Just when the memories of Enron’s ethical and financial meltdown were starting to fade, the current financial and economic mess breathed new life into the debate about corporate social responsibility. Heads are rolling and earnings are Wall Street’s least favorite holiday color – bright red.
Calls for investigations are mounting and it won’t long before a CEO is seen on the evening news taking a “perp walk.” For the moment, the loudest cries are, “See, we told you big business wasn’t to be trusted. More and tougher laws are needed to make those corporations act responsibly.”
Before picking sides in what many call the ultimate imponderable (can corporations be responsible?), let’s pick apart some of the terms and rhetoric being hurled around.
Your textbook introduces the subject by announcing firms have responsibilities that go beyond producing and selling products (p. 34). Nothing is added though to tell us what it means to “go beyond” getting products made and sold or how to go about doing it.
We are told, however, that product safety should be “ensured” and one way to do that is by “warning labels” (but weren't sub-prime borrowers warned their payments could go up?). Car sales tricks are singled out to illustrate irresponsible sales practices (hardly a shocking revelation). Federal and state laws are said to help employees get treated responsibly (but suing their employer isn't something most employees can afford to do). Owners and creditors will insist a firm be financially responsible (although things went badly wrong for Enron's shareholders and bankers). The role firms play in their community and how they affect the environment is supposed to produce responsible behaviors.
None of this provides much help to a business manager. How can a busy manager be accountable to the firm’s stockholders and creditors while being responsible to its customers, employees and community?
What can you do to satisfy all these interests? Can you be all things to all these constituents? Will making businesses more accountable produce more responsible behavior? And who decides if a firm has not been responsible enough?
Your textbook identifies various “stakeholders,” all of whom claim some interest (a “stake”) in a business (p. 10-17). Every stakeholder’s role is said to be “critical,” but no guidance is given about how to (a) rank the roles or (b) reconcile conflicts between the roles.
How stakeholder roles interact certainly is critical; it determines a firm’s operational effectiveness. Sitting at the epicenter of these interactions are the firm’s managers. When the interests of a firm’s stakeholders are perfectly aligned, the manager’s job is easy. But how often does that happen? When they conflict, how do the managers decide which stakeholder gets favored over the others?
Do they look for solutions that satisfy every interest? Is that possible? Or, because it might be impossible to satisfy every stakeholder, do managers sometimes ignore the stakeholders, which include the firm’s owners, the stockholders, and instead satisfy their own interests?
These last points illustrate some of the limitations of the “stakeholder theory” of business governance; it provides a great description for the problem, but doesn’t offer much that managers can use to solve it. It is, however, a starting point for a better approach to accountability, which in turn, might lead to greater degrees of responsibility.
Most of the ideas for making business more responsible involve (a) stiffer penalties for irresponsible acts or (b) making them more “transparent” by requiring more disclosures and oversight. Both remedies, however, are “more of the same.” They haven’t worked before and won’t magically start working now.
The law books already overflow with all manner of crimes and punishments; adding more won’t get us to a “tipping point” where all corporate misdeeds disappear. Enron's financial reports were award-winning and sending off warning signals long before it crashed; its Statement of Cash Flows showed the end was coming two years before it arrived.
Most financial reports aren’t read now; publishing more and longer reports won’t make investors read and understand the information they’re receiving. Many complained that Enron's business was too complicated and the complex information published about it wasn’t easy to understand. Why would you invest your life savings in something you didn't understand?
Another potential “fix” suggests making corporations focus less on meeting short-term earnings expectations and more on building long-term value. These initiatives are aimed at blunting the axiom, "Maximize shareholder value." But does "value" always have to be measured in financial terms? And why can't value be maximized over the next five years, not the next three months?
Who are the owners of the large, publicly-held companies traded on the New York Stock Exchange? Are they middle-class workers building an investment fund for retirement or social activists wanting more responsible environmental practices?
The biggest stock owners are institutional investors such as mutual funds and retirement programs; individual investors are “small fries” in today’s investment world.
The California Public Employee Retirement System (CalPERS), for example, buys stocks as investments for the retirement funds of California’s 1.5 million state employees; as of October 2007, it held nearly $255 billion of stock and bond investments.
85.7% of Nike’s stock is held by a total of 857 institutional investors. This equates to each investor holding on average about 391,234 shares; at a per-share price of $66.27 as of December 21, 2007, each investor then had about $26 million invested. CalPERS was one of these investors, owning 1,372,420 shares of Nike stock with a total market value of about $90.95 million.
With nearly 7/8 of its stock held by a comparatively small number of investors, Nike should and probably does pay attention to what they say. But is an investor like CalPERS interested only in short-term returns? Goal IX of their Asset Management Policies directs them to “achieve long-term, sustainable, risk-adjusted returns.”
CalPERS has implemented initiatives to assure they invest only in companies espousing reasonable levels of executive compensation, sound environmental practices and majority-vote procedures. In sum, CalPERS isn't an institutional investor/owner/stockholder concerned only with short-term gains at the expense of long-term stability.
Fixes that would direct managerial attention away from investors like CalPERS don’t seem prudent. Stakeholders frustrated by not having their interests heeded by a company’s managers might be better served by asking investors like CalPERS to represent and support them.
This discussion suggests approaches to improving accountability and responsibility include investor practices and methods. Should large investors be required to give their members a stake in how investment policies are developed, for example? After all, isn't "professional management" one of the reasons people invest through mutual funds? Is the "agency problem" found in large corporations also found in the mutual funds that invest in them?
When investing through a mutual fund, for example, voting rights obtained by the fund from its investments are delegated to the fund's management, not its members. Recent SEC rule changes now require funds to disclose how they voted and the policies and procedures associated with their voting, but member input is rarely solicited.
A growing number of institutional investors claim to be "socially responsible" in selecting investments for their members. This sort of market-driven response is probably preferable to more regulation and disclosure. But is more work needed in order to strike the best balance?
Would it be a better approach to evaluate the policies and practices of the "buy-side" (institutional investors) of the information-exchange problem rather than the "sell-side" (the corporations and their management)? For example, should an investment fund’s shares be voted en bloc or according to member shares? Should an investment fund poll its members about the issues being considered at a company’s annual meeting?
This topic is complicated and has no easy answers. This long-winded post has hopefully spurred you to think about some of these issues and how you'll deal with them when you slip into your manager's chair.
It also tried to open a door onto different ways of analyzing the problem. It's not clear how much more can be done by regulating corporations more tightly or punishing more severely bad corporate behavior. The practices used by Investment Fund and Mutual Fund managers to obtain input from their investors about important issues of firm governance and social responsibility are not well understood. No industry-wide "best practices" have been developed as doing so has been resisted by the funds managers. Would taking a different tack produce better results?
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