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5Chapter Corporate Social Responsibility Business has to take account of its responsibilities to society in coming to its decisions, but society has to accept its responsibilities for setting the standards against which those decisions are made.1

Sir Adrian Cadbury

We are not in business to make maximum profit for our shareholders. We are in busi- ness . . . to serve society. Profit is our reward for doing it well. If business does not serve society, society will not long tolerate our profits or even our existence.2

Kenneth Dayton, former chair of the Dayton–Hudson Corporation

Make the World a Better Place Ben and Jerry’s corporate mission statement

Corporations are people. Mitt Romney, former governor of Massachusetts and U.S. presidential candidate

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A corporation is an organization created by law and treated as a legal entity, literally a legal “person,” that is separate from and independent of the individuals who are involved in it. As a legal person, a corporation has legal rights and duties that are primarily determined by the laws of the state in which the organization is incorporated. Forming a corporation has several benefits, including limiting legal liability, protecting personal assets, providing tax advantages, and ensuring organizational continuation beyond the life or involvement of individuals.

Traditionally, the state of Delaware has incorporation laws that provide very generous terms for shareholders. Over 50 percent of U.S. corporations and over 60 percent of the Fortune 500 corporations are incorporated in Delaware. Among the benefits provided by Delaware law are strong legal protections for the interests of corporate stockholders. In the words of the chief justice of the Delaware Supreme Court, “American corporate law makes corporate managers accountable to only one constituency—the stockholders.”3

This framework underlies what R. Edward Freeman (see Reading 5-2, “Managing for Stakeholders”) has called the “dominant model” of managerial capitalism. Under that model, business managers act as agents of corporate stockholders and, thus, their primary responsibility is to serve stockholders by maximizing profits. This view was famously summarized in the title of a 1970 New York Times article by economist Milton Friedman: “The Social Responsibility of Business Is to Increase Its Profits.”

Framed in this way, there is an inherent tension between the legal responsibility of business managers and the call for greater corporate social responsibility. Pursuing general goals of social responsibility would violate the primary legal responsibility of business managers to pursue profits. But what if the stockholders themselves choose socially responsible goals in addition to, and perhaps even superior to, profit maximization? Benefit corporations, a new legal model created by more than 20 states (including Delaware), aim to do just this.

Like any corporation, a benefit corporation is a legal entity with legal rights and duties created to achieve the general benefits of any corporation: limiting liability, protecting owner assets, achieving tax advantages, and so on. Importantly, benefit corporations are not nonprofits; they are for-profit businesses that create value for their stockholders as a by-product of creating values for a wide range of other stakeholders. Benefit corporations differ from traditional corporations in that their boards and managers are given the legal authority to pursue social and environmental goals in addition to the financial goals that corporations generally pursue. This means that benefit corporations are free to make social and environmental goals part of the very mission and identity of the corporation and therefore make the boards and managers accountable to wider social goals. The profit sought by stockholders thus becomes one among other equally legitimate goals sought by a range of corporate stakeholders. The tension that is thought to exist between social ends and profit disappears in the benefit corporation model.

One estimate is that there were over 2,000 active benefit corporations in the United States in 2015.4  Some of the best-known companies include King Arthur Flour, Patagonia, Kickstarter, Seventh Generation, and Plum Organics. These for- profit businesses recognize that without profitability they will neither remain in business nor attract the investment needed to grow. But profit is recognized as a

Opening Decision Point Benefit Corporations

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means, not an end in itself. Profits serve socially responsible ends by making the business financially sustainable so that it can pursue social ends.

A number of advantages are claimed for benefit corporations besides the normal financial benefits of any incorporation. Perhaps the most important is that the benefit corporation model allows corporations with socially responsible missions to protect that mission by giving both managers and boards the legal ability to prioritize mission over profits. Especially at a time when corporations and their managers are judged by short-term, quarterly earnings reports, normal corporate charters can create pressures on managers to back away from social missions in order to increase short-term profit. Recognizing that there can be different paths to profitability, benefit corporations hold management accountable for finding a path that also achieves socially responsible mission goals.

Advocates also claim that benefit corporations have the advantage of attracting employees, especially among a younger generation that is concerned as much with workplace quality as with such traditional benefits as salary and status. One study reported that businesses with a clear social mission and a reputation for creating social benefits were more successful in attracting and retaining millennial employees.5

Benefit corporations are also better positioned to attract socially motivated customers and investors. There is a growing market among socially conscious consumers for businesses that serve the common good. There is also a growing capital market among institutional and individual investors seeking socially responsible investments. Pursuit of socially responsible ends is part of the legal charter of benefits corporations and not something done simply as a public relations ploy.

As in any good business practice, benefit corporations have stimulated a movement to measure, assess, and certify businesses engaged as benefit corporations. Some choose to take an additional step and become certified as “B-Corps” by working with an independent nonprofit group, B-Labs, to assess the effectiveness of their strategy in serving socially responsible goals. Becoming a certified B-Corp provides a means for assuring consumers, investors, employees, and the general public that the company is successful in its mission. It is also possible for traditional corporations to meet the criteria established by B-Labs and become certified as a B-Corps without having the underlying legal structure of the benefit corporation.

Ben and Jerry’s was among the first and best-known corporations that adopted a strong socially responsible mission. From its earliest years in the 1980s, Ben and Jerry’s made its social responsibility goals part of its corporate mission. Although legally not a benefit corporation (the legal designation did not exist when the company was incorporated in 1984), its founding owners Ben Cohen and Jerry Greenfield committed the company to a range of social and environmental causes.

Ben and Jerry’s famously identified three fundamental goals as its corporate mission: to make the world’s best ice cream, to run a financially successful company, and to “make the world a better place.” It also started a foundation that was funded from 7.5 percent of the pretax earnings of the company. However, as a publicly traded corporation the fiduciary responsibility of Ben and Jerry’s management and board remained primarily a financial duty.

These issues came to a head in 2000 when Unilever, the multinational food and consumer product corporation, offered to buy Ben and Jerry’s for $43 per share, more

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than double its recent trading value of $17. Corporate buyouts by outside groups typically happen when the outsiders judge that the company is worth more than what is reflected by its share price. In this sense, the outside groups believe that the company is underperforming and worth more than how it is presently valued by the market. Both Ben Cohen and Jerry Greenfield opposed selling the company to Unilever. They feared that a corporate takeover would jeopardize the social mission of Ben and Jerry’s. But the corporate board had an independent duty to the stockholders.

• Does the Ben and Jerry’s board of directors have an ethical duty to sell the com- pany to the highest bidder, even if this risks a change in the corporate mission?

• Should the fact that Unilever has a reputation as a socially progressive and responsible business influence that decision? Would the decision be different if Unilever planned to change the nature of Ben and Jerry’s mission?

• If things had been different and Ben and Jerry’s had been incorporated as a benefit corporation, would an offer at more than twice the present value be enough to change the company mission?

• How do benefit corporations fit into the model of private property, free-market capitalism?

• Suppose shareholders objected not to the mission to “make the world a better place,” but to the mission to “make the world’s best ice cream” and claimed that Ben and Jerry’s could maximize profits by making mediocre ice cream. Should shareholder desire override that aspect of the corporate mission?

Chapter Objectives After reading this chapter, you will be able to:

1. Define corporate social responsibility.

2. Describe and evaluate the economic model of corporate social responsibility.

3. Distinguish key components of the term responsibility.

4. Describe and evaluate the economic model of corporate social responsibility.

5. Describe and evaluate the stakeholder model of corporate social responsibility.

6. Describe and evaluate the integrative model of corporate social responsibility.

7. Explain the role of reputation management as motivation behind CSR.

8. Evaluate the claims that CSR is “good” for business.

Introduction

This chapter addresses the nature of corporate social responsibility (CSR) and how firms opt to meet this perceived responsibility. No one denies that business has some social responsibilities. At a minimum, it is indisputable that business has a social responsibility to obey the law. A large part of this legal responsibility includes the

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responsibility to fulfill the terms of contract with employees, customers, suppliers, lenders, accounting firms, and so forth. Legal responsibilities also include responsi- bilities to avoid negligence and other liabilities under tort law. Economists might also say that business has a social responsibility to produce the goods and services that society demands. If a firm fails to meet society’s interests and demands, it will fail. But beyond these legal and economic responsibilities, controversies abound. 

As Chris MacDonald explains in Reading 5-1, “BP and Corporate Social Respon- sibility,” there are ambiguities involved in each of the three terms corporate, social, and responsibilities. In general terms, we can say that the primary question of CSR is the extent to which business organizations and the managers who run them have ethi- cal responsibilities that go beyond producing needed goods and services within the law. There are a range of answers to this question and it will be helpful to clarify some initial concepts before turning to competing models of CSR.

Ethics and Social Responsibility

As a first step toward a better understanding, we should recognize that the words responsible and responsibility are used in several different ways. One meaning involves attributing something as a cause for an event or action. For example, poor lending practices were responsible for (i.e., the cause of) the collapse of many banks during the 2008 economic crisis; and the location of the gas tank was responsible for fires in the Ford Pinto. Being responsible in this causal sense does not carry any ethical attribution; it merely describes events. So, for example, we might say that the wind was responsible for the damage to a house or a particular gene is responsible for blue eyes.

In a second sense, to be responsible does carry an ethical connotation. When we say that business is responsible to someone or for something, we are referring to what a business ethically ought or should do. Ethical responsibilities establish limits to our decisions and actions. To say, for example, that a business has a responsibility to its employees is to say that there are ethical limits to how a busi- ness should treat its employees.

Laws regarding product safety and liability involve these various meanings of being responsible. When a consumer is injured, for instance, a first question to ask is whether the product was responsible for the injury, in the sense of having caused the injury. Several years ago a controversy developed over the drug Vioxx, produced by the pharmaceutical company Merck. Evidence suggested that Vioxx was responsible for causing heart attacks in some users. In the debates that fol- lowed, two questions required answers: Was Vioxx the cause of the heart attacks, and was Merck ethically responsible (i.e., should it be held legally liable for the heart attacks)? Once the causal question is settled, we then go on to ask if the manufacturer is responsible in the sense of doing what was expected ethically.

When we speak of corporate social responsibility, we are referring to the ethi- cal expectations that society has for business. Ethical responsibilities are those things that we ought, or should, do, even if sometimes we would rather not. We

OBJECTIVE

1

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are ethically expected to fulfill our responsibilities; and we will be held account- able if we do not. Thus, to talk about corporate social responsibility is to be con- cerned with society’s interests that should restrict or limit business’s behavior. Social responsibility is what a business should or ought to do for the sake of society, even if this comes with an economic cost.

Philosophers often distinguish between three different levels of responsibilities on a scale from less to more obligatory. First, there are ethical responsibilities to do good. Volunteering and charitable work are typical examples of responsibilities in this sense. While doing a good thing is ethically responsible and something that ethics encourages, we normally do not fault someone for choosing not to contribute to charity. To call an act volunteer work is precisely to suggest that it is optional; one does not have a duty to do it, but it is still a good thing to do. Examples of corporate philanthropy, as when a business sponsors a charity event or contributes to a school project, fit this sense of social responsibility. Ethical considerations would encourage business to support charities or the arts, but it is not something ethically mandatory or required.

A second, more obligatory sense of ethical responsibility is the responsibility to prevent harm. What are often referred to as Good Samaritan cases are examples of people acting to prevent harm, even though they have no strict duty or obliga- tion to do so. Thus, for example, we might say that a company has a responsibility to use renewable energy, even though its actions alone are not causing harm and fossil fuels are legal to use.

The most demanding sense of responsibility is the responsibility not to cause harm to others. Often called a duty or an obligation to indicate that they oblige us in the strictest sense, responsibilities in this sense bind, or compel, or require us to act in certain ways. Society expects fulfillment of these responsibilities and uses the full force of social sanctioning, including the law and legal punishment to enforce them. Thus, a business ought not to sell a product that causes harm to consumers, even if there would be a profit in doing so. 

Is there a duty for business not to cause harm? Let us consider how each of these three types of responsibilities might be seen in business. The strongest sense of responsibility is the duty not to cause harm. Even when not explicitly prohib- ited by law, ethics would demand that we not cause avoidable harm. If a business causes harm to someone and, if that harm could have been avoided by exercising due care or proper planning, then both the law and ethics would say that business should be held liable for violating its responsibilities. By all accounts, this ethical duty not to cause harm overrides business’s pursuit of profit.

In practice, this ethical requirement is the type of responsibility established by the precedents of tort law. When it is discovered that a product causes harm, then business can appropriately be prevented from marketing that product and can be held liable for harms caused by it. So, in the classic case of cigarettes, tobacco companies can be restricted in marketing products that have been proven to cause cancer even if this prevents them from maximizing profits for shareholders.

Is there a responsibility for business to prevent harm? There are also cases in which business is not causing harm, but could easily prevent harm from occurring.

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A more inclusive understanding of corporate social responsibility would hold that business has a responsibility to prevent harm. Consider the actions taken by the pharmaceutical firm Merck & Co. with its drug Mectizan. Mectizan is a Merck drug that prevents river blindness, a disease prevalent in tropical nations. River blindness infects between 40 and 100 million people annually, causing severe rashes, itching, and loss of sight. A single tablet of Mectizan administered once a year can relieve the symptoms and prevent the disease from progressing—quite an easy and effective means to prevent a horrendous consequence.

On the surface, Mectizan would not be a very profitable drug to bring to mar- ket. The once-a-year dosage limits the demand for the drug among those people who require it. Further, the individuals most at risk for this disease are among the poor- est people living in the poorest regions of Africa, Asia, Central America, and South America. However, in 1987 Merck began a program that provides Mectizan free of charge to people at risk for river blindness and pledged to “give it away free, forever.” Cooperating with the World Health Organization, UNICEF, and the World Bank, Merck’s program has donated billions of doses of Mectizan to tens of millions of peo- ple since 1987. The program has also resulted in the development of a health care sys- tem, necessary to support and administer the program, in some of the poorest regions of the world. Merck’s actions were explained by reference to part of its corporate identity statement: “We are in the business of preserving and improving human life.”6

Clearly Merck was not at all responsible for causing river blindness and, there- fore, according to the narrow model of CSR discussed earlier, Merck had no social responsibility in this case. The drug was not profitable and Merck had no legal obligation to provide it. In fact, the narrow economic model of corporate social responsibility might well fault Merck’s management for failing to maximize shareholder value. But, Merck’s management saw the issue differently. Given the company’s core business purpose and values, its managers concluded that they did have a social responsibility to prevent a disease easily controlled by their pat- ented drug. George Merck, grandson of Merck’s founder, explains, “We try never to forget that medicine is for the people. It is not for the profits. The profits follow and, if we have remembered that, they have never failed to appear. The better we have remembered it, the larger they have been.”

Is there a responsibility to do good? The third, and perhaps the most wide- ranging, standard of CSR would hold that business has a social responsibility to do good things and to make society a better place. Corporate philanthropy would be the most obvious case in which business takes on a responsibility to do good. Corporate giving programs to support community projects in the arts, education, and culture are clear examples. Some corporations have a charitable foundation or office that deals with such philanthropic programs. (See the Reality Check “Cor- porate Philanthropy: How Much Do Corporations Give?”) Small-business owners in every town across America can tell stories of how often they are approached to give donations to support local charitable and cultural activities.

Some people argue that, like all cases of charity, philanthropy is something that deserves praise and admiration; but it is not something that every business ought to do. Philosophers sometimes distinguish between obligations and responsibilities

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precisely in order to make this point. A responsible person is charitable, but donating to charity is not an obligation. Others argue that business does have an obligation to support good causes and to “give back” to the community. This sense of responsibility is more akin to a debt of gratitude and thankfulness—something less binding than a legal or contractual obligation perhaps, but more than a simple act of charity. Perhaps a clear way to understand the distinction is to compare it to your obligation to write a thank-you note for a birthday gift. You might not have a legal requirement to send the note, but nevertheless you have a responsibility to do so. 

These considerations suggest that there are competing understandings of cor- porate social responsibility and management’s role in fulfilling these responsibili- ties. What we will call the narrow economic model of CSR directs managers to maximize profit and shareholder wealth and recognizes only legal limitations on the pursuit of profit. A variation of this model acknowledges that philanthropy is an ethically good thing that can indirectly contribute to profit by improving repu- tation and brand recognition.

Another model recognizes that there is a wide range of ethical responsibili- ties and duties that are owed to others and that management must balance these responsibilities against the responsibility to shareholders. What we will call the stakeholder model asserts that neither a business nor the individuals who work for it are exempt from the ordinary ethical responsibilities that everyone has to cause no harm, to prevent harm, and to sometimes do good. 

Finally, some businesses might choose to make social responsibility part of its very purpose and mission. In what we will call the integrative model of CSR, part of the managerial responsibility to shareholders is to serve the social good. These three models are summarized in Figure 5.1.

Economic Model of CSR

Most involved in the business would accept the general definition of the term  corporate social responsibility (CSR) as referring to the ethical respon- sibilities that a business has to the society in which it operates. From a narrow economic perspective, a business is an institution that exists to benefit society by producing goods and services and, by doing this, creates jobs and wealth that provide further social benefits. 

OBJECTIVE

2

In 2011, total charitable giving in the United States was estimated to be almost $300 billion. Individual contribu- tions totaled more than $200 billion. Corporate giving totaled $14.5 billion, or 5 percent of the total giving rate that has remained flat over the past 40 years.

Source: “2012 Giving USA: The Annual Report on Phi- lanthropy for the Year 2011/Executive Summary” (June 18, 2012), www.givingusareports.org/.

Reality Check Corporate Philanthropy: How Much Do Corporations Give?

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The law has created a form of business called a corporation, which promotes these economic ends by limiting the liability of individuals for the risks involved in these activities. Legislatures thought that businesses could be more efficient in raising the capital necessary for producing goods, services, jobs, and wealth if investors were protected from undue personal risks. This fact reminds us that business organizations in general, and corporations specifically, are social institu- tions created by society to serve human ends.

What we shall refer to as the economic model of CSR holds that businesses’ sole social responsibility is to fulfill the economic functions they were designed to serve. This general model has direct implications for the proper role of busi- ness management. Corporations are understood to be a particular legal form of property which the owners get to use for their own ends. Managers are employ- ees, or agents, of those owners and must work to further the owners’ interests. In Reading 5-2, “Managing for Stakeholders,” as discussed at the beginning of this chapter, R. Edward Freeman identifies this perspective as the dominant model of CSR and refers to it as “managerial capitalism.”

This economic model of CSR places shareholders at the center of the corporation and, from this point of view, the ethical responsibility of management is to serve those shareholders. Specifically, managers have a primary responsibility to pursue profit within the law. Because profit is assumed to be an indication that business is efficiently and successfully producing the goods and services that society demands, profit is a direct measure of how well a business firm is meeting society’s expectations. 

OBJECTIVE

3

economic model of CSR Limits a firm’s social responsibility to the minimal economic responsibility of produc- ing goods and services and maximizing profits within the law.

FIGURE 5.1 Models of Corporate Social Responsibility

Economic model of CSR

Integrative model of CSR

Stakeholder model of CSR

Primary responsibility of management: Maximize profit within the law.

“Managerial capitalism”

Management may also CHOOSE to contribute to society as a

matter of philanthropy, but not as a matter of duty or social

responsibility.

Contribute for reputational purposes. Social responsibility

contributes to profitability.

Contribute because it is the right thing to do.

Business is embedded within a web of social relationships of mutual

rights and responsibilities. Business managers have responsibilities to a

range of stakeholders.

Social responsibility is integrated directly into the mission and purpose

of the corporations (e.g., Benefit corporations, Ben and Jerry’s).

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Because corporations are created by society and require a stable political and economic infrastructure in which to conduct business, like all other social insti- tutions, they are expected to obey the legal mandates established by the society. The economic model of CSR denies that business has any social responsibilities beyond the economic and legal ends for which it was created.

Nobel Prize–winning economist Milton Friedman’s classic 1970 New York Times article, “The Social Responsibility of Business Is to Increase Its Profits,” is perhaps best known as an argument for the economic model of CSR. Contrary to popular belief, Friedman does not ignore ethical responsibility in his analysis; he simply suggests that managers fulfill their ethical responsibility by increas- ing shareholder wealth and pursuing profit. Friedman explains that a corporate executive has a

responsibility to conduct business in accordance with [his or her employer’s] desires, which generally will be to make as much money as possible while conforming to the basic rules of society, both those embodied in law and those embodied in ethical custom (emphasis added).

This common view of corporate social responsibility has its roots in the utilitarian tradition and in neoclassical economics (as discussed in the section on utilitarianism in chapter 3). As agents of business owners, the contention is that managers do have social responsibilities, but their primary responsibility is to serve shareholders. By maximizing profits, a business manager will allocate resources to their most efficient uses. Consumers who most value a resource will be willing to pay the most for it; so profit is the measure of optimal allocation of resources. Over time, the pursuit of maximum profit will continuously work toward the optimal satisfaction of consumer demand which, in one interpretation of utilitarianism, is equivalent to maximizing the overall good.

But even within this dominant economic model, there is room to pursue social responsibilities. What we might identify as a philanthropic offshoot of the economic model holds that, like individuals, business is free to contribute to social causes as a matter of philanthropy. From this perspective, business has no strict obligation to contribute to social causes, but it can be a good thing when it does so. Just as individuals have no ethical obligation to contribute to char- ity or to do volunteer work in their community, business has no strict ethical responsibility to serve wider social goods. But, just as charity is a good thing and something that we all want to encourage, business should be encouraged to contribute to society in ways that go beyond the narrow obligations of law and economics. This approach is especially common with small, privately owned businesses where the owners also often play a prominent leadership role within their local community.

Within the philanthropy offshoot there are occasions in which charity work is done because it brings the firm good public relations, provides a helpful tax deduction, and builds goodwill and/or a good reputation within the community. (See the Reality Check “Putting Your Money Where Your Mouth Is?”) Many cor- porate sponsorships in sports or the arts, or contributions to community events,

corporate social responsibility (CSR) The responsibilities that businesses have to the societies within which they operate. In various contexts, it may also refer to the voluntary actions that companies undertake to address economic, social, and environmental impacts of their business opera- tions and the concerns of their principal stake- holders. The European Commission defines CSR as “a concept whereby companies decide voluntarily to contribute to a better society and a cleaner environment.” Specifi- cally, CSR suggests that a business identify its stakeholder groups and incorporate its needs and values within its strategic and opera- tional decision-making process.

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benefit businesses in this way. Peruse the program you receive when entering a local art gallery, museum, theater, or school event and you will likely see a list of local businesses that serve as donors or sponsors that have contributed to the event. In these cases, businesses have engaged in supporting these activities, and they have received some benefit in return.

Two important assumptions underlie much of the con- troversy surrounding corporate social responsibility. First, many people assume that the competition between profit and other social goals is a zero-sum game and that if a business manager pursues one she must sacrifice the other. The second assumption is that stockholders always desire the highest possible rate of return on their investment. But once again, this is an area where careful thinking can go a long way toward resolving some of the controversies.

The tension between social responsibility and profit will vary significantly whether we are focused on pursu- ing profit, increasing profit, or maximizing profit. The goal of pursuing profit simply recognizes that to keep a busi- ness operating, management must maintain profitability. But there is nothing inherently contradictory about pursu- ing profit and social goals at the same time. The Opening Decision Point in this chapter provides Ben and Jerry’s as a case of a business that did just that. Ben and Jerry’s was profitable for many years while also vigorously pursuing, and attaining, social goals.

To increase profits suggests that business should be looking for ways to grow and improve profitability. Con- sistent with a utilitarian justification of market econom- ics, this prescription advises managers to continue to increase profits because, in an ideal market, this would ensure increasing efficiency in the allocation of resources. This approach is reflected in the title of the Milton Fried- man article quoted earlier: “The Social Responsibility of Business Is to Increase Its Profits.” But once again, there is no inherent contradiction between increasing profit and pursuing some social agenda. Ben and Jerry’s increased its profits annually while pursuing its social agenda.

The only time that the pursuit of social goals does cause conflicts is when one assumes that the busi- ness goal should be to maximize, or optimize, profit and assumes that a social agenda cannot be a means to that goal. The dominant economic model makes both of these

assumptions. In this case, any corporate resource that is used for a social goal instead of being retained for profit violates managerial responsibility to “make as much money as possible” (in Friedman’s words) for sharehold- ers. But why should we assume that business always ought to aim to maximize profit?

The most common answer is that this is what share- holders (or “owners” as Friedman describes them) desire. But is this answer true? In one sense, it seems to be. Every investor presumably prefers more rather than less return on his or her investment. However, two important and related variables should cause us to be cautious in assuming that every investor wants to maxi- mize profits.

First, as we learn in finance and economics, increas- ing profits typically come with increasing risks. Many investors, particularly institutional investors such as mutual funds, pension plans, and insurance companies, much prefer less risk and steady profit than higher risk for the possibility of higher profit. Second, the desire for maximum profits also depends on the time frame involved. Short-term investors, perhaps better described as traders rather than as owners, may well prefer that managers use all the corporate resources to maximize profits. But short-term profit poses greater risks, especially to those investors seeking stable long-term returns on their invest- ments. Managing quarterly earnings reports to demon- strate maximum profit over the short term can greatly increase the risk to long-term profitability. 

Thus, we should be careful when using general terms like shareholders or stockholders. Corporate shares are owned by individuals and institutions who have a variety of purposes. Asserting that the primary responsibility of management is to maximize profit can give those who seek short-term maximum profit a priority over other share- holders that is unjustified. Whenever one hears the claim that business should maximize profit, one should immedi- ately ask: “Over what time period?” and “For whom?”

Reality Check Profits: Pursue, Increase, or Maximize?

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You might notice that cases where a business supports a social cause for the purpose of receiving good public relations, or other business benefits, are not much different from the economic view of CSR. In these situations, a business manager exercises managerial discretion in judging that the social contribution will have economic benefits. In these cases, the social contribution is as much an investment as it is a contribution. Certainly, proponents of the economic model of CSR would support social responsibility from this perspective. Thus, there is a great deal of overlap between decision makers who engage in the economic model for reputational reasons and those who follow the economic view of busi- ness’s social responsibilities.

But, there are also those cases in which a business might contribute to a social cause or event without seeking any reputational benefit. Some firms contribute to charity anonymously. Some support causes that have little or no business or financial payoff as a matter of giving back to their communities. In such cases, one might contend that corporate support for these social causes is not done for potential business benefits, but instead because the business manager or owner decides that it is simply a good and right thing to do. Others could suggest that the contributor has concluded that the society in which the firm does business is a stronger or better one if this particular activity exists.

The economic model in which business support for a social cause is done sim- ply because it is the right thing to do differs from the reputational version only in terms of the underlying motivation. To some, this seems a trivial difference. In one case, the social good is done as a means to economic ends; in the other, it is done as an end in itself. Yet, this different motivation is, in the opinion of

Do you make purchases based on a company’s social con- tributions? Are you more or less likely to buy something if you know that a company supports causes that are (or are not) important to you? Philanthropic CSR suggests that businesses contribute to society in the hopes that this will have beneficial reputational payoffs.

According to a 2011 global survey conducted by Cone Communications, consumers in general do care about cor- porate responsibility. For instance, 94 percent of respon- dents worldwide indicated that where price and quality are the same, they would be likely to switch brands to one associated with a worthwhile cause. And 93 percent of consumers indicated that they would boycott a com- pany that they felt had conducted itself irresponsibly. In addition, 65 percent said that they had, within the last 12 months, bought a product associated with a cause.

Interestingly, consumers were less focused on expressing their opinions to companies directly: Only a third of consumers indicated that they had actually given feedback about social responsibility to a company within the last 12 months.

The same survey suggested interesting interna- tional differences: 95 percent of Chinese respondents said they were likely to believe a company’s statements about its social and environmental impact, whereas only 39  percent of French respondents and 42 percent of Russian respondents said the same.

Source: Cone Communications, 2011 Cone/Echo Global CR Opportunity Study (Boston, MA: Cone), www.coneinc.com/ globalCRstudy.

Reality Check Putting Your Money Where Your Mouth Is?

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others, precisely what makes one action ethically responsible and the other not. From the perspective of the economic model of CSR, only philanthropy done for reputational reasons and financial ends is ethically responsible. Because business managers are the agents of owners, they have no right to use corporate resources except to earn owners greater returns on their investment. (Milton Friedman called such acts a “tax” on owners being levied by managers.)

Stakeholder Model of CSR

A second perspective on CSR is called the stakeholder model of CSR. The stakeholder model understands that business exists within a web of social and ethical relationships. The stakeholder model holds that businesses exist to create value for a range of stakeholders, including employees, customers, suppliers, and local communities as well as investors and stockholders. Business managers have responsibilities to all those who have a stake in the success or failure of the com- pany, not only to those who have invested financially.

Philosopher Norman Bowie has defended one version of CSR that expands the economic model in this direction (see Reading 3-3, “It Seems Right in Theory but Does it Work in Practice?” and Reading 3-4. “Business Decisions Should Not Violate the Humanity of a Person”). Bowie argues that, beyond the economic model’s duty to obey the law, business has an equally important ethical duty to respect human rights. Respecting human rights is the “moral minimum” that we expect of every person, whether they are acting as individuals or within corporate institutions. To explain this notion of a “moral minimum,” Bowie appeals to the framework for distinguishing responsibilities that was described earlier and that is derived from the principle-based traditional ethics described in chapter 3.

Bowie identifies his approach as a “Kantian” theory of business ethics. In sim- ple terms, he begins with the distinction described previously between the ethical imperatives to cause no harm, to prevent harm, and to do good. People have a strong ethical duty to cause no harm, and only a prima facie duty to prevent harm or to do good. The obligation to cause no harm, in Bowie’s view, overrides other ethical considerations. The pursuit of profit legitimately can be constrained by this ethical duty. On the other hand, Bowie accepts the economic view that managers are the agents of stockholder-owners and thus they also have a duty (derived from the contract between them) to further the interests of stockholders. Thus, while it is ethically good for managers to prevent harm or to do good, their duty to stockhold- ers overrides these concerns. As long as managers comply with the moral mini- mum and cause no harm, they have a responsibility to maximize profits.

Thus, Bowie would argue that business has a social responsibility to respect the rights of its employees, even when not specified or required by law. Such rights might include the right to safe and healthy workplaces, right to privacy, and right to due process. Bowie would also argue that business has an ethical duty to respect the rights of consumers to such things as safe products and truthful adver- tising, even when not specified in law. But, the contractual duty that managers

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stakeholder model of CSR The view that business exists within a web of social relationships. The stakeholder model views business as a citizen of the society in which it operates and, like all members of a society, business must conform to the normal range of ethical duties and obli- gations that all citizens face.

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have to stockholder-owners overrides the responsibility to prevent harm or to do (philanthropic) good.

Perhaps the most influential version of stakeholder theory was introduced by R. Edward Freeman (see Reading 5-2, “Managing for Stakeholders”). Stakeholder theory begins with the recognition that every business decision affects a wide variety of people, benefiting some and imposing costs on others. Think of the best-known business ethics cases—Volkswagen, Walmart, Enron, and Arthur Andersen; AIDS drugs in Africa; executive compensation; AIG; Merck and river blindness—and recognize that decisions made by business managers produce far-ranging consequences to a wide variety of people. Remember, as well, the economic lesson about opportunity costs. Every decision involves the imposition of costs, in the sense that every decision also involves opportunities foregone, choices given up. 

Stakeholder theory recognizes that every business decision imposes costs on someone and mandates that those costs be acknowledged. A manager who seeks to maximize profit is imposing costs on employees, consumers, and suppliers. The dominant economic model argues that these costs are justified because manag- ers owe an ethical duty to shareholders. The stakeholder model simply acknowl- edges this principle and points out that other ethical duties have an equal claim on managerial decision making. Any theory of corporate social responsibility must explain and defend answers to the questions: For whose benefit and at whose costs should the business be managed?

The economic model argues that the firm should be managed for the sole ben- efit of stockholders. This view is justified by appeal to the rights of owners, the fiduciary duty of managers, and the social benefits that follow from this arrange- ment. The stakeholder theory argues, on factual, legal, economic, and ethical grounds, that this is an inadequate understanding of business. Let us examine who are the stakeholders, what reasons can be offered to justify the legitimacy of their claims on management, and what are the practical implications of this view for business managers.

R. Edward Freeman offers a defense of the stakeholder model in Reading 5-2, “Managing for Stakeholders.” He describes both a narrow and a wider under- standing of the concept of a “stakeholder.” In a narrow sense, a stakeholder includes anyone who is vital to the survival and success of the corporation. More widely, a stakeholder could be “any group or individual who can affect or be affected by the corporation.”

Stakeholder theory argues that the narrow economic model fails both as an accurate descriptive and as a reasonable normative account of business manage- ment. As a descriptive account of business, the classical model ignores over a century of legal precedent arising from both case law and legislative enactments. While it might have been true over a century ago that management had an over- riding obligation to stockholders, the law now recognizes a wide range of mana- gerial obligations to such stakeholders as consumers, employees, competitors, the environment, and individuals with disabilities. Thus, as a matter of law it is false to claim that management can ignore duties to everyone but stockholders.

stakeholder theory A model of corporate social responsibility that holds that business managers have ethical responsibilities to a range of stakeholders that go beyond a narrow view that the primary or only responsibil- ity of managers is to stockholders.

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We also need to recognize that these legal precedents did not simply fall from the sky. It is the considered judgment of the most fundamental institutions of a democratic society, the courts, and legislatures that corporate management must limit their fiduciary duty to stockholders in the name of the rights and interests of various constituencies affected by corporate decisions.

Factual, economic considerations also diminish the plausibility of the eco- nomic model. The wide variety of market failures recognized by economists show that, even when managers pursue profits, there are no guarantees that they will serve the interests of either stockholders or the public. When markets fail to attain their goals, society has no reason to sanction the primacy of the fiduciary obliga- tion to stockholders.

But perhaps the most important argument in favor of the stakeholder theory rests in ethical considerations. The economic model appeals to two fundamental ethical norms for its justification: utilitarian considerations of social well-being and individual rights. On each of these normative accounts, however, due con- sideration must be given to all affected parties. Essential to any utilitarian theory is the commitment to balance the interests of all concerned and to give to each (arguably, equal) consideration. The stakeholder theory simply acknowledges this fact by requiring management to balance the ethical interests of all affected par- ties. Sometimes, as the classical model would hold, balancing will require man- agement to maximize stockholder interests, but sometimes not. Utilitarianism requires management to consider the consequences of its decisions for the well- being of all affected groups. Stakeholder theory requires the same.

Likewise, any theory of moral rights is committed to equal rights for all. According to the rights-based ethical framework, the overriding moral impera- tive is to treat all people as ends and never as means only. Corporate managers who fail to give due consideration to the rights of employees and other concerned groups in the pursuit of profit are treating these groups as means to the ends of stockholders. This, in the rights-based ethical framework, is unjust. (Of course, ignoring the interests of stockholders is equally unjust.)

Thus, the stakeholder theory argues that on the very same grounds that are used to justify the classical model, a wider “stakeholder” theory of corporate social responsibility is proven ethically superior. Freeman argues that “the stake- holder theory does not give primacy to one stakeholder group over another, though there will be times when one group will benefit at the expense of others. In general, however, management must keep the relationships among stakehold- ers in balance.”7

Firms exist in a web of relationships with many stakeholders and these rela- tionships can create a variety of responsibilities. As we have seen in several of the cases and examples mentioned previously, it may not be possible to satisfy the needs of each and every stakeholder in a situation. But, stakeholder theory also recognizes that some stakeholders have different power and impact on deci- sions than others; that organizations have distinct missions, priorities, and values affecting the final decisions. Therefore, social responsibility would require deci- sions to prioritize competing and conflicting responsibilities.

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Integrative Model of CSR

Most discussions about CSR are framed in terms of a debate: Should business be expected to sacrifice profits for social ends? Much of the CSR literature assumes a tension between the pursuit of profit and social responsibility. But, of course, there have always been organizations that turn this tension around, organizations that pursue social ends as the very core of their mission. Nonprofits—such as hos- pitals, nongovernmental organizations (NGOs), foundations, professional orga- nizations, schools, colleges, and government agencies—have social goals at the center of their operations. The knowledge and skills taught in business schools, from management and marketing to human resources and accounting, are just as relevant in nonprofits as they are in for-profit organizations. For this reason alone, students in these various subdisciplines of a business school curriculum should be familiar with nonprofit business models.

But there is a growing recognition that some for-profit organizations also have social goals as a central part of the strategic mission of the organization. Within the growing benefit corporation movement, many for-profit businesses are plac- ing social responsibility at the core of their strategic mission and corporate pur- pose. (For more details of such a business model, see the Opening Decision Point “Benefit Corporations” and the Reality Check “Browsing for Social Good.”)

Because these firms fully integrate economic and social goals by bringing social responsibilities into the core of their business model, we refer to this as the integrative model of CSR. At first glance, firms that adopt the integrative model raise no particular ethical issues. Even advocates of the narrow economic model of CSR such as Milton Friedman would agree that owners of a firm are free to make the pursuit of social goals a part of their business model. They would just disagree that these social goals should be part of every business’s mission. 

No one claims that every business should adopt the principles of benefit cor- porations and devote all their activities to service of social goals. There are clearly other needs that businesses are designed to address. At best, benefit corporations demonstrate that profit is not incompatible with doing good, and therefore that one can do good profitably. (See the Reality Check “Fairness in a Cup of Coffee: Example of the Integrative Model.”) On the other hand, there are some who would argue that the ethical responsibilities associated with sustainability are relevant to every business concern. In some ways, sustainability offers a model of CSR that suggests that ethical goals should be at the heart of every corporate mission. There are reasons to think that sustainability promises to be a concept of growing importance in discussions of CSR.

The Implications of Sustainability in the Integrative Model of CSR Sustainability, and specifically its definition, will be discussed in greater detail in chapter 9; but as a topic within CSR, sustainability holds that a firm’s finan- cial goals must be balanced against, and perhaps even overridden by, environ- mental considerations. Defenders of this approach point out that all economic

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integrative model of CSR For some business firms, social responsi- bility is fully integrated with the firm’s mission or strategic plan.

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The popular web browser Firefox and e-mail program Thunderbird are products of Mozilla Corporation, a for-profit subsidiary of Mozilla Foundation, a nonprofit organization. Mozilla Corporation had revenues of more than $120 million and over 400 million users of its Firefox browser in 2010. Mozilla is described on its website as follows:

WHAT IS MOZILLA? We’re a global community of thousands who sin- cerely believe in the power of technology to enrich people’s lives.

We’re a public benefit organization dedicated not to making money but to improving the way people eve- rywhere experience the Internet.

The common thread that runs throughout Mozilla is our belief that, as the most significant social and technological development of our time, the Internet is a public resource that must remain open and

accessible to all. With this in mind, our efforts are ultimately driven by our mission of encouraging choice, innovation and opportunity online.

To achieve these goals, we use a highly transparent, extremely collaborative process that brings together thousands of dedicated volunteers around the world with our small staff of employees to coordinate the creation of products like the Firefox web browser. This process is supported by the Mozilla Corpora- tion, which is a wholly-owned subsidiary of the non- profit Mozilla Foundation.

In the end, the Mozilla community, organization and technology is all focused on a single goal: making the Internet better for everyone.

Source: Mozilla Foundation, The State of Mozilla: Annual Report (2010), www.mozilla.org/en-US/foundation/annual- report/2010/faq/ (accessed July 27, 2012).

Reality Check Browsing for Social Good

activity exists within a biosphere that supports all life. They argue that the pres- ent model of economics, and especially the macroeconomic goal of economic growth, is already running up against the limits of the biosphere’s capacity to sustain life. Fundamental human needs for goods such as clean air, water, nutri- tious food, and a moderate climate are threatened by the present dominant model of economic activity.

From this perspective, the success of a business must be judged not only against the financial bottom line of profitability, but also against the ecologi- cal and social bottoms lines of sustainability. A business or industry that is financially profitable, but that uses resources (e.g., fossil fuels) at unsustain- able rates and that creates wastes (e.g., carbon dioxide) at rates that exceed the earth’s capacity to absorb them, is a business or industry that is failing its fundamental social responsibility. Importantly, a firm that is environmentally unsustainable is also a firm that is, in the long-term, financially unsustain- able. (To learn more about how firms are sharing the results of their sustain- ability efforts, see the Reality Check “Will Sustainability Reports Replace the Annual Financial Reports?”)

The sustainability version of CSR suggests that the long-term financial well-being of every firm is directly tied to questions of how the firm both affects and is affected by the natural environment. A business model that ignores the biophysical and ecological context of its activities is a business model doomed to failure.

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Exploring Enlightened Self-Interest: Does “Good Ethics” Mean “Good Business”?

In one of the quotations that opened this chapter, the former chair of the Dayton–Hudson Corporation, Kenneth Dayton, explained that “If business does not serve society, society will no long tolerate our profits or even our existence.” This logic suggests that CSR not only provides benefits to society, but it can also benefit an organization by securing its place within a society. Are there other reasons besides self-interest and economics for a business to engage in socially

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The integrative model of CSR is evidenced in a company called Equal Exchange (www.equalexchange.com), which is a worker-owned and governed business committed to Fair Trade with small-scale coffee, tea, and cocoa farm- ers. Its “Vision of Fairness to Farmers” explains its model:

A VISION OF FAIRNESS TO FARMERS Fairness to farmers. A closer connection between people and the farmers we all rely on. This was the essence of the vision that the three Equal Exchange founders—Rink Dickinson, Michael Rozyne, and Jona- than Rosenthal—held in their minds and hearts as they stood together on a metaphorical cliff back in 1986.

The three, who had met each other as managers at a New England food co-op, were part of a movement to transform the relationship between the public and food producers. At the time, however, these efforts didn’t extend to farmers outside of the U.S.

The founders decided to meet once a week—and did so for three years—to discuss how best to change the way food is grown, bought, and sold around the world. At the end of this time they had a plan for a new organization called Equal Exchange that would be:

• A social change organization that would help farmers and their families gain more control over their eco- nomic futures.

• A group that would educate consumers about trade issues affecting farmers.

• A provider of high-quality foods that would nourish the body and the soul.

• A company that would be controlled by the people who did the actual work.

• A community of dedicated individuals who believed that honesty, respect, and mutual benefit are integral to any worthwhile endeavor.

No Turning Back

It was a grand vision—with a somewhat shaky grounding in reality. But Rink, Michael, and Jonathan understood that significant change only happens when you’re open to taking big risks. So they cried “¡Adelante!” (rough translation from the Spanish: “No turning back!”) and took a running leap off the cliff. They left their jobs. They invested their own money. And they turned to their families and friends for start-up funds and let them know there was a good chance they would never see that money again.

The core group of folks believed in their cause and decided to invest. Their checks provided the $100,000 needed to start the new company. With this modest financing in hand, Rink, Michael, and Jonathan headed into the great unknown. At best, the project, which coupled a for-profit business model with a nonprofit mission, was viewed as utopian; at worst it was regarded as foolish. For the first three years Equal Exchange struggled and, like many new ventures, lost money. But the founders hung on and persevered. By the third year they began to break even.

Source: From www.equalexchange.coop/story. Reprinted with permission.

Reality Check Fairness in a Cup of Coffee: Example of the Integrative Model

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responsible activities? Can we make a “business case” for CSR, such as the repu- tational value we discussed earlier? 

Perhaps the most obvious answer is the one we touched on earlier with regard to the impact that CSR can have on a firm’s reputation within a community. CSR- related activities can improve profitability by enhancing a company’s standing among its stakeholders, including consumers and employees. For example, some evidence suggests that employees who are well treated in their work environments may prove more loyal, more effective, and more productive in their work. Liz Bankowshi, director of social missions at Ben & Jerry’s Homemade Ice Cream Company, claims that 80 to 90 percent of Ben & Jerry’s employees work there because “they feel they are part of a greater good.”8 The positive impact on the bottom line, therefore, stems not only from customer preference but also from employee preference.

The problem with a focus on reputation, however, is that social responsibil- ity then can become merely social marketing. That is, a firm may use the image of social responsibility to garner customer support or employee loyalty while the facts do not evidence a true commitment. Paul Hawken, cofounder of Smith & Hawken gardening stores and an advocate of business social responsibility, reminds us that

you see tobacco companies subsidizing the arts, then later you find out that there are internal memos showing that they wanted to specifically target the minori- ties in the arts because they want to get minorities to smoke. That’s not socially

Various laws and regulations require corporations to file an annual report that provides a comprehensive account- ing of a business’s activities in the preceding year. The report is intended to provide shareholders and the public with information about the financial performance of the company in which they have invested. While varied infor- mation is contained in an annual report, it is primarily a financial report and will include an auditor’s report and summary of revenues and expenses.

As corporations move to more fully integrate social responsibilities into their corporate mission, a differ- ent type of reporting and assessment mechanism will be required. Within the last decade, thousands of com- panies have supplemented this financial annual report with a corporate sustainability report, which pro- vides an overview of the firm’s performance on envi- ronmental and social, as well as financial, grounds. In some cases, sustainability reports are replacing finan- cial reports by integrating assessment of financial,

corporate sustainability report Provides all stakehold- ers with financial and other information regarding a firm’s eco- nomic, environmental, and social performance.

environmental, and social performance into one com- prehensive report.

Global Reporting Initiative, a nonprofit organization that was instrumental in creating a widely accepted sus- tainability reporting framework, defined sustainability reporting as follows:

Sustainability reporting is a process for publicly disclosing an organization’s economic, environmental, and social performance. Many organizations find that financial reporting alone no longer satisfies the needs of shareholders, customers, communities, and other stakeholders for information about overall organizational performance. The term “sustainability reporting” is synonymous with citizenship reporting, social reporting, triple-bottom line reporting and other terms that encompass the economic, environmental, and social aspects of an organization’s performance.

Source: www.globalreporting.org.

Reality Check Will Sustainability Reports Replace the Annual Financial Reports?

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responsible. It’s using social perception as a way to aggrandize or further one’s own interests exclusively.9

Of course, the gap between perception and reality can work in the opposite direction as well. Consider Procter & Gamble Co., which was harshly criticized by respondents to a survey seeking to rank firms on the basis of their corporate philanthropy. Respondents contended that P&G did “absolutely nothing to help” after the September 11 tragedy in New York City.10 However, in truth P&G pro- vided more than $2.5 million in cash and products, but it simply did not publicize that contribution. The same held true for Honda Motor Co., which donated cash, all-terrain vehicles, and generators for use at the World Trade Center site during the same time period. Perhaps unaware of these efforts, respondents instead believed these companies to lack compassion for their failure to (publicly) sup- port America.

The practice of attending to the “image” of a firm is sometimes referred to as reputation management. There is nothing inherently wrong with managing a firm’s reputation, and in fact the failure to do so might be a poor business decision, but observers could challenge firms for engaging in CSR activities solely for the purpose of affecting their reputations. The challenge is based on the fact that repu- tation management often works! Figure 5.2 shows the elements that Harris Interac- tive considers critical to the construction of a reputation and the resulting benefits that attention to these elements can produce. If a firm creates a good self-image, it builds a type of trust bank—consumers or other stakeholders seem to give it some slack if they then hear something negative about the firm. Similarly, if a firm has a negative image, that image may stick, regardless of what good the corporation

reputation management The practice of caring for the “image” of a firm.

FIGURE 5.2 The Construction of Corporate Reputation

Source: Copyright © Harris Interactive Research. Reprinted by permission from www. harrisinteractive.com/services/ reputation.asp.

Six Dimensions of Corporate Reputation

Emotional Appeal

Products & Services

Financial Performance

Social Responsibility

EXPERT Reputation

Measurement

POWERFUL Reputation Management

Increase Sales

Secure Talented Employees

Earn Investor Confidence

Create Business Growth

Gain Market Leadership

Build Stakeholder

Loyalty

Workplace Environment

Vision & Leadership

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Would you rather be an unethical firm with a good repu- tation or an ethical firm with a reputation for injustice? Some very high-profile firms have reaped enormous praise, while at the same time conducting themselves in a manner that would soon lead to scandal. Enron and BP are good examples.

Enron included the following accomplishments in its 2000 Corporate Responsibility Annual Report. The list drives home the challenges incumbent in any awards mechanism that strives to reward a trait such as “most innovative” or “all-star, most admired” rather than an enduring, measurable element of the corporate environ- ment. On the other hand, awards such as those listed here can serve as influential motivating factors in corporate financial decisions, so many executives in fields affected by these honors would prefer they remain.

AS REPORTED IN ENRON’S 2000 CORPORATE RESPONSIBILITY ANNUAL REPORT:

The Most Innovative Company in America

—Fortune magazine for six consecutive years

100 Best Companies to Work for in America

—Fortune magazine for three consecutive years, ranked number 22 in 2000

All-Star List of Global Most Admired Companies

—Fortune magazine, ranked number 25 in 2000

100 Fastest Growing Companies

—Fortune magazine, ranked number 29 in 2000

THE CALM BEFORE THE STORM In April 2010, a tragic oil spill that polluted the Gulf Coast made BP into one of the most despised corporations in the world. The name BP became widely associated with uneth- ical, irresponsible corporate behavior. But prior to that, BP had enjoyed a strong reputation. In 2005, for example, BP was named one of the 100 Most Sustainable Companies. BP was also among the top 10 companies listed on Fortune magazine’s Accountability Rating for 2006, 2007, and 2008. In 2007, it was ranked number one on that list.

Sources: 2000 Enron Corporate Responsibility Annual Report (2001), pp. 2–3; 2005 Global 100 List, www.global100.org/ annual-lists/2005-global-100-list.html; The Accountability Rating, www.accountabilityrating.com/past_results.asp.

Reality Check Enron and BP as Most Admired?

may do. Plato explored this issue when he asked whether one would rather be an unethical person with a good reputation or an ethical person with a reputation for injustice. You may find that, if given the choice between the two, companies are far more likely to survive under the first conception than under the second. On the issue of reputation management and the impact of a variety of stakeholders on a firm’s reputation, see the Reality Check “Enron and BP as Most Admired?” and examine the perspectives of various consumer and advocacy groups in connection with well-known businesses at any of the following websites:

∙ www.ethicalconsumer.org/boycotts/boycottslist.aspx ∙ www.cokespotlight.org ∙ www.ihatestarbucks.com ∙ www.noamazon.com ∙ www.starbucked.com ∙ www.walmartsurvivor.com

In some ways, reputation may often be more forceful than reality, as with the P&G and Honda cases mentioned earlier. Shell Oil has publicized its efforts

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toward good citizenship in Nigeria; but it has an unfortunate record in terms of the timing of its responsiveness to spills, and its community development proj- ects have created community rifts in areas around oilfields. Similarly, British American Tobacco heavily and consistently promotes its high health and safety standards; but it receives ongoing reports from contract farmers in Brazil and Kenya about ill health as a result of tobacco cultivation. Which image would you expect to be more publicized and, therefore, more likely to remain in stakehold- ers’ consciousness?

A larger question involves the possible correlation between profits and ethics. Is good ethics also good business? One important justification offered for CSR, what is often called enlightened self-interest, presumes that it is, or at least it can be. A great deal of research has concentrated on examining this connection. In fact, theorists continue to dispute whether ethical decisions lead to more signifi- cant profits than unethical decisions. While we are all familiar with examples of unethical decisions leading to high profits, there is general agreement that, in the long run, ethics pays off. However, it is the measurement of that payoff that is the challenge. In Figure 5.2, Harris Interactive juxtaposes indicators of performance in the CSR arena with those traditionally used in the financial environment to provide some guidance in this area. Though executives responsible for organiza- tional measurement and risk assessment might be less familiar with the processes for assessing the elements included on the right side of the chart, those elements are by no means less measurable. Often, however, the long-term value is not as evident or obvious.

Though there are many justifications for ethics in business, often the discus- sion returns to, well, returns—is there a business case for a return on investment from ethics? There is evidence that good ethics is good business; yet the dominant thinking is that, if it cannot be measured, it is not important. As a result, efforts have been made to measure the bottom-line impact of ethical decision making.

Measurement is critical because the business case is not without its detractors. David Vogel, a political science professor at Berkeley, contends that although there is a market for firms with strong CSR missions, it is a niche market and one that therefore caters to only a small group of consumers or investors.11 He argues that, contrary to a global shift in the business environment, CSR instead should be perceived as just one option for a business strategy that might be appropri- ate for certain types of firms under certain conditions, such as those with well- known brand names and reputations that are subject to threats by activists. He warns of the exposure a firm might suffer if it then does not live up to its CSR promises. He also cautions against investing in CSR when consumers are not willing to pay higher prices to support that investment. Though this perspective is persuasive, a review of the scholarly research on the subject suggests the con- trary on numerous counts, most predominantly the overall return on investment to the corporation.

Persuasive evidence of impact comes from a study titled “Developing Value: The Business Case for Sustainability in Emerging Markets,” based on a study produced jointly by SustainAbility, the Ethos Institute, and the International

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Finance Corporation. The research found that in emerging markets cost savings, productivity improvement, revenue growth, and access to markets were the most important business benefits of sustainability activities. Environmental process improvements and human resource management were the most significant areas of sustainability action. The report concludes that it does pay for businesses in emerging markets to pursue a wider role in environmental and social issues, cit- ing cost reductions, productivity, revenue growth, and market access as areas of greatest return for multinational enterprises (MNEs).

In addition, studies have found that there are a number of expected—and measurable—outcomes to ethics programs in organizations. Some people look to the end results of firms that have placed ethics and social responsi- bility at the forefront of their activities, while others look to those firms that have been successful and determine the role that ethics might have played. (For additional areas of measurement see the Reality Check “So They Say.”) With regard to the former, consider Johnson & Johnson, known for its quick and effective handling of its experience with tainted Tylenol. As highlighted in the Reality Check “Do Codes Make a Difference” in chapter 4, Johnson

Whether at the World Trade Organization, or at the OECD, or at the United Nations, an irrefutable case can be made that a universal acceptance of the rule of law, the outlaw- ing of corrupt practices, respect for workers’ rights, high health and safety standards, sensitivity to the environment, support for education and the protection and nurturing of children are not only justifiable against the criteria of moral- ity and justice. The simple truth is that these are good for business and most business people recognize this.12

Thomas d’Aquino, CEO of Canada’s Business Council on National Issues

We all pay for poverty and unemployment and illiteracy. If a large percentage of society falls into a disadvantaged class, investors will find it hard to source skilled and alert workers; manufacturers will have a limited market for their products; criminality will scare away foreign invest- ments, and internal migrants to limited areas of opportuni- ties will strain basic services and lead to urban blight. Under these conditions, no country can move forward eco- nomically and sustain development. . . . It therefore makes business sense for corporations to complement the efforts of government in contributing to social development.13

J. Ayala II

Our findings, both cross-sectional and longitudinal, indi- cate that there are indeed systematic linkages among community involvement, employee morale, and business performance in business enterprises. To the best of our knowledge, this is the first time that such linkages have been demonstrated empirically. Moreover, the weight of the evidence produced here indicates that community involvement is positively associated with business per- formance, employee morale is positively associated with business performance, and the interaction of commu- nity involvement—external involvement—with employee morale—internal involvement—is even more strongly associated with business performance than is either “involvement” measure alone.14

Report of a study by UCLA graduate school of busi- ness professor David Lewin and J. M. Sabater

(formerly IBM director of corporate community rela- tions) in 1989 and 1991 involving in-depth, statistical research surveys of over 150 U.S.-based companies to determine whether there is a verifiable connection between a company’s community involvement and its

business performance

Reality Check So They Say

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& Johnson has had more than seven decades of consecutive sales increases, two decades of double-digit earnings increases, and four decades of divi- dend increases. Each of these quantifiable measurements can perhaps serve as proxies for success, to some extent, or at least would be unlikely to occur in a company permeated by ethical lapses.

Moreover, a landmark study by Professors Stephen Erfle and Michael Frantantuono found that firms that were ranked highest in terms of their records on a variety of social issues (including charitable contributions, community outreach programs, environmental performance, advancement of women, and promotion of minorities) had greater financial performance as well. Financial performance was better in terms of operating income growth, sales-to-assets

In April 2000, the board of directors of Ben and Jerry’s accepted Unilever’s offer and agreed to sell Ben and Jerry’s for $326 million. At least two other offers were made, one by a group that included Ben Cohen with plans to take the company private so that its social mission could be protected. At the time, one of the competing buyers was quoted as saying, “The board felt they had no choice but to let all three groups put their best offers on the table yesterday. We think it’s horrible that a company has no choice but to sell to the highest bidder or get sued.” 15

But as part of the sale, Ben and Jerry’s board negotiated a number of unusual conditions aimed at maintaining the company’s social mission. Unilever agreed to establish an independent board of directors and operate Ben and Jerry’s as an autonomous subsidiary of the parent corporation. Unilever agreed that Ben and Jerry’s independent board of directors would operate free from control by the Unilever board, would maintain the right to sue that board, and would exist in perpetuity. Unilever also agreed to sustain the 7.5 percent contribution to the Ben and Jerry Foundation, add an additional $5 million to that foundation, make additional contributions to socially responsible initiatives, and maintain jobs. It also agreed to work with Ben Cohen to find ways to improve Unilever’s own social and environmental work. From Unilever’s perspective, a large part of what it was buying was the Ben and Jerry’s brand, and that brand was strongly identified with progressive social causes. Unilever claimed that it only made sense to continue the original mission.

There were some challenges during the early years after the purchase, however. Unilever closed some operations and eliminated some jobs, something that Ben and Jerry’s never had done. But by 2015, the record seemed to show that the relationship had succeeded and Ben and Jerry’s continued to operate in ways identical to its original operating plans. In 2012, Ben and Jerry’s received certification as an official B-Corp, the first wholly owned corporate subsidiary to receive that designation. Unilever itself, due in part to the influence of Ben and Jerry’s, has continued to evolve into one of the world’s most progressive and socially responsible corporations and has been exploring the possibility of becoming a B-Corp.16

Opening Decision Point Revisited Benefit Corporations

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ratios, sales growth, return on equity, earnings-to-asset growth, return on invest- ment, return on assets, and asset growth.17 The Reality Check “So They Say” demonstrates that these perspectives are gaining traction worldwide.

Another study by Verschoor and Murphy reports that the overall finan- cial performance of the 2001 Business Ethics magazine Best Corporate Citizens was significantly better than that of the remaining companies in the S&P 500 index, based on the 2001 BusinessWeek ranking of total finan- cial performance.18

In addition, the researchers found that these same firms had a significantly better reputation among corporate directors, security analysts, and senior execu- tives. The same result was found in a 2001 Fortune survey of most admired companies. The UK-based Institute of Business Ethics did a follow-up study to validate these findings and found that, from the perspectives of economic value added, market value added, and the price/earnings ratio, those companies that had a code of conduct outperformed those that did not over a five-year period.19 The higher performance translated into significantly more economic value added, a less volatile price/earnings ratio (making the firm, perhaps, a more secure investment), and 18 percent higher profit/turnover ratios. The research concluded:

This study gives credence to the assertion that “you do business ethically because it pays.” However, the most effective driver for maintaining a high level of integrity throughout the business is because it is seen by the board, employees and other stakeholders to be a core value and therefore the right thing to do. . . . [A] sustainable business is one which is well managed and which takes business ethics seriously. Leaders of this type of business do not need any assurance that their approach to the way they do business will also enhance their profitability, because they know it to be true.20 

This chapter sought to answer the question of whether there exists a social responsibility of business. Several sources of that responsibility were proposed. The responsibility may be based in a concept of good corporate citizenship, a social contract, or enlightened self-interest. Notwithstanding its origins, we then explored the challenge of how an inanimate entity like a corporation could actu- ally have a responsibility to others and discussed the extent of that obligation, both in law and ethics.

No matter how one answers the several questions posed by this chapter, how- ever, one thing is certain: It is impossible to engage in business today without encountering and addressing CSR. Despite substantial differences among com- panies, research demonstrates that almost all companies will confront CSR issues from stakeholders at some point in the near future.21

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Questions, Projects, and Exercises

1. What is your overall perspective on CSR after reviewing this chapter? If market forces do not encourage responsibility for social causes, should a firm engage in this behavior? Does social responsibility apply only to firms, or do consumers have a responsibility as well to support firms that take socially responsible action and withhold our support from firms that fail to exhibit socially responsible behavior? If we stand by and allow irresponsible actions to take place using profits made on our purchases, do we bear any responsibility?

∙ How did you reach your decision? What key facts do you need to know in order to judge a firm’s actions or your complicity in them by supporting a firm with your purchases or other choices?

∙ How do you determine responsibility? Do you pay attention to these issues in your purchases and other choices?

∙ Would you be more likely to support a company by purchasing its products or services if the company (a) donated a portion of the proceeds to a cause that was important to you; (b) paid its workers a “fair” wage (however you would define that concept); or (c) was a good investment for its stockholders? Which consequence is more influential to you? On the contrary, would you refrain from purchasing from a firm that failed in any of those areas?

∙ How do the alternatives compare? Do you believe different purchasing decisions by consumers could really make a difference?

2. Which of the three models of CSR is most persuasive to you and why? Which do you believe is most prevalent among companies that engage in CSR efforts?

3. This chapter has asked in several ways whether the social responsibility of the compa- nies you patronize has ever made any difference to your purchasing decisions. Will it make any difference in the future as a result of what you have learned? Consider your last three largest purchases. Go to the websites of the companies that manufacture the products you bought and explore those firms’ social responsibility efforts. Are they more or less than what you expected? Do your findings make a difference to you in terms of how you feel about these firms, your purchases, and/or the amount of money you spent on these items?

4. One of the leading figures in the Enron debacle was company founder Kenneth Lay, who died in 2006 after his conviction for fraud and conspiracy but before he began serving his sentence. Prior to the events that led to the trial and conviction, Lay was viewed in Houston as one of its “genuine heroes” and Enron was a “shining beacon” according to a professor at Rice University in Houston. The Houston Astros’s field was named after Enron when the company gave the Astros a large grant. Enron also gave money to local organizations such as the ballet and national organizations based in Houston such as United Way. The Lays individually supported Houston’s opera and ballet, its Holocaust Museum, the University of Texas MD Anderson Cancer Center, and other charitable organizations. If you were on the jury, would any of this informa- tion be relevant to your decision about Kenneth Lay’s guilt or innocence? If your jury had determined that Lay was guilty, would any of this information be relevant to your decision about the sentence you would then impose? Defend your decision from an ethical perspective.

5. In 2005, Nestlé S.A. CEO Peter Braeck-Letmathe explained, “Companies shouldn’t feel obligated to ‘give back’ to communities because they haven’t taken anything away. Companies should only pursue charitable endeavors with the underlying intention of

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making money. It is not our money we’re handing out but our investors.’ A company’s obligation is simply to create jobs and make products. What the hell have we taken away from society by being a successful company that employs people?”22 Which model of CSR would the Nestlé CEO advocate, and do you agree with his assessment?

6. Supermodel Kate Moss appeared in photos in a number of tabloid magazines and else- where using illegal drugs. Subsequent to the appearance of the photographs, several of her clients, including Chanel, H&M, and Burberry, canceled their contracts (some only temporarily) with her or determined that they would not renew them when they became eligible for renewal. Other clients opted to retain her services, preferring to “stand by her” during this ordeal. Moss issued a statement that she had checked herself into a rehabilitation center for assistance with her drug use. Assume that you are the market- ing vice president for a major global fashion label that is a client of Moss at the time of these events. Use the ethical decision-making process to evaluate how to respond to the situation. What is your decision on what to do?

7. What kind of organization would you like to work for? What would be the best? What would be the most realistic? Think about its structure, physical environment, lines of communication, treatment of employees, recruitment and promotion practices, policies toward the community, and so on. Consider also, however, what you lose because of some of these benefits (for example, if the company contributes in the community or offers more benefits for employees, there might be less money for raises).

8. Take another look at the quote earlier in this chapter by Paul Hawken. He seems to be saying that it is not acceptable to use social perception as a way to further one’s own interests (exclusively). Now find the Smith & Hawken site on the web and any additional information you can locate regarding Smith & Hawken or Paul Hawken and CSR. Would you identify Smith & Hawken as a firm interested in CSR? Would you identify Paul Hawken as an individual interested in CSR or personal social responsibil- ity? Which model of CSR would you suggest that Paul Hawken supports?

9. Given the significant financial power that a retailer and sponsor like Nike can have in the sports world, does it have any obligation to use that power to do good in connection with its particular industry? A 2006 New York Times article23 suggested that “more than televi- sion packages, more than attendance at the gate, track and field is driven by shoe com- pany dough. Nike could, if it chose, threaten to pull its financial support from the coaches and trainers of athletes who are barred for doping violations. For years, the caretakers of the athletes have also been suspected as the doping pushers. Curiously, Nike hasn’t fallen in line with everyone else calling for strict liability among coaches, trainers and athletes.” The article instead suggests that Nike does not benefit when a star falls from glory so it tends to shy away from this area of oversight. In fact, it goes so far as to say that “Nike is the doping society’s enabler.” Can you make the argument that Nike has an obligation to intervene? Or, if you do not agree with an argument for its responsibility to do good, could you instead make an economic argument in favor of intervention?

10. Make a list of the five products on which you have spent the most money over the past three years. Using the Internet, find corporate sustainability reports for the companies that produced those products or that had some responsibility in their production. Are you able to find a sustainability report for each company? What can you determine about the company’s sustainability efforts by reviewing these reports? Can you deter- mine anything about their sincerity? Do you perceive that the company is undergoing a fundamental transformation in its efforts to sustainability, or does it seem more a matter of window-dressing (or, in other words, for the sole purpose of reputation)?

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Key Terms After reading this chapter, you should have a clear understanding of the following key terms. For a complete definition, please see the Glossary. corporate social responsibility (CSR), p. 182 corporate sustainability report, p. 191

economic model of CSR, p. 181 integrative model of CSR, p. 188

reputation management, p. 192 stakeholder model of CSR, p. 185 stakeholder theory, p. 186

End Notes 1. Sir Adrian Cadbury, “Ethical Managers Make Their Own Rules,” Harvard Business Review (September/October 1987). 

2. Stakeholder Alliance, www.stakeholderalliance.org/Buzz.html (accessed April 11, 2010).

3. Leo Strine, “Making It Easier for Directors to ‘Do the Right Thing,’ ” Harvard Busi- ness Law Review 4 (2014), p. 241.

4. Ellen Berrey, “How Many Benefit Corporations Are There?” (May 5, 2015), http:// ssrn.com/abstract=2602781.

5. Deloitte Millennial Survey (January 2014), www2.deloitte.com/content/dam/ Deloitte/global/Documents/About-Deloitte/gx-dttl-2014-millennial-survey-report.pdf (accessed April 14, 2015).

6. “Mission Statement: Our Values,” www.merck.com/about/mission.html (accessed April 11, 2010).

7. William Evan and R. Edward Freeman, “A Stakeholder Theory of the Modern Cor- poration: Kantian Capitalism,” in Contemporary Issues in Business Ethics, 4th ed., ed Joseph R. DesJardins and John McCall (Belmont, CA: Wadsworth Publishing 2000), p. 89.

8. Joel Makower, Beyond the Bottom Line (New York: Simon & Schuster, 1994), p. 68. 9. Ibid., p. 15.

10. Ronald Alsop, “For a Company, Charitable Works Are Best Carried out Discreetly,” The Wall Street Journal, January 16, 2002, Marketplace Section, p. 1.

11. David Vogel, The Market for Virtue: The Potential and Limits of Corporate Social Responsibility (Washington, DC: Brookings Institution, 2005).

12. Quoted in C. Forcese, “Profiting from Misfortune? The Role of Business Corpora- tions in Promoting and Protecting International Human Rights” (MA thesis, Norman Paterson School of International Affairs, Carleton University, Ottawa 1997), referred to in C. Forcese, “Putting Conscience into Commerce: Strategies for Making Human Rights Business as Usual” (Montréal International Centre for Human Rights and Democratic Development, 1997).

13. J. Ayala II, “Philanthropy Makes Business Sense,” Ayala Foundation Inc. Quarterly 4, no. 2 (July–September, October–November 1995), p. 3.

14. D. Lewin and J. M. Sabater, “Corporate Philanthropy and Business Performance,” Philanthropy at the Crossroads (Bloomington: University of Indiana Press, 1996), pp. 105–126.

15. Constance L. Hays, “Ben & Jerry's to Unilever, with Attitude,” The New York Times (April 13, 2000), www.nytimes.com/2000/04/13/business/ben-jerry-s-to-unilever- with-attitude.html (accessed April 15, 2016).

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16. David Gelles, “How the Social Mission of Ben & Jerry’s Survived Being Gobbled Up,” The New York Times (August 21, 2015), www.nytimes.com/2015/08/23/ business/ how-ben-jerrys-social-mission-survived-being-gobbled-up.html?_r=2 (accessed April 15, 2016).

17. Joel Makower, Beyond the Bottom Line (New York: Simon & Schuster, 1994), pp. 70–71.

18. Curtis Verschoor and Elizabeth Murphy, “The Financial Performance of Large Firms and Those with Global Prominence: How Do the Best Corporations Rate?,” Busi- ness & Society Review 107, no. 3 (2002), pp. 371–380. See also Elizabeth Murphy and Curtis Verschoor, “Best Corporate Citizens Have Better Financial Performance,” Strategic Finance 83, no. 7 (January 2002), p. 20.

19. Simon Webley and Elise More, Does Business Ethics Pay? (London: Institute of Busi- ness Ethics, 2003), p. 9.

20. Simon Webley and Elise More, Does Business Ethics Pay? (London: Institute of Busi- ness Ethics, 2003), p. 9.

21. Margot Lobbezoo, “Social Responsibilities of Business,” unpublished manuscript available from the author.

22. Jennifer Heldt Powell, “Nestlé Chief Rejects the Need to ‘Give Back’ to Communities,” Boston Herald (March 9, 2005), p. 33, www.bc.edu/schools/csom/ cga/ executives/events/brabeck/; www.babymilkaction.org/press/press22march05.html (accessed April 11, 2010).

23. Selena Roberts, “Coaches like Graham Still Have Their Sponsors,” The New York Times (August 2, 2006), http://select.nytimes.com/2006/08/02/sports/othersports/02roberts. html?_r=1 (accessed April 11, 2010).

Readings Reading 5-1: “BP and Corporate Social Responsibility,” by Chris MacDonald Reading 5-2: “Managing for Stakeholders,” by R. Edward Freeman Reading 5-3: What’s Wrong—and What’s Right—with Stakeholder

Management,” by John R. Boatright

I’ve long been critical of the term “CSR,” or Corporate Social Responsibility. In particular, I’ve argued that all three parts of the term—“corporate” and “social” and “responsibility”—are misleading, at least if the term CSR is thought of, as it often is, as referring

Reading 5-1

BP and Corporate Social Responsibility Chris MacDonald

to the full range of ethical issues in business. After all, many businesses, including some very large and important ones, are not corporations. So the word “corporate” is out of place there. And many important ethical issues are not “social” issues. An

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202 Chapter 5 Corporate Social Responsibility

employee’s right to a safe workplace, for example, results in his or her employer having an obligation to him or her as an individual; it is not in any clear way a “social” obligation. And the word “responsibility” does not come close to summing up all the ethical questions that apply to individuals and organizations in the world of business: we are interested in ques- tions not just about responsibilities, but also about rights, duties, entitlements, permissions, and actions that are ethically good but not required. If we think about how business should behave purely in terms of “responsibility,” we are leaving a lot out.

But for a lot of people, the word “CSR” is virtu- ally a synonym for the much broader term, “Busi- ness Ethics.” And that’s a mistake. Of course, social responsibility is still an important topic. It is good for corporations to think about what their social responsibilities are, and to try hard to live up to them. But the term “CSR” often leads such thinking astray.

The BP Deepwater Horizon explosion and oil spill of 2010 serves as a good example to illus- trate this problem. The ethical problems associated with that catastrophic event demonstrate nicely the distinction between those ethical issues that do fit nicely under the heading of “CSR,” and those that clearly do not. In particular, that oil spill illustrates the terrain carved out by the “S,” or “Social,” aspect of CSR. Too many people use the term “CSR” when they actually want to talk about basic busi- ness ethics issues like honesty or product safety or workplace health and safety—things that are not, in any clear way at least, matters of a company’s social responsibilities. But the BP oil spill raises genuine CSR questions—it’s very much a question of corporate, social, responsibility.

Let’s take a look at the range of ethical obliga- tions that fall to a company like BP. BP—the com- pany formerly known as British Petroleum—is in the business of finding crude oil, refining it, and selling the refined gasoline and various by-products that result. In the course of doing business, BP interacts with a huge range of individuals and organizations, and those interactions bring with them an enormous range of ethical obligations.

A short list of the very basic ethical obligations that fall to such a business would include things like:

a. the obligation to provide customers with the product they’re expecting—rather than one adulterated with water, for example;

b. the obligation to deal honestly with suppliers; c. the obligation to ensure reasonable levels of

workplace health and safety; d. the obligation to make an honest effort to build

long-term share value; e. the obligation to comply with environmental

laws and industry best practices;

. . . and so on. It is important to recognize that most of those obli-

gations are obligations to identifiable individuals— to individual customers, employees, shareholders, and so on. There’s nothing really “social” about any of those obligations, if we take the word “social” seriously as implying something to do with society as a whole. The possible exception is the obliga- tion to comply with the law, which probably is best thought of as a social obligation.

And it is entirely possible that BP, in the weeks leading up to the spill, met most of ethical obliga- tions on that list. In other words, the company may well have lived up to its ethical obligations to most of the individuals and groups it dealt with. The exception, of course, involves the company’s obli- gations regarding workplace health and safety— eleven workers were killed in the Deepwater Horizon blowout, likely indicating failures within the company to give safety the level of attention it deserves. But even had no one been killed or hurt during the blowout, and if we could thus conclude that the company had met literally all of its ethi- cal obligations to all the individuals it dealt with, that would certainly not mean that BP had acted ethically. A question of social responsibility would remain. That is why the Deepwater Horizon spill makes it especially appropriate to talk about CSR.

So, what makes the oil spill a matter of social responsibility? Precisely the fact that the risks of BP’s deep-water drilling operations, and the eventual

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devastating consequences of those operations, were borne by society at large, rather than just by specific individuals. The spill resulted in enormous negative externalities—negative effects on people who weren’t involved economically with BP, and who didn’t consent (at least not directly) to bear the risks of the company’s operations. The fishing industry up and down the gulf coast was brought to a standstill. The tourism industry in affected regions ground to a virtual halt. The result- ing unemployment meant huge costs for various ele- ments of the tax-supported social safety net. And the massive cleanup effort undertaken in the wake of the spill required very substantial participation by a range of government agencies, all of which implied significant costs. In other words, BP imposed risks, and eventually costs, on American society as a whole. The company seems to have failed in its social responsibilities.

Now, all (yes all!) production processes involve externalities. All businesses emit some pollution (either directly, or indirectly via the things they con- sume) and all businesses impose at least some risks on non-consenting third parties. So the question of CSR really has to do with the magnitude of those risks, and the extent to which a company is morally responsible for those effects, and maybe the extent to which companies have an obligation not just to avoid social harms (or risks) but also an obligation to contribute socially—that is, to contribute socially beyond making a product people value.

From a CSR point of view, then, the question with regard to BP is whether the risks taken were reason- able ones. Most people are likely tempted to say

“no.” But then most of us still want plentiful cheap gas. So if we are to avoid hypocrisy, most of us need to consent to the risks involved in the basic process of oil exploration and extraction. Our economy would literally come to a standstill without the massive quantities of fossil fuels currently provided by petro- leum companies like BP. The risks implied by those basic exploration and extraction practices are ones that society implicitly consents to, and so those risks can’t plausibly be seen as violating BP’s basic social responsibilities. The risks implied by the specific behaviours of BP and its employees—the behaviours that were directly responsible for the explosion and resulting oil spill—are another matter altogether. There is little doubt that those actions pushed the level of risk beyond what is socially acceptable.

We can only understand the ethical significance of the BP oil spill of 2010 by thinking of it specifically from a social point of view. The company’s ethical failures have important social dimensions, in addi- tion to the ways in which the company failed specific individuals such as employees. Thus the BP oil spill provides an excellent way to illustrate the way we should understand the scope of the term “corporate social responsibility,” and how to keep that term nar- row enough for it to retain some real meaning.

Source: This essay is based in part on: Chris MacDonald, “BP and CSR,” Business Ethics Blog, September 1, 2010, http://businessethicsblog.com/2010/09/01/bp-and-csr/; and Chris MacDonald, “CSR Is Not C-S-R,” Business Ethics Blog, August 10, 2009, http://businessethicsblog. com/2009/08/10/csr-is-not-c-s-r/.

I. Introduction The purpose of this essay is to outline an emerg- ing view of business that we shall call “manag- ing for stakeholders.”2 This view has emerged

Reading 5-2

Managing for Stakeholders1 R. Edward Freeman

over the past thirty years from a group of schol- ars in a diverse set of disciplines, from finance to philosophy.3 The basic idea is that businesses, and the executives who manage them, actually do and should create value for customers, suppliers,

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204 Chapter 5 Corporate Social Responsibility

for stakeholders” or “stakeholder capitalism,” is, first we need to understand how the dominant story came to be told.

Somewhere in the past, organizations were quite simple and “doing business” consisted of buying raw materials from suppliers, converting it to products, and selling it to customers. For the most part owner-entrepreneurs founded such sim- ple businesses and worked at the business along with members of their families. The development of new production processes, such as the assem- bly line, meant that jobs could be specialized and more work could be accomplished. New technolo- gies and sources of power became readily avail- able. These and other social and political forces combined to require larger amounts of capital, well beyond the scope of most individual owner- manager-employees. Additionally, “workers” or non-family members began to dominate the firm and were the rule rather than the exception.

Ownership of the business became more dis- persed, as capital was raised from banks, stockhold- ers, and other institutions. Indeed, the management of the firm became separated from the ownership of the firm. And, in order to be successful, the top managers of the business had to simultaneously satisfy the owners, the employees and their unions, suppliers and customers. This system of organiza- tion of businesses along the lines set forth here was known as managerial capitalism or laissez faire cap- italism, or more recently, shareholder capitalism.5

As businesses grew, managers developed a means of control via the divisionalized firm. Led by Alfred Sloan at General Motors, the division- alized firm with a central headquarters staff was widely adapted.6 The dominant model for mana- gerial authority was the military and civil service bureaucracy. By creating rational structures and processes, the orderly progress of business growth could be well-managed.

Thus, managerialism, hierarchy, stability, and predictability all evolved together, in the United States and Europe, to form the most powerful eco- nomic system in the history of humanity. The rise of bureaucracy and managerialism was so strong,

employees, communities, and financiers (or share- holders). And, that we need to pay careful attention to how these relationships are managed and how value gets created for these stakeholders. We con- trast this idea with the dominant model of business activity; namely, that businesses are to be managed solely for the benefit of shareholders. Any other benefits (or harms) that are created are incidental.4

Simple ideas create complex questions, and we proceed as follows. In the next section we examine why the dominant story or model of business that is deeply embedded in our culture is no longer worka- ble. It is resistant to change, not consistent with the law, and for the most part, simply ignores matters of ethics. Each of these flaws is fatal in business world of the 21st Century.

We then proceed to define the basic ideas of “managing for stakeholders” and why it solves some of the problems of the dominant model. In particular we pay attention to how using “stake- holder” as a basic unit of analysis makes it more difficult to ignore matters of ethics. We argue that the primary responsibility of the executive is to cre- ate as much value for stakeholders as possible, and that no stakeholder interest is viable in isolation of the other stakeholders. We sketch three primary arguments from ethical theory for adopting “man- aging for stakeholders.” We conclude by outlining a fourth “pragmatist argument” that suggests we see managing for stakeholders as a new narrative about business that lets us improve the way we currently create value for each other. Capitalism is in this view a system of social cooperation and collabora- tion, rather than primarily a system of competition.

II. The Dominant Story: Managerial Capitalism with Shareholders at the Center The modern business corporation has emerged dur- ing the 20th Century as one of the most important innovations in human history. Yet the changes that we are now experiencing call for its reinvention. Before we suggest what this revision, “managing

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occur only when the shareholders are unhappy, and as long as executives can produce a series of incrementally better financial results there is no problem. According to this view the only change that counts is change oriented toward shareholder value. If customers are unhappy, if accounting rules have been compromised, if product quality is bad, if environmental disaster looms, even if com- petitive forces threaten, the only interesting ques- tions are whether and how these forces for change affect shareholder value, measured by the price of the stock every day. Unfortunately in today’s world there is just too much uncertainty and complex- ity to rely on such a single criterion. Business in the 21st Century is global and multi-faceted, and shareholder value may not capture that dynamism. Or, if it does, as the theory suggests it must eventu- ally, it will be too late for executives to do anything about it. The dominant story may work for how things turn out in the long run on Wall Street, but managers have to act with an eye to Main Street as well, to anticipate change to try and take advantage of the dynamism of business.7

The Dominant Model Is Not Consistent with the Law In actual fact the clarity of putting shareholders’ interests first, above that of customers, suppliers, employees, and communities, flies in the face of the reality the law. The law has evolved to put con- straints on the kinds of tradeoffs that can be made. In fact the law of corporations gives a less clear answer to the question of in whose interest and for whose benefit the corporation should be governed. The law has evolved over the years to give de facto standing to the claims of groups other than stock- holders. It has, in effect, required that the claims of customers, suppliers, local communities, and employees be taken into consideration.

For instance, the doctrine of “privity of con- tract,” as articulated in Winterbottom v. Wright in 1842, has been eroded by recent developments in products liability law. Greenman v. Yuba Power gives the manufacturer strict liability for damage caused by its products, even though the seller has

that the economist Joseph Schumpeter predicted that it would wipe out the creative force of capital- ism, stifling innovation in its drive for predictabil- ity and stability.

During the last 50 years this “Managerial Model” has put “shareholders” at the center of the firm as the most important group for managers to worry about. This mindset has dealt with the increasing complexity of the business world by focusing more intensely on “shareholders” and “creating value for shareholders.” It has become common wisdom to “increase shareholder value,” and many companies have instituted complex incentive compensation plans aimed at aligning the interests of executives with the interests of shareholders. These incentive plans are often tied to the price of a company’s stock which is affected by many factors not the least of which is the expectations of Wall Street ana- lysts about earnings per share each quarter. Meet- ing Wall Street targets, and forming a stable and predictable base of quarter over quarter increases in earnings per share has become the standard for measuring company performance. Indeed all of the recent scandals at Enron, Worldcom, Tyco, Arthur Anderson and others are in part due to executives trying to increase shareholder value, sometimes in opposition to accounting rules and law. Unfor- tunately, the world has changed so that the stabil- ity and predictability required by the shareholder approach can no longer be assured.

The Dominant Model Is Resistant to Change The Managerial View of business with sharehold- ers at the center is inherently resistant to change. It puts shareholders’ interests over and above the interests of customers, suppliers, employees, and others, as if these interests must conflict with each other. It understands a business as an essentially hierarchical organization fastened together with authority to act in the shareholders’ interests. Exec- utives often speak in the language of hierarchy as “working for shareholders,” “shareholders are the boss,” and “you have to do what the sharehold- ers want.” On this interpretation, change should

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exercised all possible care in the preparation and sale of the product and the consumer has not bought the product from nor entered into any contractual arrangement with the manufacturer. Caveat emptor has been replaced in large part, with caveat vendi- tor. The Consumer Product Safety Commission has the power to enact product recalls, essentially lead- ing to an increase in the number of voluntary prod- uct recalls by companies seeking to mitigate legal damage awards. Some industries are required to provide information to customers about a product’s ingredients, whether or not the customers want and are willing to pay for this information. Thus, companies must take the interests of customers into account, by law.

A similar story can be told about the evolution of the law forcing management to take the inter- ests of employees into account. The National Labor Relations Act gave employees the right to unionize and to bargain in good faith. It set up the National Labor Relations Board to enforce these rights with management. The Equal Pay Act of 1963 and Title VII of the Civil Rights Act of 1964 constrain man- agement from discrimination in hiring practices; these have been followed with the Age Discrimi- nation in Employment Act of 1967, and recent extensions affecting people with disabilities. The emergence of a body of administrative case law arising from labor-management disputes and the historic settling of discrimination claims with large employers have caused the emergence of a body of management practice that is consistent with the legal guarantee of the rights of employees.

The law has also evolved to try and protect the interests of local communities. The Clean Air Act and Clean Water Act, and various amendments to these classic pieces of legislation, have constrained management from “spoiling the commons.” In an historic case, Marsh v. Alabama, the Supreme Court ruled that a company-owned town was sub- ject to the provisions of the U.S. Constitution, thereby guaranteeing the rights of local citizens and negating the “property rights” of the firm. Current issues center around protecting local businesses, forcing companies to pay the health care costs of

their employees, increases in minimum wages, environmental standards, and the effects of busi- ness development on the lives of local community members. These issues fill the local political land- scapes and executives and their companies must take account of them.

Some may argue that the constraints of the law, at least in the U.S., have become increasingly irrel- evant in a world where business is global in nature. However, globalization simply makes this argu- ment stronger. The laws that are relevant to busi- ness have evolved differently around the world, but they have evolved nonetheless to take into account the interests of groups other than just shareholders. Each state in India has a different set of regula- tions that affect how a company can do business. In China the law has evolved to give business some property rights but it is far from exclusive. And, in most of the European Union, laws around “civil society” and the role of “employees” are much more complex than even U.S. law.

“Laissez faire capitalism” is simply a myth. The idea that business is about “maximizing value for stockholders regardless of the consequences to others” is one that has outlived its usefulness. The dominant model simply does not describe how business operates. Another way to see this is that if executives always have to qualify “maximize share- holder value” with exceptions of law, or even good practice, then the dominant story isn’t very useful anymore. There are just too many exceptions. The dominant story could be saved by arguing that it describes a normative view about how business should operate, despite how actual businesses have evolved.8 So we need to look more closely at some of the conceptual and normative problems that the dominant model raises.

The Dominant Model Is Not Consistent with Basic Ethics Previously we have argued that most theories of busi- ness rely on separating “business” decisions from “ethical” decisions.9 This is seen most clearly in the popular joke about “business ethics as an oxymoron.” More formally we might suggest that we define:

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about how the world works. In order to create value we believe that it is better to focus on integrating business and ethics within a complex set of stake- holder relationships rather than treating ethics as a side constraint on making profits. In short we need a theory that has as its basis what we might call:

The Integration Thesis

Most business decisions or sentences about busi- ness have some ethical content, or implicit ethical view. Most ethical decisions or sentences about ethics have some business content or implicit view about business.10

One of the most pressing challenges facing busi- ness scholars is to tell compelling narratives that have the Integration Thesis at its heart. This is essentially the task that a group of scholars, “busi- ness ethicists” and “stakeholder theorists,” have begun over the last 30 years. We need to go back to the very basics of ethics. Ethics is about the rules, principles, consequences, matters of character, etc. that we use to live together. These ideas give us a set of open questions that we are constantly searching for better ways to answer in reasonably complete ways.11 One might define “ethics” as a conversation about how we can reason together and solve our differences, recognize where our interests are joined and need development, so that we can all flourish without resorting to coercion and vio- lence. Some may disagree with such a definition, and we do not intend to privilege definitions, but such a pragmatist approach to ethics entails that we reason and talk together to try and create a better world for all of us.

If our critiques of the dominant model are cor- rect then we need to start over by re-conceptualizing the very language that we use to understand how business operates. We want to suggest that some- thing like the following principle is implicit in most reasonably comprehensive views about ethics.

The Responsibility Principle12

Most people, most of the time, want to, actually do, and should accept responsibility for the effects of their actions on others.

The Separation Fallacy

It is useful to believe that sentences like, “x is a business decision” have no ethical content or any implicit ethical point of view. And, it is useful to believe that sentences like “x is an ethical decision, the best thing to do all things considered” have no content or implicit view about value creation and trade (business).

This fallacy underlies much of the dominant story about business, as well as in other areas in society. There are two implications of rejecting the Separation Fallacy. The first is that almost any business decision has some ethical content. To see that this is true one need only ask whether the fol- lowing questions make sense for virtually any busi- ness decision.

The Open Question Argument

1. If this decision is made for whom is value cre- ated and destroyed?

2. Who is harmed and/or benefited by this decision?

3. Whose rights are enabled and whose values are realized by this decision (and whose are not)?

4. What kind of person will I (we) become if we make this decision?

Since these questions are always open for most business decisions, it is reasonable to give up the Separation Fallacy, which would have us believe that these questions aren’t relevant for making business decisions, or that they could never be answered. We need a theory about business that builds in answers to the “Open Question Argument” above. One such answer would be “Only value to shareholders counts,” but such an answer would have to be enmeshed in the language of ethics as well as business. Milton Friedman, unlike most of his expositors, may actually give such a morally rich answer. He claims that the responsibility of the executive is to make profits subject to law and ethical custom. Depending on how “law and ethical custom” is interpreted, the key difference with the stakeholder approach may well be that we disagree

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Clearly the Responsibility Principle is incom- patible with the Separation Fallacy. If business is separated from ethics, there is no question of moral responsibility for business decisions; hence, the joke is that “business ethics” is an oxymoron. More clearly still, without something like the Respon- sibility Principle it is difficult to see how ethics gets off the ground. “Responsibility” may well be a difficult and multi-faceted idea. There are surely many different ways to understand it. But, if we are not willing to accept the responsibility for our own actions (as limited as that may be due to compli- cated issues of causality and the like), then ethics, understood as how we reason together so we can all flourish, is likely an exercise in bad faith.

If we want to give up the separation fallacy and adopt the integration thesis, if the open question argument makes sense, and if something like the responsibility thesis is necessary, then we need a new model for business. And, this new story must be able to explain how value creation at once deals with economics and ethics, and how it takes account of all of the effects of business action on others. Such a model exists, and has been developing over the last 30 years by management researchers and ethics scholars, and there are many businesses who have adopted this “stakeholder framework” for their businesses.

III. Managing for Stakeholders The basic idea of “managing for stakeholders” is quite simple. Business can be understood as a set of relationships among groups which have a stake in the activities that make up the business. Business is about how customers, suppliers, employees, finan- ciers (stockholders, bondholders, banks, etc.), com- munities and managers interact and create value. To understand a business is to know how these relation- ships work. And, the executive’s or entrepreneur’s job is to manage and shape these relationships, hence the title, “managing for stakeholders.”

Reading figure 2.1 depicts the idea of “man- aging for stakeholders” in a variation of the clas- sic “wheel and spoke” diagram.13 However, it is

important to note that the stakeholder idea is per- fectly general. Corporations are not the center of the universe, and there are many possible pictures. One might put customers in the center to signal that a company puts customers as the key prior- ity. Another might put employees in the center and link them to customers and shareholders. We prefer the generic diagram because it suggests, pictori- ally, that “managing for stakeholders” is a theory about management and business; hence, managers and companies in the center. But, there is no larger metaphysical claim here.

Stakeholders and Stakes Owners or financiers (a better term) clearly have a financial stake in the business in the form of stocks, bonds, and so on, and they expect some kind of financial return from them. Of course, the stakes of financiers will differ by type of owner, preferences for money, moral preferences, and so on, as well as by type of firm. The shareholders of Google may well want returns as well as be supportive of Goog- le’s articulated purpose of “Do No Evil.” To the extent that it makes sense to talk about the finan- ciers “owning the firm,” they have a concomitant responsibility for the uses of their property.

Employees have their jobs and usually their livelihood at stake; they often have specialized skills for which there is usually no perfectly elas- tic market. In return for their labor, they expect security, wages, benefits and meaningful work. Often, employees are expected to participate in the decision making of the organization, and if the employees are management or senior executives we see them as shouldering a great deal of respon- sibility for the conduct of the organization as a whole. And, employees are sometimes financiers as well, since many companies have stock owner- ship plans, and loyal employees who believe in the future of their companies often voluntarily invest. One way to think about the employee relationship is in terms of contracts. Customers and suppliers exchange resources for the products and services of the firm and in return receive the benefits of the products and services. As with financiers and

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employees, the customer and supplier relation- ships are enmeshed in ethics. Companies make promises to customers via their advertising, and when products or services don’t deliver on these promises then management has a responsibility to rectify the situation. It is also important to have suppliers who are committed to making a com- pany better. If suppliers find a better, faster, and cheaper way of making critical parts or services, then both supplier and company can win. Of course, some suppliers simply compete on price, but even so, there is a moral element of fairness and transparency to the supplier relationship.

Finally, the local community grants the firm the right to build facilities, and in turn, it benefits from the tax base and economic and social contri- butions of the firm. Companies have a real impact

on communities, and being located in a welcom- ing community helps a company create value for its other stakeholders. In return for the provision of local services, companies are expected to be good citizens, as is any individual person. It should not expose the community to unreasonable hazards in the form of pollution, toxic waste, etc. It should keep whatever commitments it makes to the com- munity, and operate in a transparent manner as far as possible. Of course, companies don’t have per- fect knowledge, but when management discovers some danger or runs afoul of new competition, it is expected to inform and work with local com- munities to mitigate any negative effects, as far as possible.

While any business must consist of financiers, customers, suppliers, employees, and communities,

READING FIGURE 2.1

Government

CustomersCommunities

Financiers Employees

The Firm

Suppliers

Primary Stakeholders

Secondary Stakeholders

Co ns

um er

Ad vo

ca te

Gr ou

ps

Special Interest

Groups

M ed

ia

C om

petitors

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it is possible to think about other stakeholders as well. We can define “stakeholder” in a number of ways. First of all we could define the term fairly narrowly to capture the idea that any business, large or small, is about creating value for “those groups without whose support, the business would cease to be viable.” The inner circle of Reading figure 2.1 depicts this view. Almost every busi- ness is concerned at some level with relationships among financiers, customers, suppliers, employ- ees, and communities. We might call these groups “primary” or “definitional.” However, it should be noted that as a business starts up, sometimes one particular stakeholder is more important than another. In a new business start up, sometimes there are no suppliers, and paying lots of attention to one or two key customers, as well as to the ven- ture capitalist (financier) is the right approach.

There is also a somewhat broader definition that captures the idea that if a group or individual can affect a business, then the executives must take that group into consideration in thinking about how to create value. Or, a stakeholder is any group or indi- vidual that can affect or be affected by the realiza- tion of an organization’s purpose. At a minimum some groups affect primary stakeholders and we might see these as stakeholders in the outer ring of Reading figure 2.1 and call them “secondary” or “instrumental.”

There are other definitions that have emerged during the last 30 years, some based on risks and rewards, some based on mutuality of interests. And, the debate over finding the one “true defini- tion” of “stakeholder” is not likely to end. We pre- fer a more pragmatist approach of being clear of the purpose of using any of the proposed defini- tions. Business is a fascinating field of study. There are very few principles and definitions that apply to all businesses all over the world. Furthermore, there are many different ways to run a successful business, or if you like, many different flavors of “managing for stakeholders.” We see limited use- fulness in trying to define one model of business, either based on the shareholder or stakeholder view that works for all businesses everywhere. We see

much value to be gained in examining how the stakes work in the value creation process, and the role of the executive.

IV. The Responsibility of the Executive in Managing for Stakeholders Executives play a special role in the activity of the business enterprise. On the one hand, they have a stake like every other employee in terms of an actual or implied employment contract. And, that stake is linked to the stakes of financiers, customers, suppli- ers, communities, and other employees. In addition, executives are expected to look after the health of the overall enterprise, to keep the varied stakes moving in roughly the same direction, and to keep them in bal- ance.14 No stakeholder stands alone in the process of value creation. The stakes of each stakeholder group are multi-faceted, and inherently connected to each other. How could a bondholder recognize any returns without management paying attention to the stakes of customers or employees? How could customers get the products and services they need without employ- ees and suppliers? How could employees have a decent place to live without communities? Many thinkers see the dominant problem of “managing for stakeholders” as how to solve the priority problem, or “which stakeholders are more important,” or “how do we make tradeoffs among stakeholders.” We see this as a secondary issue.

First and foremost, we need to see stakeholder interests as joint, as inherently tied together. Seeing stakeholder interests as “joint” rather than opposed is difficult. It is not always easy to find a way to accom- modate all stakeholder interests. It is easier to trade off one versus another. Why not delay spending on new products for customers in order to keep earnings a bit higher? Why not cut employee medical benefits in order to invest in a new inventory control system?

Managing for stakeholders suggests that execu- tives try to reframe the questions. How can we invest in new products and create higher earnings? How

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can we be sure our employees are healthy and happy and are able to work creatively so that we can capture the benefits of new information technology such as inventory control systems? In a recent book reflecting on his experience as CEO of Medtronic, Bill George summarized the managing for stakeholders mindset:15

Serving all your stakeholders is the best way to produce long term results and create a growing; prosperous company. . . . Let me be very clear about this: there is no conflict between serving all your stakeholders and providing excellent returns for shareholders. In the long term it is impossible to have one without the other. However, serving all these stakeholder groups requires discipline, vision, and committed leadership.

The primary responsibility of the executive is to create as much value as possible for stakeholders.16 Where stakeholder interests conflict, the executive must find a way to rethink the problems so that these interests can go together, so that even more value can be created for each. If tradeoffs have to be made, as often happens in the real world, then the executive must figure out how to make the tradeoffs, and immediately begin improving the tradeoffs for all sides. Managing for stakeholders is about creating as much value as possible for stake- holders, without resorting to tradeoffs.

We believe that this task is more easily accom- plished when a business has a sense of purpose. Furthermore, there are few limits on the kinds of purpose that can drive a business. Wal-Mart may stand for “everyday low price.” Merck can stand for “alleviating human suffering.” The point is that if an entrepreneur or an executive can find a purpose that speaks to the hearts and minds of key stakeholders, it is more likely that there will be sustained success.

Purpose is complex and inspirational. The Grameen Bank wants to eliminate poverty. Fannie Mae wants to make housing affordable to every income level in society. Tastings (a local restaurant) wants to bring the taste of really good food and wine to lots of peo- ple in the community. And, all of these organizations have to generate profits, or else they cannot pursue their purposes. Capitalism works because we can pursue our purpose with others. When we coalesce

around a big idea, or a joint purpose evolves from our day to day activities with each other, then great things can happen. To create value for stakeholders, execu- tives must understand that business is fully situated in the realm of humanity. Businesses are human institu- tions populated by real live complex human beings. Stakeholders have names and faces and children. They are not mere placeholders for social roles. As such, matters of ethics are routine when one takes a managing for stakeholders approach. Of course this should go without saying, but a part of the dominant story about business is that business people are only in it for their own narrowly defined self interest. One main assumption of the managerial view with share- holders at the center is that shareholders only care about returns, and therefore their agents, managers, should only care about returns. However, this does not fit either our experiences or our aspirations. In the words of one CEO, “The only assets I manage go up and down the elevators everyday.”

Most human beings are complicated. Most of us do what we do because we are self-interested and interested in others. Business works in part because of our urge to create things with others and for oth- ers. Working on a team, or creating a new product or delivery mechanism that makes customers lives better or happier or more pleasurable all can be con- tributing factors to why we go to work each day. And, this is not to deny the economic incentive of getting a pay check. The assumption of narrow self-interest is extremely limiting, and can be self-reinforcing— people can begin to act in a narrow self-interested way if they believe that is what is expected of them, as some of the scandals such as Enron, have shown. We need to be open to a more complex psychology—one any parent finds familiar as they have shepherded the growth and development of their children.

V. Some Arguments for Managing for Stakeholders Once you say stakeholders are persons then the ideas of ethics are automatically applicable. How- ever you interpret the idea of “stakeholders,” you must pay attention to the effects of your actions

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on others. And, something like the Responsibil- ity Principle suggests that this is a cornerstone of any adequate ethical theory. There are at least three main arguments for adopting a managing for stake- holders approach. Philosophers will see these as connected to the three main approaches to ethical theory that have developed historically. We shall briefly set forth sketches of these arguments, and then suggest that there is a more powerful fourth argument.17

The Argument from Consequences A number of theorists have argued that the main reason that the dominant model of managing for shareholders is a good idea is that it leads to the best consequences for all. Typically these argu- ments invoke Adam Smith’s idea of the invisible hand, whereby each business actor pursues her own self interest and the greatest good of all actu- ally emerges. The problem with this argument is that we now know with modern general equilib- rium economics that the argument only works under very specialized conditions that seldom describe the real world. And further, we know that if the economic conditions get very close to those needed to produce the greatest good, there is no guarantee that the greatest good will actu- ally result.

Managing for stakeholders may actually pro- duce better consequences for all stakeholders because it recognizes that stakeholder interests are joint. If one stakeholder pursues its interests at the expense of all the others, then the others will either withdraw their support, or look to create another network of stakeholder value creation. This is not to say that there are not times when one stake- holder will benefit at the expense of others, but if this happens continuously over time, then in a relatively free society, stakeholders will either: (1) exit to form a new stakeholder network that sat- isfies their needs; (2) use the political process to constrain the offending stakeholder; or, (3) invent some other form of activity to satisfy their particu- lar needs.18

Alternatively, if we think about stakeholders engaged in a series of bargains among themselves, then we would expect that as individual stakehold- ers recognized their joint interests, and made good decisions based on these interests, better conse- quences would result, than if they each narrowly pursued their individual self interests.19

Now it may be objected that such an approach ignores “social consequences” or “consequences to society,” and hence, that we need a concept of “corporate social responsibility” to mitigate these effects. This objection is a vestigial limb of the dominant model. Since the only effects, on that view, were economic effects, then we need to think about “social consequences” or “corporate social responsibility.” However, if stakeholder relationships are understood to be fully embed- ded in morality, then there is no need for an idea like corporate social responsibility. We can replace it with “corporate stakeholder responsibil- ity” which is a dominant feature of managing for stakeholders.

The Argument from Rights The dominant story gives property rights in the corporation exclusively to shareholders, and the natural question arises about the rights of other stakeholders who are affected. One way to under- stand managing for stakeholders is that it takes this question of rights, seriously. If you believe that rights make sense, and further that if one per- son has a right to X then all persons have a right to X, it is just much easier to think about these issues using a stakeholder approach. For instance, while shareholders may well have property rights, these rights are not absolute, and should not be seen as such. Shareholders may not use their property to abridge the rights of others. For instance, share- holders and their agents, managers, may not use corporate property to violate the right to life of others. One way to understand managing for stake- holders is that it assumes that stakeholders have some rights. Now it is notoriously difficult to parse the idea of “rights.” But, if executives take

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managing for stakeholders seriously, they will automatically think about what is owed to custom- ers, suppliers, employees, financiers and commu- nities, in virtue of their stake, and in virtue of their basic humanity.

The Argument from Character One of the strongest arguments for managing for stakeholders is that it asks executives and entre- preneurs to consider the question of what kind of company they want to create and build. The answer to this question will be in large part an issue of character. Aspiration matters. The business virtues of efficiency, fairness, respect, integrity, keeping commitments, and others are all critical in being successful at creating value for stakeholders. These virtues are simply absent when we think only about the dominant model and its sole reliance on a nar- row economic logic.

If we frame the central question of management as “how do we create value for shareholders” then the only virtue that emerges is one of loyalty to the interests of shareholders. However if we frame the central question more broadly as “how do we create and sustain the creation of value for stakeholders” or “how do we get stakeholder interests all going in the same direction,” then it is easy to see how many of the other virtues are relevant. Taking a stakeholder approach helps people decide how companies can contribute to their well-being and kinds of lives they want to lead. By making ethics explicit and building it into the basic way we think about business, we avoid a situation of bad faith and self deception.

The Pragmatist’s Argument The previous three arguments point out important reasons for adopting a new story about business. Pragmatists want to know how we can live better, how we can create both ourselves and our com- munities in ways where values such as freedom and solidarity are present in our everyday lives to the maximal extent. While it is sometimes useful to think about consequences, rights, and character in isolation, in reality our lives are

richer if we can have a conversation about how to live together better. There is a long tradition of pragmatist ethics dating to philosophers such as William James and John Dewey. More recently philosopher Richard Rorty has expressed the pragmatist ideal:20

. . . pragmatists . . . hope instead that human beings will come to enjoy more money, more free time, and greater social equality, and also that they will develop more empathy, more abil- ity to put themselves in the shoes of others. We hope that human beings will behave more decently toward another as their standard of liv- ing improves.

By building into the very conceptual framework we use to think about business a concern with free- dom, equality, consequences, decency, shared pur- pose, and paying attention to all of the effects of how we create value for each other, we can make business a human institution, and perhaps remake it in a way that sustains us.

For the pragmatist, business (and capitalism) has evolved as a social practice, an important one that we use to create value and trade with each other. In this view, first and foremost, business is about collaboration. Of course, in a free society, stakeholders are free to form competing networks. But, the fuel for capitalism is our desire to create something of value, and to create it for ourselves and others. The spirit of capitalism is the spirit of individual achievement together with the spirit of accomplishing great tasks in collaboration with others. Managing for stakeholders makes this plain so that we can get about the business of creating better selves and better communities.

Endnotes 1. The ideas in this paper have had a long

development time. The ideas here have been reworked from: R. Edward Freeman, Strategic Management: A Stakeholder Approach [Bos- ton: Pitman, 1984]; R. Edward Freeman, “A Stakeholder Theory of the Modern Corporation,

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Drucker’s classic work, The Concept of the Corporation, New York: Transaction Publish- ers, Reprint Edition, 1993.

7. Executives can take little comfort in the nos- trum that in the long run things work out and the most efficient companies survive. Some market theorists suggest that finance theory acts like “universal acid” cutting through every possible management decision, whether or not actual managers are aware of it. Perhaps the real difference between the dominant model and the “managing for stakeholders” model proposed here is that they are simply “about” different things. The dominant model is about the strict and narrow economic logic of mar- kets, and the “managing for stakeholders” model is about how human beings create value for each other.

8. Often the flavor of the response of finance theorists sounds like this. The world would be better of if, despite all of the imperfec- tions, executives tried to maximize shareholder value. It is difficult to see how any rational being could accept such a view in the face of the recent scandals, where it could be argued that the worst offenders were the most ideo- logically pure, and the result was the actual destruction of shareholder value (see Break- ing the Short Term Cycle, Charlottesville, VA: Business Roundtable Institute for Corpo- rate Ethics/CFA Center for Financial Market Integrity, 2006). Perhaps we have a version of Aristotle’s idea that happiness is not a result of trying to be happy, or Mill’s idea that it does not maximize utility to try and maximize util- ity. Collins and Porras have suggested that even if executives want to maximize share- holder value, they should focus on purpose instead, that trying to maximize shareholder value does not lead to maximum value (see J. Collins and J. Porras, Built To Last, New York: Harper Collins, 2002).

in T. Beauchamp and N. Bowie (eds.), Ethi- cal Theory and Business [Englewood Cliffs: Prentice Hall, 7th edition, 2005], also in ear- lier editions co-authored with William Evan; Andrew Wicks, R. Edward Freeman, Patricia Werhane, and Kirsten Martin, Business Ethics: A Managerial Approach  [Englewood Cliffs: Prentice Hall, 2008]; and, R. Edward Freeman, Jeffrey Harrison, and Andrew Wicks, Man- aging for Stakeholders  [New Haven: Yale University Press, 2007]. I am grateful to edi- tors and coauthors for permission to rework these ideas here.

2. It has been called a variety of things from “stakeholder management,” “stakeholder capi- talism,” “a stakeholder theory of the modern corporation,” etc. Our reasons for choosing “managing for stakeholders” will become clearer as we proceed. Many others have worked on these ideas, and should not be held accountable for the rather idiosyncratic view outlined here.

3. For a stylized history of the idea see R. Edward Freeman, “The Development of Stakeholder Theory: An Idiosyncratic Approach,” in K.  Smith and M. Hitt (eds.), Great Minds in Management, Oxford: Oxford University Press, 2005.

4. One doesn’t manage “for” these benefits (and harms).

5. The difference between managerial and shareholder capitalism is large. However, the existence of agency theory lets us treat the two identically for our purposes here. Both agree on the view that the modern firm is characterized by the separation of decision making and residual risk bearing. The result- ing agency problem is the subject of a vast literature.

6. Alfred Chandler’s brilliant book, Strategy and Structure, Boston: MIT Press, 1970, chroni- cles the rise of the divisionalized corpora- tion. For a not so flattering account of General Motors during the same time period see Peter

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9. See R. Edward Freeman, “The Politics of Stakeholder Theory: Some Future Directions,” Business Ethics Quarterly, 4, 409–422.

10. The second part of the integration thesis is left for another occasion. Philosophers who read this essay may note the radical departure from standard accounts of political philosophy. Sup- pose we began the inquiry into political phi- losophy with the question of “how is value creation and trade sustainable over time” and suppose that the traditional beginning ques- tion, “how is the state justified” was a subsidi- ary one. We might discover or create some very different answers from the standard accounts of most political theory. See R. Edward Free- man and Robert Phillips, “Stakeholder Theory: A Libertarian Defense,” Business Ethics Quar- terly, Vol. 12, No. 3, 2002, pp. 331f.

11. Here we roughly follow the logic of John Rawls in Political Liberalism, (New York: Columbia University Press, 1995).

12. There are many statements of this principle. Our argument is that whatever the particu- lar conception of responsibility there is some underlying concept that is captured, like our willingness or our need, to justify our lives to others. Note the answer that the dominant view of business must give to questions about responsibility. “Executives are responsible only for the effects of their actions on share- holders, or only in so far as their actions create or destroy shareholder value.”

13. The spirit of this diagram is from R. Phillips, Stakeholder Theory and Organizational Ethics two styles in these notes (San Francisco: Berret- Koehler Publishers, 2003).

14. In earlier versions of this essay in this volume we suggested that the notion of a fiduciary duty to stockholders be extended to “fiduciary duty to stakeholders.” We believe that such a move cannot be defended without doing damage to the notion of “fiduciary.” The idea of having a special duty to either one or a few stakeholders is not helpful.

15. Bill George, Authentic Leadership, San Francisco: Jossey Bass, Inc., 2004.

16. This is at least as clear as the directive given by the dominant model: Create as much value as possible for shareholders.

17. Some philosophers have argued that the stake- holder approach is in need of a “normative justification.” To the extent that this phrase has any meaning, we take it as a call to con- nect the logic of managing for stakeholders with more traditional ethical theory. As prag- matists we eschew the “descriptive vs. norma- tive vs. instrumental” distinction that so many business thinkers (and stakeholder theorists) have adopted. Managing for stakeholders is inherently a narrative or story that is at once: descriptive of how some businesses do act; aspirational and normative about how they could and should act; instrumental in terms of what means lead to what ends; and manage- rial in that it must be coherent on all of these dimensions and actually guide executive action.

18. See S. Venkataraman, “Stakeholder Value Equilibration and the Entrepreneurial Process,” Ethics and Entrepreneurship, The Rufffin Series, 3: 45–57, 2002; S. R. Velamuri, “Entre- preneurship, Altruism, and the Good Soci- ety,” Ethics and Entrepreneurship, The Ruffin Series, 3: 125–143, 2002; and, T. Harting, S. Harmeling, and S. Venkataraman, “Innovative Stakeholder Relations: When ‘Ethics Pays’ (and When It Doesn’t),” Business Ethics Quar- terly, 16: 43–68, 2006.

19. Sometimes there are tradeoffs and situa- tions that economists would call “prisoner’s dilemma” but these are not the paradigmatic cases, or if they are, we seem to solve them routinely, as Russell Hardin has suggested in Morality within the Limits of Reason, Chicago: University of Chicago Press, 1998.

20. E. Mendieta (ed.), Take Care of Freedom and Truth Will Take Care of Itself: Interviews with Richard Rorty (Stanford: Stanford University Press, 2006), p. 68.

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The concept of a stakeholder is one of the more prominent contributions of recent business ethics. Since the introduction of this concept by R. Edward Freemen in Strategic Management: A Stakeholder Approach (Freeman, 1984), a concern for the inter- ests of all stakeholder groups has become a widely recognized feature, if not the defining feature, of ethical management.

Although the stakeholder concept has been developed in various ways, it has been expressed most often in the moral prescription that manag- ers, in making decisions, ought to consider the interests of all stakeholders. The list of stakehold- ers is commonly taken to include employees, cus- tomers, suppliers, and the community, as well as shareholders and other investors. This obligation to serve all stakeholder interests, which is often called “stakeholder management,” is generally contrasted with the standard form of corporate governance, in which shareholder interests are primary. This latter view—which might be called “stockholder man- agement”—is regarded by advocates of stakeholder management as morally unjustified. To focus atten- tion on only one stakeholder, they allege, is to ignore other important groups whose interests a business organization ought to serve.

Advocates of stakeholder management get one point right: the modern for-profit corporation should serve the interests of all stakeholder groups. On this point, however, there is no conflict with the argu- ment for the current system of corporate govern- ance. Where stakeholder management goes wrong is in failing to recognize that a business organization in which managers act in the interest of the share- holders can also be one that, at the same time, ben- efits all stakeholder groups. This failure is due to a second mistake on the part of those who advocate

Reading 5-3

What’s Wrong—and What’s Right—with Stakeholder Management John R. Boatright

stakeholder management. It is the simple fallacy of passing from the true premise that corporations ought to serve the interests of every stakeholder group to the false conclusion that this is a task for management. Stakeholder management assumes that management decision making is the main means by which the benefits of corporate wealth creation are distributed among stakeholders, but these benefits can also be obtained by groups interacting with a corporation in other ways, most notably through the market. Insofar as the market is able to provide the desired benefits to the various stakeholder groups, they have no need for management to explicitly con- sider their interests in making decisions.

At bottom, the dispute between stockholder and stakeholder management revolves around the ques- tion of how best to enable each stakeholder group or corporate constituency to benefit from the wealth- creating activity of business. Stakeholder manage- ment goes wrong by (1) failing to appreciate the extent to which the prevailing system of corporate governance, marked by shareholder primacy, serves the interests of all stakeholders, and (2) assuming that all stakeholder interests are best served by mak- ing this the task of management rather than using other means. Stakeholder management is right, however, to stress the moral requirement that every stakeholder group benefit from corporate activity and to make managers aware of their responsibility to create wealth for the benefit of everyone.

Two Forms of Stakeholder Management It is important at the outset to distinguish two forms of stakeholder management. The main point of difference is whether stakeholder management

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is incompatible with and an alternative to the pre- vailing form of corporate governance, or whether it is a managerial guide that can be followed within corporations as they are currently legally structured.

First, it is a simple fact that a corporation has stakeholders in the sense of “groups who can affect, or who are affected by, the activities of the firm” (Freeman, 1984). And any successful cor- poration must manage its relations with all stake- holder groups, if for no other reason than to benefit the shareholders. To manage stakeholder relations is not necessarily to serve each group’s interest (although this might be the effect) but to consider their interests sufficiently to gain their coopera- tion. The manager’s role is not merely to coordinate the contribution of the various stakeholders but to inspire them to put forth their best efforts in a joint effort to create valuable products and services. Any firm that neglects its stakeholders or, worse, alien- ates them is doomed to failure.

Second, managers also have obligations to treat each stakeholder group in accord with accepted ethical standards. These obligations include not only those that are owed to everyone, such as hon- esty and respect, but also the obligations to abide by agreements or contracts made with a firm. In most countries, basic moral obligations concerning the treatment of employees, customers, and other parties as well as agreements and contracts are codified in laws that constitute the legal framework of business. Treating all stakeholders ethically is a requirement of any form of business organization, although differences may exist about what ethics requires.

This version of stakeholder management, which is roughly what Donaldson and Preston (1995) call instrumental, does not constitute a system of cor- porate governance. Another form of stakeholder management, however, goes beyond the necessity of managing stakeholder relations and the obliga- tions that are owed to stakeholder groups to the question of how stakeholder interests ought to be considered. Indeed, most advocates of stakeholder management hold that stakeholder interests should

be central to the operation of a corporation in much the same way that shareholder interests dominate in the conventional shareholder-controlled firm. In general, they contend that in making key decisions, managers ought to consider all interests, those of shareholders and non-shareholders alike, and bal- ance them in some way.

This form of stakeholder management, which corresponds more or less to Donaldson and Pres- ton’s normative stakeholder theory, does have implications for corporate governance. More specifically, the prevailing system of corporate governance may be expressed in three related propositions: (1) that shareholders ought to have control; (2) that managers have a fiduciary duty to serve shareholder interests alone; and (3) that the objective of the firm ought to be the maximization of shareholder wealth. The main theses of stake- holder management can then be stated by modify- ing each of these propositions as follows: (1) all stakeholders have a right to participate in corpo- rate decisions that affect them; (2) managers have a fiduciary duty to serve the interests of all stake- holder groups; and (3) the objective of the firm ought to be the promotion of all interests and not those of shareholders alone.

The issues in these two sets of propositions— who has control or the right to make decisions, who is the beneficiary of management’s fiduciary duty, and whose interests ought to be the objec- tive of a firm—are at the heart of corporate gov- ernance. Consequently, stockholder management and this form of stakeholder management consti- tute two competing models of how corporations ought to be governed. Stakeholder management goes wrong when it is developed as an alternative system of corporate governance. As a prescription for corporate governance, stakeholder manage- ment not only is inferior to the prevailing system but involves several crucial mistakes. Stakeholder management as a guide for managers, on the other hand, contains much that is helpful to managers and constitutes a valuable corrective to some com- mon misunderstandings of the argument for stock- holder management.

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input provider’s contribution to the productive activity of a firm. Accordingly, every asset contrib- uted to joint production will be accompanied by a governance structure of some kind, which may vary depending on the features of the asset pro- vided. That is, the governance structure for secur- ing employees’ wages and other benefits may be different from those protecting suppliers, and simi- larly for other input providers.

When the protection for each group’s input can be provided by fully specified contracts or precise legal rules, the governance structure is relatively uncom- plicated. Customers, for example, are adequately protected, for the most part, by sales contracts, warranties, and the like. The market also provides some protection. Thus, customers are protected by the opportunity to switch from one seller to another. The greatest problems of governance occur for firm- specific assets, which are assets that cannot easily be removed from production. When assets are firm specific, the providers become “locked in.”

For example, employees, who ordinarily assume little risk when they can easily move from one firm to another, are at greater risk when they develop skills that are of value only to their cur- rent employer. When their skills are firm specific, a move to another firm usually results in lower pay. Similarly, a supplier who invests in special equipment to manufacture goods used by only one customer is providing a firm-specific asset. In both cases, the input provider becomes “locked in” and thus has a greater need for protection than, say, customers.

Developing governance structures to protect input providers is also more complicated when contracts and legal rules cannot be developed easily due to complexity and uncertainty. Contracts and legal rules provide protection only when the situ- ations likely to be encountered can be anticipated and the ways of proceeding in each situation can be specified. When planning is difficult because of the complexity and uncertainty of the situations that might arise, other means must be found to protect stakeholder interests.

An Economic Approach to Corporate Governance The prevailing stockholder model of corporate gov- ernance is founded on an economic approach that conceives a firm as a nexus of contracts between a legal entity called the firm and its various con- stituencies, which include employees, custom- ers, suppliers, investors, and other groups. This approach begins with the assumptions that in a market, all individuals with economic assets—such as employees with skills, suppliers with raw mate- rials, customers and investors with money, and so on—would trade with each other in order to obtain a greater return, and that the greatest return will often be obtained by combining individual assets in joint production. That is, individuals will fre- quently realize a greater economic return by coop- erating with others in productive activity than by participating in a market alone.

* * *

The Role of Governance A firm requires many inputs. Economists classify these as land, labor, and capital, although they also recognize the need for managerial expertise to coordinate these inputs. Traditional stakeholder groups interact with a business organization or firm as input providers—employees providing labor, suppliers providing raw materials, and so on. Each input brings a return such as employees’ wages, suppliers’ payments, and investors’ interest and dividends. It is necessary in a firm for each input provider to secure their return, that is, to employ some means for ensuring that wages are paid, sup- plier payments are made, and so on. Generally, this security can be obtained by contracts or legal rules that obligate a firm to provide the return due to each corporate constituency.

Governance can be understood as the contrac- tual agreements and legal rules that secure each input provider’s claim for the return due on that

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operated for maximum profit. By contrast, the right of control is of little value to other input providers or stakeholder groups because their return is secure as long as a firm is solvent, not maximally prof- itable. In addition, the return on the firm-specific contribution of other, non-shareholder groups is better protected by other means.

That equity capital providers have control is in the best interests of the other stakeholder groups. First, everyone benefits when business organi- zations are maximally profitable because of the greater wealth creation. If firms were controlled by groups whose interests are served only by firms that are solvent, not maximally profitable, then they would create less wealth. Second, every non-shareholder group benefits when shareholders assume much of the risk of an enterprise because their return is all the more secure. Shareholders are willing to assume this risk—in return for some compensation, of course—because they are better able to diversify their risks among a large number of companies. Employees, by contrast, are very undiversified inasmuch as their fortunes depend wholly upon the employing firm. Third, with- out the right of control, equity capital providers would require a greater return to compensate for the increased risk to their investment. This in turn would drive up the price of capital, thus increasing the cost of production for everyone.

Firms can be owned by groups other than equity capital providers. Some corporations are employee owned, and others are owned by customers or suppliers (these are usually called cooperatives). Mutual insurance companies are owned by the policy holders. These forms of ownership are not common, however, because of their relative inef- ficiency. It is only under certain economic condi- tions that they would be preferred by the corporate constituencies involved.

The bottom line is that equity capital providers are usually (but not always) the shareholders of a firm, the group with control, because control rights are the best means for protecting their particular firm-specific asset. Each group has the opportunity

Despite the three problems of lock-in, com- plexity, and uncertainty, governance structures for the assets of each input provider are relatively easy to provide for each stakeholder group except one, namely shareholders, the providers of equity capital.

Shareholder Governance Although shareholders are commonly called the owners of a corporation, this sense of ownership is different from its ordinary use. Shareholders do not “own” General Motors in the same way that a per- son owns a car or a house. Rather, shareholders have a certain bundle of rights that includes the right of control and the right to the profits of a firm. . . .

Equity capital is money provided to a firm in return for a claim on profits—or, more precisely, for a claim on residual revenues, which are the revenues that remain after all debts and other legal obligations are paid. Just as customers buy a com- pany’s products, equity capital providers “buy” the future profits of a firm; or, alternatively, in order to raise capital, a company “sells” its future profits to investors. In addition, since future profits are risky, investors not only provide capital but also assume much of the risk of a firm. The willingness of share- holders to bear this residual risk—which is the risk that results from having a claim on residual reve- nues rather a fixed claim—benefits all other input providers. As long as a firm in solvent—which is to say that it can pay all its fixed obligations, such as employee wages, suppliers’ payments, and so on— then the claims of these groups are secure.

The remaining question, then, is why equity capital providers, who in effect “buy” the future profits of a firm and “sell” their risk bearing ser- vices, should also have control and thus the right to have the firm run in their interest. The answer is very simple: control is the most suitable protection for their firm-specific asset. If their return on the asset they provide, namely capital, is the residual earnings or profit of a firm, then this return is very insecure unless they can ensure that the firm is

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220 Chapter 5 Corporate Social Responsibility

group’s interest is mainly an empirical one about what works best in practice, and the evidence tends to support the prevailing stockholder-centered sys- tem of corporate governance.

Finally, insofar as stakeholder management assigns to managers the task of ensuring that the wealth created by a firm is distributed in a fair way that departs from the distribution that results from purely market forces, this task, too, is better done by other means, most notably through the politi- cal process. Managers lack both the ability and the legitimacy that are required to fulfill this task, and, in any event, the attempt to address pressing social problems by making changes in corporate govern- ance is ill-conceived. Corporate governance, which is designed to solve specific problems of economic organization, is simply the wrong tool, like using a screwdriver to hammer a nail.

What’s Right with Stakeholder Management Despite this generally negative appraisal of stake- holder management, it is still an important, con- structive development in business ethics. Its positive contributions are obscured to some extent by those who present it as an alternative form of corporate governance and thus create a false choice between stakeholder and stockholder management. Stakeholder management can be understood in a way that complements rather than challenges the prevailing system of corporate governance.

First, stakeholder theory rightly insists that the purpose of a firm is to benefit every corporate constituency or stakeholder group. The prevail- ing system of corporate governance may obscure this purpose by failing to emphasize that man- agement’s fiduciary duty to shareholders and the objective of shareholder wealth maximization are merely means to an end. These benefits result from the agreements that a firm makes with one input provider, namely shareholders. However, a firm also makes agreements or contracts with other constituencies, including employees, customers,

to seek the best protections or safeguards for their own interests, which is to say the return on the firm-specific assets that they provide to a firm. Usually, non-shareholder groups are better served by safeguards other than control, which is left to shareholders. This outcome is not only efficient but also morally justified because it best serves the interest of all stakeholder groups and results from voluntary agreements or contracts made by all the relevant groups.

* * *

Comparing Stockholder and Stakeholder Management Viewed in terms of an economic approach to the firm, stakeholder management offers managerial decision making as a means for protecting and advancing stakeholder interests. Insofar as it pro- poses that managers have a fiduciary duty to serve the interests of all stakeholders and that maximiz- ing all stakeholder interests be the objective of the firm, it seeks to extend the means used to safeguard shareholders to benefit all stakeholders. In short, stakeholder management proposes that all stake- holders be treated like shareholders.

The fundamental mistake of stakeholder man- agement is a failure to see that the needs of each stakeholder group, including shareholders, are different and that different means best meet these needs. The protection that shareholders derive from being the beneficiaries of management’s fiduci- ary duty and having their interests be the objective of the firm fit their particular situation as residual claimants with difficult contracting problems, but employees, customers, suppliers, and other inves- tors (such as bondholders, who provide debt that rather than equity) are better served by other means, which include contractual agreements and various legal rules. Management decision making is a rela- tively ineffective means for protecting the interests of non-shareholder stakeholders. In any event, the choice of means for protecting each stakeholder

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Second, corporate governance is concerned with how business organizations should be legally structured and controlled. The provisions that man- agement has a fiduciary duty to serve shareholder interests and that shareholder wealth maximiza- tion should be the objective of the firm dictate how decisions about major investment decisions and overall strategy should be made. They tell us very little about how managers should actually go about their task of managing a firm so as to create wealth for shareholders or anyone else. Everyone can ben- efit from the productive activity of a firm only if there is a vision for a creating a valuable product or service as well as a strategy for achieving this vision. . . .

Freeman and his colleagues (Freeman, Wicks, and Parmar, 2004, p. 364) describe stakeholder management as addressing this matter of what managers and other need to do to create wealth. They write,

Economic value is created by people who vol- untarily come together and cooperate to improve everyone’s circumstances. Managers must develop relationships, inspire their stakeholders, and create communities where everyone strives to give their best to deliver the value the firm promises.

The first sentence expresses the fundamental principle that firms exist to benefit all those who take part in them, which is shared with the eco- nomic approach. The second sentence is concerned with how managers should actually carry out their role. Left unaddressed, though, is who should have control of a firm and in whose interest a firm should be run. If, as the economic approach holds, the answer is the shareholders, then stakeholder management is not only compatible with stock- holder management but an essential complement.

Stakeholder management, then, as a guide for managers rather than a form of corporate govern- ance, provides a valuable corrective to managers who fail to appreciate how shareholder primacy benefits all stakeholders and use it a reason for

suppliers, and other investors, all for mutual advan- tage. When the assets contributed by these parties are firm-specific, they are accompanied by safe- guards that constitute forms of governance. The agreements between these groups and a firm create both moral and legal obligations that are every bit as binding as those owed to shareholders. In addi- tion, each stakeholder group, including managers, has an obligation to treat all others in accord with accepted ethical standards.

Although stockholder and stakeholder man- agement are agreed on the purpose of a firm—to conduct economic activity in ways that benefit everyone—there is disagreement on how this is done. In particular, the stakeholder view makes it a task of management to ensure that this outcome occurs, whereas on the economic approach, mutual benefit is a result of the opportunity each group has to make mutually advantageous agreements. That is, a firm works like a market in creating mutual benefit from the opportunity to trade. Just as a mar- ket achieves this result without any person direct- ing it, so, too, does a firm—in theory!

In practice, though, some stakeholders fail to benefit as they should from a firm’s activity. This may occur for a variety of reasons including man- agement’s willful violation of agreements, market failures, and externalities or third-party effects. For example, a company might fail to make expected contributions to a pension plan, sell a product to consumers with undisclosed defects, or operate a polluting factory. In general, it is the responsibility of government to prevent or correct for these possi- bilities, but managers, especially those at the top of a business organization, might also be held to have some responsibility. Stakeholder management asks managers to recognize that a firm should benefit all stakeholders, to be aware when it fails to do so, and to take some responsibility for correcting the prob- lems that lead to this failure. Just as we all have a responsibility to make sure that markets work as they should to produce a benefit for all, so, too, do we all, including managers, have a responsibility for ensuring the proper functioning of firms.

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stakeholder group is not achieving the full poten- tial of a firm. Source: John R. Boatright, “What’s Wrong—and What’s Right—with Stakeholder Management,” Journal of Private Enterprise 21, no. 2 (2006).

Note: References have been removed from publication here, but are available on the book website at www.mhhe. com/busethics4e.

disregarding other stakeholders. Such manag- ers commit a mistake of their own by confusing how a corporation should be governed with how it should be managed. There is no reason why man- agers who act in the interests of shareholders and seek maximum shareholder wealth cannot also run firms that provide the greatest benefit for every- one. Indeed, a manager who fails to benefit every

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