Toward Moral Capitalism

Reconciling private interest with the public good

CauxRound Table

BUSINESS LAW 5175 -- Business, Law & Ethics in Modern Society

John Friedman – Sustainable Business Network of Washington

The Caux Round Table (CRT) is an international network of principled business leaders working to promote a moral capitalism.

The CRT advocates implementation of the CRT Principles for Business through which principled capitalism can flourish and sustainable and socially responsible prosperity can become the foundation for a fair, free, and transparent global society.

The Caux Round Table

Steve Young

www.cauxroundtable.orgtwitter: @CauxRoundTable

Co-founding board member of the Sustainable Business Network of Washington (SB NOW); a partner organization with CRT

20 years+ career including corporate communications/organizational development, public/community relations, sustainability and CSR

About Myself

www.sbnow.orgtwitter: @SustBusNOW

@JohnFriedman

Background History and theory Global financial crisis

◦ What happened◦ What can/should we learn from it

Moral Capitalism ◦ Determining ‘true’ value◦ The Caux Round Table principles in action

Overview

Capitalism is an economic, not a political model

Culture (nationality, faith, etc.) define how capitalism is implemented

Individual wealth creation – the ability to earn and retain capital – is a tremendous force for change

Short-term thinking is inconsistent with long-term best interests

At the outset …

15th/16th Century Venetian accounting system and argosy voyages - entrepreneurs began to combine

capital and labor in discrete projects. Evolved into going concerns called corporations

1600 – 1750 Capitalism grows prosperous in Holland, England and Scotland

1776 An Inquiry into the Nature and Causes of the Wealth of Nations

- Adam Smith

1830 – 1870 Abuses of capitalism(mills of Manchester; Ebenezer Scrooge)

Communist Manifesto – Marx, EngelsDas Kapital - Karl Marx

A Brief History of Capitalism

1880 – 1980 Non-communist response:welfare state capitalism

Bismarck’s reformsFree trade unionsJohn Maynard Keynes / New DealJapan, Inc.Austrian school of economics

1989 – 2004 Collapse of communismRise of CSRCRT Principles for Business (1994)United Nation’s Global Compact

(2000)Moral Capitalism - Stephen B. Young

A Brief History of Capitalism

Adam Smith

Observed economic reality - people act in their own interest. Self-interest not always good but alternative is worse: "By pursuing his own self interest he frequently

promotes that of society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.” (p. 456).

In free/open markets, how does a nation keep its capitalists from moving their capital out of the nation and into other countries where labor could be bought more cheaply?

“(By) preferring the support of domestic to that of foreign industry," the capitalist will in a sense be "led by an invisible hand to promote an end which was no part of his intention."

On the Wealth of Nations

Does that (still) hold true in 2010?

Cash for Clunkers - Results

Sub-prime mortgage loans made, increasingly against future resale value of the home, not against real income

Mortgage loans packaged and sold to global capital markets

Collateralized debt obligation (CDOs) issued to finance purchases of packages of sub-prime mortgages and to invest in hedge funds

Credit default swaps invented to give added value to CDOs

Debt upon debt upon debt

Low interest rate environment

Incentive structure driven by fees, not investment in long-term returns

So what happened?

1620 Tulip mania 1711/1720 South Sea Company London 1719/1720 Mississippi company France 1929 Wall Street 1980s Junk bonds 1990s Dot.coms/telecom Today Sub-prime mortgages/CDOs

Financial meltdowns are a systemic dysfunction of capitalism

Men, it has been well said, think in herds; it will be seen that they go mad in herds,

while they only recover their senses slowly, and one by one. – Charles MacKayIrrational exuberance – Alan Greenspan

Current crisis is global AIG Fortis Iceland EU guarantees bank deposits UK takes over two banks Equity markets in Asia tank Price of oil drops by 50% Real economies lose employment and consumer

demand

Why is this time different? Is it?

World Trade Organization International Monetary Fund World Bank G20 Bank for International Settlements Etc.

World economic order has inadequate mechanisms to prevent financial crises

Principles Outcomes

Principles Congruent with Self-Interest

Premises of Moral Capitalism

Principles Drive Real Outcomes

Whenever a system produces a consistent result, the inevitable conclusion is that that system was designed to produce that result, regardless of whether or not the outcome matches the intended outcome.

What are the principles that are driving outcomes?

When short term shareholder returns are elevated to a core value, corruption is inevitable. – Noel Purcell, CRT Chair

When financial markets implode, markets lose liquidity, exchanges of goods and services fall, output is reduced, employment is cut

Debt must be taken out of the financial system

Asset values have to be reset at lower levels

Asset owners lose wealth

What happens when bubbles burst?

When the distance between the haves and have-nots is perceived as insurmountable; the status quo is threatened …

Bear Stearns (2008)◦ March 14 - $80/share book value ◦ March 17 - $2/share◦ May 10 – sold at $10/share after shareholder outcry

and assistance from Federal Reserve Bank

Lehman Brothers◦ Despite billions in assets, management liquidated the

company as no buyers emerged with confidence in it as a going concern

How do you determine ‘real’ value of assets? It is the INTANGIBLES that define value

Most simple calculation:

What is a company worth?How do we measure its value?

Discounted net present value of future income

Capitalization multiplierx

You cannot establish value without putting risk into the calculation

◦ What is the risk of not achieving predicted future revenue?

◦ How certain are estimates of future income?◦ What are the risk factors that determine the

capitalization multiplier? ◦ A higher risk demands a lower multiplier

First Fundamental Conclusion

Note: Each source of risk drives business value up or down

Higher Increased LowerRisk Uncertainty present value

Management of risk enhances enterprise value

- Risk management leads to more certain income

- Risk reduction leads to higher valuation

Second Fundamental Conclusion

Stakeholder relationships entail risk - customers - investors - government regulators - employees Each relationship is an intangible asset of the

business (assets can appreciate or depreciate) Lowering risk for each relationship enhances the

quality of intangible assets and increases business valuation

Strategies for Managing Risk

The Good The Bad The Ugly

How do companies create value?

Risk Assessment/continuous Risk Reduction

Optimize Stakeholder Benefits

Moral Capitalism

The Good

Feed Shareholders, Abuse Stakeholders

Commodity pricing/ compete on pricing/low costs

Rent seeking (market power)

Take the money and run: short-term thinking

Unsustainable Valuations = Eventual Failure

The Bad

No net wealth creation; speculation in trading (Rob Peter to pay Paul)

Irrational Exuberance (Market traders/short termism)

False Valuations (Enron: Ponzi Schemes; sub-prime mortgages, CDOs…)

Encourage unsustainable pricing (of securities CDOs, CDSs)

INEVITABLE FINANCIAL MELTDOWN

The Ugly

Intangible Assets = CSR Stakeholder Relationships◦ Customers◦ Employees◦ Owners/Investors◦ Suppliers◦ Competition Strategies◦ Community Support

CSR and Valuation

Tangible Values

Intangible Values

Financial Capital

Physical Assets

(Generally Audited Financial Information)

(Generally Non-audited, Non-financial Information)

Intellectual property

Unallocated goodwill

Labor environment

Brand loyalty

Sustainability

Quality of employees Community

support

To improve company valuation,Improve CSR relationships!

Good CSR Relationships Lead to The Sustainable Corporation

Conclusion:

Far beyond the goods and services your company provides

The IMPACTS* those goods and services and the manner in which they are produced have on peoples’ lives

What does your company do?

* Real and perceived

Needed for quality income

Necessary to get low cost of capital

Critical to hire/retain the best employees

Gets you through rough times

Avoids commodity pricing/builds value added

Reputational Capital(brand equity; goodwill)

Taking Due Care of Stakeholders Enhances Capital Accounts

Undermining Stakeholders Puts Capital Accounts at Risk

The power of reputational capital

For whom would you rather work?For whom would you rather tell people you work?

The Theory of the Moral Firm(self interest considered upon the whole)

ReputationalCapital

SocialCapital

FinancialCapital

PhysicalCapital

HumanCapital

ConversionProcess

Output(Goods/

Services)Customers

$$$Sustainable profits; maximum

value

INPU

TS

RETURN ON CAPITAL(preserve adequacy of capital inputs)

The Corporate Improvement Cycle

Management Action

CRT Assessmen

t

Performance Feedback to Management

Performance Improvemen

t

Board of directors CEO Senior management Division heads and group managers Unit managers Employees

Who participates?

An exampleA.

Fundamental Duties

B. Customers

C.Employees

D. Owners/

Investors

E. Suppliers/ Partners

F. Competitors

G. Community Performance by

Principle

1.Responsibilities of Businesses 6.5/5.2 6.3/5.1 6.0/4.8 6.8/5.2 5.9/4.9 6.1/4.8 6.4/5.4 44.0/35.4

2.Economic/ Social Impact of Business

6.0/5.3 5.6/4.7 6.7/4.5 4.9/4.4 4.9/4.4 6.6/4.6 5.1/5.2 39.8/33.1

3.Business Behavior 6.4/5.0 5.8/5.0 5.8/4.2 6.2/5.0 5.0/4.5 5.5/4.6 5.2/4.5 39.9/32.8

4.Respect for Rules 5.9/5.3 6.8/5.9 6.5/5.6 6.5/5.7 6.1/5.6 6.2/5.6 6.9/5.2 44.9/38.9

5.Support for Multilateral Trade 6.9/5.2 6.3/5.0 6.5/5.2 6.2/5.2 6.0/4.8 6.4/4.4 7.2/5.0 45.5/34.8

6.Respect for Environment 7.0/6.6 6.0/5.3 5.7/4.4 6.3/5.6 5.2/4.2 4.4/4.4 4.7/4.0 39.3/34.5

7.Avoidance of Illicit Operations 6.7/5.8 6.5/5.8 6.8/6.5 6.3/5.4 6.5/5.2 6.0/5.2 5.9/5.7 44.7/39.6

Performance by Stakeholder 45.4/38.4 43.3/36.8 44.0/35.2 43.2/36.5 39.6/33.6 41.2/33.6 41.4/35.0 298.1/249.1

Caux Round Table Japan

Vision not yet fully embedded across the company.

No integrated local community development program across different countries.

Company internal communication is poor on the issue of environment.

Customers' trust is weak. Communication with suppliers/partners is poor.

High level of compliance, risk management and internal audit have been achieved.

Caux Round Table Japan

“It's not your blue blood, your pedigree or your college degree. It's what you do with your life that counts.”

- Millard Fuller◦ Businessman/entrepeneur◦ attorney◦ self-made millionaire by age 29◦ founder/president of 8th largest homebuilder in

America

Thank you!Questions? Comments? Thoughts?