THEORIES OF CORPORATE GOVERNANCE

By Emmanuel Q. Fernando

In PLDT President Manuel V. Pangilinan’s keynote speech at the 43rd annual meeting of the Philippine Economic Society in November, when he had just been chosen as “Management Man of the Year” by the Management Association of the Philippines he likened corporate governance with public governance. “It is tempting—if not hazardous—to draw similarities between corporate governance and public governance, between our experience at PLDT and our view of the Philippine economy.”

He argued that public governance has much to learn and benefit from the financial cost-cutting and income-generating techniques and measures used in corporate governance, and provided the example of his stewardship of PLDT, to show how a once problematic and cash-strapped company can be transformed into a booming and profitable one. This series of articles, instead, will focus on the other aspect of the relationship between corporate and public governance: that is, whether corporations should take upon the functions of public governance.

The classical view, as presented in Friedman’s seminal article entitled “The Social Responsibility of Business Is to Increase Its Profits,” a 1973 article, answered the question in the negative. It presented the problem thus: “Should business be concerned merely with profit or also with promoting desirable social ends?”

He provided several arguments for his conclusion. First, he claimed that the managers of a corporation, being agents of its owners, the stockholders, bear a direct and primary responsibility towards them to conduct business in accordance with their desires, which is to make profit. Unlike owner-managed corporations, the money used is not management’s own to dispense with in any manner they wish. Hence, spending other people’s money for a social interest is just like taxing them.

Secondly, there is the argument based on competence. Businessmen are trained basically to make profit for the corporations they manage, and they do not enjoy a specific competence in matters affecting the public welfare. Hence, if they are required to perform this additional function of public governance, they are likely not to do a good job out of it.

Finally, implicit in his article is the “hidden hand” argument. If business were allowed freely and fully to function in its own specific competence, which is to make profit, then society will be better off in the long run. Thus, Friedman concludes that business has only one function, which is “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.”

These arguments, however, are not conclusive. To the first argument, it is countered that, strictly speaking, management is not the agent of the stockholders. For it is a curious kind of agency, where the agent does not ask the principal what the latter’s wishes are.

In truth, management bears a fiduciary relationship to the owners, to run the business on their behalf. However, the duty to make profits for them has only prima facie, and not absolute force, and may be overridden by his other obligations in running a company: to wit, to deal fairly and honestly with his suppliers, to attend to the working conditions of his employees, to provide safe products to his customers, not to pollute the environment, etc.

To put the same point another way, such a fiduciary duty stems from his role as the management of the corporation. Although the manager has the obligation to fulfill the duties attendant to his station, it does not mean that, in handling corporate affairs, he must approach problems only from a profit-oriented perspective, in the process forgetting his entire humanity. Sometimes, his duty to be human overrides his duty to make profits for the company.

As to the argument of competence, engaging in activities for the public welfare does not require such a high degree of competence which is beyond the capacities of an ordinary businessman, or indeed of any member of society.

Finally, as to the “hidden hand” argument, it is, on the contrary, observed that if businesses were left to themselves, they would enrich themselves while impoverishing society, will pollute the environment, will discriminate racially and sexually, will deceive customers, will eliminate competition and keep prices high through oligopolistic practices. In other words, the jury is still out as to the truth of the “hidden hand” argument.

Partly as a result of these counterarguments, the theory of business as having also a public function developed first in the form of corporate social responsibility and eventually in the form of stakeholder theory, which are the subjects of the next succeeding articles.

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The assertion that corporations ought to have a social or public purpose was perhaps first expressed at the dawn of the previous century, when both Dewey in the United States and Ravenaugh of Germany maintained that business had the ethical duty to consider social and public interests. Thereafter in the ‘30s, Berle and Means’ book, “The Modern Corporation and Private Property,” clearly set out the central problem of corporations, namely the fact that the ownership and the control of the corporation were bifurcated. How were the owners, then, to ensure that management, which exercised control over the corporation, was acting on their behalf? But it also stressed the other problem of whether the corporation should pursue purposes other than profit-making.

This other problem gained some prominence in the Untied States during the ‘60s due to three significant issues. First was the urban crisis, which involved problems of crime, racism, poverty, housing, ghettoes, riots and the like, and the contribution of big business to those problems and its corresponding failure to address them. Secondly, was the rise of environmentalism. Clearly big business was responsible for the increase in pollution, the damage to rivers and forests, for example. Finally was the phenomenon of consumerism. The public became increasingly aware of the false or exaggerated claims of manufacturers, their possibly defective and dangerous products and the fact that some of these manufacturers were willing or prone to endanger customers’ health in exchange for profit.

In the Philippines, there are two reasons, perhaps, for the growing importance of the issue. The first is the gross imbalance in wealth in society, where most of it is concentrated in the hands of an elite few. The second is the fact that we are a Third World nation where large multinational companies are raking in great profits often at the expense of the Filipinos. There is, as of yet, insufficient awareness of environmental and consumer issues. Indeed, these two problems gave rise to the revolutionary fervor expressed by the youth, the students, the working classes, the peasantry and other sectors of society during the late ‘60s and early ‘70s, to which martial law became the answer of government.

In answer to the claim that the corporate responsibility in only to make profit, three reasons are usually cited in support of the view that it ought to include social and public purposes as well. The first is due to the fact that the corporation wields great power. Indeed some of the assets of multinational corporations rival those of governments. They have the power to create great wealth, provide jobs for the multitude, advance the frontiers of science and technology by financing and conducting research, either maintain the ecological balance of or pollute the environment, create goods and services that increase the safety, health and welfare of its consumers, provide basic needs, affect the stock market and the economy for better or worse, and the like. Clearly, with such awesome power comes the corresponding responsibility.

The second reason is that of gratitude. Corporations exist and thrive because the government and society provides the conditions for their continued existence. The government enacts favorable laws for the corporations while the community supports them.

Finally, there is the reason of citizenship. The corporation has legal personality, and therefore should have duties and responsibilities toward the community just as the ordinary individual citizen does.

This focus on corporate social responsibility, was eventually provided systematic and theoretical underpinnings by means of the stakeholder theory of corporate governance. Indeed in the mid-80s, the problem of corporate social responsibility began to be expressed in terms of the debate between stockholder and stakeholder theory, the latter theory being the topic of the next article.

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As mentioned in the previous article, stakeholder theory provided the theoretical underpinnings for a mode of corporate governance, which takes into account ethical and public concerns, and not just profit making. The moral environment of stockholder theory was tightly constrained, focused as it was only on the duties of management toward the stockholders to maximize the profits of the corporation. Stakeholder theory, on the other hand, opened the door to bringing fundamental moral principles to bear on corporate activity. For under that theory, the obligation of business was not to seek profit for its stockholders but to coordinate stake­holder interests.

There are many definitions of what a stakeholder of a corporation is. Briefly put, a stakeholder is any group or individual who can affect or is affected by the achievement of the organization’s objectives. Hence, the stockholders or the owners are only one among the many stakeholders of the corporation. Others include management, the creditors and financiers, the suppliers, the employees, the customers, the local community and the government. The corporation manifests its concern for ethical and public issues, and thereby puts on a human face by not taking the profit of the stockholders as the sole or primary consideration, but only as one among many considerations in weighing and balancing the needs of these various stakeholders.

In coordinating stakeholder interests, the corporation may function in a variety of ways. It may provide safe and healthy working conditions as well as meaningful life experiences for its employees, pay dividends to stockholders, develop new products and technologies, expand business, protect and enhance the environment, donate to various charities, install safety mechanisms to its products and help society solve its pressing problems. The manager therefore is not uni-dimensional, who takes his role as an agent of the stockholders at the expense of his humanity. Rather he infuses his humanity into his role as the steward of the corporation, who places importance on and fulfills his various responsibilities toward all those who affect and are affected by the corporation.

With the increase of large multinational corporations, the need to develop stakeholder theory became even more imperative. For these corporations, whose assets may rival even those of governments, play a vital and active role in the socioeconomic development of Third-World countries. Greater responsibility, therefore, is expected from them. Hence arose the Clarkson Principles, otherwise known as the Stakeholder Management Principles, the Caux Roundtable Principles, which are the product of European corporate executives who met in Caux, Switzerland, the Sullivan Principles, which were applied in South Africa and the Principles of the United Nations Global Compact. All of these principles were intended to ensure that multinational corporations be aware of their social responsibility toward developing countries.

Despite the praiseworthiness of stakeholder theory, two main criticisms can be made against it. First, it fails to provide adequate guidance to decision making by management. In insisting that the corporation or management has many responsibilities toward its various stakeholders, it does not furnish a neat or suitably precise formula with which the weighing and balancing of competing considerations are to be made. All it basically says is that the manager should not forget his humanity or to be so myopic as to consider only profit making in the formulation of policy or in the making of business decisions. The second criticism is related to the first. It asserts that the responsibility of management toward its owners or stakeholders is of a distinct or special kind, not to be put on the same level as its responsibility toward other stakeholders. This brings us to Strategic Stockholder Theory, which is the topic of the next article.

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Because of the introduction of stakeholders other than stockholders in developing theories of corporate governance, a number of intermediate theories between the two extremes of Stockholder Theory on one side and Stakeholder Theory on the other arose.

Whereas stockholder theory in its original form only spoke about the duty of the corporation toward its stockholders, these intermediate theories also accounted for the duties of the corporation toward stakeholders other than stockholders.

And although the first stakeholder theories acknowledged the existence of other stakeholders and the moral duties the corporation had toward them, they did not sufficiently explain the nature of these duties, how they are to be weighed and measured against each other in case of conflict and whether there was an ethical difference between them. These two intermediate theories to be discussed will explain in more specific detail how the duties of the corporation toward the various stakeholders are to be weighed and measured against each other by insisting on an ethical difference between the kinds of duties that management had toward stockholders and toward other stakeholders. Whereas the duty of management toward stockholders is fiduciary in character, its duty toward other stakeholders is nonfiduciary.

The first intermediate theory, which I call the Moral Minimum Stakeholder Theory, insists that the corporation must not behave toward the other stakeholders of the corporation below a certain moral minimum.

This moral minimum involves duties not to cause avoidable harm, or to honor individual stakeholder rights or to adhere to ordinary canons of justice. It can go about its fiduciary duty of making profit for the stockholders of the corporation so long as it does not transgress the requirements of the moral minimum. Corporate actions, humanitarian in character with a social or public goal, are not required, although they may be encouraged.

The second intermediate theory, which I refer to as Strategic Management Theory, insists that the corporation, in honoring its fiduciary duty toward stockholders to increase profits, should treat other stakeholders strategically. This allows business both to act within the moral minimum and even to go beyond it by undertaking humanitarian endeavors which help solve social problems.

For example, the corporation may honor its contractual obligations with its creditors or suppliers, lest it acquire a ruinous reputation. Or it may justify the rise in cost in manufacturing a more adequately safe product to avoid the costly litigation in the form of damage suits arising from the harm or accidents caused by an unsafe or defective product. Or it may engage in charitable projects in order to buy the goodwill of the public and enhance customer loyalty. Hence much moral good may result in this kind of theory.

Like other theories, either of these theories has its drawbacks. I will make only two criticisms and against only the Strategic Management Theory. First, this theory allows for the possibility of unethical behavior. For acting strategically is treating stakeholders only as a means toward the end of profit. Hence, if it were not profitable to treat stakeholders ethically, then management would soon abandon such behavior. However, since the corporation must look toward its long-term interests, in which maintaining a good reputation is important, the possibility for unethical behavior is greatly minimized. The second criticism refers to the fact that even if the corporation is acting morally, it is practicing a deception. For the theory’s successful application, corporations should disguise their intentions and instead make it appear to the public that they are motivated purely by ethical considerations. Customer loyalty would be more steadfast and binding if the public were convinced that corporations truly had their interests at heart, and were not only using ethical behavior strategically in order to increase their profits. In this regard, I am reminded of a remark once made by Groucho Marx: “The secret to life is honesty and fair dealing; now if you can fake that, you’ve got it made.”

The theory of corporate governance underlying the Corporation Code of the Philippines is essentially the classical Stockholder Theory in the Friedmanesque mode. The function of the corporation to increase or maximize profits is implicit in the entire Code. Duties only toward the stockholders are specified, and no mention is made of the other stakeholders. This is understandable because the Corporation Code took effect only on May 1, 1980, whereas Stakeholder Theory was introduced in the mid-eighties.

The elegantly formulated doctrine regarding the existence and nature of the fiduciary duty of directors toward stockholders was expressed in Gokongwei v. Securities and Exchange Commission, a 1979 case. In that case, a regulation in the amended by-laws of San Miguel Corp. to the effect that board members are disqualified for being engaged in any business which competes with or is antagonistic to the corporation was upheld by the Supreme Court, thus preventing Gokongwei from being elected as a board director. The Supreme Court stated: “Although in the strict and technical sense, directors of a private corporation are not regarded as trustees, there cannot be any doubt that their character is that of a fiduciary insofar as the corporation and the stockholders as a body are concerned. As agents entrusted with the management of the corporation for the collective benefit of the stockholders, ‘they occupy a fiduciary relation, and in this sense the relation is one of trust.’”

The fiduciary duties are those of loyalty, obedience and diligence, which are found in different provisions of the Code. Hence with regard to the duty of loyalty, directors must not “acquire any personal or pecuniary interest in conflict with their duty as directors” (Section 31); and must not acquire “for himself a business opportunity which would belong to the corporation, thereby obtaining profits to the prejudice of the corporation” (Section 34). Moreover there are restrictions against directors dealing with the corporation (Section 32), as well as restrictions on corporations with interlocking directors (Section 33). Finally, there are limitations on the compensation of directors during stockholder meetings. To pay directors too much will eat into the profits of the stockholders.

The duty of obedience requires that the board of directors act to increase or maximize profits, which can be assumed as the primary purpose for stockholders’ investment. However, no specification of this duty is located in the Code. Obedience also requires that the board act within its corporate powers.

Finally, the duty of diligence is provided for in the requirement that the director “not be guilty of gross negligence” (Section 31). It is also found in the business judgment rule, which states that the directors cannot be held liable for mistakes or errors in the exercise of their judgment provided they acted in good faith and with due diligence and care.

The business judgment rule also allows for leeway for the corporation to act in an ethical way toward other stakeholders, or even pursue a social, public or charitable purpose. Whereas the aforesaid doctrine was applied in cases which justified the acts of the corporation with respect to the pursuit of profit, there are two cases where it justified ethical behavior toward other stakeholders.

In Montelibano v. Bacolod-Murcia, the duty of a sugar central mill to honor its contractual obligations to its suppliers or planters, which would increase the planters’ share in the resultant product, was justified in terms of the business judgment rule, regardless of whether it will cause losses or decrease profits of the sugar central.

In Board of Liquidators v. Kalaw, the Board’s act to ratify contracts to deliver copra to various companies at a loss, operations having been hampered by four typhoons, was held to be a matter of the business judgment to be fair. Hence, the Court concluded: “Obviously, the board thought that to jettison Kalaw’s contracts would contravene basic dictates of fairness. They did not think of raising their voice in protest against past contracts, which brought enormous profits to the corporation. By the same token, fair dealing disagrees with the idea that similar contracts, when unprofitable, should not merit the same treatment. Profit or loss resulting from business ventures is not justification for turning one’s back on contracts entered into.” It is, more importantly, a matter of fair dealing to the corporation’s customers.

Under the Code of Corporate Governance, the theory espoused is a form of intermediate theory, where the corporation has a fiduciary duty toward shareholders and is to deal with other stakeholders observing the moral minimum. It is assumed that observing the moral minimum will help enhance the value of the corporation, so it can be considered a kind of Strategic Management Theory as well.

Its fiduciary duty toward the shareholders is expressed in articulating the Board’s Duties and Responsibilities. Hence, the board has the duty and responsibility “to foster the long-term success of the corporation and secure its sustained competitiveness in a manner consistent with its fiduciary responsibility, which it should exercise in the best interest of the corporation.” Transparency is also required. For the “shareholders shall be provided, upon request, with periodic reports which disclose personal and professional information about the directors and officers and certain other matters such as their holdings of the company’s shares, dealings with the company, relationships among directors and key officers, and the aggregate compensation of directors and officers.”

The duties of loyalty, obedience and diligence to the shareholders as found in the Corporation Code have been expanded to include the requirements of conducting fair business transactions with the corporation and ensuring that personal interest does not bias board decisions; devoting time and attention to work; acting judiciously; exercising independent judgment; knowing the law affecting the corporation, observing confidentiality and ensuring the continuing soundness, effectiveness and adequacy of the company’s control environment.

That it is a form of Strategic Management Theory is found in the very definition of corporate governance, which “refers to a system whereby shareholders, creditors and other stakeholders of a corporation ensure that management enhances the value of the corporation as it competes in an increasingly global market.” Thus the code emphasizes the role of stakeholders in enhancing the value of the corporation. It is also reflected in the state policy “to actively promote corporate governance reforms aimed to restore investor confidence, develop capital market and help achieve sustained growth for the corporate sector of the economy.” The corporation’s duties toward investors and the public as stakeholders are here stressed in line with State policy of sustained growth for the corporate sector.

Observing the moral minimum toward other stakeholders is found, among others, in the provision that the corporation’s major and other stakeholders are to be identified and a clear policy on communicating or relating with them accurately, effectively and efficiently is to be formulated. It is also expressed in the board’s general responsibility, where a director is to assume certain responsibilities toward different constituencies or stakeholders, who have the right to expect that the institution is being run in a prudent and sound manner. For a director’s office is one of trust and confidence. He should act in the best interests of the corporation in a manner characterized by transparency, accountability and fairness.

More particularly, the board should conduct itself with utmost honesty and integrity in the discharge of its duties to ensure a high standard of best practice for the company and its stakeholders. There must be an accounting rendered to the stakeholders regularly to serve their legitimate interests.

This requirement of the moral minimum extends to the chief executive officer and the corporate secretary, who should work and deal fairly with all the constituencies of the corporation, namely the board, management, stockholders and other stakeholders.

Conspicuously absent in these moral requirements is that of the corporation serving a public or social purpose. However, the possibility for such is found in the corporation’s vision and mission statement, which is required by the code. Hence, “The board should establish the corporation’s vision and mission, strategic objectives, policies and procedures that may guide and direct the activities of the company.” The vision and mission statement is the topic of the next and last of this series of articles on the theories of corporate governance.

As mentioned in the previous article, it is through the mission and vision statements that a corporation is able to express its adherence to social responsibility, a concern which is not required by the Code of Corporate Governance. Normally, mission and vision statements include three aspects: (1) a statement of the obligation of the company toward its investors or stockholders as to the maxi­mization or increase of profit; (2) a commitment to observe basic moral standards with respect to its dealings with the various stakeholders of the corporation; and (3) an affirmation of corporate social responsibility. This article will deal only with the last aspect to show that corporations in the Philippines, at least by express intent, go beyond the fundamental requirements of the Code of Corporate Governance.

For example, Benguet Corp. acknowledges its social responsibility and its concern for the community in its mission statement. Hence, it is committed to “be a socially responsible and environmentally conscious corporate citizen adhering to the highest ethical business standards” as well as “achieve competitiveness and excellence as a natural resource development company through the enhanced productivity of its people and through the improvement in the quality of life of its employees and their families, and its host communities.”Lepanto Consolidated Mining Co., on the other hand, expresses its social responsibility in terms of community involvement and research on the effects of mining activities on the environment and the community. Thus, it achieves its vision by continually “involving communities in decisions, which affect them, treating them as committed partners, respecting their cultures, customs and values and taking into account their needs, concerns and aspirations and “conducting and supporting research programs to expand [its] knowledge of the impact of mining activities on the environment and the community.”

A more elaborate articulation of its various ethical duties which include social responsibility is found in the mission and vision statement of Meralco. Indeed, it enumerates the various stakeholders of the corporation toward which it owes distinct obligations expressed in terms of stakeholder principles. These stakeholders include its investors, customers, employees, suppliers, competitors and the community.

It is the enumeration of the corporate principles concerning the community which best expresses its social responsibility. Thus it has the responsibility, among others, to “fulfill with dedication and commitment its social responsibilities,” “undertake activities that support and contribute to the economic development of the country” and “employ proactive measures and lead the development in [its] areas of interest by working with government and other institutions to serve society toward [their and its] collective benefit.”

Moreover, its commitment toward social responsibility has gone beyond articulation in its mission and vision statement. It has established a Corporate Social Responsibility Office. This office is a concrete manifestation and reaffirmation of its civic consciousness, which has been part of its commitment to society for decades. The vision of this Office, established in January 2001, is to “further strengthen this dedication to help uplift the quality of life in the communities within the Meralco franchise area.”

I do not mean to sound cynical, but there is no way to tell, by means of a mission and vision statement, whether a corporation is truly socially responsible or is merely using the statement as a means by which to increase its profits. For in acknowledging its commitment to social responsibility, a corporation is able to increase or enhance customer patronage and loyalty, attract more investors as well as minimize losses. If that is the motive, then the corporation subscribes merely to the Strategic Management Theory. In other words, it is not adhering to a moral standard or pursuing virtue for its own sake, but for the beneficial consequences to the corporation an ethical course of action brings about. To it, being ethical makes nothing but good business sense. It is only in the case of conflict, when a corporation chooses to be ethical rather than make profit, that its commitment toward social responsibility is demonstrated.

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Corporate Social Responsibility and Media

[07 July 2007, The Manila Times]

At a roundtable on “Corporate Social Responsibility (CSR): A Two-way Street,” the media was urged by businessmen to give greater importance to CSR stories and not just to relegate it to the press releases section of a newspaper.

The rationale behind this proposal was the claim that CSR should be something for the media not only to write about but also to carry out. After all, a media corporation, just like any corporation, has a responsibility not only toward shareholders, but also to other stakeholders, which comprise management, creditors and financiers, suppliers, employees, the local community, the government and most significantly the public in general.

The crux of this argument seems to be that the media, because of its duties to the public and other stakeholders, must feature with greater prominence stories concerning social-welfare projects or charitable activities of corporations. With all due respect to the businessmen, I beg to disagree.

That business expects the media also to adhere to CSR principles is, of course, welcome news. For the mischief of a corporation being concerned solely with profit at the expense of social responsibility must be vigilantly guarded against. After all, the prevailing theory in the sixties and the seventies was to recognize only the interest of the shareholders. According to Friedman, business has only one function, which is “to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game . . .”

His conclusion was based on the argument that since management is merely the agent of its owners, comprised of the shareholders, it bears a direct and primary responsibility toward them to conduct business in accordance with their desires, which is to make profit. Unlike owner-managed organizations, the corporation’s money is not for management to dispense with in any manner it wishes, such as engaging in welfare projects.

Obviously if the media took into account the public interest in responsible reporting and not just the shareholders’ interest in profit-making, it would cover and emphasize stories of a less gossipy or sensationalistic kind and feature with prominence stories of a more substantial and significant nature. This, obviously, would be of greater benefit to the public. It does not necessarily follow from this, however, that accounts of welfare projects of corporations should be prominently featured.

This is because of the fundamental tension between the interests of the shareholders and that of the other stakeholders, which the corporation has to coordinate and to weigh and balance against each other. In whatever way this balancing is done, there is no doubt that the making of profit is primary. For profit is the very reason for the corporation’s existence. A corporation would be unable to survive, much less engage in welfare projects, without it.

Hence, most corporations adhere to what is known as Strategic Management Theory. It insists that a corporation, in honoring its duty to shareholders to increase profits, should treat other stakeholders strategically as a means to generate profit. This allows business to undertake ethical or charitable activities because it is profitable to do so.

For example, a corporation may justify the rise in cost in manufacturing a more adequately safe product, to avoid the costly litigation in the form of damage suits arising from the harm or accidents caused by an unsafe or defective one. Or it may pursue charitable activities in order to buy the good will of the public, to enhance customer loyalty or to use as a tax write-off.

The media’s social responsibility, therefore, requires it to be more discerning in deciding which CSR activities should be displayed prominently. Since stories concerning charitable projects of corporations may simply be a way of promoting a good public image, they may, as a result, properly belong to the press relations part of a newspaper. On the other hand, if a story concerns faulty, defective or harmful products like some cars, tobacco, or infant milk formula, it should belong to the front page. But this, I suspect, is not the type of story which the businessmen in the roundtable discussion complained about as not being given sufficient prominence.

CSR also demands the media to exercise greater vigilance. Business, nowadays, cannot afford but to be engaged in manifesting some CSR. But in acting strategically, a corporation treats stakeholders only as a means toward the end of profit. Were it not profitable to do so, the corporation would soon abandon such behavior. It thus behooves the press to expose unethical practices so that the corporation will not be able to get away with them. The corporation must be convinced that it doesn’t pay to be unethical or, conversely, that being ethical makes good business sense. That is possible only with an informed public opinion. Without it, the public would fall prey to the corporation’s deception. In this regard, I am reminded of a joke of Groucho Marx: “The secret to success is honesty and fair dealing; now if you can fake that, then you’ve got it made.”

A CONCEPTUAL VIEW OF A CORPORATION

In the Light of Corporate Governance, Ethics, and Corporate Social Responsibility

By Dr. Jesus P. Estanislao

Institute of Corporate Directors

Institute for Solidarity in Asia

[27 May 2003]

The Law Constitutes the Corporation as a Person

1. In a modern free and open society, a corporation is constituted as a juridical person

2. As a juridical person, a corporation has standing on its own. It enjoys freedom and autonomy. It is not a mere extension of anybody else, nor an instrument for anyone else’s private or personal use. It has rights of its own, and the fundamental rights it enjoys cannot and should not be trampled upon or violated by others.

3. As an institution with autonomy, a corporation has the power and capacity to act in pursuit of its goals. Since corporate goals bring the corporation beyond what it already is or what is already has, its capacity to act is generally oriented externally. It acts to go beyond itself.

4. A corporation, then, has the fundamental right to act and inter-act with others. It can enter into relationships with other persons. It can contract or take on duties towards others in the process of inter-acting and dealing with them.

5. As a corporation acts and inter-acts with others, it becomes a subject not only of rights, but also of duties. Its rights others are duty-bound to respect. In return, its duties towards others it is bound to discharge and carry out. Thus, in the process of living out its corporate life, a corporation becomes a complex institution, with claims upon others (its rights), and upon whom others may have rightful claims (its duties).

Why a Corporation Needs to Practice Good Governance

6. Among these other persons it deals with—they are separate and with a personality distinct from that of the corporation itself—are its different stakeholders. Chief amongst these stakeholders are the owners of the corporation, its shareholders. But there are other stakeholders as well. These include the officers and employees; customer; creditors and suppliers; the local community and the regulations; society and the economy in general.

7. It is incumbent upon the corporation, that it deals with all its stakeholders fairly, i.e. in accord with justice. Thus, a corporation is called upon to give to each of its many stakeholders what is their due. It is duty-bound to consider, protect and promote the legitimate claims of all its different stakeholders in an equitable manner.

8. A corporation is then called upon to be transparent about its operations and the results of such operations. Its reports to all its stakeholders need to be accurate and true, timely and comprehensive, in line with globally accepted standards of reporting.

9. A corporation holds itself accountable for all its actions to all its stakeholders, and these include the regulators and the general public (society and the economy as a whole). Since it has duties towards others, the corporation should make it possible for others to determine whether it has fully lived up to its duties and to take appropriate action, by way of rewards or sanctions, as a consequence.

10. The Board of Directors of the corporation is vested with original powers to act in behalf of the corporation. It is through the Board of Directors that a corporation performs corporate acts. It is therefore the Board of Directors—with its fiduciary duties—that is called upon to ensure that it acts with fairness, transparency, and accountability.

11. To secure fairness, transparency and accountability in all corporate acts, the Board of Directors takes responsibility for directing the body or the internal organization through the management it installs. It serves as the head by reserving to itself final decisions on strategy, major policies and capital expenditures as well as operating plans and budgets. It acts as the conscience of the corporation, installing a corporate culture that is fully ethical, professional, and compliant with laws and regulations.

12. The Boar of Directors is a collegial body and must always act collegially. It operates by a code of proper practices. This code helps nurture a culture of independence, diversity and openness on the part of individual directors, each of whom is expected to add value and contribute to the collective decisions and actions the Board of Directors eventually makes and takes. It also specifies guidelines on how the Board works during Board meetings through its committee structure. It further specifies how the Board empowers management through the authorities and powers it delegates and through the reporting accountability system it installs. It includes the mechanisms by which the Board evaluates its performance, assesses and reports on corporate performance, renews and rejuvenates itself, makes and carries out succession plans.

13. The Board of Directors takes in the big picture by looking at and caring about the entire forest, leaving operations, the small details, and the individual trees to the charge of management. Thus, it does not take its focus away from the long-term sustainability, development and progress of the entire corporation. Such a focus would highlight the critical importance of an ethical, socially responsible culture that a corporation must observe. As with any other person-natural or judicial—a corporation sustains itself and secures its long-term development and progress by taking diligent care of its relations with others, and by its strict observance of the norms of ethics and social responsibility.

Why a Corporation Needs to be Ethical

14. Its view of itself, of others, and of its wider environment shapes the corporate culture it observes and lives. But this view cannot be unrelated to—in fact it needs to be determined by—what the corporation fundamentally is.

15. As a juridical person, with goals it pursues beyond itself, and therefore with a capacity to deal with others and its wider environment—in the process acquiring rights over them and assuming duties towards them—a corporation needs to have a culture characterized by openness and participation. The corporation, in all its aspects and levels, needs to be open to relationships that can be productive, meaningful, and beneficial. It also promotes participation from everyone up to the full extent of their ability and capacity to contribute towards the attainment of corporate goals.

16. In its relationship with others, its culture of solidarity leads it to look for ways and means by which it can serve others’ needs, help promote their genuine welfare, and contribute to their further development. Its ability to put flesh and substance to its spirit of solidarity towards others is a test of its own progress towards its corporate goals. Indeed, these goals are best achieved to the extent that a corporation can help meet the others’ needs with efficiency, effectiveness, and excellence. In always trying to do this, the corporation needs to stimulate fresh and varied thinking within its ranks and maintain dynamism in responding to the changing demands and requirements of others.

17. In its dealing with its wider environment, its culture of stewardship imposes upon the corporation a deep sense of responsibility for securing long-term sustainability. Thus, it needs to invest on resources so these are property maintained, improved, and kept productive for the use of succeeding generations. It also needs to contribute towards maintaining and improving natural and man-made systems that provide the environment for societies and economies to thrive in and progress. It is in this light that a corporation needs to constantly assess itself and monitor all aspects of its operations to ensure that it acts properly and within bounds in contributing to a safe, sustainable, and positive environment.

18. A culture of openness and participation, of solidarity and stewardship is guided by norms and standards. It is ideal for the corporation on its own to set the highest possible norms and standards for all its corporate acts in all aspects and levels of corporate operations. Self-regulation and self-determination in securing a high moral tone for one’s corporate culture, with the commitment to compliance and enforcement that go with these, would provide the surest and strongest defense against possible deviation from, or falling below, those norms and standards.

19. An internal corporate culture of ethics would also need to be complemented and reinforced by external norms and standards. Intermediate associations, to which a corporation belongs, should make their own articulation of a code of proper ethical practices and set up mechanisms for its enforcement and compliance. Higher bodies are also called upon to do the same. Regulatory authorities do not stop at issuing rules and regulations that the laws may mandate; they should also be vigilant about strict compliance, thereby imposing appropriate sanctions for non-compliance and giving rewards and public recognition for very high levels of compliance. Global conventions and universally accepted practices also set external standards for ethical corporate behavior. Indeed, in an increasingly interdependent world, these standards are gaining currency and wider acceptance.

20. The corporation, then, as a juridical person acts and behaves according to its view of itself, others, and its wider environment. This view is shaped by the culture of openness and participation, solidarity and stewardship that flows out of its fundamental character as a free and autonomous personality. That culture is necessarily ethical since it is guided by norms and standards that draw the line between what is acceptable and proper, what is good and correct, what is moral and legal—and what is not.

21. A corporate culture that is highly ethical and strictly observed, with effective enforcement mechanisms to facilitate over-all compliance, would make the corporation true to its fundamental character and its foundational identity. Moreover, such a culture greatly helps the corporation to move unswervingly towards its long-term corporate goals and puts it on the right and sure track towards the realization of its vision and fulfillment of its mission. Such a corporate culture faithfully lived would be a clear sign that its governance is trying to abide by the principles of fairness, transparency and accountability. Finally, that culture enables the corporation to act at all times, at all levels of its operations in a socially responsible way.

Why a Corporation Needs to be Socially Responsible

22. Social responsibility is inherent in the corporation. As a juridical person, it is called upon to aim towards goals, which it can achieve only together with other persons. Thus, a corporation is essentially oriented towards others that it deals and works with. In the process of dealing and working with them, it takes on responsibilities towards them through the duties it assumes in relation to them. These responsibilities it discharges with due cared and diligence in order to move forward to its corporate goals.

23. The very first demand of social responsibility is for the corporation to maintain its viability, secure its vitality and dynamism, and strengthen itself institutionally for the long term. In other words, the corporation owes it to tall its stakeholders to take very good care of itself so as to sustain itself in effectiveness, and operate with greater efficiency and higher levels of excellence over the long haul. For the corporation to be able to continue to consider, protect and promote the interests of all its stakeholders, its first and foremost responsibility is to stay alive, dynamic, strong and progressive. To be able to do so, it needs to foster a spirit of enterprise within its internal organization that it entrusts to management. The spirit of enterprise calls for due observance of the principle of subsidiary, which promotes from the ground up continued self-renewal, non-stop self improvement and institutional strengthening.

24. The second demand of social responsibility is for the corporation to observe self-restraint and a commendable degree of selflessness in its focus of rendering genuine service to others, more specifically to all its stakeholders. The orientation to serve needs to be deeply embedded, and take a long-term dimension. It is against this long-term horizon that it aims to harmonize the many seemingly conflicting claims between shareholders and the other stakeholders. The corporation, in many instances, may have to endure short-term pain and may cause such temporary pain on some, perhaps even n many, of its stakeholders, in view of the long-term gain it should win for all. Indeed, the spirit of solidarity drives a corporation to trying to make a real difference for the better, adding as much value as possible, and meeting the needs of customers and others who can reward it with their custom, favor, support and other resources. Solidarity oftentimes requires it to put in a lot of sacrifice or even to suffer temporary losses to secure the loyalty and the vital interests of other it is duty-bound to serve. Its generosity and grandeur of spirit under trying circumstances would often be more than amply rewarded.

25. A third corporate social responsibility is towards the wider environment in which the corporation operates. The corporation is duty-bound to maintain and improve both the physical as well as the economic and social environment, which provides the milieu for its operations. As a steward, the corporation must see to it that in the course of undertaking its operations, it eventually leaves the environment much better that the one it found when it started. The over-all physical environment and natural systems that its corporate operations may affect should be renewed and brought back to a self-sustaining level. Of equal importance is the over-all economic and social system, which also needs to be bought up to a much higher level of conduciveness for corporations to achieve their goal and for society and the economy to progress. Thus, the corporation must exercise due care and sensitivity so that it helps--rather than hinders--the capacity of physical and natural systems as well as of economic and social systems to sustain themselves and provide a positive environment for long-term growth and development.

26. The help that a socially responsible corporation may extend can be systemic or specific. By doing its part of being a responsible citizen in keeping the over-all system healthy and sustainable, a corporation would already be doing what is strictly necessary. In many instances, however, particularly in developing economies, this may not be enough. Indeed, the circumstances may often call for corporations to be deeply involved in specific programs aimed at reducing the levels of poverty and corruption, improving the immediate prospects of the marginalized sectors of society, and helping those who cannot help themselves to acquire the skills, knowledge and attitudes to bring themselves beyond the poverty line. Continuing education for life for all offers many specific niches that corporations can claim as their most direct and effective contribution to helping targeted groups of people develop themselves.

The Essential Need for Responsible Citizenship

27. A socially responsible corporation seeks to achieve sustainability not only for itself, but also for the others it must serve as well as for the environment it works in. Corporate commitment to sustainability is derived form the outward-oriented character of the corporation. It drives the corporation towards governance practices that take on a long-term and broad perspective, mindful of the delicate but firm inter-relations within micro-systems in the wider-physical, economic and social environment. In taking on such a perspective, it fosters a highly ethical culture that asks to be actually observed and strictly enforced within the corporation.

28. It is the recognition that it is part of a much broader system, including the physical natural environment but particularly the wider economy and society that makes a corporation acknowledge its citizenship. Indeed, the corporation is born within that wider system, with the law constituting it, investing it with rights, and ensuring respect for its rights as a juridical person. It acts in inter-relationship with other in that system. It operates within the environment that the wider system provides, and depends to an essential degree upon that system of which it is a citizen.

THE DIVINE RIGHT OF CAPITAL

Is Maximizing Returns to Shareholders a Legitimate Mandate?

By: Marjorie Kelly

Where does wealth come from? More precisely, where does the wealth of major public corporations come from? Who creates it?

To judge by the current arrangement in corporate America, one might suppose capital creates wealth―which is odd, because a pile of capital sitting there creates nothing. Yet capital-providers (stockholders) lay claim to most wealth that public corporations generate. They also claim the more fundamental right to have corporations managed on their behalf. Corporations are believed to exist for one purpose alone: to maximize returns to shareholders. This principle is reinforced by CEOs, The Wall Street Journal, business schools, and the courts. It is the law of the land―much as the divine right of kings was once the law of the land. Indeed, “maximizing returns to shareholders” is universally accepted as a kind of divine, unchallengeable mandate.

It is not in the least controversial. Though it should be. What do shareholders contribute, to justify the extraordinary allegiance they receive? They take risk, we’re told. They put their money on the line, so corporations might grow and prosper. Let’s test the truth of this with a little quiz:

Stockholders fund major public corporations―True or False?

False. Or, actually, a tiny bit true―for the most part, massively false. What’s intriguing is that we speak as though it were entirely: “I have invested in AT&T,” we say―imagining AT&T as a steward of our money, with a fiduciary responsibility to take care of it. In fact, “investing” dollars don’t go to AT&T but to other speculators. Equity “investments” reach a public corporation only when new common stock is sold―which for major corporations is a rare event. Among the Dow Jones Industrials, only a handful have sold any new common stock in 30 years. Many have sold none in 50 years.

The stock market works like a used car market, as accounting professor Ralph Estes observes in Tyranny of the Bottom Line. When you buy a 1989 Ford Escort, the money doesn’t go to Ford. It goes to the previous owner. Ford gets the buyer’s money only when it sells a new car. Similarly, companies get stockholders’ money only when they sell new common stock―which mature companies rarely do. According to figures from the Federal Reserve and the Securities and Exchange Commission, about 99% of the stock out there is “used stock.” That is, 99 out of 100 “invested” dollars are trading in the purely speculative market, and never reach corporations.

Public corporations do have the ability to sell new stock. And they do need capital (funds beyond revenue) to operate―for inventory, expansion and so forth. But they get very little of this capital from stockholders. In 1993, for example, corporations needed $555 billion in capital. According to the Federal Reserves, sales of common stock contributed 4% of that. I used this fact in a full-quote for a magazine article once, and the designer changed it to 40%, assuming it was a typo. Of all capital public corporations needed in 1993, stockholders provided 4%.

Well, yes, critics will say―that’s recently. But stockholders did fund corporations in the past.

Again, only a tiny bit true. Take the steel industry. An accounting study by Eldon Hendriksen examined capital expenditures in that industry from 1900 to 1953, and found that issues of common stock provided only 5% of capital. That was over the entire first half of the 20th century, when industry was growing by leaps and bounds.

So, what do stockholders contribute, to justify the extraordinary allegiance they receive? Very little. And that’s my point.

Equity capital is provided by stockholders when a company goes public, and in occasional secondary offerings later. But in the life of most major companies today, issuance of common stock represents a distant, long-ago source of funds, and a minor one at that. What’s odd is that it entitles holders to extract most of the corporation’s wealth, forever. Equity investors essentially install a pipeline, and dictate that the corporation’s sole purpose is to funnel wealth into it. The pipeline is never to be tampered with―and no one else is to be granted significant access (except executives, whose function is to keep it flowing).

The truth is, the commotion on Wall Street is not about funding corporations. It’s about extracting from them.

The productive risk in building businesses is borne by entrepreneurs and their initial venture investors, who do contribute real investing dollars, to create real wealth. Those who buy stock at sixth or seventh hand, or 1,000th hand, also take a risk―but it is a risk speculators take among themselves, trying to outwit one another like gamblers. It has little to do with corporations, except this: Public companies are required to provide new chips for the gaming table, into infinity.

It’s odd. And it’s connected to a second oddity―that we believe stockholders are the corporation. When we say. “A corporation did well,” we mean it stockholders did well. The company’s local community might be devastated by plant having its groundwater contaminated with pollutants. Employees might be shouldering a crushing workload, doing without raises for years on end. Still we will say, “The corporation did well.”

One does not see rising employee income as a measure of corporate success. Indeed gains to employees are losses to the corporation. And this betrays an unconscious bias: that employees are not really part of the corporation. They have no claim on wealth they create no say in governance and no vote for the board of directors. They’re not citizens of corporate society, but subjects.

Investors, on the other hand, may never set foot inside “their” companies, may not know where they’re located or what they produce. Yet corporations exist to enrich investors alone. In the corporate society, only those who own stock can vote ― like America until the mid-1800s, when only those who land could vote. Employees are disenfranchised.

We think of this as the natural law of the free market. It’s more accurately the result of the corporate governance structure, which violates free-market principles. In a free market everyone scrambles to get what they can, and they keep what they earn. In the construct of the corporation, one group gets what another earns.

The oddity of it all is veiled by the incantation of a single, magical word: “ownership.” Because we say stockholders “own” corporations, they are permitted to contribute very little, and take quite a lot.

What an extraordinary word. One is tempted to recall Lycophron’s comment, during an early Athenian slave uprising against the aristocracy, “The splendour of noble birth is imaginary,” he said, “and its prerogatives are based upon a mere word.”

Quintessence of CSR: How Do We Know We Are Doing it Right? By Jose Mario B. Maximiano

Ultimate Foundation of CSR: Where Do We Base Our Ethico-logical Arguments? By Jose Mario B. Maximiano

THE SOCIAL RESPONSIBILITY OF BUSINESS IS TO INCREASE ITS PROFITS

By: Milton Friedman

When I hear businessmen speak eloquently of the “social responsibilities of business in a free-enterprise system,” I am reminded of the wonderful line about the Frenchman who discovered at the age of 70 that he had been speaking prose all his life. The businessmen believe that they are defending free enterprise when they declaim that business is not concerned “merely” with profit but also with promoting desirable “social” ends; that business has a “social conscience” and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers. In fact they are – or would be if they or anyone else took them seriously – preaching pure and unadulterated socialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.

The discussions of the “social responsibilities of business” are notable for their analytical looseness and lack of rigor. What does it mean to say that “business” has responsibilities? Only people can have responsibilities. A corporation is an artificial person and in this sense may have artificial responsibilities, but “business” as a whole cannot be said to have responsibilities, even in this vague sense. The first step toward clarity in examining the doctrine of the social responsibility of business is to ask precisely what it implies for whom.

Presumably, the individuals who are to be responsible are businessmen, which means individual proprietors or corporate executives. Most of the discussion of social responsibility is directed at corporations, so in what follows I shall mostly neglect the individual proprietors and speak of corporate executives.

In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. Of course, in some cases his employers may have a different objective. A group of persons might establish a corporation for an eleemosynary purpose – for example, a hospital or a school. The manager of such a corporation will not have money profit as his objectives but the rendering of certain services.

In either case, the key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation or establish the eleemosynary institution and his primary responsibility is to them.

Needless to say, this does not mean that it is easy to judge how well he is performing his task. But at least the criterion of performance is straightforward and the persons among whom a voluntary contractual arrangement exists are clearly defined.

Of course, the corporate executive is also a person in his own right. As a person, he may have many other responsibilities that he recognizes or assumes voluntarily – to his family, his conscience, his feelings of charity, his church, his clubs, his city, his country. He may feel impelled by these responsibilities to devote part of his income to causes he regards as worthy, to refuse to work for particular corporations, even to leave his job, for example, to join his country’s armed forces. If we wish, we may refer to some of these responsibilities as “social responsibilities”. But in these respects he is acting as a principal, not as an agent; he is spending his own money or time or energy, not the money of his employers or the time or energy he has contracted to devote to their purposes. If these are “social responsibilities”, they are the social responsibilities of individuals, not of business.

What does it mean to say that the corporate executive has a “social responsibility” in his capacity as businessman? If this statement is not pure rhetoric, it must mean that he is to act in some way that is not in the interest of his employers. For example, that he is to refrain from increasing the price of the product in order to contribute to the social objective of preventing inflation, even though a price increase would be in the best interests of the corporation. Or that he is to make expenditures on reducing pollution beyond the amount that is in the best interests of the corporation or that is required by law in order to contribute to the social objective of improving the environment. Or that, at the expense of corporate profits, he is to hire “hard-core” unemployed instead of better qualified available workmen to contribute to the social objective of reducing poverty.

In each of these cases, the corporate executive would be spending someone else’s money for a general social interest. Insofar as his actions in accord with his “social responsibility” reduce returns to stockholders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customer’s money. Insofar as his actions lower the wages of some employees, he is spending their money.

The stockholders or the customers or the employees could separately spend their own money on the particular action if they wished to do so. The executives exercising a distinct “social responsibility”, rather than serving as an agent of the stockholders or the customers or the employees, only if he spends the money in a different way than they would have spent it.

But if he does this, he is in effect imposing taxes, on the one hand, and deciding how the tax proceeds shall be spent, on the other.

This process raises political questions on two levels: principle and consequences. On the level of political principle, the imposition of taxes and the expenditure of tax proceeds are governmental functions. We have established elaborate constitutional, parliamentary and judicial provisions to control these functions, to assure that taxes are imposed so far as possible in accordance with the preferences and desires of the public – after all, “taxation without representation” was one of the battle cries of the American Revolution. We have a system of checks and balances to separate the legislative function of imposing taxes and enacting expenditures from the executive function of collecting taxes and administering expenditure programs and from the judicial function of mediating disputes and interpreting the law.

Here the businessman – self-selected or appointed directly or indirectly by stockholders – is to be simultaneously legislator, executive and jurist. He is to decide whom to tax, by how much and for what purpose, and he is to spend the proceeds – all this guided only by general exhortations from on high to restrain inflation, improve the environment, fight poverty and so on and on.

The whole justification for permitting the corporate executive to be selected by the stockholders is that the executive is an agent serving the interests of his principal. This justification disappears when the corporate executive imposes taxes and spends the proceeds for “social” purposes. He becomes in effect a public employee, a civil servant, even though he remains in name an employee of a private enterprise. On grounds of political principle, it is intolerable that such civil servants insofar as their actions in the name of social responsibility are real and not just window-dressing should be selected as they are now. If they are to be civil servants, then they must be elected through a political process. If they are to impose taxes and make expenditures to foster “social” objectives, then political machinery must be set up to make the assessment of taxes and to determine through a political process the objectives to be served.

This is the basic reason why the doctrine of “social responsibility” involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce resources to alternate uses.

On the grounds of consequences, can the corporate executive in fact discharge his alleged “social responsibilities”? On the other hand, suppose he could get away with spending the stockholders’ or customers’ or employees’ money. How is he to know how to spend it? He is told that he must contribute to fighting inflation. How is he to know what action of his will contribute to that end? He is presumably an expert in running his company – in producing a product or selling it or financing it. But nothing about his selection makes him an expert on inflation. Will his holding down the price of his product reduce inflationary pressure? Or, by leaving more spending power in the hands of his customers, simply divert it elsewhere? Or, by forcing him to produce less because of the lower price, will it simply contribute to shortages? Even if he could answer these questions, how much cost is he justified in imposing on his stockholders, customers and employees for his social purpose? What is his appropriate share and what is the appropriate share of others?

And whether he wants to or not, can he get away with spending his stockholders’, customers’, or employees’ money? Will not the stockholders fire him? (Either the present ones or those who take over when his actions in the name of social responsibility have reduced the corporation’s profit and the price of its stock.) His customers and his employees can desert him for other producers and employers less scrupulous in exercising their social responsibilities.

This facet of “social responsibility” doctrine is brought into sharp relief when the doctrine is used to justify wage restraint by trade unions. The conflict of interest is naked and clear when union officials are asked to subordinate the interest of their members to some more general purpose. If the union officials try to enforce wage restraint, the consequence is likely to be wildcat strikes, rank-and-file revolts and the emergence of strong competitors for their jobs. We thus have the ironic phenomenon that union leaders at least in the U.S. have objected to Government interference with the market far more consistently and courageously than have business leaders.

The difficulty of exercising “social responsibility” illustrates, of course, the great virtue of private competitive enterprise: it forces people to be responsible for their own actions and makes it difficult for them to “exploit” other people for either selfish or unselfish purposes. They can do good but only at their own expense.

Many a reader who has followed the argument this far may be tempted to remonstrate that it is all well and good to speak of Government’s having the responsibility to impose taxes and determine expenditures for such “social” purposes as controlling pollution or training the hard-core unemployed, but that the problems are too urgent to wait on the slow course of political processes, that the exercise of social responsibility by businessmen is a quicker and surer way to solve pressing current problems.

Aside from the questions of fact – I share Adam Smith’s skepticism about the benefits that can be expected from “those who are affected to trade for the public good” – this argument must be rejected on grounds of principle. What it amounts to is an assertion that those who favor the taxes and expenditures in question have failed to persuade a majority of their fellow citizens to be of like mind and that they are seeking to attain by undemocratic procedures what they cannot attain by democratic procedures. In a free society, it is hard for “good” people to do “good”, but that is a small price to pay for making it hard for “evil” people to do “evil”, especially since one man’s good is another’s evil.

I have, for simplicity, concentrated on the special case of the corporate executive, except only for the brief digression on trade unions. But precisely the same argument applies to the newer phenomenon of calling upon stockholders to require corporations to exercise social responsibility (the recent G.M. crusade for example). In most of these cases, what is in effect involved is some stockholders trying to get other stockholders (or customers or employees) to contribute against their will to “social” causes favored by the activists. Insofar as they succeed, they are again imposing taxes and spending the proceeds.

The situation of the individual proprietor is somewhat different. If he acts to reduce the returns of his enterprise in order to exercise his “social responsibility”, he is spending his own money, not someone else’s. If he wishes to spend his money on such purposes, that is his right and I cannot see that there is any objection to his doing so. In the process, he, too, may impose costs on employees and customers. However, because he is far less likely than a large corporation or union to have monopolistic power, any such side effects will tend to be minor.

Of course, in practice the doctrine of social responsibility is frequently a cloak for actions that are justified on other grounds rather than a reason for those actions.

To illustrate, it may well be in the long-run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community or to improving its government. That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage and sabotage or have other worthwhile effects. Or it may be that, given the laws about the deductibility of corporate charitable contributions, the stockholders can contribute more to charities they favor by having the corporation make the gift than by doing it themselves, since they can in that way contribute an amount that would otherwise have been paid as corporate taxes.

In each of these – and many similar – cases, there is a strong temptation to rationalize these actions as an exercise of “social responsibility”. In the present climate of opinion, with its widespread aversion to “capitalism,” “profits,” the “soulless corporation,” and so on, this is one way for a corporation to generate goodwill as a by-product of expenditures that are entirely justified in its own self-interest.

It would be inconsistent of me to call on corporate executives to refrain from this hypocritical window-dressing because it harms the foundations of a free society. That would be to call on them to exercise a “social responsibility”! If our institutions, and the attitudes of the public make it in their self-interest to cloak their actions in this way, I cannot summon much indignation to denounce them. At the same time, I can express admiration for those individual proprietors or owners of closely held corporations or stockholders of more broadly held corporations who disdain such tactics as approaching fraud.

Whether blameworthy or not, the use of the cloak of social responsibility, and the nonsense spoken in its name by influential and prestigious businessmen, does clearly harm the foundations of a free society. I have been impressed time and again by the schizophrenic character of many businessmen. They are capable of being extremely far-sighted and clear-headed in matters that are internal to their businesses. They are incredibly short-sighted and muddle-headed in matters that are outside their business but affect the possible survival of business in general. This short-sightedness is strikingly exemplified in the calls from many businessmen for wage and price guidelines or controls or income policies. There is nothing that could do more in a brief period to destroy a market system and replace it by centrally controlled system than effective governmental control of prices and wages.

The short-sightedness is also exemplified in speeches by businessmen for social responsibility. This may gain them kudos in the short run. But it helps to strengthen the already too prevalent view that the pursuit of profits is wicked and immoral and must be curbed and controlled by external forces. Once this view is adopted, the external forces that curb market will not be social consciences, however highly developed, of the pontificating executives; it will be the iron fist of government bureaucrats. Here, as with price and wage controls, businessmen seem to me to reveal a suicidal impulse.

The political principle that underlies the mechanism is unanimity. In an ideal free market resting on private property, no individual can coerce any other, all cooperation is voluntary, all parties to such cooperation benefit or they need not participate. There are no values, no “social” responsibilities in any sense other than the shared values and responsibilities of individuals. Society is a collection of individuals and of the various groups they voluntarily form.

The political principle that underlies the political mechanism is conformity. The individual must serve a core of general social interest – whether that be determined by a church or a dictator or a majority. The individual may have a vote and say in what is to be done, but if he is overruled, he must conform. It is appropriate for some to require others to contribute to a general social purpose whether they wish to or not.

Unfortunately, unanimity is not always feasible. There are some respects in which conformity appears unavoidable, so I do not see how one can avoid the use of the political mechanism altogether.

But the doctrine of “social responsibility” taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collectivist doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means. That is why, in my book Capitalism and Freedom, I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, “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.”