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07/24/2005

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Matt Burgess

Wes,

You are correct, of course, that when shareholders will tolerate sub-competitive returns charity is possible. Equivalently, shareholders could expect competitive returns and donate a portion of dividends (or paper value of shares) to charity.

The question, however, is whether companies should be expected or compelled to be charitable in spite of their owners' wishes, and we seem to be running out of reasons for why they should. What you have proposed for getting corporations to be socially responsible is either already in place or arbitrarily burdens companies with tasks we agree, I think, government is better suited for. Governments can and do pay corporations to deliver social services, but it does not follow that all corporations should follow suit, particularly in view of the mixed success of these programs.

Your story is most entertaining, however the performance of stock is measurable and can be compared to other investments. Company stocks have over time outperformed cooperative investment returns in at least some industries, so I question whether your theory has general validity. Even if you are right that management swindles shareholders when ownership and control is separated, you must explain why forms of organization that do not separate control and ownership, and presumably avoid management swindles you say exist and offer superior returns, have not proliferated in their place. The evidence, I think, is against you.

Palooka

"But you seem to beg the question of whether corporations should be aimed only at making money."

Corporations are using shareholders' money when they give to charity. The question becomes why the responsibility (if it can be considered a responsibility to give to charity) should be placed with management rather than with shareholders. There are only two suitable answers. One, that management will more efficiently and productively use those funds because they are more informed, and that a large percent of shareholders are happy with this arrangment (Posner's suggestion). The second reason, which I find unacceptable, is that one believes shareholders should be forced to spend more than they would on their own. This argument pressuposes that management has a right to extract profit from shareholders to further what management feels promotes "social justice" or "social responsibility." I don't see how that squares with management's fudiciary duty. In fact, I think it's a pretty clear violation of it.

If instead of charity management decides to increase dividends or invest further into the business, the shareholder will see either income increase or the value of their stock increase, both of which can be used at the stockholder's discretion to donate to the charity's which harmonize with their values. Unless you think those decisions do not belong to the individual, and that shareholders should be coerced through a sort of tax to give, then this sort of arrangment is clearly preferrable.

I would also like to address the concept of "implied consent." Though many investors are undoubtedly happy with management which gives to and supports charitable causes, I would venture to say a large majority of stockholders would prefer to make those decisions directly. This can no more be viewed as "implied consent" than if management was engaged in other violations of their fiduciary duty. Just because individuals continue to buy a stock does not mean they support the specific action. Management is using their position, then, to extract a premium from stockholders, which of course violates their fiduciary duty just as if managment recklessly spent company money on personal expenses (Tyco, for example). Many investors most certainly knew of Kozlowski's extravagance (though perhaps not his criminal extravagance), but that is not to say they impliedly consented to it. All an investor is saying when they purchase a stock is that they think, on balance, it's a good investment, a value. Management, however, always has the ethical duty to eliminate violations of their fiduciary duty, even if their stock price is soaring.

Palooka

I would like to point out that I do not believe the ethical responsibilities of corporations end with obeying the law. I only mean to attack the premise that for profit corporations should double as philanthropic ones.

Chris

Palooka,

I don't disagree with much here. I would construe the fiduciary duty, though, as the duty to act in the interest of the stockholders; this may include acting responsibly in a variety of ways, as well as not wasting their money.

Also, it might not always be the case that fulfilling philanthropic or other moral responsibilities is always best accomplished when separated from profit-making aims. As Posner points out, there might be synergies there.

Bernard Yomtov

you must explain why forms of organization that do not separate control and ownership, and presumably avoid management swindles you say exist and offer superior returns, have not proliferated in their place.

That's pretty easy. The advantages of the corporate form outweigh this particular disadvantage. Enabling investors to hold very small ownership positions with limited liability makes it much easier to raise capital, both because the investor's risk is reduced and because the existence of many shareholders simplifies the trading of stock, thus increasing the investor's liquidity.

Your question presumes the possibility of a generally superior form of business organization. What do you think it is?

Wes

Company stocks have over time outperformed cooperative investment returns in at least some industries, so I question whether your theory has general validity.Imagine a type of long-term lottery where lottery tickets are sold by the government at the beginning of the year, traded by the public on an open market over the course of the year, and possibly chosen as the winning ticket in a series of government controlled drawings culminating at the end of the year.In terms of money flow between the government and the public, money would go from the public to the government in the initial sale and it would go from the government to the public in the drawing at the end of the year. The interesting thing, however, is that even if the net flow of money was from the public to the government (ie. the government made a profit), one would still see demand / positive prices for lottery tickets on the open market over the course of the year.Getting back to corporations and the stock market, the lottery example makes it clear that as long as there is even just the expectation that dividends will be paid in the future, then there will be demand / positive prices for stock even if the overall system results in a net flow of money from the public to corporations.In fact, in societies where people are accumulating savings (ie. not in major recessions), stock prices would be likely to rise over time due to increasing demand even if expectations of dividend payment remained unchanged. This means that it is possible to claim "positive performance" for the stock market even in situations where there is actually a net flow of money from the public to corporations.In reality stock prices reflect a number of factors. Some corporations do pay real dividends but prices are also elevated by the lottery / gambling effect and, of course, sentimental considerations (eg. being able to say "I own Microsoft.") are very important in the real world.Even if you are right that management swindles shareholders when ownership and control is separated, you must explain why forms of organization that do not separate control and ownership, and presumably avoid management swindles you say exist and offer superior returns, have not proliferated in their place.People who really own and control successful corporations do actually give themselves all the profits / value and become fabulously wealthy as a result. As to why stockholders are not given these fabulous returns, the short answer is that they are lenders who have to compete with interest rates set by the government. Although the money a corporation gets from stockholders has the advantage of not needing to be repaid on a fixed time schedule, at most that would be worth a few extra percentage points above the rate a corporation could get on something like a bank loan or a corporate bond.For all real intents and purposes, stockholders are lenders - except without the right to require repayment of their loans.

Matt Burgess

"That's pretty easy. The advantages of the corporate form outweigh this particular disadvantage."

That's my point. There is competition between ways to organize production. That investors choose corporations over rival forms of business organization tells you shareholders are getting a good deal.

"Your question presumes the possibility of a generally superior form of business organization. What do you think it is?"

I had co-operatives, and franchised owner-operators in mind.

Palooka

"I don't disagree with much here. I would construe the fiduciary duty, though, as the duty to act in the interest of the stockholders; this may include acting responsibly in a variety of ways, as well as not wasting their money."

Yes, that is a good definition. But what is in the "interest" in stockholders is pretty much an unanswerable question with regards to "social responsibility." Profit, on the other hand, is a little simpler. Again, when decisions can be made by the stockholders themselves, why not do it? Maximize shareholder value, something every shareholder desires, and let the shareholder decide how to best promote "social responsibility."

Posner's suggestion that corporations are more suited to finding the best charities would partly justify "social responsibility" among corporations, but I simply do not think it is correct, for a number of reasons. It is, however more palatable than the rationale I have discussed, which is a coercive one.

Bernard Yomtov

Matt,

Sorry. I misunderstood what you were getting at. However, if I may raise another issue, I don't think it's accurate to discuss corporate social responsibility strictly in terms of charitable activities. That's obviously the easiest one for "Beckerites" to deal with. "If you think the company should donate more to the Red Cross then donate some of your dividend yourself."

I think the bigger question has to do with things the shareholders cannot do themselves. Consider my example of pollution, posted at 6:09 yesterday. This sort of thing has to be decided at the corporate level. And I think to say that the manager who makes the decision is required to consider only the shareholders' financial interests is wrong.

BTW, it is not the case that a firm that incurs expenses in order to conduct its business in a socially responsible fashion will necessarily fail. It will earn lower profits than otherwise, and the value of its equity will fall as a result, but that does not mean it cannot survive.

John Kelsey

One interesting question (to me, anyway) is how often attempts to be socially responsible on the part of some corporation, perhaps in response to social or shareholder pressure, actually do some harm. My least favorite example of this was the story of Nike being convinced by bad publicity to stop employing teenaged girls in sweatshop conditions in Thailand. Nobody seemed to publically wonder what other jobs were available for poor teenaged girls in Thailand....

Sometimes, pursuit of profit makes you do worse things than you might otherwise have done, but sometimes, it makes you do better things. Would a socially conscious company in 1920 employ blacks to do "white mens' work?" How about a company run by ruthless capitalists?

--John

Palooka

"However, if I may raise another issue, I don't think it's accurate to discuss corporate social responsibility strictly in terms of charitable activities. That's obviously the easiest one for "Beckerites" to deal with. "If you think the company should donate more to the Red Cross then donate some of your dividend yourself."

True enough. I find myself much less opposed to corporate "social responsibility" when it comes to business activities, like reducing pollution beyond legal requirements or providing a work place which is safer than legally required (as opposed to activities as I think of beyond the scope of what they should concern themselves with, e.g. philanthropic causes). But it's important for a company to maintain its reputation, and conducting business in an ethical (and not merely legal) way helps do that. It's also wise to error on the side of ethical rather than only legal lines because that helps reduce (at least usually) the probability of lawsuits.

JS

Sad news about the death of Jack Hirshleifer.

http://levine.sscnet.ucla.edu/General/hirshleifer.htm

Matt Burgess

Bernard,

Corporations exceed minimum legal requirements in many areas, consistent with being "socially responsible" as seems to be understood here, because this raises shareholder value. However, the debate concerns whether corporations should go further and reduce shareholder value in the name of being responsible. I am using "charitable" to isolate only management activity that destroys shareholder value in pursuit social objectives. A decision not to pollute a river when it would be unprofitable to do so is not charity under this definition.

Your water example is instructive. Whether it is legal to pollute water or not is not the end of the matter; it may still be in shareholders' interests for the firm not to pollute the water. Pollution may cause the introduction of costly regulation; the firm's reputation among customers or employees may suffer costly harm; the firm may annoy a neighbor who can retaliate, etc. Thus the manager's decision to pollute is wider than you appear to believe.

The question then is whether the firm should pollute when, after all these things are considered, it is still in it's shareholders interests to do so. My answer is, "it should" for three reasons. First, the pollution may be efficient i.e. net social benefit exceeds cost. Second, environmental standards among countries vary; they are lower in poor countries. As Becker notes with respect to wages, the Third World is generally not helped by slapping First World constraints on companies operating there. Third, if the pollution is in fact not efficient, it is incumbent on the local government to set or enforce laws to correct this. Relying instead on company goodwill merely penalizes and possibly excludes responsible companies and rewards polluters.

Shareholders who disagree are free to pull their money out and invest elsewhere, or vote to replace their board.

It is worth mentioning, I think, that local and foreign direct investment is overwhelmingly concentrated in countries with strong laws and enforcement.

"...it is not the case that a firm that incurs expenses in order to conduct its business in a socially responsible fashion will necessarily fail"

A firm that is unable to earn a competitive return has no long term prospect of survival unless it can attract investors willing to accept lower returns. For-profit investors will not invest in a firm they can achieve higher returns elsewhere. Charity, as defined here, will be lost in noise provided it is small enough, of course, but the basic point that charity is not sustainable under competition stands.

Thomas

Matt is mostly right when he says that "The question then is whether the firm should pollute when, after all these things are considered, it is still in it's shareholders interests to do so." That's half of it. The full question is whether the firm should pollute when 1) it's in shareholder interests AND 2) it is actually socially irresponsible. (Whether social irresponsibility is ever in anyone's interest is an interesting question for another day, for now, let's assume it somehow can be.) So Matt's first two responses (net social benefit despite harms & meddling hurts the third world more than it helps), which both suggest how polluting might actually be the socially responsible thing to do after all, are as off point as his critics who suggest that social responsibility can be the path to financial success. Attempts on both sides to fight the hypothetical are charmingly irrelevant. But perhaps forgiveable, as Becker made the same mistake decrying abritrary wage increases in developing nations. Funny, Becker's basically saying that such wage increases would be socially irresponsible. Is that altogether consistent?

Thomas

Since the hypos are getting so muddy, here's some more to play with: Should a corporation engage in slavery, murder, genocide, or even, dare I say, violations of widely recognized intellectual property rights if it furthers shareholder interests and happens not to be against the law?

A strict reading of Becker's original rule suggests they should. Thoughts?

Jim S

Several posters note that companies are obliged to obey the law. Let's be honest and admit that in today's America if the company doesn't like a law they just get it changed if they can figure a way around it.

Costco does have much better employee retention than Wal-Mart or Sam's Club. The experienced employees that they have also put in more hours than many Wal Mart employees. What kind of advantage does that give them? Well, for one I'm probably going to go join Costco and if I can get what I need from them with better service the Sam's Club membership will probably go bye-bye.

Matt Burgess

Thomas,

Much of the disagreement in these debates turns on unanswerable questions of what "social responsibility" means and how much of it is right, which I think is the gist of your first post. It is simply unworkable as a yardstick for anything.

Re: your second post, even if a company could convince it's employees to enage in such behavior and it's suppliers and consumers to still deal with it, the company must still operate consistent with it's owners' values, whatever they are. A goal of value maximization obviously need not be to the exclusion of everything else. You have misunderstood Becker's point.

zhi yuan

Yes, they have no obligation to do this,
but I think we should advocate that those corps should take this kind of responsibility.

--- a chinese reader

Thomas

Matt -

On Post 1) Definitions can be tricky, agreed. So I'm happy to stay away from the more devious semantic particulars. But if your examples of Social Responsibility incur great social harms, and if your descriptions of Social Irresponsibility offer grand benefits, I suspect something's gone so grossly wrong and it needs addressing. (Consider Pollution leading to greater efficiency; Arbitrary Wage Increases leading to intellectual drains - is it right to call the former socially irresponsible, or the latter socially responsible?)

On Post 2) Misinterpretation is the hallmark of my career. To avoid misreading, let's look to Becker's exact formulation:

"Do corporations have ANY responsibilities beyond trying to maximize stockholder value, adhering to contracts, implicit as well as explicit, and obeying the laws of the different countries where they operate?" (emphasis mine)

You offer an obligation to "operate consistent with it's owners' values, whatever they are," which may not be very substantive, as owners can have any values they choose. And if it is substantive, it seems like a departure from Becker.

So even with your extra-Becker caveat (which I'm still not sure counts), I'll put the question more directly: If owners value slavery as a-ok and laws chance to permit it and it's not contrary to stockholder interest, what part of Becker's original formulation allows us to criticize them? Genocide? (Recall American plantation owners, or IBM's somewhat disputed role in the Holocaust if you think these examples are too implausible.)

Eh Nonymous

Nice post.

As someone said, "Costco" - but I think Costco proves your point, not challenges it.

You echo thoughts I'd had in law school - that the long-term maximization of SH value is not through rapacious cost-cutting and downsizing and reckless competition alone, but by true selfishness (Rand, as properly understood):

there is nothing more competitive and selfish than getting what you want, even if you must give others what they want in the process.

This is the pinnacle understanding of negotiation, and perhaps of politics and economics as well.

For example, Henry Ford tried to ensure that his own workers could afford his cars. The Dodge folks insisted that this did not maximize SH value. I say, which shareholders?

If employees are shareholders, improving their lot obviously implies conflicts-and-cooperation of interests. If employees are the public face and one of the main focuses of the company, then the positives flow quite obviously: word of mouth, free advertising, higher work ethic, public approval, less burden on the government's safety net.

If employees are cogs or tools or depreciating assets, on the other hand, you get GM, or worse, United, or worst of all, Unisys (promises made to former employees are vitiated by later professional managers unfamiliar with culture, custom, implicit and explicit contract, and with no ties to the retirees).

Bernard Yomtov

The question then is whether the firm should pollute when, after all these things are considered, it is still in it's shareholders interests to do so. My answer is, "it should" for three reasons.

First, the pollution may be efficient i.e. net social benefit exceeds cost.

First, there's no way to know this. Second, the utility argument just doesn't work when all the benefits flow to the shareholders, and all the costs to the local residents. It also ignores the notion of marginal utilities. Even if you could show a net social benefit on a pure financial basis, that doesn't make it efficient. Most important, your position does not seem to rest on this at all. You do not claim, "It's OK if it's legal and efficient." You claim "It's OK if it's legal."

Second, environmental standards among countries vary; they are lower in poor countries. As Becker notes with respect to wages, the Third World is generally not helped by slapping First World constraints on companies operating there.

Irrelevant. The point is that people are harmed. My hypothesis is clear that there is no regulation, and does not address the question of why this is so.

Third, if the pollution is in fact not efficient, it is incumbent on the local government to set or enforce laws to correct this. Relying instead on company goodwill merely penalizes and possibly excludes responsible companies and rewards polluters.

Again, irrelevant. This utterly disregards the issue. Who knows why the government does not make sensible rules. Perhaps it is corrupt, or ill-informed. So what. The question is what the company should do in the absence of such laws. You cannot justify unethical behavior by arguing that there should be stricter rules against it. Unethical is unethical.

The essence of your case, I think, is that making money for the company trumps all other considerations for the manager of a firm, so long as no lawbreaking is involved. I think Thomas' post about slavery etc. characterizes the ultimate consequences of this position well.

Shareholders who disagree are free to pull their money out and invest elsewhere, or vote to replace their board.

If they are aware of the practices they are free to invest elsewhere. Does that make it OK for the others? Just because lots of shareholders don't object to the practice does not make it ethical. And as you surely know it is virtually impossible for shareholders to vote out the board, so perhaps we can leave that option as a purely theoretical notion, with zero practical value.

A firm that is unable to earn a competitive return has no long term prospect of survival unless it can attract investors willing to accept lower returns. For-profit investors will not invest in a firm they can achieve higher returns elsewhere. Charity, as defined here, will be lost in noise provided it is small enough, of course, but the basic point that charity is not sustainable under competition stands.

Yes. It must attract investors willing to accept lower returns. But not all investors in the firm must be willing to do so. To take a simple example: suppose I am the sole owner of a "socially responsible" firm, and hence make less profit than my competitors. This in itself does not mean my firm cannot survive indefinitely, just that I will earn less money than my competitors.

Now suppose I need to raise capital for some reason. First, I may find investors who share my values, so the problem is solved. But if I don't I can still survive by offering shares at a lower price than my competiton, hence providing investors with a competitive return. Clearly, this can't go on into infinity if I continually face this problem. But there is nothing that says I will. And it can go on for quite some time.

Matt Burgess

Thomas

"You offer an obligation to "operate consistent with it's owners' values, whatever they are," which may not be very substantive...if it is substantive, it seems like a departure from Becker."

I think it is substantive when talking about your example of genocide. I doubt many shareholders would be comfortable earning a return from mass murder. It is not a departure from Becker because he mentioned implicit contracts. Even if it is not explicit in their employment contract, shareholders will not endorse a manager who murders in pursuit of a profit when it violates their values. That is a substantive constraint on managers.

"If owners value slavery as a-ok and laws chance to permit it and it's not contrary to stockholder interest, what part of Becker's original formulation allows us to criticize them?"

Becker's formulation mentions implicit and explicit contracts. Firms have implicit and explicit contracts with government, consumers, suppliers and employees. Slavery, I would hope, is a breach of at least some of those contracts. Thus, even without legal restrictions, shareholders are constrained in the pursuit of their interests under Becker’s formulation.

Bernard Yomtov

shareholders will not endorse a manager who murders in pursuit of a profit when it violates their values. That is a substantive constraint on managers.

Fair enough. Does this apply only to murder, or to homicide in general? Suppose the manager's action results, predictably, in the death of some number of people. That is, suppose that the disposal of waste measurably shortens the life span of local residents. How does that fit with your previous arguments, again assuming no law is violated? If shareholders do not object, possibly because they do not understand the details, does that matter? Are managers allowd to kill in the pursuit of profits if shareholders don't object?

Matt Burgess

Bernard,

"Are managers allowd to kill in the pursuit of profits if shareholders don't object?"

Doesn't my earlier response cover this? A manager that breaches the values of his shareholders isn't going to be employed by them. And you are ignoring other constraints on company behavior.

There isn't a part of your 1:45pm response I agree with. Net social benefit of pollution can be measured. The benefits of polluting need not accrue only to shareholders. I certainly do not claim the only question is legality. For obvious reasons, developing countries are more willing to tolerate pollution in exchange for investment, and this is relevant to the ethics of polluting. In "making money" a company is subject to more constraints than buying low, selling high and following the law. And companies will face "this problem" (last para) for precisely as long as they are charitable and earn less than competitive returns.

Underpinning your response is a view that shareholders' ethics are wrong and somebody else's (yours?) are right. Please justify this.

Anonymous

Yomtov -
Profit is an anomaly. If you're operating with lower returns than the competition, be it through your commitment to SR or otherwise, you should be operating at a loss, and will eventually run out of money. If you're breaking even or making a profit, and the industry average is even better than you, then why aren't firms flooding this profitable industry, increasing costs associated with competition and reducing margins until they disappear?

Yes, it occasionally happens in practice. But that doesn't mean it's really sustainable.


Matt - greatest respect for fighting off several antagonists at once. But you seem well equipped for the task, so here's my next volley.

"I doubt many shareholders would be comfortable earning a return from mass murder."

I suspect history indicates otherwise, and predictably so. As you've so astutely noted: you can't simply rely on goodwill in open competition and hope for the best. (Consider IBM's role in the holocaust, ColTan mining, the trade of blood diamonds...).

But those examples all have complications, so let's just say you're right and it's crazy unlikely: in those few situations where stockholders, buyers and suppliers are complicit, can we sanction gross immorality by a company?

You claim that we can sanction our devilish firm's immorality, citing Becker's "implicit contracts" clause. I have two main concerns with this response.

1) If corps have "implicit contracts" with their stockholders to be basically moral, and if Social Responsibility is just an extension of basic morality, then haven't we just let SR in through the window of implied contracts? Surely Yomtov feels exactly as you do, that it's implicit in his contracts as a stockholder that the firm be basically moral. And basically moral for him includes Social Responsibility.

2) If your behavior is immoral, it doesn't matter what kind of stockholders you have. If you're being immoral, then you're wrong simply because you have a duty not to be immoral. It's not magically mitigated when the people who own your company (or anyone else you contract with) turn out to be real bastards as well.

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