The Morality of Profits

Here is this month’s piece from Brand Velocity, an Atlanta-based consulting firm that is putting Peter Drucker’s ideas into practice at major corporations.

 

In the frenzy of today’s presidential campaign, a lot of sound bites have made wealth and profits sound like instruments of evil. But it is important not to lose sight of—in most cases—the ultimate morality of profits.

Peter Drucker, in The Practice of Management, wrote that profits served three important purposes: validation of the soundness of an enterprise’s efforts, compensation for the risks that the business is incurring, and the generation of resources needed to fund future growth.

In our role as consultants, Bob Guido is someone we respect very much on the subject of managing value, risk and profits. Bob was vice-chair of Ernst & Young, serving boards and executive teams, and is involved with several leading corporate and nonprofit boards today. Bob always reminds us how important it is to look at managing profits through a more holistic lens.

At Brand Velocity, we call this approach “Value Risk Management” because companies ultimately create value by incurring risks. Indeed, not creating value in a sustainable way is the most significant long-term risk of all.

More broadly, there has been a great deal of discussion of late over the question “Should companies try to maximize shareholder value?” Asked this way, the answer is no; there clearly needs to be consideration of other stakeholders, including the community and society, rather than just a focus on the shareholder. This was Drucker’s view. It is ours, as well.

But Drucker also focused on asking the right questions. And in this case, the core assumption behind “Should companies try to maximize shareholder value?” is that most executives have, in fact, been managing to maximize shareholder value. They have not, and most cannot. That’s because they do not have valid and accurate (even directionally accurate) measures of shareholder value that correlate with actual changes in their companies’ stock price over time. Instead of “maximizing shareholder value,” most executives are defaulting to maximizing short-term reported accounting profits.

In the end, then, the question of “should companies maximize shareholder value?” is really two separate and distinct questions with very different answers: First, should companies manage to create maximum shareholder value? Here, the answer is an absolute yes—provided it is real and sustainable shareholder value. A better term might even be “enterprise value.” The second question, meanwhile, is: What should companies do with the shareholder value they create? This is the question more of us need to be wrestling with.

Profits shouldn’t be seen as a malevolent Gordon Gekko-esque goal. With our national deficits, government debts, cuts to social programs and underfunded pensions, profits are much more than a necessary evil. They are a critical mechanism to help companies and individuals allocate resources properly and fund our country’s private and public sectors over time.

—Jack Bergstrand and Wally Buran