For these firms, successful performance not only requires compliance with laws and regulations but also requires fulfilling broader responsibilities. Firms make charitable contributions, provide pharmaceuticals to those in need, respect and support human rights, exercise self-regulation, and take measures beyond those required by law to protect the environment and the safety of employees and customers.
Formulating integrated strategies requires consideration of the market and nonmarket environments as well as attention to moral concerns and social responsibilities.
The public trust in large firms is low, and criticisms of business are viewed with a degree of credibility that is not accorded to the communication by firms.The trust gap between NGOs and global firms gives the advantage to NGOs in most contexts involving communication with the public. Closing this trust gap through corporate social responsibility is a considerable challenge.
Philosophical underpinningsFriedman views a corporation as a voluntary association of individuals that maximizes the value of their property not only because of economic efficiency considerations but also because it is consistent with a philosophy of individualism, liberty, and personal responsibility.The social responsibility labelFrom Friedman’s perspective a conception of CSR that differs from shareholder value maximization can have only two interpretations:Either a political process is to be used to make decisions.Managers are to act as principals rather than as agents.Understanding Friedman’s perspectiveThe economic justification for Friedman’s position is based on an environment in which citizens can both invest their funds in the capital markets and make personal gifts to social causes.
Shareholders are principals and the corporation is managed by agents—the managers—who are to operate it in the best interests of the principals.
The financial crisis has resulted in numerous fines by regulators and court decisions against banks and other lenders.In addition to proscribing actions, the law assigns certain duties to firms and managers.
Market capitalism - The reliance on markets to direct the allocation of resources.Managerial capitalism - The reliance on managers for the allocation of resources.The corporate form involves a separation of ownership and management. This separation is essential for the efficient allocation of capital, but it also gives managers a degree of discretion to pursue interests other than those of owners.
The Business Roundtable identified seven constituencies: customers, employees, financiers, suppliers, communities, society at large, and shareholders.“Responsibility to all these constituencies in total constitutes responsibility to society, making the corporation both an economically and socially viable entity.”The objective of a corporation is not as clearly identified in the Roundtable statement as it is in Friedman’s theory.Business leaders advocate CSR for a variety of reasons. Some argue that there are societal objectives that can be achieved only through corporate action. Other business leaders call for restraint on the pursuit of profits and for self-regulation in the hope that it will forestall additional government regulation.
In the figure, customers are represented separately as the providers of revenue for the firm.According to the Roundtable, customers have “a primary claim for corporate attention.”
From one perspective what matters is social performance and not the motivation for it.The framework for CSP begins with individuals who can allocate their resources among consumption goods, investments in the shares of firms that do and do not conduct social activities, and direct contributions to social causes.
Moral motivationSocial activities can be undertaken because of a moral concern for which the duty is assigned to the firm. The moral concern could be associated with the stakeholders of the firm, the environment, or the general public.Managerial perquisitesCSP could be a perquisite for management in the sense that managers themselves have a preference for the social activities or receive a warm glow from theaccolades of the advocates of broadened social performance.Social pressureA firm could conduct social activities in response to social pressure from government or NGOs and social activists.Strategic (CSR) motivationCorporate social activities could be undertaken for strategic reasons.They increase profits. The activities could strengthen local community relations or improve employee morale and productivity.
To illustrate the notion of CSP that makes business sense, the figure presents a hypothetical relation between CSP and profit for a firm, where associated with the CSP are social benefits to others in addition to shareholders.
Consumer rewardsIndividuals could reward a firm in their roles as consumers. Consumers could prefer to buy a product from a firm with CSP rather than from a firm without CSP.Employee rewardsIndividuals as employees could also reward a firm through higher productivity motivated by the social activities of their employees.A firm that conducts social activities could attract higher-ability employees or find it easier to retain them.Investor rewardsPurchasing shares of a firm with CSP provides both a financial return and a social return, and the market value of the firm is composed of the value of its financial return and the value of its social return.Government rewardsCSP could be rewarded by government. Politicians may be more willing to listen to a firm with good CSP, which can facilitate lobbying and other nonmarket strategies.
Some firms experimented with independent “social audits” of their efforts, and some published those audits.
The Roundtable argued that board attention should focus on strategic decisions and the social impacts of corporate decisions, although it drew considerably narrower boundaries on social responsibility than did the task force statement on corporate social responsibility.
Critics of Sarbanes–Oxley argued that it went too far. They worried that it would make it harder to recruit new board members, spur a rash of lawsuits, impose heavy costs for meeting documentation requirements for financial controls, and make firms risk averse. The first two concerns have not materialized, but firms, particularly small firms, have complained about the costs of documentation of their internal controls as required by Section 404.
The provision was spurred by criticism of high executive compensation that often did not appear to be the result of good corporate performance.
The Cheeseburger Bill - The bill provided protection from obesity and weight-based lawsuits unless the weight gain was due to the violation of a state or federal law
Suppliers - McDonald’s developed aCode of Conduct for Suppliers which covered employment practices pertaining to the use of prison and forced labor, child labor, working hours, compensation, nondiscrimination, and the workplace environment.Franchisees - McDonald’s purchased hundreds of franchises, and by 2003 only 184 of 582 restaurants in Brazil were owned by franchisees.Vegetarianism - A 2000 Roper poll commissioned by the Vegetarian Resource Group found that 6 percent of girls and 2 percent of boys between 6 and 17 years never eat meat.Brand Name Attractions - Animal Liberation Front and the Earth Liberation Front firebombed McDonald’s in California and New Mexico.
Mba1034 cg law ethics week 4 cg accountability 2013
CORPORATE GOVERNANCEANDACCOUNTABILITYStephen Ong, BSc(Hons) Econs(LSE), MBA International Business(Bradford)Visiting Fellow, Birmingham City UniversityVisiting Professor, Shenzhen UniversityMBA1034 GOVERNANCE, LAW & ETHICS
• Discussion: Governance& Accountability1• Corporate SocialResponsibility & Accounting2• Case Discussion:McDonald’s• Video : Supersize Me3Today’s Overview
1. Open Discussion• Niamh M. Brennan, JillSolomon, (2008),"Corporategovernance, accountability and mechanismsof accountability: anoverview", Accounting, Auditing &Accountability Journal, Vol. 21 No. 7 pp. 885– 906
2. Corporate Social Responsibility &Social Accountability• Reassess the impact of corporate activities on theenvironment and society at large• Cases of environmental accidents, productfailures, etc. impact on the firm’s value and itsmarket share.• Review types of corporate policies of stakeholdermanagement and pay off, including policies thatdestroy rather than create firm value.• Review the increasing importance of indices ofcorporate social responsibility as well as sociallyresponsible investment.
Learning Outcomes• By the end of this lecture, you should be able to:1. Critically review the studies that investigate theimpact of corporate social responsibility (CSR) onfirm value and vice-versa2. Describe some of the CSR indices that are availablefrom commercial providers and evaluate theirusefulness3. Discuss the definitions of CSR and sociallyresponsible investment (SRI) and how these maychange with an investor’s set of values4. Assess the evidence on whether investors pay a pricefor SRI.
Overview• Introduction• The trust gap• What is corporate social responsibility?• Compliance with the law• Market and government failures and stakeholders• Broader conceptions of social responsibility• Corporate social responsibility and corporate socialperformance• A framework for corporate social performance• Corporate governance
IntroductionDid you ever expect a corporation to have aconscience, when it has no soul to bedamned, and no body to be kicked?Edward, First Baron Thurlow 1731-1806Lord Chancellor during King George III’s reign.
Introduction (Continued)• Craig Carter, Rahul Kale and Curtis Grimmdefine corporate social responsibility asfollows– “*Corporate] social responsibility deals with themanagerial consideration of non-market forces orsocial aspects of corporate activity outside of amarket or regulatory framework and includesconsideration of issues such as employeewelfare, communityprograms, charitabledonations, and environmental
• While CSR may be in the interest of thetargeted recipients, it is less clear a prioriwhether it is in the interest of the company’sshareholders.• At worst, CSR may just be a reflection of theprincipal–agent problem.• Let’s attempt to answer the questionwhether CSR is in the interest of theshareholders.Introduction (Continued)
• Many firms go beyond what isrequired by their market andnonmarket environments–Some explicitly attempt to servedirectly the needs of theirstakeholders or, more broadly, ofsocietyIntroduction (Continued)
The Trust Gap• In interacting with the public or withstakeholders, it is useful to beginwith caution• The lack of trust in globalcompanies stands in stark contrastto the trust in NGOs
Milton Friedman’s ProfitMaximization•“To conduct the business in accordancewith *owners’+ desires, which generallywill be to make as much money aspossible while conforming to the basicrules of society, both those embodiedin law and those embodied in ethicalcustom”
Compliance with the Law• A fundamental component ofresponsible management–In recent years the numberand size of corporate scandalsand incidents of wrongdoinghave been alarming
Market and Government Failuresand Stakeholders• The market perspective of Friedman leavesunresolved a number of issues about the role ofbusiness in society– Market imperfections can cause a divergencebetween private and social costs– The reliance on private ownership and markets togenerate well-being is justified by utilitarianism– Just as markets can be imperfect, so too cangovernment– The agency problem - Market capitalismcoexists with managerial capitalism
Broader Conceptions of SocialResponsibility• The Business Roundtable wasfounded to:–Examine public issues that affectthe economy and developpositions which seek to reflectsound economic and socialprinciples
Corporate Social Responsibility andCorporate Social Performance• CSR focuses on the responsibility ofa firm for social performance• Arises from a combination of:–An ethical failure that establishesa moral duty–The assignment of that duty to thefirm
A Framework for UnderstandingCorporate Social Performance• Corporate social performance (CSP)refers to social activities that satisfytwo conditions–Social activities extend beyond therequirements of the law andregulations–Social activities involve the privateprovision of public goods or private
Motivations for CSP• Moral• Managerial perquisites• Social pressure• Strategic (CSR) motivation
Corporate Social Performanceand Business Sense
Rewards• Consumer rewards• Employee rewards• Investor rewards• Government rewards
Corporate Governance• Social accountability–Continues to be an issue for firmsthat adopt social responsibilities
The Duties of Boards of Directors• According to the Business Roundtable:– Select, regularly evaluate and, if necessary, replace the chiefexecutive officer, determine management compensation, andreview succession planning– Review and, where appropriate, approve the major strategies andfinancial and other objectives, and plans of the corporation– Advise management on significant issues facing the corporation– Oversee processes for evaluating the adequacy of internalcontrols, risk management, financial reporting andcompliance, and satisfy itself as to the adequacy of suchprocesses– Nominate directors and ensure that the structure and practices ofthe board provide for sound corporate governance
Sarbanes-Oxley• The act is called the Public Company AccountingReform and Investor Protection Act• Requires:–Companies to identify an independent“financial expert” on its board auditcommittee–The CEO and CFO to certify the firm’sfinancial statements
Say-on-Pay• A provision in the Dodd–Frankfinancial reform act of 2010• Required corporations to conduct anonbinding shareholder vote onexecutive compensation at leastonce every 3 years
The Market for Control•Disciplines management anddirectors to serve shareholderinterests throughmergers, acquisitions, hostiletakeovers, proxy contests, anddepressed market valuations
CSR and Financial Performance• Can the lack of corporate socialresponsibility or bad stakeholdermanagement can cost acompany dearly and may evenbe exploited by the company’scompetitors?• Case : Perrier and Benzene
Perrier and Benzene• Benzene is a chemical which occursnaturally in crude oil– In laboratory tests on animals, it hasbeen found to cause cancer– It is also believed to cause cancer in humans.• Perrier was the number one mineralwater, charging premium prices based on itsreputation of the “champagne of bottledwater”.• In early February 1990, traces of benzene werefound in Perrier bottles in North Carolina, USA.
Perrier and Benzene (Continued)• Perrier initially wanted to hush up theincident, shifting from explanation toexplanation and delaying any action.• It finally recalled 160 million bottlesworldwide at a cost of £150m.• By 1995, its market share in the USA haddropped by half.• Its market share in the UK fell from 60% to9%.
CSR and Financial Performance(Continued)• Early studies have found mixed evidence on thelink between financial performance and CSR– Stanley Vance finds a negative link, suggesting thatCSR is a net cost to the firm– Jean McGuire et al., and Richard Wokutch andBarbara Spencer find a positive link– Gordon Alexander and Rogene Buchholz find norelationship between the two.• However, apart from McGuire et al., none of theabove studies raises the issue as to the directionof causality between the two.
• Sandra Waddock and Samuel Gravesacknowledge this issue–Higher levels of CSR may causehigher levels of financialperformance and vice-versa–Better performing firms have morefunds to spend on CSR.CSR and Financial Performance (Continued)
• A reason why the direction of causality flowsfrom financial performance to CSR is given byJensen’s free cash flow problem– Managers who have access to significant free cashflow may divert some of this to social causes.• The reason why the direction of causality shouldflow from CSR to financial performanceis that CSR is part of good management and partof having good relationships with the firm’sstakeholders.CSR and Financial Performance (Continued)
• Waddock and Graves’s measureof CSR is based on theKinder, Lydenberg and Domini(KLD) index which rates US firmsaccording to several aspects ofCSR (e.g. community relationsand workforce relations.CSR and Financial Performance (Continued)
• They first regress the level of CSR for each firm in1990 on the financial performance for the previousyear– They find that there is a positive linkfor eachof their three measures of performance (ROA, ROE andreturn on sales)– This suggests that the free cash flow hypothesis is valid inthe context of CSR.• They also regress financial performance for 1991 onCSR for 1990– They find a positive link for ROA andreturn on sales– This gives support to the hypothesis of goodmanagement.CSR and Financial Performance (Continued)
• Hence, Waddock and Graves find thatthe direction of causality between CSRand performance flows bothways–Firms with better past performance havemore funds to spend on CSR–Firms with higher levels of CSR performbetter.CSR and Financial Performance (Continued)
• Amy Hillman and Gerald Keim develop a model ofCSR and financial performance.• They argue that there are two components of CSR1. One component relates to improving the firm’srelationships with its primary stakeholdersThey call this stakeholder management (SM)SM has a positive impact on firm performance2. The other component relates to social issues that donot improve the relationships of the firm with itsprimary stakeholdersThey call this social issue participation (SIP)This component reduces financialperformance.CSR and Financial Performance (Continued)
• Hillman and Keim’s SM and SIP areequivalent to Waddock and Graves’s goodmanagement and free cash flowhypotheses.• They find that financial performancedepends positively on SM and negatively onSIP.• However, they do not find that the levels ofSM and SIP depend on financialperformance.CSR and Financial Performance (Continued)
• To summarise, recent empirical researchsuggests that it is important to distinguishbetween the two types of CSR–CSR that targets a company’s directstakeholders, such as its customersand employees, has a positive effecton profitability–CSR that targets wider socialissues has a negative effect.CSR and Financial Performance (Continued)
CSR Indices• CSR indices (e.g., FTSE Kinder, Lydenberg andDomini (KLD) 400 Social Index) tend to be based on– Exclusionary screens– Strengths along the lines of a series of attributes.• Exclusionary screens consist of excluding firmsfrom the index with significant involvement in e.g.– alcohol,– gambling,– tobacco,– fire arms, and– military weapons.
CSR Indices (Continued)• Attributes include e.g.–Community relations• Support for education, social housing, …–Diversity• The firm has policies in place to promotewomen and minorities, …–Employee relations• Relationships with trade unions, employeeprofit sharing schemes, …
–Environment• Policies aiming to reduce or preventpollution, carbon neutrality, recycling, …–Product• Quality, innovation, productsafety, antitrust, policies enablingsocially disadvantaged groups to benefitfrom the firm’s products and services, …–Corporate governanceCSR Indices (Continued)
• There are now indices whichcater for investors concernedabout e.g.–Catholic values (KLD)–Sustainability (KLD)–Islamic values (Dow Jones).CSR Indices (Continued)
Conclusions• The link between CSR and firm performance.• The performance of SRI funds.• How do you define SRI?
Case - Nonmarket Environment ofMcDonald’s• Obesity - Economists studied theincrease in the body mass index andconcluded that it was due to severalfactors:– Increase in calorie intake– Decrease in strenuousness of work– Decrease in cost of food due totechnological change leading people toeat more1-49
Case - Nonmarket Environment ofMcDonald’s• Meal and Menu Nutrition Information - Publicattention to the obesity issue led to the introduction ofthe Menu Education and Labeling Act (MEAL) in theHouse and the Senate• Healthy Lifestyles - As a result of the concern aboutobesity, McDonald’s suspended its promotion ofsupersize meals1-50
Case - Nonmarket Environment ofMcDonald’s• Children’s Advertising– McDonald’s promoted its trademark goldenarches on Barbie dolls and backpacks– Some schools had McDonald’s days for lunch– Used plastic toys for promotion1-51
Cases - Nonmarket Environment ofMcDonald’s• Acrylamide – Activists argued that theconcentrations of acrylamide exceeded theEPA and WHO standards for water specificallyin french fries from McDonald’s• Mad Cow Disease - McDonald’s had dealtwith the issue of mad cow disease in anumber of other countries and had used thatexperience to prepare for such an event inthe United States1-52
Cases - Nonmarket Environment ofMcDonald’s• Antibiotics and Growth Hormones -McDonald’s, the environmental groupEnvironmental Defense, and Elanco AnimalHealth joined together to create the AntibioticsCoalition• Animal Welfare - McDonald’s adopted newstandards for its beef suppliers, includingminimum space standards for cattle in feedlots• The Environment - McDonald’s established anenvironmental policy pertaining to naturalresources, rain forests, sustainability, and wastemanagement1-53
Further Reading• Solomon, Jill (2010) Corporate Governance andAccountability 3rd Edition, Wiley, UK. Ch.9-11• Goergen, Marc (2012) International CorporateGovernance, Pearson. Ch.8• Gary, Owen & Adams (1996) Ch.2-4• CIMA - Performance Strategy: Study Text (2012)BPP Learning Media Ltd. Part B : 4• Baron, David P.(2013) Business and itsenvironment, 7th Edition, Pearson
Additional Readings (1)• Mallin, C. A., Saadouni, B. and Briston, R. J. (1995) ‘The financialperformance of ethical investment funds’, Journal of Business Financeand Accounting, 22, 483–96.• Gregory, A., Matatko, J. and Luther, R. (1997) ‘Ethical unit trust financialperformance: small company effects and fund size effects’, Journal ofBusiness Finance and Accounting, 24(5), June, 705–725.• Drexhage, G. (1998) ‘There’s money in ethics’, Global Investor, 109, 56.• Williams, S. (1999) ‘UK ethical investment: A coming of age’, Journal ofInvesting, summer, 58–75.• Hancock, J. (1999) Making Gains with Values: The EthicalInvestor, Financial Times/Prentice Hall, London.• Friedman, A. L. and Miles, S. (2001) ‘Socially responsible investment andcorporate social and environmental reporting in the UK: An exploratorystudy’, British Accounting Review, 33, 523–548.• Sparkes, R. (2002) Socially Responsible Investment: A GlobalRevolution, John Wiley & Sons, Chichester, UK.• Solomon, J. F., Solomon, A. and Norton, S. D. (2002) ‘Socially responsibleinvestment in the UK: Drivers and current issues’, Journal of GeneralManagement, November 2001.
Additional Readings (2)• Mercer Investment Consulting (2005) SRI: What Do InvestmentManagers Think? 12st March, Mercer Human Resource ConsultingLLC and Investment Consulting Inc., New York, USA.• Cobb, G., Collison, D., Power, D. and L. Stevenson (2005)FTSE4Good: Perceptions and Performance, ACCA Research ReportNo.88, Certified Accountants Educational Trust, London, UK.• Freshfields Bruckhaus Deringer (2005) A Legal Framework for theIntegration of Environmental, Social and Governance Issues intoInstitutional Investment, UNEP Finance Initiative, produced for theAsset Management Working Group of the UNEP FinanceInitiative, October.• Solomon, J. F. and L. Darby (2005) "Is Private Social, Ethical andEnvironmental Disclosure Mythicizing or DemythologizingReality?", Accounting Forum, Vol.29, pp.27-47.• Mercer Investment Consulting (2006) 2006 Fearless Forecast:What Do Investment Managers Think About ResponsibleInvestment? March, Mercer Human Resource Consulting LLC andInvestment Consulting Inc., New York, USA.• Solomon, J. F. and A. Solomon (2006) "Private Social, Ethical andEnvironmental Disclosure", Accounting, Auditing andAccountability Journal.• Solomon J. F. (2008) Preliminary Report on Pension Fund Trusteesand Climate Change, ACCA (on blackboard).
NEXT Ideas for Discussion• Carcello, JosephV., Hermanson, Dana R. &Ye, Zhongxia (Shelly) (2011)Corporate Governance Research inAccounting and Auditing:Insights, Practice Implications, andFuture ResearchDirections, Auditing30. 3 (Aug