Social and environmental responsibility of corporations

March 28, 2013, 4:39 pm
Content Cover Image

Global Reporting Initiative (Wikimedia Commons)

This article will provide a broader assessment of large corporations beyond the realm of simple economics. Under the textbook conditions of perfect competition, business firms maximize their contribution to human well-being simply by seeking to maximize the returns to their shareholders. Yet, the large multinational corporations (MNCs) generally operate in oligopolistic markets. Oligopolies do not tend to be efficient from either an economic or social perspective. By virtue of their sheer magnitude, the activities of MNCs can have large spillover effects on society. The conception of corporations as merely economic entities is being replaced by a view that places corporations in a broader economic, social, and environmental context – often called the “triple bottom line.”

Benefits of Large Corporations

The growth of large multinational corporations (MNCs) in recent decades has produced some undeniable benefits. The ability of large corporations to seek out low-cost production opportunities provides a benefit to consumers in the form of lower prices. The prices of many manufactured goods, such as televisions and home appliances, have declined in real terms through improvements in technology and cheaper labor. In addition to low prices, large corporations are also capable of providing a familiar product of consistent quality in different regions of the world. For example, the fast-food restaurant chain McDonald’s serves food with similar standards in more than 30,000 locations in over 120 countries. Large corporations offer some advantages to their employees, who are more likely than workers in small firms to receive fringe benefits such as health care and pensions. Average wages in the U.S. for employees in firms with more than 500 employees tend to be higher than in firms with fewer employees. Also, many large corporations that have been in existence for decades are unlikely candidates for bankruptcy (although there are some recent exceptions to this such as United Airlines and K-Mart). The stability of large corporations is attractive to investors seeking security and relatively stable returns. Large corporations implicitly recognize their interconnection with society in their donations to non-profit organizations. For example, Wal-Mart donated a total of $200 million in 2002 to thousands of organizations. Exxon-Mobil describes how they helped create the Save the Tiger Fund, which has collected about $9 million since 1995 to fund conservation projects around the world. General Motors reports on their cooperative efforts with Detroit-area schools to curb youth violence. In the late 1990s, annual contributions by American companies and their foundations amounted to over $8 billion.

Corporate Scandals

Perhaps the most obvious responsibility of corporations is that they obey existing laws. The regulation of corporate business practices has received increased attention in response to a wave of corporate scandals in the last few years. While the specific circumstances vary in each scandal, the primary issue has been the exaggeration of profits, and consequently stock prices, using unethical or illegal accounting practices. In most cases, top corporate executives sold billions of dollars worth of stock at inflated prices, while ordinary investors suffered large losses when the firm’s financial problems eventually became known.

The accounting scandals in recent years can be linked to the widespread use of stock options as a means of executive compensation in the late 20th century. Many economists supported this practice – arguing that executives would manage corporations for the benefit of all shareholders if their compensation were linked to the firm’s stock price. In addition to a regular salary, top executives are given shares of the firm’s stock.

Unfortunately, economic theorists and corporate regulators failed to address a critical problem with the practice. Executives with large stock holdings also have an incentive to temporarily inflate the firm’s stock price and sell their shares at elevated prices. By the time the firm’s stock price eventually falls, executives can make huge profits while those holding the stock during the crash lose billions.

Complex accounting methods often permitted executives to keep losses and liabilities off the books. Consider the case of WorldCom, the telecommunications firm whose stock price fell from over $60 a share to just pennies as it became evident that the company’s profits had been overstated by nearly $4 billion. While WorldCom’s bookkeeping deception has been the largest measured in dollars, the scandal at Enron is perhaps the most famous because of its fast-paced culture of greed and influence at the highest levels of government.

Social and Environmental Impacts of Large Corporations

Economic activities often impact those who are not involved in the activity. For example, a corporation manufacturing automobiles generates pollution and the cost of this pollution is borne by nearby residents. External costs (or benefits) arising from economic activities are referred to as externalities. While firms of any size can create externalities, multinational corporations can use their political influence to avoid bearing responsibility for significant external costs.

“Given the close relation between minimizing costs and maximizing profits, it is natural to assume that an organization that seeks profits and has significant political power will feel some motivation to use that power to externalize costs, where possible. This motivation may be held in check by ethical considerations, by regulation, or by a fear of backlash from groups that might harm the organization; for example, consumer groups, or others who could mobilize effective public opinion.” (Goodwin, 2003)

The benefits firms obtain from being able to impose externalities and shift costs to others are difficult to measure in economic terms. The only available estimate of the total public cost incurred to support the operations of private corporations was $2.6 trillion for 1994 in the United States.

Voluntary Efforts at Corporate Reform

Corporations are required by law to publish annual financial reports. Recognizing their broader responsibilities conceptualized in the triple bottom line, nearly all large multinational corporations (MNCs) also publish reports detailing their impacts on societies and the environment. For example, Shell publishes annual data on its efforts to reduce emissions of greenhouse gases and Unilever describes their efforts to purchase raw materials from local suppliers in developing countries.

A problem with these publications is a lack of standardization and independent verification. A notable effort to increase the transparency and consistency of corporations’ environmental and social performance is the Global Reporting Initiative (GRI). The GRI, founded in 1997, seeks to:

“develop and disseminate globally applicable sustainability reporting guidelines for voluntary use by organizations reporting on the economic, environmental, and social dimensions of their activities, products, and services.” (GRI, 2000, p. 1)

The GRI has published reporting guidelines for firms wishing to participate in the project. So far, over 500 corporations have adopted these guidelines in preparing reports, including AT&T, Ford Motor Company, Nike, Nissan, and Shell. These guidelines explicitly incorporate the triple bottom line concept of financial, environmental, and social issues.

Another voluntary attempt to increase the transparency of corporate activities is eco-labeling. Eco-labels either indicate the overall environmental impacts of a product, or else identify those products that pass certification criteria. Eco-labeling is now common in such industries as major home appliances, forestry products, and organic foods. For example, Home Depot seeks to purchase wood that has been certified by the Forest Stewardship Council as meeting a list of ten environmental and social criteria.

A controversial issue is whether firms with elevated social or environmental performance also perform better financially. Until the recent stock market downturn, the majority of research suggested that firms with high social performance, as measured by various indices, also have better-than-average economic performance. However, about one third of the studies comparing economic and social performance find a negative relationship between the two variables. Further research is needed, particularly on the validity of techniques for measuring social and environmental performance.

Institutional Reform of Large Corporations

It is unlikely that multinational corporations (MNCs) will fully align their behavior with the broader social and environmental goals of society solely through voluntary measures. A significant limitation is that corporate decision makers typically focus on the demands of shareholders and fail to consider the impacts of their decisions on other affected groups. These stakeholders include all parties who are impacted by corporate decisions, including consumers, workers, suppliers, creditors, those living near production facilities, and people of the future who will be affected by environmental and other impacts.

We will next consider the ability of stakeholders to initiate corporate reforms through direct action. Yet these efforts alone will not be sufficient to institute meaningful change. Rules and regulations, at national or international levels, will be necessary if the interests of stakeholders are to be formalized. We will conclude with a discussion of some types of regulations that can influence corporate behavior, first at the national level then at the international level.

Stakeholder Actions

Consumers, non-governmental organizations, and other stakeholders can make their preferences known through boycotts and protests. Consumer boycotts and public information campaigns have been instrumental in leading to corporate change in some instances, such as the packaging used by McDonald’s and the fishing techniques used to harvest tuna.

The unfavorable media attention arising from consumer boycotts can lead to reduced sales and profits. A Business Week (2000) article notes:

“Citizen attacks on corporations have been surprisingly effective, and many executives have seen how stonewalling and defensiveness have boomeranged. In some cases, the criticism intensifies, with the potential to damage brand images and sales, undermine companies’ standing with regulators and politicians, and, ultimately, whack a company’s stock price.”

The nascent protest movement commonly referred to as “global democracy” and epitomized by the Seattle protests at the World Trade Organization’s ministerial conference in 1999, emphasizes the goal that all stakeholders be fairly represented in international trade negotiations. The effectiveness of the global democracy movement has been limited by a couple of factors. First, it is still loosely organized, comprised primarily of single-issue groups dedicated to the environment, workers rights, women’s issues, or health topics. It is also hampered by being perceived as a group of radical elitist protesters rather than one that offers logical discourse.

Another way that stakeholders can influence corporations is through their investment decisions. Increased transparency on environmental and social issues allows investors to seek out corporations that behave in a socially responsible manner or screen out corporations based on certain criteria. Between 1995 and 2003 the amount of money involved in socially responsible investing in the U.S. grew 40% faster than the overall growth in investments. In 2003, about 11% of all investments in the U.S. were in socially responsible assets, or about $2.2 trillion. As mentioned earlier, the evidence is unclear whether socially responsible firms perform better or worse, on average, than other firms. Some investors may even be willing to accept below-market rates of return when investing in corporations that pay good wages, provide job security, reduce environmental impacts, or otherwise benefit the broader community.

Another potentially important investment trend is the growing concentration of corporate stock held by institutional owners, including mutual funds and pension plans. In the early 1970s individuals owned about 75% of corporate stock in the United States. By 2000, institutions owned about 60% of the stock in the 1,000 largest U.S. corporations. The increase in institutional ownership provides an opportunity for organized and effective influence in matters of corporate governance. While institutional influence on corporations has been, so far, primarily used to promote the interests of shareholders, the influence of institutional owners continues to increase and could be used to promote the interests of other stakeholders as well. As an example, in November 2003 institutional investors representing over $1 trillion in assets met at the United Nations to call for increased disclosure by corporations of the risks of global climate change to investors.

Corporate Reform at the National Level

While direct action by consumers and investors has initiated some corporate reforms, it still remains the task of governments to set the legal boundaries for corporate behavior. Several reforms could be instituted at the national level to reduce the externalities multinational corporations (MNCs) impose on society and increase social well-being.

Corporate taxation can be viewed as a way to collect fees from corporations to finance public services and as compensation for external costs imposed on society. As mentioned above, existing loopholes in national tax policies allow some corporations to achieve very low, even negative, rates of taxation on profits. Some proposed reforms that could be enacted in the U.S. include:

“focusing on the long list of corporate tax breaks, or as they are officially called, ‘corporate tax expenditures’ … They could rethink the way the corporate income tax currently treats stock options. They could adopt restrictions on abusive corporate tax sheltering … They could reform the way multinational corporations allocate their profits between the United States and foreign countries, so that U.S. taxable profits are not artificially shifted offshore. In short, the corporate income tax code is overdue for a deep examination of how we tax, or fail to tax, our major corporations.” (McIntyre and Nguyen, 2004, p. 15)

The benefits of corporate tax avoidance accrue to a small portion of any society, while the loss of tax revenue means that the majority suffer from loss of services or higher taxes. The fact that there has not yet been serious debate on the prospect of outlawing the use of offshore tax havens is persuasive evidence for the deep political power of MNCs.

Enforcement of antitrust laws is an obvious means to limit the power of large corporations that obtain monopoly power. More rigorous enforcement could be used to increase competition in industries with high concentration ratios. Greater scrutiny of proposed mergers is another measure for preventing the concentration of market power.

Campaign finance reform could limit the power of corporations in the political arena. The McCain-Feingold reform bill passed by the U.S. Congress in March 2002 was designed to end unlimited soft money contributions to political parties. Yet, as demonstrated in the 2004 election cycle, this reform can be essentially circumvented through donations to independent organizations that supposedly support issues rather than candidates. Some reformers propose that the ultimate solution to control the influence of money on politics is to finance campaigns with public funds.

National regulations can stipulate that stakeholders need to be formally integrated into the decision-making process of corporations. One movement that has met with some success is increasing the role of labor in corporate decisions. In Germany, as well as other European countries, works councils are elected to:

“institutionalize worker rights to information and consultation on the organization of production and, in some cases, codetermination of decision making, In addition to institutionalizing worker input, works councils also enforce state regulation of the workplace in such areas as occupational health and safety. They are seen as being able to extend their reach beyond the unionized sector while supplementing the work that unions already do.” (Gallagher, 1998, p. 220)

Other proposals for corporate restructuring are more radical. As corporate behavior has broad impacts on a community, some theorists argue that the broader community needs to be explicitly brought into the management process of corporations. Modest proposals would require a community representative or other external voice on the board of corporations. More ambitious proposals would transfer varying degrees of ownership to the community or seek to reestablish large corporations as entities that are specifically chartered to provide for the overall welfare of society.

Corporate Reform at the International Level

As corporations increasingly operate in a global market that transcends national boundaries, the possibility of using their mobility to avoid national regulation increases. Thus, the regulation of multinational corporations (MNCs) is often best approached at the international level through treaties, international institutions, and the coordination of national policies: “… there is no world government with enforceable laws for markets. Hence international are needed to develop civil governance.”

For all practical purposes international institutions to enact and enforce corporate regulations are currently non-existent and unlikely to arise in the near future. Fortunately, an effective global corporate regulatory system does not necessarily require international rules and oversight. Distinct national approaches can be effective if structured within a flexible and enforceable international framework. Consider the current variability of national tax policies. International competitiveness for corporate investment can lead to inefficient corporate behavior as firms spend resources to shift income across national boundaries to lower their taxes. There could be significant public benefit if nations could agree to set tax policies that are similar enough to discourage corporate mobility that has no productive purpose.

Currently, international trade agreements likely provide the most effective means to regulate MNCs. The key to international trade agreements that reduce corporate externalities is that all stakeholders be represented. Progress is slowly being made to include non-corporate interests in international trade negotiations and advisory committees. However, a look at the composition of trade advisory committees in the United States reveals a striking imbalance. Of the 111 members of the three major trade advisory committees in the early 1990s, 92 represented individual corporations and 16 represented trade industry associations. Only two represented labor unions and one represented environmental advocacy groups.

The prospect for international trade agreements that direct corporations to incorporate social and environmental objectives rests on the issues of accountability and transparency. Unfortunately, international trade policy is currently conducted under circumstances that are deficient on both counts. Trade representatives are appointed, not elected, and the meetings of the World Trade Organization (WTO), the primary international trade agency, are conducted behind closed doors.

The global democracy movement, mentioned above, is leading the push for greater accountability and transparency in international trade agreements. This movement still needs to present a coherent alternative to the Washington consensus dominating trade discussions. Another necessity is to form alliances with other parties pursuing similar, but not necessarily the same, objectives. For example, developing nations are often doubtful of the benefits of globalization based on rules dictated by the wealthy nations and MNCs. But the developing nations are also fractured, disagreeing about what constitutes fair trade rules. Any meaningful counterweight to the current regime of globalization will require that different stakeholders work out their differences to present a just and sustainable alternative.

Further Reading


 


This is a chapter from Environmental and Social Issues in Economics (collection).
Previous: Trade and the environment  |  Table of Contents  |  Next: none
 

 

Glossary

Citation

Roach, B. (2013). Social and environmental responsibility of corporations. Retrieved from http://www.eoearth.org/view/article/156067

0 Comments

To add a comment, please Log In.