The Purpose of the Corporation and Its Implication for Law and Business in Japan

MIYAJIMA Hideaki:
This webinar series is jointly organized by RIETI, ECGI, and the Waseda Business Finance Center (WBF). Over the last few years, the purpose of the corporation has been the subject of active debate. In place of shareholder maximization, a new definition of the corporate purpose has been proposed, and the implications for law, ownership, regulation and governance, measurement, and performance of businesses have been widely discussed. RIETI, ECGI, and the WBF have come together to organize a webinar series, and we will discuss the new concepts of the corporation, the EU-UK experience, and its lessons for Japanese corporate governance reform.

Learning from Colin MAYER's book, Prosperity: Better Business Makes the Greater Good, is vital because it can assist Japan in solving its corporate governance issues. They are very different from the U.S. and UK, where short-termism and enlarging inequalities are serious. Reforms under Abenomics aim at encouraging the entrepreneurship and recovering dynamics by strengthening the shareholder value. While this task is not fully realized yet, Japanese firms also have to consider the environmental and social issues. As a result, there are serious dilemma. Pushing the shareholder supremacy might resulted in short-termism. However, nominal emphasis of social purposes and stakeholders' interest without proper incentives is likely to be an excuse of top managers being from their discipline. Therefore, it is clearly important that future reform in Japan should strategically follow a third way that neither maintains the old Japanese style nor exclusively orient toward the shareholder primacy model, and thus we should carefully design what kind of corporate governance structure such as ownership, board, law, regulation would be realistic. It is in this context that we learn a lot from Colin's new concept of the corporation.

Colin MAYER:
Business is going through one of its most profound changes in its history. It has obviously been a source of immense economic prosperity and the growth of nations around the world. However, increasingly, it has been realized to be a source of growing problems in relation to the environment, inequality, social exclusion, and mistrust. Underpinning this is the conventional notion of a firm, which is reflected in a statement that Milton Friedman, the Nobel Prize winning economist, made 60 years ago. In this Friedman Doctrine, he said that there is one and only one social purpose of business: to increase profits so long as it stays within the rules of the game. That has been the basis of business practice, policy, and education ever since. However, increasingly, it has been realized that that is not an adequate description or purpose of the corporation.

We have had statements by leading investment management firms, by the Business Roundtable in the U.S., by the Financial Times with its new campaign, and by the World Economic Forum on rethinking the purpose of business in the 21st century. This is no longer a question of whether or why; whether or not companies need to adopt a purpose beyond the Friedman Doctrine or why they should do it. It is now a matter of what does one mean by a corporate purpose, and how should businesses imbed it in their organizations.

The purpose of a company is the reason why it exists, why it is created, and its raison d'etre. Underpinning the notion of why a company exists is a concept that suggests that it is not simply there to produce profit, but to produce solutions to problems which individuals and society face. Companies help solve those problems in commercially viable, financially sustainable, and profitable ways. We define the purpose of a business as producing profitable solutions for the people and the planet, and not profiting from producing problems for either. This definition is not a marketing campaign, slogan, charity, philanthropy, or CSR. It is the core of a business, and it is linked to the strategy of the business.

For example, consider the Danish pharmaceutical company Novo Nordisk. It makes insulin which is used in the treatment of type-2 diabetes. It found its purpose to help people treat type-2 diabetes, which might involve taking insulin, but frequently did not. It started working with hospitals, doctors, and universities around the world to identify the best ways of treating type-2 diabetes in different countries. It thought further about its purpose and concluded that it was more than treating type-2 diabetes. It was about helping people avoid getting type-2 diabetes in the first place. It started working with national governments, local authorities, and health workers to identify the changes in lifestyles by individuals which would help them avoid getting type-2 diabetes at all. This may lead people to think that this approach undermines the basic business model of Novo Nordisk to sell insulin. On the contrary, its business has flourished because in the process of building those relations with hospitals, doctors, universities, governments, local health workers, and authorities, it built relations of trust by which it became a trusted provider of advice and health products.

This illustrates two important points about corporate purpose. First, the importance of bringing clarity to exactly what the corporate purpose is in terms of solving problems. Second, once the corporate purpose is clear and committed to, then it creates one of the most valuable assets that a company can have, and that is to be trusted.

We have been working in Oxford with the boards of some of the largest European companies, North American companies, and investors around the world in a research program called Enacting Purpose. We have developed a framework which we call the SCORE framework. S stands for "to simplify;" to simplify the purpose in exactly the way Novo Nordisk simplified its purpose. C is for "connect;" to connect that purpose with the company's strategy so that it is core to the business and to connect with other parties that are required to help the company deliver on its purpose. O stands for "ownership;" the ownership of that corporate purpose, and partly with the formal ownership and the shareholders of a company. Ownership is more than just about the formal ownership. It is about the ownership of that purpose throughout the business, from the board down to the shop floor, and making sure everyone in the organization understands what their part in contributing to the corporate purpose should be. R stands for "reward;" the reward system in a company such as the incentives and promotion, etc. The culture of an organization and its values are critical to it fulfilling its purpose, along with the ways in which it measures its performance. So, underpinning the reward of a company should be the measurement of performance of the company against delivery of its purpose, and the reward system, incentives, and promotion, should be related to the extent that people contribute to the successful delivery of that purpose. E stands for "exemplify;" to bring that purpose to life through narratives that describe how the company is fulfilling its purpose, and where it is finding challenges in doing so because it is important to be authentic in setting out the problems and successes in delivering on a company's purposes.

Many companies are realizing the importance of adopting a corporate purpose and imbedding it in the business. This is particularly prevalent and important in the oil industry. Oil companies are no longer oil companies. They have now become energy companies which are not simply there to extract fossil fuels from the ground and the seas but to help with the energy transition by which they become providers of sources of energy that are efficient and climatically clean in terms of their environmental impact. Companies like British Petroleum and Shell have shifted their purposes dramatically over the last two years to an emphasis on the production of renewables and the transition to, for example, the adoption of electric forms of energy by their users.

The coronavirus pandemic has only accentuated the importance of corporate purpose because, in the process of destroying a lot of economic value, the pandemic created an immense number of new problems for society. These problems have been a cause of the economic value destruction. If seen within the lens of our definition of a corporation, these problems have created opportunities for companies that have adopted the approach of solving problems in a profitable manner.

The coronavirus has really brought out the strength of a corporate purpose as being viewed in terms of solving problems. It provides a narrative around which people inside and outside an organization can coalesce. It is inspiring to think of a business as being there to find commercially viable ways of solving problems. It is motivational, fulfilling, and meaningful for those who work in those organizations because they feel a sense of pride and dignity instead of shame or blame. Above all, it creates the most valuable asset: trust in and of a company.

It is important to recognize that this is not a stakeholder view of a company. It is about fulfilling the purpose of delivering profit through solving problems, not from producing profit from producing problems. In the Japanese context, the issue that we want to focus on in the talk around the fiduciary duty of directors of companies has really revolved around to whom are those fiduciary duties due. The view most conventionally projected is that the fiduciary duty of directors is to promote the long-term value creation and success of a company for the benefit of their shareholders.

Since the banking crisis in the 1990s, Japan has suffered from a combination of low productivity, growth, and profitability. The problem has often been seen as being associated with the nature of the ownership of Japanese corporations. Namely, ownership by other companies in the form of cross shareholdings. Abenomics has been designed to strengthen the position and role of outsiders, particular foreign institutional shareholders, and weaken the cross shareholdings with the objective of making management more accountable to shareholders. This raises the concern that Japanese firms and the processes will become more short-term and potentially more environmentally and socially damaging as a consequence of the shift to greater outside oversight and interventions by shareholders. This suggest that there is a tradeoff between the efficiency of companies, their shareholder interest, and fairness and the interest of other stakeholders. However, it is incorrect to view this as being a tradeoff between efficiency and fairness if one thinks about it in the context of the corporate purpose we are discussing.

The purpose of profiting from producing solutions not problems means that companies should be doing both. They should be delivering solutions for the benefit of individual societies and the natural world, and in the process, profiting from doing so. In addition, they should not be profiting at the expense of any other parties in the process of generating profits.

When the purpose of a business is clear, then the responsibility of executives to define and implement the purpose becomes clear. The company should measure its performance against its delivery of its company purpose. Additionally, the board should be accountable to shareholders and to stakeholders involved in delivering its purpose. It focusses the fiduciary duties and governance of a company appropriately on why the company exists.

Thinking about this ownership structure, the observation that the Japanese system has been too dominated by insider cross shareholdings is probably an accurate description. On the other hand, the UK and the U.S. have been dominated by short-term institutional outside investors. Japan needs more engaged, long-term, committed, outside ownership and less long-term, committed, inside ownership. The UK and the U.S. also need more long-term, committed ownership in place of the present focus on relatively short-term, transactional, outside ownership. Alongside dispersed outside shareholders, Japan, therefore, needs to identify some long-term block-holders who can act as those committed shareholders, as the cross shareholdings will begin to diminish. Otherwise, Japan will flip from the problem of low productivity, profitability, and growth to the UK and U.S.-type problems of environmental, social, and individual human damage.

Starting from the purpose of solving problems profitably helps to identify the appropriate duties of directors and the board, the appropriate governance and accountability of the board, and the appropriate ownership of companies. It moves the debate on from stakeholders versus shareholders, inside versus outside shareholders, and domestic versus foreign shareholders to what is really needed for both the benefits of shareholders and society.

Sophie L'HELIAS:
I will start by highlighting three noteworthy things from Professor MAYER's speech. First, the focus on distrust. Distrust is not only in relation to corporations, issuers, or management. It is also in relation to investors, inequalities, and policy makers that may have not embraced topics and addressed issues that society is pushing. As a result, we are discussing how to find solutions to address these major societal issues and having companies play a major role in it. The primary difference is from a legal and financial cultural perspective. The European markets have a civil law system in which the corporation's purpose is to society, not shareholders particularly. For years, corporates looked for investors and the markets started to develop a strong investor base. So, the corporates' purpose shifted from society to shareholders. Now, the purpose is shifting back to society. We are seeing local legislation adopt rules and laws that require companies to either think about purpose or to ensure that the boards have that conversation with their stakeholders. It shows the complex balance between policy makers, corporates, and investors.

Purpose cannot replace performance. Corporates need to make sure that purpose is embedded in the corporate strategy and that it makes sense for the business. Purpose is a good tool to attract and retain talent. We are seeing this in many markets, particularly in the U.S. and Europe.

The U.S. and the UK come from a very different perspective. For example, in some European countries, a company's wrongdoings would fall under the criminal code, not the civil code. However, in the U.S. and UK, it would fall under the civil code. Also, the U.S. and UK have a strong institutional investor base giving a lot of weight to the investors as compared to European markets. In addition, the economic and financial philosophy of the late 1950s and onwards has dominated global markets, which has set shareholder value as the purpose of the corporation.

We are seeing that social inequality and many issues around the world are pushing companies to rethink social purpose, and the Business Roundtable that was mentioned earlier is the embodiment of that change of philosophy. We cannot underestimate the power of the statements of the Business Roundtable because it is about rethinking the corporation, not pushing back at investors. Also, it is about rethinking the corporation back to what existed prior to the Milton Friedman era where there was a notion of purpose and stakeholders.

The U.S. and UK have two important frameworks. One is the Taskforce of Climate Financial Disclosure (TCFD), which is used now by investors and has been recently adopted and declared mandatory in the UK. It is an incredible framework to incorporate financial disclosure on climate related risk. The other is the Sustainability Accounting Standards Board (SASB). This shows a very different approach between these two markets. The notion in the U.S. and UK is of creating standards and frameworks so investors can navigate it, process the information so they can measure it, measure their financial impact, and give a roadmap to companies on how investors are thinking about it.

Regarding purpose, we expect there to be tension between materiality and meaningfulness. Also, there will be a cultural difference between what the U.S. and UK investors expect as they dominate global markets versus the notion of purpose in other countries.

The role of technology sets the stage for what we should anticipate in the future. Technology has been a tool to amplify issues such as social injustices and corporate wrongdoings. These issues are not just increasingly uncovered, but also increasingly shared. The push for technology should be considered as it relates to purpose, because if purpose is not authentic, and not materialized and operationalized in strategy, then it will cause significant backlash on the companies that promote a purpose that is not authentic.

The second aspect on technology is how easy and cost effective it is for investors to use. Also, it is convenient for companies to use to collect data on a wide range of topics. They can actually find relations and causality between different themes that they probably did not think about or have access to 10 years ago. The tool of technology really provides boards, management, investors, and policy makers with incredible information to make better informed decisions, particularly when it comes to purpose.

The board also needs to be involved in defining the purpose of the corporation. The role of the board is to oversee and sometimes set strategy, and incentivize management. To the extent that the purpose can be translated into key performance indicators or objectives that can be defined and measured or assessed in a certain way, the board has an important role to play. The board is also responsible for engaging investors. Increasingly, directors speak to investors directly and the topics of conversation are not limited to executive compensation. They are increasingly about purpose and the pandemic only enhanced that. If the board does not play its role effectively with management and also does not understand the concerns of stakeholders, then there is a risk of the purpose for a corporation discussed here being only theoretical and having no measurable impact.

TANAKA Wataru:
First, I would like to introduce the basic structure or paradigm of corporate law. Generally, the purpose of a company or a for-profit stock corporation has been understood as maximizing long-term interest of shareholders. This principle is called shareholder primacy. In order to achieve this goal, corporate law provides two basic structures. In the first basic structure, shareholders have the controlling power over a company, especially the power to appoint and remove directors. In the second basic structure, directors have a fiduciary duty to maximize long-term shareholders' interest. In order to maximize long-term shareholders' interest, directors can consider and pursue the interest of other people. For example, they can pursue employees' interests in order to encourage employees to work hard and make investment in firm-specific human capital.

Generally, the corporate law in Japan supports the shareholder primacy principle. Courts agree that directors are fiduciaries of shareholders, shareholders are owners of a company, and in a contest of corporate control, shareholders should make the final decision on who will control the company. Of course, there is a caveat. Legal doctrines and business practices may have been very different. At least until the 20th century, shareholders' control had been substantially limited by cross shareholdings.

I will explain possible problems brought by shareholder primacy that are related to Professor MAYER's presentation. One problem might be shareholder myopia or short-termism. Shareholders may demand short-term profits and demand the company to return the profits by dividends, which is detrimental to the long-term value. The second is negative external effects. Companies under shareholders' control may pursue profits at the sacrifice of the interest of third parties, including future generations, such as climate change and other types of damage to the environment.

How serious are those problems? There are several law professors who question how serious the short-term problems are. I think this is a real problem but mostly empirical, so I would like to focus on another question.

Will changing corporate purpose lead to other problems; especially, the weakening of the discipline of the management? Traditionally, Japanese firms had been under less pressure from shareholders than their U.S. or UK counterparts, but have they succeeded in increasing the long-term value? In 1980s, it used to be the case that U.S. corporate governance systems were severely criticized and quite a few prominent scholars argued that U.S. firms must learn from Japanese firms. However, that is no longer the case. Low profitability and growth rate in Japanese firms and the Japanese economy have substantially degraded traditional Japanese corporate governance systems.

Professor MAYER mentioned that there is no tradeoff between efficiency or profitability and achieving purpose of a company. He believes that a new paradigm is required to achieve purpose while maintaining profitability. If my understanding is correct, I wonder if this is a real change from the traditional paradigm of corporate law. The traditional paradigm of corporate law requires directors to pursue the long-term interests of shareholders. It requires long-term value of the firm or company. So, if the new paradigm from Professor MAYER does not require the board to do any action, such as protect interests of third parties, at the sacrifice of long-term profitability, then this new paradigm does not look very different from the traditional paradigm of corporate law.

Q1: Please reply to Professor TANAKA's questions and comment on what Ms. L'HELIAS said.

Colin MAYER:
Let me explain why there is no tradeoff between the purpose of solving problems and creating value to shareholders because this is something that is frequently discussed in that there inevitably are tradeoffs. The purpose of a company is to produce solutions profitably. A company should not be engaging in philanthropy, namely solving other people's problems, without earning a commercial return when having solved those problems. If that is the case, what is the difference from the Friedman Doctrine of increasing profits, and is there any change in what is expected of a board? First, the problem with the existing approach is that it is a confusion of cause and effect. The purpose of a company is to produce solutions, and in the process, it should produce profits. So, profits are the result of solving problems, and not the lone objective of the company. The particular significance is the company should not be profiting from producing problems because that is exactly where the current difficulties have arisen. The issues that I discussed in relation to environmental problems, inequality, social exclusion, and mistrust derive from exactly that: a failure to recognize that the prime purpose of a corporate is solving problems, that profits are derivative of that, and in the process of solving those problems, companies need to ensure that they do not profit from producing problems.

I agree with the comments from Ms. L'HELIAS. One of the main benefits in terms of having purpose is the way in which it creates trust and attracts talent. This current generation of employees is much more focused on what they believe to be meaningful, fulfilling work as they work to deliver some real benefits beyond the financial returns.

TANAKA Wataru:
Many Japanese business founders started companies with the interest of society at large, but they also thought that their business would be profitable, such as the founders of Toyota and Sony. In some sense, your ideas are similar to these great Japanese business founders.

Colin MAYER:
I agree that many founders, when they establish companies, have exactly this purpose in mind, and that is what they see as the vision for their companies. The problem that typically arises is they have investors and owners who are simply interested in the financial performance of the company, which is where the focus on solving problems is often lost in favor of short-term shareholder returns.

Q2: Do you have any comments on the resignation of the CEO of Danone due to putting stress on social purpose issues and being rejected by shareholders?

Sophie L'HELIAS:
One view is that there seems to have been a very severe governance failure within the organization. The other view is that purpose does not replace returns. In the case of underperforming returns, the issue is governance failure. Having a company that is not performing well with a governance structure and board that do not reflect what investors believe will provide an effective oversight, then the results can be disastrous. The fallout is that some people believe the failure is due to socially conscious targeting. I would argue that it is because they did not have the results and they had a governance structure that did not measure up to expectations as the reason they were targeted.

Colin MAYER:
I agree with what Sophie has said. The problem is that the CEO and chairman of Danone was absolutely a fervent supporter of the notion of moving the company beyond just shareholder returns. However, there was an element of reflecting this as a stakeholder versus shareholder issue, and not really as a business model to drive both better financial performance as well as benefits for society. Balance was lost and shareholders believed the company was not fulfilling the purpose to produce profitable solutions to problems.