July 24, 2005 to July 31, 2005
The Social Responsibility of Corporations
Do Corporations Have a Social Responsibility Beyond Stockholder Value? BECKER
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? My answer is "no", although maximizing value, meeting contracts, and obeying laws help achieve many of the goals by those claiming corporations should be "socially responsible" by taking care of the environment, considering the effects of their behavior on other stakeholders, and contributing to good causes. Still, laws and contracts, and individual use of their own resources, rather than corporate behavior, should be the way to implement various social goals.
References to the behavior of corporations really mean the behavior of top management who are in essence employed by stockholders through their representatives-boards of directors. In most cases, it is rather obvious that management should try to increase stockholder value through their pricing policies, the products they offer, where they locate plants, and so forth. CEO's who fail to do this are subject to termination either through takeovers or by being fired. In fact, the tenure of corporate heads seems to have become shorter over time.
In many other situations, apparent conflicts between maximizing stockholder value and social goals disappear on closer examination. A corporation may give money to local charities, play up its contributions to the environment, and do other things that appear to reduce shareholder value because that sufficiently improves the government regulations that affect their profitability. Or a company may give to various public causes, like Ben and Jerry's ice cream company did in the past, because this attracts customers who want to support these causes partly by buying the products of companies that make contribute to these causes.
Treatment of employees that on the surface appear to reduce profitability often are in fact consistent with the criteria of maximizing stockholder value while respecting laws and contract. For example, a company may raise the value to shareholders by keeping on older workers beyond the age where their productivity is sufficiently high to justify their earnings because that attracts younger workers at lower wages since they expect too that they will not be let go when they get older. Or employees may invest in their on the job training because of an explicit contract or implicit agreement with their employers that their earnings will rise with their tenure as their productivity rises because of their investments. It would be inconsistent with my criteria if a company did not raise wages appropriately of some employees when their tenure and productivity increased because the company realized that these employees did not have good opportunities at other companies. This behavior would violate my recommendation that a company maximize stockholder value, subject to obeying all laws and contracts, implicit as well as explicit.
To take an example of what I do not believe companies should do, a global company operating in a poor country should not pay higher wages for either adult or child labor, adjusted for the quality of the labor, than is the prevailing standard in the labor market of this country, as long as higher wages would lower the profits of the company. I am assuming the wages they pay do not violate any laws or contracts of the countries where they operate, and that they are not subject to such bad publicity that their profits actually would increase if they paid more. I should add that pressure to pay much higher wages in labor markets of developing nations reduces the number employed there by international companies, and would tend to worsen, not improve, the plight of the poor populations of these countries.
Even in cases where this does not contribute to profitability, top management may want to use company resources to promote environmental ends that are not required by law, give to local symphonies, promote fair trade coffee or other fair trade products, and engage in other acts that increase the managers' utility, prestige and standing in their communities. In a competitive market for managers, management would have to take sufficiently lower earnings, bonuses, and options to in effect pay for the company assets and profits they use to boost their own welfare and community standing. So in such a competitive management market, management essentially engages in "socially responsible" behavior out of their own earnings. This would not lower stockholder value, and is consistent with my criteria.
If the management is entrenched, they might be able to give away resources to environmental and other groups without lowering their own earnings, but by lowering instead dividends and other payments to stockholders. Even this, however, would not affect stockholder returns if instead management could have taken higher earnings, bonuses, or stock options for themselves. Depending on what they would have done with their higher earnings, the use of company profits for particular social causes may or may not lead to better overall outcomes. But surely an important goal of any reform in corporate management is to reduce the entrenchment of management, and inject more competition into the market for CEO's and other top corporate leaders.
Whatever the degree of competition in the market for top management, the market for stock ownership is highly competitive. Those stockholders that want companies to use potential profits for environmental or other social causes might be willing to buy the stocks of companies that do this, even if that means lower monetary rate of return on their investments. If there are enough of these stockholders, then companies that engage in these practices would be maximizing stockholder values, and their behavior would be consistent with the criteria for corporate behavior that I advocate.
But such socially conscious stockholders are a small fraction of all owners of stocks, especially of large institutional funds and investors. These funds would avoid companies that are "socially responsible" until prices of the stock of these companies fell sufficiently to give the same risk-adjusted monetary rate of return provided by companies that do not engage in social behavior. This implies that new companies that are expected to contribute to various social goals beyond making profits, and respecting laws and contracts, will have lower IPO prices if they issue stock than they otherwise would have. In that case, the founders of socially-minded companies will bear the cost of their social responsibility. That is appropriate and is not objectionable. I am bothered only when managers, founders, or others in control of corporations that behave in a "socially responsible" manner try to pass the cost of behaving in this way on to others rather than bearing the costs themselves.
The Social Responsibility of Corporations--Posner's Comment
I agree with almost everything that Becker says, but will suggest a few qualifications. I can think of one situation in which "pure" charitable donations by corporations, i.e., donations that do not increase profitability, could benefit shareholders. Assuming that most shareholders make some charitable donations, they might want the corporations they invest in to make modest charitable donations on the theory that a corporation will have more information about what are worthwhile charitable enterprises than an individual does. For example, charities differ greatly in the amount of money that they spend on their own administration, including salaries and perquisites for the employees of the charity, relative to the amount they give to the actual objects of charity. Presumably corporations are in a better position to determine which charities are efficient than individuals are; if so, then shareholders may impliedly consent to some amount of charitable giving by their corporations. But not much. The reason is that one person's charity is another person's deviltry: a shareholder who is opposed to abortion on religious grounds would be offended if his corporation contributed to Planned Parenthood. The practical significance of this point is that corporations avoid controversial charities, so that the issue of implied consent becomes whether the shareholder would like his corporation to make a modest contribution to some set of uncontroversial charities.
For the reason suggested above, the answer may be "yes"--and for the additional reason that there is a tax angle. If the shareholder receives a dividend, the corporation will have paid corporate income tax on the income from which the dividend is paid. Suppose the corporation and the shareholder are both in the 20 percent bracket. The corporation earns $10, pays $2 in tax, and gives the shareholder $8. The shareholder gives the $8 to charity, which costs him $6.40, since he gets a 20 percent tax deduction. If the shareholder wants the charity to have $10, it has to dig into his pockets for another $2, which costs him $1.60 (because of the 20 percent deduction), and so the total cost to him of giving the charity $10 is $8. Now suppose that, instead, the corporation gives the $10 to charity, a deductible expense, at a cost to it therefore of $8. Then the charity receives $10 rather than, as before, only $8. The shareholder loses his $2 deduction, which means that the total cost to him of the transfer is, as before, $8. But the corporation is better off to the tune of $2, since it avoids the corporate income tax on the $10 in income that it gave the charity. And anything that benefits the corporation benefits the shareholder.
Given product market as well as capital market competitive pressures, charitable spending that is not profit-maximizing because the cost exceeds the private benefits that Becker lists (public relations, advertising, government relations, and so forth) is unlikely to be significant. Even if corporate managers are not effectively constrained to profit maximization by their shareholders, expenditures that do not reduce the cost or increase the quality of the corporation's products will place it a competitive disadvantage with firms that do not make such expenditures.
A more difficult question has to do with a corporation's policy on obeying laws. From a strict shareholder standpoint, it might seem that corporate managers should obey the law only when the expected costs of violating it would exceed the expected benefits, so that managers would have a duty to their shareholders to disobey the law, perhaps especially in countries in which law enforcement is very weak, a country for example which had a law against child labor but was unable to enforce the law. This would be a case of a pure clash between ethical and profit-maximization duties. My view is that, given external (i.e., social as distinct from private) benefits of compliance with law, the ethical argument should prevail, so that a shareholder would be precluded from complaining that corporate management, by failing to violate the law even when it could get away with it, was violating its fiduciary duty to shareholders.
Another argument based on an externality, an argument that lies behind the law that forbids U.S. firms to engage in bribery abroad, even in countries where bribery is extremely common, is that reducing the amount of bribery in those countries will benefit U.S. firms in the long run by making the markets in these countries more open, to the advantage of efficient firms.
The fact that it will sometimes be in the shareholder interest for management to violate the law provides, moreover, a ground for punishing corporate managers sufficiently severely for corporate crimes that the punishment is not offset by shareholder gains for which the managers could be expected to be rewarded.
Social Responsibility: Posner's Response to Comments
These were, as usual, very interesting comments. The most common was that corporate CEOs are overpaid, and this is argued to contradict concerns expressed by Becker and me with corporations' conceiving their role as that of charitable, or "socially responsible," enterprises, rather than as pure profit maximizers--if they are really maximizing profits, why are they overpaying their CEOS?
I don't know whether CEOs are in general overpaid, but let's assume they are. This would imply that the shareholders, who are the nominal owners of the corporation, are incapable of controlling management--in other words, that there is a problem of what economists call "agency costs." (The term signifies the costs resulting from the principal's inability to constrain his agents to serve his goals exclusively.) If so, we certainly would not want the management to make gifts to charity, because that would exacerbate the problem of agency costs. Managers who are not controlled by shareholders can't be presumed to make charitable gifts that will promote the shareholders' welfare, rather than the managers' own. So, paradoxically, liberals who believe that CEOs are not honest agents of the shareholders should be more critical of corporate "social responsibility" than conservatives!
One comment that I am quite sympathetic to is that the social return to profit-maximizing activities may actually be higher than the social return to corporate philanthropy, when "corporate philanthropy" isn't just a fancy name for public relations. As I argued in an earlier post, philanthropy directed at poor countries may actually reduce the welfare of those countries, and the same is probably true to an extent of purely domestic charity. The general effect of charity is to postpone the making of difficult decisions. For example, philanthropic gifts, private or public, to the arts retard serious efforts by artists and artistic organizations to create work for which there is a genuine interest on the part of the public, and philanthropic gifts to universities help to shield them from competitive pressures. Also, the agency costs problem is particularly acute in the charitable arena, as donors to charitable enterprises have even less control over the enterprises than shareholders do over their corporations.
This is not to suggest that the net benefit of charitable giving is negative, but only to raise a question whether the net benefit of the expenditures devoted to charity might be greater if directed to commercial or other private ends instead.
Let me respond finally to two comments about the issue of criminal liability of corporations. One comment suggested that as long as individual managers are liable for crimes committed by them on the corporation's behalf, there is no reason to impose liability on the corporation as well, and therefore no need to place a duty of law-abidingness on the corporation. But imposing criminal liability on errant managers is insufficient. If their crimes benefit the corporation (though imposing, as I assumed in my original posting, greater costs on society as a whole), then their salaries will be set by a rational corporation at a level that will compensate them for assuming the risk of criminal punishment.
The other comment pointed out correctly that corporate criminal liability is not an either-or thing. Often it will be unclear whether a proposed course of action will violate criminal laws applicable to the corporation. There is no reason the corporation should be thought under a duty to avoid all risk of legal liability; that would be paralyzing, and also would discourage socially worthwhile tests through litigation of the outer bounds of liability. Rather, the duty should be to avoid conduct known to carry a very high probability of being deemed criminal.
With respect to many civil as distinct from laws, it is unclear whether they should be thought to impose a duty of compliance, or merely to impose a price (in the form of an expected liability cost) for engaging in particular activity. If the law imposes only damages liability for a particular unlawful act, and the damages are fully compensatory, then a corporation that commits the act is not imposing net social costs; it would not engage in the act unless the expected benefits exceeded the exepected costs to any victim of the act, as measured by the damages that the victim would be entitled to recover.
Response on Social Responsibilities of Corporations-BECKER
A large number of mainly interesting comments. I shall try to respond and clarify my position.
I believe corporations have as much right to lobby for laws as other interest groups, and should not be under any obligation to ignore the laws that are passed, even those that favor them. To take an example from the non-corporate world, the most powerful interest group in the United States is probably the AARP, the association of older, and mainly retired, men and women. They have managed to pass many laws dealing with social security and medicare that are too generous to richer retirees, and are on balance harmful to the general welfare. But I do not hear many people argue that rich persons should refuse the social security checks that they receive because in a better system that money and perhaps still more resources would go to poorer persons.
Some of the comments claim that since stockholders often cannot get rid of their top management, they cannot get their views known other than by selling their stock. I dealt with that case in my comment. The market for top management is indeed not perfect, and that means entrenched management gets greater compensation then they would receive in a more competitive market for managers. Entrenched managers do not have to fully consider stockholder interests in their decisions, and can take higher compensation, and have the corporations they manage engage in various actions. Perhaps they will be "socially responsible", but surely we do not want to rely on entrenched management to set the standards for corporate behavior? Entrenched and powerful management was the heart of the problem with World Com, Enron, and most other companies that had corrupt leadership.
I said several times in my entry that if stockholders of a company are willing to pay for various "socially responsible " non-profit maximizing actions of the company, then the company should indeed deviate from pure profit maximizing behavior to cater to the stockholder interests. But such a company would still be maximizing stockholder value, including the values of stockholders about pollution behavior, employee compensation, and charitable giving of the corporation. But we know from the relatively small number of funds that claim to invest only in socially responsible companies that the vast majority of owners of stock do not want their companies to deviate much from profit and value maximization.
Of course, if corporations can find charities better than stockholders can, then my criteria imply that corporation should do that. I even gave the example of fair trade coffee. But that is hardly the most common situation.
Some hard questions were raised about whether corporations should knowingly pollute, encourage use of unhealthy milk formula, and the like. Some of these cases would be consistent with my criteria because corporations might be sued if they knowingly encouraged behavior that would poison water, or stockholders would not hold stock in companies that they knew used slave labor, and so forth. However, I do not believe corporations have the obligation in the pollution case to go beyond their legal and contractual requirements. For example, corporations should not follow the Kyoto Agreement with regard to their production in the United States. I take this position because it is impossible to know where to draw the line. Why stop at the reduction in emissions called for by Kyoto? After all, many environmentalists believe Kyoto is far too limited. Pollution standards should be set by legislation and judicial decisions. Corporations should obey those standards, not lie about what they are doing, and follow the environmental wishes of their stockholders, but not try to be substitutes for voters and legislators.
Someone remarked on the death of Jack Hirshleifer. Not directly relevant to our subject, but he was an outstanding and creative economist, and a good friend since my graduate student days. I believe he would have adopted a position on this subject similar to mine; perhaps he has written on corporate goals.