Hello, welcome to visit Shanghai Forum
Oliver Hart 2016 Nobel Laureate in Economics
Let me start off by saying that I am delighted to be able to speak in the Shanghai Forum 2020. I have been to Shanghai several times and enjoyed it very much each time, and I am looking forward to my next visit.
'Harnessing Corporate Objectives' is the title of my speech. I am interested in how companies should be behaving these days, what I am thinking of large companies, whose shares are publicly traded. There are many of such companies in the United States and Europe, and now increasingly in China. This is an old question: should they be maximizing profit or should they be doing something else? Some of my remarks will actually be quite consistent with what we heard from Chairman Chey Tae-won earlier, who was saying that maybe profit maximization is not obviously the right thing. I am going to be agreeing with that.
But this is a rather new view, because 50 years ago, the famous economist Milton Friedman argued in the New York Times that corporations had only one social responsibility, which was to make money for their owners. He was saying that a profit maximization or value maximization market is what companies should do and nothing else.
This view has been enormously influential, but not everyone agrees with it these days. And indeed in 2019, the Business Roundtable made a statement that companies have a responsibility to stakeholders as well as shareholders, stakeholders being other groups that interact with the company like workers, consumers, and maybe the local community.
Now, in a 2017 article, Luigi Zingales and I took a middle-ground position. It was conservative in some respects, and not so conservative in other respects, because we actually agreed with Friedman that most companies are set up to act on behalf of shareholders rather than stakeholders. Because after all, people can set up companies in any way they like. If you want to put workers on the board, or give them votes, you could do that if you want but by and large, the companies I am talking about have been set up in such a way that the votes are allocated to shareholders and that suggests that the company is meant to be acting on their behalf.
We take that view in this 2017 article, but we depart from Friedman, because we argue that the company should act on behalf for shareholders, but do they necessarily just want to make money? Is that the only thing they are interested in the company doing? We said in general that that is not right, because after all, shareholders are regular, ordinary people like you and me and in our own private lives, we do not just emphasize monetary goals. We are not only interested in the bottom line. We are concerned about what is happening to other people and what is happening to the environment. For example, people buy electric cars because they are concerned about the environment. Even though these automobiles may be typically more expensive than the regular automobiles, they will do it anyway.
Basically, if you are the kind of person who cares about other things than yourself and acts that way in your own life, why wouldn't you want the companies you own to do the same thing? That was our basic point. Let us take climate change which has already been discussed tonight and is hugely important. In an ideal world, this is the way economists think about this. National governments would solve the problem of climate change to the best extent we can by agreeing that there should be a worldwide carbon tax. This is the economist solution. That means, if you damage the environment, you have to pay for it. That will optimally discourage people from doing bad things, but this requires action not only at the national government level—which is hard enough, as we have seen in recent years in a number of countries, including the one I live in—but it requires more than that. It requires coordination among many national governments. Although we have the Paris Agreement and so on, it goes very slowly and not everybody is a member of it.
I think it is safe to say we do not live in this world. There are political failures at both the national and international level. As a result, individual actions and corporate actions matter, too. As an individual, I can try to reduce my own carbon footprint, maybe by buying this electric car, but the companies I own are in a much better position to do that. They have a comparative advantage in doing that. They are much bigger. They can reduce their carbon footprint to much greater effect than a group of individuals can. That may be the efficient way to go. We use the language of economics: companies have a comparative advantage in tackling climate change relative to individuals in a situation where governments have not solved the problem. Pollution would be another example where companies have a comparative advantage.
Now, to the extent then that shareholders being ordinary people, may often want their companies to be environmentally friendly, how can they bring this about? How could they make companies they own become cleaner or greener? In practice, there are two ways: exit or voice. So they can exit by divesting. They basically declare that they are not going to hold shares in dirty companies and they are only going to hold shares in clean companies.
There are a lot of activity like this in the United States and in Europe these days. If it is not happening in China, I am sure it will. The mechanism here is that by divesting from dirty companies, the share price of these companies will fall and so, even a value maximizing or a profit maximizing company will be induced to change its strategy, because it does not like to see its share price falling. The alternative mechanism is for shareholders to use voice, which means they use the fact that they have votes, they have voting power, so they engage with management to change company policy. They do not get out. They try to change.
In a recent paper with Eleonora Broccardo, Luigi Zingales and I compare these two strategies theoretically. We argue that voice is under-appreciated relative to exit. People talk a lot about divestment. They do not talk enough in our opinion about “voice”, because we think voice can actually work surprisingly well, if shareholders have an opportunity to exercise their voice by voting say. Let me give you an example. Imagine that we talk about a company, a particular company that can install a technology which will make it cleaner or greener, but let’s suppose this is costly. It costs 100RMB to do it, but it helps the environment by more, by 120RMB. Everything here is measured in monetary terms.
If you had a planner who was looking out for social welfare (a sort of planner economists often have in mind in their analysis), he would definitely want to do this. It is just a cost-benefit analysis. You pay 100 that you get something worth 120, so it is a good thing to be doing. We argue that actually, if shareholders were allowed to vote on whether the company should do this. They might indeed vote exactly the way a benevolent planner would. And let us just see why that is. You see, if shareholders are well diversified, which many are these days. It is certainly true in the United States that a lot of people hold index funds, which means they are holding just a little bit of thousands of companies.
Their shareholding in this particular company is really small, so if the company does become greener, it will have to incur this cost of 100 and so its market value will fall by 100. There will be a capital loss. But as one of these very small shareholders, you will personally experience a very small capital loss, because it will be a very small percentage and you will hardly notice it. In contrast, if you are socially responsible, even a little bit, you will put some weight on what is happening to the rest of the world. Just like the person who buys the electric car, you look at the amount you have to pay extra, but you also take into account the benefit you are doing to the world, so that is the kind of thing I am imagining here. And so, this shareholder will say, I have a very, very small hit loss myself, but the gains for the rest of the world is positive—I am going to actually vote that we go ahead.
Of course, if they were a large shareholder, they would have to be more socially responsible to do this but for a small shareholder, even a small degree of social responsibility will get them to vote the way a benevolent planner would vote. In other words, just look at it in cost-benefit terms. In this example, vote for the company to become more environmentally friendly. The conclusion is that if the majority of shareholders are socially responsible, a desirable outcome will be achieved through a vote.
The alternative mechanism, exit, is less likely to be effective and the reason is that even under the circumstances I just posited, which is a majority of investors being slightly socially responsible, that is not going to be enough for divestment to work. Because the problem is, if I sell my shares, if I say I am going to get out of this company, you might be a little bit socially responsible. But because if the share price goes down, then you have a great profit opportunity here. You can buy these shares at a discount as opposed to their regular price and you are going to make a big game. If you do not do that, you are really missing out on a significant amount of money. You would have to be quite socially responsible to reject that. You would actually find that you would need a much higher degree of social responsibility for divestment to lead to a significant fall in share price, and the company would then respond by saying they will become clean and green because they are seeing their share price fall so much. The circumstances are much more stringent in that case, compared to the “voice” case.
If you are interested, you could look at this paper, “Exit versus Voice” on my Harvard website. The conclusion of my co-authors and me is that voice should be encouraged much more than it is. In particular, among other things, companies should listen to their owners and consult with them about how much profit they are willing to sacrifice for a cleaner environment, instead of just blindly assuming that their goal is to maximize profit for the shareholders. My hope is that we are going to see a shift in the way people think about these things in the U.S. and Europe, in the next few years, and maybe this will happen in China, too. Just to give a couple of examples, China's green development, this mandate, could be implemented at the firm level by harnessing corporate goals, by recognizing in other words that companies are not just all about making money. Other social mandates could also be implemented with the help of firms. Empowering the poor to alleviate poverty is another example. This is basically saying we do not want to totally rely on government, we are going to need individuals and companies to step up and do the right thing. I think this is possible going forward, and I hope that is what we are going to see happening.
Thank you very much.
