This is the second of a series of four articles on “corporate social responsibility” (CSR). The shareholder theory of CSR adopts the economists’ model of the corporation. Its analysis is fairly negative regarding the role and consequences of CSR on politics and the economy. Put simply it objects to the idea of forcing corporate executives to assume social responsibility for their business because they are not selected as public servants and cannot properly be made accountable. Moreover if they were to pursue social interests on behalf of the business then key stakeholders in that business, including shareholders, customers, employees, or suppliers would be directly or indirectly affected. It concludes that a corporation’s social responsibility is to increase its profits or maximize the firm’s long-term value.
The stakeholder view of CSR is not about “having to do well to do good”, but rather “having to do good to do well”. The former idea concerns philanthropy not CSR; it is about the social responsibility of wealth rather than the social responsibility of business. In this sense the monuments that many leading businessmen had erected, beginning with the 15th century Florentine Medicis, are not CSR initiatives: libraries, galleries, museums, opera houses, universities and foundations.
Prominent examples of acts of philanthropy show casing the social responsibility of Wealth include Duke University founded by American Tobacco’s James B Duke, the University of Chicago founded by Standard Oil’s John D Rockefeller, and Stanford University founded by Pacific Railroad’s A Leland Stanford. A contemporary equivalent might be the Bill and Melinda Gates Foundation, launched by Microsoft’s Bill Gates. These are individual acts of philanthropy or the social responsibility of wealth, but not the social responsibility of businesses. CSR claims that corporations have to be socially responsible – “do good” – in order to be profitable – “do well”.
The Business School Stakeholder Theory
The business school stakeholder theory focuses on how corporations can be best managed to maximize the firm’s long term value. Unlike the shareholder theory it does not concern the nature of the corporation, but rather how to manage it. From this perspective serving the interest of all relevant stakeholders – usually defined to include shareholders, financiers, customers, suppliers, employees and the local community – is considered the foundation of all best management practices. The challenge is to devise a set of rules or principles for such practices, and there have been many such attempts by management scholars. R. Edward Freeman’s Strategic Management: A Stakeholder Approach (1984) is the classic statement of the stakeholder theory.
On the surface, the economist shareholder theory appears to differ from the business school stakeholder theory. The former is narrowly focused on profits while the latter considers the interests of all relevant stakeholders. But conceptually the two are not so distinct. Much of the difference appears to be a matter of rhetoric rather than substance. Indeed Professor R. Edward Freeman claims that economists like Milton Friedman, Oliver Williamson, and Michael Jensen are really stakeholder theorists.
According to Freeman, a more nuanced understanding of business would claim that maximizing shareholder value might look like this: “You’ve got to have great products and services people want, that do what you say they are going to do. You need suppliers who want to make your company better, and who stand behind what they do. You need employees who show up and want to be there, be creative and be productive. You need communities for whom you are at least a good citizen so they do not use the political process to destroy the value you create. And, you have to make money for the financiers.”
To the business school stakeholder theorist, maximizing profits is not the goal or purpose of the corporation, but an outcome of a well-managed company. CSR is about what it takes to be a well-managed corporation. And creating value for stakeholders would lead to profits being maximized. There is no fundamental disagreement between the two theories regarding the ultimate purpose of CSR, which is to increase profits or the long-term value of the firm, there is merely a disagreement about how to achieve it. The bread and butter of what schools of management teach an executive is not simply to maximize profit, but all kinds of management principles and know-how.
It is useful at this point to draw a sharp distinction between maximizing short-term profits or the equity value of the firm, versus maximizing the firm’s long-term value. For example, if a corporation remunerates its chief corporate officers based heavily on commissions and bonuses derived from the value of transactions then there will be an incentive for them to take excessive risks by driving up short-term profits that damage the long-term value of the firm. It is therefore appropriate for insurance agents to be paid on a commission basis, but not the CEO of the insurance company. One of the much discussed issues of senior executive compensation since the financial tsunami has been the alignment of executive decisions with the firm’s long-term risk and yield profile. Another example is where corporations might prematurely deplete common-pool resources in the environment and, in the process, destroy the foundations of a sustainable business.
The caricature of businessmen as greedy, avaricious individuals obsessed with short-term profits and bent on destroying sustainability almost always springs from a failure to align the short term interests of corporate executives with the long term interests of the firm. The business school stakeholder theory seeks to align these potentially divergent interests using a commitment to CSR principles. The great challenge is that these CSR principles and operational tools are difficult to articulate if they are to be accepted as universal ones. And for the most part they tend to be politicized quickly in public debate.
CSR as Political Creed
The quiet rise and spread of the bourgeois economy in the towns of Western Europe met its first detractors in the late 18th and early 19th centuries. After 1848, or a little before, the critics grew increasingly disenchanted with capitalism and began to hope for its demise. Literary indignation with bourgeois life, evident in the works of Stendhal, Poe, Baudelaire, Flaubert, and late Dickens became, after the failed revolutions of 1848, a political creed. The sons of bourgeois fathers grew enchanted with the revival of secularized faith, called nationalism, and of secularized hope, called socialism.
The confession of the economic historian Arnold Toynbee, in 1883, to an audience of working men reveals the guilt of his generation: “We – the middle classes, I mean not just the rich – have neglected you. But I think we are changing. If you will only believe it and trust us, I think that many of us would spend our lives in your service….You have to forgive us, for we have wronged you; we have sinned against you grievously.”
George Bernard Shaw noted in Introduction to Hard Times (1912), “The first half of the 19th century despised and pitied the Middle Ages as barbarous, cruel, superstitious, and ignorant….The second half saw no hope for mankind except in the recovery of the faith, art, the humanity of the Middle Ages….For that was how men felt, and how some of them spoke.” For many social reformers and activists, CSR is a contemporary reincarnation of a century-old political creed suspicious of the activities of corporations.
These social reformers and activists are, in effect, self-appointed stakeholders of various social interests and causes. On behalf of these causes they challenge corporations whom they think should be held responsible for damages and injustices resulting from their activities. Theirs is, in effect, a nascent political movement similar to that which emerged in the mid-19th century and swept through the world leaving its hellish mark on civilization: a mark which lasted more than a century and included two world wars.
Drucker on Social Responsibility
Management theorist Peter Drucker was probably the first to recognize the revolutionary nature of Julius Rosenwald’s innovation at the Sears Roebuck & Company and James Couzens’ innovation at the Ford Motor Company.
Rosenwald was deeply enamored of the need to develop the poor American farmer’s competence, productivity, and income. He saw as no other American businessmen did that Sears Roebuck’s fortune depended on the prosperity of its customer, the farmer, which in turn depended on the farmer’s skill, productivity, and competence. He invested heavily, through the creation of the county farm agent, in developing scientific farming knowledge and farming skills and made them accessible to most farmers long before the US Government took up the task.
Even greater was the impact of James Couzens, co-founder of the Ford Motor Company, who introduced skill training to American industry as a social responsibility of business. In 1913 he also established the “five dollar a day” wage, both out of deep compassion for the suffering of the worker, and as a highly successful and immediately profitable cure for rates of absenteeism and turnover so high that it threatened Ford’s competitive position in the market place.
For Drucker, the revolutionary nature of Rosenwald’s and James Couzens’ innovations stemmed from his view that, in the future, the most needed and most effective – and perhaps the only truly effective – approach to social responsibility will be of the type pioneered by these businessmen. He argued that only if business learns that to do well it has to do good, can we hope to tackle the major social challenges facing developed societies today. He saw that government, the agency to which the generations since Rosenwald and Couzens increasingly came to look for the solution to social problems, cannot tackle these challenges. They can be solved only if they are seen and treated as opportunities. And the economic realities ahead are such that social needs can be increasingly financed only if their solution generates capital, i.e., generates a profit. This government cannot do. But it is precisely what business is being paid for.
For Drucker, the idea that only government can undertake these tasks and tackle these problems – and that no other institution is capable of to doing so – is only200 years old. It is a child of the Enlightenment and presupposes a modern civil service and a modern fiscal system. In the last 50 years of the 20th century the idea was elevated to an article of faith – to the point where a great many people considered it practically immoral and certainly futile for a social need to be tackled any other way than by a government program. Many people were of the view that such problems could only be solved by government intervention. Yet today, in the developed world, no-one expects government programs to succeed.
One reason why they fail is that governments are overly-diversified. Drucker related the observation by Arthur Altmeyer the father of the US Social Security system, and David Lilienthal the creator of the Tennessee Valley Authority, that in their experience there were, at most, enough first-rate people available at any one time in any one country to launch one major social program.
Government Handicap in Implementing Major Social Programs
Another reason is that government is congenitally unsuited to the time dimensions of social programs. Governments require immediate results, especially in a democracy with frequent and regular elections. The growth curve of social programs is naturally small displaying very few results over several years followed, if the program is successful, by years of exponential growth.
A third reason is that a government which finds it hard to start small and exercise patience, finds it even harder to abandon the program. Every program immediately creates its own constituency, if only in the people who are employed by it. It is easy, all too easy, for government to give, but it is nigh on impossible for it to take away. The rule for failures is therefore not to bury them but to redouble the budget and divert them to those able individuals who might produce results.
A fourth reason is that social needs themselves are challenging problems, with so many constituencies that it is difficult to set specific goals and targets. In a sense the social problems of the 20th century were even more formidable than those faced in the 18th and 19th centuries. Yet the problems of the 21st century promise to be even harder to tackle.
For Drucker, non-governmental organizations, whether business or institutions of the non-profit Third Sector, can, however, direct themselves to a single objective. They can potentially break down difficult problems into several easy ones with fewer constituencies, each capable of solutions. It is not the old mixed-economy of two sectors – public and private – but a new mixed-economy of three sectors – public, private, and a mixed sector.
This mixed sector may be an amalgamation of for-profit and non-profit corporations that compete against each other and is funded by a combination of public funds, donations, and customer payments. The mixed sector tackles the hard social needs by converting them into profitable business opportunities. To those who believe that profit is a rip-off, Drucker’s view amounts to converting what is seen as a virtue into self-interest. For Drucker such a conversion is absolutely necessary because in a modern economy the main source of capital formation is business profit. Without these profits it is impossible to finance these social needs. The taxing of these profits by government and relying on public provision to solve these social needs have proven unsuccessful. For this reason Drucker differs from the shareholders view of CSR. He supports the Third Sector rather than pinning his hopes on the public sector.
Peter Drucker, “A New Look at Corporate Social Responsibility”, McKinsey Quarterly, 1984.