lost – can be restored to the disenchanted world, either by projecting subjective values onto it, or by locating value as objectively existing in nature itself.
One interpretation of a shift in the market for beauty products might employ these concepts. Is the move towards a greater interest in the active ingredients of cosmetics a sign of an increasingly ‘scientific’ mindset, as society becomes more rational? Or is this in fact a form of re-enchantment, whereby ‘science’ – however ‘science’ is understood – is elevated to the status of religion and becomes a new dogma or article of faith? Do those who seek to buy plainly packaged cosmetics that resemble medicines display a tendency to deify ‘science’, almost to the point of seeking purpose and meaning in it? If influencers with questionable credentials in dermatology are helping to drive sales, perhaps such an account is not so far-fetched.
Perhaps the disenchantment thesis is able to make some sense of the disproportionate interest in beauty among young people, with children buying – or being given – adult cosmetics. In a disenchanted society in which transcendent values and traditional notions of meaning are lacking, preferences are shaped by other forces – or themselves become the locus of value and meaning. In either case, they can become disordered and unrestrained. Might skewed and superficial notions of beauty, driven in part by the forces of consumerism and assisted by social media, be behind the behaviour of some children? Where certain values have lost their influence, it is possible that people no longer see anything wrong with eleven-year-olds using anti-ageing products. If that is what they want and their parents have no objection, the thought might run, then so be it.
It is no surprise that there are calls to regulate access to social media for children. Social media – or its excessive use – has been associated with all manner of ills. The question is whether restriction will solve the problem. Likewise, we might ask whether, should the trend towards childhood use of adult cosmetics reach a scale at which it is felt that something must be done to protect the physical and developmental health of children, regulation would prove effective.
Markets simply match vendors with buyers, and it is something of a truism that businesses, if they want to survive, adapt to markets – or seek to shape them – in order to be able to offer a product for which demand exists. In the sense that the demand side of the ‘supply and demand relationship’ characteristic of markets is shaped by societal values, it is clear that markets do not simply serve society; they reflect it, too. When we hear calls for regulation to address problems, it is important to consider whether regulation can achieve the desired outcome. For instance, what manner of legislation could ever prevent parents from buying anti-ageing or beauty products for their barely-teenage children? In the absence of parental oversight, can any regulation really prevent determined teenagers from accessing social media? Parents who buy £1,000 phones and let their children scroll through social media until the small hours, or buy expensive, adult cosmetics for their children because ‘this is what she wants’ or ‘these are what her friends have’ are arguably not matters for regulation. These are questions of values.
Markets can only serve a society because to some degree, they act as a mirror of that society. Where markets are an expression of who we are or what we have become, concerns ought perhaps to be directed not at the statute book with a view to controlling the market itself, but at our own values: the attitudes of the society that the market both reflects and serves.
Image by Freepik (www.freepik.com)
Neil Jordan brings to CEME seventeen years’ experience of academic publishing, having previously served as a senior commissioning editor for Ashgate and Routledge where he specialised in research level publications in the social sciences. His primary focus was on sociology and social theory. Neil has also been employed as a teacher of philosophy and religious studies. He holds bachelor’s and doctoral degrees in philosophy, both from the University of Southampton, and has published on the subject of ethics.
Richard Turnbull
Capitalism is a complex word, even inadequate. Marxism uses the term in contrast to ‘labour’ (with the assumption that the accumulation of capital can only be at the expense of labour, a zero-sum game). Economic theory holds capital to be one of the ‘factors of production’, land, capital, labour and entrepreneurship, which at least allows for economic growth. Capitalism, at least in the public mind, may be linked with the opportunities, personal responsibility and individual freedom that lead to wealth creation, or with greed, lack of opportunity and inequalities that may lead to poverty – sometimes even in the same survey.[1] The Ipsos Mori Veracity Index 2016 lists ‘bankers’ and ‘business leaders’ in 19th and 20th places out of 24 professions in terms of being ‘trusted to tell the truth’.[2]
There are many dilemmas. The globalisation of world trade has extended the benefits of growth, not least reductions in global poverty, but not only is the growth shared unevenly, the exclusion of many from the benefits leads to alienation. Corporate structures have tended to reinforce rather than resolve the problem. Oligopolistic markets that lack real competition are not really capitalism at all. Neither are public bailouts for failed businesses – even banks; more like socialism for the already wealthy. Corporate values and ethics as expressed in a firm’s statement of purpose, mission or values have not prevented scandal.
So for some, the recovery of moral purpose in capitalism is an oxymoron. Nevertheless, the fact remains that it is the capitalist economic system that, for all its failings, delivers goods and services, well-being of individuals and communities, provides employment and opportunity and encourages enterprise and entrepreneurship. The recovery of moral purpose for capitalism, rather than being a contradiction, is the essential prerequisite for its effectiveness.
Therefore perhaps capitalism is the wrong word to describe an enterprise, market-based economy built on values of purpose, service and integrity. In other words, an economy with values shaped historically by the Judaeo-Christian ethic, encompassing growth, reward, incentive and opportunity, but also fairness, responsibility and compassion as integral elements. Yet capitalism is here to stay. Adjectives such as inclusive, conscious, restorative, relational have all failed to capture the imagination. What capitalism needs is not a new definition but the restoration of moral purpose in markets, in business purpose, conduct and structure and, indeed, in the character of market participants.
However, we should begin by setting out the contours of capitalism or enterprise. The debate too often begins in the wrong place – a rogue trader in a bank, a corporate scandal or issues of executive pay. From the problems, solutions are debated. The issues may indeed be very important, but if there is to be a holistic approach to creating an enterprise economy, then it is essential to begin with a vision for the market economy itself.
At the heart of the moral case for enterprise and capitalism is, first, the necessity of wealth creation for the economic and moral well-being of society. The most effective mechanism for achieving the economic growth necessary for the common good is the market economy. This is the means for the provision of goods and services, the management of savings and investment, the encouragement of the propensity to save, the provision of employment and a tax base. The market economy brings inestimable benefits to society. As the late Michael Novak (1933–2017) notes:
Of all the systems of political economy which have shaped our history, none has so revolutionized ordinary expectations of human life – lengthened the life span, made the elimination of poverty and famine thinkable, enlarged the range of human choice – as democratic capitalism.[3]
This, he argues, means ‘a predominantly market economy; a polity respectful of the rights of the individual to life, liberty and the pursuit of happiness; and a system of cultural institutions moved by ideals of liberty and justice for all’.[4] The evidence for the positive impact of the market on poverty reduction is insurmountable. Extreme poverty has fallen.[5]
A second crucial element to capitalism is freedom to trade and undertake economic activity. The market brings buyer and seller together, who trade, to mutual advantage, at the agreed price. William Bernstein tells the extraordinary story and history of trade and the overwhelming mutual benefit humanity has gained from the principle of trade: ‘World trade has yielded not only a bounty of material goods, but also of intellectual and cultural capital.’[6]
Both these points, which are all too frequently lost in debate, are reinforced by Milton Friedman’s observation that he knew of ‘no example in time or place of a society that has been marked by a large measure of political freedom, and that has not also used something comparable to a free market to organise the bulk of economic activity’.[7]
Economic growth, of course, is a contested area. For some, ‘only relative growth is possible: the global economy is playing a zero-sum game, with an ever-shrinking pot to be divided among the winners.’[8] However, without the wealth creation generated by the market, which leads to economic growth, it is impossible to deal effectively with issues of poverty and social welfare; to suggest otherwise is illusory.[9] Indeed, ‘higher per capita income is strongly correlated with some undeniably important factors, such as longer life expectancy, lower incidence of disease, higher literacy and a healthier environment.’[10]
Third, the propensity to save. The importance of savings – deposits, investment funds, life and pension funds – is often overlooked. The efficient pooling and investment of this capital in high-quality, innovative companies, technological advance and product development is an essential driver of growth and employment in an enterprise economy.
The market is an efficient mechanism but it is not perfect. There are problems of monopoly, oligopoly, price fixing and the fact that the market is populated by individuals who are themselves not perfect but flawed. In the same way that the benefits of the market cannot be ignored, neither can its imperfections. Similarly, economic growth may accrue unevenly. Thus the market may lead to inequalities. Equality is not a goal per se – but extreme inequalities reinforce the loss of opportunity in an economy, significantly dampen aspiration and may result in lack of access to justice or the other basic institutions of civil society.
The first problem lies then in the failure of competitive markets. So, for example, in both banking and energy sectors in the UK, the market is dominated by a small number of large players. The consequence of this is that price competition is reduced, consumer choice may be limited and there are significant barriers to entry and the potential for restrictive practices. Reduced choice and high prices disproportionately affect the poor. In the early 1800s there were some 800 country banks, outside London. With the advent of joint-stock companies there were, by 1866, some 154 joint-stock banks that were members of the clearing house system; now there are just five.[11]
The second problem is the painful consequences of reallocating capital. The impact of the movement of capital from a dying or declining industry into new areas of growth has significant and negative structural impact. This may be true in terms of unemployment, the knock-on effect on consumer spending, issues of poverty and structural decline of communities. The market may indeed bring about long-term recovery but the impact of the decline and its effects cannot be denied. For example, in 1971 there were, in the UK, 320,000 people employed in the steel industry. By 2015 this had fallen to 21,000 (with a further 10,000 in steel processing). From 1975 to 2015, employment in the steel industry in Wales fell from over 60,000 to 8,500.[12] The brunt of this impact has fallen on particular communities, such as, for example, Port Talbot in South Wales.[13]
The third issue is the exploitation of power often seen in examples of corporate and personal greed. This perception of corporate greed is further reinforced by apparent rewards for failure, excessive remuneration and failings in corporate governance. All of these things underline the sense of ‘crony capitalism’, the accumulation of capital by the few, and greed.[14]
The point is that a combination of capital accumulation, globalisation of production, structural decline in industries and failings of corporate governance, combined with greed and malpractice, produces effects that cannot be ignored.
The market economy has always attracted people of faith. The reasons are, of course, varied. Sociologists will point to the ‘Protestant work ethic’ and the formation of what Max Weber referred to as ‘the spirit of capitalism’.[15] In other words, Protestants worked hard for the Lord in the world, their faith of individual discipline shaping a work ethic. For others, such as the Quakers, persecution and exclusion from the universities and from public office meant that many turned not only to business per se but also to technological research and development. Quaker involvement in manufacturing and banking went considerably beyond their numerical influence. It is quite extraordinary how many of our companies – Cadbury, Barclays, Huntley & Palmer, Clarks – had Quaker origins. The Quakers produced ‘advices on trade’ over many decades, warning against everything from overtrading to indebtedness and advocating the priority of good accounting. They made provision for the welfare of their employees – from sick pay to pensions; from savings banks to model housing.[16]
However, these explanations are only partial. Two other factors have formed and shaped how people of faith have influenced business. First, the development of culture. People of faith have often formed networks of families, contacts, even schools and so on. These factors led to a culture of trust and integrity in business dealings. Trade networks, credit finance, apprenticeships all developed through these culturally shaped groupings. In addition to that, most religiously minded people had clearly developed moral codes – for the Christian most usually the Bible – and as a consequence, habits of moral behaviour (honesty) also translated into business practice: fair pricing, resistance to bribes, weights and measures and indeed concern for employees and wider society.
Faith provided, for some though not all, a framework of culture and conduct. Both of those aspects of a moral, purposeful, inclusive business ethic are today often sadly lacking.
In 1987 one of the leading chemical conglomerates at the time, ICI, described its purpose as follows:
ICI aims to be the world’s leading chemical company serving customers internationally through the innovative and responsible application of chemistry and related science. Through the achievement of our aim we will enhance the wealth and well-being of shareholders, employees, customers, and communities which we serve and in which we operate.
In 1994 the company objective had changed to:
Our objective is to maximise value for our shareholders by focusing on businesses where we have market leadership, a technological edge, and a world competitive cost base.[17]
So what changed? What changed so that ICI no longer aimed to be ‘the world’s leading chemical company’? What changed such that ICI’s application of science was no longer to be ‘the innovative and responsible application of chemistry and related science’ but only that in which they had ‘a technological edge’? What happened to the ’employees, customers, and communities which we serve’, to be replaced by ‘to maximise value for our shareholders’?
The case of ICI is illustrative of the way business has become separated from ethics, values and a truly holistic purpose that serves the economy and society well.[18]
The problem lies in the way ‘shareholder value maximisation’ has become the single measure of business return. Continued adherence to this mantra imperils the future of the enterprise economy.
Profit – the surplus of revenues over costs, the value added to goods in the process of manufacture and sale – is a deeply moral concept. Profit is essential to the proper, effective and long-term functioning of a business. However, profit is essentially a by-product of purpose.
The objective of profit does not stand alone but is set in the context of a business’s wider purposes. It is one that brings value to our ever globalised, ever competitive marketplace, in a manner that continually strives for a goal that is greater than itself. Profit becomes a by-product of this purpose-driven business model.[19]
Shareholder value maximisation is one of several factors that encourage short-term decision-making over long-term values. Others would include the tenure of CEOs, the expectations of quarterly reporting and executive remuneration based on short-term performance. Current shareholders benefit at the expense of future shareholders. The conclusion might be that all that matters is the current share price and hence company valuation. Not so.
Bill Drayton, founder and chairman of Ashoka: Innovators for the Public, and named in 2005 as one of the 25 best leaders in the USA by US News and World Report, observes: ‘For three centuries the social and business halves of society drifted apart. So far apart that they developed different languages, styles, legal structures, and mutually negative stereotypes of one another.’[20] This separation goes to the heart of why business has become compartmentalised from the communities and societies whose fundamental consent and licence is essential for enterprise to operate effectively. The social contract is breaking down.
This separation is not one that can be simply bridged by corporate social responsibility, which is more a symptom of the divide than a solution.
Historically the business world has been more connected to communities and society in both direct and indirect ways. In the nineteenth century many factory owners developed ‘model villages’.[21] The idea that industrialists, entrepreneurs and business owners might build such model villages is, to many, surprising if not somewhat baffling. These villages remain today as monuments to a bygone age. However, their development reminds us that in the period of the great Quaker firms, business magnates had a real vision for the relationship of business, family, workforce, locality and wider society.
The model villages were an expression of this integrated vision. In Bournville the houses had gardens; there was planned open space, a village green, cricket ground; and provision was made for schools, worship, shops, adult education facilities, libraries, schools, baths and so on. Both Cadbury and Rowntree decided against ‘out and out sale of housing at cost price’[22] or anything that had the ‘stamp of charity’,[23] preferring long leases with mortgages and deposits on a sliding scale.
There were wider housing examples in London. The Artizans’, Labourers’ and General Dwellings Company, a for-profit joint stock company whose President was the Christian social reformer Lord Shaftesbury, built 6,400 residences for working people by 1900, accommodating 42,000 people. Other examples included the Four Per Cent Industrial Dwellings Company – the clue being in the name – and the Metropolitan Association for Improving the Dwellings of the Industrious Classes, which adopted business principles for social purposes. Business principles and capital return for social good.
The nineteenth century also saw the beginnings of micro-finance and local banking. The Emily Loan Funds were established in memory of Lord Shaftesbury’s wife, who died in 1872. They were aimed especially at flower sellers who could not operate in winter. The Fund would loan an amount to enable these women to purchase stocks of goods suitable for sale in winter or else the hire of a potato oven. Other similar ‘finance societies’ funded the purchase of barrows or donkeys with low-cost loans. We also see banking at work among the poor, pertinent today in our debates about credit unions and so on. Penny Banks and Provident Societies were effectively savings banks, taking small deposits on a weekly basis.
Today this application of business skills to social problems is called ‘social entrepreneurship’ and ‘social impact investing’. The Organisation for Economic Co-operation and Development (OECD) defines social impact investment as investment made ‘with the intention of generating a measurable, beneficial social and environmental impact alongside a financial return’.[24] There are other ways of approaching the issue of definition but the essence is that social impact investing involves both financial returns and measurable social impact.
Social enterprises have become one of the new modes of business organisation for social purposes. The most effective social enterprises use a variety of means of capital, including venture capital and private equity. In addition, there will be robust governance structures, highly skilled individuals, diverse partners and a clarity of social vision. In this way it is possible to harness significant funds to achieve social purposes through the application of business skill and commercial objectives.
How then are we to respond to these changing features of capitalism and restore moral purpose to the heart of an enterprise economy?
Purpose needs to be restored to business. This restoration of purpose cannot be reduced to either legislative or corporate social responsibility. However, as a starting point, the repeal of section 172 of the Companies Act 2006 would signal intent. Section 172 requires directors to act for the success of the company for the benefit of members (effectively shareholder value maximisation), while having regard for employees, customers, suppliers and environmental impact. The effect of the section is to establish a hierarchy of priorities. As Professor Andrew Keay has said, the bottom line is: ‘Did the action promote the success of the company for the benefit of the members?’[25]
However, purpose cannot simply be legislated for. Purpose and values can only be implemented in a culture. Both the history and academic study tells us, as Professor Mark Casson has argued, that ‘the quality of entrepreneurship depends on the quality of business culture.’[26] So one further step is to emphasise that business success cannot be measured by a single numerical value. A second step is to think about how culture is determined. There may, in this regard, be considerable differences between the culture of a small- or medium-sized enterprise (SMEs) and that of a large corporate entity. A small, family-run company is likely to have a very strong culture, which may be benevolent or otherwise; a large corporate may have more defined processes and perhaps a very open culture, but face significant pressures on culture from middle management in particular.
A business culture can be defined as the attitudes, expectations and processes that shape the behaviour of a company and its employees in the conduct of business. Culture therefore includes both formal and informal aspects, personal characteristics and example, as well as good-quality processes. The key challenge is how to implement these expectations throughout a company.
The complexity is this: to argue that, for example, a culture should be transparent is easy to write but less so to implement. However, there are some questions that might help in forming and shaping an appropriate corporate culture:
The idea of the joint-stock company – that is, a company with external shareholders who share fully in the profits but are limited in their losses – has been a vehicle for raising capital for investment for over 150 years. While the structure has many advantages, its ambiguity is shown by the simple fact that prior to 1855 (the introduction of the Limited Liability Act), the establishment of a joint-stock company required an Act of Parliament. Even The Economist recognised the complexity: in 1856 the magazine regarded limited liability as overrated; by 1929 as indispensable.[27]
The answers to the problems of capitalism do not in themselves depend on corporate structure. However, structure can provide a framework from which other matters flow. Indeed, society is increasingly recognising the importance of corporate governance.
There are two aspects to consider. The first is formal structure. There are those, such as the B Corporation movement, who advocate formal changes to corporate structure, such as through the Memorandum and Articles of Association and an accreditation process. Professor Colin Mayer advocates a ‘trust company’ with a ‘board of trustees’ responsible for the stewardship of corporate values and voting rights dependent on the length of time equity shares are held.[28] More detailed reflection on the relative merits of such approaches is beyond the scope of this chapter. However, in essence the more company law allows for a wider and greater variety of structures, the greater the opportunities for exploring new ways of inculcating purpose and values within a corporate structure.
The second aspect is new approaches within the current structures. The idea of the non-executive director is a powerful one in terms of checks and balances within the system. The problem is that many non-executives fail to maintain the vigorous independence the role requires. Similarly, for some the non-executive role becomes a career in itself. Thus the professions and the professional bodies should be encouraged to widen the pool of potential non-executive directors through identification, mentoring and training. Similarly, some consideration should be given to restricting the number of non-executive roles that may be held by one individual simultaneously, so that full attention can be given to the discharge of the responsibilities.
There is also the question of the handling of certain ‘hot potato’ topics. Executive remuneration is probably the most significant of these but there may also be supply-chain, environmental or employee-related issues. In essence these are reputational matters. A healthy capitalism does not mean that executives should not be well remunerated or that credit should not be taken from suppliers. However, companies with good ethics and values will want to ensure that pay reflects merit and long-term performance; that smaller suppliers are not exploited in respect of payment terms; that the contractual arrangements of employees are not abnormal, unreasonable or exploitative; and that firms take seriously their environmental impacts. In essence, clear and transparent policies are the key here, although some would argue, for example, that a company’s annual remuneration report (if applicable) should be formally voted on by shareholders or the ratio of pay within the company published. These suggestions may indeed warrant adoption, but a more radical approach would be for an annual report from the independent non-executive directors covering all the key areas of risk or contention, such a report requiring to be approved at the AGM, published on the website and circulated to all employees, key customers and suppliers.
We are, in our current age of diversity and tolerance, very wary of enjoining moral codes on others. Ultimately the question is one of character. No amount of legislation, structural organisation or regulation can force good behaviour. However, society needs, for the good of business, the economy and civil society to draw a distinction between the moral and moralising. The former is a state of mind, an attitude of heart, a recognition of responsibility and an appreciation of the impact of values on behaviour. The latter is more of the nature of ‘injunctions’ concerning particular behaviours. The consequences of a failure to appreciate the central importance of moral character was clearly espoused by a quote, which although unsourced, is famously attributed to Theodore Roosevelt: ‘To educate a person in the mind but not in morals is to educate a menace to society.’
Among the consequences of moral character are a responsible attitude to wealth and also to society. The steely discipline that shapes an entrepreneur – the patient wait for return – is likely to enhance a view of wealth that recognises that such wealth was hard earned, is transient and carries responsibility. Equally, the apparent rugged individualism of the entrepreneur usually belies the reality of a team and a culture. Values shaped in such a setting are more likely to recognise a wider responsibility to civil society – or as was illustrated in the original corporate objectives of ICI: ‘to serve … the communities in which we are set’. Just like Cadbury at Bournville.
The future of capitalism, its nature, shape and organisational features, is essential to a healthy society and indeed an inclusive economy. Capitalism carries innumerable advantages for everyone. However, all is not well. This is partly due to structural problems within the market economy but much more so because capitalism as practised today has, regrettably, rather lost its way. A breadth of purpose, responsibility towards wealth, recognition of the impact on our communities and civil society, and above all the restoration of moral character and discipline, would go a long way towards repairing the tear. We need not call this ‘moral capitalism’ or ‘inclusive capitalism’; better just ‘capitalism’. Yet the word is problematic. An ‘enterprise economy’ sounds so much better.
[1] Public Religion Research Institute, Economic Values Survey 2013.
[2] Ipsos Mori Veracity Index 2016, www.ipsos-mori.com/researchpublications/publications/1896/Enough-of-Experts-Ipsos-MORI-Veracity-Index-2016.aspx.
[3] Michael Novak, The Spirit of Democratic Capitalism, Lanham, MD: Madison Books, 1982, 1991, p. 13.
[4] Novak, Spirit of Democratic Capitalism, p. 14.
[5] United Nations, The Millennium Development Goals Report 2015, New York: United Nations, 2015.
[6] William J. Bernstein, A Splendid Exchange: How Trade Shaped the World, London: Atlantic Books, 2009, p. 384.
[7] Milton Friedman, Capitalism and Freedom (40th anniversary edn), Chicago: University of Chicago Press, 2002, p. 9.
[8] Richard Heinberg, The End of Growth: Adapting to Our New Economic Reality, Gabriola, BC, Canada: New Society Publishers, 2011, p. 2; emphasis in original.
[9] Daniel Pinto, Capital Wars, London: Bloomsbury, 2014, ch. 2.
[10] Wayne Grudem and Barry Asmus, The Poverty of Nations: A Sustainable Solution, Wheaton, IL: Crossway, 2013, p. 47.
[11] A Report on the Culture of British Retail Banking, Cass Business School/New City Agenda, November 2014. See also British Banking History Society, www.banking-history.co.uk/history.html.
[12] House of Commons Library Briefing Paper, October 2016, ‘UK Steel Industry: Statistics and Policy’, p. 6.
[13] National Assembly for Wales, Research Briefing, ‘The Steel Industry: An In-depth Look’, May 2016.
[14] Examples include the original ‘rogue trader’, Nick Leeson, who brought down Barings in 1995, the recent accounting scandal around overstated profits at Tesco in 2014 and the controversy over Philip Green’s sale of BHS and its pension fund deficit in 2015.
[15] Max Weber, The Protestant Ethic and the Spirit of Capitalism, first published in German in 1905. Multiple modern translations and editions are available.
[16] For a full analysis see Richard Turnbull, Quaker Capitalism, Oxford: Centre for Enterprise, Markets and Ethics, 2014.
[17] www.theguardian.com/business/2007/jun/24/manufacturing.observerbusiness.
[18] See analysis by John Kay, Obliquity: Why our Goals are Best Achieved Indirectly, London: Profile Books, 2011.
[19] Andrei Rogobete, Ethics in Global Business: Building Moral Capitalism, Oxford: Centre for Enterprise, Markets and Ethics, 2016.
[20] Bill Drayton, ‘The Citizen Sector Transformed’, in Alex Nicholls (ed.), Social Entrepreneurship: New Models of Sustainable Social Change, Oxford: Oxford University Press, 2006, p. 51.
[21] Examples include Bournville, Saltaire, New Earswick, Port Sunlight.
[22] P. Henslowe, Ninety Years On: An Account of the Bournville Village Trust, Birmingham: Bournville Village Trust, 1984, p. 3.
[23] Joseph Rowntree Village Trust, One Man’s Vision: The Story of the Joseph Rowntree Village Trust, London: Allen & Unwin, 1954, p. 4.
[24] OECD, ‘Social Impact Investment: Building the Evidence Base’, Paris: OECD, 2015, pp. 58–9.
[25] Professor Andrew Keay, presentation at Guildhall Chambers on ‘Promotion of the Success of the Company – Section 172’.
[26] Quoted in A. Prior and M. Kirby, ‘The Society of Friends and Business Culture 1700–1830’, in D. J. Jeremy (ed.), Religion, Business and Wealth in Modern Britain, London and New York: Routledge, 1998, p. 115.
[27] Quoted in B. C. Hunt, The Development of the Business Corporation in England 1800–1867, Cambridge, MA: Harvard University Press, 1936, p. 116.
[28] Colin Mayer, Firm Commitment: Why the Corporation is Failing us and How to Restore Trust in it, Oxford: Oxford University Press, 2013.
Chris Pinney
Few would disagree that capitalism is the most powerful economic system humanity has developed. Capitalist societies have experienced unprecedented economic and social progress, creating the highest standard of living the world has ever seen. It is the principles behind capitalism, such as individual rights, private property and free markets that generated the entrepreneurship, technological innovation and wealth that gave rise to the middle class in the seventeenth century. This in turn drove the political movements that overthrew monarchies and autocrats, leading to the development of the modern democratic state and the many freedoms its citizens now enjoy.
At the same time, it was the rise of nineteenth-century industrial capitalism and the impact on workers and income inequality that created a populist backlash against capitalism in the early twentieth century, giving rise to socialist movements and communism. As we enter the twenty-first century, it is a global capitalist economy that is once again seen as driving income inequality and disenfranchising workers in developed economies while exploiting those in emerging markets. As at the turn of the last century, we once again see a strong populist backlash against global capitalism and a growing political turmoil and uncertainty. In How Will Capitalism End? the economist Wolfgang Streeck notes that capitalism for the foreseeable future will hang in limbo, dead or about to die from an overdose of itself. Streeck envisages a ‘society devoid of reasonably coherent and minimally stable institutions and a period of uncertainty and insecurity’.[1]
Despite these sorts of gloomy predictions, there is good reason to believe that capitalism can be re-imagined to avoid a rerun of the early twentieth century. To do so will require a fundamental rethink of the failing social contract that successfully balanced the interests of markets with the broader interests of society for the last 60 years. We now need to re-examine the responsibilities of the private, public and civil society sectors in managing a global capitalist system. We should question what each must now do to ensure capitalism continues to play its vital role as an engine for economic and social progress. Finally, we must also examine the values and principles required to ensure that markets work effectively and fairly.
This chapter offers some thoughts on these themes from three perspectives. The first considers how the technological innovations driven by capitalism reshape society and its political and social institutions. The second considers the values, principles and assumptions that gave rise to capitalism and how they can inform the future. The third explores the unravelling social contract that has governed capitalism for the last 60 years and how it can be restructured to support twenty-first-century capitalism.
Over the last 500 years, capitalists in search of new ways to produce products more efficiently and profitably have been the driving force behind successive waves of technological innovations that transformed the economy from an agricultural to a mercantile one, from an industrial to a now globally integrated ‘post-industrial’ society. Each wave of innovation has dramatically lifted productivity, driving economic growth and increasing the returns to capital and to labour. While each advance has destroyed jobs in the previous economy, they have at the same time generated new jobs and income for workers as capitalists and their companies created new categories of products and services that raised the standard of living for all. For example, real per capita GDP in the USA grew nearly sevenfold during the twentieth century, and despite fluctuating levels of income inequality, standards of living improved for all economic groups, including the bottom 20 per cent of income earners. In 1900, fewer than one in five homes in the USA had running water, flush toilets, a vacuum cleaner or gas or electric heat. In 1950, fewer than 20 per cent of homes had air conditioning, a dishwasher or a microwave oven. Today, 80–100 per cent of American homes have these modern conveniences. As for standards of health:
Average life expectancy in the U.S. has grown by more than 50 per cent since 1900. Infant mortality declined from 1 in 10 back then to 1 in 150 today. Children under 15 are at least 10 times less likely to die, as one in four did during the 19th century, with their death rate reduced by 95 per cent.[2]
As we enter the twenty-first century, capitalism is driving the next wave of technological innovation, namely machine intelligence. This new wave of technology, coupled with the impact of the globalisation of the world economy, has profound implications for our economic model and society. On the one hand, this innovation has the potential to continue to improve quality of life and dramatically reduce the need for human labour in dangerous industrial jobs or boring and repetitive tasks in service industries. On the other hand, it raises fundamental questions about the future of work and the way income is distributed in society. This leads to far-reaching implications for our economic model and the political and social institutions that govern capitalism.
According to David Autor, an MIT economist who has studied the loss of middle-class jobs to technology, ‘it will be harder and harder to find things that people have a comparative advantage in versus machines’, a point reinforced in a blog called Welcome, Robot Overlords: Please Don’t Fire Us?[3] Indeed, half of the 7.5 million jobs lost during the ‘Great Recession’ were in industries that pay middle-class wages, which are defined as ranging from $38,000 to $68,000. Since the official end of the recession in June 2009, only about 70,000 – or 2 per cent – of the 3.5 million jobs gained have been in such mid-paying industries. At the same time, nearly 70 per cent of the restored jobs have been in low-paying industries. In the 17 European countries that use the euro as their currency, the numbers are even worse. Almost 4.3 million low-paying jobs have been gained since mid-2009, but the loss of mid-paying jobs has never stopped. Indeed, a total of 7.6 million such jobs are said to have disappeared between January 2008 and June 2013.
As more of the wealth generated by globalisation and machine intelligence goes to capital and large firms, so their influence on political systems increases. As the MIT economist Daron Acemoglu and James Robinson, a Harvard political scientist point out, although free markets tend to create widespread prosperity, they also have the potential to create concentrations of wealth and political power that are often used to suppress competition and entrench rent-seeking elites. This in turn further slows economic growth and income to labour. This skewed distribution of wealth has contributed to rising inequality, the decline of the middle class and the growth of a working poor ‘underclass’ whose inadequate education and low skills leave them with poor prospects for full participation in the economy as wage earners or consumers.
Some economists, including Thomas Piketty in his bestselling book Capital in the Twenty-First Century,[4] have argued that the period of high economic growth and moderate levels of income inequality in the developed economies during the last century are in fact an anomaly compared to historical norms. Piketty attributes the low levels of income inequality during this period to social upheavals, economic depressions and wars that shook up the social order, destroyed wealth and returns to capital and gave rise to pressures for higher taxation on both high-income earners and inherited wealth. But Piketty suggests that during the last 50 years, a period of relative stability and rising incomes in the developed economies, these pressures have moderated, contributing to a steady decline in tax rates on the wealthy. Therefore he postulates that we may now be returning to a norm in which the private return to capital exceeds the rate of national income and output. This condition, in the absence of high levels of taxation, is expected to accelerate the flow of income to those with capital and away from labour, leading to ever greater inequality and potential political unrest.
Piketty’s analysis is clearly reinforced by recent data. Until a decade ago, the share of total US national income going to workers was relatively stable at around 70 per cent. The share going to capital – mainly corporate profits and returns on financial investments – made up the other 30 per cent. Slowly but steadily, however, labour’s share of total national income in the USA and other OECD countries has been falling, while the share going to capital owners has gone up. During the period 2010–12, the top 1 per cent are said to have received 95 per cent of the growth in income and, according to a 2013 Credit Suisse report, now own 41 per cent of all global assets.
It is not surprising given these trends that capitalism finds itself in crisis. Once again, those who feel behind or maltreated by global capitalism are rallying behind populist and socialist movements seeking to challenge rising inequality and the power of capital over the economy and society. As in previous transitions, there is a heated debate about the values, principles and assumptions that underlie capitalism and the social contract that supports it.
Central to capitalism’s future success will be the need for a set of principles that can balance the self-interest of market participants with the broader interests of society. As we consider the road ahead, it will be useful to reflect on the values that have driven capitalism’s success in the past and how they can be drawn on to shape the path forward.
The foundations of capitalism were laid at a time when Catholicism still predominated and daily work itself was considered profane and mundane. It was the early Protestants Martin Luther (1483–1546) and John Calvin (1509–64) whose writings first established the perspective that daily work and self-improvement was a legitimate way to be in service of God’s will and therefore encouraged. It was Calvin’s writings around asceticism – frugality, rational planning and delayed gratification in service of God – that formed the backbone for the Protestant work ethic that in turn provided a strong underpinning for an emerging capitalist society.
Building from this foundation on the value of work, John Locke (1632–1704) championed free will and the right of individuals to own property, two principles that remain cornerstones of capitalist society today. His philosophy was founded on a belief in property rights, which are earned through work and can be transferred to other people only at the will of the owner. He believed that shareholders should receive profits because they have risked their property. Therefore it is the responsibility of the company’s workers to help the enterprise generate profits. Locke’s work on property rights and free enterprise is often seen as setting the groundwork and legal basis for the modern corporation.
Adam Smith (1723–90), following on Locke, was the champion of two additional principles that are still core to capitalism today. These are the principles that the best economic system for society is one that recognises individual self-interest, and that the means of production are best in private hands rather than the state’s. In his renowned Inquiry into the Nature and Causes of the Wealth of Nations (1776), Smith stated that society is best served when each person is allowed to pursue his own best interests and that the ‘invisible hand’, or the competition between individuals in the marketplace, would ensure benefit to all. Importantly, however, Smith viewed this competition played out within the confines of government regulation. He reasoned this would ensure that the self-interested behaviour of the individual would serve the common social good.
Also critical to both Locke and Smith’s reasoning was the assumption that the participants in the market were themselves moral beings who, acting in the spirit of the Protestant work ethic, adhered to the golden rule (see Tim Weinhold’s chapter below) and acted in the interests of themselves and their fellow man. This was further elaborated by Immanuel Kant (1724–1804). Under his ‘categorical imperative’, he held that people should act according to the maxims they would be willing to see become universal norms. People would adhere to the rules and keep promises, such as contracts, and follow the rules out of enlightened self-interest and therefore would never treat others simply as a means to an end.
Max Weber (1864–1920), in The Spirit of Capitalism, noted that the countries that adhered to the values espoused by Protestant theology had the highest rate of business and economic growth. Weber saw the emerging bureaucratic organisation of the industrial age with its high degree of specialisation of activities as the organisational form most capable of achieving commercial success and meeting the needs of a modern economy. He argued that this form of organisation was the most efficient and was technically superior to all other forms of administration. To him it was the most effective way of maximising efficiency and eliminating favouritism. The rise of the large, highly specialised and compartmentalised bureaucratic organisation, however, was to have a profound impact on society, and increasingly disconnected individuals from a view of work and capitalism being in the service of a higher purpose.
Weber later in his career became highly concerned about this. He noted that:
each man becomes a little cog in the machine and, aware of this, his one preoccupation is whether he can become a bigger cog. … The problem which besets us now is not how can this evolution be changed? That is impossible. The question is what will come of it.[5]
As capitalism developed in the twentieth century, Weber’s fears around the impact of the bureaucratic organisation were soon realised. While the power of large firms and the state grew in the industrial age, the influence of faith and the Protestant ethic diminished dramatically and was replaced by in an increasingly secular society focused on individualism, materialism and consumption. The values of respect for others and being of service to a higher social purpose that were an essential foundation for capitalism’s early success rapidly eroded. Business owners became narrowly focused on maximising profits in highly competitive markets. Workers became a commodity in fragmented specialised workplaces devoted to efficiency. The alienation and disregard for rights and needs of workers under this form of organisation gave rise to trade unions and in turn became the fodder for socialist movements that called for state control over the economy. This culminated in the communist revolution in Russia and the subsequent spread of communism through Eastern Europe and later China. In the Western developed capitalist economies that survived this tumultuous era, we saw the rise of the democratic welfare state with a popular mandate to ensure measures were in place to regulate the marketplace and that workers were fairly treated, including the right to form labour unions.
The rise of the social welfare state and the trade union movement brought balance back to the relationship between the interests of capital and society. It ensured that the benefits of a capitalist-driven economic growth were shared broadly with society. At the same time, this clear division of responsibility for social well-being between the public and private sectors allowed the private sector to continue focusing ever more narrowly on profits and wealth generation for their shareholders, leaving all responsibility for regulation of markets and care for society to government. This was most succinctly articulated in the late twentieth century by the economist Milton Friedman, who famously said:
there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud.[6]
We now live in a global economy in which the ability of sovereign states to set the ‘rules of the game’ and sustain the social welfare of their citizens is in rapid decline. Built for the industrial age, the large bureaucratic institutions of most governments have little capacity to keep up with the pace of change and the needs of their citizens. As governments prove increasingly unable to serve the public interest, we see public confidence in them and their leaders falling to unprecedented lows. At the same time, companies and markets have flourished. Stock market valuations continually reach new highs. Large businesses now often have unprecedented power and influence on our political system and society. Indeed, if they were compared to the size of national economies, they would account for over half of the top 150 such entities.
It is not surprising in this environment that society is now demanding that capitalists and their companies take much greater direct responsibility for their impact and role in society. This lies not only in taking more responsibility for their environmental and social impacts but also in playing an active leadership role in helping address social challenges, from global warming to world poverty. As noted by Richard Edelman, the author behind the annual Edelman Trust Barometer, heads of large global firms must now understand that they are part of global governance and must see themselves as statesmen as well as business leaders.
This is a new paradigm for companies and their leaders. Corporate leaders must now consider the role and purpose of their firms in society in ways that go well beyond the Friedman doctrine. It requires them to think holistically about all the stakeholders their firm affects and manage their relationship with them. Operating legally is now simply one component of earning the licence to operate; the rest must be earned from the stakeholders they impact, including their workforce and customers.
At a personal level, this shift requires the leaders of large firms to rethink their role as leaders not simply of businesses but of organisations with a profound impact on society. Their challenge internally is to drive and align incentive systems around a purpose-driven culture that is about more than financial performance and the next bonus cheque.
There are signs that this reflection by business leaders on capitalism’s purpose and their role as leaders is beginning to happen. In the USA there are forums such as Conscious Capitalism that focus corporate members from mid- and small-sized firms around an agenda of higher purpose, stakeholder engagement and conscious leadership and culture. Catering to a similar audience, the B Corporation movement provides a framework for certification for businesses with explicit social-purpose statements in their mission.
At the large enterprise level there are global initiatives focused on business leadership on a wide variety of systemic issues. One example is the B Team, a not-for-profit initiative formed by a global group of leaders to catalyse a better way of doing business for the well-being of people and the planet. This organisation is led by executives from Global 500 firms including Richard Branson and Paul Polman. Similarly, the World Business Council on Sustainable Development (WBCSD) is a global, CEO-led organisation of over 200 businesses and partners working to accelerate the transition to a sustainable world. This council has played a major role in mobilising business behind COP21 and other initiatives to address climate change. In 2016 the World Economic Forum, with the support of business leaders, launched the Global Commission on Business and Sustainable Development to decode the newly launched UN Sustainable Development Goals (SDGs) and show why it makes sense for business to engage in sustainable development at a far more strategic level.
Turning to finance, the Focusing Capital on the Long Term initiative led by McKinsey and major financial and corporate leaders is committed to developing practical approaches that encourage long-term behaviours in business and investment decision-making. At the national and local level, we are also seeing growing engagement by business leaders. A good example is Business in the Community, a UK charity with more than 800 corporate members and 30 years’ experience tackling a wide range of issues that are essential to creating a fairer society and a more sustainable future. These are but a few examples of business-led initiatives working to help CEOs and their companies understand their changing role in society and expand their positive impact.
Another important driver pushing CEOs and their companies to consider the broader social impact and purpose of their firms is the competition for talent and the expectation of customers. There is a growing realisation by corporate leaders that having a clear sense of social purpose is increasingly important to attract and retain motivated employees from the millennial generation. A recent Babson College study found that companies with a strong sustainability commitment see increases in employees’ productivity by as much as 13 per cent, reductions in turnover by as much as 50 per cent, and workers willing to take a pay cut of up to 5 per cent to work there.[7] The corporate purpose conversation is complemented by the spirituality and mindfulness in the workplace movements. A study by a large multinational firm in 2013 showed that employees working in environments that support their right to be open about their religious beliefs feel safer, have better working relationships with colleagues and are more likely to be engaged in their work.[8]
Turning to consumer expectations, a 2015 Nielsen study showed that 66 per cent of global respondents said they were willing to pay more for sustainable goods, up from 55 per cent in 2014 (and 50 per cent in 2013). At the same time, there is a small but rapidly growing movement by investors in putting their money behind their beliefs. According to the US SIF Foundation’s 2016 report Sustainable and Responsible Investing Trends in the United States, as of year-end 2015, more than one out of every five dollars under professional management in the USA – $8.72 trillion or more – was invested in socially responsible and sustainable investment funds.
These kinds of marketplace drivers, coupled with broader societal expectation for business leadership in society, provide a useful platform for considering how to restore the values of enlightened self-interest and reciprocity with society that are essential to restoring faith in capitalism in the twenty-first century.
Central to the success of capitalism to date has been a social contract that relied on the ability of governments to ensure that the competitive and profit-driven ambitions of the marketplace played out within the confines of government regulation. This, as Adam Smith reasoned, would ensure that the self-interested behaviour of the individual would serve the common social good.
During most of the latter part of the twentieth century this arrangement worked well. Governments regulated markets, placed constraints on the movement of capital, set labour standards and the right of workers to organise unions, and imposed progressive taxation regimes to redistribute wealth. Labour unions operating within protected labour markets were in turn able to negotiate effectively for their share of income from the profits generated by capitalism. This ensured that the wealth generated by capitalism raised all boats and drove an increasingly consumer-based economy.
As we entered the twenty-first century, this social contract was fast unravelling in the developed nations due to an increasingly globally integrated economy driven by rapid advances in technology. Global economic integration began in the 1970s as new shipping and communications technologies gave the private sector unprecedented access to a global labour market and supply chain. Global labour market arbitrage enabled capital to escape the constraints of the high-cost developed-economy labour markets, reducing capital’s costs and increasing its profitability while diminishing the power of unions. For the first time in a century the developed economies saw financial gains from rising productivity no longer shared with their workforce. At the same time, the economic forces of globalisation created political pressure on governments to reduce tariffs and lower taxes on corporations and the wealthy to compete for capital investment and jobs in a global marketplace.
The net effect of globalisation and technological innovation over the last 50 years has been a dramatic change in the balance of power between capital, government and labour in favour of capital. While the power of government and labour has declined in relative terms, the power of civil society has increased dramatically. Today there are a host of activist NGOs, from Greenpeace to Human Rights Watch, that are now at the forefront of holding capitalism and the private sector accountable to the public interest. At the same time, it is organisations such as the Environmental Defense Fund and the Fair Factory Coalition that are working with companies to help them find practical ways to discharge their new responsibilities as corporate citizens.
Moving forward, we can expect a continuous decrease in the capability of governments to set viable rules for global capitalism and in providing services to citizens. Falling revenues, an ageing workforce and mounting entitlement spending will leave little room for governments to lead the innovations now needed. This will leave increasing responsibility for setting the rules to protect the public interest and for delivering public goods to the private sector and civil society. Successful twenty-first-century capitalism will require a much more collaborative and adaptive social contract where responsibility and accountability for setting the rules and ensuring provision of public goods and services are distributed across the public, private and civil society sectors. Central to this transition will be the need for governments to see their role not as the sole mandator of the ‘rules’ and primary deliverer of social services but rather as enabler and collaborator with the private and civil society sectors to ensure that rules are in place and services delivered.
The first decades of the twenty-first century have shown the beginnings of a move to this new social contract. Every major global firm is now issuing a corporate responsibility report of some kind and has dedicated staff working on corporate sustainability and social responsibility. Over the last 20 years, ‘rule setting’ for these firms has moved well beyond compliance with the law. It now includes embracing a wide variety of ‘soft law’ or voluntary codes and standards that have been actively negotiated with NGOs and other stakeholders, including governments. These range from standards on labour practices and human rights to consumer packaging to environmental practices. Governments have begun to appreciate that industry-level voluntary initiatives such as the Responsible Care programme of the American Chemistry Council, with some government oversight and monitoring, can make an important contribution to protecting the public interest. At the same time, governments are starting to understand that enabling adaptive problem-solving by the participants in a dispute can often be more effective than, or a useful supplement to, formal rules and regulations. The UN ‘Protect, Respect and Remedy’ Framework for Business and Human Rights, for example, sets out a set of principles for valuing human rights and a framework for dialogue designed to enable multisector solutions to human-rights challenges. The framework relies on voluntary corporate leadership recognising that respecting rights is not currently an obligation that international law generally imposes directly on companies. This kind of framework is a good example of adaptive problem-solving and multisector burden-sharing of the public interest that will be required as we go forward.
We will also need to see much more robust public–private partnerships to address systemic social and environmental challenges. A good example of emerging models for this can be seen in the active involvement of global firms in developing the COP21 framework to control global warming. The final COP21 agreement includes commitments from more than 5,000 companies that together represent over $38 trillion in revenue. Also in Paris, the Science Based Targets initiative announced that 114 companies – including Ikea, Coca-Cola, Walmart, Kellogg and Dell – voluntarily committed to set emissions reduction targets in line with what scientists say is necessary to keep global warming below the threshold of 2 °C.
From reducing poverty through the UN Sustainable Development Goals to improving education, there are now thousands of initiatives at the local and international levels in which business leaders are active participants trying to solve systemic social challenges with NGOs and governments. Scaling up these forms of collaborative governance and service delivery initiatives on a global scale is essential to build a twenty-first-century social contract. It is a contract in which the private sector must now take much greater direct responsibility for managing its impacts on society and partner with the public sector and government to address broader challenges. It is only through this kind of active sharing in responsibility for society by the private sector that we ensure capitalism can remain a key driver for economic and social progress.
The challenges facing capitalism today are many but there is good reason to believe that by drawing on the values that guided the founders of capitalism and by re-imagining the social contract, these challenges can be overcome. None of this will be easy or simple to achieve. It will require business leaders who understand that the business of business can no longer simply be maximising returns to shareholders. It will require government leaders who are willing to move beyond the twentieth-century command-and-control mindset of their industrial-age bureaucracies. It will require civil society leaders who are more than critics but are solutions-orientated.
As some of the most powerful actors in society, private-sector leadership will be particularly critical. It is also the private sector that has the most at stake in the current crisis in capitalism. It is only through their active participation and leadership that we can expect to achieve the kind of robust partnerships with government and civil society needed to address the complex challenges ahead. As we have seen, this kind of leadership is possible and the seeds of this transformation in the role of business in society are emerging. The challenge now is to make sure they develop fully into a new social contract that can ensure capitalism can continue to play its vital role in driving economic and social progress in the twenty-first century.
[1] Wolfgang Streeck, How Will Capitalism End? Essays on a Failing System, London: Verso, 2016.
[2] Stephen Moore and Julian Simon, It’s Getting Better All the Time: 100 Greatest Trends of the Last 100 Years, Washington, DC: Cato Institute, 2000.
[3] K. Drum, Welcome, Robot Overlords. Please Don’t Fire Us?, Mother Jones, 2013.
[4] Thomas Piketty, Capital in the Twenty-First Century, Cambridge, MA: Belknap Press of Harvard University, 2014.
[5] ‘Max Weber on Bureaucratization in 1909’, in J. P. Mayer, Max Weber Classic Monographs, Vol. 4: Max Weber and German Politics, London: Faber & Faber, 1944; repr. Routledge, 1998, pp. 126, 127.
[6] Milton Friedman, Capitalism and Freedom, 40th Anniversary Edition, Chicago, IL: University of Chicago Press, 2002, p. 133.
[7] S. Rochlin, R. Bliss, S. Jordan and C. Y. Kiser, Project ROI: Defining the Competitive and Financial Advantages of Corporate Responsibility and Sustainability, 2015, p. 3.
[8] Sirota Survey Intelligence report presented at the Society for Industrial and Organizational Psychology’s annual conference 2013.
Lord Griffiths of Fforestfach
I am a great admirer of Alasdair MacIntyre. He is one of the world’s greatest living philosophers, invariably provocative and controversial but never without interest or depth of thought. A few years ago he gave a lecture with the arresting title ‘The Irrelevance of Business Ethics’. He set out to argue that the financial crisis of 2008 was not the result of a lapse in ethics by bankers but that the very nature of dealing in financial markets was to offload risk on to a counterparty or client with no ethical consideration whatever, ‘the better the trader the more morally despicable’. The result is that trying to teach ethics to traders is like reading Aristotle to a dog.
From the evidence of opinion polls the very expression ‘business ethics’ is an oxymoron. Since the financial crisis, banks have been fined over $300 billion, Volkswagen has admitted cheating on emission tests on potentially 11 million cars, Mitsubishi has acknowledged that it intentionally misled regulators, shareholders of blue chip companies have revolted over executive pay and a House of Commons Select Committee has investigated the sale for £1 of BHS, subsequently put into administration with a huge pensions deficit. All these suggest that business ethics is for the general public a contradiction in terms.
Ethical behaviour by business is important for a number of reasons.
One is that the public expect business to be ethical. They expect business to be conducted in an honest, fair and transparent manner, which serves the greater good of society and not just the interests of management and shareholders. They expect the senior managers of business firms and the entrepreneurs who set up private companies to have a moral compass that respects the dignity of those who work in the organisation and those they serve as customers. They expect that businesses will have standards that do not seek to mislead or misinform customers regarding the true price and the quality of the products and services they provide.
The fact that the public hold such views is important because through their elected representatives who pass legislation in parliaments, it is ultimately the public who grant business a licence to operate. Without such a licence, for example, limited liability companies would not exist. That licence can be changed at the will of Parliament. What has become increasingly clear is that the public will not put up with unethical business. Without ethical business, regulation will increase – just look at what’s happened in banking following the financial crisis. Regulation is at best a blunt instrument in that it cannot easily be tailored to meet the needs of individual companies. Not only that but regulation is a form of taxation, and like most taxes it has a deadweight cost to society.
A second reason why ethics in business matters is that it underpins the legitimacy and attractiveness of a market economy. From the latter half of the eighteenth century and Adam Smith’s great work on the causes of growth in The Wealth of Nations,[2] a market economy that fosters enterprise and freedom and allows markets to work is by far the best driver of prosperity that we know, and not only that but a market economy entails a degree of economic freedom, which is a key element of political freedom. Business without ethics and values therefore undermines the appeal of a market economy and a free society.
A third reason why ethics in business matters is a personal observation. Working in a company with ethical business principles and a culture built around strong values is far more fulfilling than working in a company that turns a blind eye to ethical standards and in which the culture is based principally on success and money. I have sat on the boards of 15 companies in the private sector since working for the first 25 years of my career in the public sector. These companies were varied. Some were main boards with shares traded on the NYSE, NASDAQ or LSE; others were wholly owned subsidiary boards; some were large, others medium, some small in terms of size; two were joint ventures. The products and services covered were extensive: banking, broking, rail freight, care homes, music, cable communications, television, cleaning, killing bugs.
For me and, I suspect, for most of those who worked for the companies, the most distinguishing factor in terms of a company being ‘a great place to work’ was the respect shown to fellow employees, the pride the firm took in its products and services, the sense of community that existed in the organisation, management’s commitment to help people develop to their full potential and the fact that it served a greater purpose than just focusing on maximising the bottom line. It is because of these qualities that such a company is trusted by its customers and the community in which it operates. It is also the reason it is able to build up a culture of trust within the organisation so that management can be trusted to make the right decisions.
If businesses are to act ethically there are three questions business leaders must ask themselves.
First, Who are we? Or to put it differently, What do we stand for? What is our purpose?
This, I believe, is the most fundamental and difficult question for any business leader to ask. To explore the purpose of a business is to go beyond profit. Without profit – which is the financial return to those who provide equity capital – a business will not survive. However, asking about purpose raises broader issues than the bottom line. Does the company take pride in the product or service it provides? Is being part of the firm a source of human flourishing? How does the company contribute to the common good by what it does?
The reason it is difficult to ask these questions is that they in turn ask each of us to look inwards and ask ourselves a far more searching set of questions, such as Who am I? What am I doing with my life? What is the purpose of my existence? Most of us most of the time want to park such questions and get on with the day-to-day challenges of running the business. Far better and more productive to log on and check what the markets have been doing overnight. Then respond to emails. After that, a look at today’s calendar with slots filled in from early morning to late at night.
I served for 21 years on the Board of a US company, Herman Miller, which designed and manufactured office furniture. It was in the twentieth century a world leader in its field both in terms of design (it attracted great designers such as Eames, Noguchi, Nelson, Gehry, Stumpf) and environmental stewardship well before that became an important item on corporate agendas. The Chairman who invited me to join the board was Max de Pree. It was only many years later that I came across an essay written by Nicholas Wolterstorff, a distinguished Yale professor of philosophy, that I became aware of the importance of the purpose of a business. This is what he said:
About ten years ago now I served – quite amazingly – as a philosophical consultant to the Herman Miller Furniture Company in New Zeeland, Michigan. Max de Pree, the executive officer of the company, had invited an architect, a physician, a journalist, a furniture designer, a theologian, and me to an all-day session with him and about five of the top officers in his company. At the beginning of the day he posed ten questions that he wanted us to discuss, in whatever order we wished. He asked us not to concern ourselves with trying to say things that we thought would be useful to the company; he wanted the discussion to take whatever shape it wanted to take. I remember three of the questions. ‘What is the purpose of business?’ he asked. Some of his younger executives were saying that the purpose of business was to make money. He himself didn’t believe that; but he wanted to talk about it. Second, he wondered whether there was ‘a moral imperative’, as he called it, for companies to produce products of good design. And third, he wanted to discuss whether it was possible to preserve what he called ‘intimacy’ in a large company.
It became clear, in the course of the discussion, what de Pree himself regarded as the purpose of business. The purpose, as he saw it, was twofold: to produce products that serve a genuine need and are aesthetically good, and to provide meaningful work in pleasant surroundings for those employed in the company. He added that these purposes had for a long time shaped his operation of the company.
Now it seems to me that these two purposes are, or can be, an expression of charity – that is, both consist to promote the welfare of the other. As a matter of fact, it became clear in the course of the discussion that it was de Pree’s religious commitment – specifically, his Christian commitment – that had led him to embrace these goals. He saw his operation of the company as an exercise of charity – though he didn’t use the word. His own case, at least as he presented it, was a case of ‘transcendental faith’ shaping economic activity.
Was he prevaricating? Or deluded?[3]
Second is the question What are our values? Have they been set out explicitly? Are they so general as to be vacuous? Who in the firm owns the values?
It is easy to write down a set of values for a business. Indeed, nearly all large companies have similar sets of values: respect for the individual, honesty and integrity, social responsibility to the community, environmental stewardship and so on. Far more difficult is to assess their effectiveness. How do the values shape the way I work and the decisions I make? How do I behave differently because these values are set down and I am a member of that firm? What responsibilities do I now have because of these values? Do I treat colleagues differently? Do I treat clients differently?
I have found that the key to effective values in business is that they must be lived by the leadership of the company. The leadership must walk the talk. Without that the values are empty and the leaders guilty of hypocrisy – preaching one thing but practising another. The leaders of a business cannot rely on regulation. Leadership cannot outsource the values of a business to regulators.
One test is what the leaders of a business think their values really are. Would that be shared by the average employee? Would it also be the perspective of clients and suppliers?
I was reminded of this recently in an article in Forbes magazine by James Heskett, professor emeritus at Harvard Business School, on the subject of servant leadership, which is a term used more in the USA than in Europe. The concept of servant leadership places great emphasis on the role of a business leader serving employees. Heskett recalls an incident at a ServiceMaster board meeting at which I was present and remember distinctly when the Chairman and CEO, William Pollard, spilled a cup of coffee prior to the board meeting.
Instead of summoning someone to clean it up, he asked a colleague to get him a cleaning compound and a cloth, things easily found in a company that provided cleaning services. Whereupon he proceeded to get down on his hands and knees to clean the spill up himself. The remarkable thing was that board member and employees alike hardly noticed as he did it. It was as if it was expected in a company with self-proclaimed servant leadership.[4]
The third question is What is going on in our business?
As a non-executive director of a company whose board meets four or six times a year, one of the most frustrating challenges is obtaining sufficient information to really find out what is happening in the business. I believe it is very important that non-executives meet not only senior but middle management and even junior staff. Only once have I ever found senior management reluctant to allow non-execs to talk directly to management. Frequently the binding constraint is the time non-execs are able to devote to meeting employees. However, it is only then that they find out what is really happening in the business.
In small companies, finding out what is really going on in the business is not really a problem. In large multinationals, however, the issue is a major challenge. In the money-laundering activities carried on by certain banks the sheer size, organisational structure and large number of countries in which the bank operated have proved a major obstacle to effective control.
A number of steps are necessary in making values effective in business.
First, it is important to set out explicitly the purpose of the business. For this a one-time mission statement is typically far too general and vague and begs the question of what the purpose of a business really is when spelt out in practical terms.
Second, it is important to set out in some detail the ethics, values and business principles of the firm. The temptation is to frame these in general terms. Management must accept that the actions of today will be judged by the standards of tomorrow, which means being ahead of the curve.
Third, on the basis of its purpose and values, the company must build a culture with implications for all employees, affecting every aspect of the business: reporting, firing, promotion, human resources, selling, buying, accounting, auditing and so on.
Fourth, senior leadership must show through ‘the tone from the top’ that they live the values and are committed to ensuring that the same values permeate the middle and lower echelons, the ‘permafrost’ of the firm.
Fifth, the leadership must be able to continually appraise the effectiveness of its values, code of ethics, business principles on conduct. They must trust, but verify. This will include keeping a close eye on disciplinary matters and terminations, with regular surveys of staff and clients. Such information is important in compensation discussions and promotion recommendations.
Sixth, in all of this, non-executive directors have a key role to play in that on behalf of the shareholders and stakeholders, they are the guardians of the purpose, values and ethics of the company.
The challenge of implementing values in a business can be made easier or more difficult by certain factors, namely size, ownership and the extent of competition in the markets in which the firm operates.
The size of a business matters. Implementing values in a small firm is easier than in a large firm. In a small firm it is much easier for senior management to know what is going on. A large firm needs systems of control and trust in those responsible for them. It may also be easier in a firm delivering a single product or service rather than in a conglomerate in which there are different kinds of businesses with different business cultures, something that becomes even more challenging when the company has operations in different countries.
Different forms of ownership will face different challenges. A private firm and especially a family business may find it easier to develop an effective culture than a publicly traded company. A partnership may have built in checks and balances to maintain high standards. It can be that in larger companies any concept of intimacy has disappeared.
The competitiveness of the markets in which a firm operates is a further factor to be taken into account. Competition is beneficial. It drives down costs and will lead to lower prices for consumers. It allows new firms to enter the business. It encourages innovation. However, in a highly competitive market when margins are under pressure, hiring staff is difficult and expensive; if competitors begin to use questionable methods (‘tolerated practice’), ethical standards will be under pressure. This raises an important issue for public policy. What is the optimal degree of competition? Reducing barriers to entry and opening markets to foreign companies is beneficial, but is there a point at which competition becomes excessive and undermines ethical behaviour? Will the market itself be self-correcting? Should it be left to regulation? And if the market is left unregulated, at what social cost?
I believe that the subject of maintaining ethical standards in business, of creating business cultures in firms that make them ‘great places to work’ and of punishing wrongdoers for illegal activity, is fundamental to a market economy and a free society.
[1] This chapter formed the basis of a lecture given by Lord Griffiths of Fforestfach at an event organised jointly by the Centre for Character and Values at the Legatum Institute and Clifford Chance LLP and chaired by Christina Odone, Chair of the Centre (9 May 2016).
[2] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, London, 1776.
[3] Extract from Nicholas Wolterstorff, ‘Should the Work of Our Hands Have Standing in the Christian College?’, in Ronald A. Wells (ed.), Keeping Faith: Embracing the Tensions in Christian Higher Education, Grand Rapids, MI: Eerdmans, 1996, pp. 133–51.
[4] Professor James Heskett, ‘Why isn’t Servant Leadership more Prevalent?’, Forbes, 5 January 2013.
If these observations are accurate, NEDs face such potentially severe liabilities, and the mismatch of expectations is so great, that there will be problems in recruitment and retention as well as more serious issues. A role may have been undermined that serves business and society with high standards of corporate governance. High-quality candidates will be lost.
What could be done about this?
The importance of the educational task was noted several times above; that is, educating society – tuning its expectations – about the proper role of NEDs, and NEDs about the expectations of society. This process might cover:
Professional bodies, trade groups, think tanks, individual companies and directors themselves have a shared responsibility for this task.
As a society, how do we get NEDs to do the job we want them to do? How do we implement good practice? Directors perform an essential role and must be held to the highest standards of governance, but proportion, balance and perspective are essential, along with recognising the complexities and the tensions.
Business and indeed business organisations have an educational responsibility, not only to their own constituents but also to society and policymakers, about the role of business, boards and directors. Society too has a responsibility to make known the benefits as well as the responsibilities of business. There needs to be more open dialogue about: principles rather than rules; an acceptance of learning from mistakes; and a need for greater realism. Fairness is a two-way street – the framework must be fair to individuals, business and wider society. NEDs need to be aware of their duties and the expectations put on them. We need to create a new system to encourage high-quality, thinking people to become NEDs – and they need to know that the legal standard is clear and the enforcement system fair. There must be clarity over what liability comes with honest decisions made in good faith.
Recommendations arising from this discussion are as follows:
Non-executive directors should be reminded of their duties and responsibilities and given clarity as to society’s expectations. The answer is not further liabilities. Knee-jerk reactions to scandal are unhelpful – not all failures involve scandal and some, in the normal course of business, afford opportunity to learn lessons. We should clarify and celebrate. The NED is a bridge between business and society – ensuring proper corporate governance while playing a wider role in societal leadership. We need people of character and experience to discharge this role. With this clarity, we can say that the non-executive director is indeed worth saving.
[1] Financial Reporting Council, ‘UK Corporate Governance Code’, London: FRC, January 2024; see https://media.frc.org.uk/documents/UK_Corporate_Governance_Code_2024_kRCm5ss.pdf.
The public narrative around NEDs illustrates a real tension between a proper desire to hold directors to account and a lack of understanding of the nature and complexity of the NED role. Complaints about ‘cosy clubs’, ‘asleep at the wheel’ or ‘overpaid’ NEDs will often feature on front pages at times of crisis.
We might ask, therefore: What is the real point of a non-executive director? Do we need such a role and, if so, what are the reasonable expectations and standards against which we might measure performance and accountability? Reputation matters for qualified individuals, and if we fail properly to establish expectations and boundaries, fewer quality candidates will accept the role, particularly if rather than being overpaid, as per the popular narrative, the risk/reward ratio becomes a disincentive to accepting office.
There is also a clear distinction to be drawn between SMEs and large public companies, often with multiple subsidiaries and geographical locations. How much grasp of detail should be expected of NEDs? How much can NEDs reasonably rely on assurances from management or professional advisors? Are NEDs expected to know of every activity, or even error or fraud, in every small subsidiary in a complex corporate structure? Society must be clear if that is what is expected – and then not be surprised if few wish to accept the responsibility.
There is a clear disconnect with the public, policymakers and regulators, which has led to the emphasis on criminal liability. There is a reason why we have NEDs as part of the functions of corporate structure at the level that we do, namely the proper exercise of governance. However, we do need greater clarity over their role and the expectations of society.
The nature of boards is a central feature of corporate governance reviews and discussions. The tradition in the UK, at least for listed and significant private companies, has been for a unitary board containing both executive and non-executive directors. This contrasts with some European approaches to corporate governance, which feature a supervisory board composed exclusively of NEDs sitting over a board of executives. There have sometimes been suggestions that the UK should adopt a similar model. In company law there is nothing to prevent UK companies adopting that approach (at least notionally, even if legally there remained one board), but in practice they have not. Nevertheless it is an important principle that nothing in law or practice requires a director to function as an executive; indeed, there is something both distinctive and important in the very idea of a non-executive director.
The contention here is that boards, executives and NEDs are all more effective in their strategic and accountability roles if they sit on the same single board, in the same room, have the same information before them (although, as discussed below, in practice the executives will have more company knowledge and information at their disposal), interact with one another and hold one another to account.
The attractions of the supervisory board – with its inherent separation of structure, people and function and yet within a system that views all directors as equal – are illusory. Indeed, the existence of such a model with Volkswagen did not prevent the 2015 emissions scandal and little suggests it assisted with the response. There is no evidence that a supervisory board model results in more effective corporate governance than a unitary system.
A single unitary board also brings both executives and non-executives into regular contact with advisers (auditors and lawyers), which can only enhance the governance process. Boards have traditionally, of course, been the slaves of the shareholders. Although these still appoint or remove the board, there is increasing recognition of the importance of other stakeholders. A variety of personnel on a single board not only prevents the passing of responsibility to others who are not in the room, but can also ensure a mix of voices are heard at the table.
However, that is not to say the existing structure works perfectly. There are several improvements that would enhance the role of all directors but which have particular relevance for NEDs.
One question relates to the number of executive directors on a board relative to non-executives. It is revealing that the regular flow of governance reports saw a steady increase in the recommended proportion of NEDs. This went from one-third (Turnbull Report, 1999), to a majority (Higgs Review, 2003), to the practice that seems most common today, especially in larger companies, of only two executive directors on the main boards (the Chief Executive Officer and the Chief Financial Officer, although others such as the General Counsel may be invited to attend).
This trend carries a number of implications. First, there is a potential concentration of power in the hands of one or two directors, in particular a chief executive, who might easily dominate one other senior executive on a board. Even if others attend, the effect is to diminish the range of comment and expertise. This may also weaken the wider insight available to NEDs and render them more dependent on the chief executive, in detriment to their strategic role. Second, and related, the existence of a wider group of executives on the board can act as a constraint on the chief executive – there are more voices that might challenge and/or offer alternatives. There is always the contrary danger, of course, that executives might not challenge a chief executive, but formal board membership rather than an invitation to attend makes the wider responsibilities much more explicit to all parties. Consequently, a board is likely to be better advised and able to make better decisions.
This does also raise the wider question of board composition and diversity in relation to NEDs, which Section 4.4 below will consider.
In conclusion, the role of non-executive director is best discharged within a unitary board, with a minimum of one-third executive directors (although NEDs should remain in the majority). This would enhance not only the diversity of skills on a board but also the shared mutual responsibilities it bears. It is a structure that gives the maximum weight to ensuring the appropriate balance of expertise and experience.
Clarity over the role and purpose of a non-executive director is core. There is a clear tension in the governance reports and the academic literature between the strategic and the monitoring roles of the NED. This goes to the heart of purpose. It is, perhaps, imbalance between these two roles that has led to unrealistic expectations among the public and policymakers, a confusion that might also lie behind the failure of some recent actions for disqualification, when the actual actions of directors are compared to legal duty and found wanting.
The NED is a long-term company steward if nothing else, and must therefore be both allowed and encouraged to focus on long-term strategy, alongside the expectations of monitoring, accountability and compliance. An effective NED will give weight to strategy, its development and assessment of progress towards achievement. This should lie at the heart of expectations.
As well as steward, Christopher Pass, noted earlier, sees the non-executive director as guardian. But steward or guardian of what? On a narrow basis we might argue that NEDs are stewards of the assets of the company, although that is not a responsibility specific to them but resides in the whole board. But the stewardship specific to a non-executive director goes much deeper. For Pass, the guardianship offered by the NED is of the corporate good of the company, although this still leaves the issue of definition. Some might argue that corporate good lies specifically in the maximisation of shareholder value, others that it should embrace a wider concern for stakeholders, for purpose and for society.
A few observations can be made. First, the NED role is long term. A recent report from PwC noted that the median length of service for a chief executive was five years. In addition, in the years reviewed (2000–18), although there were some longer-term CEOs there was also increased turnover. The report also noted a rise in ethical lapses and failures.[1] The NED can take the long view of a company, its history and wider purposes and what one might call the company’s well-being. Could we, then, see NEDs as long-term stewards of the company’s well-being and purpose?
Second, the NED role is, at least in part, strategic. We need to articulate, and have recognised in law, that a key role of a non-executive director is strategic oversight. Clearly, as the Higgs Review noted,[2] there is a balance to be struck between the strategic and monitoring roles, but an overemphasis on compliance may have the unintended consequence of directing NED attention away from strategy. Both are needed. Executives are focused on company performance, probably rightly; non-executives can place that in a broader context of strategic direction. This requires high levels of competence, independence of mind, vision and experience (see Section 4.4). The combination of the long-term and strategic aspects of the role of NEDs is essential to their very purpose, fundamental to the success of a company and foundational to the proper exercise of corporate governance in the social contract between business and society. It is for this reason that we need both greater clarity about the role but also more celebration of the NED.
Third, the NED is independent. This is more complex than it appears because some of the allegations laid at the door of NEDs concern actual or perceived threats to independence and the problem of loss of objectivity through long periods of service (that is, there is a degree of tension here with the long-term role of the NED). These are often issues of culture, and one function of an independent NED is to observe and, where necessary, challenge inappropriate cultures.
The NED represents an independent check on the executives, at one remove from the daily business of the company. He or she expresses the principle of independence in both approach and function. In terms of approach, their role is to bring an external view and an enquiring mind to the board. Their independence is born of both character and experience (again, more on this in Section 4.4). In terms of function, independence is in practice written into board structures through the particular roles and functions of NEDs, worked out in how they operate in respect of specific board committees. We see this in examples such as the nominations committee (appointing of board members), remuneration committee (setting remuneration, incentives and bonuses for senior executive) and audit committee (accounting and internal control oversight and liaison with external auditors). These are essential functions and activities of corporate governance, and the role of the NED is indispensable to their effective discharge. Society benefits from the external voice, the proper assessment of – and even constraint on – executive remuneration, the ensuring of good governance. These activities and responsibilities are key levers for the oversight of the company, its strategy, performance and key appointments, including advisers. In addition, NEDs play a central role in both the hiring – and firing – of the chief executive.
One of the complexities contributing to the confusion about role is the danger of overemphasis on monitoring, policing and compliance. Inevitably, the more weight put on this, the stricter will be the liabilities applied (‘Did the NED tick this box or that?’) and the less useful will be the role itself. There is an appropriate place for monitoring and accountability, but without the independent NED’s strategic, long-term stewardship of the company’s well-being and purpose, the corporate governance process will be the poorer and the flow of quality candidates reduced. Society will be less well served.
Time and information are central matters of concern in non-executive directors’ proper role and discharge of responsibilities. It has been shown that although the law recognises only one type of director, there are differences in the way directors’ duties apply, according to context. This was clear in discussion of Section 174 of the Companies Act and the various proceedings for potential disqualification under the Company Directors Disqualification Act. It was also noted that there is one general duty of care, skill and diligence, but that duty is limited by a general test of reasonableness and by the particular responsibilities and context.
Nowhere does this distinction come more into play than in the amount of time dedicated to a task by – and the nature of the information in the hands of – a non-executive director and an executive respectively. Any proper appreciation of the role of the NED requires evaluation of this difference.
The first issue is the time directors are able to dedicate to the business. The executive director is full time and their entire focus is on the company and their particular responsibilities. Hence the Chief Financial Officer, both in skill and role, will have considerably more expertise and capacity to acquire, process and indeed understand financial information. The same is true across the range of executive responsibilities. Contrast that with the typical NED, who might spend perhaps two days a month on company business. Not only is this a fraction of a full-time executive’s time, it may not be the NED’s only appointment. Consequently, the NED may feel they are always playing catch-up, needing to absorb and analyse information in a short timescale and possibly under pressure. Equally, the NED is always learning – no bad thing, but they have to contend with what is the daily beat of the executive with less time and potentially fewer direct skills.
This is not to excuse NEDs from their proper duties and responsibilities. Rather the intention is to expose the problem of the time gap between executives and non-executives.
It is largely for this reason that although the general duty still applies, it is unreasonable for the law to expect identical liabilities to accrue under such different circumstances. As was shown, the law does not so expect. A non-executive director cannot have full awareness of every issue or problem in a complex corporate structure. Perhaps corporate structures themselves have become too complex, impeding the flow of information (a topic in itself); in any event there needs to be greater understanding, clarity of expectation and proper responsibility in recognising the consequences of the time differential.
This issue is reinforced by the information challenge. Executives and non-executives are in possession of different information, at different levels of detail, for the very reason that their roles and time commitments are different. Hence it is more than possible for the volume of information to overload (a quantity problem) or even overwhelm (a comprehension problem) a non-executive director. This may result in poor decision-making if papers are not properly read, understood or weighed up, and if trends and material changes are not identified and assessed. Similarly, the outcome may affect the ability of the NED properly to discharge their legal duties and, indeed, their wider responsibilities to society.
As a result, what is important for the effective NED is not quantity of information but quality. They must have in their possession information that is summative, strategic and suited to the decisions in hand, as well as access to relevant company personnel and professional advisers. Information is also power, hence it is a further test of NED quality and independence that they be able to secure the most apposite information, presented to them in the most useful way for their purposes. Information must also be delivered to the directors – but especially the NEDs – in a timely fashion.
If the role of the NED is to make effective long-term strategic decisions in the best interests of the company, then the information received will inevitably be summative – covering key issues, backed by analysis, but avoiding excessive detail that might hamper effective decision-making. Nonetheless, the NED has a responsibility to press for the information they need to facilitate decision-making.
The question, then, is not whether the NED knows everything, or even made the correct decision, but whether they made a decision that a reasonable person could have made in the context.
There is also a gap between what information actors in media and public policy seem to assume NEDs have at their disposal and the reality – the nature of the information, its presentation and its digestibility. To define expectations of NEDs and appreciate their role, this gap needs to be closed – essentially, then, an education exercise (see Conclusions and recommendations below).
It is clear that the role of the NED carries significant responsibility but also serves wider business and society. While debating role, function, purpose, independence and so on, there is something more intangible at the heart of the effective NED, namely character. The combination of high moral character with the experience acquired over many years of executive responsibility delivers the highest-quality NED who, other things being equal, will deliver integrity and honesty in all dealings.
We should not shy away from a debate around moral character, by which is not meant particular religious convictions or commitments to various personal behaviours, but something deeper. What are the values that form and shape the life of the particular individual? Do they reflect the central importance of integrity, honesty, transparency, objectivity, selflessness, accountability and leadership – in other words, the ‘Nolan’ principles of public life?[3] These values represent moral character and we should expect them in all walks of public life, including business, boards and NEDs.
Hence character is an important starting point, not least because it is about the inner person, before that is overlaid by other aspects of life within or without business. The effective NED does not lay moral character over other skills and experiences, rather it forms their very basis.
How might this character be expressed in the potential or actual NED? We would expect some combination of service and leadership but also curiosity and an enquiring mind. These are the characteristics that lead to asking the right questions, probing effectively and providing an outlook of long-term stewardship and strategic direction and decision-making.
But while character is central it is not alone in the formation of the NED. The most effective NEDs bring to the board experience, wisdom and insight gained from careers elsewhere in business, most often as executive directors.
This does, of course, raise again the question of board appointment and diversity. It is hardly surprising that corporate governance reports and academic reflection lend weight to the question of appointment, ensuring proper processes – rather than informal networks – and enhancing boards’ diversity. There are good reasons to welcome this trajectory – it would be strange to argue that boards do not benefit from a diversity of backgrounds. However, elevating monitoring over strategy is likely to result in recruitment of lower-quality NEDs, with insufficient weight lent to business experience and leadership.
The effective NED will be a person of moral character and relevant experience. They will be naturally inquisitive and curious, deeply imbued with the values and principles reflected in Nolan. The law does provide protection for acting in good faith, and when the director has acted honestly and reasonably in their decision-making. Perhaps we need to make these expectations of character and experience more explicit. This would make clearer the qualities necessary for effective discharge of the role.
Company failures happen, alongside frauds and other misdemeanours. Most people consider it appropriate for society to hold individuals to proper account. In some cases there may be culpability, and the law can impose sanctions, from prosecution for criminal offences to civil proceedings for disqualification as a director. However, in other cases, instances of failure, insolvency or simply corporate difficulty are just part and parcel of the nature of the market economy.
In holding directors to account, the question arises whether society’s expectations of what boards and NEDs can achieve are out of kilter with reality, reflecting at the least misunderstanding. There is too the problem of the desire to apportion blame. The high bar (gross incompetency) in the case of official actions (for example, proceedings for disqualification) may be difficult to prove and not even accurate in law. Yet there is pressure to take action due to the mismatch of expectations. The burden of court proceedings can pressurise defendants to settle, which might not be entirely just. The government Insolvency Service has faced criticism from the courts for its handling of disqualification cases (see for example Farepak (2012) and in Re Keeping Kids Company (2021)). Liability must be about actual culpability based on fair evidence, not simply potentially arbitrary allocations of fault.
What is important is the nature of any potential liability. Recent cases have pursued what is generally known as a strict liability, and this may have significant consequences. It means holding a director liable for certain conduct or actions without regard to either their state of mind or the reasonableness of their actions. Thus in the case of Carillion, it was argued that the NEDs were strictly liable in the matter of executives’ misconduct in respect of alleged false accounting, regardless of their efforts to inform themselves. The consequence is that from the moment of appointment the director is strictly liable, assumed to be in possession of full information and knowledge of the company, its finances and all other aspects of its operation, without taking into account the reasonableness of their actions. Hence they may be subject to proceedings (for example for disqualification), irrespective of their actual role, knowledge or actions. This is not the law as it stands, nor should such a strict liability form part of the regulatory armoury – it would be damaging to the NED role, to business and to society.
The Insolvency Service, however, seems to have pursued exactly this policy in some recent cases. The aim here is not to debate the merits of recent failures and scandals or to apportion blame and culpability, rather to consider specific liabilities laid at the door of NEDs (leaving them exposed to disqualification proceedings), as well as implications for the role itself. Thus, in Re Keeping Kids Company (2021), Falk J made clear that the Official Receiver had failed to make out a single allegation against any of the directors. What is perhaps more surprising is that the mistake was repeated in the failed attempt to proceed against the NEDs of Carillion:
legal experts and defense counsel said the case was unclear, wrong in law and repeated mistakes made in the government’s failed attempt to disqualify the trustees of a charity in 2021, which was subject to criticisms over its handling of the case and for leaving defendants in the dark.[4]
The concept of a strict liability in respect of directors’ duties is and could not be the law in any reasonable assessment. This returns to the distinction between strategic and monitoring roles. The role of the NED is not essentially operational. It is to ask the right questions, probing, exercising skill and judgement and displaying curiosity, while not stifling management. The job is strategic oversight. As has also been shown, in terms of resources at their disposal, NEDs are disadvantaged relative to executives, auditors and other professional advisers.
In the wake of scandal, governments have to be seen to act. One temptation is to view everything through the eyes of criminal law, perhaps prompting draconian regulatory action. Hence a regulator views failure to prevent fraud – which may have multiple causes and not necessarily involve liability for directors – from an exclusively criminal or regulatory angle, which may not be to the general good: attempts to sanction directors, not least NEDs, for every failure or failing may have negative consequences for recruitment, retention and the role of NEDs. In a free and responsible society, not every action of a director that might be challenged, or for which a different decision could reasonably have been made, or that might be criticised or fall short of the ideal, should result in criminal or even regulatory action.
There is a rather fundamental mismatch of expectations. Directors cannot predict or know everything. The law recognises this, not however the political world, media and wider society. A narrative develops around what directors should have known, which then suggests that, as the chief architects of the company’s structure, organisation, policies and direction, directors may have been asleep at the wheel and hence should be held to account. The problem, though, is whether in law this constitutes a breach of duty and a liability, and whether in public policy it is a reasonable expectation of a non-executive director.
The danger is that we make British business an unattractive place to work, damaging aspiration and economic efficiency. This issue, again, is fundamentally one of education.
[1] PwC CEO Success Study, 2018, https://www.strategyand.pwc.com/gx/en/insights/ceo-success.html.
[2] The Higgs Review, paragraph 6.2.
[3] ‘The Seven Principles of Public Life’, https://www.gov.uk/government/publications/the-7-principles-of-public-life. For their latest iteration, see The Committee on Standards in Public Life, ‘Upholding Standards in Public Life: Final report of the Standards Matter 2 review’, November 2021, Appendix 1 (p. 92), https://assets.publishing.service.gov.uk/media/617c02fae90e07198334652d/Upholding_Standards_in_Public_Life_-_Web_Accessible.pdf.
[4] Joanne Faulkner, ‘Axing Carillion Case Puts Watchdog’s Approach in Spotlight’, 25 October 2023, LAW360, https://www.law360.com/articles/1736763.
What expectations are set out in law in respect of directors? The legal provisions are found in sections 170–177 of the Companies Act 2006.
Section 172 is intended to clarify the wider expectations and responsibilities relating to a director, who must act in ‘good faith’, and in acting for the benefit of the company’s members (shareholders) as a whole, must take into account several other factors, including the long-term consequences of decisions, a company’s various stakeholders (employees, customers, suppliers), sustainability, fairness and the ‘desirability of the company maintaining a reputation for high standards of business conduct’ (s 172(1)(e)). The Oxford Business Law Blog discusses the reasonableness of decision-making by directors in company law:
Under s 172 of the Companies Act 2006 (‘the Act’), courts will not interfere with the board’s decision concerning an alleged breach of the duty to promote the success of the company unless it is one that no reasonable director could have made, which is known as the Wednesbury standard. Section 172 has been interpreted to mean that courts are to abstain from reviewing on objective grounds whether the board’s decision was actually in the best interest of the company; it is for the directors, in their subjective view, to decide. Courts will only intervene if the decision is one that no reasonable director could have considered to be in the company’s best interest. In short, the standard of conduct required of directors under s 172 is subjective, and the standard of review adopted by courts is rationality or plausibility.[1]
The Wednesbury standard referred to derives from Associated Picture Houses Ltd v Wednesbury Corporation (1948): a decision is unreasonable or irrational only if it is so unreasonable that no reasonable person acting reasonably could have made it. In essence it puts in place a reasonableness test in the discharge of directors’ duties under Section 172.
Courts have generally been reluctant to find directors in breach of their Section 172 duties if they have acted reasonably. One recent example is in Re Marylebone Warwick Balfour Management Limited (2022), where the court found that the directors had discharged their duties under Section 172 by taking and relying on professional advice in respect of a tax avoidance scheme.[2] A further example is Atkinson & Mummery v Kingsley and Smith (2020), where a director was found not to be in breach of their Section 172 duty in failing to prevent access to the company bank account for one of the directors with whom relationships had deteriorated and who made a transfer from that account. While the facts are specific to the case, the point under Section 172 is that the initial test is subjective: based on the information available, did the director honestly believe they were acting in the best interests of the company and its shareholders? The court then applied an objective test: would an honest and intelligent person have taken the same actions to comply with their duties? This ensures that directors cannot simply ignore things and absolve themselves of responsibility, but there is also a reasonableness test in place. The recent case of ClientEarth v Shell Plc (2023) reinforced these points. It is for the directors themselves, acting in good faith, to determine how to act in the best interests of the company under Section 172. A breach requires proof of conduct other than in good faith. Indeed, under the general duty of reasonable skill, care and diligence imposed under Section 174 (discussed below), the law does not ‘superimpose on that duty more specific obligations as to what is and is not reasonable in every circumstance’.[3]
Section 172 is not without its controversies and detractors, and forms part of the wider debate around company purpose. Some criticism focuses on the expectation that the directors must act for the success of the company rather than any stated wider purpose.
A further important provision is Section 174 of the Companies Act 2006. This sets out that a director must exercise reasonable skill, care and diligence – a legal provision that applies to all directors, not just NEDs, in accordance with the principle that all directors have the same duty of care and diligence. This duty, however, is also qualified by both an objective reasonableness test and a subjective contextual test, set out in Section 174 (2) as follows:
2) This means the care, skill and diligence that would be exercised by a reasonably diligent person with –
a. the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and
b. the general knowledge, skill and experience that the director has.[4]
In respect of proceedings under the Company Directors Disqualification Act 1986, the test under its section 6 (1) (b) is that of unfitness. The courts have found that this test is also one that must be measured by context, by the actual responsibilities undertaken by the director. In Re Keeping Kids Company (2021), Falk J, at paragraph 144, cited Jonathan Parker J, in his judgment in Re Barings plc (No. 5) (1999), summarising the principles to be used in respect of disqualification and making clear that conduct must be evaluated in context, by reference (paragraph 144 (h)) to the actual role and responsibilities.
We might summarise the legal position around directors’ duties as a standard duty of care but tested by reasonableness and context. Thus, Gower’s Principles of Modern Company Law (11th edition) states:
What does this all mean for directors? First, although directors, executive and non-executive, are subject to a uniform and objective duty of care, what the discharge of that duty requires in particular cases will not be uniform. As the statutory formulation itself recognises, what is required of the director will depend on the functions carried out by the director, so that there will be variations, not only between executive and non-executive directors but also between different types of executive director (and equally of non-executives) and between different types and sizes of company.[5]
[1] Ernest Lim, ‘Judicial Intervention in Directors’ Decision-Making Process: Section 172 of the Companies Act 2006′, Oxford Business Law Blog, 22 February 2018, https://blogs.law.ox.ac.uk/business-law-blog/blog/2018/02/judicial-intervention-directors-decision-making-process-section-172.
[2] This case is under appeal.
[3] ClientEarth v Shell plc, [2023] EWHC 1897 (Ch), paragraph 31.
[4] Companies Act 2006, Part 10, Chapter 2, ‘General duties of directors’, Section 174, https://www.legislation.gov.uk/ukpga/2006/46/section/174.
[5] Gower: Principles of Modern Company Law, 11th edn, ed. Paul Davies, Sarah Worthington and Chris Hare, London: Sweet & Maxwell, 2021.
The current debates around the roles, responsibilities and liabilities of NEDs are not occurring in a vacuum: as recently as October 2023 the Insolvency Service’s disqualification action against the NEDs of Carillion (on behalf of the Secretary of State) was dropped a few days before the trial was due to commence. The aim here is not to analyse individual cases but to understand the background issues and the implications in respect of NED duties and expectations more broadly. Not only are there relevant contemporary cases and challenges but also a history of reviews and reports on corporate governance, as well as academic reflection. In the short space available it is at least possible to summarise how we have got to this point.
Corporate governance reports have been a feature of the British corporate and regulatory scene for many decades. They have been in more or less direct response to failure or scandal. As well as a regularly updated ‘UK Corporate Governance Code’[1] reflecting best practice there is also a history of reports that have specifically discussed the role of the NED. In addition, though beyond the main concern here, there have been proposals for a new governance regulator to replace the Financial Reporting Council (FRC).
This section will review the Corporate Governance Code and its guidance and also summarise the relevant provisions of previous corporate governance reports. Section 3 will return to legal and Section 4 to practical implications for this discussion.
The current Code, applicable to all UK companies with a premium listing on the London Stock Exchange and representing best practice for other companies, is the 2018 version published by the FRC. It has also published additional guidance, the most relevant being the ‘Guidance on Board Effectiveness’.
In 2024 the FRC published a revised Code that makes a number of amendments to that of 2018, particularly in relation to internal controls. The FRC also combined three elements of guidance, including ‘Guidance on Board Effectiveness’, into one document, the ‘2024 Code Guidance’, to which the online Code contains hyperlinks. The 2024 Code will apply mainly to financial years beginning on or after 1 January 2025.
The 2024 Code Guidance sets out the responsibilities of the various actors, including board chair, executive directors, the senior independent director and NEDs. Before turning to the specific roles and duties of the NED, it is worth noting what the Guidance says about directors more generally. Paragraph 69, dealing with the role of executive directors, states:
Executive directors have the same duties as other members of a unitary board. These duties extend to the whole of the business, and not just that part of it covered by their individual executive roles. Nor should executive directors see themselves only as members of the chief executive’s team when engaged in board business. Taking the wider view can help achieve the advantage of a unitary system, meaning greater knowledge, involvement and commitment at the point of decision. Executive directors are likely to be able to broaden their understanding of their board responsibilities if they take up a non-executive director position on another board.[2]
This paragraph recalls some of the basic principles of the roles and duties of a director and emphasises the importance of experience across the executive and non-executive roles. This is rather contrary to the perceived public narrative of ‘revolving doors’ – that is, of executives retiring from an executive role and immediately taking up a non-executive appointment – and a reminder of the educational theme at the heart of this publication.
The ‘Guidance on Board Effectiveness’ sets out several areas of guidance on board composition, roles, divisions of duties and other matters. The role of the NED is specifically commented on in paragraphs 75–78 and elsewhere. These points may be summarised as the importance of devoting sufficient time, demonstrating integrity, understanding the business and its culture and insisting on high-quality information. For example, the Guidance states in paragraph 76 that it ‘is vital that non-executive directors have sufficient time available to discharge their responsibilities effectively’.[3]
Paragraph 77 continues:
Non-executive directors need to insist on receiving high-quality information sufficiently in advance so that there can be thorough consideration of the issues prior to, and informed debate and challenge at, board meetings. They should seek clarification or amplification from management where they consider the information provided is inadequate or lacks clarity.[4]
The ‘UK Corporate Governance Code’ itself reflects a history of reports that have included the role of NEDs in wider reviews of corporate governance. The 1992 ‘Report of the Committee on the Financial Aspects of Corporate Governance’ (Cadbury Report) lays the foundation of the roles and responsibilities of NEDs in corporate governance. Paragraph 1.8 reinforces the position, now firmly established in both law and guidance, that ‘all directors are responsible for the stewardship of the company’s assets … [and] … whether or not they have executive responsibilities, have a monitoring role.’[5]
The Cadbury Report strongly advocated the unitary board system – that is, one single board (see Section 4.1) – and argued for the role of the NED in these terms: ‘the appointment of appropriate non-executive directors should make a positive contribution to the development of [the] businesses.’[6]
In paragraphs 4.1–4.6, Cadbury sets out its view that the roles of the NED are to:
A Remuneration Committee, consisting of NEDs, is an example of the last item in that the independent mind can reconcile the wider needs of the company with executive-director claims around pay, bonuses and other incentives, and ensure an alignment of interests between executives and members of the company.
Two other qualities the report brings out are independence and calibre. In respect of independence: ‘non-executive directors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct.’
Naturally there are instances when such independence is threatened (for example, remaining on a board for too long or becoming too close to the executives), but sight should not be lost of the fact that Cadbury makes an articulated case and vision for the role and positive impact of NEDs in the conduct of business.[7]
Appearing in 1998, the Hampel Report[8] was another key building block in the development of the ‘UK Corporate Governance Code’. This reinforced Cadbury’s points on board balance, independence and the importance of the information supplied to NEDs – a recurring theme. Hampel also endorsed common duties for all directors but differed importantly from Cadbury in respect of the role of the NED.
Hampel argued that Cadbury overemphasised the monitoring role of the NED and insisted that NEDs ‘should have both a strategic and a monitoring function’.[9] This is an important corrective: in terms of public understanding of the NED’s roles, and indeed the media narrative, an overemphasis on monitoring at the expense of strategy has certainly been a feature of regulatory and legal actions against directors. Both Cadbury and Hampel argued for a substantial proportion of NEDs on boards.
A further piece of the framework came in 1999 with the Turnbull Report.[10] This focused principally on internal controls. The main points raised concerning NEDs are in respect of board balance. Turnbull argued that boards should be at least one-third NEDs and that no individual or group should exercise excessive power, and made other provisions, including in relation to audit committees and terms of office.
The Higgs Review of 2003, commissioned in the light of scandals and corporate failure, was specifically titled a ‘Review of the Role and Effectiveness of Non-Executive Directors’.[11] Higgs returns us to the strategy-versus-monitoring discussion and draws a distinction between US and UK developments, noting that: ‘the role of the non-executive director in this process contrasts with that of US regulators, who have tended to emphasise the monitoring role at the possible expense of the contribution the non-executive director can make to wealth creation.’[12] The report argued that lack of clarity around the role of the NED had been a recurrent theme in submissions to the committee.[13] Higgs reinforced the role of the NED around strategy, performance, risk and remuneration. The report also argued that at least 50 per cent of a board, excluding the chair, should be NEDs, hence a majority. One new feature was a recommendation that the NEDs should meet alone once a year.[14] Although some might argue that this introduces a division in the unitary view of a director, Higgs saw these as informal meetings that did not conflict with the wider partnership and trust across the board as a whole. The Review also picked up the question of diversity and the dangers of informality, and the use of personal contacts in the appointment process, which not only lacked rigour but tended simply to replicate the background of existing directors.
A final area of interest concerned the question of liability, which has become increasingly prominent. The overall position set out in Higgs has stood the test of time:
Although non-executive directors and executive directors have the same legal duties and objectives as board members, the time devoted to the company’s affairs is likely to be significantly less for a non-executive director than for an executive director and the detailed knowledge and experience of a company’s affairs that could reasonably be expected of a non-executive director will generally be less than for an executive director. These matters may be relevant in assessing the knowledge, skill and experience which may reasonably be expected of a non-executive director and therefore the care, skill and diligence that they may be expected to exercise.[15]
Consequently, there needs to be clarity around roles and expectations, appropriate induction and training and clear reasons given in case of resignation.
Higgs recommended a further review committee that would give prominence and guidance around the skills and experience needed to expand the pool of NEDs by identifying suitable candidates in the non-commercial sector. That came to fruition, also in 2003, as the Tyson Report,[16] which argued that: ‘Individuals with successful leadership careers in the non-commercial sector are likely to have attributes, skills and experience relevant to NED positions in the commercial sector.’[17] Examples included the chief executives or finance directors of large charities. Expanding the recruitment pool into the non-commercial sector was also likely to increase the representation of women. Tyson further recommended looking outside the domestic market.
Much of the discussion around non-executive directors in corporate governance codes draws on the academic literature, a review of which reveals three key aspects:
The evolution of corporate governance has been shaped by a confluence of global changes and academic developments, each playing a crucial role in transforming governance structures worldwide. In the 1970s and 1980s, a seismic shift occurred, marked by more widespread shareholding, increased shareholder activism, hostile takeovers and leveraged buyouts, particularly in the USA. This period prompted a re-evaluation of corporate governance structures, emphasising the need to align the interests of shareholders and managers. While managers are tasked with maximising shareholder value (or at least acting in shareholders’ best interests), without adequate governance mechanisms they may make decisions that benefit themselves at the expense of shareholders. Simultaneously, in academic circles the 1970s saw the emergence of agency theory (though the ideas existed prior to the term), a foundational framework that scrutinised the principal–agent relationships within organisations. It refers to the idea that a principal actor (for example, the shareholders) appoints an agent (the board) to act on their behalf. This theoretical underpinning provided crucial insights into the conflicts of interest between shareholders and executives, laying the foundation for subsequent academic research and discussions on corporate governance.
The practical reforms in corporate governance gained momentum after the 1980s, not least with the many UK reports into it, the most significant of which, as they relate to NEDs, were discussed above. Consequently, the role of the NED became more prominent and was placed under more scrutiny, as a governance mechanism aimed at introducing objectivity and reducing potential conflicts of interest. Hence the global evolution of corporate governance has been influenced by both practical proposals and academic insights, representing an interplay between theory, regulatory responses and the ever-changing landscape of business practice.
The focus on agency theory has been significant. Each successive wave of scandal or failure has exposed divergence of interests between executives and shareholders, but also between business and society more generally. Mahmoud Ezzamel and Robert Watson summarised the thinking around independent directors, examining ‘the managerial and governance functions of the board of directors and the changes in terms of their composition and governance roles brought about by recent reforms’, and focusing on ‘the governance roles now expected of the non-executive directors on the board’:
In the US and UK, these part-time NEDs are now expected to undertake two distinct and somewhat contradictory roles. One the one hand, they are expected to be full members of the top corporate management team with exactly the same responsibilities for the formulation and management of corporate strategy as their executive board colleagues. On the other hand, however, they are also required to be independent of these same colleagues. This is because NEDs are also now expected to be primarily responsible for ensuring the quality and reliability of corporate information disclosures, keeping executives focused on the generation of shareholder value, via the design and implementation of appropriate employment and remuneration schemes, and the disciplining of their executive director colleagues that appear to be underperforming.[18]
The role of the NED has generally been affirmed in the literature. For example, Svetlana Mira, Marc Goergen and Noel O’Sullivan argue, albeit with perhaps an overemphasis on the monitoring role of the NED, that:
In the UK, over the past 25 years the board of directors has been emphasized as one of the most important instruments of corporate governance. Central to this has been an emphasis on the monitoring potential of non-executive directors, with successive governance codes stressing the need for significant non-executive participation on boards. Consequently, a majority of board positions in large UK companies are now held by non-executive directors. The expectation is that non-executives are able to actively monitor the behaviour of management, ensuring that corporate decisions are made in the interests of shareholders.[19]
Anup Agrawal and Sahiba Chadha found that the presence of independent directors and, indeed, good governance more widely, had a positive influence when dealing with accounting scandals.[20] Mira et al. found that ‘the non-executive labour market is efficient and rewards non-executives for good acquisitions’, by which they meant that a non-executive director associated with good board decisions is likely to have other future non-executive opportunities. Nevertheless, it is also the case that deficiencies in the role of the NED may be seen as contributing to the global crisis of corporate governance,[21] and that NEDs may be failing to make the executives accountable. There are also significant debates around appointment, not least the reliance on informal networks.[22]
A 2010 article by Alessandro Zattoni and Francesca Cuomo reviewed the literature on NEDs and concluded that:
In a sense this academic discussion reflects both the strengths and weaknesses of the public narrative around NEDs, which will figure more below. Independence is key, but also the idea of NEDs as guardians or buffers – stewards of the corporate good and a barrier between the executive directors and shareholders. Christopher Pass represented a more empirical approach in the literature with his study of 51 large UK companies and their boards drawn from annual reports.[24]
A further example of this empirical methodology came from John Roberts, Terry McNulty and Philip Stiles, who argued that too much of the academic literature on NEDs, governance and board effectiveness was dominated by agency theory and its underlying assumptions. Their study examined the effectiveness of boards and NEDs based on 40 interviews with directors commissioned for the Higgs Review, and concluded that board effectiveness was determined by conduct and behaviour more than governance and structure, though clearly these are not mutually exclusive. They argued that it is perceptions of board effectiveness, rather than the actual experience of directors, that might shape approaches to corporate governance reform.[25]
This swift consideration of the academic literature serves as a reminder of the conceptual basis on which the various reviews of corporate governance were built, and the continued importance of both ideas and practicalities.
[1] Financial Reporting Council, ‘UK Corporate Governance Code’, London: FRC, January 2024; see https://media.frc.org.uk/documents/UK_Corporate_Governance_Code_2024_kRCm5ss.pdf.
[2] Financial Reporting Council, ‘Guidance on Board Effectiveness’, July 2018, paragraph 69, https://media.frc.org.uk/documents/Guidance_on_Board_Effectiveness_MmfcOrz.pdf.
[3] ‘Guidance on Board Effectiveness’, paragraph 76.
[4] ‘Guidance on Board Effectiveness’, paragraph 78.
[5] ‘Report of the Committee on the Financial Aspects of Corporate Governance’, December 1992 (Cadbury Report), paragraph 1.8, https://www.icaew.com/-/media/corporate/files/library/subjects/corporate-governance/financial-aspects-of-corporate-governance.ashx?la=en.
[6] The Cadbury Report, paragraph 3.15.
[7] The Cadbury Report, paragraph 4.11.
[8] ‘Committee on Corporate Governance, Final Report January 1998’ (Hampel Report), https://www.icaew.com/technical/corporate-governance/codes-and-reports/hampel-report.
[9] Hampel Report, paragraph 3.8.
[10] Internal Control Working Party of The Institute of Chartered Accountants in England & Wales, ‘Internal Control: Guidance for Directors on the Combined Code’ (Turnbull Report), September 1999, https://www.ecgi.global/publications/codes/internal-control-guidance-for-directors-on-the-combined-code-turnbull-report.
[11] Derek Higgs, ‘Review of the Role and Effectiveness of Non-Executive Directors’, January 2003 (Higgs Review), https://webarchive.nationalarchives.gov.uk/ukgwa/20121212135622/http://www.bis.gov.uk/files/file23012.pdf.
[12] Higgs Review, paragraph 1.12.
[13] Higgs Review, paragraph 6.4.
[14] Higgs Review, paragraph 8.8.
[15] Higgs Review, Annex A, p. 92.
[16] ‘The Tyson Report on the Recruitment and Development of Non-Executive Directors’, June 2003, https://web.actuaries.ie/sites/default/files/erm-resources/250_tyson_report.pdf.
[17] Tyson Report, p. 13.
[18] Mahmoud Ezzamel and Robert Watson, ‘Boards of Directors and the Role of Non-Executive Directors in the Governance of Corporations’, in Corporate Governance: Accountability, Enterprise and International Comparisons, ed. Kevin Keasey, Steve Thompson and Mike Wright, Chichester: Wiley, 2005, pp. 118–36.
[19] Svetlana Mira, Marc Goergen and Noel O’Sullivan, ‘The Market for Non-Executive Directors: Does Acquisition Performance Influence Future Board Seats?’, British Journal of Management 30:2 (2019), pp. 415–36, https://doi.org/10.1111/1467-8551.12290.
[20] Anup Agrawal and Sahiba Chadha, ‘Corporate Governance and Accounting Scandals’, The Journal of Law & Economics 48:2 (2005), pp. 371–406, https://doi.org/10.1086/430808.
[21] Jill Solomon, Corporate Governance and Accountability, 3rd edn, Chichester: Wiley, 2010.
[22] Jay A. Conger and Edward Lawler, ‘Building a High-Performing Board: How to Choose the Right Members’, Business Strategy Review 12:3 (2001), pp. 11–19, https://doi.org/10.1111/1467-8616.00179.
[23] Alessandro Zattoni and Francesca Cuomo, ‘How Independent, Competent and Incentivized Should Non-executive Directors Be? An Empirical Investigation of Good Governance Codes’, British Journal of Management 21:1 (March 2010), pp. 63–79, https://doi.org/10.1111/j.1467-8551.2009.00669.x.
[24] Christopher Pass, ‘Corporate Governance and the Role of Non-executive Directors in Large UK Companies: An Empirical Study’, Corporate Governance 4:2 (June 2004), pp. 52–63; DOI: 10.1108/14720700410534976.
[25] John Roberts, Terry McNulty and Philip Stiles, ‘Beyond Agency Conceptions of the Work of the Non-Executive Director: Creating Accountability in the Boardroom’, British Journal of Management 16:s1, pp. S5–S26 (2005), https://doi.org/10.1111/j.1467-8551.2005.00444.x.
There is a view that the public square is ‘secular’ and that therefore religious believers should leave their baffling theology at home and learn to speak sensible, non-theological language in public. One well-known expression of this view came from the eminent German philosopher and public intellectual, Jürgen Habermas, who for a long time held that the onus is on religious people, when they speak in public, to translate what they have to say into common, non-religious terms.
There are a number of problems with this, I think. First, Western societies are not ‘secular’ in the sense of predominantly anti-religious or areligious. In fact, we comprise a plethora of different moral and metaphysical views, some atheist, others dogmatically religious, but most more or less agnostic, more or less religious. We are plural rather than ‘secular’ in the sense of being generally hostile or indifferent to religion.
A second objection I have to the Habermasian view is that theological expressions are by no means uniquely baffling. Bafflement is a common feature of human conversation; the political left and right frequently baffle each other. Nonetheless, we ordinarily find ways of exploring viewpoints that initially nonplus us, to reach a measure of understanding, perhaps even to discover points of common ground. Many people who think and speak in theological or religious terms are perfectly capable of that—or at least as capable as anyone else.
For those reasons, I prefer Augustine’s concept of the secular to Habermas’s. For Augustine, the saeculum is the age between the Resurrection of Christ and its fulfilment at the End of Time. The ‘secular’ age is one of ambiguity and mixture, and a ‘secular’ society is a religiously and philosophically plural one, not one that is predominantly or systematically hostile to religion.
In such a plural society, it seems to me, religious believers should be free to speak their minds in their own terms—just like anyone else. They should be free to refer in public to such things as God, Jesus, the Bible, and the afterlife. That said, if they want to be understood, they will often have a lot of explaining to do.
I find the thought of the leading English-speaking political philosopher, John Rawls, to be closer to the mark than Habermas’s. Rawls—who took a serious interest in theology as an undergraduate at Princeton—argues that ‘reasonable’ versions of humanism, Christianity, Judaism, and Islam can all sign up to ‘public reason’ on their own terms. By ‘public reason’ he means a set of presuppositions and rules for governing public discussion, not least ‘fairness’. This is something, Rawls argues, that certain kinds of Christian theology—alongside certain other worldviews or ‘comprehensive doctrines’—can own and endorse. In that sense, ‘public reason’ does not require ‘reasonable’ Christians to leave their theology at home when they venture out into public, for ‘public reason’ is itself an expression of that theology—albeit not only of that theology.
So far, I agree with Rawls. Nonetheless, I think he underestimates the scope for divergence and disagreement within ‘public reason’. He is inclined to think that ‘public reason’, once endorsed by ‘reasonable’ worldviews, floats free of them, a common creed whose content is entirely independent of each of its supporting worldviews. I think that is a mistake. I think that ‘public reason’ contains difference, both in the sense of limiting it and including it. That is why I refer to it, not simply as a consensus, but as a tense consensus.
So, for example, suppose a common presupposition of ‘public reason’ is the idea of the dignity of the individual. A post-modern Romantic humanist will understand that dignity as consisting in the individual’s expression of the self’s inimitable genius. A Christian, however, seeing the human individual as a sinful creature, will suppose that there’s a lot in human selves that is not worthy of expression at all. Instead, what makes for the individual’s dignity is his investment in objectively given goods such as truth, justice, and beauty. For sure, this investment will express itself in a particular self’s inimitable manner. But the main point is this: for a Christian, human dignity consists in the individual’s responding to and expressing a moral order that is God-given. It does not consist in the individual staring into his own murky depths and bringing out whatever he finds there, willy nilly.
Rawls is correct that non-religious humanists and Christians share a common idea and value: the dignity of the individual. And that is good, for it limits disagreement. However, within those limits, it also contains difference and controversy. Rawls underestimated that.
As affirmed above, my view is that religious believers should feel free to make explicit references to God, Christ, the Parables, the Bible—as I have heard Anglican bishops do in the House of Lords. Some peers may be irritated by that, others might be baffled, but irritation and bafflement can stimulate thinking and rethinking, which is often no bad thing. And besides, anyone who claims to support a liberal society has no business resenting the expression of viewpoints he does not agree with.
That said, how explicit or implicit theological expression should be depends on the circumstances. I am a Christian and a theologian trained to think in theological terms. I always intend to have my moral and political thinking derived from, or at least governed by, my Christian beliefs about God, Christ, the afterlife, etc. However, whether or how far I reveal the theological roots of my thinking depends on the nature and purpose of the gathering. In a church context, where I’ve been asked to talk about a Christian view of a certain topic, I will, of course, be explicit. But in a plural, public context where the topic is, say, the legalisation of assisted suicide, the surrender of the Chagos Island to Mauritius, or the banning of corporal punishment, I will make moral arguments that will not expose all or any of their theological roots. Why? Am I biting my theological tongue out of embarrassment? Not at all. I am merely reserving some of my thinking out of respect for my fellow citizens, who agreed to gather and discuss an ethical question, not to have a debate about the meaning and veracity of theological claims. I am merely respecting the purpose of our meeting. Should anyone tap me on the shoulder afterwards in the corridor or the bar and ask me to explain what my theology has to do with my ethical views, I would gladly tell them.
All the same, the fact that I usually do not talk theologically in the public square does not mean that what I say there is not theologically informed. So, for example, my opposition to the legalisation of assisted suicide is shaped by my Christian view of human beings as finite and fallible creatures. This makes me realistically sensitive to likely practical result of implementing assisted suicide in a healthcare system constantly under financial pressure and run by harassed and impatient—and, very occasionally, malevolently sinful—creatures. In contrast, it seems to me that the proponents of assisted suicide are recklessly idealistic, assuming that healthcare professionals and relatives are gods and saints, not creatures and sinners. In a sense, then, when I express my views on assisted suicide, I am speaking theologically—or at least I am speaking out of my theological worldview—even when the theology is not apparent.
In recent years, to my surprise, I have found myself fighting in public for the right to free speech. I do so as a Christian and because of my theological anthropology. One consequence of that is that, whereas some other free speech advocates explain what they are contending for in terms of the individual’s right to self-expression, my rationale is different. A signal advantage of believing in God is that you are less inclined to mistake yourself for one. Believing as I do in God, I regard humans as creatures and not gods, sinners and not angels. Our understanding of what’s true and good and beautiful is often incomplete or distorted. So, in order to reach a better understanding, we need to be free to challenge and test reigning orthodoxies, because if those orthodoxies are false and if they misshape our schools and workplaces, and the policies of our police and government, then we all suffer. Therefore, we need the freedom to challenge prevailing views and call them to public account. We need the freedom to prophesy. In this way, my Christian theology inclines me to be liberal in the classical, Millian sense.
In addition to fighting for the right to free speech, I have also found myself fighting the corner of reason. Since religious believers are typically accused of being irrational, I take a lot of smug pleasure in playing such a role. I have found myself doing it mainly in relation to the public controversy over Britain’s colonial history, our involvement in slavery, and whether or not we owe reparations. One thing I have observed of the ‘progressive’ advocates of ‘decolonisation’ and slavery reparations is that their claims typically run out way ahead of the facts, evidence, and reason. Evidently, personal and political passions so possess them that they are driven beyond reason. And these passions render them absolutely unfree to do justice to critics such as me. So instead, they resort to personal abuse, smearing, misrepresentation, and political manipulation. Rather than reason, they resort to unscrupulous power. They behave like little tyrannical gods, and they behave like that because they are driven, possessed, … demonic.
Observe: in order to explain the phenomenon of ‘progressive’ irrationality and illiberality, I have recourse to spiritual and theological terms: ‘gods’, ‘demonic’. And at the end of my books on colonialism and reparations, and in my next one on the culture wars, I am quite explicit about that. I turn explicitly theological because those terms illuminate something that other terms just do not.
But often, as I have said, the theology is, while still effective, nonetheless implicit. I think that one of the most important contributions that theologically-formed Christians can make to public controversy over colonial history—or racism or transgender identity or whatever—is to develop, exercise, and model virtues that are vital in keeping controversy civil and reasonable. These are virtues that make sense if you understand human beings to be creatures and sinners who find their fulfilment in aligning themselves with, and being answerable to, a moral order they did not create but is given to them.
These are virtues such as: courage in the face of ideas that are alien and threatening; strict justice in representing the views of others; charity in construing their ambiguities, preferring the strongest rather than the weakest possibility; docility in admitting the possibility that they might have something to teach; humility in admitting the possibility of correction by them; forbearance and temperance in the face of the unfairness and provocation that opponents may perpetrate; and above all, such a love for the truth that one keeps on saying it—prophesying it—in the face of hostility.
These virtues are not uniquely Christian. One can find many of them endorsed in Jewish, Muslim, and Confucian traditions. On the other hand, some are explicitly repudiated by the likes of Aristotle and Nietzsche, who did not recognise humility and compassion, respectively, as virtuous at all. So, my list of virtues is characteristically Christian and, as such, it is relatively distinctive. In general, my view is that authenticity is what is important, not distinctiveness. After all, how distinctive we are depends entirely on what issue is at stake and with whom we are being compared. As I have long said of myself, whether I am ‘right-wing’ or ‘left-wing’ depends entirely on what we are talking about and whom I am standing next to. Distinctiveness is relative.
Nevertheless, if the virtues I have mentioned are not uniquely Christian, they are rarely talked about in contemporary Western culture, where rights-talk so dominates as to push almost every other kind of moral vocabulary off the table. That is not to say that no one intuits virtue or exercises it. But it is to say that talk about it is so repressed that it is difficult to name, and being difficult to name, it is difficult to identify, communicate, and promote. The result is that vice flourishes unopposed.
Therefore, by developing, displaying, and naming intellectual and social virtues in the midst of no-holds-barred culture wars, theologically informed Christians have a very important role to play in giving voice to them and reminding their fellow citizens of their importance. In so doing, they will contribute to the vital task of defending and promoting a generously, responsibly, rationally liberal culture among us—and of preserving us from political bloodshed.
Nigel Biggar is Regius Professor Emeritus of Moral Theology at the University of Oxford.
Anthropomorphising AI is rhetorically seductive but intellectually unsound. We must remember that the analogy between artificial intelligence and human intelligence is a distant one. Otherwise, we risk conflating computer systems with human-like agents and automation with autonomy. The anthropomorphisation of artificial intelligence – i.e. the attribution of human characteristics, intentions, or moral status to computational systems – has become a pervasive feature of public discourse, marketing (particularly in the private sector), and even some strands of academia. Popular narratives describe AI systems as entities that ‘think’ ‘understand’ or ‘want’, and conversational interfaces are explicitly designed to reinforce such impressions. The problem is that anthropomorphising AI is both conceptually mistaken and practically harmful. It obscures the technical limitations of AI systems, and misleads users about capabilities and risks, and ultimately cloaks moral reasoning behind syntax with no regard for semantics. More importantly, it confuses our understanding of what it is to be human: to be able to build authentic loving relationships as beings who are not only physical and mental (particularly with regard to our assumed rationality), but also emotional and spiritual.
Anthropomorphising AI leads users to systematically overestimate what such systems can do. Statements such as ‘the model knows’, ‘the system decided’, or ‘ChatGPT says…’ suggest agency and human-like comprehension where neither exist. In reality, most deployed AI systems optimise objective functions (which in turn are defined by human designers), using training data curated – often imperfectly – by institutions with specific incentives (i.e. Meta, Alphabet, Anthropic, etc).
Researchers in machine learning have repeatedly emphasised this point – Professor Emily Bender from the University of Washington famously pointed out that large language models are ‘stochastic parrots’: systems that reproduce patterns in data without grounding in the world. While the phrase is polemical, it captures an important truth. The appearance of understanding is an emergent property of scale in datapoints and statistical regularity, not evidence of human-like cognition. Treating this appearance as reality risks unwarranted trust in AI outputs, particularly in high-stakes domains such as medicine, law, or public administration. This is not to diminish the significant potential of AI in such spheres but rather to acknowledge the inherent risks involved.
Contemporary AI systems, including large language models, are fundamentally artefacts: engineered systems that operate through statistical pattern recognition and optimisation. Mental states such as beliefs, intentions, or understanding belong to agents with human consciousness and intentionality, not hardware-intensive, software-executing algorithms. John Searle’s well-known critique of complex AI remains instructive here. Searle argued in his Chinese Room thought experiment that symbol manipulation alone does not constitute understanding: ‘Syntax is not sufficient for semantics’. When an AI system generates fluent language, it does not follow that it understands the content of that language. It cannot, because understanding in any normal sense requires human consciousness. Anthropomorphic descriptions blur this distinction, encouraging the false inference that linguistic competence entails cognitive or experiential depth.
There is also a further consequence of anthropomorphisation: When AI systems are framed as quasi-persons, responsibility subtly shifts away from human actors. Failures can be deflected to ‘the AI’, rather than to designers, deployers or institutions that selected training data, defined objectives and chose deployment contexts.
Anthropomorphising AI also affects how users relate to technology. Human beings are predisposed to attribute agency and emotion, particularly in interactive settings. Designers exploit this tendency through conversational cues, names and simulated empathy. While such design choices may improve user engagement, it remains an illusion that risks fostering emotional dependency or misplaced trust.
A recent article in The Economist illustrated some worrying concerns regarding the use of AI in early years education. Children growing up anthropomorphising AI companions that never express fatigue, frustration or any form of negative emotion is poor preparation for human relationships later in life. It is also emerging that users who perceive AI systems as social actors are more likely to disclose sensitive information and less likely to critically evaluate outputs, leaving children particularly vulnerable to the pitfalls. When a system appears to ‘care’ or ‘understand’, children may suspend scepticism. This is not merely a theoretical concern but has wider practical implications for privacy, manipulation and informed consent.
Many ethical systems point to humanity which is more than its biochemical build. Aristotle himself saw the cultivation of intellectual and moral virtues as realising a distinctly human form of flourishing (i.e. eudaimonia), that transcends basic biological functioning. A Christian perspective would focus not only on the development of the whole human person, in body, mind and spirit, but in particular on the mystery of love. Christianity points to the formation of committed, loving relationships as the supreme human ability gifted to us from God – indeed, human beings were created for a loving, covenantal, transformative relationship with the Creator and with each other.
The transformative power of this intimate love between God and human beings is expressed in its fullness in Christ. The Triune God – Father, Son and Holy Spirit – is defined as three persons consubstantially rooted in the perfect relationship of selfless love. When the Son embraces full humanity in the incarnation, it is this interpersonal selfless love that becomes available to all. It is in Him, as the true image of God (Latin: imago Dei), that true humanity is revealed, and it fundamentally includes the question of love. This is indeed the uniqueness of the Christian faith: in Christ, divine, eternal and selfless interpersonal love is not only revealed as an external reality, but as fully available and accessible to every human being. Humanity in Christian thought is both interrelational and fundamentally defined by love. AI systems do not have the capacity to partake in this. These ethical issues are crucial and a misconceived engagement with AI will likely leave us face-to-face with many of the dangers discussed here.
A disciplined refusal to anthropomorphise AI is therefore not a matter of pedantry, but a prerequisite for technical accuracy, moral lucidity and responsible adoption. If AI is to be conscientiously integrated into our spheres of social and institutional life, it must be understood for what it is: a powerful class of tools created, constrained and deployed by humans that ought to be accountable to human values and institutions. Clear, non-anthropomorphic language would also support clearer policy. Describing AI systems as tools with specific affordances and limitations enables policymakers to focus on risk management, transparency and accountability, rather than non-existent computer semantics.
This is not a call for the adoption of a luddite lifestyle or indeed for all kinds of regulation to limit our use AI, but rather an effort to maintain proper perspective and understanding of a technology that is already permeating our daily lives.
Andrei E. Rogobete is Associate Director at the Centre for Enterprise, Markets & Ethics. For more information about Andrei please click here.
