Business Cannot Ignore Its Environment

Introduction
The social responsibility of corporate management is to maximize the respect earned by the business from its transactions with customers and stakeholders in a manner that is consistent with long-term profitability. This strategy is parallel to profit maximization but at odds with the Friedman Paradigm which calls for ignoring the social implications of concentrated corporate economic power.

Coelho, McClure and Spry (the "authors" hereafter), in their article "The Social Responsibility of Corporate Management: A Classical Critique" defend the stockholder theory or Friedman Paradigm on the basis of its practical, legal, and economic strengths. Post, in his "Response" to the authors, points out the weaknesses and errors of their views.

The Brutal Clarity of the Friedman Paradigm

The practical strength of this theory resides in its brutal clarity and frank admission that business need only comply with law and maximize profit. The authors claim corporate social responsibility is "inherently vague and ambiguous" (Coelho p. 15) without acknowledging that if ethics were simple and clear no debate of any kind would be necessary or possible. The clarity of their theory arises from its advocacy of nothing, and denial that business or business managers have any social responsibility.

The Legal Minimum Non-Existent Corporation

The legal foundation of the Friedman Paradigm is based on 19th century corporation statutes which do indeed impose a fiduciary duty on corporate managers. However, this duty exists with respect to the company itself as Post, citing work by Boatright, states: "...management acts as the agent for the artificial legal person (the corporation) not the stockholder." (Post p. 29). The authors, on the contrary, assert that management has unfounded "...fiduciary duties owed to shareholders." (Coelho p. 21).

It is ironic that the authors deride as "reification" the idea that corporations exist and are subject to social responsibility as is the case for any moral actor with power to do good or ill. Their dismissing the very real existence, economic, legal, factual, of corporations as entities is a tactic designed to avoid this responsibility by claiming that the subject to be charged with responsibility doesn't exist.

Perhaps it is by magic that the trillions of dollars in market value related to these non-existent corporations does in fact exist. When abstractions and "legal fictions" acquire a dollar value they become real and concrete for all practical and economic purposes and it is silly to pretend otherwise. Similarly, conceit might motivate a cynic to disbelieve in Santa Claus when billions of dollars and millions of children have overwhelmingly voted him into a very real and tangible existence. The author’s claim of reification is wrong as is their claim that "[c]orporations have no existence beyond this legal fiction." (Coelho p. 16).

Prime Minister Margaret Thatcher of England infamously declared in a 1987 speech: "there is no such thing as society." (Deer.) Evaluated at the level of companies it's clear these "legal fictions" are very much alive and well and continue to survive changes in stockholders, changes in management, and changes in employees. Publicly traded companies have a true entity-level existence which is synergistically more than the mere sum of their components and which endures above and beyond the interchanging of these components.

CEO's can be fired, boards of directors come and go, officers come and go, but companies endure and, unlike how a principal may fire an agent, can almost never be fired and are virtually beyond the reach of shareholders. The largest modern public corporations are an independent power unto themselves that have achieved sovereignty akin to that of nations. The 2,000 largest public companies in the world, called the "Forbes Global 2000" reported $38.61 trillion in market value at the end of 2008, an amount that is larger than the total GDP of several of the most advanced countries in the world. (Kichen.)

Perhaps there is no such thing as a human being to be held responsible under law and ethics. Instead, there is a collection of cells endowed with a tendency and animated by the coincidence of mutual action.

Economics and the Ownerless Corporation

Since the final failure of socialism in the 1990's there can be no disputing that capitalism is clearly the most effective economic system available. But as Post implies in his response, there is no need to have recourse in the 21st century to 19th century ideas of property in order to continue to wage a 20th century cold war against socialism. Western democratic capitalism has won this debate, as Francis Fukuyama boasted in 1989 when he claimed an "end to history." (Fukuyama.)

The heart of the Friedman Paradigm is the idea that the shareholders of a corporation are the sole reason and motive for all its actions. But who are these faceless shareholders and where are they? In modern times they have become as invisible as Adam Smith's "invisible hand" and represent the one idea in the authors’ article that is a true reification. Post states in his response, citing work by Boatright and Nesteruk, that "...shareholders are not really "corporation owners" at all, but simply "stock owners" or mere beneficiaries of company dividends (Post p. 28.)

The primary relationship of an owner of stock is between the owner and the stock market where the shares are traded. Such an individual may or may not have performed company research, and may or may not know much about the company he or she owns shares of. Many stockholders are transients or speculators who may own shares for a few fleeting hours or days. Turnover among many shareholders is far greater than other stakeholder groups such as employees, communities and suppliers, each of whom may have an enduring relationship with the company for many years. Post explains how each of these stakeholder groups may have more nexus with the company than shareholders. (Post p. 31.)

The need for diversification to minimize market risk actually makes it a bad idea for an investor to own just one company, or have a significant relationship with one business alone. Friedman's celebrated "shareholders" have become a statistical abstraction founded on a necessary divorce from any one company. Shareholders have run away from the pedestal Friedman placed them on in order to seek safety in diversification, profit in short selling, and amusement in day trading. No company stock is ever more than one impersonal mouse-click away from being sold.

From the point of view of the company, the primary equity relationship is between the corporation and the impersonal stock markets where its shares are traded. These equity markets are both an impersonal source of capital when new shares are floated and an impersonal source of statistical judgment by the market on the company.

Evaluated at the level of shareholders we again confront the blunt truth: The logical consequence of Post's criticisms of the shareholder theory is the fact that modern publicly traded corporations actually own themselves. The owned has become the owner. The legal, managerial and psychological distance between nominal shareholders and companies means there is no longer any true third party owner. The authors themselves acknowledge the problems of shareholders trying to control companies, an issue known as the "principal-agent problem": "[A]n important cost of big business arises from the separation of ownership and control." (Coelho p. 21).

Companies largely chart their own destinies free from micromanagement by scraps of paper or digital certificates that carry little writ beyond the stock market where they are traded. This fact alone causes the self-collapse of the Friedman Paradigm, which implodes into nonsense once its vaunted "stockholders" are shown to be as non-existent as the corporate social responsibility espoused by this theory.

The Zero Value Corporation and the Costs and Consequences of Contempt

Post in his response focuses primarily on rebutting the authors and the Friedman paradigm by exposing their inconsistencies and "factual inaccuracies." He goes on to explain the stakeholder model of what companies ought to do. However, Post does not fully explain the costs and consequences of the Friedman Paradigm, and his abstract rebuttal followed by prescriptive statements of what management should do is unlikely to convince hard core supporters of the Friedman Paradigm. The true and provable cost of blindly following the Friedman Paradigm is
cumulative loss of public respect which sooner or later becomes a measurable and objective financial cost that limits growth and opportunity.

Public contempt is measured in units of badwill, or the lack of goodwill. The single most glaring contradiction contained in the authors’ article is buried in their footnote five, which states, in its entirety:

In addition to this assumption [that decisions made by ethical people benefit all of society] are the rewards or punishments met out in the marketplace to firms with clean or tarnished reputations. Alan Greenspan articulated that, "...reputation or 'good will' is as much an asset as its [the firm's] physical plant and equipment." From the same source, Greenspan stated: "Capitalism is based on
self-interest and self-esteem; it holds integrity and trustworthiness as cardinal virtues and makes them pay off in the marketplace, thus demanding that men survive by means of virtue, not vices." (Coelho p. 22.)

But companies that pretend they do not exist as tangible moral actors (“reification”), that pretend they have no social responsibility, and pretend that their social impact on people is to be disregarded will find themselves haunted by a lack of the very goodwill ("tarnished reputations") the authors, and Greenspan, enshrine at the heart of their theory. These individuals seem completely blind to the fact that the reputation and goodwill of a business is effected not only by its market relationships, but also by its key non-market relationships with the stakeholders elaborated by Post and Freeman. (Post p. 32.) The strength of the former is measured by profit or loss and is reflected in cash
surpluses or deficits; the strength of the latter is measured by respect or contempt and is reflected in goodwill or badwill. Baron, confirming these views held by Post, states: "An important nonmarket asset is a reputation for responsible actions and principled behavior." (Baron p. 49).

The authors and Friedman are demanding that the reputation of companies be untouched and untainted by how and whether these companies practice social responsibility. The viability of their entire theory crucially depends on this assumption. But we do not live in the 19th century anymore. Laissez-faire capitalism is gone and is not likely to return. People want companies to respect the environment. People want companies that don't use sweatshop labor. People want companies that treat their communities with respect. The authors and Friedman may resent these demands. They may regard them as creeping socialism. But their resentment, their wishful thinking, and their desire to return to the past will not change the fact that the reputation of companies is keenly impacted by the degree to which companies accept and practice social responsibility: Business cannot ignore its environment.

Companies earn respect and build their social reputations by using "...[m]anagement ...to balance relationships, [and] not always side with just the interests of the shareholders...." (Post p. 31). Respect is earned by respect given following basic rules of reciprocity informed by the Social Contract Theory.

Imagine a company whose products are loved by the public with precisely the same intensity as the company's rejection of any social responsibility is publicly hated. In this case one might formulate an economic theory where each dollar of profit earned by this company practicing disdain for social responsibility is precisely offset by a dollar of negative goodwill. The result is a Zero Value Company, a bankrupt entity with zero net worth.

As Friedman and the authors count and treasure the dollars of profit, Post could count and report the dollars of disdain, of public contempt, of badwill earned by such a company, which is killing itself to get absolutely nowhere, and whose balance sheet remains forever stuck at zero net worth. Such a company has turned its back on its own future potential. It is business folly to allow a dollar's worth of success in private transactions to be negated by a dollar's worth of public disrespect.

Of course the purity of this abstract model must be refined to make sense in a murky real world. Two refinements are needed to apply this paradigm to reality.

First, a Zero Value Company would be a ripe target for a hostile takeover. Such an entity is inherently unstable. New management would change course, and adjust company strategy to repair dangerous imbalances between market versus social perceptions. Logically, the opposite extreme to the Zero Value Company is the Beloved Company, where a dollar of loss is precisely offset by a dollar of gain in goodwill. Such companies exist because enough people believe they will have a future that just has not yet arrived. Amazon.com appears to fit this profile since it survived and grew for years without benefit of profits.

Second, consumer research and surveys may prove that company products are loved with exactly the same intensity as stakeholders and the broader public hate the company for its spurning any social responsibility. But this observation is incomplete because it fails to account for the effect of varying cultural factors. A new term, a culture coefficient, must be applied to goodwill to value it correctly. This term expresses the degree to which the reputation (and other secondary non-market characteristics) of a company impacts its financial valuation via goodwill.

For example, Scandinavian culture has a strong degree of suspicion and dislike of arbitrary and arrogant power. In Scandinavian countries I would speculate that the culture coefficient applicable to goodwill is near its maximum possible value. If this is true, any business explicitly practicing open rejection of social responsibility there would soon grind to a halt, no matter how great its business plan, no matter how efficient its logistics are, no matter how effective its management is.

Conversely, in the US there is a well known tendency to admire money and power which outweighs public contempt for rejection of social responsibility. Thus, in the US I would speculate that the culture coefficient applicable to goodwill has a moderate value. This means there is still a long term cost of contempt that will pose a growing danger to the well being of companies.

In the US Wal-Mart faces vast opposition and routinely wins the title of the most hated company in America. Its own CEO recently admitted the company has lost billions in potential profits because of public disrespect: "We could be three to four times bigger in the U.S." (Baron, p. 150). Ultimately, survival and maximization of opportunity requires respect as well as profits. In the long run these two values go hand in hand, which is why maximizing respect is a parallel, not a competing, strategy to maximizing long term profits.

In the very poorest and most desperate countries of the world, local cultures may ignore the fact that companies show them no respect and dignity. All they value is cash. Here, the cultural coefficient is at its minimum. Perhaps this is why so much success has been attained exploiting cheap foreign labor in some of the most destitute nations of the world. Yet even here a pale ghost of yearning for respect and dignity must remain, and form the seeds for a future culture that will become far less tolerant of contempt. In the US the 19th century 'Robber Baron' era has given way to 21st century values which expect much more from business.

Friedman and His Icon

Milton Friedman, who won the Nobel Prize in Economics in 1976, was a decent and honorable man who justly championed the cause of free markets during a dangerous time of world-wide competition with the socialist adversaries of the west. (Holcomb.)

Unfortunately for Friedman and the authors there is an icon in our culture which exemplifies the formal values of the Friedman Paradigm. While Friedman personally would probably be appalled at this icon there is nothing in his theory which rejects it. This, then, is the peril of theorizing. Personal virtues can get lost. For many writers the blank white page in front of them is an abyss. Many scientists including Einstein have declared their prejudice that any theory that is not beautiful is probably wrong. One could also speculate that any theory devoid of kindness is also probably suspect in an ethical sense.

A 19th century English writer once described "an excellent man of business" (Dickens p. 1) who operated a "counting-house" or accounting firm (p. 3) When this business was solicited for charitable contributions, the owner stated: "It's not my business...It's enough for a man to understand his own business, and not to interfere with other people's." (p. 7). This business complied with all laws. It paid all taxes charged to it. It made spectacular profits. It completely rejected all social responsibility of any kind. It followed Friedman's stated business model perfectly:

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.
(Post, p. 26).
The owner of this business was Ebenezer Scrooge.

Conclusions

Post correctly points out that the one true strength of the Friedman Paradigm is its mere simplicity. Since corporations do in fact have tangible physical effects in the real world, they are real themselves and not mere "legal fictions" as asserted by the authors. Since corporations do exist, they must be held responsible both ethically as well as legally. Post clearly explains why law cannot be substituted for ethics since law represents a legal minimum which may lag behind the current requirements of ethical practice that await future laws yet unwritten.

Blindly following the Friedman Paradigm exposes companies to financial costs arising from cumulative damage to their reputations which impacts the valuation of goodwill. Variations over time and place in a culture coefficient, which measures the degree to which the social reputation of a business impacts its financial value, can alter the financial impact of reputation on a business. Increasing expectations of stakeholders results in a nonmarket demand for social responsibility by business. In the sufficiently long run it is folly for business to refuse to supply this demand.

NEWS UPDATE 4/30/2012:

Shares of Accretive Health fell 42% after the New York Times reported the company was stationing bill collectors in hospital emergency rooms and using other hard-ball tactics against patients in violation of federal and state laws. This incident occurred after the State of Minnesota sued Accretive for losing a laptop containing confidential medical records for thousands of patients. These events have ignited a series of investor securities fraud lawsuits against the company. See:

Accretive

References

Baron, David. Business and Its Environment. New York: Prentice Hall, 2009.

Coelho, McClure & Spry, The Social Responsibility of Corporate Management: A Classical Critique, American
Journal of Business, Spring 2003: Vol. 18, No. 1.

Deer, Brian. “Epitaph for the eighties? 'there is no such thing as society.’” Assessed December 14, 2009.
http://briandeer.com/social/thatcher-society.htm;.

Dickens, Charles. A Christmas Carol. New York: Bantam Classics, 2008.

Fukuyama, Francis "An End to History?" The National Interest, Summer 1989: Vol. 19, No. 2.

Kichen, Steve. “The Big Picture.” Forbes April 8, 2009. Assessed December 14, 2009. <Global 2000
http://www.forbes.com/2009/04/08/global-aggregates-recession-business-global-09-big-picture.html;.

Noble, Holcomb. “Milton Friedman, 94, Free-Market Theorist, Dies .” New York Times November 17, 2006.
Assessed December 14, 2009. http://www.nytimes.com/2006/11/17/business/17friedman.html;.

Post, A Response to “the Social Responsibility of Corporate Management: A Classical Critique“, American Journal
of Business, Spring 2003: Vol. 18, No. 1.

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