Stewardship: the natural evolution of fiduciary duty?

In the wake of the recent financial crisis and the subsequent Kay Review into long-term decision making in capital markets, the Law Commission in the UK has been charged with performing a root and branch review of fiduciary law. This is a huge opportunity to inspect the essential plumbing of our modern democratic capitalist system.

Getting there from here       

The long-running debate over fiduciary duty reminds me of the familiar joke about asking for directions from a less than helpful local: “if I was going there I wouldn't start from here.” Those of us who look at fiduciary law through the lens of business ethics may wish we could uninvent it and simply start afresh. To do so we need the collective moral imagination to conceive anew the nature of the fiduciary relationship; not in a way that dilutes or diffuses accountability but instead clarifies and strengthens it. It is to view the fiduciary relationship as just that, marked by mutual trust and respect.

The notion of a fiduciary can be greatly enriched if we reassert our shared humanity into real-life economic relations. As we do, the relationship between ‘self’ and ‘other’ is free to evolve into something we might usefully call ‘stewardship’. It is a phenotype of the fiduciary genotype. A steward inherits the same essential traits of a fiduciary: service to others. But unlike its forebear a steward can be trusted to do so. The real task for the lawyers is to figure out how the legal framework can facilitate the development of trusting relationships, rather than simply seeking to enforce them. I suggest the ascent of man-as-fiduciary towards man-as-steward proceeds through five evolutionary generations.

1 - Fiduciary Duty: to serve the interests of an other

Grounded in the principal-agent view of contracts in financial economics...

• Interests are ‘given’ and delegated by the principal to an agent with requisite skills and specialist knowledge.
• In its narrowest terms, the ‘interest’ is in private property – an asset over which a legitimate property right exists.
• The interests served by the fiduciary are the ‘self-interests’ of the principal only.
• Agents are similarly motivated by self-interests and are inherently self-serving and opportunistic.
• The agent-as-fiduciary must be incentivised, including by force of law, to serve the self-interests of the principal.
• These mechanisms are sub-optimal; they impose agency costs on contracting.

According to the basic economic model, the principal is an isolated individual, save for his entrusted agent. No other relationships are necessary to the standard agency model. Using his specialist knowledge or skills, with some degree of discretion, the agent-as-fiduciary is expected to act prudently and in the best interests of the principal; exercising the sole virtue of undivided loyalty with respect to his self-interests.

Of course this is simplified picture of real human relationships: both parties are in reality situated in a wider social setting. And even those who would defend a narrow concept of fiduciary duty concede that fiduciaries must at least respect the legal and social norms of civilised behaviour. This is to admit that principals and their agents stand in relationship with not just one but a range of others. It is the case that the fiduciary relationship imposes special obligations on fiduciaries. But contracting takes place in a wider social milieu in which others may also assert certain claims or rights. In some cases, these rights might be secured by a corresponding duty of care on fiduciaries to take reasonable steps to avoid inflicting harms on third-parties (the common law tort of negligence). Participation in civilised society attaches at least some minimum duties beyond those explicitly expressed in private, legally enforceable contracts. Both principal and agent are economic and moral agents.

As my local MP, Jesse Norman, recently remarked in the Daily Telegraph, making profits has never been the sole duty of companies, or the fiduciaries that run them. Indeed, if companies' only responsibility were to maximise shareholder returns in the name of financial wealth creation, society should happily allow them to avoid tax and shift environmental costs on to someone else to the maximum extent permitted by law. But it doesn't and for good reason. As social institutions business cannot afford to ignore the norms, expectations and indeed values of wider society. Arguably it never has.

2 - Enlightenment: the interests of the self are tied to those of others

Thus, the principal as a nexus of relationships...

• Self-interests are given but contingent on those of others.
• Human behaviour and conduct is governed by institutions, formal and informal.
• Property is a ‘bundle of rights’ which includes control surrendered to a fiduciary.
• Rights and duties imply mutually respected reciprocal obligations.
• Contracts may be explicit and implicit.

The simplifying axioms of economic rationality and behaviour have never been seriously advanced as a full and accurate portrayal of the human condition. Neither are the assumptions made for the purposes of economic analysis intended to faithfully describe the richness of human experience, character or motivation. And neither are they normative. The self-interests of rational economic actors are 'enlightened' only by the acknowledgement that humans do not live isolated existences. Our actions and decisions usually affect others; and the behaviour of others usually affect us. We cannot so easily isolate the interests of ‘self’ from those of ‘other’. Moreover, just as self-interest should not be confused with greed, neither should enlightened self-interest be viewed as a form of altruism.

The duty of the enlightened fiduciary is to still to serve the self-interests of a single principal, though now aware that his actions may have consequences for others too. To the extent that those consequences may be detrimental to the interests of the principal, either now or in the distant future, they must be taken into account by the fiduciary in the exercise of his responsibilities. Nevertheless, it is stretching the point somewhat to suggest that either actor has somehow become 'socially responsible'. The principal is still motivated by the interests of 'self'; and the enlightened fiduciary is still bound by the duties of prudence and loyalty to serve those interests alone. And as long as human behaviour is governed by the assumptions of agency theory he must be suitably incentivised to do so. Trust remains at a premium.

And so does legitimacy. Now ‘enlightened’ to the wider interests, claims, and duties of countless others the principal is obliged to instruct his fiduciary to ‘take account’ of them. On receiving such an instruction, a loyal fiduciary must nevertheless seek to preserve the self-interests of the one he serves. The interest of the principal must come first whenever a conflict arises: at least until he is expressly instructed otherwise. At best he can try to balance the principal’s interests in the long run with those of others who might be affected by his actions. If they are really to count at all, the interests, claims, rights, etc. of others matter only in a ‘tie-break’ between two alternative courses of action. If the interests of the ‘self’ and ‘other’ can be mutually advanced that is a real bonus.

And so the enlightened fiduciary’s job has just got a lot harder. In the pursuit of the principal’s best interests he is to try to balance or reconcile the interests of others with his principal duty towards the best interests of the principal. The enlightened fiduciary is now accountable to one - and all.
     

3 - Stewardship Theory: serving a common interest

Towards a revised ‘model of man’...

• A richer view of human nature and motivation.
• A steward makes the interests of the ‘other’ his own – psychological interest alignment.
• A focus on the content of human relationships: trust and respect.
• A common interest implies a shared goal.

Once the simplifying assumptions of agency theory are relaxed, a less pessimistic and perhaps more realistic view of human motivation is allowed in. It is one informed as much by psychology and sociology as economics and legal theory. According to stewardship theory, a steward is someone who receives greater satisfaction (or ‘utility’) from serving the interests of the principal than by simply serving his own. Indeed, a steward is a trustworthy agent precisely because he has made the interest of an ‘other’ his own. The principal and his agent, once in a stewardship relationship, in fact share a common interest. But, one might ask, an interest in what exactly?

This insight from stewardship theory goes further than the ‘enlightened’ realisation that we can’t entirely isolate the interests of ‘self’ and ‘other’. Real people – not autonomous ‘agents’ – are motivated by the things they believe in or 'value' as important, fulfilling or meaning-making in their lives. Stewardship shifts the emphasis from external mechanisms of control and enforcement to the personal motivation of an ‘agent’ and the intrinsic rewards he receives from performing his duties. The task of the principal is to inspire a genuine commitment to the sort of shared goal that can satisfy the ‘higher needs’ of a steward.

4 - The Stewardship Chain: recasting both principal and agent

Mutuality of interests allows accountability to flow in two directions...

• Extending the principal-agent relationship upwards and downwards
• Corporate stewards as public fiduciaries
• Who is the principal at the end of the chain? 
• The steward-steward relationship
• Discovering our shared values

Apart from recognising the possibility of a genuinely aligned interest in a mutually agreed goal, stewardship theory permits an extension of this relation from two to multiple actors along a 'stewardship chain'. Each pair of actors along its length may form a steward-steward relationship whenever they share a common interest. This of course means a stewardship chain can in theory only be completed if these interests are held in common along its entire length. But where does the chain of delegated responsibilities end and accountability terminate?

Firstly, looking downwards, the chain ends with the ultimate beneficiary owner, for example individual savers in a pension vehicle governed by trust law. As stewards, the company's management have a 'downstream' duty to serve their interests. But looking upwards it is easy to envisage the terminal ‘principal’ as the public at large or ‘society’. Viewed as a ‘public fiduciary’ a corporation must therefore also act in the 'public interest'. In their role as stewards, corporate management therefore have both upward ‘social responsibilities' to serve the public good and downward responsibilities to serve the interests of its owners.

So, although the notion of a stewardship chain may not diffuse accountability as widely as the ‘stakeholder theory’ of enlightened self-interest, a potential conflict of interest nevertheless remains. Moreover, the stewardship chain breaks down completely if interests are not properly aligned along its length and truly held in common. If this happens, we are rapidly returned to a bleak principal-agent world of mutual distrust, shirking and opportunism. Clearly, company management is still in a tight spot.

One way to resolve their dilemma is to see the chain not so much in linear terms with two dangling ends but rather as a loop. The two loose ends need to be tied together through the formation of a stewardship relationship between the owner-beneficiaries and the public at large. Like the companies they own, investors may be conceived as public fiduciaries subject to an implicit social contract or covenant. True stewardship demands the reconciliation of private self-interest with civic virtue, only possible through processes of engagement and moral deliberation in which the interests and values savers share as citizens can be revealed and discovered. The ultimate owners of capital are in fact persons-in-community not autonomous economic agents. Societies and the global community frequently form institutions that express a commonly held interest in certain social 'goods', reflecting broad agreement on the values they share. Why should the same not be true of the dominant social institution of democratic capitalism: the publicly-owned corporation?
      

 5 - Ethical Stewardship: Rediscovering Purpose

From common interests to a shared purpose...

• A common purpose reflects shared values.
• Shared values are discovered through dialogue. 
• Accountability is responsiveness to societal values.
• A closer integration of ‘ownership and control’.

By inserting the ‘public interest’ into the stewardship chain one can make the normative claim that that both the corporate steward and its owners should both serve the public interest and respect the norms, values, and expectations of society at large. Yet this ‘ethical stewardship’ does not fall into the trap set by ‘enlightened self-interest’and into which stakeholder theory and its various approaches have fallen. That way is marked ‘multi-fiduciary’ and is indeed a paradox. While enlightened self-interest is a welcome riposte to the cruder and narrower interpretations of fiduciary duty, ethical stewardship is in fact closer in many respects to the Friedmanite account of corporate responsibilities.

Ethical stewardship, then, adds to a commitment to service and genuine accountability a strong sense of purpose. Purpose is a motivator. It is how human beings derive a sense of identity, fulfillment and meaning in their lives. The formal purpose of an organisation may have been originally defined by its founders and former owners or through a process of engagement with its current owners. It embodies its values as well as a sense of mission or direction. A shared purpose builds commitment to a common endeavour: it adds tensile strength to the stewardship relation.

Little wonder that companies have rediscovered their interest in the question posed by Charles Handy: “what’s a business for?” It is a question that the Corporation 2020 organisation in the US has set out to answer with welcome clarity. And it is one answered in its own way by the B-Corp movement. It is to define the ‘ultimate ends’ of any business enterprise.

Clarity of purpose also establishes clear lines of accountability between those that ‘own’ the purpose and those charged with fulfilling it. Strictly, purpose should be jointly owned. The shareholding owners must 'own' the purposes to which their capital is being deployed. Ideally, the board should be custodians and defenders of the corporate purpose, upholding and protecting it on behalf of its owners. Above all, the corporate purpose must secure the crucial common interest of end investors and the public at large.

There are any number of candidates for a common purpose and the values or ‘goods’ it represents. Stewardship conceives wealth or value creation in broad terms. Individual companies will express it in their own way, with particular reference to the profitable delivery of specific products and services. Profitability is evidence of the wealth created by business through freely functioning markets. A company cannot attract the capital it needs to fulfill its purpose if it is unable to deliver the financial returns required by its providers.

But stewardship also advances a positive ethic of value creation and contribution to wider society, including but not limited to the material and financial. Ethical stewardship doesn't rule out the perfectly legitimate contribution business makes solely through privately accrued financial wealth. But this isn't wealth creation in the broader sense if its financial contribution is outweighed by wealth destroyed elsewhere: for example, through the social cost of environmental damage or unsafe working conditions.
    

Conclusion: The Role of Citizen Savers

The stewardship relationship between corporations and society-at-large is founded on shared values reflected in a clearly articulated business purpose. Corporate purpose establishes legitimacy and trust with the wider public only if it is accompanied by real accountability for its contribution to the public good. In that regard, the advent of ‘integrated’ financial and sustainability reporting is an important new mechanism for ensuring transparency and developing social trust. It means companies must demonstrate that they are serious about being responsive to the needs and expectations of society within and beyond the marketplace.

The crucial stewardship relation is that which must be forged between saver and society. There is no interface between them as such. Rather, one is the simple aggregation of the other. The best interests of the investment beneficiaries therefore can and must be reconciled with the public interest. Savers-as-citizens surely share an interest in some conception of a common good. And they inevitably share the values of the society in which they in a very real sense belong. The corporate purpose simply codifies that reality and articulates a shared commitment to make a positive contribution to society. It is a clear recognition that ‘value creation’ in human terms inevitably has both an economic and moral dimension.

The real challenge for those lawyers revisiting the notion of fiduciary duty is to create a safe environment in which the ultimate owners of companies may pursue their financial self-interest by making investments in corporations with a clear and legitimate purpose. The challenge for corporations is to be genuinely accountable to them alone, and not to try and be all things to all men.

Integrating reporting, disintegrating values?

<IR> for the 21^st Century

Since the 16^th April the International Integrated Reporting Council (IIRC) has been consulting on its draft framework for integrated reporting to which it gives the cutesy abbreviation <IR>. It aims, it says, to create a framework that can help businesses communicate value in the 21^st century. It defines an ‘integrated’ corporate report as:

“a concise communication about how an organisation’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long-term.”

The <IR> Framework is a principals-based approach. It is not prescriptive of measurement methodologies but conceives value-creation strictly in terms of an extended economic metaphor of ‘capital’. Capital is defined in multi-various forms: financial, manufactured, intellectual, human, social, and natural. They are each conceived as ‘stores of value’ and value creation as a circular process of ‘uses and effects’ of the capitals. Thus, the capitals are an input, output and outcome of the value-creation cycle. The six forms of capital are “increased, decreased or transformed through the activities and outputs of the organisation in that they are enhanced, consumed, modified, destroyed, or otherwise affected by those activities and outputs.”

Although organisations may create value overall, the process may involve destruction of value stored in some capitals or a net decrease to the total stock. Whether the net effect is positive or negative, the consultative Framework warns, will depend on the perspective chosen: different agents or stakeholders may value things differently. Somewhat confusingly, value creation, it says, includes instances when the overall stock of capitals is reduced – when value is diminished or destroyed.

Recognising natural limits..

The <IR> Framework seeks to guide a “Comprehensive Value Creation Story” in the form of narrative, qualitative and quantitative information. It doesn’t try to over-reach itself by seeking to attach numbers to everything but adopts a practical and pragmatic tone. The story should however show the ‘combination, inter-relatedness, and dependencies between the components that are material’ to value creation over time. It is this ‘integration’ of information beyond financial and historical matters that distinguishes <IR> from  traditional corporate reporting.

If anything, the Framework restrains its ambitions in the face of the apparent difficulties involved. It acknowledges that it is not practical to require quantification of all the uses and effects on the capitals or to provide an exhaustive account of inter-dependencies between them. Reporters must, however, disclose how the latter have been considered in determining the reporting boundary and trade-offs that influence value creation.  It says that <IR> is not intended to measure the value of an organisation or all of the capitals. Rather, it is to enable the intended users of the report to assess the ability of the organisation to create value over time. But, one might legitimately ask, if <IR> does not – or cannot – actually measure the use, effects, and inter-dependencies of capital, does the ‘capitals approach’ to integrated reporting mark real progress in the quest for sustainable capitalism?

The Value Creation Story

The <IR> Framework offers little guidance on how trade-offs or conflicts that inevitably arise in the value creation process may be resolved. The purpose of integrated reporting is simply to assist its intended users to assess value creation, rather than to attempt to measure the value created ‘through’, ‘in’, or ‘of’ all the capitals. It proposes that an organisation can ‘create and maximise value by serving the interests of its key stakeholders’. Value created in this way, it maintains, ‘manifests itself in financial returns to providers of financial capital’. But, equally, in so doing it also has ‘positive or negative effects on other capitals and (hence) on other stakeholders’. Value, it says, is created over different time horizons and for different stakeholders through different capitals.

The Framework therefore acknowledges the existence of ‘other forms of value’, albeit confined to those created through effects on the capitals, and that these may ultimately affect financial returns. As such, it comes close to admitting a plurality of perhaps incommensurable conceptions of value into the value creation framework. But, at the same time, it does not regard a 'single-value’ definition of business success as a problem for stakeholder legitimacy. 

While not exclusively so, it is clear that the intended users of integrated reporting are primarily providers of financial capital. According to the Framework, <IR> can assist providers of financial capital to assess value creation over time, supporting decision-making and engagement. It ‘also supports broader societal interests’ by encouraging the allocation of financial capital to value creation ‘within planetary limits and societal expectations.’

In its account of value creation, the <IR> Framework notes that externalities may ultimately increase or decrease value to providers of financial capital. They need information about ‘material’ externalities to ‘assess their effects and allocate resources accordingly.’ That does not guarantee of course that externalities will be internalised by the organisation, or even that financial capital providers will encourage them to do so. Indeed, materiality is defined in the Framework as any matter which ‘could substantively influence the assessments of the primary intended report users with regard to the organisation’s ability to create value over the short, medium, and long-term.’ It also includes any matters which substantially affects the organisation’s strategy, business model, or one or more of the capitals it uses or effects. We should expect integrated reporting to be expansive in its coverage of the externalities of business activities. But it will be left to stakeholders to take their own view on how corporations should respond to them. A reminder that reporting is just reporting, not a policy instrument.

Overall, the Framework appeals roughly to a notion of ‘shared value’ grounded in an economics-based variant of stakeholder theory. Although it sounds at times very close to simply presenting the case for enlightened shareholder value, the <IR> Framework avoids becoming ensnared by the ambiguities of fiduciary law. It is left to the ‘intended users’ – providers of financial capital - to grapple with a familiar problem: how to strike the right balance between financial value creation and a range of other values which may or may not be measurable?

Relational Value Drivers

According to the Framework, the organisation’s value drivers include relationships with others, including employees, customers and suppliers, as well as its responses to societal expectations and values such as integrity, trust and teamwork. This richer account of the relational aspects of business activities marks a curious departure from the strictly ‘resource view’ in the prevailing capitals narrative. Relational values do not fit as neatly into the narrow economic metaphor. 

Despite the potential risk of incoherence, the Framework seems content to encourages organisations to connect economic values to societal ones. An integrated report should tell us, it says, how the organisation’s culture, ethics, and values are reflected in its use of, and effects on, the various capitals. Including, it adds, its relationships with key stakeholders. This, the Framework suggests, should include insights into the extent to which it ‘understands, takes into account, and responds to their legitimate needs, interests, and expectations’ and helps the organisation to understand ‘how stakeholders perceive value’.

Searching for an ethical foundation

The awkward juxtaposition of transactional and relational 'goods' in the account of value creation continues in the Framework’s discussion of stewardship. Again, one can detect an equivocation between the narrow (financial, instrumental) conception of value and a wider normative or moral (perhaps intrinsic) sense of ‘values’. According to the Framework, <IR> enhances transparency and accountability. The latter it says is ‘closely associated with the concept of stewardship’. It defines stewardship broadly in terms of an organisation’s responsibility to ‘care for or use responsibly the capitals that its activities and outputs effect’.

This is nevertheless a somewhat truncated account. Stewardship certainly involves ‘accountability’ in its ethic of corporate responsibility. Stewardship theory seeks to resolve the the familiar agency problem by assuming the interests (and values) of the agent are, or can be, aligned with those he serves. Ethical stewardship as a theory of management emphasises service over self-interest, and examines the conditions in which loyalty and trust can be established in a stewardship relationship. Thus, accountability in a stewardship relationship exists in a context of mutually-held values, interests and goals. Accountability in a principal-agent model of governance performs a monitoring role, defending the former's interests from moral hazard in a relationship threatened by opportunism.   

The Framework suggests that in the case of capitals owned by the organisation, stewardship responsibility is imposed on management via their legal responsibilities to it. Even so, the organisation may nonetheless ‘accept stewardship responsibilities in accordance with growing stakeholder expectations to do so’. In other words, stakeholders want and expect corporations and their managers to behave as good or trustworthy stewards of the resources, power and influence that have been granted, not only by financial capital providers but by wider society too (here represented by the other capitals).

  

According to the Framework, as it responds to the ‘legitimate needs, interests and expectations’ of stakeholders organisations can ‘create and maximise value’ by serving them and working with them. This comes very close to a more authentic description of stewardship responsibility, if by ‘maximise value’ it is referring to both stakeholder and societal values: the 'goods' they jointly pursue.

But, as we have seen, in the end the Framework falls back on enlightened self-interest to justify the steward’s role. By rehearsing the familiar argument, the <IR> Framework unnecessarily conflates fiduciary obligations with stewardship responsibilities. I would argue that these are not the same and ought not to be confused. But the extended capitals qua economic capital account of value creation in effect forces the <IR> framers back into a ‘single value’ world in which the return to financial capital is the ultimate measure of all things. If, however, value creation is genuinely shared as <IR> seems to intend, corporations must not only strive to understand and ‘take account’ of the diverse interests, values and expectations of stakeholders but make them actually count. It cannot truly ‘serve them’ if the ultimate goal is to create financial value for one privileged class of stakeholder.

Re-drawing the lines of responsibility

To be fair, the capitals account of value creation is entirely consistent with management’s fiduciary responsibilities to both the organisation and its legal owners. The best interests of financial capital providers are indeed served by increasing the economic return on the total capital base; growing or maintaining the stock of resources on which long-term sustainability rests.

A form of corporate reporting that can truly integrate multiple sources and conceptions of value in a pluralist society is an urgent task if trust in our economic institutions is to be properly re-established. But the chosen method of integration – the extended capitals approach - is unable to do this. It creates a useful accounting bridge into the economic theory of sustainability. But by re-casting stakeholders as ‘capital contributors’ the <IR> Framework reduces the richness of human experience, roles and relationships to a series of stock-and-flow transactions. In this model economic values alone matter in the end. Moral values are either absent or are only instrumental to a single ultimately measurable store of value. The purpose of a corporation therefore remains unchallenged: the creation of financial value accruing to one class of stakeholder.  

There is nothing wrong with this in our capitalist economy of course. It fulfills the fiduciary obligation. But financial returns should be the outcome or result of creating stakeholder value, not a goal in itself. The capitals account of value is therefore not compatible with an organisation’s separate and distinct stewardship responsibilities. These are established on quite different ethical foundations: a vision of a better future and a corporate purpose (or 'telos') aligned to this - an intrinsically valuable state of the world. The moral foundation of a 'common good' supplies the grounds for ethical obligations often missing in vague allusions to 'social responsibility'. It can provide meaning, foster moral motivation, and help our ethical commitments in business life to run rather deeper.

Stewardship values and virtues may re-integrate business and ethical goals in a richer narrative of economic and moral value. It can connect the world 'out there' to that 'in here' and 'in me'. In turn, as management seeks to balance the interests of multiple stakeholders in this larger context it must recognize these values as instrumental. Its task is to integrate and align as far as possible the intrinsic value-purpose of the corporation with stakeholder interests and ultimately shareholder value. This is an enlarged vision of a successful and sustainable business. In the end, it is a search for integrity - at the level of the collective, and of individual leaders and employees. It is a deliberative and participatory endeavour which takes corporate strategy and governance beyond a stakeholder balancing act of mutual advantage and 'enlightened' self-interest.  A company driven and governed by an ethic of stewardship honours a range of additional values: service, servanthood, care, relationship, inter-dependence, partnership, empowerment, character, human capacities and flourishing. None of these can be articulated in an account of value described only as the accumulated stock of economic benefits accruing to the owner/provider of capital.

Stewardship is a higher calling that requires strong moral leadership and a corporate commitment that goes further than accountability and reporting. And yet, reporting must play an important part in the process of creating a stewardship relationship with stakeholders. It can do so by fostering dialogue and participation in the quest for greater alignment and trust in a joint endeavour of discovering and creating meaning and value. Those of us hopeful that a revolution in corporate reporting could help re-align our measure of business success with the best interests of wider society may be disappointed. And yet in places <IR> comes tantalisingly close.

"The objectives of <IR> is to communicate the full range of factors that materially affect the ability of an organisation to create value over time; to inform decision-making and the allocation of financial capital to that end; and enhance accountability and stewardship.."