MI DENERO ES SU DINERO.

Corporate Citizenship: A Tax in Disguise (Richard Teather, Ludwig von Mises Institute, 8/5/03)

Corporate Social Responsibility is the new field that has united a variety of campaigning groups, including environmentalists, poverty campaigners, third world charities, and unions in a collective call for business to support their agenda. More unusual, it even has prominent supporters within the business community.

Charitable giving by business has a long history, although in the case of large corporations with a diffuse shareholding it carries the moral hazard of executives buying social respectability (in England, even knighthoods) with their shareholders' money. The morally, and socially, superior position would be for shareholders to receive their full dividends and themselves support charitable action.

However Corporate Social Responsibility is said to be about more than this; linked to the concept of 'Corporate Citizenship,' it calls for a company's whole actions to be carried out with an eye to their social impact; on the environment, employees, and 'communities' at home and globally.

Back in the 80's, I made my living litigating hostile takeovers. Each offer would go through a well-defined dynamic. The management of the target would denounce the offer. It was bad for shareholders, because it was too low. It was bad for the company, which would be broken up. It was bad for employees, who would be layed off. It was bad for the community, which would lose a major employer. It was bad, management would say, for the stakeholders, meaning all those who had an interest in the company continuing on. By and large, the stakeholders would agree. The employees, who might not theretofore have agreed with management about much of anything, would talk about how terrible it would be to have new management. The mayors of the home cities would talk about how devastating the loss of the company would be. The governors and legislators would threaten new legislation to prevent this immoral raid.

The shareholders mostly sold their stock in the first few days after the announcement to speculators who were betting on the price going up and a deal getting done.

Usually, the offer would continue to rise. At some point, the company's bankers would conclude that the price was fair and fully financed. The company's lawyers would advise the Board that, because their only legal duty was to the shareholders, they had no choice but to sell. The Board would work out the best deal it could, and then sold. The stakeholders took their chances.

The corporate form is one of the great innovations of the industrial age, ranking right up there with the steam engine. It allows people to invest in companies without having to concern themselves with managing the company. This allows diversification, which is better for investors. It also allows equity funding, which has certain advantages for companies. There are a number of ways in which this is achieved, but the two most important are limited liability and fiduciary duty.

The liability that is limited is that of the shareholders. They can lose their investment but, under all but the most extraordinary circumstances, no more. They are not responsible for the debts of the company. Because stockholders can limit their exposure, they can invest as much money as is comfortable for them without having to worry about the day-to-day business.

The fiduciary duty is owed to the shareholders by the Board of Directors, who are responsible for the day-to-day management of the company. It is common to say that the shareholders own the company and, as a body, they do. But because stock ownership is so dispersed, this is also misleading or, rather, it is a legal fiction. Think of the company as a sort of trust with the directors as the trustees and the shareholders as the beneficiaries. The Board must manage the company in the best interests of the shareholders. The other stakeholders are legally irrelevant. As one might expect, because the shareholders' interest is purely economic -- they want their stock price to go up -- the company must be managed to increase the stock price. In theory, each decision the Board makes must be judged against that standard. That's the law.

There are two worms in the apple: agency costs and lawyers. Agency costs are pretty simple: they are the costs imposed on the shareholders by management actions that are meant to benefit management, not the shareholders. This can be compensation set too high, for example. Or company limousines or private planes. But it can also be subtler. It can take the shape of, as Mr. Teather notes, charitable contributions made to boost the social standing of the CEO, rather than for the good of the company. In a posting below, we discussed Berkshire Hathaway's charitable contribution plan, which was used to make contributions that Warren Buffet favored. This is an agency cost.

Except maybe it's not, as Berkshire Hathaway's lawyers would be quick to explain. Warren Buffet is a genius. He is the best investor in the country. If he were to leave, Berkshire Hathaway would suffer -- or at least the Board could reasonably conclude -- and who's to say he wouldn't leave if his preference in charitable donations were thwarted (I know that, in reality, Berkshire Hathaway gave up its charitable fund, but it makes for a nice hypothetical). Consumers like to do business with good corporate citizens, so who's to say that the Board is wrong in concluding that being eco-friendly is good business, even if it increases costs, or that making charitable donations isn't a good use of corporate resources if it makes the customers feel warm and fuzzy. Nor do I want to be too cynical about this. These are perfectly good arguments and the last thing we want is courts second-guessing every decision a Board makes.

Finally, the stock market is, first, last and always, a market. It exists to make judgments about risks and future earnings. Investors who like to own stock in good corporate citizens are free to do so, those who don't will sell. In the end, there is less to Corporate Social Responsibility than meets the eye. Environmentalists like it because they can use someone else's money. Management and employees like it because it dresses agency costs up in nice moral clothing like "corporate citizenship" and "paying a living wage" and "keeping jobs in America." And the shareholders? They'll stick around if they think the company can make money from being a good citizen. If they don't, they'll sell to speculators willing to bet that someone else will come along who will lower costs and increase profits. This is the real story of Ben and Jerry's, which Teather cites as a company whose business plan depends on appearing to be a good corporate citizen.

See also, KERRY IN SWEAT FLAP ON EVE OF UNION CONVENTION (company says "It Was More Important For The “Socially Responsible” Esprit To Stay In Business Than It Was For The Corporation To Pay Its Garment Workers A Livable Wage. “Esprit’s affable spokesman Dan Imhoff says that garment workers should be paid a wage that ‘allows them a reasonable life style.’ But asked specifically about what Esprit could do to insure this, he shifts the responsibility back to the contractor. ‘The bottom line is Esprit has to pay its own workers a fair wage. Do you think a socially responsible business would survive if it would pay twice as much to its contractor? How can a company stay in business?’” quoting Laurie Udesky, “Sweatshops Behind The Labels,” The Nation, 5/16/94.) Posted by David Cohen at August 5, 2003 12:07 PM