Aneel Karnani, professor of strategy at the Ross Business School, University of Michigan, just wrote a commentary in the Wall Street Journal on August 23 provocatively titled “The Case against Corporate Social Responsibility.”
To make his case, Professor Karnani sets up a straw man: a deceptive rhetorical device in use since at least the days of the Sophists in ancient Athens. Karnani posits that corporate social responsibility (“CSR”) and profitability are incompatible. To seek one is to harm the other.
Given his definition, how could CSR support affirmative arguments for its use in business strategy?
In seeking profits no firm can assume extra costs in providing for social welfare. In seeking social welfare, on the other hand, profits must be sacrificed so that the costs of providing needed public goods (e.g. higher employee wages) and avoiding public “bads” (e.g. air pollution) can be paid.
Like Prof. Karnani, many people – and too many from my point of view in the business ethics and CSR advocacy business – presume and assert that CSR is a kind of charitable undertaking, separate from, and a cost to, business as usual.
CSR, it is said, is putting on a business the costs of doing “nice” things for the environment or for the poor or culture or non-profit organizations and taking money from its owners to pay for those “nice” things.
Prof. Karnani rightfully asks why can’t we consider what markets provide to be the true test of what society wants and needs?
Professor Karnani therefore considers the concept of CSR to be “an illusion” and a “potentially dangerous one” at that.
But is this true? Is CSR just public social welfare engineering decentralized to private hands? Is CSR no more than using markets to do what government can’t afford (or doesn’t want to regulate) and asking market players to internalize the costs of providing such socially desirable goods and services?
No, CSR tells us how to run a business; it is not charity and it is not a costly distraction from core business functions.
The case for corporate social responsibility is simple: it makes firms more valuable.
The strategic economic logic behind CSR is called responding to “externalities”.
Externalities are the outcomes that flow from enterprise activity. They can be good or bad; public in their impacts or private only in their effects.
Firms can create public “goods” and they can also create public “bads”. Social welfare grows if they produce more public goods like jobs and better health and reduce the output of public “bads” like pollution and unemployment.
The CSR equation holds that firms will have higher capital values over time if they incorporate the output of significant public goods into their business model and reduce the output of public and private “bads”. Simply put, firms will attract higher brand equity for producing a set of public goods and avoid the liability costs associated with the production of public and private “bads”.
But firms under CSR strategies seek these outcomes primarily to serve themselves. It is not altruism only. Nor is it the selfless sacrifice of shareholder profits in order to benefit society. Actually it is thoughtful protection of long-term shareholder value that supports CSR strategies in the marketplace. It is enlightened self-interest, or as the moral philosopher Thomas Reid said “self-interest considered upon the whole”
To the contrary, Prof. Karnari assumes that when profit maximization will lead to the generation of public “bads”, firms will ignore CSR considerations and keep producing the “bads”. Their self-interest, he assumes, will never achieve enlightenment.
Yes, they may indeed so ignore the consequences of producing public “bads” but, if they do so, they will end up losers in the long run and their shareholders will suffer from a loss of capital asset value.
Take BP’s recent encounter with creating a public “bad”: the company is now saddled with a US$20 billion liability on its books, a lowered price for its shares, and with more costs on the way.
What would BP’s value be today if there had been no oil leak into the Gulf of Mexico?
CSR management of stakeholder relationships 1) forestalls liability for negligence; 2) minimizes the likelihood of new, intrusive government regulation; 3) enhances brand equity; and 4) minimizes risk of loss to intangible assets that impact the discount rate used to determine the net present value of future income.
Consider the New York financial industry: is it happier and more valuable with Dodd-Frank now added to the United States Code Annotated? With proprietary trading now spun off, with higher capital requirements now imposed, with regulators now poised to jump on any practice that might, in their judgment, lead to a “systemic risk”, how did seeking short-term profit through building an asset price bubble and using excessive leverage benefit Wall Street banks? What capital write-offs did they have to take? Wasn’t it in the billions of dollars lost? Losing money like that is successful capitalism?
Avoiding the stupid exuberance that grew the asset bubble in home prices, sub-prime mortgages, and resulting derivatives would have precluded Dodd-Frank from ever becoming law.
Companies align their business models with public goods – healthier foods, fuel efficient vehicles - because doing so minimizes losses. Such CSR thinking is not altruism or charitable promotion of social welfare. It is sound strategy in risk management.
Karnani then argues that shareholder pressure for sustainable growth in profitability will lead to removal of incompetent or wrongly incented executives. He makes my case. Sustainable growth in profitability only occurs when CSR management of stakeholder relationships is in place.
Such management, by the way, is demanded of a corporate board of directors under its duty to exercise due care. You can’t ignore public goods and public and private “bads” and the potential responses and real needs of all stakeholders, and still exercise suitable due care.
Karnani is wrong on another point: he said executives are hired to maximize profits. That is not entirely true. Profits are sought in order to build capital value for owners. It is more correct to say that executives are hired to build value. Consider the track records of Bill Gates Jr. and Warren Buffet. They built value.
Company success is not only measured by the profit and loss statement but by the balance sheet as well. Just ask Jamie Cayne of Bear Stearns or Dick Fuld of Lehman Brothers how much their ownership shares in their respective firms are worth today.
Strategic focus on short-term profits tips the balance away from balance sheets towards P&L statement and destabilizes a business from the virtuous course of prudence and moderation in its treatment of its stakeholders.
CSR is not about sacrificing shareholder profit to promote the common good. That is sophomoric. It is about smart value accumulation. CSR is hard-core management, not charity.
The frightening part of Karnani’s argument arrives when he says that the “ultimate solution” to striking a balance between profits and the public good is “government regulation.” That invitation for government to step in whenever private markets fail will progressively lead to more and more regulated markets and expanding government. Markets fail on a regular basis, especially as new technology or legal arrangements are introduced to upset old expectations and allow innovators to load the dice of market competition disproportionately in their favor.
Look at history: whenever profit maximization gets too greedy and exploits market opportunities with no sense of social responsibility, bad things happen, the public gets mad, and the government steps in to replace the private sector abuses with laws and regulations. Consider the trusts, cartels and monopolies that followed the widespread introduction of the stock corporation; the practices that lead to the crash of 1929; the efforts to repress free trade unions; Enron/WorldCom abuse of accounting conventions; and now the credit collapse of 2008 through securitization of mortgages, CDOs and CDOs squared, and credit default swaps. Each episode of overreaching in use of market power was countered with increased government regulation.
Again and again, the big winners in this process of market excess followed by more government regulation are the lawyers who step up to guide businesses through compliance with the new laws and regulations and who sue businesses to take advantage of new causes of action created by remedial legislation.
Bad business behaviors just bring on more regulation and less market freedom.
Surprisingly Professor Karnani ends up his commentary by praising the work of civil society advocacy movements and self-regulation by business. Civil society drives part of the CSR agenda and smart companies know this and engage to modify their business models as market conditions change and NGOs bring to the fore new concerns about public and private “bads” flowing from what is brought to market.
Self-regulation is CSR at its best. Public “bads” are identified by industries and new approaches are tested and legitimated.
Thus, in the end, Professor Karnani comes to terms with the need for companies to do more than pursue short term profits if they want to grow in value.