Corporate Social Responsibility

"The Social Responsibility of business is to increase its profits."

Milton Friedman

Our Best Practices view:

The Social Responsibility of Business is to Increase its Economic Profits¹.  However, CSR is an overly ambiguous term and obscures the real complexity of business.  For that reason, we do not examine the CSR label, but instead the substance of the issue.

We are generally skeptical of shareholder resolution calling for social responsibility agenda because we feel that stakeholder relations should be the management responsibility (see micromanagement resolutions).  Our approach to corporate social responsibility policies is that of healthy cynicism, probing whether the policy is really a part of what makes the business tick or merely benefits the stakeholder group numero uno – the insiders.

CSR is

a broad and nebulous topic, often used as much by demagogues as by well-meaning people, who feel that companies should undertake certain constraints or responsibilities to stakeholders.

The topics usually focus on the following issues, but can also span the political and social agenda of the particular group promoting particular stakeholder interests:

• Environmental protection;
• Worker, customer and vendor rights;
• Alleviation of poverty;
• Responsibility to the community;
• Protecting human rights and dealing with unfriendly states.

Empirical literature on CSR practices shows that it can be used to obscure bigger problems.  Hence, management’s overemphasis on the CSR agenda can be a red flag for bigger governance problems.  In the recent study, appropriately entitled “Are Socially Responsible Managers Really Ethical?  Exploring the Relationship between CSR and Earnings Management,” researchers from Carlos III University of Madrid demonstrated that companies that overemphasize CSR also tend to cook their books.  Their findings are consistent with earlier research in the United States. 

The Complexity of Business

There have been many wonderful books written about business.  One of them is called {“The Emperor’s Nightingale”} and written by a shareholders activist and an entrepreneur Robert Monks.  Though it is a bit dated now in its examples and predictions, it makes one point that is timeless, but we frequently forget: a business is not mechanical.  It is in fact a very complex system that cannot be defined by any set of simple rules.  Some call this complexity the “soul of the corporation.”

Indeed, business begins with entrepreneurs’ creativity and lives on a complex set of relationships between a great many individuals, including investors, employees, customers, management, etc.    A successful and valuable business, one that produces maximum shareholder value is the one that can sustain these complex relationships. 

At the same time, the Nobel Prize winning Economist Milton Friedman, was very cynical about CSR in general.  In his book {Capitalism and Freedom,} he referred to CSR as a “subversive ideology.”  If CSR happens to be good for the company, he called that “hypocritical window dressing.”  To be sure, despite being hypocritical, Friedman considered this kind of “window dressing” to be a legitimate business expense. 

We believe that both works present good ways to look at CSR.  Here is where we draw the line:

Capitalism cannot exist without the motivational force behind business.  If you put the owners of a business on the same plane with other “stakeholders” and require that the board be accountable to all stakeholders, as many CSR talking heads insist, the board will be accountable to no one.  It must be the duty of the management and the board to report to the shareholders and uphold the primacy of shareholder rights.

Even a big champion of CSR, John Mackey, said: “The investors still own the business, are entitled to the residual profits, and can fire the management if they wish. A doctor has an ethical responsibility to try to heal her patients, but that responsibility doesn't mean her patients are entitled to receive a share of the profits from her practice.”

In fact, some stakeholders maybe have too much power over the corporation and should be opposed instead of having their rights upheld.  For example, bad suppliers, politicians and entrenched managers are all stakeholders.  When Alexander Krakovsky was buying companies in the former Soviet Union, the first task was in fact to get rid of leaching stakeholders, such as the red directors and uncompetitive customers and suppliers.

In a well-functioning company, it should be the responsibility of the management to mange stakeholders. Customer service, contracting with vendors, managing employees and the workplace, engaging with communities, and evaluating project environmental risk are all functions that are best performed by those who manage the business day-to-day.  There is no set of rules; it all has to do with the uniqueness of the business.  If the management is good, it will engage all the stakeholders in the best way possible and communicate its strategy to the shareholders.  In overdoing standards and best practices, especially in CSR, we sometimes forget that business is all about being unique.  In order to be competitive, good management will build the “soul of the corporation” through their unique approach to customer service, workplace design, community engagement, as well as their products and services.  When shareholders have to get involved in these critical details, the management is not doing their job. In this case, shareholders should also seek to replace the management. 

It is too much of an oversimplification to describe the building of relationship with stakeholders as merely “hypocritical window dressing,” even if Friedman believes it’s OK.  There is nothing hypocritical about sustaining a complex set of relationships and aspirations that make the company what it is.  However, getting carried away with the idea that a corporation has a real soul is silly.  A corporation is a legal figment.  In fact, it can be “killed,” dismembered, sold in parts and re-incardinated at the whim of the majority of its shareholders and/or the board.  A for-profit corporation is created and exists to benefit its shareholders.  It does not exist merely for itself.  It also does not exist for its stakeholders other than the shareholders, legally binding or mandated claims notwithstanding. In pursuing economic profit, the corporation also provides jobs, goods and mostly positive externalities that benefit its stakeholders.  In that respect, Friedman is absolutely correct.

Trying to impose external or standard rules on a corporation that require it to pursue or not pursue certain stakeholder interests would be to go against its complexity… its "soul," as well as its purpose.  Good management should carry the corporation’s "soul."  However, when the corporate insiders use CSR to entrench or promote themselves instead of the corporations, they become bad stakeholders and should be removed. 

CSR “Standards”

Corporate Social Responsibility has been a hip topic.  Just google or bing it and see.  Now many organizations are even attempting to provide quasi regulation on corporate social responsibilities.  One of the most widely referenced standards is the UN’s “Global Compact.”  It calls for very general ideas in respecting human rights and the most basic labor rights.  It is also voluntary.  The “Compact” has been criticized, however, for being not encompassing enough and for being voluntary.  Consequently, ISO (yes, the International Standards Organization) decided to develop a Social Responsibility Standard.  The effort began in 2000.  In 2005 ISO launched the drafting of ISO 26000 Standard for Social Responsibility. 

The final product, expected in 2010, will be a voluntary social responsibility standard for all types of organizations (not just for profit) that is supposed to be used as a guide and not a standard… that is although it is called a standard.   No matter how much some may have wanted to create a true standard that could later be adopted and certified, in earnest it could not be done because it is impossible to standardize the behavior of a complex system such as a business.  A recent draft of the ISO 26000 is a 106 page document.  It clearly includes many issues not applicable to a for-profit business, such as:

• Common sense Business Management advice that could be construed as gratuitous by businesses;
• Calls for catering to a “wide range of stakeholders,” which can be important to local governments or non-profit NGOs, but not to for-profit businesses;
•  Calls for complete transparency with respect to all of organization’s actions, which may be unadvisable for a company that needs to protect its trade secrets.
• A call to comply with about a dozen other codes and standards.
• Many one-liners which are too general to preserve the for-profit motive.

Alas, in case companies are still compelled to try to adopt a corporate social responsibility standard, based on ISO 26000, we narrowed down the draft ISO 26000 for application to for-profit businesses.  Using the draft ISO 26000 as a guide, we came up with a one-page draft of

Lemonjuice.biz Corporate Social Responsibility standard (or guide):

The social responsibility of a Corporation is to create long term value for its shareholders (otherwise known as economic profit).

In pursuit of long term shareholder value, the management seeks to act in a commercially optimal manner to:

1.  Reduce risks by:

• Always complying with relevant regulations and legislation;
• Avoiding unnecessary exposure to potential litigation that may result from, among other things, safety issues, environmental damage, health impact, human rights impact or any sort of bad acting;
• Dealing fairly with stakeholders;
• Protecting the Corporation from pressures that may conflict with the interests of its shareholders.

2.  Better our image by:

• Undertaking activities that promote the Company’s long term goals and presence in communities;
• Providing attractive working conditions in order to build our human capital;
• Delivering great products and services at competitive prices;
• Honoring human rights,
• Searching for more sustainable and environmentally sound solutions that are also economically sound;
• Being wise and shrewd in our dealings;

3.  Increase the value of our investments by:

• Wisely planning for the expected future regulatory change;
• Seeking out opportunities for sustainability that would increase our long term growth potential;
• Assuring quality of our products and services;
• Acting with reasonable frugality and respect for shareholders’ funds;

4.  Assure the Company is an attractive partner to other stakeholders on mutually beneficial basis by doing all that is listed above.

Despite now having our own “CSR standard,” we will be extremely skeptical about shareholders telling management to adopt any CSR standard (yes, including ours) or any CSR actions.  Such resolutions have a micromanagement feel to them.  Good management will use good judgment and integrity to optimize that complex system, called business. If shareholders do not like the way the company is being managed, they should seek to fire the management instead of making them do something that does not come naturally to them.  We would also sometimes question the management’s motives in indulging too much in sexy CSR. 

Some Examples:

Example 1

A company designs its new industrial site to exceed current environmental norms. 

This sounds like “CSR.”  However, is this in the best interest of shareholders?  The answer is likely yes because the expectation is that the environmental costs will increase in the future, making the added capital cost economically justifiable on Present Value basis.  Additionally, exceeding environmental norms can be good for public relations.  And this not even just hypocritical either.  Obtaining permits, support of the community and political considerations can be very valuable to a business.  It could speed-up time to commercial operations and even reduce pressure to unionize.  The motivation behind the PR portion is no more hypocritical than sponsoring a reality show to advertise your product.  This is the complexity of business.

However, another motive could be for the CEO to advertise his CSR credentials in order to divert the attention from the bigger problems, such as entrenchment, poor performance, other environmental violations or even fraud.  Many people forget, but Enron’s escapades into building stadiums, allegedly promoting worker’s rights and sponsoring every social event under the sun was perhaps the best example of CSR camouflage.  However, CSR used for the purpose of the management’s “hypocritical window dressing” instead of the company’s “hypocritical window dressing” is a widespread and endemic problem.

How does one know which is which?  There is no purely objective indication; it is partly a judgment call.  It takes observing the management and the pattern.  Generally, any emphasis of CSR should be viewed with healthy skepticism.  Usually, over promoting the CSR agenda that feels a bit like a personality cult may very well be a way for the management to build own constituents other than the shareholders.

Example 2

A company, whose customer base cares highly for the environment, chooses to buy renewable power and advertises that it does so. 

This is good for shareholders because this is a form of advertising and the company positioning itself.

“CSR experts” would call it CSR unless they decide this is hypocritical.

Milton Friedman would definitely call this “hypocritical window dressing.”  However, how is sponsoring a TV show to advertise your product any more hypocritical than reaching your customers through sponsoring what is important to them?

On another hand, if there is no clearly identifiable customer base or operational reason, voluntarily subsidizing wind power can be a bad use of shareholder money and can well be used to cover up something a lot more sinister.

Example 3

There are practices that fall squarely into the definition of Friedman’s “subversive ideology.” 

Take for example a company that is “environmentally bad” because it uses a lot of coal.  An activist shareholder proposal requests the company to invest in biofuels, wind and solar to offset its “environmental footprint.”  Instead of allowing such a proposal to be vetted at a shareholder’s meeting, the management agrees with the activist shareholder behind the scenes and announces its new agenda. 

Many CSR-related shareholder proposals had exactly this outcome, especially with companies traditionally operating in “dirty technologies,” such as fossil fuels or conventional energy.  

This may be labeled CSR, but in effect, this is bad governance, bad for the company value and bad for the environment.   

The reason is that companies that do not specialize in renewable energy will not make the best investments.  Even worse, they will get distracted from their core competency, where they can probably have a much greater impact by reducing their own effect on the environment.  For example, a power company that mostly operates coal power plants could do much better by optimizing their coal plant efficiency than by competing with entrepreneurial companies in wind or solar or biofuels.  The math is simple: if a company operates 5,000 MW of coal plant capacity, it will create as much reduction in greenhouse gas by improving their efficiency by 1% as investing $250 million in wind-generated power.  A 1% improvement in efficiency will generate as much electricity as about 84MW² of wind power, which would roughly have a capital cost of over $250 million.  In the absence of further organic improvement, if the company has spare $250 million, it would be in shareholders’ best interest to pay out the funds and allow the shareholders to invest it in specialized renewable energy companies if they so desire instead.  Such private ordering would steer the funds to businesses that specialize in renewable energy, usually need capital, and are able to develop better, more efficient projects.  This is a lot better than trying to engage in the business in which the company has no competency.

Maybe upgrading coal plants or paying out dividends and reducing its size is not as sexy as engaging in an act of Corporate Social Responsibility, but the actual positive societal effect and shareholder value is much greater with the former than the later.

Unfortunately, what is worse, instead of allowing such a shareholder initiative to run through the shareholder meeting, where it is virtually guaranteed to be defeated, some companies actually compromise behind the scenes, motivated only by keeping the proxy “clean.”  This is a double whammy because not only has the management accepted a bad idea to begin with, it circumvented a proper corporate governance process where important decisions, such as using shareholder money to engage in non-core projects, should be put to a shareholder vote.

A well-governed for profit company will act to increase its economic profit, hence long term shareholder value.  In doing so, the company will invest in its reputation, retention of its employees, legal compliance, reduction of pollution taxes, etc.  This is a much better mode of operations than throwing money at things that happened to be labeled CSR de-jure.

Finally…. This piece is too long, which probably violates our social responsibility of not taking up unnecessarily too much of our readers' time.  Hence, without further delay, we view Social Responsibility with healthy skepticism.  The CSR field and is good for justifying conferences and white washing mischief, but is misleading in determining the real shareholder and societal value of investments.  Governance efforts and shareholder energy should be focused on monitoring and selecting good management.  This is a lot more than the US investment community has lived-up to so far.  We find many of the purely socially-oriented shareholder proposals to be representing one group’s interests or ideology at the expense of other shareholders with little if any reason.  CSR should be left to the good judgment and integrity of the management.  However, the suitability of the management’s social responsibility choices can be a good clue to its judgment and integrity.

[1] As an Economist, Milton Friedman used the Word “profit” in an Economic, and not accounting sense.  In economic sense, profit is value creation.  Even if actual financial profit materializes 20 years in the future or even never, but the activity increases value (usually NPV), it increases economic profit.  This difference in definitions has been exploited in ambiguity arguments by some demagogues to claim that shareholders only care about short-term profits.

[2] Wind farms operate at a maximum of 33% capacity, while coal plants can operate at as high as 90%, however we used 60% in our estimate.