Adam Smith: America's new regulator

Image: Daniel Hertzberg for Forbes

Off a quiet street in Seattle’s dingy industrial district, 11 miles from the rolling lawns of Microsoft’s Redmond campus, the neglected-looking warehouse hardly stands out. But inside, you’ll find a small server farm, with 20 racks of machines running off natural-gas-powered fuel cells instead of standard electrical outlets. The eventual goal of this test is to cut data center electricity use in half while producing only reusable water, heat and a modest amount of carbon dioxide as waste—one of several energy moon shots that Microsoft will be rolling out over the next two decades, at a cost of hundreds of millions.

“It’s much more of an existential priority for us, to be at the vanguard and forefront of energy efficiency,” says Satya Nadella, Microsoft’s chief executive. While altruistic, it’s not altruism: Microsoft’s recent formidable growth centers on its $23 billion cloud business, particularly its Azure cloud computing unit. The big constraint to Azure’s growth, Nadella says, lies in the acres of electricity-guzzling server farms it requires.

Successfully aligning business practices with an indisputable public good helps explain why Microsoft tops this year’s Just 100 list, which ranks public companies based on how they fulfill Americans’ expectations for good corporate behaviour. “Is your business interest really helping the world solve some of its pressing challenges?” Nadella says he asks himself. “If not, then we have a problem.”

To that end, Microsoft has publicly committed to slashing its carbon emissions 75 percent from their 2013 level by 2030—equivalent to eliminating all emissions from Detroit. And that’s certainly not because the US Environmental Protection Agency is requiring it. To the contrary, the Trump administration has made chopping regulations a priority. Some of this is long overdue, from loosening rules that made it hard for small companies to offer 401(k)s to fast-tracking potentially innovative cell and gene therapies. History will cringe at other moves, most notably those motivated by Trump’s climate change denialism, such as the fact-challenged withdrawal from the Paris Agreement and his limitless fealty to coal-burning power plants.

But it’s largely irrelevant whether you believe the government should make internet providers get their customers’ permission to share their personal information or dictate that financial advisors act in their clients’ best interests. Leading American corporations have increasingly begun to hold themselves to standards in all sorts of areas involving the public interest—from wages to paid leave to emissions—that the current government shows no interest in mandating.

This corporate-led self-regulation, it turns out, reflects the will of the public better than anything emanating from the ranks of political hacks. To arrive at its standards, Just Capital has surveyed more than 80,000 Americans about what they expect from corporations when it comes to workers, the environment, customers and products, the community, shareholders and human rights. This purportedly divided country has large majorities that believe companies should pay their workers fairly, protect their customers’ privacy and minimise pollution.

In living out these principles, the Just 100 companies exemplify Adam Smith’s core maxim in The Wealth of Nations—that in the course of rationally pursuing their economic interests, business leaders will end up serving society’s interests as well. The numbers support this. In the 50 weeks ended November 30, the S&P returned 3.6 percent, the Just 100 7.5 percent and Microsoft 29.9 percent.

The invisible hand, it turns out, was never supposed to be amoral.

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Perhaps no issue demonstrates the limited functionality of today’s Washington more than the minimum wage. In principle, many laissez-faire purists stand against it as a government intrusion, including Trump’s economic advisor Larry Kudlow, who recently called the notion of a federal wage floor “a terrible idea”. In practice, because it hasn’t been raised since 2009, the paltry $7.25 an hour minimum wage means you can work an honest 40-hour workweek and still fall under the poverty line if you’re supporting a child or spouse. In some ways, our current policy is the worst of both worlds.

Yet when it comes to business, American citizens value nothing more than whether companies pay a fair wage—84 percent tell Just Capital they should. These sentiments play out in terms of which companies people want to buy from and—in a tight labour market, even at the lower end—which companies they want to work for.

Which is why many businesses are voluntarily stepping into the breach. The retail industry is the most prolific provider of low-wage jobs: Just Capital estimates 4.2 million retail workers don’t earn a living wage. In 2017, Target, the top-ranked brick-and-mortar retailer on the Just 100 list at No. 53, began raising its internal minimum wage from $10 (it’s $12 today) and made a commitment to raise it to $15 by the end of 2020—the threshold many worker advocates would like governments to mandate. (New York, California and Massachusetts have passed laws that will eventually take their minimums to $15, while San Francisco and Berkeley are already there.) Target basked in glowing headlines, then saw an immediate payoff in more applicants, says Stephanie Lund­quist, the company’s chief HR officer. This past November, to great fanfare, Amazon (No. 30 on the Just list) boosted the minimum wage for its 250,000 year-round and 100,000 seasonal workers straight to $15.

The American public sees workers’ benefits as similarly important. For example, 82 percent believe they should have paid maternity leave, according to Pew Research Center. Given that the US, unlike the vast majority of wealthy developed countries, does not mandate paid maternity leave, paid vacations or even paid sick leave, many companies are leaping ahead to bridge that disconnect before the regulatory pendulum swings back to do it for them. The semiconductor maker Nvidia, which ranks first for worker treatment on the Just 100 list, provides 22 weeks of paid leave to new mothers and offers a concierge service that does up to six hours of errand running a month for each worker. Adobe (No. 9) offers up to $20,000 in reimbursements for fertility drugs, up to $25,000 for surrogacy expenses and adoption assistance, and up to 100 hours of child care per year. Pay equity is another area that in another time might have fallen under the regulatory yoke, but now the best companies are self-policing. Of the Just 100, 69 have conducted gender-pay-equity analyses. Salesforce, No. 29 on the Just list, is now conducting annual reviews to ensure equal pay for equal work across gender, race, and ethnic lines. Its 2018 review, the third, found that 6 percent of its workforce was underpaid, down from 11 percent in 2017. Why wasn’t the problem fixed the first year? “Every time we conduct these assessments, we learn more about the numerous factors that contribute to pay inequality... all of which we are proactively working to address,” chief people officer Cindy Robbins explained in a blog post.

Millennials, and Gen Z behind them, are driving many of these changes; more than half of Millennials say it’s important for brands to align with their values, according to Euclid, a market research firm. Yet only a third of boomers feel that way.

Generational differences play out most dramatically in the fight against climate change, the consequences of which young people will have to live with for decades longer than most members of the Trump administration.

Accordingly, 29 of the Just 100, including VMware, Procter & Gamble and General Mills, have signed up for the Science Based Targets initiative, which requires companies to adopt carbon-reduction efforts in line with the Paris Agreement. Others, such as Microsoft, are adhering to that goal without officially signing on. “We as a company can’t say, ‘There’s no law, we don’t need to do anything,’ ” Nadella says. “You absolutely need to have a set of principles that govern how you show up on any big issue.”

Consumer-goods giant P&G (No. 8 on the list), one of the world’s biggest generators of plastic waste, promotes a brand-new Tide container that’s made with more cardboard and less plastic and a Head & Shoulders bottle made with recycled plastic. More than just a PR stunt, the recycled shampoo bottle gets special display treatment—meaning more sales potential—from retailers that want to signal to customers that they, too, care about the environment.

David Taylor, P&G’s CEO, describes his company’s approach to environmentally minded product innovation as “always in compliance with local laws, but [going] further than that. It starts with the consumer and a problem they want to solve.” He points to a recent extension of Pampers, a brand accounting for more than $8 billion in annual sales. Pampers Pures, which rolled out in April, contain cotton and fewer chemicals and sell at about a 25 percent premium to an older model. Pures are already number one in the natural disposable category.

This doesn’t mean that socially conscious employees and customers get to call the shots at America’s largest companies. Last July, as the Immigration and Custom Enforcement agency was separating undocumented children from their parents at the border, some 500 Microsoft employees joined 300,000 other people in signing a petition calling on the company to cancel a contract it has with ICE. Microsoft didn’t ignore the uprising, but it also didn’t budge. Instead, Brad Smith, the company’s president, responded with a public blog post on immigration and Nadella emailed his thoughts to employees.

“We’re very, very clear. We unilaterally, as unelected officials, are not going to make editorial decisions to just cut away customers, whether it’s the government or in the private sector,’’ Nadella says. “But at the same time, we’re going to have ethical principles.” Meaning? Microsoft, Smith says, has refused deals with foreign governments that don’t meet its standards on “human rights or societal needs” and has turned down a US entity that planned to use its services in a way that could risk “excessive discrimination”. (Neither he nor Nadella would name names.)

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Until recently, the golden age of corporate self-governance was after World War II. Rising profits in the booming postwar economy enabled companies to enact all manner of policies that unified workers, management and shareholders, and there was already a shared sense of mission. “The government and industry were focused on winning the war, so there was a lot of cooperation and that carried over into the postwar period,” says Marina von Neumann Whitman, an emeritus professor at the University of Michigan, who was at various points a top GM executive and a board member at JPMorgan Chase, P&G and other corporate titans.

Then came the 1970s. Government regulatory burdens piled up as oil prices spiked and foreign competition grew—and profits began slumping. So began the era of Milton Friedman, who said the only “social responsibility of business is to increase its profits,” an admonition that became gospel. Customers and employees took a backseat to the demands of investors. CEOs who were slow to close plants, lay off workers or trim retiree health benefits were targeted by corporate raiders, hedge funds and “activist” investors pushing changes designed to maximise short-term profits and stock prices. Americans thought companies could “marry profit-making and social responsibility,” Robert Samuelson wrote in a 1993 essay famously titled ‘R.I.P.: The Good Corporation’. That assumption was wrong, he concluded.

Or was it? Given the role it played dismantling the notion of the good corporation, it’s notable that Wall Street now pressures corporations to act responsibly. “High-quality companies need to manage risks in terms of not being worse off than their peers in terms of labour relations or environmental liabilities,” says Ka­rina Funk, a portfolio manager at Brown Advisory who oversees the firm’s $1.8 billion Large Cap Sustainable Growth fund, which has Microsoft as its largest holding. “What sets a company apart are the ones that aren’t just managing risks, because they need to do that—that’s the table stakes—but they’re also going after the opportunities. The opportunities that flow through the P&L are revenue growth, cost improvements and enhanced franchise value.”

In other words, Wall Street’s needs—more revenue, less cost—are increasingly dovetailing with the needs of workers, consumers and the public interest. For one intriguing new study, Stephen Stubben, of the University of Utah, and Kyle Welch, of George Washington University, got access to software tracking more than 1.2 million internal whistleblower reports filed at 937 public companies. The two accounting professors were able to gauge through the software how conscientiously companies followed up on the tips. Over the next three years, those companies that took whistleblower reports seriously faced 7 percent fewer lawsuits and paid 20 percent less when they were sued.

“It’s not generosity as much as it is enlightened self-interest,” says Jack Bogle, the founder of the low-cost Vanguard Group, one of the greatest Wall Street disruptors ever.

Indeed, investors may still be underestimating the long-term downside of an iffy corporate culture. Simon Glossner, of Catholic University in Eichstätt, Germany, recently looked at the performance of US stocks with controversial reputations—meaning they had already experienced a high-profile environmental, social or governance problem. Since the stocks of these companies had already been beaten down, might this be a buying opportunity? Nope. From 2009 to 2016, the compromised stocks underperformed their benchmarks by 3.5 percent a year, suggesting that their internal management failings went deeper, and took longer to flush out, than investors at first appreciated.

Buyers of Wells Fargo and Facebook stock might want to take note.

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At 89, Jack Bogle, whose Vanguard lived the ethos of a publicly minded company even in the decades when it wasn’t cool, still spends time looking to the future, mentoring and funding scholarships at his alma maters of Blair Academy and Prince­ton. “They’re much more global in their inspiration, much less material,’’ he says.

In other words, this trend toward self-regulation isn’t going anywhere. Perhaps if it moves fast enough, it will head off clunkier attempts by government to achieve the same goals.

Worldwide assets invested in impact funds jumped 50 percent between 2016 and 2017 to $228 billion, according to the Global Impact Investing Network. But the sector could really explode as huge wealth—some $17 trillion, according to the asset research firm Cerulli Associates—is transferred from older generations to those purpose-conscious Millennials.

Ditto corporate leadership. Look no further than Coinbase, which operates in the least regulated area of capitalism right now, cryptocurrency. In 2013, a lawyer suggested to its young cofounders, Brian Armstrong and Fred Ehrsam, that they ignore some “interpretive guidance” from the US Financial Crimes Enforcement Network that would require their bitcoin-wallet startup to register as a money transmitter and comply with burdensome Bank Secrecy Act rules. Instead, they fired that lawyer and decided to spend their meager funds on doing things right, from the start.

Two months later, Union Square Ventures led Coinbase’s $6.1 million Series A round. Its most recent round—a $300 million infusion from Tiger Global and others—valued the company at $8 billion, turning CEO Armstrong, now 35, into a billionaire. The reason Coinbase has risen above its peers: Trust and integrity in a field lacking both.


Even the traditional corporate raiders are now getting into the impact game. Jana Partners, a hedge fund notorious for its activist campaigns, recently formed a social impact fund. Its first crusade? Pressuring Apple to increase parental controls for those who have given their kids iPhones. “There are some things that require government regulation, but the position we’re taking is it’s much better if companies can figure out these things on their own,” says Charles Penner, a partner at Jana.

“How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others,’’ Adam Smith began his early book The Theory of Moral Sentiments, in 1759. He went on to describe how a prudent man should curb his selfish passions by regarding his own behaviour as an “impartial spectator would”. That guidance is at the ethical foundation of Smith’s Wealth of Nations, published in 1776, at the same time the ultimate capitalist experiment, America, was being born.

Some wisdom proves eternal. It just takes time to calibrate. Two hundred and sixty years later, Smith is suddenly right, yet again.