Tag: Milton Friedman

Lessons from Emmanuel Faber’s departure from Danone

Danone

On 26th June 2020 99% of the shareholders in Danone voted for it to become an enterprise à mission, or purpose driven company, required not only to generate profit for its shareholders, but do so in a way that it says will benefit its customers’ health and the planet.

Less than nine months later, Emmanuel Faber, Danone’s chief executive and the architect of the new strategy, was ejected by the board in the face of pressure from activist investors.  The FT leader writer observed on 18th March that “a backlash against purpose-driven capitalism was overdue” and that the debacle was “a reminder that distractions from the core goal of making a profit can be dangerous” before concluding that it did “not …. signal that leaders should rein in their ambition to go further and reassert the role of companies in society” and that to “revert now to simplistic and damaging pursuit of crude share-price maximisation would be a mistake.”

The ejection of Faber was not an illustration of the primacy of Friedmanite shareholder value, but an example of a chief executive failure to manage the investor market interface.  We don’t know precisely what the activist investors were thinking, but they were clearly dissatisfied with the returns they were expecting and believed that their investment returns would be increased with a different chief executive.

Under Faber’s successor, the activist investors hope that the value of their investment (in terms of capital growth and dividend returns) will increase as a result of improved internal operational performance and a changed strategy towards the customers at its other market interfaces – including suppliers, employees, consumers, owners of real estate and local communities, regulators, and government (recalling the appetite of the French government to view large domestic consumer businesses as strategic national assets when threatened by acquisition by overseas multinationals).  The choices of the different types of customer will include some consideration of ESG: consumers with an eye to environmental consideration (packaging, use of sustainable resources; employees preferring to work for companies whose conduct they can take pride in; investors wanting to see good governance.  The rhetoric employed by the activist investment customers may reflect discontent with financial returns, but implicitly they are concerned with how the Danone’s mission is translated into strategy and the possibility that Faber’s rhetoric around purpose conceals a lack of grip on operational performance.

The Danone debacle generated further commentary on whether this apparent backlash represented a retreat from “purposeful capitalism”.  John Plender wrote a powerful article for the FT on 4th April reflecting both on the Danone story and on the lessons from the Covid about the impact on stakeholders (particularly suppliers) who were unable to diversify  their risk (unlike investors) when a business hit rocks as the pandemic closed down parts of the economy.  He shared the view, which we addressed during the debate in 2017 on corporate governance reform in the UK, that appointing employee directors (or by implication directors representing any other specific stakeholder group) does not address the governance gaps.  He went on to argue for changes to the incentive models for senior managers to address short-termism and that profit or share value metrics determining them should be supplemented by ESG related metrics.  In short, “stakeholder capitalism must find ways to hold management to account” and that “the prevailing commitment to short-termist shareholder value has undermined corporate resilience.”

Hakan Jankensgard, Associate Professor of Corporate Finance at Lund University responded to Plender in a letter published by the FT on 7th April with an assertion that the firms should adopt the Hippocratic oath since this “would ensure that firms act as good corporate citizens”, with focus on long term profitability and “not become do-gooders picking sides in social debates”.  It is probably a reflection of the challenge of drafting a letter of appropriate length for publication, but some steps in his logic seems to missing.  However, other parts of his letter are compelling, echo arguments within the Escondido Framework view on how firms work and pitfalls in contemporary corporate governance, and are worth producing in full:

“As far as everyone is concerned, shareholders are the root cause of all the troubles afflicting our societies.

“Well, think again.  The real problem today is managerial capitalism – that managers run firms primarily to increase their own wealth and prestige.  A few decades back, managers were busy building wasteful empires, and the shareholder model arrived as a particular remedy for this gross inefficiency.

“Another innovation that arrive about the same time prove more fateful.  It was the idea that managers, if given the right financial incentives, would rediscover their entrepreneurial spirt. It caught on, to say the least.  What it really did, however, was to shift managers’ focus from building empires to extracting wealth through compensation packages.

“As manager took n their new role, they found willing accomplices in a cabal of short-term oriented investors looking for a quick return.  This unfortunate marriage is the problem at the heart of today’s economy as it creates short-termism that adds to long-term risk.”

Time to bury Milton Friedman?

Milton Friedman got a name check twice in today’s FT, on the letter’s page and in an article by Philip Delves Broughton on the facing comment page.  What was it that Keynes said about defunct economists?*

The first reference was in a letter from Philip G Cerny, Professor Emeritus of Politics and Global Affairs, University of Manchester and Rutgers University, writing in response to Jo Iwasaki who was calling for moral leadership to prevent behaviour like that revealed in the VW Dieselgate:

“The first mandatory prerequisite for company executives is maximum profitability, whether for the company as a whole or shareholders in particular, as Milton Friedman and others have so successfully argued. Culture comes a long way behind, and only comes into play if it actually contributes to profitability. In other words, there is an inherent structural conflict between profitability and the kind of moralistic behaviour Ms Iwasaki wishes to prescribe.

“On the contrary, there is in fact a deep culture of profitability that prevents other sorts of cultural values from working. Only factors outside the company — whether government regulations, the courts, consumer rebellion, strong public interest pressure groups or exposure to scandal (as with Dieselgate) — can be effective, and only then if they do not seriously dent profitability. That’s capitalism.”

The shortcoming in the Friedman perspective on which Cerny relies is the failure to understand that the primary driver for the company executive is self interest, rather than corporate profitability.  Corporate profitability is a driver of behaviour only to the extent that it affects self interest.  Self interest is a function of lifestyle preferences, reputation enhancement, job security, bonus targets and personal moral compass.  The challenge facing boards and investors, and indeed all those with an interest in how the company behaves, is how to align the interests of executives with their own.

The second reference to Milton Friedman is more insightful and comes in Philip Delves Broughton’s column, which is titled “American business is the master, not victim, of globalisation: If businesses saw more value in investing in US workers, they could have done so”. 

Delves Broughton addresses the prospects for bring offshored jobs back to the United States, as promised by Donald Trump.  Referring to Steve Jobs telling Barak Obama in 2011 that the jobs manufacturing iPhones wouldn’t be coming to the US anytime soon, he notes that manufacturing jobs are increasingly disappearing as automation takes over, and that Shenzen is way down the learning curve and now delivers quality that Apple would struggle to find in the US.  However, the principle point of the article is that

“….the best US companies had become brilliant at managing across borders and directing resources to where they generate the highest returns. They weren’t victims of globalisation. They were its masters and had become less and less American.”

Delves Broughton continues later in the article:

“If one accepts Milton Friedman’s argument that a corporation’s sole responsibility is to its owners, then one cannot find fault with these multinationals. They plant their flag where the money is. Their shareholders don’t want them playing the “Star Spangled Banner” in the boardroom. And while they may not directly be investing in American workers, they are generating returns for US investors who can reallocate their capital as they see fit. Mr Trump has done precisely this with his own business, investing in property deals far beyond US shores.

“But this is a fragile argument and Mr Trump is gleefully smashing it to pieces. He knows you cannot respond to stagnant wages and economic insecurity among the working and middle classes with the crystalline logic of a Nobel-winning economist. And he is threatening to perp walk before the press any companies that disappoint him.”

Offshoring in order to harness skills and low cost labour has probably generated greater benefits overall for the US population as a whole, as a consequence of lower prices, higher quality and, for that matter, returns to shareholders.  But Delves Broughton is right to challenge the shareholder value orthodoxy that is an expression of the Milton Friedman view of the world.  One of the consequences of this way of looking at, and describing capitalism has been the increasing inequality in US society that has fuelled American populism and landed the US, to say nothing of the wider world, with President Trump.

We can only hope that the resilience of American society and politics can withstand four years of a Trump presidency.  US companies face a challenging time, notwithstanding the appointment of representatives of large corporations to cabinet posts and promises of tax breaks, as the government tries to deliver on its promises to the rust belt.  One way of understanding their plight is to reflect on an excessive focus on the “crystalline logic of a Nobel-winning economist” (while, at the same time, being complicit in the way that top managers were being rewarded by boards composed of their peers at everyone else’s expense) and not paying sufficient attention to the wider constituencies, particularly employees, suppliers and the political world.

*”The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” The General Theory of Employment, Interest and Money (1936), Ch. 24 “Concluding Notes” p. 383-384