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Title: Re-issuing a Social License to the Financial Services Industry
Date: 06-Jan-2010
Category: Opinion Essays
Source/Author: Stephen B. Young, Global Executive Director, Caux Round Table
Description: A trite justification for business ethics and corporate social responsibility has been the assertion that business needs a “social license” from the community in order to prosper. The cost of such a license, it is said, is good behavior towards customers, employees and the community. Without such a license, it is also said, business will meet with obstacles and difficulties. Frankly, until recently I never took this approach that seriously. In what form is the “license” from society written down? Who negotiates it for the community? Is it a single license legitimating all businesses or different licenses for different industries and companies?

A trite justification for business ethics and corporate social responsibility has been the assertion that business needs a “social license” from the community in order to prosper. The cost of such a license, it is said, is good behavior towards customers, employees and the community. Without such a license, it is also said, business will meet with obstacles and difficulties.

Frankly, until recently I never took this approach that seriously. In what form is the “license” from society written down? Who negotiates it for the community? Is it a single license legitimating all businesses or different licenses for different industries and companies?

I thought the concept too vague, too impractically theoretical, and the product of wishful thinking on the part of critics of capitalism.

And, importantly, I did not find the concept useful in my conversations with business managers and academics in business schools. They did not see any practical footprints of such an idea that would impact one way or another proposed business decisions.

But then I heard Judge Richard Posner present some luncheon remarks on the great financial meltdown of 2008 and his ideas challenged my thinking. Posner is one of the great minds to articulate the premises of the Chicago School on free markets and apply them in many books and articles to issues in law and economics.

Looking at the death of Wall Street in hindsight he made no change to his position: the purpose of business is to make profit for owners – no more, no less. Businesses are to follow pricing signals from the markets and adjust costs and take up opportunities accordingly. They should not be held to any level of responsibility for externalities or wider long-term consequences of their actions. If bad things happen from time to time, such as a great credit crunch, so be it. Markets will correct affairs, sort out the sheep from the goats, and get the economy growing again. The broader role of social stewardship is for government. Where business fails society, it is up to government to step in and remediate any such negative externalities produced by the private sector.

Ironically, I thought, this formula does not secure robust free markets but, to the contrary, is a doom of continually expanding government regulation. There is something in human nature which, when focused on short-term self-interest and money in circumstances of accumulated and unaccountable market power, especially in trading markets for securities and other financial instruments, continually generates negative externalities for society. Thus, there is a perpetual need for government to step in again and again and regulate to prevent re-occurrences of those dysfunctions.
Posner suddenly provided for me the mechanism of social licensing of business in modern democracies: regulation in hindsight - bolting the barn door after the horses have fled.

We are in the middle of a grand attempt to re-issue a social license to the global financial industry. The rules by which it seeks to profit from financial intermediation are being changed. Derivatives must now be cleared in a public market; big firms will have more regulation; higher requirements for capital will be imposed; consumer products in the US must be vetted by regulators for risk; compensation packages for top executives may be restricted; the failure of firms and their liquidation will be managed in a more public process of allocation of losses.

The process of social licensing of business seems to me to be one of re-issuance by the state with ever more restricted terms every time there is a failure of ethics and responsibility. The legislature represents society in telling business how it should conduct its affairs. Separate re-issuances are offered on an industry by industry basis to minimize the reoccurrence of past negative externalities.

In the 19th century in the US, when railroads overcharged some and gave sweetheart subsidies to others, their social license was re-issued subjecting them to the Interstate Commerce Commission with public supervision of rates. When business combinations gave too much market power to too few, the social license given to all businesses was re-issued with a limitation placed on anti-trust opportunities. Scandals in food production were met with public inspection requirements and the Federal Drug Administration was a similar response to ethical failures medicine.

After the Wall Street crash of 1929, the issuance and sale of securities and the substance of accounting practices came under regulation and public supervision. When air and water pollution became worrisome, the social license was re-issued with limitations on emissions and outputs from industrial production. When smoking tobacco became a health hazard, the social license issued to tobacco companies was thoroughly revised through litigation and subsequent negotiations with such companies. After Enron and WorldCom, the social license to do business given to American corporations and accounting firms was re-written with the Sarbanes-Oxley Act.

And now, after the Wall Street meltdown of 2008, we are once again re-issuing with new conditions the social license granted to the financial industry.

Another conclusion from this analysis, thanks to Judge Posner, is that if business wants an indulgent, open-ended license from society, then it must not abuse its position with unethical and irresponsible practices.
To put it another way, doing business is a privilege contingent on good behavior, not a right to rule the roost as lord and master.
The principle at work is the generic one supporting liability for negligence: when our freedom has substantial negative impacts on others, we are called to account for our actions in retrospect.
Business in particular depends on social capital for its opportunities to profit. Business needs to honor its subordinate status and deliver wealth justly to society in return for rights of private property, contract law, public goods of education, infrastructure, financial intermediation, and all the other benefits of modern civilization.



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