CHAPTER 2

Business Sustainability Shared Value

Executive Summary

In the past several decades, the purposes of public companies have evolved from profit maximization to securing value for shareholders and now creating shared value for all stakeholders. Ever-growing business sustainability creates opportunity for business organizations to adopt shared value creation for all stakeholders as their mission. Under the shared value concept, to maintain their financial sustainability and continuity, business organizations engage in activities that create wealth for their shareholders and thus enhance firm value while achieving social, environmental, and community impacts. This chapter focuses on the concept of shared value creation for all stakeholders, from shareholders to employees, customers, suppliers, communities, society, and the environment.

Introduction

The effective implementation and achievement of the profit-with-purpose mission for business organizations enable them to create shared value for all stakeholders. The board of directors are responsible for protecting the interests of all stakeholders. Management, as the steward of business resources, has the primary role in improving sustainability performance and managing related risks, maximizing utilization of all capitals from strategic to financial, reputational, manufactured, human, social, and environmental to create shared value for all stakeholders. The other emerging approach considers sustainability in enabling opportunities to create shared value by focusing on the continuous improvements of short-term performance and long-term growth. This chapter examines the concept of share value creation for all stakeholders, from shareholders to employees, customers, suppliers, communities, society, and the environment.

Sustainable Shared Value Creation

As business sustainability gains more attention and is integrated into the business culture and corporate environment, there has been a shift from the creation of shareholder value to the development of “sustainable shared value creation” to protect the interests of all stakeholders.¹ The concept of shared value is defined as “policies and practices that enhance the competitiveness of a company while simultaneously advancing the economic and social conditions in the communities in which it operates.”² Under the shared value creation concept, management focuses on the continuous performance improvement of business operations in generating long-term value while maximizing the positive impacts of operations on society and the environment by measuring sustainable performance in terms of both financial economic sustainability performance (ESP) and nonfinancial environmental, ethical, social, and governance (EESG) sustainability performance. Thus, corporate objectives have advanced from profit maximization to increasing shareholder wealth and now to creating shared value for all stakeholders.

Managers differ widely in their views and understanding of how to address apparently conflicting multidimensional aspects of sustainability, and often the amorphous nature of the sustainability concept has made it difficult to understand legitimate differences across corporations in their approaches to sustainability. Investors and public companies now focus on both financial and market long-term performance indicators such as long-term stock prices, return on investment, return on assets, earnings growth, and research and development in measuring ESP. A survey of 1,400 directors and executives reveals that boards and executives are “spending more time talking about leading indicators that reflect the long-term health of the company … and sharpening their focus on the company’s drivers of long-term value creation.”³ Academic research suggests that ESP is essential in creating shareholder value by examining the value relevance of financial information and its link to stock prices and cost of capital and finds that firms with better ESP exhibit better financial and market performance and lower cost of equity, and such link between ESP and cost of equity is more pronounced in the presence of EESG.⁴ Amid the global COVID-19 pandemic crisis, CEO confidence in global growth within their companies has decreased around one-third (32 percent); however, only 17 percent are less confident about the future of their company altogether. In fact, the crisis has accelerated digital growth for most of the respondents as 75 percent say that the pandemic has accelerated the creation of a seamless digital customer experience, with over one in five (22 percent) of those saying progress “has sharply accelerated, putting us years in advance of where we expected to be.”⁵ As companies plan for their strategic shift for long-term growth, many business leaders are now recognizing a shortage in talent and keeping their workforce productive. Talent risk was rated at 2 percent in 2019 but shot up to 21 percent in July/August 2020, which makes it the highest risk to most businesses according to their CEOs.⁶

In the context of shared value creation, stakeholders are classified as internal stakeholders, (shareholders) who have direct interest (stake) and bear risks associated with business activities, and other external stakeholders. Other stakeholders have reciprocal relationships and interactions with a firm in the sense that they contribute to firm value creation (stake) and their well-being is affected by the firm’s activities (risk). Stakeholder interests in a firm are equity capital, human capital, social capital, and compliance capital, and sustainability-related risks are strategic, financial, operational, compliance, and reputational risks as presented in Figure 2.1. Agency theory (viewing management as only accountable to shareholders for creating shareholder value and whose interests may diverge from those of their shareholders) has traditionally been the dominant theory of corporate finance, management, and governance research in creating shareholder value.⁷ While agency theory has been used to explain the principal–agent relationship and interest divergence for individualistic utility maximization and motivation, this theory may be irrelevant and undesirable under the emerging complex organization structure oriented toward stakeholders and the corporate strategy of shared value creation. Under stewardship theory, management, in considering interests (stakes) and risks to shareholders (its main and direct stakeholders), may engage in nonfinancial EESG sustainability performance activities to protect the interests of nonshareholding stakeholders and to ensure firm legitimacy and its own reputation.⁸

Figure 2.1 Sustainability Risks

Source: Adopted from Rezaee, Z. February 2021. Business Sustainability Factors of Performance, Risk, and Disclosure. Business Expert Press.

Corporate governance should promote shared value creation and enable and incentivize seven corporate governance functions described in the next section to add value to the organization’s sustainable and enduring performance. Shared value creation for all stakeholders can be promoted within the wealth-maximization framework in pursuing the goal of profit-with-purpose for corporations. Corporations can create a right balance between the wealth maximization for shareholders under the shareholder primacy concept while achieving the welfare maximization for all stakeholders (e.g., safety, health and well-being of employees, suppliers, and customers) under the stakeholder primacy concept. The concept of impact investing of focusing on the importance and relevance of corporate investment strategies in creating returns on investment for shareholders and providing positive social and environmental impacts is gaining acceptance and is more relevant in the post-COVID-19 pandemic. Business organizations must attempt to maximize financial performance as well as to have positive and measurable effects on the environment and society. Positive effects on the environment, communities, and society cannot be achieved without allocating scarce resources that could otherwise be used to maximize firms’ financial economic performance. The board of directors and executives play an important role in promoting business sustainability performance, assessing and managing continuity and sustainability risk, and properly disclosing sustainability information in an integrated sustainability report.

1. Move Toward Shared Value Creation Concept

Public companies in the United States have moved toward shared value creation for all stakeholders in recent years. For example, in August 2019, the Business Roundtable (BRT) announced the adoption of a new Statement on the Purpose of a Corporation, signed by 181 high-powered chief executive officers (CEOs), which promotes the move toward sustainability by creating shared value for all stakeholders.⁹ The BRT statement has been considered by many business organizations in the past year in creating shared value for their constituencies. According to the op-ed, “Stakeholder, Capitalism, Seems Mostly for Show,” posted by Lucian Bebchuk and Roberto Tallarita on Harvard Law School Program on Corporate Governance, many CEOs opted to sign the BRT statement without seeking approvals from the board of directors. This can be explained by the fact that CEOs tend to consider signing BRT statement an unimportant corporate commitment or a minor decision about the way companies take care of their stakeholders. A possible reason is that these CEOs are already confident about how their companies treat stakeholders. On top of that, BRT statement is usually regarded merely as a public relations tool, especially for corporates pursuing the shareholder primacy model. Regarding this issue, Alex Gorsky, CEO of Johnson & Johnson and Chair of the Business Roundtable Corporate Governance Committee, expressed his thoughts on LinkedIn:

One of the questions raised in “BRT Statement of Corporate Purpose: Debate Continues,” posted by Randi Val Morrison on Harvard Law School Forum on Corporate Governance in August 2020, is whether BRT CEOs might neglect their shareholders. To answer this question, the new statement emphasizes the significance of shareholders in the development of business, as well as the needs for companies to maintain values for shareholders in the long run. However, it is also important to take the interests and expectations of other stakeholders, such as customers, employees, and the communities into consideration to maintain durable values for shareholders. Another concern to raise is whether BRT CEOs want to change to stakeholder governance in an attempt to avoid accountability. Addressing this concern, Morrison confirms that radical changes to corporate governance are neither expected nor supported because of possible negative consequences. In bad scenarios where companies fail to provide shareholders with durable returns, shareholders are still expected to hold companies accountable. On another note, there are concerns regarding political and social objectives in BRT: What are the reasons for BRT to consider societal goals higher than shareholders? And should the responsibilities for politics and society belong to the government? As of the aforementioned concerns, the BRT statement does not prioritize societal objectives over shareholders. In fact, the statement just acknowledges the importance of meeting expectations of a wider range of stakeholders to maintain the company’s “long-term success.” In short, according to the aforementioned facts of BRT statement, CEOs do not consider this a major change in the way they operate their business and take care of their shareholders. Instead, the statement reminds companies to pay attention to a wide range of stakeholders in addition to shareholders to create and maintain greater corporate returns value.

The purpose of the corporation has evolved in the past several decades from profit maximization to shareholder wealth maximization to creation of shared value for all stakeholders. The latter purpose can be achieved when corporations focus on generating desired financial returns for their shareholders while protecting interests of other stakeholders including customers, employees, suppliers, communities, society, and the environment. Corporate purpose and stakeholder considerations have gained recognition in the business community worldwide. In August 2019, 181 out of 188 member CEOs of the U.S. BRT signed on to an amended Statement on the Purpose of a Corporation, moving away from the traditional shareholder primacy of maximizing shareholder returns¹⁰. The stakeholder primacy challenges companies to put stakeholders at the heart of a company’s purpose. A shift in corporate purpose from shareholder primacy to stakeholder primacy is reinforced by the U.S. BRT’s Statement on the Purpose of a Corporation. This focus is combined with public pressure for CEOs to engage on social and political topics (e.g., human capital, diversity, immigration, gun control, and gender pay equity).

Several examples of the new-purpose mission for high-profile companies are BP, International Paper, Microsoft, and FedEx among others. For example, in its 2019 Annual Report, BP defines corporate mission as “Energy with Purpose”: “Our purpose is reimagining energy for people and our planet” and “We want to help the world reach net zero and improve people’s lives.” In its 2019 Annual Report, the Swedish private equity firm EQT defines its “Statement of Purpose” as “To future-proof companies and make a positive impact, To be the most reputable investor and owner” with the mission of “With the best talent and network around the world, EQT uses a thematic investment strategy and distinctive value creation approach to future-proof companies, creating superior returns to EQT’s investors and making a positive impact with everything we do.” Corporations are moving toward purpose strategies that drive value for all stakeholders. With these emerging “profit-with-purpose” mission, the finance function leads of the CFO is an integrated strategic, operating, and finance activities and performance, which is tasked with achieving specific financial and performance reporting objectives that can be measured, held accountable, and rewarded. Determinants of shared value creation are as follows:

2. Role of Board of Directors in Shared Value Creation

The board’s role under stakeholder primacy/capitalism as opposed to shareholder primacy/capitalism is to oversee managerial function of focusing on the long-term sustainability performance, effectively communicating sustainability performance information to all stakeholders. The board should be informed and understand the stakeholder objectives, rationales for focusing on sustainability factors of performance, risk and disclosure, and managerial strategic planning, sustainable operational performance, and executive compensation in promoting long-term corporate value. The board should also provide oversight, insight, and foresight function on the achievement of both financial ESP and non-financial ESGE sustainability performance driven by financial, human, social, environmental, and manufacturing capitals as well as innovation, culture, and corporate governance.

Shared value creation for all stakeholders can be promoted within the wealth-maximization framework in pursuing the goal of profit-with-purpose for corporations. Corporations can create a right balance between the wealth maximization for shareholders under the shareholder primacy concept while achieving the welfare maximization for all stakeholders under the stakeholder primacy concept. The concept of impact investing of focusing on the importance and relevance of corporate investment strategies in creating returns on investment and providing positive social and environmental impacts is gaining acceptance by retail and institutional investors. The investment managers are trying to maximize financial performance as well as to have positive and measurable effects on the environment and society. Positive effects on the environment and society cannot be achieved without allocating scarce resources that could otherwise be used to maximize firms’ financial economic performance. The board of directors and senior executives, especially the CFO, play an important role in promoting business sustainability performance, assessing and managing sustainability risk, and properly disclosing sustainability information in an integrated sustainability report.

The primarily oversight function of the board of directors remains in protecting interests of multistakeholders during this challenging time and appointing competent, responsible, accountable, and ethical executives including the chief executive officers (CEOs), chief financial officers (CFOs), and other C-suite executive to manage the business for the benefit of all stakeholders. It is expected that the boards of directors engage more proactively in the oversight function in setting strategic priorities in dealing with global economic and political uncertainties and challenges caused by the pandemic, and the potential risk of substantial interruptions in business operations and supply chain. The fiduciary duties of the board of directors are expected to be extended to multi-stakeholders including shareholders, creditors, customers, suppliers, employees, government, society, and the environment with the move toward profit-with-purpose mission. The expanded fiduciary duty to all stakeholders requires the board of directors to establish proactive strategic profit-with-purpose missions, goals, and objectives to ensure business continuity and sustainability in creating long-term shared value and oversee managerial decisions and actions in effectively implementing these strategic goals.

The COVID-19 pandemic has brought on many challenges and responsibilities for the board of directors to oversee that management addresses and responds to the emerging challenges, particularly those associated with assessment and management of human capital risks. The pandemic has introduced complexity to the fundamental roles and responsibilities of directors who must oversee managerial function under the emerging risks and uncertainties. In the aftermath of the pandemic, protecting interests of all stakeholders from shareholders to employees, customers, and communities become priorities of the board of directors. Many boards pay particular attention to “protect our people” by redesigning their human capital resources policies and procedures. The pandemic has introduced unique risks to business operations and performance that need to be considered by the board and assessed and managed by management. Although many businesses in most states have begun to reopen their business adopting a new normal, COVID-19 challenges will remain for a long period.

The board of directors should work with management to modify the corporate culture and business environment and behavior in developing and implementing a “reopening plan” that creates shared value for all stakeholders. The board of directors should set an appropriate tone at the top of reserving and promoting the corporate culture of competency, integrity, and transparency. Revising and reinforcing the corporate purpose of protecting interests of all stakeholders is becoming more relevant and important to the board of directors in the aftermath of the COVID-19 pandemic. The board of directors should review and revisit executive compensation by creating a right balance between managerial efforts and compensation on surviving the pandemic and ensuring the safety, health, and well-being of employees, customers, suppliers, supply chain partners, communities, shareholders, and other stakeholders. There should be a move away from the traditional fiduciary loyalty model of the board of directors to shareholders under the shareholder capitalism and shareholder primacy and a move toward the board fiduciary due to all stakeholders under the stakeholder capitalism and stakeholder primacy model. There is an alternative to changing corporate law on fiduciary duties of the board of directors as related to board composition and adding the corporate purpose statement and allowing nonshareholder stakeholders get to be represented on the board.

3. Management Role Under Shared Value Concept

Management, as the steward of business resources, has the primary role of improving sustainability performance and managing related risks, maximizing utilization of all capitals from strategic to financial, reputational, manufactured, human, social, and environmental to create shared value for all stakeholders. Second, the main goal and objective function for business organizations is to maximize the firm value. The goal of firm value maximization can be achieved through continuous improvements of both financial ESP and nonfinancial ESG sustainability performance. The ESP and EESG sustainability performance dimensions are interrelated and complement/complete each other and thus they should be integrated to supply chain management. Third, the focus of business sustainability should be on creating long-term and sustainable shared value for all stakeholders including investors, creditors, suppliers, customers, employees, the environment, and society. Finally, companies should effectively and transparently communicate their business sustainability with all stakeholders by periodically releasing their sustainability reports.

Management should know what “the purpose” is. Every company should have its unique purpose determined in its charter of incorporation to maximize its positive impacts on all stakeholders including society and the environment and to minimize the negative impacts on multistakeholders. In case of nonexistence of and/or inadequate “Statement of Purpose,” management should work with the other executives in the C-suite under the oversight function of the board of directors and approval by majority shareholders to establish an appropriate stakeholder-inclusive “Statement of Purpose.” Management should work effectively with other executives under the oversight function of board of directors to implement and achieve the adopted “Statement of Purpose.” Finally, the CFO should work in collaboration with the CEO in preparing and certifying the integrated sustainability reports and in disclosing the achievement of the adopted “Statement of Purpose.” This integrated sustainability report can disclose the achievement of both financial returns and social and environmental impacts. This integrated report enables shareholders and other stakeholders to learn and assess the company’s success in achieving its adopted purpose. This assessment can have a positive impact on investor risk premium and their wiliness to invest in the company’s stock. This is the only path forward toward the stakeholder capitalism rather than societal socialism to achieve long-term, durable, and sustainable growth and performance. It is obvious that the challenge is not whether “Statement of Purpose” is desirable and achievable, but the hurdle is whether high-profile corporate executives including CEOs, CFOs, and institutional investors collaborate to make it happen. Management is under continuous monitoring from policymakers, investor activists, regulators, and ratings agencies demanding real action on both financial ESP and nonfinancial EESG sustainability performance goals and achievements. Time has passed for using sustainability to greenwashing and branding companies and their management for writing climate, sustainability, and diversity reports without firm commitments to pursue the mission of profit-with-purpose in creating a shared value for all stakeholders. Management should be held accountable for failure to achieve ESP and EESG sustainability.

The board of directors should set an appropriate tone at the top promoting the concept of profit-with-purpose and oversee managerial commitments, decisions, and actions in achieving both financial ESP and nonfinancial EESG sustainability performance. Management should establish the following policies and procedures to achieve the profit-with-purpose mission:

4. Effects of COVID-19 Pandemic on the Shared Value Concept

The COVID-19 pandemic has delivered an exogenous shock on the global economy and capital market with substantial impacts on individuals, organizations, and society. The pandemic has changed the everyday life of people, and new realities of economic shutdowns, business closures, and social distancing and individual lockdowns have created unique challenges for firms. Many countries have begun to reopen their economies and businesses by adapting a new normal. Daily activities and business practices have significantly adjusted to the “new normal” with new social distancing, remote working, virtual meetings, business office designs, business continuity, and transformation. The pandemic has significant implications for people and organizations around the world, and it may affect sustainability of many business organizations. In the post-COVID-19 era, business organizations are now focusing on the shared value concept as they are more concerned about safety, health and well-being of their employees, customers, and suppliers relevant to human capital and business sustainability.

The COVID-19 pandemic affects business sustainability, human capital, and can have impacts on shared value in several ways. First, the idea of remote work and the flexible work schedule has been promoted for some time and has become a new normal during the COVID-19 pandemic and created adaptive behaviors and new norms. Second, firms need to invest in human capital as the use of technology in corporate governance has accelerated in the post-COVID-19 era in enabling remote work and virtual meetings. Finally, despite the devastating effects of the COVID-19 pandemic on human lives, the economy, and business operations, people and business organizations worldwide have demonstrated their resilience and determination to transform these challenges into opportunities by adopting a new normal that affects human capital and business sustainability. It is expected that firms pay more attention to their financial ESP as well as nonfinancial EESG sustainability performance including human capital.

The COVID-19 pandemic encourages business organizations and their board of directors and executives to take the following actions in creating shared value for all stakeholders:

Conclusion

Business organizations worldwide are now recognizing the importance of sustainability performance and the link between financial ESP and nonfinancial EESG sustainability performance. Justifications for business sustainability are moral obligation, social responsibility, maintaining a good reputation, ensuring sustainability, environmental conscientious, licensing to operate, and creating stakeholder value. In creating shared value for all stakeholders, corporations identify potential social, environmental, governance and ethical issues and integrate them into their strategic planning and supply chain management. There are many factors of why a company should integrate sustainability performance to its supply chain management, including the pressure of the labor movement, development of moral values and social standards, the development of business education, and the change in public opinion about the role of business, environmental matters, governance, and ethical scandals. Companies that are, or aspire to be, leaders in sustainability are challenged by raising public expectations, increasing innovation, continuous quality improvement, effective governance measures, high standards of ethics and integrity, and heightened social and environmental problems.

Globalization has provided incentives and opportunities for business organizations and their stakeholders and executives to influence their business sustainability initiatives and strategies and integrate them to their supply chain management. Corporations can choose from a variety of sustainability initiatives and performances about the scope, extent, and type of sustainability strategies that focus on different issues, functions, areas, and supply chain management. Although integrating the proposed framework, consisting of four integrated strategies of stewardship theory implication, continuous performance improvements, sustainable shared value creation, and sustainability performance reporting and assurance may be a challenging task, the failure to act can be detrimental to the company’s success.

Organizations of all types and sizes can integrate the suggested sustainability framework consisting of the stewardship theory implementation, continuous improvements of both ESP and EESG sustainability performance, shared value creation, and sustainability disclosures into their corporate culture and business model to effectively achieve their missions and goals of creating shared value for all stakeholders.

Chapter Takeaway