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Capitalism in Service of Society


One of the most important changes in business in the coming decades could be the shift from TSR to TSI. Which means…what, exactly?


In 1970, economist Milton Friedman wrote a highly influential article in the New York Times Magazine in which he declared that the sole purpose of a corporation was to maximize profits for shareholders(1). This is otherwise known as the shareholder primacy model. Under this model, a corporation has no obligation to minimize, mitigate or avoid negative externalities (costs that are borne by an unrelated third party) associated with its business operations. Friedman's philosophy quickly gained acceptance and was a central tenet of American business governance in the decades that followed.


Society in service of capitalism took hold and became broadly accepted in all corners of the investing and business universe. When I attended business school in the late 1990s, it was simply taken as obvious that the sole purpose of any business was to make money for shareholders. And management compensation should be stock based so as to align incentives entirely with owners. Obvious. Epitomizing the zeitgeist, in 2006 Jeffrey Ubben, then a principal at ValueAct Capital, wrote an op-ed in the Wall Street Journal about TSR - Total Shareholder Return - and the importance of aligning management incentives with owners. TSR was all that mattered.


Fast forward 14 years, and Ubben thinks about business a little bit differently. In June this year, he departed ValueAct, and along with three other co-founders started Inclusive Capital Partners. Speaking at the Bloomberg Green Festival in September(2), Ubben acknowledged that the shareholder primacy model he helped advance has become problematic. Financial engineering and optimizing balance sheets for shareholders have run their course, and system incentives are now mostly short-term oriented. Ubben noted that he's been appointed to 15 public company boards over 20 years of activist investing, and never once has there been any discussion about the health of:


  • Customers

  • Employees

  • Community

  • Planet


Ubben now talks about TSI: Total Societal Impact. TSI takes a different perspective on the corporation. It's one that says, "we are here to create value for shareholders, but as we do that, we also need to address the needs of other stakeholders." TSI provides a model for management incentives that are sustainable, aligned with the corporate mission, and beneficial to all stakeholders. Many people in business think of shareholder capitalism and stakeholder capitalism as mutually exclusive, but that need not be true. Being a good partner to customers, suppliers, and employees can reduce risk and make a business more resilient…less risk lowers the cost of capital, which improves returns for shareholders.


In the Bloomberg interview, Ubben gave some examples of what Inclusive Capital is doing to promote long-term change, especially in industries with large negative externalities:


  1. Strategic Education had a big student loans problem, with regulators threatening to action to address that problem. Inclusive Capital helped change the mission (educated workforce AND affordable education), change the business model (enterprise education partner, not online student recruitment), and change management incentives by tying management compensation directly to reductions in student loans outstanding.

  2. AES Power changed its mission to reliable energy AND reductions in carbon footprint, and Inclusive Capital tied management compensation to making the shift to cleaner fuels. Ubben says coal-based generation has fallen from 45% of total generation to 10%.


Owners must have the potential for reward. Incentives foster innovation and risk-taking that are essential to problem-solving and progress.


But blending those incentives with TSI has the potential to confer rewards to shareholders for decades - not just next quarter or next year.


TSR to TSI. Capitalism in service of society could be really powerful.


  1. https://www.businessinsider.com/milton-friedmans-theory-role-of-business-feels-emptier-than-ever-2020-9?op=1

  2. https://events.bloomberglive.com/bloomberg-green-festival/agenda

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