Does Corporate Social Responsibility and Ethical Business Practices Pay?

By:  Marc Babel, Lynx Global Intelligence

 

Companies spend hours, months, years, lifetimes to build a reputation that they can hang their hat on.  It only takes seconds to lose that reputation if ethical business practices aren’t fostered throughout the entirety of an organization. The word, ethics, is drawn from the Greek word, ethikos, which signifies character – the distinctive, noteworthy quality of an individual or organization. Perhaps one of the best qualities of ethics is that it is well understood across all cultures, languages, races, and income levels.

At best, organizations believe ethics to be an intangible idea that should be promoted in the stockholders’ annual report but nothing on which a financial analyst or CPA can calculate a rate of return. After all, ethics are not a profit center but a cost center, right?  It won’t generate revenue or attract new stockholders, will it?  Customers can’t tell a highly ethical firm from one who puts it on the back-burner, can they?

Research from The Institute of Business Ethics, leaders in promoting corporate ethical best practices, has shown for the first time that companies with a clear commitment to ethical conduct outperform those that don’t [1]. Using four indicators of business success – economic value added, market value added, price/earnings ratio volatility, and return on capital employed – it compared two groups of companies: those with a demonstrable commitment to ethical behavior through having a published code of business ethics and those without [1]. Their performances were then analyzed over five years to discover the firms with established ethics had clearly superior metrics in these indicators.

Furthermore, the market research organization GfK NOP surveyed 5,000 consumers in the United Kingdom, United States, France, Spain, and Germany and discovered a third of those claimed they would pay a 5 to 10 percent premium for the products and services from an ethical company over its competitors [1]. Another survey performed by Gfk NOP uncovered that 80 percent of U.S. and European consumers are willing to pay more for goods and services from a company with a well-regarded labor and environmental record [1]. Clearly it is becoming more difficult for the C-suite to justify watered down versions of ethical conduct in their firms.

Forty-five years ago, Milton Friedman penned a famous article for The New York Times Magazine whose title appropriately abridged his main opinion: “The Social Responsibility of Business Is to Increase Its Profits.” Friedman has since maintained his position of having no patience for those who believe otherwise, claiming corporate social responsibility is merely pure and unadulterated socialism [2]. Do firms owe their complete allegiance to the benefit of shareholders alone? John Mackey, the founder and CEO of Whole Foods, is one businessman who disagrees with Friedman. Mackey holds that Friedman’s view of capitalism ardently ignores the humanitarian facet common to many businessmen in the 21st century. According to Mackay,

“I strongly disagree. I’m a businessman and a free market libertarian, but I believe that the enlightened corporation should try to create value for all of its constituencies. From an investor’s perspective, the purpose of the business is to maximize profits. But that’s not the purpose for other stakeholders–for customers, employees, suppliers, and the community. Each of those groups will define the purpose of the business in terms of its own needs and desires, and each perspective is valid and legitimate.” [2]

Mackay does believe this can be done without holding profit hostage.  The challenge many of those on board with his train of thought is how much attention does each stakeholder receive in terms of value?  Mackay believes there is no magic formula for everyone, however, it can be a dynamic, fluid approach that attempts to satisfy stakeholders since stakeholders are usually satisfied for short periods at a time.

Some refute corporate social responsibility on the grounds that using resources and funds towards philanthropy is blatantly stealing from investors. After all, by legal definition, a firm’s assets belong to the investors, right? A firm has a fiduciary responsibility to maximize shareholder value; therefore, any activities that don’t maximize shareholder value are violations of this duty. If you feel altruism towards other people, you should exercise that altruism with personal resources, not with the assets of a corporation that doesn’t belong to you.

While that may be true, this argument is not wrong as it is too narrow. It is important to have an understanding with the investors since most firms can “hire” their initial investors, not vice versa. When philanthropy is regarded as a fundamental ethics practice in the corporate vision, shareholders and investors are bound by any investment to this type of corporate culture. Shareholders of company stock do so voluntarily, so if the philosophy of corporate social responsibility of a firm does not match with their own, they are free to exit their relationship with said firm.

The business model that Whole Foods has embraced could represent a new form of capitalism, one that more consciously works for the common good instead of depending solely on the “invisible hand” to generate positive results for society. The “brand” of capitalism is in terrible shape throughout the world, and corporations are widely seen as selfish, greedy, and uncaring. This is both unfortunate and unnecessary, and could be changed if businesses and economists widely adopted the business model of Whole Foods [2].

Advocates of CSR ought to reflect on the fact that the “triple bottom line” and the bogus pay scheme which rewards bad performance with riches have something important in common: the idea that the interests of “mere owners” should not be allowed to come between managers and their personal objectives [3]. Broken corporate governance and CSR are close relations. You often see them together.

However, CSR can be regarded as the antithesis to short-termism. Managers are increasingly seeing the importance of placing more of an emphasis on long term goals mixed with ethical practices alongside the short-term goals of profit. Companies deliver superior results when executives manage for long-term value creation and resist pressure from analysts and investors to focus excessively on meeting Wall Street’s quarterly earnings expectations [4]. New research, led by a team from McKinsey Global Institute in cooperation with FCLT Global, found that companies that operate with a true long-term mindset have consistently outperformed their industry peers since 2001 across almost every financial measure that matters [4]. As shown below:

ethics 2

While this can’t necessarily be the result simply of long-termism in the form of ethics and corporate social responsibility, it is hard to argue that those aspects didn’t contribute. For corporations, social responsibility has become a big business. Companies spend billions of dollars doing good works — everything from boosting diversity in their ranks to developing eco-friendly technology — and then trumpeting those efforts to the public.

Extensive research performed by The Wall Street Journal has delved into the consumer mind, uncovering just how much ethics can pay.  Results concluded that oftentimes, those consumers that will pay a premium for ethically sourced products will outweigh those that seek a cheap product without regards to ethics [5]. The lessons are clear. Companies should segment their market and make a particular effort to reach out to buyers with high ethical standards, because those are the customers who can deliver the biggest potential profits on ethically produced goods [5]. All stakeholders are becoming a priority in the 21st century. Firms employing corporate social responsibility and ethical practices will be the ones receiving long term benefits while pushing the envelope on the benefits capitalism can bring to society.

 

[1] http://www.fraud-magazine.com/article.aspx?id=374

[2] http://reason.com/archives/2005/10/01/rethinking-the-social-responsi

[3] http://www.economist.com/node/3555286

[4] https://hbr.org/2017/02/finally-proof-that-managing-for-the-long-term-pays-off

[5] https://www.wsj.com/articles/SB121018735490274425