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The sustainable corporation and its governance: long-run performance and

social responsibility

Alessandro Vercelli

Department of Economic Policy, Finance and Development (DEPFID) University di Siena

2 lectures based on:

Borghesi, S., and A.Vercelli, 2008, Sustainable Globalization. Social and Environmental Conditions, Palgrave Macmillan, New York

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1st lecture

Sustainable business practices and CSR

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CSR and sustainable business practices (SBP):terminological clarification

CSR (also CR, C accountability, responsible business):

society

responsibility for the impact of their activities { → C sustainability

environment

umbrella term to discuss the rights and duties of actors in business

c. (or business) strategiesstrategies

→ progressive upgrading { → sustainable {

c. (or business) practices practices

this obligation is seen to extend beyond the duty to comply with legislation

CSR self-regulation

→ relationship {

legal regulation

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Recent historical trends

deterioration of CSR

Apparent paradox {

↑ CSR initiatives → SBP

• CSR jeopardized by

- Globalization:

• ↓ transparency and accountability

• ↑ global markets without global regulation

• ↓ ratio dimensions controller/controlled

- Deregulation → e.g. in the USA:

• OTC derivatives (Commodity Futures Modernization Act, 2000)

• Glass-Steagall Act (1933) partially repealed in 1999

• Insufficient re-regulation (Sarbanes-Oaxley Act, 2002)

• Shadow finance

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The CSR paradox

• From an endemic disease to an epidemics → antibodies:

initiatives by firms meant to strengthen CSR through

sustainable business practices

i.e. behavioral rules that characterize a sustainable firm

• What is a sustainable firm? :

Def.1: a sustainable firm is a firm that complies with the principles of sustainable development

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Sustainable development: definitions

Development:

process of expansion of individual economic freedom (Sen, 1999)

Sustainable development:

“Development is sustainable if it satisfies present-day needs without compromising the capacity of future generations to satisfy their needs”

(Brundtland Report, 1987)

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Definition of sustainable firm

Def.2: “For the business enterprise, sustainable development means adopting business strategies and activities that meet the needs of the enterprise and its stakeholders today while protecting, sustaining and enhancing the human and natural resources that will be needed in the future”

(International Institute for Sustainable Development, 1992)

This implies a different view of the firm also in economic terms:

Def. 3: a firm is sustainable if creates durable value for all its stakeholders

two crucial specifications:

• A) average profitability fairly high and stable in the long period

• B) orientation not only towards its shareholders but all its stakeholders

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A) Reference to the long period

• The performance of a firm is usually evaluated and compared within a short-period horizon

This tendency has been recently strengthened by:

- ↑ FIR of Goldsmith- Globalization of financial markets: ↑ risk of fluctuation of values- Incentives based on short-period performance (stock options)

Consequences:

- ↑ focus on financial aspects- ↑ so-called “creative accounting” to boost short-term

performance- ↑ interest conflicts between managers and stakeholders- ↑ short-termism of managerial decisions- → insufficient productive investment

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B) Reference to all the stakeholders

strict definition: all the subjects that have a legitimate interest in the performance of the firm as they contributed with a specific investment: employees, suppliers, customers, local communities

According to the traditional theory of the firm and civil law:

the firm should only be concerned with creation of value for its shareholders

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B) Reference to all the stakeholders

This is a necessary but not sufficient condition of sustainability: the firm is sustainable only if value is created for all its stakeholders

– Ethical: the firm’s performance depends on the contribution of all the stakeholders

Reasons {– Instrumental: ↑ attention for all stakeholders → ↑ average

long-term performance

-stakeholders typically have long-term interests

in fact { -assures the necessary social

consensus

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CSR initiatives, SBP, and the stakeholders’ feedback

ETHICAL CODE SMS CERTIFICATION REPORTING

BOARD MANAGEMENT STAKEHOLDERS

Green arrow: implementation & information flowRed arrow: behavioral and dialectic influenceBlack arrow: influence through shareholders meetingsBlue arrow: strategic and managerial influence

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CSR initiatives: conditions of effectiveness

• These initiatives may have an effective and durable influence on CSR iff stakeholders react actively to the additional information flow

• The closure of the feed-back by the stakeholders should be

-active but also

-pro-active soliciting new information and CSR initiatives

→ the firm is pressed to direct its strategic and managerial choices:

-increasing stakeholders satisfaction

towards{ → virtuous circle

-corroborating sustainability

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Critiques to CSR self-regulation

A) with high confidence in the market

Critics {

B) with a limited confidence in the market

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A) Critics with high confidence in the market

Critique focused on the “stakeholders theory” that provides the foundations for CSR self-regulation:

objective function of the firm → creation of value for all stakeholders

(e.g. Jensen, M.C., 2001, Value maximization, Stakeholder Theory, and the Corporate Objective Function, Journal of Applied Corporate Finance)

i ) logical argument: function that max. a unique variable2 arguments{

ii) substantive argument: max of profits

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i ) The “logical” argument

based on a syllogism:

• An efficient objective-function should max. a unique magnitude

→ otherwise impossible to measure & evaluate performance

• Stakeholder theory: the objective-function depends on different variables while weights and trade-offs are not

fixed

• Thus the objective-function of stakeholders theory is inefficient:

• Impossible to evaluate the performance• Managers’ preferences prevail → interests conflicts• Politicization of firm’s choices

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ii ) The “substantive” argument

• The variable to be max. should be the traditional one:

max. of the value for the shareholders

200 years of economic theory proved that the systematic max. of value for shareholders max. social wealth

• If there are monopolies and externalities, the public authorities must intervene; however, this is not the job of entrepreneurs

• satisfies the legitimate interests of all stakeholders

• crucial qualification → long-period maximization:

short-period max. may damage the interests of a few stakeholders

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Defense of CSR initiatives: the logical argument

the first kind of critiques undermines the normative role of CSR initiatives

however the arguments are not robust:

• the “logical” syllogism is not compelling:

-Index-numbers theory-Multi-criteria analysis: active participation of stakeholders

objectives must be weighted and trade-offs fixed

• The “logical” problem is not solved by the critics

trade-off between short\long period:

- conflict also between shareholders- where is the border between short and long period?

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Defense of CSR initiatives: the substantive argument

max. value → max. social wealth only in a perfect competition market

not only without monopolies and externalities,

but also with complete markets, perfect foresight or RE, unbounded rationality, no transaction costs, time reversibility, weak uncertainty, etc.

→ it is the gap between real and ideal market that justifies CSR initiatives:

allocation distortions and suboptimal wealth of some stakeholders

→ CSR justified to the extent it succeeds in correcting the distortions

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B) Critics aware of the gap between real markets and the ideal model of perfect-competition

they believe that its negative implications may be mitigated only trough the traditional instruments of law:

e.g. Guido Rossi (The epidemic conflict, 2003) →

CSR self-regulation would be useless if not counterproductive:

-without sanctions and enforcement mechanisms

-alibi to weaken legal regulation

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B) Critics aware of the gap between real markets and the ideal model of perfect-competition

This argument is only partly convincing:

- CSR self-regulation is not devoid of enforcement mechanisms provided that there is an active participation of the stakeholders

- the legal system guarantees only a minimal standard

→ synergy between legal regulation and CSR self-regulation:

-progressive awareness of stakeholders

virtuous circle between { -effectiveness of legal norms-upgrading of ethical standards

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The scope of CSR and SBP

The assumptions underlying the ideal model of a perfect-competition market are very demanding: completeness, absence of transaction costs and externalities, unbounded rationality, “soft” uncertainty, full reversibility of time, and so on

most of these assumptions are not true in real markets → the allocation of resources and social welfare is suboptimal → in principle, we may improve on the existing situation trough regulation of markets and CSR self-regulation

This is the rationale of CSR self-regulation: but there is no guarantee that CSR initiatives improve the existing situation rather then further worsening it

We need a thorough analysis of the costs and benefits of CSR initiatives in a given situation and context

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Ethics and CSR initiatives

Since CSR depends also on the behaviour of the stakeholders, the latter (and their representatives) share with managers and directors (and control authorities) the ethical responsibility for inadequate standards of CSR

The CSR initiatives can only aim at reducing the gap between individual behaviours and acceptable ethical standards by stimulating a constructive dialogue between firm and stakeholders to solicit:

– Convergence towards common values and respect for different values

– Awareness of the ethical consequences of alternative decisions

– A process of learning towards a sort of fair “social contract” between the firm’s DMs and its stakeholders (Sacconi, 2004)

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Concluding remarks

• CSR self-regulation and legal regulation must be both strengthened at the same time in a synergic way in order to assure the sustainability of firms and of development itself

• In this perspective CSR self-regulation may play an important role in checking the deterioration of ethical standards in business, triggering a virtuous circle between expanding CSR initiatives and increasing ethical awareness and activism of the stakeholders

• From the point of view of corporate sustainability, corporate governance has to be extended in order to include the CSR feedbacks between the DMs of the firm and all its stakeholders