Chapter 7: Corporate social responsibility and corporate governance

Chapter learning objectives

Upon completion of this chapter you will be able to:

• explain and explore social responsibility in the context of corporate governance
• discuss and critically assess the concept of stakeholders and stakeholding in organisations and how this can affect strategy and corporate governance
• analyse and evaluate issues of 'ownership', 'property' and the responsibilities of ownership in the context of shareholding
• explain the concept of the organisation as a corporate citizen of society with rights and responsibilities.

1 Corporate social responsibility (CSR)

A corporation:

• Is an artificial person in law. It has the same rights and responsibilities as human beings.
• Is notionally owned by shareholders but exists independently of them. The shareholder has a right to vote and be paid a dividend but the company owns its assets.
• Managers have a fiduciary right to protect shareholder investment.

Milton Friedman argued that, in relation to this definition, a corporation has no responsibility outside of making profit for shareholders:

• Only human beings have moral responsibility for their actions.
• It is the managers' duty to act solely in the interest of shareholders:
  • this is a point of law. Any other action is shareholder betrayal.
• Social issue are the province of the state and not corporations.

The argument against this viewpoint needs to provide theorganisation with an alternative view that leads to the same outcome ofprofit.

Enlightened self-interest

• Corporations perceived as ethically sound are rewarded with extra customers.
• Corporations which are ethically unsound are boycotted.
• Employees are more attracted to work for, and are more committed to, socially responsible companies.
• Voluntarily committing to social actions and programmes may forestall legislation and promote independence from government.
• Positive contribution to society may be a long-term investment in a safer, better educated and more equitable community creating a more stable context in which to do business.

The nature of CSR

Carroll devised a four-part model of CSR: economicresponsibility, legal responsibility, ethical responsibility andphilanthropic responsibility.

True CSR requires satisfying all four parts consecutively.

From this, Carroll offers the following definition of CSR:

'CSR encompasses the economic, legal, ethical andphilanthropic expectations placed on organisations by society at a givenpoint in time.'

Economic responsibility

• Shareholders demand a reasonable return.
• Employees want safe and fairly paid jobs.
• Customers demand quality at a fair price.

Legal responsibility

• The law is a base line for operating within society.
• It is an accepted rule book for company operations.

Ethical responsibility

• This relates to doing what is right, just and fair.
• Actions taken in this area provide a reaffirmation of social legitimacy.
• This is naturally beyond the previous two levels.

Philanthropic responsibility

• Relates to discretionary behaviour to improve the lives of others.
• Charitable donations and recreational facilities.
• Sponsoring the arts and sports events.

Carroll's model of CSR

Economic

Economic responsibilities must be satisfied by organisations.Responsibilities relate to the ability of the organisation to stay inbusiness and therefore provide for its stakeholders. For example:

• shareholders requiring a return on their investments
• employees to be provided with safe and fairly paid jobs
• customers to be able to obtain good quality products at a fair price.

The responsibilities are connected with why the organisation wasestablished. The economic responsibility must be achieved in order toattain higher level responsibilities.

Legal

Legal responsibility implies that an organisation will follow thelaws of the jurisdiction in which it is based as well as any internalmoral views or objectives that the organisation has set. As witheconomic responsibility it is assumed that the organisation must actwithin the law to show that it is socially responsible.

Not complying with the law results in lack of social responsibility. For example:

• anti-competitive behaviour focusing on maximising market share and profits may be seen as lacking in social responsibility by limiting competition and charging excessively high prices (e.g. antitrust actions against Microsoft)
• price fixing by collusion (operation of cartels – always thought to be the case in the oil industry).

Legal responsibilities may therefore limit economic responsibilities by providing some social stance to organisations.

Ethical

Ethical responsibilities relate to what is expected by society fromorganisations compared with what those organisations have to do from aneconomic or legal viewpoint. Ethical responsibilities therefore relateto doing what is seen to be right compared with doing what is simplylegal. For example:

• a company may decide to limit carbon emissions from its factory to a level below the legal maximum because this is seen to be acting in the interests of society
• Shell disposed of an oil platform on land rather than sinking it at sea (as it legally could have done) due to concern about the environmental consequences of this action.

Ethical responsibilities are therefore higher than both economic and legal responsibilities.

Philanthropic

Philanthropic responsibilities generally concern actions desired oforganisations rather than those required by organisations. For example,organisations may:

• make donations to charities
• provide sports facilities for employees
• sponsor the arts (e.g. Tate & Lyle sponsoring the Tate Gallery in London).

These activities are carried out more because the organisationbelieves it is the correct thing to do rather than because it must. Theterm 'philanthropic' derives from the Greek 'love of society', so thereis no obligation to act.

It has been argued that philanthropic responsibilities are lessimportant than the other three levels because they are simply desired,not required, of organisations.

Social responsiveness

This refers to the capacity of the corporation to respond to social pressure, and the manner in which it does so.

Carroll suggests four possible strategies: reaction, defence, accommodation and proaction.

Reaction

The corporation denies any responsibility for social issues.

Defence

The corporation admits responsibility but fights it, doing the very least that seems to be required.

Accommodation

The corporation accepts responsibility and does what is demanded of it by relevant groups.

Proaction

The corporation seeks to go beyond industry norms.

Developing a CSR strategy

The details on stakeholders will be covered in the following sections.

2 Stakeholders and their claims

As already stated in chapter 1 Freeman defines stakeholders as 'any person or group that can affect or be affected by the policies or activities of an organisation'.

• The definition is important since it shows the bidirectionality of stakeholder claims in as much as they can impact on the corporation as well as being the recipient of the actions of the firm.

The traditional model of capitalism provides us with:

• customers, suppliers, shareholders and employees.

The stakeholder model extends this to include:

• government, civil society and competitors.

Stakeholder claims

These are the demands that the stakeholder makes of an organisation. They essentially 'want something' from an organisation.

• The stakeholders may seek to influence the organisation to act in a certain way, or may want it to increase or decrease certain activities that affect them.
• Direct stakeholder claims are usually unambiguous, and are often made directly between the stakeholders and the organisation.
• Stakeholders typically making direct claims will include trade unions, employees, shareholders, customers and suppliers.
• Indirect claims are made by those stakeholders unable to express their claim directly to the organisation. They have no 'voice'.
• This lack of expression may arise from the stakeholder being powerless (an individual customer of a large organisation), not existing yet (future generations), having no voice (natural environment) or being remote from the organisation (producer groups in distant countries).
• The claim of an indirect stakeholder will need to be interpreted by someone else in order to be expressed.

Refer to the Examiner's article published in Student Accountant in January 2008 "All about stakeholders – part 1”

3 Stakeholder classifications and relations

Classifications of stakeholders

There are a number of ways of classifying stakeholders according tocriteria based on how stakeholders relate to organisational activities.

Internal and external stakeholders

This is the distinction between stakeholders inside the organisation and those outside.

• Internal: includes employees and management, and possibly trade unions.
• External: includes customers, competitors and suppliers.

Narrow and wide stakeholders

This is the extent to which the stakeholder group is affected by organisational activity.

• Narrow: those most affected or who are dependent on corporation output, shareholders, employees, management, customers, suppliers.
• Wide: those less affected or dependent on company output such as government, the wider community and non-dependent customers.

Primary and secondary stakeholders

This focuses on the opposing view in Freeman's definition, thatstakeholders affect organisations as well as being affected byorganisations.

• Primary: those that have a direct affect on the company and without whom it would be difficult to operate, government, shareholders and customers.
• Secondary: those that have a limited direct influence on the organisation and without whom the company would survive, the community and management.

Active and passive stakeholders

This categorisation distinguishes between those that seek to participate in organisational activity and those that do not.

• Active: those that wish to participate of course includes management and employees, but may also include regulators, environmental pressure groups and suppliers.
• Passive: those that do not wish to participate may include shareholders, local communities, government and customers.

Voluntary and involuntary stakeholders

This categorisation removes the element of choice associated withactive and passive participation, sub dividing the active group into twoelements.

• Voluntary: those stakeholders that choose to be involved in organisational decision making such as management, employees' environmental groups and active shareholders. These stakeholders can withdraw their stakeholding in the short-term.
• Involuntary: those stakeholders that do not choose to be involved in organisational decisions, but become involved for a variety of reasons. This could include regulators, key customers, suppliers, government, natural environment and local communities. They cannot withdraw in the short- to medium-term.

Legitimate and illegitimate stakeholders

This is the extent to which the claim of the stakeholder isconsidered a valid claim. It can be a subjective classification withdebate surrounding certain group's claims, and can lead into the conceptof whether stakeholders are recognised by the organisation or not.

• Legitimate: those with an active economic relationship with an organisation, such as customers and suppliers.
• Illegitimate: those without such a link, such as terrorists, where there is no case for taking their views into account when making decisions.

Managing stakeholder relations

Stakeholder mapping: The Mendelow model

The model provides a framework for assessing the general nature ofaction to be taken following classification of stakeholders according topower and interest.

Mendelow model

The matrix was designed to track interested parties and evaluatetheir viewpoint in the context of some change in business strategy.

Power relates to the amount of influence (or power) that thestakeholder group can have over the organisation. However, the factthat a group has power does not necessarily mean that their power willbe used.

The level of interest indicates whether the stakeholder isactively interested in the performance of the organisation. The amountof influence the group has depends on their level of power.

Low interest – low power

These stakeholders typically include small shareholders and thegeneral public. They have low interest in the organisation primarily dueto lack of power to change strategy.

High interest – low power

These stakeholders would like to affect the strategy of theorganisation but do not have the power to do this. Stakeholders includestaff, customers and suppliers, particularly where the organisationprovides a significant percentage of sales or purchases for thoseorganisations. Environmental pressure groups would also be placed inthis category as they will seek to influence company strategy, normallyby attempting to persuade high power groups to take action.

Low interest – high power

These stakeholders normally have a low interest in theorganisation, but they do have the ability to affect strategy shouldthey choose to do so. Stakeholders in this group include the nationalgovernment and in some situations institutional shareholders. The lattermay well be happy to let the organisation operate as it wants to, butwill exercise their power if they see their stake being threatened.

High interest – high power

These stakeholders have a high interest in the organisation andhave the ability to affect strategy. Stakeholders include directors,major shareholders and trade unions.

Assessing stakeholder importance

Customers, shareholders and employees may be the most importantstakeholders but continual assessment helps to focus in on those thatrequire immediate action.

Three attributes may be assessed:

• Power: the perceived ability of the stakeholder to affect organisational action.
• Legitimacy: whether the company perceives the stakeholder action to be legitimate.
• Urgency: whether the stakeholder claim calls for immediate action.

Definitive stakeholders (possessing all three) require immediate action, the others are latent stakeholders.

Further stakeholder relationships

Beyond the specific nature of the action taken, there are differentrelationships between the company and its stakeholders. In general weconsider these to be antagonistic but they do not necessarily need to beso.

• Challenge: relationship based on mutual opposition and conflict.
• Sparring partners: relationship based on healthy conflict.
• One-way support: relationship based on sponsorship and philanthropy from one party to the other.
• Mutual support: formal and informal two-way support.
• Endorsement: relationship based on paid public approval through a specific product or programme, e.g. ISO standards.
• Project dialogue: major regeneration and construction project dialogue.
• Strategy dialogue: relationship based on discussion over future regulation.
• Joint venture: mutual commitment to achieve a specific goal.

Organisational motivations regarding stakeholders

Donaldson and Preston draw a distinction between two motivations asto why organisations act in relation to the concerns of stakeholders.

The instrumental view of stakeholders:

• This relates to motivation stemming from the possible impact of stakeholder action on the objectives of the organisation.
• The organisation reacts to stakeholder input because it believes that not to do so would have an impact on its primary objectives (which may be profit, but could be other objectives for organisations such as charities).
• Such a view of stakeholders is therefore devoid of any moral obligation.

The normative view of stakeholders:

• This relates to motivation stemming from a moral consciousness that accepts a moral duty towards others in order to sustain social cohesion (the good of society).
• Such an altruistic viewpoint appreciates the need to act in a general sense of what is right rather than in a narrow interpretation of what is right for the company to achieve its profit targets.

Refer to the Examiner's article published in Student Accountant in February 2008 "All about stakeholders – part 2”

4 Impact of stakeholders on corporate governance

A key area of impact is in relation to the increased need for, andexistence of, social accounting. There are various forms of socialaccounting produced for inclusion in the Business Review as part ofannual accounting reports.

• Ethical accounting: tends to focus on internal management systems or codes of practice at an individual level and how the company audits and complies with this.
• Environmental accounting: tends to focus exclusively on the organisation's impact on the natural environment.
• Social accounting: has a broader remit to incorporate employee conditions, health and safety, equal opportunities, human rights, charity work.
• Sustainability accounting: is a grand title that incorporates the triple bottom line of the first three with possible emphasis on environmentalism.

These areas will be discussed further in the chapter on social and environmental issues.

Effective social accounting

The following factors are key to ensuring effective social accounting:

• Inclusivity: suggests a two-way conversation with key stakeholders not just a one way reporting process.
• Comparability: benchmarking previous periods or industry standards provides meaning to the extent of work being carried out.
• Completeness: suggests inclusion of negative as well as positive areas of organisational activity.
• Evolution and continuous improvement: commitment to learning from the past and changing practices.
• Management policies and systems: the development and consolidation of policies into real systems for evaluation and control.
• Disclosure: clear disclosure in reporting to meet stakeholders' needs.
• External verification: the perceived independence of verifiers where needed .

5 The organisation as a corporate citizen

Corporate citizenship (CC) suggests an expanded viewpoint of thecorporate role, moving beyond the boundaries of direct stakeholderrelationships.

It is linked to the concept of corporate accountability.

• Corporate accountability refers to whether the organisation is in some way answerable for the consequences of its actions beyond its relationship with shareholders.

The demands for corporations to be more accountable and step up totheir new role as valid members of society comes from two main sources:government failure and corporate power.

Government failure

One consequence of a modern society with an abundance of productsand services is the failure of governments to deal with risks thataccompany these rapid changes.

• Sometimes the risks are beyond the control of a single government.
• Sometimes electoral impact dampens political will.
• Sometimes they are part of the problem.
• Sometimes it is simply too difficult to change lifestyles.
• Sometimes sub-political activism such as Greenpeace impedes political will.

Corporate power

Corporations can shape lives in many ways:

• Liberalisation and deregulation of markets increase market power and restrict the ability of governments to intervene.
• Privatisation of many previous state monopolies places greater power in the corporate hand.
• Countries struggle with unemployment and yet the decision to locate and support societies is often not theirs but that of corporations.
• The pressure on low-wage economies to maintain low wages (and hence low costs to attract customers) is vast.
• Complex cross-border legal agreement is very difficult and so corporations are encouraged to self-regulate.

Scope of corporate citizenship

Corporate citizenship (CC) implies a role for corporations in the societies upon which they impact.

There are three views as to the scope and nature of CC.

• Limited view of CC: this is Carroll's fourth level or philanthropic view. The scope is limited to charitable donations to the local community in which the organisation operates.
• Equivalent view: this is CC as being the equivalent to CSR. 'The extent to which business meets economic, legal, ethical and discretionary responsibilities'.
• Extended view: this is most appropriate viewpoint since here citizenship has rights and responsibilities. Rights include the right to freedom of speech and the right to own property. Responsibilities include the right to uphold civil liberties where governments may be failing in their duty.

Test your understanding 1

JV Limited manufactures cleaning chemicals at its factory in asmall town in the Lake District. It employs 300 people, and is thelargest employer within a 20-mile radius.

The factory is located on the side of a lake, at the end of a single track road.

Identify five social responsibilities of this company.

6 Shareholder ownership, property and responsibilities

It is worth considering the nature of shareholder ownership inorder to determine the extent to which this responsibility exists.

Ownership and property generally have three elements:

• Owner (O) has the right to use property (P) as he wishes. If it is food he can eat it, if it is land he can build on it.
• O has the right to regulate anyone else's use of P. If it is food he can share it or not, if it is land he decides who crosses the boundary.
• O has the right to transfer rights of P on whatever terms he wishes. He can sell the food or the land.

A generally agreed fourth point is:

• O is responsible for making sure that his use of P does not damage others. If P is a dog then O must make sure it does not bite others.

Ownership of a share in a large corporation is different:

• In a legal sense, because you do not own the organisation. It is a separate legal entity. The shareholder owns a right to participate in the risks and rewards of ownership but only to a limited degree.
• Risk is limited by liability and reward to the value of the share and dividends, both organised by those outside of individual control.

It would seem reasonable to afford the shareholder some protection against misuse of their money.

Shareholders have the following rights:

• The right to sell their stock.
• The right to vote in general meeting.
• The right to certain information about the company.
• The right to sue for misconduct.
• Certain residual rights in the case of liquidation.

Shareholders have responsibilities

The unique nature of the ownership of a share may suggest that shareholders have a limited responsibility for corporate action.

However, this responsibility still exists and can be seen in:

• Shareholder democracy: the concern here is whether shareholders, particularly institutional shareholders, can use their position to influence greater corporate accountability.
• Shareholder activism: buying shares in a company gives you the right to have a voice at the AGM and so make other shareholders aware of company policies and challenges.
• Ethical investment: is the use of ethical, social and environmental criteria in the selection and management of investment portfolios' of company shares.

Investment selection criteria

Criteria for selection of companies in which to invest can be negative or positive:

Negative

• Animal rights violation.
• Child labour.
• Trading with oppressive regimes.
• Genetic engineering.
• Nuclear power.
• Poor employment practices.
• Weapons.

Positive

• Conservation and environmental protection.
• Ethical employment practices.
• Inner city renovation.
• Green technologies.

Test your understanding 2

The LKJ company is a distributor of electricity in a large country.In effect, LKJ purchases electricity from companies making electricityand then distributes this through a network of cables to companies andprivate individuals throughout the country. Electricity is generatedfrom a variety of sources including burning coal and natural gas,nuclear power and a small amount from renewal resources such as wind andwave power.

LKJ's shares are owned by three other companies, who take an activeinterest in the profitability of LKJ. There are three other electricitydistribution companies in the country LKJ operates in.

The board of LKJ are currently considering the proposal to purchaseelectricity from another country. This source of supply is quoted asbeing cheaper from those within LKJ's home country, although theelectricity is generated by burning coal. If this supply is taken, LKJwill stop purchasing electricity from an old nuclear power station andsome of the expensive wind power plants. The Clean-Earth environmentalgroup has learnt of the proposal and is currently participating in amedia campaign in an attempt to block the change by giving LKJ badpublicity.

The board, managers and employees in LKJ appear indifferent,although changing the source of supply will provide a price advantageover LKJ's competitors, effectively guaranteeing their jobs for the nextfew years.

Required:

Identify the stakeholder groups who will be interested and/oraffected by the decision of the LKJ company to change electricitysuppliers, evaluating the impact of that decision on the group.

Discuss the actions the board can take with respect to each stakeholder group.

7 Chapter summary

Test your understanding answers

Test your understanding 1

Many points can be included:

• not polluting the lake with waste chemicals
• making sure employees use adequate protection when working with the chemicals
• complying with legislation regarding the use of hazardous chemicals
• minimising the impact of traffic on local roads
• minimising the visual impact of the factory on the area.

Test your understanding 2

Large institutional investors

The main strategy of the board regarding a large institutionalinvestor is communication with the need for change followed byparticipation in strategy determination. Most codes of corporategovernance indicate the bi-lateral approach to be taken. The largeinvestor is interested in the success of the organisation while at thesame time having the ability to adversely affect the organisation iftheir shareholding is sold. The organisation must therefore keep thestakeholder informed regarding important strategic decisions. Similarly,there is a responsibility on the part of the stakeholder to take aninterest in the activities of the organisation and to use theirinfluence responsibly.

The three investors in LKJ are likely to be keen for theelectricity to be purchased from the different country as this willincrease the return on their investment.

A dialogue should be established between the chairman and largeshareholders, as a minimum by discussion at the annual general meeting.However, more frequent meetings throughout the year are also expected.The chairman needs to ensure that the expectations of return from LKJare congruent with the investing companies.

Environmental pressure group

The pressure group will attempt to influence other groups with highpower to change the strategy of the organisation. The board of LKJtherefore need to communicate with the group with the aim of explainingand educating them in respect of the actions being taken by LKJ.

Currently Clean-Earth are attempting to influence the strategy ofLKJ by the media campaign. The basis of this campaign is likely to bethe fact that obtaining electricity from coal is more harmful to theenvironment than renewable sources and possibly nuclear generation.Explanation of the reason for change in terms of increased profit maynot, however, be acceptable.

However, the board must be prepared to learn from the pressure.Many pressure groups do have responsible and knowledgeable people withinthe group. Not to listen may mean that valuable advice and assistanceis rejected on grounds of prejudice against this type of stakeholder.While it is likely that advice from the group will be biased towardsrenewable resources, they may have ideas regarding cost efficiency thatLKJ can use.

Directors/managers/employees of LKJ

The directors of LKJ are stakeholders in the organisation. In termsof corporate governance, they have the responsibility to act in thebest interests of the company and its shareholders. In this sense, thereis no conflict in the decision to source electricity supplies fromanother country; LKJ profits are forecast to increase while there is jobsecurity for the directors. While the directors have high power andinterest in LKJ, this power appears to be being used correctly.

Similarly, the actions of the directors appears to meet therequirements of the managers and employees of LKJ in that their jobs areprotected.

However, the environmental impact of their action may be a causefor concern. If LKJ, and therefore the directors, are considered not tobe acting ethically then customers may choose alternative suppliers.This action will mean that the profit forecasts are incorrect and thedirectors may need to consider alternative courses of action.

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