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.."

Stewardship and Value Creation

In a recent contribution to the Harvard Business Review blog, Paul Druckman, CEO of the International Integrated Reporting Council (IIRC), made the following observation:

“The system has lost sight of reporting: to give companies access to financial capital by communicating their value to investors.”

He went on to say that as a result of a systemic failure “companies focus on short-term financial performance – because that is what they believe investors are interested in – to the detriment of long-term value creation.” He claims that integrated reporting is a better way to communicate about the sources of value creation.  Moreover, he suggests that it supports investor decision-making by providing a more complete basis for dialogue with the company’s board and an assessment of present and future value.

At the heart of the on-going pursuit of a new, more integrated form of corporate reporting is the acknowledgement that “financial capital is not the only asset in a business that drives value creation”. Paul Druckman lists six different types of capital: financial, manufactured, intellectual, human, social, and natural all of which are somehow involved in creating “value”.

These are strong and clear arguments for a new approach to company reporting. It is certainly true that a sustainable form of capitalism must achieve a more efficient allocation of capital consistent with some criteria of ‘sustainability’. But it is not necessarily the case that the purpose of reporting is to communicate value to investors only. This may be necessary but not entirely sufficient, especially if the claims made for an extended view of 'capital' (I call this the "extended capital model" or ECM) and value creation are to be upheld.

I propose in conclusion that an alternative framework that focuses on the accountability and ownership relationships implicit in ECM might shed more light on the role of reporting. It might clarify what we mean by ‘value’, how it is ‘created’, and establish more precisely the basis for the wider responsibilities corporations (and investors) have, if any, to society. I shall call this a “Stewardship Approach”. It is for now a rough sketch of what a new sustainable capitalism might look like. 

The traditional model of Shareholder Value

The shareholder value model is regarded by many proponents of sustainable capitalism as too narrow and incapable of guiding free enterprise towards sustainability. It is grounded in the notion of fiduciary duty established by legal contract. Owners of ‘capital’ (which in ECM is viewed in its initial form as financial capital) establish an obligation on its recipient through the terms of a legal instrument. In the case of joint stock company this includes a property right (ownership) which imposes a conditional duty on the company to return the financial rewards from capital provided by shareholders in the form of dividends. Thus, shareholders have a contractual and legally enforceable interest in the fortunes of the business, defined in purely financial terms.

These institutional arrangements also establish a separate obligation of accountability to the owners of capital which is fulfilled through legally enforced corporate reporting. Thus, in the shareholder model, the reporting isn't done for its own sake, or even to communicate ‘value’ as such. Rather, it is to satisfy the requirements of answerability. It is presumably intended to reassure the owners of capital that its recipients are using it wisely and in their interests. It is to answer the question: have those to which I have entrusted been good stewards of what they have received on my account? In so doing it may cement the contractual relation established through legal contract with something less tangible - trust. 

   

What a corporation does with the financial capital entrusted to it determines whether ‘value’ is created for the shareholder. In a simple uni-directional linear model of value creation, financial capital is transformed into productive capacity (capital goods or ‘manufactured capital’) which generates an economic surplus. This is reflected in the (market’s) present valuation of the future flow of financial benefits in the share price. Shareholder value is created by increasing the return on the capital employed.  

The Extended Capital Model

In our expanded view there are many more productive assets involved in value creation. Labour is recast as ‘human capital' in which a corporation may invest through the training and development of its workforce, thereby increasing their productive potential. The accumulated stock of knowledge resident in a business can be appropriately managed as an intangible asset; while the value of a portfolio of patents and trade-marks lies in an often substantial prior investment in intellectual capital. Corporations can contribute to and draw on a stock of social resources: the rule of law, community cohesion, social norms, trust etc. They can create or alter the pattern of social ties: the bonding, bridging and linking forms of social capital. They can 'invest' in building and strengthen intra- and extra-organisational relationships, fostering a culture of solidarity in a common purpose rooted in shared values. Finally, the stock of natural resources on which business success may crucially depend is now viewed as 'natural capital' with both use and non-use value derived from the range of ‘ecosystem services’ it provides.

Value creation according to ECM is an extension of that proposed by the simple shareholder value model. Companies create value by increasing the return on total capital employed and hence the economic value of its total asset base. However, there are however a number of related difficulties and limitations associated with the extended capital view of value creation:

1. It stretches the economic metaphor too far.
2. It doesn't fit easily into a linear view of value creation; and.
3. It perceives 'value' in narrow terms.

By applying an economic metaphor to a wider range of goods as 'capital', the ECM approach builds-in certain assumptions about their character. ECM is an appeal to 'donor-type' values preferred by ecological economists. But the various forms of capital envisaged all find their counterpart in 'assets' which deliver a flow of benefits over time: i.e. in receiver-type values. Therefore 'social capital' conceives of the social goods to which it refers as long-lived assets, the value of which can be affected by business decisions. Similarly, the ecosystem services concept bestow an asset value upon 'nature' which can be increase or - more likely - decrease as a result of business activities. The changes in asset values contribute to the full or social cost of business expressed in strict economic terms.

Applying the ECM approach to all social and environmental goods risks stretching the metaphor to breaking point. It requires that their social benefits can be quantified, preferably in monetary amounts as financial benefits. Values that are not amenable to monetisation in economic valuation are hence described as 'non-economic' or intangible. Yet these are likely to be pervasive in certain forms of capital even if a corresponding receiver-type value is difficult to discover from market prices or estimation of willingness to pay (WTP). What price a happy, fulfilled and committed workforce in social capital valuation? Or the difficult-to-price 'cultural value' of a tract of rain forest to indigenous people that have inhabited it for centuries? Since the capital approach cannot easily accommodate these values, they are more likely to be ignored by decision-makers concerned only with maximising tangible total capital.

A little further reflection on the 'new' forms of capital envisaged reveals that they don't fit very easily into a simple linear model of value creation. Private, internal, benefits to the business are produced jointly with costs to society, so-called 'externalities'. The latter may be revealed by ECM approaches in economic valuation of social and natural capital. But the opposite is also true of human and intellectual capital. Internal costs to the business of investing in these assets generates a corresponding external benefit to society. These wider benefits establish a positive feedback loop to all businesses. Most adherents of sustainable business argue that internal and external costs and benefits converge in the long-run. As such, the ECM approach favours the valuation of total capital from the perspective of society irrespective of the divergence of internal and external costs and benefits in the short term. In so doing it sets up a potential conflict with the narrower interests of shareholders and companies' fiduciary duty, at least in the short term.

Finally, ECM commits decision-makers to a narrow or restricted 'theory of value'. As alluded to above, in the economic 'resource' perspective adopted, all values are strictly 'instrumental'. It locates ultimate value in consumer preferences revealed in prices or WTP, treated equally and impartially in markets and market-based methods. The only good of intrinsic value is some measure of utility or welfare to be maximised. The great strength of the ECM approach is its direct link to a welfare optimising goal. The obvious downside is that it requires that all values are revealed in prices by markets, rather than discovered. That is to say that what is a 'good' for society is whatever its 'consumers' prefer. Many would argue that this is completely the wrong way around! They argue for a far richer account of the things to which humans attach meaning and significance. That is to recognise a wider range of intrinsically valuable goods than economic theory admits. A more pluralistic theory of value suggests that economic values need to be supplemented with other values discovered through other 'value-articulating' or deliberative institutions. In these individual stakeholders are cast in the role of citizens, rather than self-interested consumers, concerned with some notion of a common good.

Goodwill Hunting

In short, the extended capital approach widens the goods but restricts the values considered in its model of value creation. The problem of intangible values is not new to the accounting profession. 'Goodwill' is the difference between the market valuation of a company and the book value of its assets. It is assumed to represent the 'hidden' value in the business: brand value, intellectual assets, quality of management and so on. The economic valuation of capital assumed by ECM does not deny that non-economic or intangible assets exist. We can therefore conceptualise the Total True Capital (TTC) employed by a company as inclusive of these values even if they are not estimated or fungible with monetary values. Furthermore, a True Capital Employed cannot be imputed from a companies' market value since non-economic values cannot - by definition - be reflected in market prices.

Interestingly, 'good will' is also the term that Kant gave to one's motivation to do one's duty and in his moral philosophy it is the only thing of intrinsic value. The ECM concerns itself with economic goods, not moral goods. Social and natural capital, as we have seen, are conceived in this framework as economic goods. Moral goods are the domain of ethics, not economics. In this sense, economic approaches may be said to be 'value-free'. Moral goods, on the other hand, are another source of intangible - perhaps intrinsic - value to society. Society applauds good behaviour or conduct by moral agents in a wider moral community according to some ethical standard or set of principles. If corporations are also moral agents in this sense then their ethically praiseworthy behaviour is of some 'value' to society. If so, values in this moral sense may qualify as another hidden 'asset' which isn't captured in measured total capital. Can a corporation 'invest' in moral assets? Certainly, to the extent that its reputation can have economic consequences. But even if morality can't be described in narrow economic terms, society surely values 'good' or 'right' behaviour by its corporate citizens nonetheless.

Thus, the moral values upheld and promoted in the corporate culture and in its business practices are important. Some may say the erosion of moral values from business and economic life lie at the heart heart of a crisis of confidence in capitalism. Economics is a powerful decision-making tool and free markets are still the best way of allocating scarce resources when they exist and work well. But, by definition, markets do indeed have moral limits. If markets and market approaches can't help with ethics, how can moral values be restored and rewarded in the marketplace?

       

The Sustainability Criterion

The real attraction of the ECM approach is found in its direct connection with the macroeconomic account of inter-generational justice - a non-declining welfare function with respect to time. Macro-economic indicators of sustainability may thus be 'flow-based' (e.g. 'green' national accounts) or 'stock-based'. The ECM belongs to the second class of approaches in which sustainability may be defined as a non-declining capital stock. This criteria may take a weak or strong form, depending on the assumed marginal rate of substitution between different types of capital. In the strong form, the natural capital stock must be non-declining in aggregate and in an even stronger form a certain level of 'critical natural capital' must be protected (for which thresholds, safe minimum standards and the precautionary principle may also hold sway). These conceptualisations of sustainability in economic terms chime with the more recent narrative of 'ecosystem services' (a flow measure). Thus, the ECM is seen as a vital link between corporate accounting and sustainability outcomes. If companies are able to measure changes in in total capital employed and show that either the total stock is non-declining (or its components) they will have a way of reporting sustainable value creation. This is the great hope of integrated accounting and sustainability reporting.

What can stakeholder theory add?

In many respects the ECM is simply a version of stakeholder theory grounded in economics (or at least appealing to economic concepts) rather than ethics, political theory or sociology. Stakeholder Theory’s close cousins, for example the ‘social licence’ or ‘corporate citizenship’ (both contractarian), find their justification and appeal from the other social sciences. It many respects ECM adds some practical analytical rigour but it does so at the cost of simplification.

One such simplification of ECM already mentioned is in its implicitly narrow theory of value. This raises a number of related problems but for now we may highlight the following:-

1. It blurs the obligations of corporations hitherto defined by fiduciary duty.
2. It multiplies the lines of accountability to the providers of capital.
3. It fails to establish any moral requirements in its account of ‘responsibility’.

Stakeholder theory, on the other hand, offers little by way of a practical or theoretical framework for measuring value creation. It does, however, attempt to clarify the lines of accountability and establish ethical grounds for doing so. This is achieved through its emphasis on weighing the ‘interests’ of multiple stakeholders, whose moral standing as such imposes duties on the corporation to have regard to those interests. Stakeholders have a commensurate ‘right’ to demand that their interests are upheld. This is a vastly extended conception of a corporation’s fiduciary duty, consistent what has been called the principle of corporate effects (PCE).

Who, then, are these interested ‘stakeholders’? They are none other than the providers of ‘capital’ in the ECM. This includes the different socio-economic roles played by actors in ‘society’ affected by corporate activity, including customers and local communities. If nature is cast as capital provider and has an ‘interest’, it relies on social institutions to protect them on its behalf. The stakeholder model imposes a moral obligation to do so only on the grounds that nature has a ‘good’ of its own – it has interest in its own flourishing. Some argue instead that it has only an instrumental value to human society and therefore society has a direct (rather than fiduciary) duty to safeguard the natural world. The stakeholder approach attempts to arbitrate between and balance these, potentially competing, interests. But it doesn’t provide a ready-made solution to how to do so.

Towards a Stewardship Model

Can an alternative model help overcome some of the drawbacks of the extended capital and stakeholder models of corporate responsibility? Stewardship in its secular and religious conceptions emphasises accountability and ownership relations from which moral and non-moral obligations extend. The extended fiduciary duty is indeed to grow ‘true total capital employed’ in a conceptual sense. It does so by looking after the interests, and hence values, of all capital providers that have a stake in value creation. These are in fact the duties performed by any good steward. Assurance that the corporate steward is in fact doing so relies on its full accountability to the ‘owners’ of capital in all its forms. An effective board can only safeguard these interests and values if they are all properly represented on it or by it. Further, these interests and values must define the purpose of a good and accountable corporate steward as a creator of true value.

 

By defining responsibilities in terms of accountability and ownership, a stewardship approach can establish a corporation’s instrumental and moral responsibility to all sources of 'capital' and to protect the full range of values they represent. In this sense it imposes an obligation on corporations to create economic value and moral value. That is, to preserve and grow the ‘moral goods’ that society values, as well as the non-moral goods it wants or needs. It is perhaps to envisage the corporation’s value-creating purpose in terms of a broader concept of human and non-human ‘flourishing’ than utility (welfare) maximization. 

Corporate reporting of the kind being pursued by IIRC is the content of the accountability relation; it is a means to an end but not an end in itself. An expanding toolkit for measuring and valuing ‘total capital’ serves the steward’s duty to be properly and fully accountable to all capital providers. It does not fulfill it. It is only through engagement and deliberation with stakeholders as capital owners that the true values missed by economic instrumentalism can be discovered and incorporated into a fuller account of truly sustainable value creation.