What helps notions such as fairness, honesty, and reciprocity to be codified into law?

12.1 The Shared Value Creation Framework

LO 12-1

Describe the shared value creation framework and its relationship to competitive advantage.

The shared value creation framework provides guidance to managers about how to reconcile the economic imperative of gaining and sustaining competitive advantage with corporate social responsibility (introduced in Chapter 2 ). 5 It helps managers create a larger pie that benefits both shareholders and other stakeholders. To develop the shared value creation framework, though, we first must understand the role of the public stock company.

PUBLIC STOCK COMPANIES AND SHAREHOLDER CAPITALISM

The public stock company is an important institutional arrangement in modern, free market economies. It provides goods and services as well as employment, pays taxes, and increases the standard of living. There exists an implicit contract based on trust between society and the public stock company. Society grants the right to incorporation, but in turn expects companies to be good citizens by adding value to society.

To fund future growth, companies frequently need to go public. Uber, featured in the ChapterCase, is one of the few companies that achieved a huge valuation before an initial public offering. Private start-up companies valued at a billion dollars or more are called unicorns, because at one time they seemed as rare as the mythical beast. But their elusiveness has changed. The tech sector now has the lion’s share: more than 160 unicorns valued at $1 billion or more, for a total of $615 billion. 6 The top five most valuable private startups (as of the summer of 2017) are Uber, Didi Chuxing (Chinese ride-hailingPage 422 company and mobile logistics network, similar to Uber), Xiaomi (Chinese smartphone maker), Airbnb, and Palantir. These new ventures may eventually go public such as did Snap (2017), Twitter (2013), Facebook (2012), and LinkedIn (2011). As long as these unicorns remain private, however, they do not have to follow the stringent financial reporting and auditing requirements that public stock companies do. Consider that there may be a connection between firm structure and the degree that it integrates ethics. Not needing to expose themselves to as much public scrutiny as a publicly traded company also allows unicorns such as Uber to push the envelope in their legal and ethical business practices. A potential downside is, however, that a track record of ethics and legal problems may prevent a successful initial public offering (IPO) in the future.

A picture of a unicorn. In capital markets, private companies that achieve a valuation of $1 billion or greater were once rare enough to be called unicorns. ©Catmando/Shutterstock.com RF

Exhibit 12.1 depicts the levels of hierarchy within a public stock company. The state or society grants a charter of incorporation to the company’s shareholders—its legal owners, who own stock in the company. The shareholders appoint a board of directors to govern and oversee the firm’s management. The managers hire, supervise, and coordinate employees to manufacture products and provide services. The public stock company enjoys four characteristics that make it an attractive corporate form: 7

EXHIBIT 12.1 The Public Stock Company: Hierarchy of Authority

A diagram. Access the text alternative for Exhibit 12.1

1. Limited liability for investors. This characteristic means the shareholders who provide the risk capital are liable only to the capital specifically invested, and not for other investments they may have made or for their personal wealth. Limited liability encourages investments by the wider public and entrepreneurial risk-taking.

2. Transferability of investor ownership through the trading of shares of stock on exchanges such as the New York Stock Exchange (NYSE) and NASDAQ, 8 or exchanges in other countries. Each share represents only a minute fraction of ownership in a company, thus easing transferability.

3. Legal personality—that is, the law regards a non-living entity such as a for-profit firm as similar to a person, with legal rights and obligations. Legal personality allows a firm’s continuation beyond the founder or the founder’s family.

4. Separation of legal ownership and management control. 9 In publicly traded companies, the stockholders (the principals, represented by the board of directors) are the legal owners of the company, and they delegate decision-making authority to professional managers (the agents).

The public stock company has been a major contributor to value creation since its inception as a new organizational form more than a hundred years ago. Michael Porter and others, however, argue that many public companies have defined value creation too narrowly in terms of financial performance. 10 This in turn has contributed to some of the black swan events discussed in Chapter 2 , such as large-scale accounting scandals and the global financial crisis. Managers’ pursuit of strategies that define value creation too narrowly may have negative consequences for society at large, as evidenced during the global financial crisis. This narrow focus has contributed to the loss of trust in the corporation as a vehicle for value creation, not only for shareholders but also other stakeholders and society.

Nobel laureate Milton Friedman stated his view of the firm’s social obligations: “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.” 11 This notion is often captured by the term shareholder capitalism . According to this perspective, shareholders—the providers of the necessary risk capital and the legal owners of public companies—have the most legitimate claim on profits. When introducing the notion of corporate social responsibility (CSR) in Chapter 2 , though, we noted that a firm’s obligations frequently go beyond the economic responsibility to increase profits, extending to ethical and philanthropic expectations that society has of the business enterprise. 12

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A survey that measured attitudes toward business responsibility in various countries provides more insights into this debate and how opinions may vary across the globe. The survey asked the top 25 percent of income earners holding a university degree in each country surveyed whether they agree with Milton Friedman’s philosophy that “the social responsibility of business is to increase its profits.” 13 The results, displayed in Exhibit 12.2 , revealed intriguing national differences. The United Arab Emirates (UAE), a small and business-friendly federation of seven emirates, had the highest level of agreement, at 84 percent. Roughly two-thirds agreed in the Asian countries of Japan, India, South Korea, and Singapore, which completed the top five in the survey.

EXHIBIT 12.2 Global Survey of Attitudes toward Business Responsibility The bar chart indicates the percentage of members of the “informed public” who “strongly agree/somewhat agree” with Milton Friedman’s philosophy, “the social responsibility of business is to increase its profits.”

A bar chart.

Source: Depiction of data from Edelman’s, Trust Barometer, 2011 as included in “Milton Friedman goes on tour,” The Economist, January 27, 2011. Access the text alternative for Exhibit 12.2

The countries where the fewest people agreed with Friedman’s philosophy were China, Brazil, Germany, Italy, and Spain; fewer than 40 percent of respondents in those countries supported an exclusive focus on shareholder capitalism. Although they have achieved a high standard of living, European countries such as Germany have tempered the free market system with a strong social element, leading to so-called social market economies. The respondents from these countries seemed to be more supportive of a stakeholder strategy approach to business. Some critics, however, would argue that too strong a focus on the social dimension contributed to the European debt crisis because sovereign governments such as Greece, Italy, and Spain took on nonsustainable debt levels to fund social programs such as early retirement plans, government-funded health care, and so on. The United States placed roughly in the middle of the continuum—a bit more than half (56 percent) of U.S. respondents subscribed to Friedman’s philosophy.

CREATING SHARED VALUE

In contrast to Milton Friedman, Porter argues that executives should not concentrate exclusively on increasing firm profits. Rather, an effective strategic leader should focus on creating shared value, a concept that involves creating economic value for shareholders while also creating social value by addressing society’s needs and challenges. He argues that managers need to reestablish the important relationship between superior firm performance and societal progress. This dual point of view, Porter argues, will not only allowPage 424 companies to gain and sustain a competitive advantage but also reshape capitalism and its relationship to society.

The shared value creation framework proposes that managers maintain a dual focus on shareholder value creation and value creation for society. It recognizes that markets are defined not only by economic needs but also by societal needs. It also advances the perspective that externalities such as pollution, wasted energy, and costly accidents actually create internal costs, at least in lost reputation if not directly on the bottom line. Rather than pitting economic and societal needs in a trade-off, Porter suggests that the two can be reconciled to create a larger pie. The shared value creation framework seeks to enhance a firm’s competitiveness by identifying connections between economic and social needs, and then creating a competitive advantage by addressing these business opportunities.

GE, for example, has strengthened its competitiveness by creating a profitable business with its “green” Ecomagination initiative. Ecomagination is GE’s strategic initiative to provide cleaner and more efficient sources of energy, provide abundant sources of clean water anywhere in the world, and reduce emissions. 14 Jeffrey Immelt, GE’s former CEO, would often say, “Green is green,” 15 meaning that addressing ecological needs offers the potential of gaining and sustaining a competitive advantage for GE. Through applying strategic innovation, GE is providing solutions for some tough environmental challenges, while driving company growth at the same time. Ecomagination solutions and products allow GE to increase the perceived value it creates for its customers while lowering costs to produce and deliver the “green” products and services. Ecomagination allows GE to solve the trade-off between increasing value creation and lowering costs. This in turn enhances GE’s economic value creation and its competitive advantage.