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Beyond Corporate Citizenship

28 Feb, 2009

By: Jane Mather, Ph.D.
Lessons from the Financial Crisis

With all the talk, and action, on sustainability and corporate social responsibility, you might think that we are finally on the road to averting the climate crisis and achieving other environmental and social goals. Unfortunately not. Consider this quote from Alan Greenspan, head of the Federal Reserve from 1987 to 2006:

“I made a mistake in presuming that the self-interest of organizations, specifically banks and others, was capable of protecting their own shareholders and the equity in the firms.”

What does Alan Greenspan have to do with corporate citizenship, sustainability and corporate social responsibility? In the decades before the recent financial meltdown, we saw an increasing reliance on free markets and limited government intervention. Policy makers assumed corporations would do what was best for their shareholders, consumers and employees because it was in their own “self-interest.” If they didn’t provide good products and working conditions, their reputations would suffer, and they would go out of business. Self-interest would ensure that corporate leaders evaluated the risks and made short-term decisions that were in their companies’ best long-term interest.

We all know what happened. Even Alan Greenspan, one of the strongest supporters of free markets and limited government intervention, now agrees that self-interest was not sufficient to avoid major financial and economic problems.

Like the financial markets, the success of corporate social responsibility and sustainability initiatives rely on reputation, good risk assessment and long-term perspective. Given how dramatically our financial markets could collapse without the right regulations, incentives and enforcement, what can we expect from corporate social responsibility and sustainability initiatives, especially their ability to avert the potentially disastrous affects of climate change?

Certainly, the dramatic increase in attention to corporate social responsibility and sustainability has driven many significant improvements in the environment, climate change, human rights, community development, labor standards, and public health and safety. While these voluntary initiatives may be sufficient to reach some goals, for climate change and other goals, more government intervention will be necessary. In fact, many major corporations, typically better known for advocating limited government regulations, are calling on the federal government to provide better enforcement and additional regulations and incentives.
 

Limits to Effectiveness

The incentives for corporate social responsibility and sustainability initiatives show why they won’t be sufficient to produce many needed changes, especially climate change. Many corporations note that a major incentive is greater profits. Construction practices that reduce energy consumption can provide favorable investment returns. When Starbucks Coffee started providing health insurance for part-time workers, turnover fell, reducing hiring and training costs, and morale improved.

These profit-driven decisions will only lead to sufficient change if corporations face the “right prices,” that is, prices that include all of the relevant costs. In the United States, we use too much energy because it is too cheap; energy costs don’t include the cost of providing security to protect oil supplies in the Middle East, health costs of respiratory problems, or the potential costs of climate change. If these costs were included, our construction, site selection and transportation decisions would lead to less energy consumption. As long as we don’t face the right prices, free markets and corporate social responsibility won’t lead us to invest as much as is needed to reduce energy usage and greenhouse gas (GHG) emissions.

Consumer and employee preferences provide another incentive for sustainability and socially responsible initiatives. Some consumers are willing, and able, to pay more for products from companies with these initiatives. Some employees prefer to work for these companies, even if it means receiving a lower salary. Consumer activism can also encourage companies to change their actions. For companies targeting these consumers and employees, corporate social responsibility will increase profits.

Economic development teams can show similar encouragement for better corporate citizenship. They can provide better incentives for corporations that will bring better paying jobs, better working conditions, and better environmental practices to the community. Explicit agreements, such as clawbacks, which recoup subsidies paid to companies that don’t fulfill job creation promises, and community benefit agreements, which specify developers’ obligations, are improving results.

Similarly, some investors are moving from a limited focus on profits to a focus on a triple-bottom line - profit, people and planet. But trends in socially responsible investment show how slowly we are moving in this direction. Of the $25 trillion dollars invested in the U.S. market, only $3 trillion involves an element of “socially responsible investment.”

These initiatives are limited because they only change the behavior of part of the economy. Other investors, consumers and employees will continue to be attracted to companies with the highest profit, lowest prices and highest wages. They have less concern for social and environmental goals, they feel that they can’t afford the luxury, or they will rely on others to “do their part.”

Voluntary approaches are sufficient when social and environmental goals reflect personal preferences. For climate change, a partial approach won’t be sufficient. The changes needed to avert a global climate crisis are too dramatic. For example, if the world economy must reduce greenhouse gas emissions by 20 percent and only half of the economy participates, those changing their behavior will need to reduce emissions by more than 40 percent to offset the emissions from organizations that continue their current behavior. Global agreements and government intervention are needed to ensure comprehensive adoption.
 

Lessons from the Financial Industry

The recent financial meltdown illustrates these limitations. Consider this example from Michael Lewis, bond trader turned author, whose books include Liar’s Poker and Panic: The Story of Modern Financial Insanity. If any one of the major bank CEOs “had set himself up as a whistleblower – had stood up and said “this business is irresponsible and we are not going to participate in it” – he would probably have been fired. Not immediately, perhaps. But a few quarters of earnings that lagged behind those of every other Wall Street firm would invite outrage from subordinates, who would flee for other, less responsible firms, and from shareholders, who would call for his resignation. Eventually he’d be replaced by someone willing to make money from the credit bubble.” Despite what’s written in annual reports, short-term profits drive most business decisions.

The financial industry provides another lesson. Many people continue to question whether climate change will be as disastrous as suggested. Once more Alan Greenspan provides some insights. According to Greenspan, financial professionals made poor decisions because “the data inputted into the risk management models generally covered only the past two decades, a period of euphoria.” Most financial models didn’t consider what might happen at the extremes, for example, if housing prices fell by 20 percent, an outcome not seen since the depression.

For those who don’t believe that the climate change could be as dire as many scientists predict, they still need to consider what might happen if scientists are right. Global climate change is uncertain, just like financial markets. When a possible event, say falling housing prices or rising temperatures, can have such a significant impact, we need to consider how we can avoid the results.
 

The Corporate Call for Government Action on Climate Change

Recognizing that good corporate citizenship will be insufficient to address climate change, many corporations are now asking for additional regulations, incentives and monitoring. The United States Climate Action Partnership (USCAP), a group of businesses and environmental organizations, is calling on “the federal government to quickly enact strong national legislation to require significant reductions of greenhouse gas emissions.”

The Council on Competitiveness, a group of corporate CEOs, university presidents and labor leaders initially brought together by President George H.W. Bush, recommends that their members “work together with private sector standard-setting bodies to accelerate the development, rapid adoption and international recognition of the world’s leading energy efficiency standards, together with a labeling, measurement and verification system.”

These groups cite many reasons for greater government intervention in the near future.
• Government intervention will “level the playing field.” Competitors who don’t feel the same responsibility to reduce greenhouse gas (GHG) emissions won’t be able to undercut the prices of more responsible corporations.
• It’s better to be part of setting the parameters than waiting for them to be set for you by others.
• Decisions will be more efficient with national and international standards rather than a collection of state and local standards.
• The sooner the government sets the regulations, the sooner companies will have better information for investment decision-making.
• Delays in response will only mean steeper reductions in the future, with potentially greater economic costs and social disruption.
• For those companies that are already developing solutions to limit carbon emissions, the sooner policies are set, the sooner other companies will start buying their products.

Many environmental groups note that these groups’ proposals fall short of the needed changes and that their proposals include special provisions for particular industries. Even so, it’s a big step when corporations start calling for government intervention. It’s a sign that we can’t just rely on voluntary initiatives.

From Free Trade to Fair Trade

Increasing corporate interest in reaching social and environmental goals is also likely to change government trade policies, shifting them from “free trade” to “fair trade.” Traditionally trade agreements promoted “free trade,” limiting tariffs, quotas and subsidies, with the goal of increasing global production and reducing prices.

With increasing global competition, corporate and labor leaders have been taking another look at global cost differences. When located in the U.S., companies needed to follow environmental and labor regulations. In most cases, when located overseas, companies could avoid the costs associated with these laws. The exception – high profile companies such as Nike, which faced consumer criticism of its labor policies. Differing regulations and attitudes provided subsidies to production in different countries. Current trade agreements allow for challenges to explicit industry subsidies, but don’t address subsidies created through lax regulations. There is a growing belief that trade policies should do a better job of leveling the playing field between countries.
 

Executive Compensation and Corporate Governance

Public outrage over high executive salaries, bonuses and perks is prompting calls for government intervention in this area as well. While limits on executive pay may sound like a simple fix, other changes are needed in executive compensation and corporate governance if we want to achieve the social and environmental goals discussed here.

True, it’s hard to consider a company a good corporate citizen if it pays its executives tens of millions of dollars in salary, bonuses, options and other perks. Every $50 million in executive compensation could have paid 1,000 workers $50,000 each.

As important as the level of compensation are the incentives provided in compensation agreements, as illustrated in the earlier Michael Lewis quote. As long as corporate leaders’ retention and pay are based on short-term profits, it will be difficult to shift corporate attention to long-term goals.

In the end, it is up to a company’s board of directors to set executive compensation policies and corporate direction, but shareholders have limited influence in selecting board members who represent their interests. Under Security and Exchange Commission (SEC) policies, the current board is responsible for proposing new board members. They present a slate and shareholders can either vote in favor of the slate or withhold their vote. Shareholders who want to change the status quo, as promoted by the current board, or ensure better oversight, must undertake a costly and complex proxy solicitation process to propose alternative board members. Many shareholder groups are asking the SEC to set more democratic processes for electing board members.

Beyond Voluntary Initiatives

Certainly sustainability and corporate social responsibility initiatives are making major strides towards environmental and social goals, but these efforts won’t be sufficient. The financial crisis shows that corporate reputation, reasonable risk assessment, long-term values and good corporate citizenship often succumb to short-term profit goals. Even major corporations agree that government encouragement will be needed. To avert an even greater climate crisis, the government needs to set standards and establish markets that provide more accurate prices for decision making, sooner rather than later. Trade agreements need to be revised to recognize that lax environmental and social polices represent subsidies just as much as monetary contributions. Executive compensation and corporate governance policies need to change so that corporations can truly reflect shareholder interests.
 

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