The Mystery of Corporate Social Responsibility In a Market Economy

The topic of corporate social responsibility (CSR) is old, but still much debated. For a long time, the dominant view has been that corporations do not have social responsibility, but the tide appears to have changed. Recently, both governments and corporations have explicitly endorsed CSR. But how can corporations pursue the common good in a competitive market economy? Clearly, by providing employment, goods and services, and entering into various transactions, corporations advance welfare, but in what sense other than normal commercial behavior can they be “socially responsible”?

According to the European Commission, companies are socially responsible by “integrating social, environmental, ethical, consumer, and human rights concerns into their business strategy and operations.” As a result, the economy would become “more sustainable” and society “more cohesive.” Business leaders have declared that they endorse or support the UN Sustainable Development Goals, including no poverty, zero hunger, and good health and well-being. It has been argued that these goals are “good for business”. Increasingly, companies ask how they can integrate CSR’s sustainable development goals into their business models. Little is settled, however, and expectations about CSR’s promise diverge widely, from “hypocritical window-dressing” to “the salvage of capitalism.”

The CSR debate raises important questions about a for-profit corporation’s role in society. From a lawyer’s perspective, it is by no means clear that for-profit corporations indeed can and should pursue the common good. Even if they can, given the existing legal and economic structures, it may not be realistic to expect that corporations will pursue the social good. So, in what sense can and should corporations act socially responsible? Put differently, under which circumstances or conditions, if any, will corporations act socially responsible?

This post discusses these questions. It first analyzes whether corporate law allows a corporation to pursue the common good independent of the shareholders’ interests. If the law does not permit corporations to pursue the common good, the CSR debate would appear to be moot until the law has been amended. This issue is addressed under Belgian law, but the analysis may well be similar under the laws of other countries.

Having identified the relevant legal framework, I briefly review concepts of CSR and relevant models of the corporation, which play a key role in the debate. Subsequently, I discuss whether and, if so, under what conditions, corporations will, in fact, pursue CSR. Where the law does not prevent a corporation from acting socially responsible, economic and market conditions are likely to affect its ability to do so. On the other hand, even though, under the law, a corporation could not make CSR its purpose, some activities that could be deemed to fall within the scope of CSR, may be feasible. On the basis of this analysis, we can obtain a better understanding of the real world possibilities of CSR, and the conditions under which a push to make corporations endorse CSR may be effective. Based on this analysis, the place of CSR in our legal system and competitive market economy can be better understood.

A Corporation’s Purpose and Activities

Under Belgian corporate law, three concepts define the boundaries of a corporation’s endeavors. Article 1 of the Belgian Corporate Code (W. Venn.) specifies that a corporation is established with the objective of profit making. The lack of a profit making objective, however, does not cause a corporation to be null and void (art. 454 W. Venn). Thus, if a corporation is not intended to make profit, there is no direct consequence; in this sense, Article 1 of the Belgian Corporate Code does not set forth a legally enforceable condition. A court, however, has the power to annul individual actions of the directors in violation of the profit making objective.

Further, a corporation’s by-laws must define the specific activities in which the company is to engage. Belgian law does not specify what these activities should be; it merely provides that if the activities set out in the by-laws are unlawful or contrary to public order, the corporation is void (art. 454, 3° W.Venn.). If the corporation engages in activities that are not in accordance with the by-laws, the corporation’s directors are responsible and can be held liable if damage ensures (art. 522 jo. 528 W. Venn.).

Third, case law and legal doctrine stipulate that a company’s management should act in accordance with the “corporation’s interest”. The Belgian Supreme Court has held that the corporate interest is identical to, and determined by, the shareholders’ collective interest in profits (Cass. 20 September 2013). Thus conceived, the corporate interest implements the profit-seeking objective set forth in Article 1 of the Belgian Corporate Code. If management fails to act in the corporate interest and thereby causes losses, such an act may be deemed to be null and void, or constitute tortious interference. In such cases, private parties that have a legally recognized interest, i.e. the corporation’s shareholders, creditors and some third parties, such as contractors, may have a cause of action.

In practice, the corporate interest requirement imposes the strictest limitations on a corporation’s acts, and de facto serves as the standard of behavior for a corporation’s management.  Thus, the applicable Belgian law can be summarized in one rule: the corporation’s management is required to act in the interest of the shareholders, and to strive to make profit. Acts that are not intended to, or, in fact, will not generate profit, are subject to challenge.

US law is similar to Belgian law, although the standard of review might be somewhat more onerous (the specific requirements and conditions that must be met for shareholders or creditors to be able to assert claims against the corporation depend on the state involved). A typical test uses the standard of “waste of corporate assets,” i.e., “the exchange was so one-sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration.” To demonstrate that there is a ‘waste of corporate assets,’ it must be shown that the board did not make a ‘valid business judgment.’ According to the Delaware Supreme Court (2014), a decision is not a valid business judgment if ‘the directors irrationally squander or give away corporate assets.’

At first impression, the conclusion would be that the law does not allow a for-profit corporation to engage in CSR activity that is inconsistent with the corporate interest. Clearly, social activities that do not contribute to current or future profits are inconsistent with the shareholders’ interests. Such acts would therefore be either void or voidable and subject to legal challenge.

But how does this square with the widespread and explicit endorsement of CSR by corporations? Would they all be engaging in void or voidable activities? Upon further reflection, this conclusion might be premature. Before we can say whether CSR is by definition inconsistent with the corporate interest, we need to further explore the concept (or, better, concepts) of CSR, as well as the possible models of the corporation.

Concepts of CSR

In the 1960s, Milton Friedman famously stated that a corporation’s only social responsibility is to make a profit. He even suggested that a corporation’s purpose is to maximize its profits for the benefit of its shareholders, subject only to compliance with applicable law. Profit maximization as a corporation’s ultimate objective raises the issue of short versus long term: striving at long term profits reduces short term profit, and an objectively determinable optimal point may not exist. As discussed above, Belgian law, like other legal systems, requires merely that a corporation strive to make a profit, not to maximize profits. Even under this model, however, the corporation is required to act in the interests of the shareholders. In other words, the corporation is a perfect agent for the shareholders, and the shareholders are its principals.

There are also practical and economic arguments against CSR. CSR implies that a corporation acts in the public interest (or works for the common good). This would require that the corporation establish a standard to identify the common good and a decision-making process to determine what specific activities flow from that standard. A corporation, however, is established to pursue private interests, not the public interest, and its structure and decision-making processes are not attuned to understanding and pursuing the common good. Even if a business wanted to be socially responsible, it would not be able to do so, because it has no way of knowing what the common good requires and possesses poor tools to advance it. In addition, if corporations were required to pursue the public good, they would no longer be an attractive instrument to pursue private, profit-seeking activities. The interest of investors operating through the capital markets would dissipate, which would deprive corporations of access to capital. So, also on pragmatic grounds, CSR poses serious problems.

Over the last couple of decades, however, the CSR debate has been revived, and novel CSR concepts have been articulated. Current CSR advocates are not only social activists, but include also mainstream thinkers. Events such as globalization, with its perceived adverse effects on the working class, repeated financial crises, human rights violations, non-compliance with law, and scandals involving corporate greed and excessive executive compensation, are invoked to support the proposition that corporations cannot pursue private gains without harming the public interest. CSR would be necessary to address these deficiencies. Moreover, the help of corporations is deemed to be necessary to solve society’s biggest problems. Corporations should change the way they do business to reflect broader, societal interests. Fundamental economic and social transformation, and long term thinking would be required. For corporations, this is believed to translate into the ‘triple bottom line’ of ‘people, planet, profit.’

Modern versions of CSR are intended to find a compromise between the position reflected in corporate law and the demands for better social outcomes. Soft law instruments such as the ISO standard on CSR, and a few hard law requirements, such as the EU non-financial reporting legislation, have been enacted to shape CSR. ISO 26000 on CSR defines the concept as:

“[The] responsibility of an organization for the impacts of its decisions and activities (including products, services and processes) on society and the environment, through transparent and ethical behavior that

• contributes to sustainable development, including health and the welfare of society;
• takes into account the expectations of stakeholders;
• is in compliance with applicable law and consistent with international norms of behavior; and
• is integrated throughout the organization and practiced in its relationships;

within its sphere of influence.” (emphasis supplied)

Through this modification of the concept of CSR, a corporation might simultaneously advance both private and public interests. The idea that both the company and society benefit at the point where social and business interests coincide is also known as “shared value.”

Viewed from this angle, the CSR business model would be that companies create “measurable business value by identifying and addressing social problems that intersect with their business.” Such ‘shared value’ would allow a corporation to pursue profit-making while meeting social obligations and relieving social pressure. Indeed, some corporations that have endorsed CSR and implemented CSR measures emphasize this concept of ‘shared value.’

 Models of the Corporation

CSR activists, however, are not satisfied with this limited concept of CSR. Their critique is that CSR is not necessary where corporations can make a profit; as one author said, “where profits and social welfare are in synch,” CSR is irrelevant. CSR is relevant, however, where it requires that a company take action (“reconnects with society”) when doing so does not generate profit. Under this broad concept of CSR, a corporation’s moral and social obligations go beyond “shared value,” and apply where there is no profit to be had.

In this debate, the model of the corporation takes center stage. In the conventional view reflected in the law, the corporation is based on a shareholder model. Corporate management is the agent of the shareholders and acts in the financial interest of the shareholders, who are the principals. Under this model, corporate management has fiduciary obligations only vis-à-vis the shareholders who have invested in it. Through their ownership of the corporation’s stock, the shareholders are financially invested in the corporation, and management should therefore pursue their interests.

In addition, there is a strong economic incentive for corporations to act in accordance with the shareholder model. In our market economy driven by competition, the corporation is subject to incentives to show robust profits or growth, either by reducing costs or increasing revenues. Shareholders in publicly traded corporations, often investors operating in capital markets, generally require a solid return on their investments. As a consequence, to attract capital and keep the stock price up, corporations are effectively forced to maximize their profit-making potential. Thus, the market conditions leave little room to allocate corporate resources to CSR, unless these expenses contribute, directly or indirectly, to corporate profits.

CSR advocates understand that the shareholder model is not amenable to ambitious, serious CSR. Under this model, CSR is likely to remain a marginal activity, and will not become integrated into the core business. For this reason, they have also pushed for a different model of the corporation that does not grant supremacy to the shareholders’ interests. Two such models have gained some prominence (the first more so than the second): the stakeholder model and the trust model. The critical issue in this debate is the separation of the interests of the shareholders (as ‘quasi-owners’) from the corporate interest and purpose.

In the stakeholder model promoted by some reformers, a corporation should serve the interests of all stakeholders, including employees, customers, suppliers, authorities, NGO’s, and the environment (or the planet, in the case of climate change). Under this model, corporate management has fiduciary duties towards all stakeholders and the corporation is accountable to all stakeholders. The interests of the shareholders are no longer dominant, as shareholders are merely one of the stakeholder groups. As a result, the corporation’s profit-seeking motive is diluted or even subordinated. Ice cream giant Ben & Jerry’s, for instance, states “[o]ur commitment to social and economic justice and the environment is as important to us as profitability.”

Critique of the stakeholder model has focused on the principles on which it is based, as well as its practical effects. According to Mansell (2013), the stakeholder model implies the political concept of a ‘social contract’. Through this feature, the stakeholder theory undermines the principles on which a market economy is based; instead, he proposes a qualified version of the shareholder model as the proper account of the purpose of a corporation. Further, the stakeholder model has been criticized for not producing the social benefits the CSR advocates were looking for; like the narrow CSR concept, it works best where it is least needed.

For some CSR advocates, the stakeholder theory does not go far enough. Some of them are already conceiving of an even more radical ‘trust’ model. The trust model would require that the corporation directly serve the general public interest or the social good. Stakeholders have no special status; they are some of the many interests the corporation needs to take into account in its decision-making. Under this model, a corporation serves as the trustee for the benefit of the entire community. A corporation operated as a social trust, however, cannot expect to be able to attract investors in the capital markets. It may be able to raise some capital through direct capital contributions from employees or the public through ‘crowd funding’, but the amounts will likely be small while the transaction cost may be substantial. This is a severe limitation of the trust model.

As discussed above, neither the stakeholder model nor the trust model is grounded in the corporate laws of Belgium or the US. Corporate management is accountable to the shareholders and, with respect to compliance with the law and contracts, also to the government and courts, but not to any undefined ‘stakeholders,’ let alone to the entire community. Since the current model of the corporation is the shareholder model, the corporate interest is a reflection of the collective interests of the shareholders. A corporation that wants to implement CSR is therefore limited by this condition.

 Conditions for CSR

 On the basis of the analysis presented above, we can now identify the conditions under which a corporation is able to implement CSR. As we saw, CSR must generate profits to be feasible, i.e. it must produce ‘shared value.’ Understanding this limitation is key to identifying the conditions under which companies will engage in CSR.

For CSR to be feasible, it needs to have a favorable effect on the debit or the credit side of the balance sheet. It must reduce costs or prevent increased costs. Or it must increase revenue or prevent a drop in revenue. In addition, the cost associated with the CSR activities should be less than the incremental cost-savings or profits resulting from CSR. Reflecting both the debit and credit sides of the balance sheet, CSR has also been conceived of as a risk management tool. Nike, following the “sweatshop” controversy, for instance, has applied CSR in this fashion by linking CSR with its core business functions and planning.

On the debit side, CSR must reduce costs or prevent increased costs. CSR could reduce costs in any number of ways. For instance, it may reduce the cost of recruiting and retaining employees. To “attract and retain valuable talent’’ Timberland has provided employees the opportunity to take significant amounts of paid time off to volunteer for social causes of their choosing. Environmental initiatives can benefit the environment and reduce cost. Wal-Mart reduced transportation costs by $3.5 million through an initiative to reduce packaging on toys. It has also been reported that superior CSR performance causes lower capital costs and greater access to capital.

On the revenue side, CSR must result in the expansion of existing markets, avoid the loss of a market, or create new markets. The expansion of existing markets is straightforward: a corporation will do CSR, if it enhances its reputation or generates customer ‘goodwill’ that results in additional profits as customers prefer to purchase goods from it as a result. Further, CSR may avoid the loss of a market: the general goodwill built by corporations ‘doing good’ can protect the business’ reputation to some extent; this is also known as the “halo effect”. In 2010, for example, when Apple Inc. had to deal with negative publicity about the bad antenna design of the iPhone 4, its reputation of ‘good corporate citizen’ protected it against the fall-out.

The prospect of new markets may also prompt CSR. New markets can arise ‘spontaneously’ through consumer demand, or ‘artificially’ through government, NGO, and media intervention. Whether CSR is able to spontaneously create new markets depends on specific economic conditions. In other words, any spontaneous markets arising from CSR may well be “niche-markets”. An example is the market for organic food. Since some consumers in large metropolitan areas have become more health- and environment-conscious, Whole Foods was able to create a new sustainable and organic food market by engaging in CSR activities and building its image around it. Whole Foods shows solid financial performance, in spite of the higher production and CSR-related costs, because its customers are willing to pay a premium for the products it sells and the values it embodies. As noted, this cannot be generalized; consumer willingness to pay more for the products of CSR-active companies is limited and specific to certain markets.

Contrary to spontaneous markets, government- or NGO-steered markets require non-market incentives such as subsidies, taxes, regulatory programs, NGO pressure, etc.  If companies strategize well with authorities or big influential NGO’s, they may be able to create a market for their own benefit. To incentivize companies to engage in CSR, the European Commission facilitates “socially responsible procurement” by authorities in the Member States – companies with strong CSR ratings would thus have an advantage in selling to governments. NGO’s can help corporations by ‘naming and shaming’ or boycotting their competitors for their poor CSR record, thus skewing customer preferences. Toymaker Lego, for instance, was forced to end its partnership with Shell following a Greenpeace campaign, which may have benefitted other toy producers. The NGO ‘Ethical Consumer’ runs a website listing ongoing boycotts. This phenomenon raises the specter of ‘regulatory capture’ and ‘crony capitalism,’ however, and, thus, involves drawbacks and risks.

At the level of overall corporate financial performance, research has not established an unambiguous positive relation with CSR. Moreover, insofar as there is a positive relation, the direction of causation has not been established – it is unclear whether engaging in CSR increases corporate financial performance, or whether companies that enjoy better financial performance can afford to spend more on CSR. Researchers have suggested that the effects of CSR are specific and contextual.

 Conclusions

 As the discussion above demonstrates, corporations may engage in CSR if it is consistent with the corporate interest, i.e. the shareholders’ interests in profits. Likewise, the market economy pushes them towards profit maximization, which causes them to engage in CSR if it generates profits. CSR can increase profits by reducing costs (or preventing cost increases) or increasing revenues (or preventing revenue drops). CSR can have a positive effect on costs in a number of ways. Revenue increases will result from CSR if it creates new markets, expands existing markets, or prevents loss of markets. CSR activities do not necessarily have such favorable financial effects, however. Corporations will only engage in CSR to any significant extent if they believe it will have such effects. Conversely, if CSR causes a corporation’s profits to drop, and therefore harms the shareholders’ interests, the corporation will forego this activity.

This analysis leads to the conclusion that CSR does not comfortably fit into the legal and economic model of the corporation. It is a conundrum: because it is strictly linked to profits, it has little effect where CSR advocates believe it is most needed (e.g., in alleviating poverty in developing countries). The current legal and economic system, however, cannot produce other results; it requires ‘shared value’. It is the C, not the S, that determines the meaning of CSR.

Indeed, the system is not perfect. The remedies proposed by some activists, however, such as the trust model of the corporation, would make things worse for all. Likewise, aggressive CSR in the current model may increase the risk of crony capitalism and strategic behavior. So, at least for the foreseeable future, the concept of CSR will remain a limited one.

To conclude, whatever corporations might do, they will not be able to respond to calls for CSR solely on social grounds, where there is no profit to be had. A corporation’s financial statement has a single, not a triple, bottom line.

Penelope Bergkamp
Bachelor of Laws (expected 2017), KU Leuven