May 15, 2019, 08:00am
Michael Posner Contributor
I write about human rights and leadership in a global context.
An aerial view of a new industrial park built in Hawassa, Ethiopia. Google
In the last several years, a growing number of global apparel companies have begun having their products manufactured in Ethiopia. For these firms, Ethiopia has become the new low-wage frontier. The East African country now competes with Bangladesh, Vietnam and other South and East Asian nations for a share of the massive volume of global garment production. In this competition, Ethiopia has the dubious distinction of offering the lowest pay anywhere in the worldwide clothing supply chain—and that’s the main reason the big brands are drawn there.
But increasingly it has become clear that these firms need to invest more resources into Ethiopia both to make their make production profitable and sustainable over time, and to ensure that Ethiopians are better off because of their presence. Among the steps they will need to take are to increase wages, enhance training, and help provide housing and other basic necessities to the young women who come from around the country to work in the clothing factories. The challenge these firms face in Ethiopia is to balance the pressures to reduce the costs of production with the realization that to succeed over the longer term, they will need to invest more money. This longer-term view is in tension with what many Wall Street investors and analysts are expecting them to do, driven in part by a mistaken understanding of directors’ legal duties to shareholders.
For the last half-century, most analysts and investors have embraced an antiquated investment model that focuses heavily on maximizing short-term shareholder returns. They have focused on these short-term returns at the expense of longer-term wealth creation for corporations and society at large. This focus took shape in the 1970s, when economist Milton Friedman and then others asserted that corporate CEOs are merely agents of shareholders, responsible for conducting business in accordance with shareholders’ core interest: maximizing stock prices. In an often-quoted 1970 article in The New York Times Magazine, Friedman wrote that corporate executives have a fiduciary duty to conduct business in accordance with the desires of shareholders, which he defined as making “as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.” Since Friedman first articulated this rigid view almost 50 years ago, the negative consequences of his perspective have become more apparent. Wall Street’s preoccupation with short-term returns has led too many corporations, like the apparel firms in Ethiopia, to forgo the longer-term investments they need to create maximum societal wealth and to build sustainable business models. Instead, they are doubling down on cost-cutting measures and excessive share buybacks or simply declining to make needed internal investments. What results is a chronic failure to invest in the future and a global financial system that is leaving too many people behind.
One cause of this problem is the mistaken notion that corporate directors “duty of care” to their shareholders necessitates that they deliver maximum quarterly earnings. But, in Delaware, where over 60% of Fortune 500 companies are incorporated, the courts are increasingly clear that corporate directors need to be thinking about and maximizing long-term value for their shareholders. The Chief Justice of Delaware Supreme Court, Leo E. Strine, Jr., has advocated for a broader understanding of business’ role in society than that of the Friedman model, writing: “the generation of durable wealth for its stockholders through fundamentally sound economic activity, such as the sale of useful products and services, is the primary goal for the for-profit corporation.” Strine has highlighted the role investors have to play in encouraging this mindset, saying: “To foster sustainable economic growth, stockholders themselves must act like genuine investors, who are interested in the creation and preservation of long-term wealth, not short-term movements in stock price.”