INTRODUCTION TO CORPORATE GOVERNANCE AND SOCIAL RESPONSIBILITY

Atty. Gerard L. Chan, LL.M.

Director, Legal Service Office Department of Transportation & Communications (DOTC) Mandatory Continuing Legal Education (MCLE) IBP Zambasulta Chapter 28 March 2014

Scope of the Lecture - Brief History of Corporate Governance

- Corporation and the Agency Problem

-Reducing/Eliminating the Agency Problem: Corporate Governance Mechanisms

- Internal Governance Mechanisms o Ownership Structure o Executive Compensation o Board of Directors and Committees o Shareholder Activism: Governance by Litigation
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- External Governance Mechanisms o Corporate Takeovers as a Governance Mechanism o Gatekeepers o Government

- Corporate Social Responsibility: Stakeholder Approach

o Shareholder vs. Stakeholder Theory of the Firm o 4-Part Model / Dimensions of CSR o CSR as a Corporate Governance Mechanism o Sustainability
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Brief History of Corporate Governance - Since the late 1970s corporate governance subject of much debate in the US and other countries o Efforts to reform corporate governance driven by need and desire of shareholders to exercise Their rights of corporate ownership and Increase value of their shares (i.e. wealth)

- First half of 1990s, corporate governance received considerable press attention

o Wave of institutional shareholder activism due to cozy relationships between CEO and Board of Directors oWave of CEO dismissals by their boards (e.g. IBM, Kodak, Honeywell)
- 1997 Asian Financial Crisis o Phenomenal record of economic growth between 1987-1996 in the East Asian Region
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o With growth came wealth and with wealth came greed, cronyism, structural weaknesses and mismanagement o East Asian economies mishandled easy money flowing into the region o Private sector borrowed recklessly, financial institutions borrowed heavily offshore with exchange rate impunity o Obscure insider lending practices diminished discipline in the financial systems poor corporate governance

o Poor corporate governance contributed to collapse of many banks and corporate firms.
o Exit of foreign capital after collapse of property assets
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- Early 2000s massive bankruptcies (and criminal malfeasance) of Enron, WorldCom, Arthur Andersen and Tyco o Powerful executive teams and autocratic, unaccountable, overpaid CEOs o Fraudulent accounting practices and poor auditing by auditors o Increase shareholder and governmental interest in corporate governance

- 2002 Sabarnes-Oxley (SOX) Act passed in the US

- 2003 Combined Code of Corporate Governance (UK) - 2004 OECD Principles of Corporate Governance (EU)
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- 2008 Global Financial Crisis

o Withdrawal of Glass-Steigall Act (1933) in 1999 which separated commercial banking activity from investment banking o Commercial banks became investment banks and investment banks became hedge funds engaging in subprime lending o End of real estate boom in the US and fall of real estate prices o Increase in foreclosures and failure of mortgage lenders o Fall of Bear Stearns and Lehman Brothers due to losses on derivative contracts related to US mortgage industry (subprime loans) o Collapse of financial markets spread internationally

Corporation and the Agency Problem Stage 1:

Introduction
Stage 1:
Equity
Voting Rights

Company founded (owned and managed) by individual, family, partnership, government or company.

Stage 2:

Equity
Voting Rights

New Equity
Voting Rights

Debt

Company expands by issuing more equity and debt. New equity holders also get voting rights as to who manages the company.
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Stage 2:
Introduction
Company founder must now choose between keeping control of the company or allowing the company to be managed by professional managers.
Equity
Voting Rights

New Equity
Voting Rights

Debt

If they keep control there is a potential conflict between the founders and other shareholders.

If they pass management to professional managers there is a potential conflict between owners and managers.
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Agency Theory - Separation of Ownership & Management Control o Shareholders purchase stock and OWN the firm and bears the risk o Professional managers CONTROL the firm (officers and executives)

- Many investors own only a small stake of a large public corporation = No incentive to get involved in monitoring activities of managers

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Agency Theory
Agency Theory
An agency relationship exists when:

Agency Relationship
Shareholders (Principals) Firm Owners
Risk Bearing Specialist (Principal)

Hire

Managerial DecisionMaking Specialist (Agent)

Managers (Agents) Decision Makers

which creates

Transparency 10-17

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Agency Problem

- Why would managers care about the owners?

o Managers being freed from vigilant owners would

only pursue enough profit to keep stockholders satisfied while

pursue self-serving gratification in the form of perks, power, and/or fame Use firms assets to enhance their own lifestyles buying a corporate jet using corporate funds and using it for personal trips
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- Occurs when the desires or goals of the principal and agent conflict; and - It is difficult or expensive for the principal to verify that the agent has behaved appropriately

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Reducing/Eliminating the Agency Problem

- Who watches the managers/executives?

o Board of Directors appointed by shareholders to run the corporation on their behalf o Board of Directors represent shareholders interests in running the corporation o Board of Directors appoint/replace executives who will run the day-to-day operations of the company oBoard of Directors as the primary monitor of the mangers/executives
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- Solving the Agency Problem o Incentives Aligning desires executive incentives with shareholders

Tie the wealth of the executive to the wealth of the shareholders so that executives and shareholders want the same thing Board of Directors design compensation contracts to tie management salaries to the firms performance Managers act and behave in a way that is also best for the other shareholders
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o Monitoring Monitoring mechanisms for monitoring behaviour of managers

Monitors
Board of Directors Auditors and External Counsel Credit Rating Agencies and Securities Analysts Government Market Forces Stockholders
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- Integrated system of corporate governance

o Incentive contracts = align executive incentives with shareholder interests

o Accountants and auditors = check firms financial statements o Board of Directors= represent shareholders o Investment Banks/Analysts = evaluate and sell securities to the public

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oCreditors/Credit Rating Agencies = monitor the firms ability to handle debt o Shareholders

oCorporate Takeover Markets = good firms take over bad firms

oGovernment = official regulators of the securities industry

o Corporate Citizenship = instilling a sense of corporate social responsibility to the executives

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Corporate Governance - A system of checks and balances between the Board, Management and Shareholders to produce an efficiently functioning corporation, ideally geared to produce longterm value - A relationship among Board of Directors, Top Management and Shareholders in determining the direction and performance of the corporation - Corporate governance is about minimizing the loss of value that results from the separation of ownership and control -Deals with the ways in which suppliers of finance assure themselves of getting a return on their investment
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- Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals - A governance framework to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources - Aims to align as nearly as possible the interest of individuals, corporations and society
- A framework of rules, systems and procedures of the corporation that govern the performance of the Board and Management of their respective duties and responsibilities to the stockholders (SEC MC No. 6 Series of 2009)
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INTERNAL GOVERNANCE MECHANISMS

Ownership Structure
- US companies usually owned by widely-dispersed shareholders and controlled by professional managers (no single party is in control of the company) - Other countries= ownership concentrated in hands of family groups or government entities (one group is in control and shareholder has no option other than sell)

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- Identity of controlling owner may have corporate governance implications o Family-controlled companies may use cross-holdings and pyramidal structures to gain effective control with least cash ownership o Government-owned and widely-held companies more likely to follow the rules.

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- Presence of large block of non-management related shareholder can increase monitoring of the firm, these blockholders include: o Government

o Financial institutions
o Individuals o Other companies - Large block shareholders have strong incentive to spend time, effort and expense to monitor management closely

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Executive Compensation

- Tying executives wealth to the wealth of shareholders so that everyone shares the same goal
o Stock ownership o Stock Options - Types of Executive Compensation o Base Salary and Bonus Bases salary of CEO determined through benchmarking method Cash bonus based on the performance of the firm over the past year

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o Stock Options Contracts that allow executives to buy shares at a fixed price (exercise or strike price) If stock price rises above the strike price, the executive will capture the difference as a profit Gives executives the incentive to manage the firm in such a way that the stock price increases (increase shareholder value)

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- Issues in Executive Governance Devise o Base Salary and Bonus

Compensation

as

Corporate

Accounting-Based Incentives = accounting profits may be manipulated CEOs may place too much focus on manipulating shortterm earnings instead of focusing on long-term earnings and shareholder wealth

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o Stock Options
Stock option is only affected by price appreciation, CEO might forego increasing dividends and use cash to increase stock price Stock price likely to increase when CEO accepts risky projects, CEO may pick a higher risk business strategy Stock price falls below strike price= stock options lose their effectiveness to establish motivation CEO may manipulate earnings and maximize profits in one target year to time stock price movements to match the time horizons of their stock options
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 Executives only have partial influence on stock prices which are affected by company performance and market forces Values of options may depend on circumstances unrelated to the performance of the executive Stock ownership makes managers more susceptible to market changes which are partially beyond their control

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o Incentive-based compensation tied to reported earning or stock prices creates temptation for managers to manipulate or even falsify earnings Incentive-based compensation not a perfect fix to the agency problem of managers not acting to increase shareholder value o Incentive systems do not guarantee that managers make the right decisions, but they do increase the likelihood that managers will do the things for which they are rewarded

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Board of Directors and Committees

Duties of Board of Directors - Setting corporate strategy, overall direction, mission and vision
- Hiring and firing the CEO and top management - Controlling, monitoring or supervising top management - Reviewing and approving the use of resources - Caring for shareholder interests - Shareholders agent in charge of running the company
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- Fiduciary duty to conduct activities to enhance profitability and share value oDuty of loyalty and fair dealing = put shareholders interest before their own individual interests oDuty of care = being informed and making rational decisions oDuty of supervision = establish rules of ethics and disclosure - The firms most important internal monitor

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Corporate Governance
Setting corporate strategy, overall direction, mission or vision Hiring and firing the CEO and top management Controlling, monitoring, or supervising top management Reviewing and approving the use of resources Caring for shareholder interests

Board of Directors

Prentice Hall, 2002

Chapter 2 Wheelen/Hunger

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Board of Directors Continuum

DEGREE OF INVOLVEMENT IN STRATEGIC MANAGEMENT Low (Passive) Phantom Never knows what to do, if anything; no degree of involvement. Rubber Stamp Permits officers to make all decisions. It votes as the officers recommend on action issues. Minimal Review Formally reviews selected issues that officers bring to its Nominal Participation Involved to a limited degree in the performance or review of selected key decisions, indicators, or programs of management. Active Participation Approves, questions, and makes final decisions on mission, strategy, policies, and objectives. Has active board committees. Performs fiscal and management audits. Catalyst Takes the leading role in establishing and modifying the mission, objectives, strategy, and policies. It has a very active strategy committee. High (Active)

Prentice Hall, 2002

Chapter 2 Wheelen/Hunger

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Board Size

- Should be an appropriate size = not too big and not too small
- Depending on company size = within range of 5-15 is ideal - Too small = lack of monitoring - Too big = problems reaching a consensus for decision making

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Board Independence - Inside Directors o Management directors o Officers or executives employed by the corporation

- Outside Directors
o Non-management directors

oExecutives of other firms but not employed by the corporation

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- Should have a high proportion of outside/independent directors - Outside/independent directors should have no personal interest in the company - Firms with a higher fraction of outside/independent directors presumed to be more effective at monitoring management - Firms with higher fraction of independent directors more likely to fire the CEO for poor performance

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- Outsider overly simplistic = some outsiders are not truly objective and could be considered insiders = Related Outsiders o Affiliated Directors
o Retired Directors o Family Directors

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- Direct Interlocking Directors

o Two firms share a director

oAn executive of one firm sits on the board of a second firm

- Indirect Interlocking Directors oTwo firms have directors who also serve on the board of a third firm

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Chairman of the Board / CEO Position - Chairman of the Board = responsible for overseeing the Board of Directors - CEO = responsible for day-to-day operations of the company

- Common in family-controlled corporations for Chairman and CEO to be the same person = concentrate power and reduce monitoring - Outside director as lead director or Chairman to oversee and evaluate management
- Firms that separate the two positions perform better than those that combine the two positions

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Two-Tier Board Structure - Some European countries have two-tier board structure o Management Board = runs the corporation oSupervisory Board = appoints and supervises the management board controls the firms compliance with the law and articles of incorporation and business strategies

- A person cannot belong to both boards

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Board Committees - Board of Directors can delegate certain duties to Board Committees to provide increased monitoring on specific issues - Many actions of committees require Board approval while other committees are given authority to act directly

- Audit Committee
o Responsible for internal audit function and appointment of external auditor
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- Remuneration Committee o Responsible for setting appropriate compensation for directors and executives

- Nomination Committee
oResponsible executives for finding appropriate directors and

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Issues of Board of Directors as a Corporate Governance Device

- One of the main functions of the Board is to evaluate top management, specially the CEO
o In most firms the Boards Chairman is also the firms CEO oSame person who manages the firm also calls the board meetings and sets the meeting agenda

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o Directors receive information about the firm from management, which information is controlled by the Chairman/CEO as well - Directors do not have a significant vested interest in the firm o Directors own nominal shares

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- Directors serve on multiple boards o No time to fully understand the major operating and financial decisions of the firm o Most directors have their own highly demanding full-time jobs

- Directors do not have the expertise to be a board member

o Independence, in and of itself, is not a sufficient quality for being an effective director

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- Independent directors not truly independent

- Correlation between board quality and firm performance

oIndependent and small boards may be better at monitoring but no clear correlation with better firm performance

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Shareholder Activism

- Effect of poorly managed firm felt by shareholders through loss of share value
- Shareholders express opinions to affect or influence a firm or they could sell their shares and walk away - Actions available to shareholders = modes of shareholder activism o Shareholder Proposals = make proposals to change firm government

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o Director Election Contests = vote to replace ineffective director o Shareholder Lawsuits - Types of activist shareholders o Individual shareholders o Large shareholders = owner of a large portion of shares

Have incentive AND power to be effective monitors

o Institutional shareholders
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Shareholder Proposals - Shareholders submit proposals which may be voted on during annual meeting - Difficult and expensive for one shareholder to communicate with other shareholders

o Expense is not a concern for management and the Board who can freely spend corporate funds to lobby against shareholder proposals

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- Difficult and expensive to garner the votes required

oManagement controls the votes of uncommitted shareholders who return their voting proxy but take no position on shareholder proposals

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Director Election Contest (Proxy Fights)

- Proxy Fight = Each side (management v. shareholders) lobbies the list of shareholders seeking proxy votes in their favour to replace directors serving on the Board o Individual shareholders do not have an incentive to become involved in monitoring the corporation.
o Difficult for shareholders to fire their Board

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- Proxy solicitation o Voting rules favour management returning unfilled proxy forms = shareholders

- Nomination of board members typically handled by a committee of the current board o Current board picks candidates who will be voted on by shareholders

- Usually only one nominee for each seat

oOnly power of shareholder = not to vote for said candidate
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Shareholder Lawsuits
- Derivative lawsuit
o Special type of lawsuit brought in the companys name against the executives and/or directors o Theory = while the Board is shareholders agents, shareholders retain the right to step in and enforce company rules if directors ignore them

o Shareholders bring an action on behalf of the company to force directors and officers to comply with the rules or repay money to the corporation

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- Derivative = shareholders are not the parties suing, money paid goes to the company, not to the shareholders - Direct suit by shareholders against officers and directors o Theory = officers and directors are agents who owe a duty to act in shareholders best interest and that officers and directors intentionally took action that harmed shareholders

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Issues in Shareholder Activism as a Corporate Governance Device

- Investors (including institutional investors) have a speculative or short-run view of the stock markets and make trading and investment decisions based on short term trends
o Limit desire to be activists oIndividual shareholders do not have an incentive to become involved in monitoring the corporation. o Difficult for shareholders to fire their Board

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EXTERNAL GOVERNANCE MECHANISMS

Corporate Takeovers
- The purchase of a company that is underperforming relative to industry rivals in order to improve the firms strategic competitiveness - Managements underperformance noticed by the market and other players will want to take control of the company

- Fear of potential takeover represents a powerful disciplinary mechanism to make sure managers perform and managerial discretion controlled
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- Potentially powerful way to dismiss (or motivate) managers that might not be looking out for shareholders best interest - Important source of incompetency and waste discipline over managerial

- Court of last resort for assets that are not being utilized to their full potential

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- Mergers and Acquisitions o Friendly mergers = acquirer and target management and board agree to the deal firms

o Hostile takeover = target firm management and the board does not want to be acquired and attempt is made to take over control of the target firm

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- Hostile Takeover (Disciplinary Takeovers) o Bad firms acquired by other corporations/individual investors who subsequently impose dramatic changes to improve the acquired firms profitability

o Acquirer attempts to buy all the firms stock by making a temptingly high offer to shareholders
oOnce controlling block is acquired, acquiring firm uses the voting power to approve a merger and replace the board and management

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o Acquirers goal = take over the firm and turn it around

by cutting fixed or variable costs by improving operational efficiency by getting rid of bad managers
o Rationale = acquire an unsuccessful firm by paying a relatively small sum, subsequent net gains significant if turnaround successful

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o Stock market anticipates subsequent improvements = target firms share prices immediately increase when acquisition announced Acquirers end up paying significant premium for target firms = gains go to the target shareholders
Target firms shareholders like their firms taken over but management team and board resist/oppose being acquired

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Takeover Defenses
- Pre-emptive Takeover Defenses
o Poison-Pill = Any strategy that makes a target firm less attractive immediately after it is taken over Favorable rights given to its shareholders = target firm shareholders have the right to buy the acquirers stock for a deep discount Dilute ownership percentage of a potential acquirer making acquisition difficult and makes the firm less attractive as well
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 Blank-Check Preferred

Allows the board the right to issue preferred stock at any time with any voting rights
Allows the board to resist a takeover by putting super-voting preferred stock in friendly hands Firms debt becomes immediately due once taken over

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o Immediate deep-discount selling of fixed assets once taken over o Golden Parachute = automatic payment made to managers if their firm gets taken over and acquirer ultimately bears the cost of parachutes o Supermajority Rules = 2/3 or even 90% of the shareholders have to approve a hand-over o Staggered Boards = only a fraction of the board can get elected each year making it difficult to gain control of the board in any one particular year

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- Reactionary Takeover Defenses o Greenmail = a bribe that prevents someone from pursuing a takeover o White Knight = finding another acquirer who might not fire management after the takeover oWhite Squire = finding an investor to buy enough shares to have sufficient power to block the acquisition

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- Issues of Takeovers as a Corporate Governance Device o Whether takeovers mechanism are an effective governance

Acquirer may have to pay too much for a target Takeovers could occur for the wrong reason (e.g. empire building, corporate diversification) Fair price paid by acquirer for a target still significant

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o Corporate raiders seen as villains = cut jobs to control costs, only cared about making profits
o Whether takeover defences are bad for corporate governance Takeover defences contributed to the end of disciplinary takeovers

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Gatekeepers - Outside professionals who serve the board or investors -Independent monitor tasked to screen out errors and defects and to verify an institutions compliance with standards and procedures -One of the earliest private enforcement tools for advancing public objectives as screeners for prospective wrongdoers at city gates -Positioned to observe clients use of their goods/services and to identify and/or prevent illicit/deceptive use of their goods/services in a cost-effective way -Includes external auditors, external counsel, securities analysts and credit rating agencies

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External Auditors

- Accountants keep track of quantitative financial information of the firm

-Banks, creditors and investors rely on these financial statements to get an accurate picture of the firms financial health and value -External auditors review the financial information and determine whether companys public financial statements reflect the true level of business -External auditors must be independent of the firm being audited as their job is to check for accounting fraud which hurts the firms shareholders

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External Counsel - Render legal advice and opinions to the Board and management - Represent the corporation in litigation Securities Analysts

- Rate stocks for potential stock investors

-Employed by brokerage and investment banks and make earnings forecasts for a firm to help investors make their own buy/sell decisions -Review the firms operating and financial conditions, immediate and long-term future prospects, effectiveness of its management teams and the general outlook of the industry in which the firm belongs

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Credit Rating Agencies

- Rate bonds for potential bond investors = opinion on the likelihood that obligations will be repaid - Credit rating = an opinion on the creditworthiness of a debt issue or issuer

- Creditworthiness = risk that a loan instrument will decline in value as a result of debtors failure to satisfy the contractual terms of the borrowing arrangement

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- Debt as a disciplinary management

mechanism

on

the

firms

o Management has to generate enough revenue to cover interest expense otherwise firm goes bankrupt/defaults and loses control to a creditor oCreditor rights superior to shareholders, debt provides better protection than equity

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Issues of Gatekeepers as a Corporate Governance Device - Conflict of Interest o The corporation is at the same time the auditing/law firms client and subject of audit Auditing/law firm may become less confrontational in order to keep the corporation as a client

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o Auditing/law firm also provide consulting services to advise companies on how to improve accounting methods and business activities May reduce the monitoring role of auditors Sarbarnes-Oxley Act prohibits accounting firms from providing both auditing and consulting services to the same company

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o Analysts want to gather good information through access to the firms management team which requires good relationship Difficult to give firm a bad rating even if firms prospects are poor Difficult for analysts to give objective evaluation o Analysts make slightly conservative earnings estimates in response to what management wants/expects CEO happy and willing to grant future access to the analyst Company will either make or beat the estimate and still be considered a good company

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o Companies pay to have their bonds rated

Threat that client takes the business to a competitor if they do not receive the rating that they want
oCredit rating agencies obtain private information that other monitors and analysts might not receive They may follow the lead of company executives instead of independently validating information and making conclusions based on their own analysis

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Government

Codes of Corporate Governance

- Securities and Exchange Commission o Revised Code of Corporate Governance (SEC MC No. 6, Series of 2009)

- Bangko Sentral ng Pilipinas

o BSP Circulars on Corporate Governance (Circular No. 283, Series of 2001)

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- Insurance Commission
o Corporate Governance Principles and Leading Practices (Circular No. 31-2005) - Governance Commission for GOCCs o Draft Code of Corporate Governance for GOCCs

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Revised Code of Corporate Governance (SEC MC No. 6, Series of 2009) - Board of Directors o Regular Directors = 5-15 oIndependent Directors = at least 2 for listed/registered corporations o A combination of executive and non-executive directors

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- Chairman and CEO o Roles of Chair and CEO should, as much as practicable, be separate to foster an appropriate balance of power, increased accountability and better capacity for independent decision-making by the Board o Clear delineation of functions should be made between the Chair and CEO upon their election oIf positions are unified, proper checks and balances should be laid down to ensure that the Board gets the benefit of independent views and perspectives

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- Term limits for Independent Directors

o Only 5 companies of a conglomerate (parent, subsidiary or associate) o Serve only for 5 consecutive years (6 months = 1 year) o Cooling off period of 2 years o Serve for another 5 consecutive years in the conglomerate
- Disqualifications o Temporary = may be remedied within 60 business days from such disqualification, otherwise becomes permanent disqualification

Refusal to comply with disclosure requirements of the SRC and its IRR

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 Absence in more than 50% of all meetings Dismissal or termination for cause in a covered corporation until cleared Independent directors holds more than 2% of the subscribed capital stock of the corporation, subsidiary or affiliate Any judgment/order cited under permanent disqualification has not yet become final o Permanent - Migration from Regular to Independent Director o 2-year cooling off period o1 year cooling off = for emeritus/ex-officio officers and directors

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- Board Committees

o Audit Committee
At least 3 directors preferably with accounting and finance background

One of whom shall be an Independent Director and another with audit background
o Nominations Committee At least 3 members, one of whom an Independent Director
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 Review and evaluates qualifications of directornominees and appointments

Assess effectiveness of Boards processes and procedures in the election and replacement of directors o Compensation and Remuneration Committee
At least 3 members one of whom an Independent Director Establish formal and transparent procedure for developing remuneration policy to ensure consistency with corporations culture, strategy and business environment
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- Corporate Secretary o Filipino and resident of the Philippines o An officer of the corporation

- Compliance Officer
o Reports directly to the Chairman

oMonitors compliance with the Code, rules and regulations of regulatory agencies

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o Reports violations to the Board and recommend appropriate disciplinary actions

o Recommends measures to prevent repetition of violation

o Appears before the SEC if summoned regarding compliance with the Code o Issues Certificate of Compliance with the Code o Explains reasons for deviations with the Code

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- Stockholders Rights Stockholders Interests

and

Protection

of

Minority

o Board of Director shall respect the rights of stockholders under the Corporation Code

Right to vote Pre-emptive right Inspect corporate books and accounts Right to information Right to dividends Appraisal right
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- Disclosure and Transparency o Disclose material information regarding Earnings results Acquisition and disposition of assets Off balance sheet transactions Related party transactions Direct and indirect remuneration of directors and management

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- Commitment to Good Corporate Governance o Corporate Governance Manual = 180 days from effectivity of the Code o Available for inspection by shareholders at reasonable hours on business days - Administrative Sanctions

o Fine of not more than Php200K for every year that a covered corporation violates the provisions of the Code

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o Without prejudice to other sanctions that the SEC may be authorized to impose under the law o Any violation of the SRC punishable by a specific penalty shall be separately assessed

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Issues on Codes as a Corporate Governance Device

Soft-Law Approach
- Comply or explain

Corporate governance by box ticking

- Corporate governance reporting as a box-ticking exercise - Compliance vs. Commitment - Increased compliance cost

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Corporate Social Responsibility

- Should strategic decision makers be responsible only to shareholders or do they have broader responsibilities? - Who are the firms responsible to? o Traditional View / Shareholder Model (Milton Friedman) Founded on classic economic precepts Maximization of wealth for shareholders, investors and owners Increase shareholder value The Social Responsibility of Business is to Increase its Profits

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 There is one and only one social responsibility of businessto use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud

By taking on the burden of social cost, businesses become less efficient

Firms are responsible only to their shareholders

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o Modern View / Stakeholder Model (Archie Carroll)

Companies have responsibilities to groups other than to shareholders Broader view of the corporations purpose Satisfying concerns of a broader variety of stakeholders Optimization of the sustainable economic wealth of all stakeholders Corporate Social Responsibility

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Stakeholders of the Corporation - Individuals or groups who depend on the corporation to fulfil their own goals and upon whom the corporation in turn depends - Those who have a stake or claim in some aspect of a companys products, operations, markets, industry and outcomes - Provide tangible and intangible resources critical to a firms success o Employees o Customers
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o Suppliers o Investors o Communities o Government o Environment - Primary Stakeholders = continued association is absolutely necessary for a firms survival - Secondary Stakeholders = do not typically engage in transactions with the company and are not essential for the firms survival o Media o Trade Associations o Special Interest Groups
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The Stakeholder Interaction Model

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CAPITAL MARKETS

SUPPLIERS

LAW

OWNERS

MANAGERS

FIRM

BOARD OF DIRECTORS CONSUMERS

PRODUCT MARKETS

EMPLOYEES

LABOR MARKETS

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Exhibit 4.7 Stakeholders of a Large Organisation

Exploring Corporate Strategy 8e, Pearson Education 2008

4-17

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Corporate Social Responsibility (CSR) - Duty of a corporation to create wealth in ways that avoid harm to, protect and enhance societal assets - Corporations obligation to maximize its positive impact on stakeholders and minimize its negative impact - Companies have a social obligation to operate ethically, socially and environmentally responsible ways

- The extent to which businesses strategically meet their four responsibilities = economic, legal ethical and philanthropic

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Four-Part Model of CSR / Four Dimensions of Corporate Citizenship Economic - First and foremost social responsibility of a firm

-Produce goods & services at a profit so that the firm may repay creditors and shareholders
- Strong sustained economic performance - Maximizing shareholder wealth / value - Must Do
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Legal - Society expects firms to operate their business within the legal framework - Corporation obeys laws and regulations

- Rigorous (strict) compliance (conformity)

- Abiding by all laws and government regulations

- Have to Do

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Ethical
- Responsibilities over and above ones codified in laws and are in line with societal norms and customs - Expected, though not required, by society

- Follow generally held beliefs about how one should act in society
- Following standard of acceptable behaviour as judged by stakeholders - Should Do
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Philanthropic

- Purely voluntary obligations assumed by the firm

-Voluntary contributions that advance reputation and stakeholder commitment - Giving back to society - Might Do

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The Steps of Social Responsibility

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Social Responsibility

Prentice Hall, 2002

Chapter 2 Wheelen/Hunger

29

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CSR as a Corporate Governance Device

- Higher-priority responsibilities (legal/ethical) cannot be offset through greater participation in lower-priority responsibilities (corporate giving) - Corporate citizenship may include charity or philanthropy but focuses more on engagement with stakeholders to achieve mutual goals (legal and ethical goals) - CSR associated with:
o Insulation from activist actions o Establish stakeholder confidence in management
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o Increased employee commitment o Enhance firm reputation o Greater customer loyalty o Increased profits

- Corporate Governance and Social Responsibility are two sides of the same coin

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Issues on CSR as a Corporate Governance Device

- Measuring firms CSR performance o No accounting measure such as earnings and stock prices regarding effect on stakeholder welfare - Greenwashing o CSR = superficial window-dressing o Regarded as charity and image-building exercise

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- Integration of CSR into company strategy o Delinked from mainstream activities of the firm o In good times = CSR activities abound o In bad times = no CSR activities

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Sustainability - Integration of economic, social and environmental aspects to meet the needs of the present without compromising the ability of future generations to meet their own needs - Credible business practices as integral part of sustainable business o Avoiding exploitation of labour o Accounting manipulation

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- Triple Bottom Line Framework of Sustainability

o Economic
Maintain shareholder value

o Social
Community well-being

o Environmental
Environmental protection
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Triple Bottom Line Framework

Economic Sphere Maximise shareholder value Market share Current profits
All organisations have three dimensions to their strategies and operations

Economic

Environment sphere Eco-friendly products Recycling waste Climate protection Emissions control

Social

Environment

Social sphere Community wellbeing Regional development Local issues

How to move the three spheres

closer? How to align Social and Environmental spheres with the Economic sphere?

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Thank You

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