Monday, August 07, 2006

Words from a heartless bastard

This semester at uni I'm doing a subject called Governance and the International Firm, which is focused on, well, governance, and the international firm. For a less-cynical explanation, you can look at the handbook entry.

Anyhow, as part of the assessment I'm required to keep a journal of my thoughts on the topics being discussed in class. So that my handiwork is enjoyed by more people than myself and my tutor, I'll be cross-posting the best ones online.

So here's the first one - my argument against the folly of Corporate Social Responsibility:

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One of the central discussions in corporate governance is that of the tension between the stakeholder model and the shareholder model. At the heart of the dispute is the question of to whom the managers of an organization are ultimately accountable. Traditional conceptions of the company place the shareholders as the sole body to whom management are held to account. It has become fashionable, lately, however for companies to shift toward the stakeholder model, whereby shareholders are just one of many stakeholders, along with employees, unions, ‘society’, government, the environment etc. The term which has come to describe this is Corporate Social Responsibility (CSR).

Whilst such an idea appeals to our prejudices of preferring supposedly socially-conscientious companies over exclusively business-focused ones, it is weak and flawed when it is properly critiqued.

Firstly, it is problematic in principle. Understanding the origins of the company is useful in understanding why. Prior to the legal innovation of the company, individuals would carry on a private enterprise on their own, essentially operating as a sole trader would today. They would act rationally and pursue their own self-interest and sought to make a profit from their activities. In modern parlance, they had just a single stakeholder: themselves. As these enterprises would grow, it was acknowledged that it was no longer practicable for an individual to possess the resources necessary to carry out an enterprise on their own, and so there was a need for the pooling of assets (and risk!) from multiple people. With the advent of the company, multiple people could take a stake in the business and as the business succeeded they would be rewarded in proportion to their stake. On the down side, they had no guarantee of a return, and should the business fail they would have no claim on the business’s assets. Central to this, however, is the idea that the limited liability company is a collectivized extension of the individual sole-trader: it exists to take care of its own interests and to make a profit. Modern corporations are a long way from the small enterprises of centuries ago, but their purpose and interests remain the same.

The reason why shareholders are the single most important stakeholder in a company is because they are the only stakeholder to accept any risk. When an investor chooses to invest their money, they are seeking a return in exchange for accepting risk. To expect a return without risk in fanciful, and to accept risk without a return is foolish. When the risk outweighs the expected return, the investment is no longer attractive and the investor will look elsewhere. The trend toward seeking to satisfy multiple stakeholders dilutes the importance of the original stakeholder – the shareholder – and hence increases the risk to that shareholder. With this increased risk comes a requirement for an increased return. Given that this is unlikely, the effect will be that other investments will be relatively more appealing to investors, and companies will suffer.

The shareholder is the only stakeholder that bears the burden of risk: employees, government and society can all enjoy the benefits of a company’s success, but suffer no great downfall if the company fails. Unless these other stakeholders are willing to accept the risk, or insure the shareholder against any risk, they have no moral or legal right to consider themselves as equal stakeholders in the welfare of a company.


This leads to the second problem with CSR: a principal-agent dilemma. Shareholders in a company are those who are risking their wealth in the success or failure of the company, and hence are the ‘principals’. The managers, however, have no direct stake in the company (at least in their role as managers: they may be shareholders as well) and so merely act as ‘agents’ for the shareholders. When managers decide to use company funds to spend on CSR projects, they are in effect spending the money which would otherwise belong to the shareholders. They may well find that it is very easy to be generous when they are being generous with the wealth of others. In order to avoid this dilemma, it is best if companies themselves are not the sources of charitable spending, but that individual shareholders make a personal decision about whether or not to make a charitable donation from their dividend or profit upon selling their shares.

Thirdly, the evaluation of success according to the stakeholder model is flawed. The chief argument of many who advocate CSR is that it CSR is good for the bottom line: that is, company profitability and ultimately, share price. The logic of this is an ultimate concession of the supremacy of the shareholder model. The shareholder model is a happy supporter of CSR when it has positive tangible benefits for the company. For example, the shareholder model is happy to see companies develop infrastructure in the developing world, so long as this infrastructure benefits the company. The shareholder model is also happy to see corporate philanthropy and sponsorship of worthy causes, so long as the company benefits from this public exposure. It is a flawed argument to simply suggest that satisfying multiple stakeholders is a good thing because it benefits shareholders. For the stakeholder theory to be persuasive it must show that a company is acting properly when it is satisfying stakeholders other than the shareholders at the expense of the shareholders. So long as both shareholders and other stakeholders benefit from an action, both the stakeholder and the shareholder theorists are in agreement and we are no closer to drawing a distinction between them.

Finally, there is a public policy problem with CSR. Corporations are not in a strong position to determine which worthy projects are deserving of funding and which are not. They are not experts in the field of social policy. It is absurd to expect them to play this role. This is a role best performed by governments (in theory, at least), who are able to make decisions that are in the interests of the population as a whole and show wisdom and foresight. CSR forces companies into the position of making public policy decisions that they are ill-equipped to make. For example, CSR leads to companies deciding which diseases should receive funding for medical research and which ones should not, or deciding which disadvantaged communities should receive grants, and which should not. It is to be expected that companies will simply fund those projects that generate the maximum publicity or those which are least publicly contentious. Neither of these are good criteria for deciding what is worthy of funding and what is not. A far more sensible alternative is for governments to make these decisions, funded by the taxations dollars of corporations, their shareholders and others.

Whilst the intention of stakeholder theorists may be noble, the idea is fatally flawed in practice. It is counter-productive for companies to allow themselves to get caught up in the tide of public sentiment in favour of companies engaging in Corporate Social Responsibility. Unless, of course, satisfying these sentiments is good for company profitability!

6 comments:

Anonymous said...

Slurry i'm sure it's H1 material but i don't have the endurance to traverse the lofty intellectual peaks you've fashioned before us.

Be it CSR, CLS (yes, Critical Legal Studies for all you eager blowhards) or just plan CRAP (contemporary reflections on Arts-student pedagogy), there's a reason why this stuff is best left to lecturers.

They're paid to read it.

666 Meshuggah 666
- Cheese Cult Armageddon

John Lee said...

we discussed this a while back on Jeremy's blog, which I know Ari knows since he was there

Mothy said...

Holy Hell Ari, I sure as shit don't agree with great swathes of what's written here. I'll respond in more detail when not in the office, but for examples of non-shareholder risk see Here (environmental), Here (employees - under sub-title "Huon Cry") and Here (employees again).

Peter said...

G'day, A...

I had a big long reply lined up and blogger dropped it for me :( Maybe I'll add some of the detail later, but in essence I can't agree.

I think your argument is fundamentally flawed in that is sees the shareholder model as some perfect ideal, or at least a potential ideal which ought be pursued. But it isn't and never can be.

Much like Communism in it's day. A mighty fine idea, but unachievable in practice, leaving holes to be filled by whatever comes along and works for all concerned at the time.

I'm inclined to the view that what is being called CSR or this stakeholder model you're describing is nothing more than a recognition and labelling of something that has always been going on. Companies are just formalising it a bit more these days.

(In all likelihood they're probably getting a bit more structured about it for no better reason than a better explanation to the tax office why they're claiming non-business stuff as deductions.)

Also, I disagree completely with your assertion that only the shareholders bear the risk. Nothing could be further from the truth. Everyone from the consumer (Donohue and Stevenson, to draw a slightly long bow), employees, the environment. The list goes on.

Talk to the folks retrenched by Ansett or any one of a dozen others and see if they feel they've "suffer[ed] no great downfall" from the downfall of the business.

And these entities just are stakeholders. It's automatic and unavoidable. No entity, corporate or otherwise, is an island. We as employees, consumers and passers-by are concerned with the success or failure of businesses in our community.

I agree in principle with your Utopian view of what you describe here as the shareholder model, but I don't think it ever existed. Maybe we can expand on this further later.

Peter said...

Pretty funny, though, that just this post was enough for all the google ads to be about exactly the subject at hand!

I wonder if you did a post about the potential problems of Google's dominance, whether the ads would reflect that too? :)

Anonymous said...

“Neither of these are good criteria for deciding what is worthy of funding and what is not. A far more sensible alternative is for governments to make these decisions, funded by the taxations dollars of corporations, their shareholders and others.”

Therefore your position on political donations by corporation must be…..????

Good luck!

Cheers

Cameron