What Should Society Expect from Business?

What societal purpose do private companies serve, and what are their roles in society? Those questions segue to a recently trendy topic, corporate social responsibility (CSR) or the interchangeable term “stakeholder capitalism.” Over the past several years, the idea that companies have a responsibility to the broader society beyond their shareholders has received wide attention from NGOs, government and even industry groups (e.g., the Business Roundtable). This contradicts the long-held principle that companies achieve social welfare objectives in free markets when they pursue profit-maximizing objectives. Adam Smith refers to this as the invisible hand, which has recently been contested in different quarters.

One generic definition of CSR is a company integrating the interests of those directly or indirectly affected by it (e.g., the community as well as its customers and investors) into its business model and activities. Those affected are referred to as “stakeholders”, which is the reason for labelling CSR as stakeholder capitalism. 

Under the popular version of CSR, companies would go beyond full compliance with their legal and contractual obligations (e.g., to employees and suppliers) on a voluntary basis. The underlying presumption is that privately owned companies have additional moral or social responsibilities to commit resources, say, to achieve greater equity or diversity in the workspace, or other social objectives. 

Such CRS activities may include companies paying more toward mitigating pollution than the law required or hiring less-qualified workers to reduce poverty. Some CSR advocates argue that companies should address diverse problems such as below-poverty-line wages, exploitation of consumers, inadequate concern for local communities, excessive profits, exorbitant compensation to CEOs, damaging pollution and other negative externalities, and lack of diversity and inclusion in the workplace.

Looking at how markets actually operate, one can describe stakeholder capitalism as redundant: successful companies must accommodate the interests of their customers, investors and employees and not do serious harm to their communities. That, in fact, is one of capitalism’s most admirable traits, which many politicians, NGOs, and the general public often fail to recognize. I will argue below that artificial CSR, which involves companies spending money on activities that lie contrary to their profit motive, is ineffective in dealing with social issues besides overlapping with the demands already being placed by the marketplace on private companies.

Perversions with Stakeholder Capitalism

My major message—discordant with the contemporary criticism of capitalism—is that market-driven CSR, reflecting the preferences of a company’s customers, employees and investors, is the preferred approach for achieving many of the goals in an artificial CSR world. The latter world contains fundamental problems that either (1) ironically act at odds with the intended goals or (2) leave the job of addressing social problems like climate change and income inequality in the hands of a company’s management and their boards, who have highly questionable incentives to execute this undertaking effectively when it lies outside the company’s financial interest. 

We observe that when companies like Disney get entangled in political matters, they will become vulnerable to criticism from their customers, employees, investors, and others who would recognize them simply as an extension of government. This relationship resembles “corporatism,” where the government acquires more control of large companies, who reciprocate with undue influence over the government. Under corporatism, the private sector coordinates its activities with the government for social purposes. This has become increasingly true for certain industries like regulated utilities, which have acted more like social agencies.

One must ask: Why would companies want to place themselves in that predicament, jeopardizing their financial well-being and independence? Yet, some companies with social activists on their boards or in management have done just that.   

While artificial CSR may seem appealing to some, it has both latent and transparent costs. The major ones are a short-term focus on politically related matters, less management accountability, and diminished efficient resource use from a weakened profit motive.

Companies spend substantial sums of money to block legislation and regulations that would coerce them to address social problems. Why should we expect them to mitigate those problems under an artificial CSR regime? By agreeing to a “social agenda” but executing it languidly, company managers may believe that they can forestall injurious (from their perspective) governmental actions and improve their public image. It is folly to think that companies will take seriously the advancement of objectives that jeopardize their financial condition. 

The arguments against artificial CSR are compelling. They include:

• Weak incentives for companies to promote CSR objectives that reduce their profits;
• Less management accountability for weak financial performance;
• Politicization of decision-making distracting companies from their core functions, such as electric utilities providing reliable and reasonably-priced service;
• Companies already subject to constraints (e.g., via regulations) and taxes that fund social and other government programs;
• Companies ill-qualified to make decisions advancing social goals;
• Conflicting objectives forcing management to prioritize and weigh the different social activities; and
• Non-shareholder stakeholders already protected by regulations and contracts (e.g., clean air legislation, antitrust laws).

As a practical matter, it would be extremely challenging for companies to balance the conflicting interests within and between stakeholder groups. While multiple “stakeholder” groups have been identified, no one person is representative of anyone. Employees, for instance, are heterogeneous: some are childless and consider family leave policies worthless; others would rather earn higher wages than have access to on-site daycare. Artificial CSR advocates seem to presume that individual “stakeholder” groups are monolithic. 

Prioritizing the diverse interests of different stakeholders can be so overwhelming, convoluted and counterproductive that companies focus less on their core purpose of profiting from selling goods and services that consumers want. Instructive here is the phrase “accountability to everyone means accountability to no one.” 

Artificial CSR actions, for example, can also insulate management from accountability and managerial slack (e.g., inflating costs). Such actions obscure poor financial performance: a company can claim to be “socially responsible” even when losing money and continuing to raise funds from socially conscious investors. Imposing multiple objectives and performance criteria on a company weakens managerial accountability, thereby aggravating the principal-agent problem that prevails between shareholders and managers. 

Preference for a Market-Based Approach

Would society not be better off separating the actors who undertake money-making activities from broad-based social activities? One must ask: what expertise or capabilities do companies have in deciding how to address social problems that should fall under the auspices of government? Wouldn’t it be better for individual shareholders to dispose of dividends in the ways they see fit than requiring them to cede responsibility to others who might prefer to support the local opera rather than the local foodbank?

Stakeholders can reveal their preferences for “socially responsible” objectives either directly through market transactions or politically through lobbying and voting. I argue that the preferred source of CSR is market driven. As a “bottom up” approach, it places top priority on pricing and market incentives. Its flexible rules accommodate the demands of individual market players. One example is the market processes that allow companies to charge higher prices for healthier products in line with consumers’ demands.

My argument is that companies should spend money on social problems only when it leads to higher profits. We have already seen market participants revealing their preferences for environmentally friendly products by buying them, investing in companies that supply them and offering their labor services for lower wages and salaries than what they could earn elsewhere. 

There is really no difference between consumers paying a higher price for a food product that looks more appealing or is healthier than consumers paying more because, say, the company lowers its carbon footprint. The reason for consumers paying a premium for low-carbon products is immaterial. If enough consumers are willing to pay premiums for cleaner air or “fair-trade” coffee, profit-seeking businesses will deliver those goods. If market participants value noneconomic goals, companies that combine the profit motive with environmental, equity and other objectives can thrive and even prosper more in a competitive environment. 

Voluntary market transactions profoundly epitomize the economic situation where sellers and buyers cooperate in consummating a mutually beneficial deal. How could one dispute that this would not improve social welfare?

Separating Business from a Social Agenda

Just as society should not engage in activities that the private sector can do better, the private sector should avoid social activities that are better addressed by government. Many if not most people probably would agree that government should take on the responsibility to identify and redress social problems. A caveat is that the marketplace, not the government, often can better redress some of these problems. 

For example, history has shown that economic growth stimulated by profit-maximizing companies is the most effective factor in mitigating poverty. Bottom-up, market-based approaches (rather than command-and-control regulations) can be more feasible and effective in addressing climate change, especially when prices reflect prevailing supply and demand conditions. These approaches include adaptation based on the pricing mechanism and the provision of “clean products” by companies at the demand of consumers. 

A company advances its interests when it treats stakeholders well. A company can engage in goodwill to improve its profitability. Competent management cannot ignore the interests of customers, workers, investors and the local communities if it wants its company to survive. 

The public policy question comes down to what institutional arrangement can best address various social problems. The scientific assessment of most economists, and what seems practical and sensical, is that governments should assume primary responsibility for dealing with

social problems. After all, funding to mitigate social problems should come from the general public by way of taxes rather than from shareholders and consumers.

We should not forget the wisdom of Nobelist George Stigler with something he said over 50 years ago:

Let our businessmen return to making shoes and locomotives and toothpaste. Let us not seek to transform the greatest economy in all history into a third-class welfare agency. Let the reformers address their schemes, whether noble or ignoble, to the real source of power, the public [sector], and to the real administrators of that power in our society, the leaders of the political system.