Corporate governance and ethics strategy

¶ … Positioning Stakeholder Theory within the Debate on Corporate Social Responsibility by Branco & Rodrigues (2007) argues that corporations should take a total stakeholder view when considering their corporate social responsibility (CSR) initiatives. The authors also take the view that CSR should be considered within both the short- and long-term timeframe. The stakeholder view, which in the author's interpretation is squarely rooted in the utilitarian ethics of John Stuart Mill, represents one view of corporate ethics. Another view is embodied in the shareholder perspective, which roughly correlates with the ethical dictates of Milton Friedman. The view of the authors with respect to a total stakeholder perspective offers specific guidance for management, should this view be accepted by a corporation. Even if the view is not accepted, it provides a valuable counterpoint and sense of perspective in a corporate world that is seemingly becoming increasingly oriented towards Friedman's strict shareholder view.

Shareholder theory is embodied in the view that managers are agents of the shareholders and therefore should seeking to increase profits, as Friedman (1970) put it "the social responsibility of business is to increase profits." This narrow view rests on the assumption that shareholders are perfectly rational actors -- in Friedman's day there were no "ethical" mutual funds to contradict this assumption. Moreover, the presence of negative externalities associated with business activity lent credence to the stakeholder theory. Business managers are not strictly agents of shareholders and seeking to generate profits. Businesses in fact generate a number of different outputs, and managers act on behalf of a number of different stakeholders, including themselves. The "legitimate interests of the stakeholders" need to be balanced when making decisions (Smith, 2003).

Post, Preston and Sachs (2002) expand on the stakeholder model by introducing the idea of the extended enterprise. The extended enterprise is one in which the central corporation is heavily involved in not only the operations of its subsidiaries, but its partners throughout the supply chain. Many firms have tight arrangements with suppliers to the point where the actions of the suppliers are conflated in the minds of consumers and legislators with those of the central corporation. This has specific impact with respect to ethics. Consider the case of Nike, which faced harsh criticism for the ethical practices of some of its suppliers. This criticism stung the company and forced it to use its might to improve enforcement of ethical standards throughout its supply chain. The public eye is a particularly tricky issue with respect to ethics -- in some cases such as soccer balls all of Nike's competitors were using the same suppliers with the same ethical violations, but the majority of the negative public relations fell to Nike.

As businesses grow into global operations, and as companies seek to create competitive advantage from upstream and downstream partnerships, the extended stakeholder theory of management will be increasingly relevant. This is almost certainly the case with business ethics. While companies are seeking to increase profits, the means by which they do so are coming under increasing scrutiny from activist groups and watchdogs. As a result, companies are being forced to take a stakeholder view, and extend that stakeholder view. This supports the core of Branco and Rodrigues' thesis, that companies need to address ethical issues using the stakeholder theory.

Friedman's shareholder notion remains relevant in much of the business world, but the point that Branco and Rodrigues make with respect to the long-run timeframe is especially relevant. In the long-run, ethical violations and a lack of social responsibility beyond making profits will harm the company. While some shareholders are perfectly rational, many are not and take a company's ethical record into consideration when investing. Other investors believe that in the long-run ethical poor corporate social responsibility will result in lower profits than for comparable firms with higher ethical standards.

If the enhanced stakeholder perspective is truly the best for corporate social responsibility, this has significant implications not only for management but also for corporate governance. While Nohria (no date) argues that corporate governance is a hygiene factor in that its absence is a problem for companies but its presence did not correlate with improved performance, this is only for basic levels of governance. For a board to truly adopt a broad stakeholder perspective, it must be built better. Nadler (2004) argued that a well-constructed board will be one that helps to deliver superior results to the firm. Taking a broad stakeholder perspective, this means that the board should be capable of understanding the perspectives of different stakeholders rather than simply those of the shareholder. Building a board in this way, however, is constrained by the fact that the shareholders vote for the board. At times, other stakeholders may gain seats on the board (especially labor) but for the most part the shareholders dominate the board and therefore dominate the corporate interest.

When Branco and Rodrigues argue in favor of a stakeholder approach to corporate social responsibility, they are essentially arguing for boards that are structured to the needs of multiple stakeholders. The change needs to be made at the board level, because the board hires the CEO and the CEO hires the other executives. There are logistical issues in managers applying stakeholder theory and in doing so making decisions that restrict profit from flowing to the shareholders, unless the shareholders themselves dictate these terms. It is unlikely, however, with the prominence of institutional investing that the shareholders would have any interest in anything other than rational returns.

This brings us back to the core stakeholder/shareholder debate. Branco and Rodrigues argue that only the stakeholder perspective can be relevant in any debate about CSR. The shareholder view essentially rejects any notion of a CSR debate -- there is nothing to debate as there is only one social responsibility for business. Ideally, a firm could find some common ground. The main point of common ground is when CSR issues not related to profit begin to impact profit, for example in the Nike supplier ethics scandals. However, such risks are difficult to quantify, which makes it difficult for management to make the case to the board that a stakeholder approach genuinely improves profits. This is the primary challenge for advocates of stakeholder theory -- the arguments have been made, now some evidence needs to be presented.