The Long-term Business Case for Corporate Purpose

Business leaders do not have to choose between their values and creating value, according to a new study by Wharton’s Witold Henisz.

It is a phenomenon known as the “war on woke”: the political backlash against investments in companies with a corporate purpose beyond profit maximization. Some U.S. lawmakers have argued that environmental, social, and governance (ESG) investing undermines financial returns. However, a new paper by Wharton management professor Witold Henisz sets out the long-term business case for managers to pursue a wider purpose that contributes to societal goals, even as they face pushback from some in Washington.

“There’s been a big debate about whether firms should maximize shareholder value or focus on a broader purpose, but those two aims are not necessarily in conflict. Managers don’t have to choose between value and values,” said Henisz, the vice dean and faculty director of Wharton’s ESG Initiative.

His article, published in the journal Strategy Science, finds a link between a corporate purpose that emphasizes harmony among a wider set of stakeholders — customers, suppliers, communities, and government — and longer-term value creation. These stronger “relational contracts” lead stakeholders to contribute more to the firm’s success, because they see their contributions as worthwhile and likely to be rewarded fairly, according to the paper.

“That means they’re going to work harder and chip in that little bit more. And then when it comes to value distribution, they’re not fighting so much about who collects the rents,” Henisz said. “And that means the company is around for the longer term. Everyone ends up better off, even shareholders.” Consistent with this view, a white paper authored by Henisz about his work with activist hedge fund investor Engine No. 1 demonstrates that an investment portfolio containing a larger percentage of S&P 500 firms with higher “total” versus shareholder value, and fewer companies with lower such ratios, substantially outperforms benchmarks.

Corporate Purpose and Harmonizing Stakeholder Interests

That said, harmonizing varied stakeholder interests can take substantial time and effort, though Henisz insisted that it’s well worth it. “By spending upfront to nurture these relationships you fix all the problems early on, so you have less disputes down the road. We need firms to think about stakeholder relationships as an investment, instead of a cost to be managed.”

Setting a clear and credible corporate purpose beyond short-term wealth generation can speed the process up. A good place to start is having an open dialogue with stakeholders; Henisz said executives cannot define their wider mission in an ivory tower. “Spend time talking to stakeholders and treating them as part of the value-creation process. Ask them about their goals and try to find some that overlap — this is your area of win-win.”

He warned, however, that addressing every stakeholder concern can spread resources too thinly, undermining the ability to achieve organizational goals. Reflecting this, a working paper co-authored by Henisz finds that when companies focus on issues that are relevant to stakeholders but also financially material to the firm, there’s a boost to revenue growth and productivity, more than offsetting margin loss. In contrast, less targeted resource allocation to ESG issues creates stakeholder support but no net financial gain, the study shows.

“Many people will want you to fix climate change or cure poverty, but no one company can do this alone. So, you need to prioritize issues,” explained Henisz. “The best place to contribute is in areas that relate to your business. If you’re a food company, you’ll have a bigger impact on hunger or water scarcity than on education or health care. Stakeholders will understand this if you frame it in terms of maximizing impact and avoiding distractions.”

As well as prioritizing societal goals, companies should also focus on building relational contracts with the “right” stakeholders, he said — those who can most powerfully influence the firm’s stated objectives. “Think about who has specific knowledge or resources that can help you achieve your goals. How easy is it to swap them out and get someone else in? If they are a generic asset, other stakeholders will be more likely to understand if you leave them out of the conversation.”

Additionally, Henisz said that business leaders should focus less on stakeholders that are acting in their own self-interest, opportunistically, as this hampers progress toward wider goals. “For example, they might demand too good of a deal, in which case the firm can cut them out and receive support from other stakeholders for doing so.”

What Undermines Corporate Purpose?

Lastly, he said that managers themselves can be their own worst enemy when it comes to delivering on their wider corporate purpose, given that virtue-claiming or “greenwashing” is a significant problem. Another white paper co-authored by Henisz shows that when an organization “walks the talk” and addresses key stakeholder concerns, they invest more in research and development (seeding innovation) and enjoy higher and more stable return on invested capital, while also reporting higher sales growth over 10 years, based on a sample of firms in the MSCI ACWI stock market index.

“One of the biggest risks is that, if executives can greenwash and everybody believes their cheap talk, we will default back to shareholder primacy, neglecting other stakeholders and focusing on short-term thinking,” Henisz said. “So, it’s important for stakeholders to work together and ensure that ESG reporting becomes more reliable and comparable, so we can identify and expose deceptive messaging.”