By Jessica Ludescher
19 April,2009
Harvard International Review
It has become fashionable to laud corporate social responsibility as a win-win practice for business and society. Yet CSR is a misleading and distracting doctrine that blinds us to the political realities of corporate economic globalization, writes Jessica Ludescher.
Recent years have seen an increase in both the demand for and the practice of Corporate Social Responsibility (CSR), in which corporations take on ethical obligations to stakeholders, society, and the environment and do so in excess of the requirements of laws and regulations. It has become trendy to laud CSR as a win-win practice for business and society; yet it is a practice rife with problems.
For all the CSR activities in which corporations have engaged, we have seen major lapses in ethical conduct, resulting in a series of bankruptcies, bank failures, government bailouts, a credit crunch, and widespread threats to the global financial system. The economic security of billions of people across the globe has been placed in jeopardy by the supposedly socially responsible conduct of corporations.
In the current climate of fear regarding global economic instability, there is bound to be a certain amount of irrational thinking and carelessness in constructing solutions for existing problems. CSR has been a popular solution to ethical problems in business and justice problems in global society, and reliance upon such a careworn solution is likely. Should we count on CSR to solve these problems? Will CSR turn the tides of the current financial crisis?
I argue that we should not fall back on CSR to ameliorate present economic difficulties or to create a just global society. Instead we should strengthen government oversight over corporations and assign greater moral responsibility to persons who bear limited liability for corporate behavior.
We also need to devise mechanisms for holding individuals legally accountable for the effects of their actions on markets as a whole. Ultimately, governments must rethink the governance structure of corporations to ensure that corporations adhere to principles of justice.
As we will see, CSR endangers governments' capacity to fulfill their role as guardians of the public welfare. CSR has evolved into the notion that corporations should act as states that replace nation states in protecting citizens' rights.
The plausibility of a corporate state becomes all the more apparent once we realize that corporations are better understood as markets than as privately owned businesses. The logic of this analogy will lead us to abandon the CSR solution and instead forge into the terrain of justice for corporations.
Problems with Globalization, Strategic CSR, and the Corporate State
Counterintuitively, CSR may be most dangerous when practiced by multi- and transnational corporations operating in the global economic arena. On the one hand, globalization drives the demand for CSR, namely where governments do not protect human rights and the environment because they are weak, corrupt, or undemocratic.
On the other hand, CSR enables corporations to usurp the power and autonomy of governments. The socially responsible corporation comes to replace the government as the institution for meting out justice and advancing social welfare.
Because wealth maximization is the primary function of corporations, executives are obligated to pursue CSR only when it is strategic for them to do so. In troubled economic times, CSR will not be a reliable form of assistance for developing countries. More problematically, the profit motive of corporations creates an incentive for them to interfere with the activities of any institution that impedes the goal of creating wealth.
Indeed, CSR could be adopted as a ploy to shrink the political sphere of society, weaken or control national governments and intergovernmental organizations, and minimize or eliminate laws, regulations, and restrictions. In his 1958 paper "The Dangers of Social Responsibility" Theodore Levitt anticipated this eventuality, arguing that CSR causes a troubling dissolution of the distinction between the private and public sectors and would eventually lead to heightened corporate power, to the detriment of government.
Moreover, corporations have few checks against operating as unjust institutions that promote global anarchy or corporate autocracy, violating liberty, and corrupting the market system. Ironically, this possibility is the inverse of the socialist threat that libertarian Milton Friedman attributed to CSR in his 1970 article, "The Social Responsibility of Business Is to Increase Its Profits." Friedman was absolutely correct that CSR is a "fundamentally subversive doctrine" that has "been undermining the basis of a free society," but not for the reasons he supposed.
Recent developments in the Corporate Citizenship (CC) literature bear out Levitt and Friedman's worries. CC is a relatively new concept and the difference between CSR and CC is ill-defined. In Matten and Crane's 2005 paper, "Corporate Citizenship: Toward an Extended Theoretical Conceptualization" they argue that CC involves corporations acting as surrogate governments for inadequate nation states in that they secure the social, civil, and political rights of citizens.
On their view, corporations aren't citizens, but instead promote citizenship rights where governments fail to do so because of voter apathy, insufficient development, or supranational problems (i.e. climate change). They would say that the current financial crisis creates a need for CC since the proper functioning of global financial markets is not a matter that can be solved by any one national government, and "since corporations are the main global organizations active in world financial markets, they might be said to be one of the few actors able to reform them to improve protection of property rights."
Although Matten and Crane acknowledge that such an expanded role for corporations is undesirable because it lacks mechanisms of accountability to citizens, they seem to think that CC can be a stopgap for present inadequacies in global governance. However, this stopgap may be dangerous for liberty and democracy over the long run.
As Matten and Crane acknowledge, goverments sometimes fail to secure citizens' rights due to corporate lobbying and contributions to political parties. The problem they fail to acknowledge is that, in so doing, corporations create a need for the governance problem they seek to solve. In "The Economic View of Corporate Citizenship" (2008), Ludescher, McWilliams, and Siegel have labeled Matten and Crane's account of CC as advocacy of a "corporate state," and argue that CC be interpreted as a self-legitimating version of a strategically employed CSR.
The argument is that economically, an important motivation for corporations to engage in CC is to demonstrate the value of corporations to society, and hence maintain their capacity to generate profits. On this view, CC that legitimates a state-like role for corporations might be profitable, but it remains undemocratic. If CSR or CC were implemented broadly, the corporate state could supplant the democratic nation state.
The purpose of corporations is to create wealth. Despite being publicly traded, they are privately owned enterprises under the law. David Ellerman has noted in "Translatio versus Concessio: Retrieving the Debate about Contracts of Alienation with an Application to Today's Employment Contract" that inasmuch as shareholders possess the ultimate right to direct the activities of the firm through their agents, corporations are governed autocratically.
For all the talk of shareholder democracy, the important fact remains that shareholders govern workers and other stakeholders through their control over executives. Of course, in practice, it is the executives who have all the control and remunerate themselves handsomely with it. Executives are supposed to serve their principals, the shareholders, which is why Milton Friedman, Elaine Sternberg, and others have argued that non-strategic CSR is a form of theft whereby managers pursue personal moral agendas at the expense of the bottom line.
By contrast, governments are meant to promote and defend the social welfare and to secure the public's economic and non-economic needs and rights. In democratic institutions, citizens have the ultimate right to determine public objectives and the means by which their represented officials will serve those objectives.
Thus corporations serve the wealth objectives of their owners whereas governments serve the social objectives of their citizens. If corporations are to take over the role of the government, then we must understand the nature of the corporate form of enterprise and decide whether it should be altered to include the better parts of the government function in society. What is a corporation? What should it become?
Reconceptualizing the Corporation
A brief tour through some theories of the firm will allow us to challenge the notion that firms are private enterprises to be run for shareholder gain. Corporations have not always been valued as the best instruments for wealth creation and their role in society has evolved considerably over time.
Adam Smith argued that the joint stock company, a forerunner of today's corporation, was competitively unviable due to the fact that managers do not bear ultimate responsibility for the company's success or failure and may, therefore, be tempted to waste money. His vision of capitalism was built on the assumption that the sorts of firms competing with one another would be enterprises privately owned by entrepreneurs.
For some time, corporations could receive a charter from the state only if their business served a public objective that no private entrepreneur could risk or muster the capital to secure. There has been a longstanding debate about whether corporations should serve private or public ends.
An important step in the direction of criticizing the private nature of corporations was made in 1932 by Berle and Means in The Modern Corporation and Private Property. Berle and Means observe that the public trading of stock results in a "separation of ownership and control" between those who invest equity and executives who manage the firm.
This loss of shareholder control forces the question of whether it would be reasonable to regard shareholders as owners. Classically, ownership involves a bundle of rights that include control over and responsibility for the property held.
But even if shareholders gained greater control over corporations, they would still not be owners in the classical sense on account of the institution of limited liability. Unlike the classical entrepreneur, shareholders do not bear full responsibility for success or failure of the enterprise; they are only liable to the extent of their investment.
Especially without full responsibility for the business operations, shareholders should not be regarded as the private owners of corporations. Berle and Means ultimately argue that the public nature of corporations implies that they should be run for the sake of the public welfare, rather than for private gain.
Ronald Coase, on the opposite side of the ideological spectrum, also regarded corporations as problematic institutions in his important 1937 paper, "The Nature of the Firm." In a corporation, workers have to cede control to managers who then override the price mechanism and plan economic activity, which seems like the antithesis of a free market.
Coase explained the cession of economic liberty in shareholder owned corporations by positing the existence of costs to using the price mechanism, called transaction costs. Such costs include the cost of acquiring relevant information and the costs associated with negotiating and enforcing contracts. So, workers give up freedom in corporations because it is generally more efficient to produce under the direction of authority in hierarchical arrangements.
The problem with corporations that Coase exposes is that workers and suppliers of other forms of capital contract with the firm in such a way that the management directs the flow of resources and determines the prices of the goods to be sold. Workers do not act as private contractors who agree to deliver the products of their labor to capital owners; rather, they agree to be managed by agents of capital suppliers who then make decisions about how labor should be allocated across the entire organization, namely by directing workers on how to perform their tasks and moving them from one task or department to another.
The authority of the executives ultimately determines the allocation of resources. Resource allocation occurs under the direction of control, where workers abnegate some freedom with respect to the nature of the labor and the price of the products ultimately produced because of it.
Agency theory and transaction cost economics now model the corporation as a "nexus of contracts" between constituencies, such as investors, employees, suppliers, and customers. Ownership is not central to this theory of the firm as corporations are defined by their contracts, which structure ownership in varying ways.
In "Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure," Jensen and Meckling have argued that corporations be compared to markets rather than the classical entrepreneur owned enterprises of Adam Smith's world. On their view, corporations are markets that are privately owned by shareholders. When we combine the insights of Coase and Jensen and Meckling, we can see that if corporations are like markets, they are certainly not free markets. Rather, they are privately owned planned economies, or command markets.
However, it is not obvious from this point alone that there is any problem with corporations. Corporations compete with one another in the larger economy, which is by and large free (there is no global government regulating transactions between them). Labor markets, markets for managerial labor, capital markets and so on act as important checks on the power of any one corporation.
If workers do not like the way they are managed in firms, they can seek employment in a different corporation. If executives are not satisfied with their compensation, they can go elsewhere. If capital suppliers are not satisfied with their returns on investment, they can invest elsewhere. Hostile takeovers also serve as an important check on managerial abuses; corporate raiders can offer shareholders a better deal and try to manage firms more profitably after they purchase them.
Competition between corporations also ensures that the most efficient form of enterprise becomes dominant in the market overall. Economists explain the prevalence of shareholder "owned" corporations by observing that competition between these more standard firms and firms with different ownership structures such as worker-, supplier-, or consumer-owned cooperatives leads to a preference for the most efficient ownership structure. Shareholder owned firms emerge as the strongest.
Nevertheless, the fact remains that today's global free market is dominated by competition between various command markets. Given this modern conceptualization of the corporation, is CSR a good idea?
From CSR and CC to Justice
Once we regard corporations as markets, we realize that we must alter our expectations of corporate responsibility. Jensen and Meckling contend that CSR is a nonsensical concept because markets are not the sorts of entities to which the term responsibility can meaningfully be applied. In a sense, this point is an updated version of Friedman's claim that "only people can have responsibilities," "but 'business' as a whole cannot be said to have responsibilities."
If a firm is akin to a market, then, like business generally, it is not responsible for anything. With Friedman, Jensen and Meckling emphasize the responsibility of persons within a firm. For example, agents, the executives, bear contractual obligations to shareholders and other constituencies to maximize firm value.
But these rejections of corporate responsibility beg the moral question of justness. If corporations are privately owned, planned economies, then the relevance of CSR recedes--but only because, comparatively, issues of justice become prominent. The reason is that markets as opposed to businesses are essentially public institutions and as such are matters of social and political concern.
Put another way, markets are socially shared institutions, the nature of whose structure is determined through political processes. Questions therefore arise about whether those political processes and the decision outcomes for the economic structure are just. Businesses, while also critical for social life in the sense that they affect others who contract or do business with the firm, are privately owned and are not fundamentally shared social institutions.
The difference between businesses and corporations with respect to the appropriateness of justice derives from the difference in ownership between the two, primarily with respect to the responsibility dimensions of ownership.
Businesses are essentially the enterprises of individuals who own the capital used for the production of private gain or profit, where the owners both control and assume responsibility for the use made of that capital on others. Corporations, on the other hand, are essentially markets that acquire capital via contract and sometimes assign control over the use of that capital to the suppliers of equity who forgo a contractual entitlement to a fixed income in exchange for control and a right to residual revenue.
In corporations, nobody, not even the nominal owners who control the use of capital, bears full responsibility for the effects of contractual commitments on the profitability of the corporation as a whole, to say nothing of the effects of contractual commitments on all other (contracting and non-contracting) parties. It is this difference in responsibility that marks the chief dissimilarity between businesses and corporations, and ultimately makes the individuals in the latter subject to the responsibility to create justice and not merely the responsibility to behave ethically.
The transition from CSR to questions of justice is inescapable if the corporation is a market. We might hold all market participants ethically responsible for how they deal with one another, but we would not hold any one participant fully responsible for the effect of their contracts on the system as a whole. When a market crashes, we do not blame a single individual – though the recent financial meltdown has revealed a tendency to blame certain stakeholders, corporations, industries, governments, and even cultures.
It might be more reasonable to hold them all responsible to some degree: in a sense, all market participants bear limited liability for the flourishing or failures of markets. It is the institution of limited liability that makes corporations functionally equivalent to markets and dissimilar to business enterprises.
Questions of justice apply to corporations and other market institutions whether or not they are structured in such a way that nominally gives ownership to a select set of individuals who participate in the institution. The assignment of private property rights to shareholders in a corporation is not the basis of the corporation, but a product of individual decision making that occurs against the backdrop of a larger system whose operating rules are rightfully subject to questions of justice.
The fact that corporations are often privately owned does not mean that they are not public institutions to which justice considerations apply. Rather, corporations, which come into existence and take form through contractual relationships in a free market, are publicly created entities.
If firms are markets, and we analyze political economy in terms of the concept of justice, then the relevant moral question about corporations is not whether they should be socially responsible, but whether these new sorts of market institutions are just, and if not, what would be required to make them just.
In other words, we would not ask if the wheat or stock market is behaving responsibly, to use Jensen and Meckling's examples, but we would ask if the wheat or stock market is structured justly, that is, whether the structure of the system adheres to appropriate principles of justice. We might also ask whether the individual participants who bear limited liability for those markets are behaving responsibly.
In other words, we might hold all market players, which in corporations are their stakeholders, responsible for the roles they play in enhancing or diminishing the justice of the market or corporation. This responsibility to uphold justice would be in addition to the ethical responsibility to abide by contractual obligations and respect the dignity of other constituencies.
Of course, the theory of justice to which one is committed will affect the assessment of the justice of markets. A libertarian would be likely to say that a deregulated, liberalized, non-publicly owned market is just because such a market protects liberty rights. A social democrat would be likely to say that a regulated, protectionist, (at least partially) publicly owned market is just, because such a market protects an expanded set of rights and promotes other values in addition to liberty.
In posing the question of justice with respect to corporations, the point is not to impose a specific or partisan conception of justice on corporations, but to note that the appropriate structure of its economic arrangements should be subject to political evaluation.
The turn to justice in corporations should not be interpreted as a recommendation for widespread nationalization of companies because such an extensive state role might itself be unjust. We should not forget that governments suffer from justice problems as well, not least because their civil servants are beholden to corporate and other special interests as a result of lobbying.
Nevertheless, it is clear that governments, insofar as they are democratic, have a strong role to play in securing corporate justice. To say that a corporation is a public institution is not to say that it should be owned by the citizens of a given nation, but to say that its purposes and structure can and should be shaped by government.
CSR is a misleading and distracting doctrine that blinds us to the real political issues confronting us in an era of corporate economic globalization. We need to examine the principles of justice we think should be operative in markets generally and ask whether those same principles ought also be applied to corporations seen as a subset of the broader market.
So long as corporations are formed through state charters, it is the government's responsibility to ensure that corporations are just institutions. Governments need to decide what sorts of ownership schemes, governance structures, and income distributions are just. Given that shareholders do not bear full responsibility, it is not obvious that they should bear the right to control the corporation and govern the other constituencies.
Worker or consumer cooperatives may be more just, and if so, then we need to explore the means by which government can make those forms of enterprise more viable economically. If shareholder owned corporations are deemed more just, then serious public discussion needs to be devoted to the problem of fostering greater responsibility.
Either the institution of limited liability needs to be abolished, or other mechanisms need to be instituted that will hold shareholders, executives, and other key players responsible for their actions on the corporate market as a whole.Since we cannot create full liability for markets generally, fostering greater responsibility in corporate markets may be a better way of bolstering responsible action in society at large than merely "solving" the problem by converting corporations into fully private institutions.
Given an optimistic view of human nature, we might merely ask all individuals voluntarily to assume moral responsibility for corporations. Alternatively, we might devise better systems for holding individuals legally accountable for the effects of their actions on markets as a whole. Either way, it is up to government to decide the fate of corporations in global society.
Jessica Ludescher is an assistant professor of business ethics in the Albers School of Business and Economics at Seattle University, and holds a joint appointment in Management and Philosophy. Her research has focused on corporate social responsibility (CSR), theory of the firm, and globalization.
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