Friday, December 15

The Only Responsibility of Managers is to Maximize Shareholder Wealth

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There are two approaches that shape and influence the way managers prioritize and do things – the classical view and the socioeconomic view. The classical view “says that management’s only social responsibility is to maximize profits”. (Robbins etal. 2006, p.161) Milton Friedman (1970 p.6) asserted  that “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.” Friedman (1962, 1970) argued that managers’ main responsibility is to operate the organization in the interest of the shareholders, the organization’s true owners’, by increasing financial returns. He reasoned that when managers decide on their own to use the organization’s resources for ‘socialgood’, they would be adding to the costs of doing business. These additional costs would then be at the expense of the shareholders, resulting in lower profits.

Robbins etal. (2006) also mention that those supporting the classical view fear that too much focus on social goals may dilute economic productivity. As the costs incurred by many socially responsible actions do not cover their costs, profits would be affected and costs would increase. This by no means implies that those who are in favor of the classical view are opposed to organizations becoming socially responsible – they just feel that “the extent of that responsibility is to maximize organizational profits for shareholders”. (Robbins etal. 2006 p.161)

However, a major flaw with the classical view is that its focus tends to be on short term profit. A good example would be Manville Corporation in the United States: 50 years ago management decided to conceal information from employees that one of its products, asbestos, caused fatal lung disease. Chest X-rays results from employees were withheld from them. The rationale behind this was being able to save money and increase profits. Although this seemed to work for a short term period, in the long run the company was forced into bankruptcy in 1982 in order to protect itself from the increasing lawsuits in relation to asbestos liabilities. (Robbins etal., 2006)  Manville had to set up a US$2.6 billion personal injury settlement trust fund in cash and bonds, and pledge a certain percentage of future profits in 1988 when it emerged from bankruptcy due to the overwhelming claims. As a result, on 1 April 1996 Manville Corporation permanently went out of business, with only the independent trust fund continuing to pay out asbestos settlements in its name. (Rao, 1996)

Carroll (1991) has argued that there are four fundamentals to corporate social responsibilities: economic, legal, ethical, and philanthropic. These four fundamentals can be linked to corporate social processes such as environmental assessment, stakeholder management, and issues management (Wood, 1991), which in turn relates to corporate social outcomes such as social impacts, programs and policies. Carroll’s (1991) view is evident in the socioeconomic view, which is “the view that management’s social responsibility goes beyond making profits to include protecting and improving society’s welfare.” (Robbins etal. 2006, p.161) Hence, corporate social responsibility incorporates both policy and practice. (William & Gail, 2007, pg 66)

Results of studies carried out have shown a positive relationship between corporate social responsibility and corporate financial performance. (Cochran & Wood, 1984; Turban & Greening, 1996; Waddock & Graves, 1997; Bermanetal., 1999) This goes to show that there is more that managers must do than just focus on maximizing shareholders wealth. Simon Zedek (2001) further explains that when organizations have a greater sense of corporate social responsibility, they will take greater account on their actions for repercussions they may cause – the impact on environmental and social issues. (Robbins etal., 2006) Being socially responsible is not only the right thing to do, it also aids organizations that are socially responsible to create a favorable public image, improve share price in the long run, and have more secured long-run profits.

As public opinion and governments now support businesses that pursue corporate social responsibility due to the increased awareness of globalization and its effects, those who pursue corporate social responsibility can also expect less government regulation. Social responsibility includes the balance of responsibility and power, the case of Enron (Managing 401(k) Plans, 2006 p.9; Goldmann, 2006) would be a good example of a corporation that failed to implement corporate social responsibility.

Nonetheless, although the benefits of doing ‘socialgood’ and the rewards reaped are evident, it is usually not seen instantaneously as it is a long term approach and process. (Robbins etal. 2006) Thus, this may prevent shareholders from seeing the whole picture, and place pressure on managers to take short term alternatives which may or may be unethical. Corporate social responsibility encompasses of social obligation, social responsiveness and social responsibility. In turn, these three correspond to Carroll’s (1991) four fundamentals to corporate social responsibilities: economic, legal, ethical, and philanthropic.

Social obligation “is the obligation of a business to meet its economic and legal responsibilities”. (Robbins etal., 2006 p.163) It means that an organization’s behavior conforms only to the “legal requirements and competitive pressures of selected stakeholders”. (McDonald, 2007, p.13) The social obligations theory is derived from the classical view where an organization “feels its only social duty is to shareholders”. (Robbins etal., 2006 p.164) Hence, organizations pursue social goals only to the extent of their contributions to related economic goals.  Though social obligation is fundamental to corporate social responsibility, overemphasis on maximizing the wealth of shareholders coupled with a lack of ethical responsibilities, as in the case of Manville Corporation mentioned earlier, would not be beneficial to any organization and its shareholders.

In contrast, social responsiveness and social responsibility “go beyond merely basic economic and legal standards”.  (Robbins etal., 2006, p.164) According to Gellerman (1986, pg.42) “maximising profits is a company’s second priority, not its first. The first is ensuring its survival“.  Thus, in order to ensure an organization’s survival, managers must be able to implement some social obligations and accept the costs that are attached. (Robbins etal., 2006)

Social responsiveness “refers to the capacity of a firm to adapt to changing societal conditions”. (Robbins etal., 2006 p.164) It “also recognizes that society’s norms are changing and accommodates these changes into the strategy and decision-making processes of the organization”. (McDonald, 2007, p.13) “This is where the entire organization acts in support of structures and processes to proactively respond to the social demands of their environment.” (McDonald, 2007, p.13) Therefore, a “socially responsive organization acts the way it does because of its desire to satisfy some popular social need”. (Robbins etal., 2006 p.164)

For instance, U2 singer Bono’s charity, RED – a global trust fund to fight AIDS, tuberculosis and malaria – combines two unique elements: a range of differing companies employing the same brand. Although it benefits a charity, it is a for-profit effort, thus companies will have an incentive to make Red products and the aid they generate permanent. Motorola, The Gap, Armani Converse and American Express are organizations that have chosen to satisfy this popular social need – the awareness and support for AIDS, tuberculosis and malaria – by creating and selling red coloured products to support RED; with a portion of the profits donated to the charity. (Edwards, 2006)

On the other hand, social responsiveness is also an organization’s “corporate behavior that takes preventive action to avoid adverse social impact from company activities and even anticipates future movement beyond current expectations”. (McDonald, 2007, p.13) There is an implication that organizations may be more interested in improving their image and reputation than actually helping the cause. “Cause-related marketing exercises such as these pull the rug from under the feet of those who would portray brands such as Gap or Nike in a negative light following accusations that they exploit sweatshop labour. It shifts the focus away from issues where brands are weak and on to an argument they cannot lose. It may be cynical. But it saves lives.” (David, 2007 pg 25) It was reported that the organizations taking part in RED have spent more money on advertising their involvement then they have donated. (David, 2007) This coupled with the lack of transparency could “induce skepticism among consumers if they think some RED brands are donating less than others. (David, 2007 pg. 25) As a result brand promise may weaken, as more consumers become skeptical. (David, 2007)

Social responsibility is defined as “a business’s obligation, beyond that required by law or economics, to pursue long term goals that are good for the society”. (Robbins etal., 2006 p.164)  “A socially responsible organization does what is right because it feels it has a ‘responsibility’ to act that way.” (Robbins etal., 2006 p.164) The organization does so by “attempting to harmonize with prevailing norms, values and expectations of society (all stakeholders)”. (McDonald, 2007, p.13)

Managers from socially responsive organizations take a definitive stand on social issues and recognize an increase in the accountability and role that organizations play in the promotion of changing societal norms whilst maintaining the legality of the organization as an institution in the private sector. (Boal & Peery, 1985) With issues like climate change resulting from global warming, consumers are going to be expecting more and more. As a result, the business structures of organizations’ are changing accordingly. In response to globalization and global warming, organizations such as BP and Toyota Motor Corporation have come up with environment friendly products. By doing so, these organizations not only gain the attention of consumers who are becoming increasingly holistic in their selection of goods and services, but they also increase their reputation in a positive light. (Fielding, 2007)

It is not only an organization’s commitment to corporate social responsibility that is important, but also the involvement of governmental action “in both the national and international forums, to negotiate proactively with companies so as to ensure the CSR are met“, that contributes to corporate social responsibility. (William & Gail 2007, pg 65) Government action would not only encourage organizations to have more corporate social responsibility, but it also strengthens local cultural identity.

“Most major pharmaceutical companies today have expansive corporate social responsibility (CSR) policies that pledge their commitment to reducing the suffering and improving the health and quality of life of people around the world. Yet many of these companies also have difficulty offering affordable medications to the impoverished in developing countries.” (William & Gail 2007, pg 65)

In the late 1990s, Brazil was in urgent need of lower priced medication to combat its growing HIV epidemic. However, large pharmaceutical companies such as Roche, Abbot, Bristol-Meyers Squibb, and Merck refused to lower their prices. (William & Gail 2007) In response, the Brazilian government mounted a campaign, which, despite initial resistance on the part of the pharmaceutical companies, eventually resulted in the negotiation of significant price reductions.” (William & Gail 2007, pg 65)

There is a growing trend of governments playing a role in encouraging originations to be more socially responsible. China is one such example. “For years China’s top leaders have downplayed the environment, paying lip service to the need for sustainable development but arguing that alleviating poverty was a higher priority.” (Etsy, 2007) As a result, the increasing industrialization and globalization in China has led an increase in pollution. This not only affects the living condition of its citizens, but the economy as well. (http://www.chinadaily.com.cn/china/2006-11/15/content_733578.htm)

To combat this problem, the Chinese government offered incentives in the form of $220 million in clean tech-venture capital for startup companies to develop pollution-control technologies, improve energy efficiency, and create alternate sources of power. (Etsy, 2007) With the Olympics coming up in 2008, the government uses this as an incentive to encourage companies to be more socially responsible. Beijing is eliminating disqualified cars, and has lifted the bar for emission standards for all cars in Beijing. (http://english.people.com.cn/200705/31/eng20070531_379801.html) This move would push more organizations to be more socially responsive and produce environmentally friendly products, as in the case of BP. (Fielding, 2007)

In conclusion, I believe that there must be a balance of priorities on the part of managers, and that their job is not solely to increase the wealth of shareholders. There are no set rules for being socially responsible, or the lack of it, in this constantly changing globalized environment. Although the capacity of being socially responsible in which a manager is able decide on at times is limited by organizational funding and practicality of the action, one thing remains constant, the benefits of being socially responsible is endless. Even though there are repercussions, either good or bad, for every action and decision that is made, as can be seen from Enron (Managing 401(k) Plans, 2006 p.9; Goldmann, 2006) and RED (Edwards, 2006). Managers decision are shaped and influenced by the society and culture they are exposed to, as well as organizational goals, vision, and strategies, and government restrictions and incentives. It is more than just increasing the wealth of shareholders.

References:

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