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Making the Case for Corporate Social Responsibility (Part III)

December 6, 2010

For the third and final segment of this post (see part 1 and 2), I’ll examine the charge that corporate social responsibility (CSR) campaigns are ineffective when profit creation and the public good are directly opposed.

In “The Case Against Corporate Social Responsibility,” Dr. Aneel Karnani suggests that many of society’s “most pervasive and persistent problems” are cases in which social welfare and private interests conflict. Otherwise, he reasons, the quest for profits would have produced solutions long ago. In these cases, Karnani argues campaigns for greater CSR are ineffective because executives’ hands are tied. “Even if executives wanted to forgo some profit to benefit society,” he writes, “they could expect to loose their jobs if they tried – and be replaced by managers who would return profit as the top priority.” Once again Karnani situates his argument within an extreme and narrow framework that constrains executive choice in order to avoid a more nuanced and complex discussion. Yet this time, both Karnani’s  argument and its supporting framework struggle to hold before critical analysis, as they fail to account for the shifting landscape of present market realities.

First, let’s accept Karnani’s framework and take as a given that there are circumstances in which profit maximization and social welfare are in direct opposition.  This position presumes a zero-sum relationship between the two: enhancing one decreases the other. Now certainly, there are many firms that will never enhance social welfare as a natural consequence of profit maximization, and there are many for whom business as usual will actually decrease it. Yet it does not follow that all paths to profit maximization produce the same negative externalities. Executives still face choice in resource allocation and strategy execution, and this implies an ability to select a set of options that minimize social welfare loss while maximizing profits.

In these circumstances, calls for CSR are pragmatic appeals to do the least harm; to tweak a revenue model, not throw it out the window. Campaigns for CSR remain essential in this case for the same reason discussed above. They apply the pressure necessary for executives to justify the cost of CSR personnel who will seek out cost-effective strategies to reduce negative externalities. Without such dedicated resources, a company will have no means by which to measure the impact of business as usual on social welfare and identify and analyze less harmful alternatives.

But the larger problem with this argument is that its framework is built upon an outdated assumption. Can private interest and public good actually be classified as two distinct entities, entirely in opposition, as Karnani presumes? Can markets be so neatly divorced from the societies they serve? Today, the answer is increasingly, no.

Historically, it was much easier for companies to operate as if this convenient distinction existed. Companies could focus on generating profit, and government would focus on maximizing social welfare with the resources (drawn through taxes) that companies produced. But a new reality is unfolding, with a new set of circumstances that force companies to confront a long-time truth: profits are not created in a vacuum.

As Scott Henderson eloquently points out in his rebuttal to Karnani, free markets are not distinct entities that exist independent of social constructs – they are derivative of those constructs, and are shaped by them. Corporations do not generate profits and economic growth out of thin air – they rely on inputs provided by society. Resources flow between society and corporations along a two-way street. Private corporations reap the benefits of enhanced social welfare – in the form of stable government, functional communities, public infrastructure, ecological stability, and a healthy well-educated populace – just as individuals do.

Likewise, shareholders and board members exist within society. They are members of it. So Karnani’s suggestion that shareholders and boards won’t accept any constraints on short-term profit creation is bunk. They already do. As rational individuals, they are capable of weighing the private benefit of portfolio returns against the net public loss (in which they share) generated by a company’s actions. Hence most will agree that clean air, potable water, and safe working conditions are worth slightly reduced returns. That’s the pleasant side effect of free markets typically existing along side free government. If shareholders don’t sanction certain constraints, they can presumable organize to elect officials that will remove them. You may have noticed this tends to happen from time to time.

So then, if such intimate connections exist between companies, shareholders, and the public good, why have companies historically behaved as if they didn’t? And why hasn’t enlightened self-interest sufficed to check profit creation against social welfare loss? The answer lies in two factors: distance and time. Enhanced social welfare often strengthens a company’s bottom line indirectly (the connection may not be obvious), and over a long time horizon. Historically, this has caused companies to undervalue social welfare in their pursuit of short-term profits.

Simultaneously, companies’ ability to externalize social welfare loss on to distant or future populations insulated them from shareholder pressure, while centralized and relatively controlled channels information distribution enabled them to shield shareholders and consumers from inconvenient information. If shareholders and consumers do not share the burden (or even the awareness) of social welfare loss, and will not feel the benefit of social welfare gain, then they can hardly be expected to endorse decisions that will reduce their own returns (or raise the prices they face) in the name of public good.

Today, these traditional buffers between private interests and the public good are breaking down. As Henderson describes, new tools of media and information exchange are changing the game. They are collapsing the distance and time that has historically shielded corporations from internalizing the full cost of their actions. Corporations can no longer shift the burden of present decisions onto distant populations or future generations, while enjoying immediate returns. They must now contend with a new set of realities:

  • Acting in favor of short-term profit over long-term sustainability can now hurt companies in the present, not just the future.
  • The flow of information is no longer controlled or linear (i.e. from corporation to public).
  • Shareholders and consumers now have the tools to perceive the true cost of the returns and products they enjoy. They may decide, as some already have, to lend their capital and purchasing power to companies that share their values – even if slightly lower returns or higher costs are the result.

The internet – and the blogs, amateur journalism, and social media it supports – along with smart phones and ubiquitous wireless access not only intensify the connection between disparate global populations and markets, they make those connections (once abstract) tangible to consumers and shareholders alike. Furthermore, they transform connections into channels for action. A viral cell phone video or amateur photographs exposing abuse, negligence, violations, and other misbehavior can travel around the world with a click and make the consequences of distant corporate actions hit home hard and fast– in the form of negative publicity, deteriorated brand image and value, and reduced market share.

These tools make possible the well-organized activist campaigns that Karnani acknowledges are effective in modifying corporate behavior. They are creating a new reality in which private and public interests – profits and social welfare – are more intimately intertwined than ever before. In other words, the creation of private profits and social welfare may be partially opposed, but they can no longer be described as completely and directly opposed. They are always at least partially aligned.

Karnani writes, “In most cases, doing what’s best for society means sacrificing profits.” This may be true, but what about doing what is better for society? The choice between public good and private gain is a false one. The question corporations and their shareholders face is not either or. It’s how to strike the right balance between the two.

The tools of new media are moving us closer to a world in which corporations face the possibility of internalizing the negative externalities of operations. They can confront this new reality, and seek to modify their behavior in ways that are consistent with value creation, or they can deny it, and face significant losses as consumers or investors take their business elsewhere. Firms that are proactively reducing negative externalities, or generating added social value, will insulate themselves from this risk. As savvy firms already understand – CSR is one very cost effective hedge against market share loss.

Karnani is correct to argue that CSR must not be allowed to supplant formal systemic regulation. While the former is valuable, only the latter can produce binding, industry-wide compliance. Yet it does not follow that public campaigns for greater CSR are irrelevant or ineffective in modifying firms’ behavior.

Public calls for CSR create the negative pressure and positive incentives needed to stimulate the creation of CSR programs in the first place, regardless of whether social welfare is in a firm’s direct or indirect interest in short-term or long-term value creation. Not all CSR departments will produce meaningful change, and disingenuous firms may use them to generate more distraction than innovation, but does not render all CSR programs worthless. Corporations that use CSR departments to “greenwash” might defer the consequences of malfeasance initially, but will ultimately undermine their own competitiveness.

Firms that embrace robust CSR programs will be positioned to emerge as industry leaders as they innovate, discover new sources of value, and build loyalty among a growing market of social conscious consumers and investors. Wise firms will make good use of their dedicated resources, and use their CSR departments to identify and exploit opportunities to do well by doing good.

CSR programs are no substitute of formal regulation, but today more than ever there is a place, and a case, for corporate social responsibility.

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