The Issue Whether corporations should be allowed to pursue shareholder wealth without any responsibility to consider the interests of the broader society.
Over the last decade, an energetic "corporate social responsibility" (CSR) movement has emerged. Although the movement has been much more noticeable in Europe, it has begun to attract attention in the United States as well. "CSR" is premised on the notion that the responsibility of a corporation extends beyond providing financial returns to its shareholders. Instead, CSR proponents have argued, the legitimate concerns of a corporation should include such broader objectives as sustainable growth, equitable employment practices, and long-term social and environmental well-being. Corporate managers should consider not only their shareholders in making their decisions but also a variety of "stakeholder" constituencies, including employees, residents of communities affected by their activities, governments, and organizations advocating for various social and environmental interests.
Underlying these arguments is a major international debate about the nature of the corporation. Legal scholars commonly divide the corporate world into two spheres: the Anglo-American and the continental European. The United States and Britain both have well-developed securities markets with broad-based, dispersed share ownership, in contrast to Europe and Japan, which feature ownership by families, dominant shareholders, or banks. Britain and America also both depend on financial transparency, stock market valuations, and the takeover market to promote managerial accountability
Inhabitants of the two spheres are thought to make different assumptions about corporate goals. In general, the Anglo-American approach requires corporate managers to focus on Ashareholder value," while the European approach includes a broader class of "stakeholders" -- employees, creditors, suppliers, communities, and even the environment -- within the ambit of managerial concern.
CSR advocates demand that companies go beyond the creation of shareholder wealth in pursuit of such broader objectives as sustainable growth, equitable employment practices, and long-term social well-being. The CSR movement has pursued these objectives both directly, by arguing for substantive changes in corporate behavior, and indirectly, by promoting social and environmental disclosure in the hope that shareholders will eventually force the desired substantive changes. In many countries, most notably the United States and the United Kingdom, CSR advocates have grappled with the daunting task of persuading the corporate and legal communities to move from a narrow focus on shareholders' immediate financial returns to a broader measure of corporate well-being, what could be called "stakeholder value."
What People Are Fighting About
Few people will disagree publicly with the idea that corporations should behave in a legal and ethical matter. The problem lies in translating that apple-pie sentiment into concrete behavior. Many continental European countries have legislated the stakeholder theory into action. They require such measures as employee representation on corporate boards and consultation with labor about mergers and acquisitions, in addition to detailed reporting on a variety of social and environmental issues. The European Union has made a commitment to "sustainable growth," although to this point it remains largely rhetorical.
What's At Stake? Whether financial markets, as currently structured, adequately assess the long term social and environmental consequences of business decisions.
In the United States, the shareholder-value theory remains ascendant. Corporate managers are answerable to the shareholders who own the company. Most of them believe-and are advised by their lawyers--that their duty to shareholders is to do whatever the law permits to enhance profitability, and thus share value, in the relatively short term. They believe that it is proper to attend to social and environmental issues only (1) to the extent required by law or (2) if such issues will have a material financial impact on the company. In practice, this definition of corporate responsibility has meant little more than trying to avoid highly publicized disasters.
CSR proponents are now facing the difficult challenge of moving U.S. corporations beyond their narrow focus on financial returns. American voters are generally more conservative than their European counterparts in this context, unions exert far less influence here, and the low growth and high unemployment that plague the continental economies are not prompting calls for emulation among American politicians.
An answer may lie just a few miles across the Channel, in the United Kingdom. Despite the traditional alignment of British and American corporate values, the U.K. is beginning to diverge from the American model in pursuit of a long-term "enlightened shareholder value" perspective. Although this perspective incorporates some significant elements of European stakeholder theory, its key element is a focus on longer-term economic issues, which brings it much closer to U.S. mainstream investment thinking. The strategy is (1) to extend investors' time horizons and then (2) make the case that a company's social and economic performance is likely to become financially material. On a practical level, the relative robustness of the British economy makes the theory more palatable to U.S. lawmakers.
This movement toward enlightened shareholder value thinking in the U.K. has been driven in substantial part by interests that can be loosely characterized as elements of the CSR movement. These interests include the British government; large institutional investors, particularly pension funds and insurance companies (which are increasingly concerned about climate change and other long-term environmental risks); and nongovernmental organizations. The pressures that such institutions bring to bear have yet to be felt anywhere near as strongly in the United States-a recent survey revealed that NGOs are mentioned far less often in The New York Times than in leading British papers
The growing influence of CSR thinking concerning the disclosure of environmental and social risk came very close to scoring a major legal victory in the U.K.. On March 21, 2005, the British government issued regulations that required 1,290 British-based companies listed on the London Stock Exchange, or on the New York Stock Exchange or NASDAQ, to publish an annual Operating and Financial Review and Directors Report ("OFR"). The OFR, which was the culmination of a decade-long process of prestigious commissions examining corporate governance, required companies to identify, consider, and disclose material social and environmental risks. By contrast, the U.S. government requires disclosure of such risks only if they rise to the level of present financial materiality.
In a shocking policy reversal, the Blair government withdraw the OFR regulations in late November, 2005. Nonetheless, British companies are gravitating toward OFR-like disclosure norms as a matter of "best practice", and U.S. companies may well do the same as a (rare) positive side effect of globalization. Given the influence of the London Stock Exchange on global capital, and the power of British NGOs to move world public opinion, it may simply prove more efficient for multinational companies-including those based in the U.S.-to live up to British standards. But even if such enhanced disclosure does become the rule, the question will remain whether it makes any difference. In other words, will companies that disclose more behave better?
The answer will lie in the hands of the shareholders to whom corporate managers must answer. At a practical level, "shareholders" really means "institutional shareholders." In both the U.S. and the U.K, institutions such as pension funds, mutual funds, and insurance companies own a majority of the value of publicly traded shares. Their attitude toward CSR is both effect and cause-a measure of how seriously CSR is taken, and a powerful signal to other investors about the view that they should take. Thus, the ultimate test will be whether institutional investors in the U.S. will factor social behavior into their investment decisions, thereby exerting pressure on companies to modify their behavior.
In the U.K., pension funds and insurance companies, which are necessarily focused on the long term, are the dominant institutions. The American institutional sector, by contrast, is also heavily influenced by mutual funds, which may have a shorter-term outlook. Investors with a longer-term perspective are more likely to see a company's social and environmental behavior as material to investment decisions. Building on this openness to longer-term considerations, the British government has sponsored a series of "best practices" codes for institutional investors that urge-but do not yet require-them to "intervene" in the companies whose stock they own, by voting or otherwise, when doing so might enhance the value of the investment. Several important institutional investor organizations have also adopted codes that call on members to demand increased corporate disclosure on both financial and CSR issues, and to engage in discussions with companies whose approach to CSR is problematic.
It is important to remember that the investment decisions of pension funds are made by trustees and managers who owe a fiduciary duty to their beneficiaries. In the U.S., many of those in the huge pension fund sector of the institutional community argue that American fiduciary law does not require them to think beyond the short-term bottom line, and may in fact prohibit them from doing so. The closest thing to an authoritative legal statement of a pension fiduciary's proper approach to social and environmental risk is a pair of Interpretive Bulletins from the Department of Labor, which regulates private pension funds under ERISA. They do little to clarify the issue, however. They warn that investments with social purposes "will not be prudent if it would be expected to provide the plan with a lower rate of return than available alternative investments with commensurate degrees of risk," and permit monitoring of management where it "is likely to enhance the value of the plan's investment." Curiously, during the British debate over the proper role of institutional fiduciaries, the weakly-worded Interpretive Bulletins were hailed as a strong endorsement of stakeholder activism. In the United States, however, they are often seen more as an impediment than a mandate. Public employee pension funds are governed on a state-by-state basis under the common law of trusts, which is equally ambiguous.
A Progressive Perspective
In an ideal world, stakeholder thinking would reign. Corporate managers would be required by law to attend to the concerns of employees, residents of affected communities, local governments, and advocates for such broader concerns as economic justice and environmental sustainability. In the real world of early-21st century America, however, the stakeholder theory of the corporation is highly unlikely to become law anytime soon. Shareholder value thinking is too deeply entrenched, and the available role models are not terribly appealing from a political point of view.
Decisions on the Table + Whether to mandate disclosure of social and environmental risks that may materially affect a company's financial performance in the mid- or long-term.
+ Whether states and the Department of Labor will take the lead in clarifying that consideration of the mid- and long-term risks associated with corporate decisions is both consistent with and required by institutional investors' fiduciary duties.
But this does not mean that American corporations cannot be brought around to a more stakeholder-friendly outlook. The key to accomplishing this goal is to focus on risk, putting this traditional and well-understood concept to a novel use. A good starting point would be federal legislation modeled on the U.K.'s OFR. In addition to traditional financial disclosures, companies would be compelled to consider and disclose social and environmental risks that might have a material impact on their financial performance. If a company failed to disclose a foreseeable social or environmental problem (an Exxon Valdez incident, for example) and the foreseeable event occurred, causing an attendant decline in the company's stock price, the company and its managers could be liable for securities fraud. This liability might prove a more powerful disincentive than the threat of regulatory fines.
More importantly, perhaps, institutional investors might actually use this additional information on foreseeable social and environmental risks. If this information disclosure is to be effective, the law must be clarified so that institutional trustees and their lawyers understand that it is legal for them to look beyond the short-term bottom line. The Department of Labor should reissue its crucial Interpretive Bulletins to make clear that mid- and long-term social and environmental risks can be viewed as material to the financial quality of investments. Since public employee pension funds are the single largest category of American investors, state fiduciary law must undergo a parallel clarification. Because case-by-case change in the common law proceeds at a glacial pace, state legislatures must take the lead.
Even if these legal prerequisites are satisfied, the desired change will ultimately depend on private action by institutional and other large investors. Corporate managers will take social and environmental risks seriously when they conclude that inattention poses the kind of risk to share values that will put their jobs in jeopardy. By threatening to sell their holdings, institutional shareholders can demand change from those who manage the companies in which they are invested. Such quid pro quos fuel the changes that are underway in the U. K. A few public pension funds in this country (most notably the enormous California Public Employees Retirement System) have exerted this kind of pressure on selected issues, but the jury is still out on how effective their actions will prove. The American institutional investor community must be persuaded that its self-interest is best served by following these British examples.