The Social Responsibility of Business: Alex Edmans (Full Transcript)

Full text of Alex Edmans’ talk: The Social Responsibility of Business at TEDxLondonBusinessSchool conference. Alex is a Professor of Finance at London Business School. In this talk, he explains the long-term impacts of social responsibility and challenges the idea that caring for society is at the expense of profit.

TRANSCRIPT:

Alex Edmans – Professor of Finance

Why do businesses exist?

• To earn profit? or to serve a purpose?
• For shareholders? or for society, customers, employees and the environment?

Well the conventional view is exclusively to earn profit. And that’s not as narrow-minded as it sounds.

Because to earn profit, a company is forced to care about society. It has to make high-quality products or customers will stop buying. It has to treat its work as well or they’ll leave. And it can’t pollute the environment or its brand will be hurt.

Indeed leading economist Milton Friedman once famously wrote:

“The social responsibility of business is to increase profit. So just head to the land of profit and you’ll get all of these other decisions rights.” 

But this theory assumes that you can calculate the effect that ethical behavior has on your profits. In practice, you can’t reduce every decision to a mathematical calculation. 

Take Marks and Spencer, the UK high street store now. Former Chairman Simon Marks… he had a policy where all top management had to walk around the shop floors to see first-hand how customers and workers were being treated.

And one day, back in the 1930s, on one of his own visits, Simon sees a shop assistant faint. And he’s concerned. He wants to find out why. And it turns out that her husband’s unemployed and she’s not eating, so that her family can.

So the very next week, Simon introduces nutritious meals for all staff at nominal prices.

Why?

Well, Milton Friedman would say, ‘Do a calculation. If I provide nutritious meals, this many workers are not going to faint. So I’m going to make this much more money.”

There’s obviously no way you can calculate that number.

Instead Simon’s thinking was different, “I’ll provide nutritious meals even if it costs me a bit, because I care about my workers. I want to make them eat well. And because it goes above and beyond, Marks & Spencer has an excellent reputation for quality and that in turn leads to profit.”

So that’s the second view which is called ‘Corporate Social Responsibility’.

Now you might see it’s a bit tree huggy and out of touch. But it’s actually not too different from the first view. It agrees that profit is good. But profit is only a by-product. It’s not the end goal. Instead businesses exist…

• to serve a purpose,
• to make products that transform customers’ lives for the better,
• to provide employees with a healthy and enriching workplace, and
• to preserve the environment for future generations

…even if you can’t calculate the bottom-line impact of doing so. And if you do that, profits will come naturally.

So take George Merck, the former President of Merck Pharmaceuticals. His mindset wasn’t, ‘How can I make as much money as possible selling drugs?’ It was, ‘How can I use science to save people’s lives?’

Now back in 1942, Penicillin was still a new drug. It hadn’t been made outside the lab before as it was too expensive. But George takes a punt and Penicillin becomes available… made by Merck, a first company for the first time.

Now this is a photo of Ann Miller. A thirty-three old woman. She lives in New Haven. Her husband’s Ogden Miller, the athletics Director of Yale University.

And on March the 14th 1942 and lies dying in a hospital bed, stricken with Streptococcal septicaemia, which she’s caught after suffering a miscarriage. Her fever struck 104 to 106 for 11 straight days, and everything the doctors have tried has failed. Until Penicillin.

Ann becomes the first American ever to be treated with penicillin and it saves her life.

The very next morning, her temperatures back down to normal and she makes complete recovery. She goes on to having three sons and she lives until 90 years old.

And Merck then shared the secrets of how to make Penicillin with its competitors, so that they could do so, also saving thousands of lives in World War II.

As George Merck said, “We try never to forget that medicine is for the people. It is not for the profits. The profits follow. And if we remember that they have never failed to appear.”

So just serve a purpose and the profits will follow.

Nice idea. If it were true. But where’s the evidence?

Well that’s what I set out to gather. I wanted to test whether socially responsible firms actually perform better or instead distracted from the bottom line?

But how do you measure social responsibility?

Well I chose to look at employee well-being. Now that’s not the only dimension that’s important – there’s customers and the environment. But I chose employee well-being because there’s a particularly good measure out there. The list of the hundred best companies to work for in America, now published every year by Fortune magazine.

So this list is available from 1984, so I have tons of data and it’s also very thorough. It looks at not only quantitative factors such as pay and benefits, but also qualitative factors like trust and management, pride in your jobs, and camaraderie with your colleagues.

So I study the effect of being a best company to work for on future stock returns.

But how do I know whether good stock returns are down to employee well-being? It could just be your industry happens to perform well, or some other factor?

So to isolate the effective employee well-being, I control for what industry you’re in, for firm size, for growth opportunities, of past returns, and a whole list of other characteristics.

And as we all know correlation doesn’t imply causation. So I do a number of further tests to suggest that it’s employee well-being that causes good performance rather than good performance allowing a company to spend on employee well-being.

It took four years to complete this study to verify the robustness of the results and to rule out alternative explanations.

So what did I find?

I found that the hundred best companies to work for in America delivered stock returns that beat their peers by two to three percent per year over a 26-year period. Simply put, companies that treat their workers better, do better.

And this fundamentally changes the way that management should be thinking about their workers. You might think, isn’t it obvious that companies do better if their workers are happier? But it’s not obvious, because treating your workers well is costly.

Take Costco, the American supermarket chain. So Costco pays its workers USD 20 per hour. That’s nearly double the national average of USD 11 and it gives 90% of its employees’ health care. That’s expensive.

Indeed a stock analyst quoted in Businessweek said, “Costco’s management is focused on employees to the detriment of shareholders.” Why would I want to buy a stock like that?

Indeed the conventional view is that a pound paid to your employees is a pound taken away from shareholders. So pay your workers as little as possible and work them as hard as possible — just like a great football manager can squeeze that little bit extra out of his players.

I tried to get Alex Ferguson but I couldn’t find him shouting at his own players. Only at referees.

So under this view, employee well-being is a bad sign because it suggests that you’re allowing your workers to slack off. Indeed before my current life of poverty, I used to be an investment banker. You’d like to see a photo of my oak-paneled corner offices. That’s my empire.