Companies focused on profits at all costs could be missing a trick. ‘Grow The Pie’ is an intelligent commentary that proposes a new way for company CEO’s to look at the world and explains why investors should care.
Professor Alex Edmans is a rather unconventional thinker and has an infectious dynamism. After listening to him, you can’t help but feel you need to do more. Edmans started off his career as an investment banker at Morgan Stanley after studying Economics and Management at Oxford. He is now a Professor of Finance at London Business School, having previously been a professor at Wharton: an interesting and perhaps fortuitous mix!
Matthew Gordon talks to Alex Edmans, 20th June 2020
In business and investing, it is common thinking is that a company should exist solely to make money. It’s purpose is to deliver profits to shareholders and owners. It’s a reasonable assumption. Edmans argues that a company’s purpose should also be to do good for society. He asks the question, ‘why is the world a better place for this company being in it?’ Clearly, investors would be unlikely to invest in a company that focuses on altruism and does not maximise every opportunity to make profit for its shareholders. Every pound or dollar spent on ‘non-core activity’ costs the company a multiple of that, ie: if a company is valued on a multiple of the bottom line, every $1 of cost in this sense is $5, $10, $20 ‘lost’ in the event of a sale of the company. However, Edmans shows us that companies who treat stakeholders, such as employees or supplies, well can potentially ‘grow their pie’ in the long term, and benefit wider society as a consequence.
Edmans thinks the reason investors fail to understand and value a company’s purpose entirely is because of socially conditioned values. The traditional view, innovated by Henry Ford, is to squeeze as much out of stakeholders as we can for a minimum outlay. This involves working employees hard and minimising tax paid. Freedom and delegation for employees are considered important components of building positive consumer relations: a far cry from the rigid routines of the cog-like past, but is it enough? Entrepreneurship is now actively encouraged, and workers can be part of the solution rather than part of the mechanism. And how do you measure that?
So, what does the data say? One interesting data source is on employee satisfaction which started in 1984: the 100 best companies to work for in America. In his analysis, Edmans ran this study until 2011: 28-years of robust data, including busts and booms. The study doesn’t just look at basic metrics like salary. Instead, it considers components such as level of trust in management, autonomy, delegation, etc. It was important for Edmans to weigh up whether a company that is already doing well treats its employees better because it can afford to, or whether treating employees well make the company successful in the first place. Correlation or causation? However, Edmans was able to demonstrate that it is likely to be causation: treating your employees better leads to long-term stock returns. Over the 28-year period, 89-184% can be attributed to performance. He also found that the relationship was just as strong in every sector: retail, pharmaceutical, banking etc. He is also keen to stress that a focus on social purpose does not mean that companies should avoid taking commercial decisions. Responsible companies have an obligation to their shareholders as well as their employees.
Companies that have had to make difficult commercial decisions during this COVID-19 crisis will be more successful in the long-run if they take action in a humane way. Airbnb is an excellent example. The travel industry has been decimated, and the company needed to let employees go to stay afloat. As a consequence, Airbnb has given terminated employees 14-weeks of severance pay rather than the much lower legal minimum. In addition, they were provided with a year of healthcare benefits at a time when healthcare is extremely important, and they were also allowed to keep their laptops for future job roles. Edmans clarifies that “purpose is different from enlightened self-interest”, because it will encourage companies to do the right thing even if they can’t calculate the benefit of doing so. Purpose is a universal ethos/philosophy, whereas enlightened self-interest is bottom-line profiteering. If a company frees itself from having to make every decision based on a calculation, the evidence suggests that they make better long-term decisions. A great example of this is Merck & Co. sharing the secrets of how to make penicillin with its rivals. As a byproduct of this, the best talent wanted to work for Merck, and the investors, especially hedge funds, took interest in possible social returns.
What is incredibly interesting is when we try to define exactly what ‘purpose’ means for companies. A purposeful company is not here to solve all of the world’s problems. In fact, Edmans argues that a purposeful company might HAVE to take tough decisions: a purposeful company is not all things to all people; instead, it recognised which of its stakeholders it should particularly focus on. For example, some companies that are transitioning towards a low-carbon approach may have to slash jobs. It’s about knowing what to focus on and where to scale back. Provided pharmaceutical companies aren’t hiking prices, and are instead charging for the cost of R&D and innovation, this isn’t necessarily immoral behaviour in Edmans’ book.
We can improve the world as employees, consumers and individual investors. As an employee, even at entry level, positive encouragement and positive energy can massively improve a working environment via a knock-on effect. “Be the thermostat, not the thermometer.” Many big institutions have already bought into the concept and are trying to implement some of the teaching into their operations.
What did you make of Alex Edmans? Comment below and we will respond!
Book Link: https://www.growthepie.net/
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