Corporate Social Responsibility and Profit Maximisation - Literature review Example

CSR vs Profits Institution Date Introduction The idea that businesses exist to make profits has been the dominant ideology guiding the management and operation of firms. However, recent incidents disapprove this notion and point to the idea that business should be more responsible to society. It is generally agreed that businesses should be socially responsible and should care more about their environment than just treating it as merely the place they obtain revenue. Literally, ignoring societal concern can lead to the demise of the firm in the 21st century. Today, many businesses acknowledge that they have a social responsibility to their environment. Contemporary consumers are socially aware and will punish unethical and socially irresponsible companies while rewarding firms that innovate in making the world a better place. This essay brings forward two arguments used to support the idea that business should solely pursue profitability and ignored social responsibility. First, the essay introduces the concept of Corporate Social Responsibility and what it means for a firm to be socially responsible. Secondly, the essay introduces the shareholder primacy hypothesis. The shareholder primacy hypothesis is the foundation of the idea that businesses exist for the sole purpose of making profits. Shareholder primacy theorists claim that CSR is a wasteful effort that diverts the attention of company’s executives from their profit making objectives. Shareholder primacy theorist have gone as far as to provide evidence that shows that companies that are socially responsible report inferior financial performance to those that focus on profitability. Capitalist theorists on the other hand argue that allowing firms to create wealth unhindered leads to the realization of social goals. Capitalists claim that the profit seeking nature automatically yields social benefits. In the last part of the essay, the views of those who argue that profitability and corporate social responsibility are equal responsibilities of the firm are presented. What is Corporate Social Responsibility? Until recently, the idea that firms exist to maximize shareholder or owner profits has been the most dominant guiding principle of business. However, recent changes in the environment and conceptualization of the firm have placed emphasis on the social responsibility of the firm (Constantin 2012). Financial market scandal and the collapse of leading companies at the turn of the century have made corporate responsibility more important. The collapse of Enron and the World Financial Crisis in 2008 meant Governments and consumer groups demanded more socially responsible companies (Baron, Harjoto and Jo 2009). Firms also take social responsibility seriously to avoid public backlash and to keep up with trends which have turned CSR to a competitive standard. Social responsibility is a situation where firm go beyond profit making responsibilities and observe social and environmental standards in their work (Baron, Harjoto and Jo 2009). Socially responsible businesses know they owe a duty of care to customers, business suppliers, communities, partners and employees (Aguinis and Glavas 2012). Thus, social responsible companies engage in honest marketing, provide excellent customer service, participate in philanthropy and community projects, meet ethical standards in employee relations, ensure their partners and suppliers are observing ethical standards and treat employees fairly (Weber 2008). Social responsibility is also concerned with responsible use of environmental resources. Pressure from government regulators and activist groups have compelled companies to adopt green practices. Environmental responsibilities include use of recycled materials, replacing trees in the environment, and funding environmental preservation initiatives (Baron, Harjoto and Jo 2009). Making sure the business has a less negative impact on the environment is one of the CSR activities that have visible benefits to firms. The use of green materials may incur significant costs for firms but can be balanced with benefits from lesser energy and water consumed (Banerjee 2012). However, firms can still advertise that their product use green production, or green material or even recycled materials to justify increase in prices due the additional cost of social responsibility. One angle of financial responsibility that has become more important is the responsibility to shareholders and sometimes companies (Aguinis and Glavas 2012). The executives of companies have a responsibility for safekeeping the investment of the owners of the firm. The company should be prudently managed to ensure that shareholders do not lose their investment as collapse of the firm is avoided. However, corporate executives have a responsibility to shareholders to maximize the profitability of the firm. This goal sometimes conflicts with the CSR activities of the firm which many reduce the profitability of the firm. If a business donates money to charity, doesn’t always accept the lowest bid and uses expensive green techniques for production its profits will be considerably higher than those of firms that are not socially responsible (Constantin 2012). However, proponents of CSR argue that there are significant financial advantages in engaging in CSR activities. CSR activities have a number of significant benefits for firms. Firms can improve their image, gain increased customer loyalty and increase sales revenue by engaging in visible CSR activities (Constantin 2012). Philanthropy, ethical action and responsible hiring can increase the sales of a company. On, the other hand local municipalities may favour companies that are socially responsible on issues of borderline zoning and signage disputes (Aguinis and Glavas 2012). For example, funding sports may convert the fans of the sport to customers, turning the sponsorship into a significant revenue generator. Supporters of the hypothesis that business should exist for the solo purpose of maximizing profits view social responsibility as unnecessary and wasteful. They argue that CSR is an expense that has no tangible benefit on the bottom line of the firm (Constantin 2012). However, research has consistently shown that socially responsible company are attractive to both customers and employees. Many stakeholders also give priority to companies that are socially responsible. Despite this strong conviction for CSR the argument for profit maximization has continued to be strong (Northrop 2013). In the next section, the essay discusses the key points in the argument for profit maximization over social responsibility fronted by Shareholder theorists and capitalists. Shareholder Primacy Hypothesis Throughout history the idea that the business is established and carried out to primarily make profits for its shareholders has been dominant. Shareholder primacy asserts that firms exist to maximize corporate profits and create personal wealth (Keay 2010). Any engagement in CSR must guarantee the companies some benefit that enable it create more wealth for its creators or shareholders (Okpar and Idowu 2013). For firms to allocate resources to CSR projects, the investment must be profitable in the long or short term. Company activities and operations are primarily driven by the effort to increase their bottom line. They are always looking to expand their customer base, improve production and obtain cheaper inputs (Beal 2013). Businesses argue that CSR is just another mechanism for enhancing the revenue earning capability of the firm. The importance of CSR is often set against the backdrop of the role of the firm in society. Keay (2010) analyzes the shareholder primacy hypothesis with a view of finding out why it has remained popular and its main shortcomings. The shareholder primacy hypothesis asserts that the company/business should be managed in a way that maximizes the wealth of shareholders. The theory argues that a business should seek to make as much money as possible for the shareholders. Shareholder primacy means that directors’ main duties are the protection and enhancement of shareholders’ interests (Keay, 2010). In shareholder primacy, directors only have an economic duty to increase the value of the firm. Shareholder primacy is a narrow view of the role of business in society. It implies that the manager should only act in the interest of shareholders in all their dealings and should not be concerned about the welfare on non-shareholder. Shareholder primacy justifies any action that returns a profit as long as it is within the confines of the law. Keay (2010) argues that shareholder theory only calls for observation of the law as this would generate risks which will eventually compromise the interests of shareholders. Shareholder theory therefore has no space for CSR as it focuses on creation of wealth for shareholders. Shareholders’ interests are pre-eminent and the interests of other stakeholders are derivative or secondary (Keay 2010). Shareholder theorists argue that businesses should only take the interest of other stakeholders into consideration if they have a potential impact on the company’s profits (Keay 2010). For example, managers are supposed to take the interests of employees into consideration to minimize the risk of losing them. However, this concern for other constituents is limited to the point where a dollar of investment equals a dollar of return to shareholders. Hemingway (2013) analyzes the shareholder primacy argument that firms should singularly engage in the pursuit of profit. He dismisses the notion that firms should also pursue social goals like creation of employment, elimination of discrimination and protection and preservation of the environment. He asserts that the singular social responsibility of a firm is to use it resources to make profits as long as it stays within the rules of society. According to his view, firms can do anything else to make a profit as long as they do not deceive or defraud (Hemingway 2013). Hemingway (2013) backs shareholder primacy hypothesis by claiming the firm is a legal entity that has no “social conscience” . He then argues that companies lack the conscience that would guide them in implementing their social initiatives. He argues that company executives are agents and their only responsibility is to the company employees and shareholders. The responsibility to shareholders is to make as much money as possible in the operations of the firm. Shareholder theorists argue that CSR is a business cost which is subtracted from the company’s profits at the end of the year. Shareholder primacy stance means CSR is in conflict with the fact that managers are agents not principals of the company (Hemingway 2013). Hemingway (2013) argues that when executives engage in CSR they divert from their singular role and undermine the principal-agency relationship as they are spending their principal’s money on wasteful activities. Hemingway (2013) uses several examples to show that social responsibility is a diversion from the main objective of a firm. According to Hemingway (2013), social responsibility means that a business should refrain from increasing prices in order to aid the social goal of controlling inflation, even though the firm’s interest would be best served by increasing the price. He also gives an example where the firm is supposed to spend on reducing pollution beyond the requirement of the law or against the best interest of the firm. He also asserts that it would be unreasonable to expect firms to employ unskilled workers in the place of qualified workmen in order to assist the social goal of reducing unemployment. Shareholder theorists argues that executives would be unjustified as they would be spending their principals’ money on social causes the principal has not approved (Cheng et al 2013). Shareholder theorists assert that Social responsibility reduces returns to shareholders and is an unjustifiable capital expenditure. It does not also serve the interests of the firm’s employee whose wages may be kept low to enable spending on CSR (Hemingway 2013) There is plenty of empirical evidence to support the hypothesis that engaging in CSR results in inferior financial performance for firms. Micheal Jensen and William Meckling’s work in 1976 brought a new angle to the shareholder primacy argument (Husted and Allen 2011). They argued that corporate executives would be better incentivized to make more profits if they were made members of the organization through stock options (Hemingway 2013). The shareholder primacy hypothesis sometimes referred to as the shareholder theory has shaped the conceptualization of the role of the firm in society for decades. The view that the firm exists to maximize profits for its shareholders remains deeply rooted in many modern societies and corporations. CSR is then taken as diversion from the main focus of the firms and is wastage of the corporation’s time and resources. Shareholder theorists argue that the firm serves the interest of society best by acting as a wealth generating entity. Therefore, shareholders theorists assert that firms that engage in CSR report inferior financial results than those that don’t (Hemingway 2013). There is rigorous evidence to support and disapprove Shareholder primacy claim: some show that CSR involvement has no effect on corporate profitability while a second cohort of studies reveal that companies have a lot to gain by being socially responsible. Laffer et. al (2011) found no correlation between CSR involvement and increased profitability for the business entity. In their view, the results show that CSR is unnecessary as it does not add to the company’s bottom-line. The authors surprisingly found that the stock price had appreciated less rapidly for organizations that could be ranked as the best corporate citizens (Laffer et. al 2011). Similar results were obtained in Baron, Harjoto and Jo (2009) which asserted that Corporate Social Responsibility has no correlation to a firm’s financial performance. Baron, Harjoto and Jo (2009) found that high investment in CSR resulted in poor financial performance in some firms. Vogel (2008) argues that socially responsible firms are unlikely to gain any significant competitive advantage as consumers are ignorant or disinterested in “ethical” products. He points at CSR role models such as Levi Strauss, Whole Foods and Starbucks which have not been able to make any significant financial gains by engaging in CSR. Gonzalez-Perez and Leonard (2013) makes an extreme claim in his argument that the involvement of the firm in CSR is unethical. He argues that engaging in CSR is morally wrong as it means the business manager breaks his duty to the principal-agent relationship. According to Gonzalez-Perez and Leonard (2013), Shareholder primacy argument is extreme but that has not stopped some executives from engaging in socially irresponsible conduct in the pursuit of profits. Shareholder theorists claim that engagement in CSR weighs on the company ability to operate profitably. Empirical studies support this hypothesis by providing evidence that show no correlation between CSR and profitability or even a negative correlation. Studies that support shareholder primacy hypothesis have one major weakness; they are unable to justify its absolute argument. None of the studies presents definitive results that indicate CSR has a negative impact on corporate profitability. Many of the studies conclude that there is no relationship between CSR and profitability in firms (Peloza and Papania 2008). Therefore, it can be concluded that socially responsible firms perform equally well or poorly as other firms in the market. This conclusion fails to disapprove or confirm the shareholder primacy hypothesis. However, rigorous studies have been conducted to show that CSR has significant benefits to the firm and influences modern purchasing and investment patterns. The shareholder primacy hypothesis has been disapproved by many CSR advocates who have shown that CSR has a number of potential benefits to businesses. Some of these benefits end up affecting the bottom-line of the firm positively. Consumer research conducted by Northrop (2013) reveal that consumer view businesses as socially responsible entities and only 6% believe that businesses exist solely for making profits for their shareholders. According to Sexton and Sexton (2014), customers are more willing to buy goods and services from companies that are socially responsible. Study findings show that consumers are more likely to buy the goods and services of a company that engages in CSR given that price and quality is consistent with that of competitors. Contemporary consumers are often informed and conscious buyers who are aware of the firms’ need to increase value for its shareholder and its social responsibility. Contemporary consumer behavior disapproves the Shareholder primacy hypothesis as companies which are socially irresponsible would make losses (Gonzalez-Perez and Leonard 2013). If a company fails to retain or continually expand its customer base, it will not maximize value for its consumers (Schwartz 2011). Contemporary consumers care about the ethics and morals of the companies whose product they purchase. If this fact is taken into consideration, then Shareholder primacy argument is completely disapproved and has no place in contemporary business theory and practice. However, detractors of the CSR function in business may rely on capitalist production hypothesis about the social responsibility of the firm as set out in his book the Wealth of Nations. Capitalist Production hypothesis Capitalist have a more compelling case against CSR. The capitalist argument asserts that firms’ profitability fuels social progress and businesses are the lynchpin to a healthy society. According to Fleming (2012), Adam Smith argued that individuals who pursue self-interest by engaging in production end up promoting the well-being of society although this is not what they set out to do. Smith describes the unintended social benefits that arise from the pursuit of self-interest as the “invisible hand”. Smith argues that competition leads to efficiency in production and thus maximization of input for the benefit of society. He argues that increased wealth in society may be used to improve standards of living, create more jobs or enhance the quality of goods. However, Fleming (2012) shows that Adam Smith maintains that for these social benefits to flow, the markets must function properly. Smith’s Hypothesis indicates that CSR should not be part of the strategy of a company, but rather should occur naturally. He argues that self-interest is as effective as benevolence in promoting public good. Smith seems to agree with shareholder theorists that CSR is unnecessary. Smith’s main argument is that organic CSR initiatives duplicate the “invisible hand” which delivers benefits to society naturally (Freeman et al 2010). However, Smith’s argument has been disapproved by recent events and the work of scholars such as Brent D. Beal. Beal (2013) argues that there is no guarantee that the pursuit of firm’s interest will benefit society. Beal argues that society has certain social expectation for firms which should be essential in determining how firms view and implement CSR. In reality, markets do not function properly and business activities often create externalities. Beal (2013) argues that the actions and activities of business impact on others and CSR is necessary to compensate society and return equilibrium in the environment. Cooney (2012) argues that the operations of firms are sometimes the sources of social problems and it is therefore their responsibility to deal with these problems. Furthermore, the failure of firm to act ethically and uphold their social responsibility may have devastating effects on the wellbeing of society. A case in point is the 2008 financial crisis that saw several top-tier financial institutions go bankrupt and precipitated the loss of millions of dollars of ordinary investors’ savings. Shareholder Primacy and the Global Financial Crisis The shareholder primacy hypothesis holds that the sole responsibility of businesses is to maximize wealth for their shareholders. The theory’s assertion that managers have no moral obligation beyond making profits have been associated with a situation where managers result to excessive risk taking without any regard to the effects of their actions on society (Kemper and Martin 2010). Managers implementing shareholder primacy have little consideration for the detriment they might be causing to their community in their pursuit of profits. Many managers who break moral and ethical rules justify their actions by quoting the shareholder primacy hypothesis which allows them enough room to do anything to make a profit. Ultimately, excessive risk-taking and ignorance of the wider moral obligations of the firm lead to financial instability as experienced in the 2008 financial crisis. The 2008 financial crisis almost brought the world financial system on it knees and precipitated the worst financial depression in 80 years (Arevalo and Aravind 2010). According to CSR activists, the 2008 financial crisis was rooted in the belief that companies’ only sole social responsibility is the pursuit of profits for the benefit of its shareholders. To maximize profits for their shareholder, investment bankers in the US lend out money for the purchase of mortgages as this would increase the revenue earned by their employers (Kemper and Martin 2010). Unfortunately, the mortgages were sold without bothering to evaluate the risk of default by the mortgage holders. The reckless lending led to an increase in demand for housing and an artificial increase in real estate prices or the “housing bubble”. However, when the house prices began falling, banks that had held mortgages as securities were in trouble. In addition, many of the mortgage holders defaulted as their ability to repay was overestimated by bankers at the very beginning. The near collapse of the global financial market precipitated by the crisis drew renewed focus on why firms need to be socially responsible. Many CSR advocates argue that the Crisis would not have happened had the banking industry upheld its social responsibility for prudent financial management practices. The crisis was another reminder that CSR does not only serve the interest of society but also those of shareholders. Conclusion Shareholder theorists’ idea that CSR is an unnecessary cost and burden to firms has no place in contemporary business thinking. Neither can it be expected that social benefits will naturally flow from the pursuit of self-interest by firms as posited by capitalists. Businesses must realize that the value and profits they obtain from the environment come at significant social cost. It is therefore their responsibility to compensate the society for the cost they incur to facilitate the firm to create value for its shareholders. In addition, engagement in CSR has many benefits for companies in s of image and reputation. Consumers view companies that are socially responsible more favourably and are more likely to purchase their products and services. Corporate Social Responsibility has become one of the mechanisms that contemporary organizations can use to gain a competitive edge over rivals. It must also be remembered that it is disastrous to allow firms to pursue profits without any consideration on the social consequences of their action. The 2008 financial crisis is a good example where uncontrolled pursuit of corporate profits led to the near collapse of the Global financial market. References Aguinis, H., and Glavas, A 2012, "What We Know and Don't Know About Corporate Social Responsibility: A Review and Research Agenda." Journal of Management 38.4: 932-68. Arevalo, J.A., & Aravind, D 2010, The impact of the crisis on corporate responsibility: the case of UN global compact participants in the USA. 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