Growth in investors’ fortunes does not necessarily have to be at the expense of other stakeholders, including employees, the environment and society at large. Instead of “splitting the pie,” responsible businesses ought to aim to expand it, according to Alex Edmans, professor of finance at the London Business School. His new book on the subject is titled, Grow the Pie: How Great Companies Deliver Both Purpose and Profit.
“When you serve society and run the business with a purpose, you’re growing the pie, and therefore it’s not only stakeholders that benefit, but also shareholders,” said Edmans in a recent interview with Wharton management professor Katherine Klein on the Dollars and Change podcast. The podcast is produced by the Wharton Social Impact Initiative, where Klein is the vice dean. (Listen to the episode featuring Edmans above; you can listen to additional episodes here.)
The coronavirus pandemic is encouraging many companies to become “responsible” citizens. Firms are repurposing their facilities to produce essential supplies like masks and sanitizers or donating money. But some are also going above and beyond to help, such as using their planes to ferry medical supplies or hosting online classes to engage children while their parents work from home, Edmans noted.
An edited transcript of the conversation follows.
Katherine Klein: Let’s focus on the title of your book – Grow the Pie: How Great Companies Deliver Both Purpose and Profit. So why “Grow the Pie?” And what’s the difference between a grow-the-pie mentality and a split-the-pie mentality?
Alex Edmans: The book is about responsible business. Many CEOs historically have viewed responsibility as an optional extra or a luxury. That’s something you put in a Corporate Social Responsibility department, but it’s not central to the business. Why? Because they have what you refer to as the “pie-splitting mentality.” The idea is that the value that a company creates is [represented] by a fixed pie. So anything that a company gives to stakeholders, in the form of employee wages or reducing prices to customers or stewarding the environment better, is at the expense of profits….
The book title suggests that if companies deliver value to stakeholders, in the long term they do benefit their investors. For example, if you treat workers better and train them and invest in them, it might cost you more in the short term, but in the long term, they become more motivated and more productive, and therefore investors benefit. So when you serve society and run the business with a purpose, you’re not donating slices of the pie to society and making shareholders worse off. You’re growing the pie, and therefore it’s not only stakeholders that benefit, but also shareholders.
Klein: My understanding from what you’ve written is that you’re not concerned only about CEOs or even investors who have a pie-splitting mentality. You also see this pie-splitting mentality among other groups, and you think it’s misguided. Who else is getting this wrong?
Edmans: People who advocate for the reform of business. These may be policy-makers or academics who say that business needs to serve wider society. I would agree with them [on that goal], but I will disagree with them as to how to get there.
[Those business-reform advocates] practice the pie-splitting mentality from the other angle. Their belief is that if we want to serve society better, then we need to restrict what goes to investors [and company executives]. That might be through heavy restrictions on CEO pay or profit-[sharing] and so forth.
That is problematic for at least two reasons. First, if the reform on business is something that makes business worse off, the only way that you can achieve that is through regulation. There is a role for regulation, but there is a limit to what you can achieve with it, because it only leads to compliance, not commitment.
“When you serve society and run the business with a purpose, you’re not donating slices of the pie to society and making shareholders worse off. You’re growing the pie….” –Alex Edmans
Let’s say you could have a minimum wage regulation, and you can abide by that, but that doesn’t mean that you’re going to give meaningful work and training opportunities. For example, [Henry] Ford famously paid his workers five dollars a day. That was a lot back in the 1920s, but it didn’t give people the opportunities for skills development. The second limitation is that when we think about the pie being split between society/us and investors/them, we often think that investors are the enemy. But actually the investors are us. So, any reform of business needs to take investors seriously.
Klein: Who do we mean by “stakeholders?”
Edmans: A stakeholder is any constituency that is affected by the company’s presence. This could involve employees; importantly, how they’re affected is not just through an economic relationship, which is just wages. They might also care about intangible factors such as training and development, meaningful work and camaraderie and a purpose. It could include customers or the environment, taxpayers, communities, and suppliers. In the Business Roundtable’s statement last August which a number of CEOs signed, they argued that their businesses had a responsibility to not only shareholders, but also to those stakeholders.
Employee Satisfaction and Financial Performance
Klein: You build your argument on academic evidence and strong empirical research that when companies invest in stakeholders, and when they take seriously an obligation or responsibility to benefit stakeholders, their long-term profits and financial performance improve. What’s the evidence [from] your research on employee satisfaction? You find that companies that treat their employees better have more satisfied workers and seem to perform better [than those that don’t].
Edmans: Certainly so. My own work looks at employee satisfaction. Now, that’s only one stakeholder. I focused on employees for a couple of reasons. One, I had some good data from the list of the 100 Best Companies to Work for in America. The second reason I looked at employees is this concept of materiality. Employees are important in virtually [every] firm, whereas measures like environmental impact might be relevant if you’re a mining company or an energy firm, but not much if you’re a financial institution.
I wanted to link employee satisfaction to financial performance. But the big problem here is causality. Many [research] papers in the fields of management and strategy tried to correlate social performance with financial performance. Some famous meta-analyses showed that on average these relationships were positive. The meta-analyses looked at other dimensions, as well. Is it financial performance that causes social performance, including employee satisfaction, because one might think that once the company does better, it can start treating its workers well. Or, maybe you have an inspired CEO, and she both improves her performance and starts thinking about her employees.
In finance, we look at the stock return, [which] is the change in the stock price between now and in the future. There’s a lot of evidence that the current stock price does take into account tangible measures of performance, and not just profitability. So if we thought there was reverse causality, that the employee satisfaction was the result of good performance, then that good performance would already be [reflected] in the stock price.
I look at not just the future stock performance, but also future earnings and profitability of the company. Equity analysts like at Goldman Sachs and Morgan Stanley try to forecast profits, and they take in account [aspects] such as management quality and past performance. They found that these companies [with happier employees] were systematically beating analysts’ expectations, suggesting there was something about these companies which the market just wasn’t getting. That moves it closer towards causality.
“When we think about the pie being split between society/us and investors/them, we often think that investors are the enemy. But actually, the investors are us.” –Alex Edmans
Klein: The causal mechanism we expect is that when your company is a good place to work, when your company gives people purpose and meaning and pay, you attract better workers, you keep them, and you get, not surprisingly, better performance.
Let’s talk about the evidence that you are seeing that goes beyond employee satisfaction. Turning to other stakeholders and other dimensions, what are you seeing that meets the standards and rigor of research that make you, a finance professor, say, “We ought to take this more seriously. There is clear evidence of growing the pie, that this is not just good for stakeholders. It’s good also for a long-term business.”
Edmans: It is important to be skeptical and discerning about the evidence, because there is a lot of confirmation bias – we would like to believe that companies that do good do better. So we might just jump on the evidence, even if it’s not fully robust.
[However], here is evidence, looking at all the stakeholders such as environmental performance, [that in addition to enhancing stakeholder value], they also improve shareholder value – which is the idea that the pie is growing, rather than being split in favor of stakeholders.
Klein: In arguments that you might characterize more as being in the pie-splitting mentality, one view would be that CEOs are overpaid. Is CEO pay out of control? When we think about responsible business, should we see lower CEO pay? What should we see?
Edmans: Let’s look at the evidence and see what it seems to suggest. With the idea that CEO pay is too high – where does the “too high” come from? Well, if the ratio of CEO pay to worker pay is excessive, the idea is that, “If the CEO wasn’t so greedy, then you could just redistribute her pay to everybody else.” But this is based on the pie-splitting mentality – the idea that a CEO’s pay is at the expense of everybody else. If you look at, say, Bob Iger [until recently CEO and now executive chairman] at Disney, last year he was in a controversy because he had earned $65 million, but that wasn’t necessarily at the expense of society. Disney’s value had gone up by [nearly] 600% over his tenure and 70,000 jobs had been created. But again, as academics, we don’t just look at one anecdote.
What does matter is the horizon of pay – whether it’s tied to the short term or the long term. [In a paper that Boston University professor] Caroline Flammer wrote with [Ivey Business School professor] Pratima (Tima) Bansal, she showed that when companies implement long-term pay, it not only causes long-term profitability to go up, but also companies become more innovative, and also employees do better in terms of MSCI ESG ratings (or resilience to long-term environmental, social and governance risks).
“Pie-growing is about is about being innovative, thinking about, ‘What can I do to actively create value for society?’” –Alex Edmans
This suggests that the best way to improve how a company treats workers is not by reducing the CEO’s pay and redistributing it, but when the CEO thinks about the long term, then she knows that it’s more important for her to invest in employees, because they are material to the long-term success of the company.
Lessons in the Context of Coronavirus
Klein: You wrote the book before the coronavirus pandemic. What are the lessons that you think you’ve learned about great companies that are particularly relevant and helpful for us to pay attention to in the context of the coronavirus?
Edmans: I think it’s how responsibility involves pie-growing, as well as pie-splitting. There have been some great responses to the crisis, which I’d call pie-splitting — i.e., companies and investors are bearing the load of the burden to help society. This might be some CEOs working for zero, like the CEOs of Boeing and United [Airlines]. Or it might be companies giving free products, so you have, say, Unilever giving 100 million euros of food and sanitizers, or companies continuing to pay their workers – say [Las Vegas-based] Wynn Resorts, even though its hotels are closed down.
But why I think the importance of pie-growing is critical is that, what if you can’t split the pie? You don’t have pie to give. You don’t have 100 million euros lying around if you’re a small company. Or you’re not in a relevant industry, like food and sanitizer.
So pie-growing is about being innovative, thinking about, “Well, what can I do to actively create value for society?” You might be, let’s say, Ford – the car company which is now redeploying airbag material to make hospital masks and gowns. It could be you’re the New England Patriots. How can they help with football and merchandise? Well, what they have is a plane, and they’re using that plane to fly 1.2 million N-95 masks.
Or, you might be a small business, with no money. One is Barry’s Boot Camp, which is a gym offering free online fitness classes, which is important for people locked down now. You might think, “Well, that’s not hugely innovative, that a fitness company is providing fitness classes.” But here’s the thing which is really interesting. What they have is desk staff – people who work at reception. So how can they help out in the crisis?
It turns out that many of them are actors, but because acting is a volatile profession, they take this desk job in their spare time. And as a result, they’ve got great skills in entertaining. How does that help in the crisis? Well, we have a lot of working parents with their children at home. They’re offering, say, Zoom storytelling to take kids off their working parents’ [hands] for an hour. That makes a big difference.
So again, it’s not just about donating money – which is really important. I can never underestimate the companies that have done that, that have made great contributions. But the whole idea of growing the pie means that all companies can contribute, even if you’re in an unrelated industry, and even if you don’t have millions of dollars to give, just by thinking innovatively as to how you can use what’s in your hand to serve wider society.
“The whole idea of growing the pie means that all companies can contribute, even if you don’t have millions of dollars to give, just by thinking innovatively as to how you can use what’s in your hand to serve wider society.” –Alex Edmans
New Research Directions
Klein: You’ve emphasized where rigorous academic research can be helpful and convincing regarding the increasing evidence on “growing the pie.” What additional research would you like to see?
Edmans: The measures of the input are particularly important, rather than the output. I’ve talked about some output measures. I’ve looked at measures of employee satisfaction, or shareholder proposals. But we haven’t measured purpose: Are companies which are purposeful performing better in the long term? That’s tricky to do.
So there is some work by [Harvard Business School professor] George Serafeim and co-authors which uses a subset of the measures of the best companies or the best companies surveyed. That is linked to purpose, but I think it’s more [about] employee perceptions of management than actual true purpose. [It would help] if there were a way of trying to discern purpose – this might be through textual analysis of some annual reports or sustainability reports.
Klein: There is new research going on, looking at some of the companies that have signed onto the Business Roundtable statement. Are these companies serious about purpose, or are they signing onto these statements because it makes them look good? What’s the impact washing that some folks are concerned about? What would be your advice to companies, or whether it’s to the students we teach, the employees, about what kind of purpose statements are meaningful in companies?
Edmans: A strong purpose statement is one that is targeted and focused, because people often misunderstand the word “purpose.” [The concept of] “purposeful” is often seen as a synonym for altruistic, so a “purposeful” company is one that serves wider society.
There are some companies with purpose statements which say something like, “Our purpose is to benefit society, which involves shareholders, employees, the environment, customers,” and so on. But that’s difficult, because in reality, there will be some trade-offs.
Let’s say you’re an energy company. You’re thinking, “Do I shut down a polluting plant?” Well, that’s going to help the environment but hurt workers. So a purpose statement which includes every stakeholder is not going to provide guidance to those decisions. I would say for a company to have a purpose statement that is meaningful, it has to be focused. What it omits is often as telling as what it includes.