Tag Archives: nature’s economy

Faced With a Growing Need for Sustainable Development Should Corporations Aim to Maximise Profit?

In order to discuss and answer the seemingly straightforward question each element that comprises it will be unpacked and engaged. Namely in terms of defining the role of the corporation in a 21st century globalising world, and in terms of defining profit. The latter cannot be limited to one-line financial textbook definitions; it will need to probe these definitions and unpack the essence of the elements that make up those definitions. This must then be married to economic definitions of profit which will lift profit out of the microcosm of a single corporation and deal with it in a way which appreciates the interconnectedness of business and social systems on a global level. Implicit in this discussion will be the broader issue of how corporations can and should maximise profit.

Following this the significance of maximised corporate profit for the social and physical world, as we know it, will be discussed. Finally and in conclusion an answer to the problem question, supported by the discussion will be given.

Unpacking the Question Elements

The Corporation

Businesses exist in a range of forms, these will not all be laid out here but the characteristics of one of these forms, the corporation will be defined. A corporation is a business in which the business itself is constituted as a legal entity separate from the individual owners. This is called limited liability, and protects the owners from liabilities arising from obligations of the business (Graham and Winfield, 2010, p.3). The legal entity of the corporation therefore is recognised by the law to have rights and responsibilities, as if it were a person. Of interest to this discussion Wikipedia goes further to define corporations as being able to exercise human rights against individuals or the state, and very importantly, corporations themselves can be responsible for human rights violations, criminal offences, fraud and manslaughter.  If corporations can be held responsible for these things where does the imperative for the individuals, who constitute corporations, to act justly and legally come from? Jeffrey Immelt, CEO of General electric is quoted as saying, “It’s up to us to use our platform to be a good citizen. Because not only is it a nice thing to do, it’s a business imperative” (Savitz, 2006, p.21). What Immelt  is alluding to here is not an idealistic call for business to become more philanthropic but the recognition that financial investors and creditors are becoming increasingly sensitive to issues of corporate citizenship; and how good corporate citizenship is seen to decrease the chances of any future social risk or potential corporate liabilities (Tialogue, 2004, p.13). Investors are learning through the “Enron, Global Crossing, Imclone, Tyco, World Com and Martha Stewart” scandals that socially irresponsible business not only loses shareholder value but has dire consequences for larger financial systems and stakeholders (Hollender and Fenichell, 2004, p.vii). In the 21st century corporate reputation is not only as important as financial outcomes (Trialogue, 2004, p.13), but is in fact its most crucial asset (Hollender and Fenichell, 2004, p.54) which ultimately underpins a corporation’s ability to generate shareholder value.

The second characteristic of a corporation is that because it exists as an independent legal entity the business’s lifespan is not tied to specific individual owners, and the business can continue to exist in perpetuity despite change in ownership. This characteristic is called perpetual succession (Graham and Winfield, 2010, p.293). It is paradoxical then that the behaviours which erupted in the financial scandals at the start of the 21st century and during the 2009 recession were characterised by traders and CEOs employing blinkered short-term projections and strategies (Hollender and Fenichell, 2004, p.32; The Smartest Guys in the Room). The pursuit of quarterly figures and reports were leading (in some case majestic) generations old corporations by the nose towards the abattoir of catastrophic share-value collapse. This “frontier mentality” (Savitz, 2006, p.233) and its blindly optimistic short-term profit seeking ultimately depleted shareholder wealth; and destroyed corporations which, all things being equal, could have generated profit for generations to come had a longer-term approach been employed.

Profit

Financial accounting textbooks will define profit as: The residual amount that remains after expenses have been deducted from income (Graham and Winfield, 2010, p.293). This can be simplified to read as profit = revenue – costs.

Financial accounting textbooks, however, do briefly introduce a discussion around arguments that the objectives of a business need to go further than merely maximising profit for their owners but must also include the wellbeing of employees, the natural environment and the wider social environment. This is accompanied by the acknowledgment that these factors underpin and are critical to the long term achievement of the objective of maximising profit (Graham and Winfield, 2010, p.5). This has given rise to triple bottom line financial reporting, where profit as well as people and planet contribute to the bottom line.

While economics recognises the appropriateness of the accounting definition of profit (above) as being sufficient for the purpose of financial accounting, economics as a discipline also makes use of the concept of economic profit. Where the above accounting definition of profit being equal to revenue – cost, economic profit is calculated as revenue – economic costs (Schiller, 2011, p.112). The concept of economic costs is key to this discussion as economic costs don’t just include the explicit costs as used in accounting, but take into account implicit costs that are incurred through the use of resources that are not explicitly paid for (Schiller, 2011, p.112). This notion of implicit costs is important because it paves the way for the economic concept of social costs, which is defined as the full resource costs of an economic activity (Schiller, 2011, p.192); those costs that are borne by all of society, as opposed to private costs which are incurred directly by the producer. What this means is that there must be a recognition that every action undertaken by a corporation will produce two simultaneous outcomes: “an impact on profits, and an impact on the world” (Savitz, 2006, p.28). When looking at aggregated profit and cost data through an economic lens we are then able to include environmental degradation and social dissolution as costs of certain activities. An economic approach to profit needs to lead this discussion.

Profit Maximising

According to classical economic theory the production of goods and services, the core function of corporations and the means through which income is generated, is dependent on what are termed the factors of production (Schiller, 2011, p.6; Mohr and Fourie, 2009, p.6). The factors of production represent limited, or scarce, resources (Mohr and Fourie, 2009, p.4); and they include natural resources, labour, capital and entrepreneurship. Money is not a factor of production, merely a means of exchange (Mohr and Fourie, 2009, p.25). Therefore the generation of financial profit alone does not necessarily ensure a reinvestment into, or the sustainability of the factors of production. Where the factors of production are scarce or finite the production possibility curve can be pushed outwards by a more efficient use of resources (Mohr and Fourie, 2009, p.20-21), and the reduction of waste born from efficiency can create abundance, not limits (Hollender and Fenichell,2004, p.87).

Following on the above and the concept of social costs Hart (2005, p.33) argues that the global economy is in fact constituted of three superimposed economies: the money economy, the traditional economy and nature’s economy. The money economy is that sphere of industry and commerce making up the developed and emerging economies (Hart, 2005, p.34). 2 billion people participate in the money economy. The traditional economy refers to the activities of some 4 billion participants who engage very sparingly in the money economy but whose livelihoods are almost wholly based on subsistence activities, dependent on their natural environment (Hart, 2005, p.36). Finally and most critically is nature’s economy, this is the environment, its ecosystems and natural resources upon which the money and traditional economies are dependent (Hart, 2005, p.37). Some elements of nature’s economy are renewable (as long as their propensity for regeneration is not degraded) while others are non-renewable. The manner in which the money economy conducts itself directly impacts the well being and sustainability of nature’s economy and the traditional economy (Hart, 2005, p.40); that is the negative externalities of the money economy are borne by the other two economies. Based on this and the above acknowledgement that the factors of production are limited resources, choices need to be made as how best to use and allocate them (Mohr and Fourie, 2009, p.4) and these choices will be coloured by whether short-term or long-term profit maximisation is desired.

This discussion has already recognised that short-term profit strategies will need to operate within certain parameters if long-term profit maximisation is desired. These parameters may curtail the realisation of maximum short-term profit but will ensure the critical resources (including corporate reputation) for long-term profit maximisation are not depleted or degraded beyond a point from which they are able to renew themselves.

This is where sustainable development needs to enter the discussion. Sustainable development requires long-term thinking as it aims to meet current performance goals whilst both ensuring the long-term survival and performance of the company, and considering the wellbeing of future generations (Savitz, 2006, p.233; Hollender and Fenichell, 2004, p.81). Critically, however, Savitz(2006, p.244) that whilst sustainable development will require a move away from a short-term focus on maximising shareholder wealth, towards a greater focus on long-term stakeholder wellbeing it does not automatically translate to corporations needing to sacrifice profit or to be satisfied with diminished financial performance.

Savitz (2006, p.22) writes about the sustainability sweet spot, a way to conduct business in a manner that simultaneously meets and furthers company and stakeholder interests. Savitz (2006, p.243) argues that a corporation that can find and leverage this sweet spot, through being sincerely socially responsible, will make more profit than its competitors in the long run. Hollender and Fenichell (2004, p.27) support this view when they argue that visionary corporations, those driven by core-ideologies which are not primarily centred on profit maximisation, ultimately generate greater profit than their profit-driven competitors. But Hollender and Fenichell (2004, p.27) also underscore a point made earlier in this discussion about long-term orientation; they state this is a critical component because the tangible impact (maximised profit) brought about through sustainable approaches and social responsibility requires a longer time frame to manifest itself.

The Significance of Maximised Profit for the Social and Physical World

Corporations’ value chains are now global and sustainable development with an eye to profit maximisation must be discussed at a global level (Hollender and Fenichell, 2004, p.111). Hart (2005, p.33) states that the achievement of global sustainability, in the face of population growth and limited resources, will require the creation of trillions of dollars worth of new products, services and technologies. Supporting this, Dr. Brundtland (in Hollender and Fenichell, 2004, p.80) when addressing the 1985 World Commission on Environment and Development claimed that given the exploding world population, “the problems of poverty and underdevelopment cannot be solved unless we have a new era of growth in which developing countries play a large role and reap large benefits”. Echoing this, Hart (2005, p.32) argues that the wellbeing of the poor [assumedly including the traditional economy, global value chains and ultimately every human being] will “require the creation of new wealth on a massive scale”. The global population is projected to peak at between 8 and 10 billion people by 2050 (Hart, 2005, p.32). Because poverty and population growth are each positive functions of the other, and birth rates have an inverse relationship with education levels and standard of living (Hart, 2005, p.32) sustainable development without economic growth is not enough to ensure global sustainability. Hart (2005, p.32) hazards to suggest that global economic activity will need to grow to ten times its current level to support this future population.

The above paragraph highlights the fact that in order ensure the basic survival and upliftment of our social and physical world we will not only require an almost unfathomable amount of economic growth but a simultaneous fundamental shift in the way the money economy conducts itself. This demands a fundamental increase in the efficiency and sustainability with which mankind uses natural resources; and the adoption of a new paradigm of working in a socially responsible way.

 These most critical needs will be met through the outcomes and positive externalities of the corporate long-term profit maximisation behaviours discussed above.

[If] yesterday’s businesses were often oblivious to their negative impacts and today’s responsible businesses strive to reduce their impacts, tomorrow’s businesses will learn to make a positive contribution [because it is in the interests of profit maximisation].

(Hart, 2005, p.33)

In closing, “Should corporations aim to maximise profits?”

All things being equal, absolutely.

References

Books

Graham, M. and Winfield, J., 2010. Understanding Financial Statements. 2nd ed. Cape Town: Cape Business Seminars.

Hart, S., 2005. Capitalism at the Crossroads: The Unlimited Business Opportunities in Solving the World’s Most Difficult Problems. New Jersey: Wharton School Publishing.

Hollender, J. and Fenichell, S., 2004. What Matters Most: Business, Social Responsibility and the End of the Era of Greed. London: Random House Business Books.

Mohr, P., Fourie, L. and associates, 2008. Economics for South African Students. Pretoria: Van Schaik.

Savitz, A., with Webre, K., 2006. The Triple Bottom Line. San Francisco: Jossey-Bass.

Schiller, B. 2011. Essentials of Economics. 8th ed. New York: McGraw-Hill/Irwin.

Trialogue, 2004. The Good Corporate Citizen: …pursuing sustainable business in South Africa. Inaugural ed. Cape Town: Trialogue.

Websites

Wikipedia:

URL: http://en.wikipedia.org/wiki/Corporation

Date Accessed: 3/9/2011

DVD

The Smartest Guys in the Room. 2005. [DVD Documentary] Alex Gibney. United States of America: Based on the 2003 book of the same title by Bethany Mclean and Peter Elkind.

Advertisements