The joy of constraints

27/10/2015 § Leave a comment

The basis of self-government and freedom requires the development of character and self-restraint.” John F Kennedy

I was talking to a friend recently who is setting up a new company. I suggested she include a clause in the company’s articles of association obliging the director’s to pursue a purpose beyond profit (typically in a company, there is no purpose stated, which means that by default company law says the director should place shareholders’ interests first). She questionned this, suggesting that people running a business are best left free to operate “unencumbered”, in other words to focus on efficiency and growth without having to worry about things like their impact on society or the planet.

This reminded me of something and later on I realised what it was. It was Adam Smith in one of the most often-quoted sections of the Wealth of Nations:

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest….he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”

I’ve spent most of my career in business and know how exhilarating it can be to feel free to pursue an idea and not worry too much about the consequences. It’s like being a teenager again. I am also aware that there are plenty of spoilsports in the world who like nothing better than to create rules and constraints that block other people’s activities. There are plenty of good ideas that never get off the ground because they are held back by bureaucracy and excessive caution. So why not let our businesses run free?

In my view it comes down to a question of scale. In the sort of micro-businesses that Adam Smith was talking about, it is generally healthy for the business to pursue “self-interest” i.e. maximising profit. If the local butcher seeks to maximise his profits and fails to care for those around him, he will quickly get negative feedback – he will lose customers, his staff will get upset, his neighbours will complain. He will soon find it is in his self-interest to balance pursuit of profit with caring for those around him. Having minimal restraints allows him to learn rapidly.

With large, modern corporations, on the other hand, it’s quite a different story. These are very powerful creatures. As they grow, they accumulate power and are able to influence the market in ways that favour their interests. They learn how to comply with the letter but not the spirit of the law, they manipulate others through advertising and slick communications, they have friends in high places who can sort things out for them if they go too far. Their scale makes them insensitive, and allows them to disable the checks and balances that operate in all healthy markets. The “invisible hand” stops working.

We are all living with the consequences of this. The environmental destruction, social inequality and financial instability we are experiencing these days is a direct result of insufficient constraints on large corporations. It is not difficult to think of examples of excesses by large businesses across industry sectors, including the media, banking, retailing, pharmaceuticals, auto industry or energy.

Government does little or nothing to stop these excesses. Indeed all shades of government we’ve had over the last 30 years have bought into the ideology that business is at its best when “unencumbered”. That’s why successive governments have shied away from any real reform of the banking industry post-2008. That’s why when directors’ duties were reviewed in the Companies Act 2006, shareholder value remained top of the priorities of a director, with welfare of staff, the community and the planet a distant second.

It’s become clear that governments lack both the will and the ability to effectively to regulate these behemoths. The way forward is for these complex human systems to become self-regulating. This means that they have to adopt internal governance mechanisms that regulate the managers, obliging them to consider the consequences of their actions.

This may sound idealistic but in fact it’s already happening. For example, many large corporations in the mining sector have set up stakeholder councils, so that the board have direct understanding of the major social and environmental issues affecting their decisions. The retailer B&Q established a youth board to dialogue with the main board of directors. Companies are increasingly monitoring social media, seeking to listen more closely to what customers and the community want. Increasingly sophisticated ESG (environmental, social and governance) measures are being developed, pushed by demand from businesses who are seeking new, more holistic measures of success.

More radically, an increasing number of businesses are becoming employee owned or signing up to become B Corps, where they commit to a purpose beyond profit.

To me, this is a matter of maturity. As adolescents, we can kid ourselves that we have no need to take into account the needs or wishes of others. As we grow older, a more mature view takes hold. We realise that joy in life comes not from absolute freedom (an impossibility) but rather from freedom within restraints that are accepted willingly.

It is not wrong to be an adolescent – it’s just an immature phase we go through. Likewise, it’s not wrong to be a company focused primarily on profit. But it’s an immature phase and one that, for all our sakes, we need our large corporations to grow out of.

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