Comment: Rethinking standards of corporate responsibility

May 2003

by Jon Entine

There is no such thing as business ethics, only ethics of individual businessmen and women, writes Jon Entine

How do companies grow from advocates of corporate responsibility to businesses with systems of accountability and governance? Professions of “good intentions” or “social responsibility” are obviously not enough. The recent proliferation of ethical controversies underscores the need for more verifiable ethical paradigms.

It might be constructive to venture into territory that those who fashion themselves as progressive business thinkers might think taboo – the writings of Milton Friedman, who is often caricatured as a “right-wing” capitalist. In a now classic analysis, Friedman endorsed a limited concept of corporate social responsibility. He concluded that businesses that act in the best interest of shareholders maximise the benefits to all stakeholders:

“There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud … By pursuing [a person’s] own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.”

Friedman’s cynicism about “trading for the public good” paraphrased Adam Smith’s argument that those who trade by the “invisible hand” may contribute more to the public weal than those who claim altruistic motives. Under this thesis, corporate social responsibility is fulfilled by the moral constraints of maintaining open competition, establishing a framework for the rule of law, avoiding deception and exemplifying fair play.

“The only entities who can have responsibilities are individuals; a business cannot have responsibilities,” wrote Friedman. “So the question is, do corporate executives, provided they stay within the law, have responsibilities in their business activities other than to make as much money for their stockholders as possible? And my answer to that is, no, they do not.”

This view has been mischaracterised as endorsing roguish corporate behaviour in the service of enriching stockholders. Not true. Friedman acknowledged the ripple effect of a successful business such as increased community wealth, rising educational standards and an improved environment – all positive social consequences of progressive business. He notes that when Henry Ford built the Model T he realised that the long-term success of the automobile industry rested with creating a mass market for his products. Committed to making his new car affordable to even his own workers, Ford Motor paid wages twice the going rate. Although he was viciously criticised by the business community for such “generosity” and successfully sued by outraged stockholders, Ford proved prescient. He made enormous profits, the industry moved to his standards, and the automobile was transformed from a luxury to an affordable staple. He charged an “integrity premium” for his higher quality and more responsible products and eager consumers willingly paid it.

Key to Friedman’s beliefs and integral to the concept of the integrity premium is the idea that doing good can add competitive value to products or services and should not merely reflect the idiosyncrasies of corporate executives. Otherwise it is mere executive vanity, an abrogation of responsibility in a public company. Friedman once described oil companies’ television ads as “turning his stomach” for making it seem that their purpose was to preserve the environment. However, he noted that he would probably sue if they did not engage in such “nonsense” because otherwise they would endanger their competitiveness. Friedman made the point that companies must profess social responsibility to appeal to the public-at-large, keep regulators at bay and thus ensure profits.

But Friedman went beyond endorsing pure image marketing. He noted that if an energy company can demonstrate that the controversy surrounding the release of industrial effluents makes it difficult to recruit and retain employees, or offers the prospect of adverse publicity or litigation, then voluntary reduction or clean-up of the effluent makes business and ethical sense. If it could mitigate adverse consequences by modifying environmental practices, then it is compelled to act in its stakeholders’ best interest by doing so. This linkage of social marketing to intrinsic product value offers the classic win-win scenario preached by CSR and ethical investing advocates. Consumers are willing to pay extra for a Mercedes automobile or a Le Tourneau watch because its brand image – premium quality – is reflected in its operations and products.

The ABC of ethical business

Preaching is the easy part. How can companies burnish their image and increase their responsiveness to stakeholders? I offer the ABC of ethical business: Accountability, Basic stakeholder relations, and executive Character.

Accountability is the system of checks and balances – “transparency”. It is essential that companies regularly and publicly assess their performance against a broad range of standards and not just financial criteria. In the current post-Enron climate, it is not farfetched to hope that regulations might yet be enacted requiring corporations to report industry-specific non-financial measures such as environmental compliance and compensation standards. Transparency could be a part of the annual report or a supplemental social report instead of being buried in the shareholder proxy statement, which almost no one reads.

In recent years, rudimentary guidelines have evolved including the CERES Principles, the chemical industry’s Responsible Care, the Caux Principles, the European Union Eco-Management and Audit Regulations, and ISO-14001. The Association for Investment Management and Research, a US professional group of investment advisers, annually presents Excellence for Corporate Reporting awards to encourage companies to disclose more than the bare bones. Winners have included ethical investment favourites such as Cummins Engines, Wal-Mart, and Schering-Plough, as well as companies involved in oil (Ashland Oil, Chevron, Mobil, Occidental Petroleum, Phillips Petroleum), mining (Placer Dome), forest products (Boise Cascade), waste management (Browning-Ferris Industries) and chemicals (Dexter).

It’s also critical that companies accelerate the trend to install internal mechanisms: boards, ethics officers, hotlines and the like. Nothing is more revealing of the good intentions of executives than their willingness to put in place limits on their own power. Companies are also finding it prudent to appoint ethics officers and institute social and environmental reviews, if for no other reason than to protect themselves against liability concerns. The bottom-line reality is that companies cannot wait to screw up before addressing accountability.

Basic stakeholder relations means a move away from trendy social litmus tests to measures of actual impact on stakeholders. Archie Carroll, Professor of Business Ethics at the University of Georgia, laid out this thesis brilliantly in 1991 with his “pyramid of social responsibility.” According to Carroll, the base of the pyramid is financial stability: echoing Friedman, the fundamental responsibility of a corporation is to be profitable. That profitability rests on a corporation’s ability to satisfy the competing demands of stakeholders, from customers to employees to shareholders.

The next layer of the pyramid is legal compliance. But modern corporations, if they hope to survive in a world of ever-fiercer competition and shrinking profit margins, also need to focus on how they can enhance their brand identity so as to inflate their profit margin. That comes through ethical actions beyond mere legal compliance – the kind Friedman suggests he would expect a company to take to embellish its reputation and competitiveness.

These three dimensions – economic, legal and ethical – provide a base of savvy management that makes the peak of the pyramid possible: philanthropy and other acts of social responsibility. Even this is dominated by bottom-line, strategic and brand-building considerations. Curtis Weeden, former Vice President for Philanthropy at Johnson and Johnson, contends in his book Corporate Social Investing that corporate philanthropy is an oxymoron. Almost none of it represents a quiet, no-strings-attached act of conscience. Rather, it serves to support corporate goals through other means. In the case of self-styled, socially responsible firms, it also embellishes their reputation and inflates the integrity premium – the price they can charge for their products.

Character of management is the intangible that ultimately defines the ethical reputation of a corporation. A business might better be thought of as an extended family, at times dysfunctional, made up of stakeholders with competing and frequently conflicting interests. Although it may draw moral legitimacy from acts of social campaigning and philanthropy, it is defined by its stakeholder relations and the integrity of its operations. Businesses need to be held accountable for product quality, treatment of employees, vendor relations and their environmental impact as well as for their impact on those who invest money in the company through stock purchases. No corporation should be given a get-out-of-jail-free card on the basis of its inspired social rhetoric. In other words, corporate responsibility is serious business.

We live in a time when business transgressions inevitably find their way on to the front pages of The Wall Street Journal or the Financial Times. Nothing reveals ethics more starkly than senior management’s response to corporate miscues. Ethics is not about identifying right from wrong – choices are rarely so clear – but making informed choices in morally ambiguous situations. No compliance standard, corporate board oversight committee or internal ethical review can compensate for a rupture in personal ethics. Mistakes are built into life; character is defined in the breach. There is no such thing as “business ethics”, only ethics of individual business men and women.

Jon Entine is scholar-in-residence at Miami University (Ohio) and adjunct fellow with the American Enterprise Institute in Washington, DC. Jon is also an award-winning freelance journalist.