Shahin A. Shayan Page 1

Corporate Social Responsibility andMaximization of Shareholder Wealth

Shahin A. Shayan1

April 2015

AbstractIn a joint stock company an important management goal is the enhancement and maximization of the

shareholders wealth and value. Additionally, sustainability, stability, continuity and growth of this valueshould be a critical parameter that needs to be considered by the management. This is directly related to therisks that a company is willing to undertake in its ventures going forward. The higher the risks a companyaccepts in its ventures, the more volatile and less stable its value creation ventures will be. It seems that anoptimum management objective in any company should be a practical balance between the value or wealthcreation efforts and the management of the risks inherent in these efforts while reaching the intendedstrategic goals. But are shareholders the only group that company managements are responsible to?

Shareholders are considered a partial subset of a larger group called stakeholders. Stakeholders mayinclude anyone who has a direct or indirect interest in the business entity or someone with even a non-pecuniary interest in a non-profit organization. Thus it might be common to call volunteer contributors toan association as stakeholders, even though they are not shareholders. Usually there are potential conflictsamong stakeholder’s interests. It is one of the management challenges to create a balance between theseconflicting interests in such a way that the medium and long term continuity, stability, sustainability andprofitability of a business are maintained. Governments and regulatory agencies are also considered asstakeholders in most corporations and businesses. Regulatory compliance can be costly to a business andwill reduce bottom line profitability which can be in conflict with shareholders value maximizationobjective. On the other hand, non-compliance is also costly and is against the regulator’s interest and couldpotentially create reputational and credibility damages, causing additional costs and risks for a firm.Balancing the conflicting stakeholder’s interests and increasing the long term health and profitability of abusiness is one of the serious challenges that top management of firms are facing, on a day to day basis.Therefore one can state that an optimum management objective in any company should be a practicalbalance between the stakeholder’s interests and the management of the risks inherent in these interestswhile reaching the intended strategic goals

To understand the dynamics of how these challenges prevail we have analyzed the related issues inthis paper.

Corporate Governance and Corporate Social Responsibility

Fisher (2010) states that Corporate Governance can be defined as the set of

processes, customs, policies and laws and institutions affecting the way a company is

directed, administered or controlled. Although corporate governance is designed for the

protection of its funders, it also applies to government, not-for-profit and other

1 Chairman of the Board at Hoda International Financial Engineering Company in Tehran, Iran

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membership organization (Fisher, 2010). It includes the defined relationships among the

major stakeholders and the goals for which the corporation is governed. The principal

players are the shareholders, management and the board of directors. Other stakeholders

include employees, suppliers, customers, banks and other lenders, regulators, the

environment and the community at large.

An important theme of corporate governance deals with issues of accountability and

fiduciary duty, essentially advocating the implementation of policies and mechanisms to

ensure good behavior that protects shareholders. Another key focus is the economic

efficiency view, through which the corporate governance system should aim to optimize

economic results, with a strong emphasis on shareholders welfare. There are yet other

aspects to the corporate governance subject, such as the stakeholder view, which calls for

more attention and accountability to players other than the shareholders.

Stakeholders are defined as persons such as employers, customers, or citizens who

are involved with an organization and have responsibilities and interest in its success

(Cambridge Dictionaries Online, 2014).

Recently, there has been considerable interest in the corporate governance practices

of modern corporations, particularly after the high-profile collapses of a number of large

U.S. firms such as Enron Corporation and WorldCom.

When examining the blatant absence of corporate governance from a perspective of

Enron's infrastructure, one of the first issues that presented it was how Enron executives

wholly disenfranchised their stakeholders. No longer are the vulnerable individuals

merely the investors; rather, the stakeholder theory introduced in the 1980s established

that corporate obligation goes well beyond the standard investor. This new approach,

delineating to whom businesses are expected to be responsible, as well as for what sets a

precedence for those at stake to be anyone with a direct interest or risk in the firm, not the

least of which includes employees, customers, suppliers, distributors, stockholders,

interest groups, legal and regulatory bodies, as well as the general public (Poulton, 2002).

The perceived quality of a company's corporate governance can influence its share

price, stockholder’s wealth as well as its cost of raising capital The better perception on a

company’s corporate governance structure leads to a higher perceived management

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structure, company credit and hence lower cost of raising funds. This in turn leads to a

higher profitability, share price and shareholder’s wealth.

Corporate Social Responsibility (CSR) is a concept which encourages organizations

to consider the interests of society by taking responsibility for the impact of the

organization's activities on customers, employees, shareholders, communities and the

environment in all aspects of its operations. It encompasses not only what companies do

with their profits, but also how they make them. It goes beyond philanthropy and

compliance and addresses how companies manage their economic, social, and

environmental impacts, as well as their relationships in all key spheres of influence: the

work place, the market place, the supply chain, the community, and the public policy

realm (Harvard Kennedy School, 2008). This obligation is seen to extend beyond the

statutory obligation to comply with legislation and sees organizations voluntarily taking

further steps to improve the quality of life for employees and their families as well as for

the local community and society at large.

While many businesses have always behaved in a responsible manner, the debate

about CSR has been said to have begun in the early 20th century, amid growing concerns

about large corporations and their power.

CSR is often discussed at the highest levels within companies. Those advocating

CSR are essentially asking companies to look beyond how their decision-making impacts

commercial activities and examine the effect on the society around them. This is no easy

task, since an activity that generates money for the company could actually be perceived

negatively in the strict context of CSR (Kermani, 2006).

Social responsibility represents perhaps the single most critical component of

corporate culture which speaks to how the entire operation revolves around

understanding what the organization seeks to achieve and how it will reach this objective

by focusing upon the public's best interest.

Stakeholders and Shareholders' Interests

A corporate stakeholder is a party who affects, or can be affected by, the company's

actions. A narrowly defined list of stakeholders might include:

Employees

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Communities

Shareholders

Investors

Environment

Government

Broader lists of stakeholders may also include:

Suppliers

Labor unions

Government regulatory agencies

Industry trade groups

Professional associations

NGOs and other advocacy groups

Prospective employees

Prospective customers

Local communities

National communities

Public at Large (Global Community)

Competitors

Shareholders are generally seen as the primary stakeholder in any business. It is this

group of stakeholders that are considered when annual reports are prepared.

The school of shareholder wealth maximization states that it is the shareholders

interest that is the principle concern of the organization (Dobson, 1999).

When Economists argue for this singular approach to profit maximization objective,

it is not a total disregard for social or environmental consequences, they indicate that

normally accepted ethics and moral standards should apply to the situation (Chryssides et

al, 1999). They argue that profit should be generated within the law of the land. In short,

social responsibility is for a business to avoid doing what society would deem wrong

(Chryssides et al, 1999). Risk Reduction, Cost of risk or insurance against wrong deeds

by the company from society’s point of view, credibility or reputational cost or as defined

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by Basel II standards for banking, operational, compliance or legal costs, all have to be

considered and managed.

The need to abide by the rules and regulations means that business will look for other

ways to increase profits. For example, there are many rules and regulations that increase

employment costs in the US; these include minimum wages legislation as well additional

costs such as holiday payments and welfare contributions. There are also other costs; the

costs of abiding by environmental laws, both in prevention and clean up effotrs. Every

dollar spent on compliance with the laws may be argued that is a dollar less used to create

shareholder wealth or lost from the pockets of the shareholders. This can be argued as the

reason why, in an attempt to maximize shareholders interest, outsourcing as a mean of

reducing operational costs has has been utilized by many companies in the US.

Is maximization of shareholder wealth a realistic objective?

Managing risk is a central part of all corporate strategies. Corporate reputation and

credibility that takes decades to build up can be ruined in an hour through incidents such

as corruption scandals or environmental accidents. These events can also draw unwanted

attention from regulators, courts, governments, public and media. Building a genuine

culture of 'doing the right thing' and be responsible towards stakeholder’s interest within

a corporation can offset these risks (Kytle, Ruggle, 2005).

The pressure from shareholders to increase earnings and the need to compete with

numerous other firms means that companies are always seeking ways to save costs or add

value to their operations. This should be balanced with the fact that profitability should

be continuous, sustainable and even better, growing. If we try to maximize shareholder

wealth without any concerns on its sustainability, our fiduciary responsibilities as

managers or board members are under serious question. One very important cause for

sustainable wealth creation is good reputation and credibility on stakeholders list.

Through an active Corporate Social Responsibility functions, a company can easily

achieve continuous good reputation and enhance brand value.

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Conclusion

In corporations, shareholders delegate decision rights to the management to act in the

principal's best interests. This separation of ownership from control implies a loss of

effective control by shareholders over managerial and day to day decisions. Partly as a

result of this separation between the two parties, a system of corporate governance

controls is needed to assist in aligning the incentives of managers with those of

shareholders.

Board of directors often plays a key role in corporate governance. It is their

responsibility to endorse the organization’s strategy, develop directional policy, appoint,

supervise and remunerate senior executives and to ensure accountability of the

organization to its owners, authorities and in general its stakeholders.

All parties to corporate governance have an interest, whether direct or indirect, in the

effective performance of the organization.

A socially responsible firm would take proper environmental, regulatory

considerations into account when making a decision. It often falls to management and

shareholders to push for a company to be run responsibly and take initiative for its

actions. Of importance is how directors and management develop a model of governance

that aligns the values of the corporate participants and then evaluate this model

periodically for its effectiveness on stakeholder’s interest sustainability, balance and the

minimization of potential conflicts among these interests. In particular, senior executives

should conduct themselves honestly and ethically, especially concerning actual or

apparent conflicts of interest, and disclosure in financial reports.

The impacts of proper and effective governance on the stakeholders interests can be

seen in the International Finance Facility for Immunization Program (IFFIm) award that

was given to Goldman Sachs by the Financial Times and International Finance

Corporation (World Bank, 2007). The award, which recognizes banks that have shown

leadership and innovation in integrating social, environmental and corporate governance

objectives into their operations, was presented following a one-day Sustainable Banking

conference where the impact of environmental, social and corporate governance issues on

long-term shareholder value was discussed.

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In conclusion, the management objective of shareholder wealth maximization is

necessary but not sufficient. The realistic management objective should be the creation of

a practical balance between the conflicting stakeholder’s interests and the management

of the risks inherent in these interests while reaching the intended strategic goals. This

approach will lead to a more stable, sustainable and continuous growth in the wealth

creation objectives of a firm in the medium to long term horizon.

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REFERENCES

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Harvard Kennedy School, John F. Kennedy School of Government (2008). CorporateSocial responsibility Initiative, Defining Corporate Social Responsibility. RetrievedAugust 15th, 2014, fromhttp://www.hks.harvard.edu/m-rcbg/CSRI/init_defined_p.html

Kermani, F. (2006, May). Why corporate social responsibility makes sense: CSR is inthe best interest of the public at large ... and the pharmaceutical company itself.Applied Clinical Trials 15.5, 36(2).

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