It is impossible to exaggerate the significance of the contemporary claim that there is a business case for corporate responsibility, business ethics, corporate citizenship, environmental stewardship, pollution control, sustainable development, and the like. To be sure, improving the bottom line is not the only possible reason for CSR. Many executives genuinely care about conducting their businesses in ways that are more environmentally sustainable, that respect human rights, and that foster economic development. Self-regulation can also reduce the likelihood of more government regulation or place a firm in a better competitive position if and when new regulations emerge. Some of the benefits of CSR to a firm, such as higher employee morale or a better reputation, never appear on a balance sheet. For profitable firms, CSR can represent a civic-minded allocation of discretionary resources. But while profitability may not be the only reason corporations will or should behave virtuously, it has become the most influential. According to the business case for CSR, firms will increasingly behave more responsibly not because managers have become more publicspirited—though some may have—but because more managers now believe that being a better corporate citizen is a source of competitive advantage. A more responsibly managed firm will face fewer business risks than its less virtuous competitors: it will be more likely to avoid consumer boycotts, be better able to obtain capital at a lower cost, and be in a better position to attract and retain committed employees and loyal 2 Is There a Business Case for Virtue? chapter 16 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. customers. Correspondingly, firms that are unable or unwilling to recognize this new competitive reality will find themselves disadvantaged in the marketplace: both “responsible” and “sophisticated” investors will regard their shares as too risky; the value of their brands and thus their sales will decline as a result of media exposure, public protests, and boycotts; and the morale of their employees will suffer. Unfortunately, there is no evidence that behaving more virtuously makes firms more profitable. This finding is important because, unless there is a clear business case for CSR, firms will have fewer incentives to act more responsibly. Conversely, the fact that CSR also does not make firms less profitable means that it is possible for a firm to commit resources to CSR without becoming less competitive. In brief, there is a place in the business system for responsible firms, but the market for virtue is not sufficiently important to make it in the interest of all firms to behave more responsibly. This chapter begins by documenting the contemporary importance of the links between ethics and profits. It then places the relationship between ethics and profits in historical perspective, explaining why they have recently become more influential. The remainder of the chapter reviews the evidence about the actual links between ethics and profits. It presents an overview of academic research on the relationship between CSR and profitability, examines the relative financial performance of social mutual funds, and explores other evidence about the business case for CSR. Old-Style Corporate Responsibility: Doing Good to Do Good The business case for corporate responsibility is not new, though its current emphasis is. Historically, the relationship between virtue and profits was understood to be more indirect. The 1953 New Jersey Supreme Court case that legitimated corporate philanthropy was brought by a shareholder who complained that Standard Oil of New Jersey had misused “his” funds by making a contribution to the engineering school of Princeton University. This gift came to typify much corporate philanthropy. It was not unrelated to the purposes of the company: Standard Oil needed well-trained engineers, and its gift to Princeton could be expected to increase their number. But in one sense the shareholder who sued the firm’s managers was probably right: this gift was unlikely to make Standard Oil more profitable, since those engineers could just as easily work for its competitors. In effect, Standard Oil was providing a collective is there a business case for virtue? 17 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. good. Nonetheless, the court held that the allocation of such a gift was within the scope of management discretion. Many firms took advantage of this ruling. By the 1960s, corporate philanthropy had become part of the widely accepted definition of being a good corporate citizen. Allocating some portion of pretax profits, typically via a corporate foundation, had become the expected and common practice of large firms. However, the link between these gifts and the interest of shareholders was indirect, in many cases much more so than that between Standard Oil’s shareholders and Princeton University. Corporate philanthropy went well beyond higher education, supporting civic institutions in communities where the firms had employees (often through United Way) and cultural activities in the firms’ headquarters community. Many of these expenditures reflected the firm’s “enlightened” self-interest as it was broadly understood; only infrequently did these gifts reflect a strategy to increase shareholder value. The importance attached to corporate philanthropy as an expression of corporate citizenship during the 1960s and 1970s is suggested by the emergence of a “5 percent club,” so named because its members donated at least 5 percent of their pretax earnings. Many of the firms widely regarded as the leaders in corporate responsibility during this period, such as Levi Strauss, Dayton-Hudson, Cummins Engine, Atlantic Richfield, and Control Data, were members. Many cities established similar clubs, requiring minimum donations to philanthropy of 2 to 5 percent of pretax earnings. While there was substantial peer pressure among corporations to become more philanthropic, no one claimed that such firms were likely to be more profitable than their less generous competitors. And it certainly did not occur to any management scholar that correlating a firm’s membership in any of these “clubs” with its financial performance would demonstrate that corporate philanthropy “pays.” According to a study of businesses’ urban affairs programs between 1967 and 1970, the most important motivation for their establishment was “enlightened self-interest.” David Rockefeller, the chairman of Chase Manhattan Bank, whose firm was a local and national leader in these programs, stated, “Our urban affairs work is good for Chase Manhattan in a strictly business sense. Our efforts are aimed at creating a healthy economic and social environment that is vital to the existence of any corporation.” Other executives explained their participation on the grounds that business required both skilled manpower and social stability in order to survive. In light of the ghetto riots that were then sweeping so many 18 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. American cities, “it was only common sense to try to solve social problems that could threaten their future.”1 But the benefits generated by these urban programs went to the business community or to society as a whole rather than to the firms that had committed resources to them. These programs reflected, in the words of the Committee for Economic Development, a “broad recognition that corporate self-interest is inexorably involved in the well-being of the society of which business is an integral part.”2 For all his rhetoric about the interests of “business,” Rockefeller did not believe that Chase’s extensive urban initiatives would improve its earnings compared to those of other NYC banks. Significantly, only one-eighth of the 201 executives surveyed around 1970 viewed their urban affairs programs as a potential source of profits.3 Indeed, it is precisely these kinds of enlightened expenditures that prompted Milton Friedman to write the now classic 1970 New York Times article in which he argued that the only responsibility of managers was to increase shareholder value.4 Friedman had no quarrel with corporate social policies or programs that benefited shareholders—a category in which he included contributions to the community where the firm’s employees resided. What he objected to were expenditures that benefited “society.” And in the late 1960s there was no shortage of business initiatives that appeared to violate his criteria. The New World of CSR: Doing Good to Do Well Were Friedman now to revisit this subject, he would find much less to concern him. Virtually all contemporary writing on CSR emphasizes its links to corporate profitability. The typical business book on CSR consists either of examples of companies that have behaved more responsibly and thus have also been financially successful, or advises managers how to make their firms both responsible and profitable. Many of their titles and dust jackets tout the responsibility-profitability connection. Thus Cause for Success describes “10 companies that have put profit second and come in first.” The experience of these firms, its dust jacket says, illustrates “how solving the world’s problems improves corporate health, growth, and competitive edge.” The subtitle of The Sustainability Advantage is “several business case benefits of a triple bottom line,” and Walking the Talkis subtitled “the business case for sustainable development.” Corporate Citizenship presents “successful strategies for responsible companies,” and The Bottom Line of Green Is Black puts forward “strategies for creating prof is there a business case for virtue? 19 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. itable and environmentally sound businesses.” For its part, Profits with Principles offers “several strategies for delivering value with values.”5 The message of Chris Laszlo’s The Sustainable Company is that “an integrated economic, social, and environmental approach leads to more enduring shareholder value. . . . It is a long-term strategy, uniquely relevant to the twenty-first century, in which responsible social change can become a source of innovation and profits rather than added cost.” A widely used textbook on CSR, Sandra Waddock’s Leading Corporate Citizens,analyzes “responsible practices and the associated bottom line benefits.” Companies with a Conscience, now in its third edition, describes twelve companies whose experiences “prove” that “caring capitalism . . . is not only decent, it is also profitable.” Building Reputational Capital presents “strategies for integrity and fair play that improve the bottom line.” According to Faith and Fortune: The Quiet Revolution to Reform American Business, “the business case for doing the right things has become so compelling that companies that do good will also do well.”6 Writing about corporate environmental policies in the Harvard Business Review, Stuart Hart argues that “the more we learn about the challenges of sustainability, the clearer it is that we are poised at the threshold of an historic moment in which many of the world’s industries may be transformed.” He criticizes managers for looking at their environmental policies in too narrow terms: “Greening has been framed in terms of risk reduction, reengineering or cost cutting. Rarely is greening linked to strategy or technological development, and as a result, most companies fail to recognize opportunities of potentially staggering proportions” (italics added). Hart concludes: “The responsibility for ensuring a sustainable world falls largely on the shoulders of the world’s enterprises,” and that, “in the final analysis, it makes good business sense to pursue strategies for a sustainable world.”7 In another influential HBR article, Amory Lovins, L. Hunter Lovins, and Paul Hawken predict that “the companies that first make [the change to environmentally responsible practices] will have a competitive edge.” The authors add, “Those that don’t make that effort won’t be a problem because ultimately they won’t be around.”8 The business case for CSR is also widely accepted by many corporate executives. According to a 2002 survey by PricewaterhouseCoopers, “70 percent of global chief executives believe that CSR is vital to their companies’ profitability.”9 Another survey reports that 91 percent of CEOs believe CSR management creates shareholder value.10 As one corporate report put it in 2004, “If we aren’t good corporate citizens as 20 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. reflected in a Triple Bottom Line that takes into account social and environmental responsibilities along with financial ones—eventually our stock price, our profits and our entire business could suffer.”11 According to a KPMG study of 350 firms, “More big multinational firms are seeing the benefits of improving their environmental performance. . . . Firms are saving money and boosting share performance by taking a close look at how their operations impact the environment. ... Companies see that they can make money as well.”12 Trends in corporate philanthropy illustrate the extent to which “doing well” and “doing good” have become more closely linked. Michael Porter has urged companies to connect their philanthropic expenditures “to areas that improve their long-term competitive potential.”13 In fact, U.S. corporations are increasingly “adopting strategic philanthropy” by linking their philanthropy to their business missions.14 A Council on Foundations study based on interviews with 225 corporate chief executives and 100 “next-generation” CEOs reports that, “seventy-one percent felt that a company must determine the benefits to the business of each cause it supports.”15 The popularity of cause-related marketing is another illustration of the growing links between corporate social and financial objectives. Such marketing typically features promotions in which a portion of the purchase price of a product or service is donated to a social cause: it essentially links marketing and corporate philanthropy. Besides the obvious public relations benefits, one of the most important measures of its success is increased sales. One of the first cause-related marketing efforts was initiated by American Express in 1983 in connection with the restoration of the Statue of Liberty. The firm promised that over a three-month period it would contribute to this civic enterprise a portion of the amount consumers charged to their American Express cards. The results of the campaign made marketing history. AmEx card use increased 28 percent, new card applications rose 17 percent, and $1.7 million dollars was raised for the Statue of Liberty and Ellis Island.16 Cause-related marketing has since grown significantly, from $125 million in 1990 to an estimated $828 million in 2002. In 2004 this figure increased to $991 million.17 The change in the rationale for and focus of socially responsible investing (SRI) also reflects the increased links between profits and corporate responsibility. When the concept of socially responsible investing first emerged, its purpose was to enable individuals or organizations opposed to particular kinds of businesses or business activities on moral or politi is there a business case for virtue? 21 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. cal grounds to avoid purchasing shares in these companies. For example, some religious institutions and organizations established policies that excluded investing in firms that produced or sold liquor, tobacco, and in some cases military weapons. Social investment first became politicized during the late 1960s, but its purposes initially remained the same: to enable investors to reconcile their portfolios with their consciences. In 1971 the Pax World Fund was formed as an investment vehicle to register public and investor opposition to the war in Vietnam by avoiding shares in defense firms. Subsequently, activists seeking to end racial segregation in the Republic of South Africa as well as Portuguese control of Angola and Mozambique waged a determined and in many cases successful effort to pressure universities, public sector pension funds, churches, and foundations to divest themselves of their shares of companies with investments in southern Africa. The Calvert Social Investment Fund, established in 1982, excluded shares in companies with investments in South Africa and defense firms, as well as companies that “made money out of environmental degradation. . . . that failed to respect human rights (and that) trampled on the rights of indigenous peoples around the world.”18 But these initial efforts to politicize share selection did not assume that a more “responsible” portfolio would perform better or even as well as a less responsibly managed one. The students who demanded that their universities sell their holdings in firms with investments in South Africa or firms with defense contracts did not believe that this investment strategy would financially benefit their institutions. Rather, they sharply attacked their universities for financially benefiting from their “unethical” holdings in firms that made weapons and had investments in South Africa. Nor did those who excluded defense stocks from their portfolios to protest the war in Vietnam believe that this strategy would make their investments perform better. Advocates of social investment now claim that it makes financial as well as moral sense. According to the director of research for Calvert Asset Management, “We believe that a company that pollutes the environment or mistreats its workers can get away with it for a while. But eventually it’s going to come back to haunt them.”19 One purpose of promoting greater transparency in business conduct is precisely to enable investors to take advantage of the positive relationship between corporate social performance and financial success. Judy Henderson, a member of the directorate of the Global Reporting Initiative, states that a transparent 22 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. reporting framework provides a competitive advantage “because discerning investors now recognize that a company managed according to interests broader than those of only shareholders is more likely to profit over the long term.” She adds, “Corporations with a stakeholder focus have been shown to enjoy greater sales and value growth than companies with narrow shareholder focus.”20 In that same vein, the title of a report by the Global Compact on “connecting financial markets to a changing world” confidently asserts that companies that care will come out on top: Who Cares Wins.21 The strategy of many social investment funds has changed to reflect this more businesslike approach to SRI. While most ethical funds continue to exclude investing in some firms on the basis of their core business, virtually all also seek to identify and then invest in the firms with the best CSR practices. The increased use of positive screeninghas an economic as well as a political purpose: positive screening reflects the belief that more responsible firms are also likely to have superior financial performance.22 A belief in the business benefits of CSR is particularly influential in Europe. Influenced by the work of Michael Porter, who argues that more stringent environmental standards can improve the competitiveness of a nation’s businesses, the European Union has repeatedly stressed the business benefits of CSR.23 The business case for CSR informs the European Union’s influential White Paper on Corporate Social Responsibility. It also is a central motif in conferences sponsored by the EU and its affiliates, where presentations emphasize the benefits of CSR to both investors and companies.24 Advocates of social and environmental disclosure requirements for companies in Europe believe that they will help the capital markets identify more responsible firms and help predict which firms are likely to be more competitive. Academic studies have also taken an interest in the relationship between ethics and profits. The first such study was published in 1972; there are currently more than 120 and new ones keep appearing.25 The rationale for many of these studies is clear: to legitimate a broader conception of the firm’s role and responsibilities by integrating it with a narrower financial conception. As Margolis and Walsh insightfully observe: Empirical evidence of a positive causal relationship moving from social performance to financial performance also promises, for some, a solution to endless debate about the social role and responsibilities of the firm. . . . Those who construe a narrow economic role for is there a business case for virtue? 23 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. the firm would embrace a financial rationality for socially responsible practices, and those with a broader conception of the firm’s responsibilities would not need to appeal to an alternative construal of the firm’s purpose to justify expansive responsibilities.26 Such a “solution” clearly appeals to those who study and teach business and society and business ethics at business schools: it places what they teach and study much closer to the mainstream of business education and practice. The influence of the business case for CSR also has affected the strategies of some NGOs. While many NGOs remain indifferent or hostile to the financial objectives of business, some have developed more cooperative relationships with firms, often helping companies to reconcile their business missions with other objectives, notably environmental quality.27 They frequently urge firms to behave more responsibly on the grounds that doing so is also good business. The antiwar activists who, during the 1960s, pressured Dow Chemical to stop producing napalm, framed their argument exclusively in moral terms: they neither knew nor cared whether producing napalm would affect Dow’s earnings. In contrast, the contemporary environmental activists who are working with Dow to reduce its carbon emissions argue that doing so will make Dow more profitable by lowering its costs. Many socially oriented investors articulate their interest in sustainable environmental practices or human rights issues in similar terms: they ask corporations to act more responsibly on the grounds that doing so is in the best interests of their shareholders, in part by reducing business risk. The New Business Environment Never before has the claim that corporate virtue can and should be profitable enjoyed so much currency or influence. Two factors help account for this development: One has to do with a change in the structure of the business system, another with changes in attitudes toward business. Both are particularly influential in the United States, but their influence is apparent in Europe as well. The Changing Nature of the Firm The view that corporate responsibility reflected the enlightened selfinterest of business or its obligations to society rather than its contribution to profits was associated with a distinctive structure of industrial 24 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. organization. Such a firm was typically large and professionally managed, and its shares were widely held. It enjoyed a reasonably secure or very secure market position—often an oligopolistic one—and faced little if any foreign competition, at least in its domestic market. Importantly, neither the compensation nor the tenure of its managers was directly linked to its earnings or share price. The emergence of the modern doctrine of corporate responsibility in the United States is linked to the managerial revolution that occurred around the turn of the century. George Perkins of U.S. Steel, the professional manager of the world’s first billion-dollar corporation, wrote in 1908: The larger the corporation becomes, the greater become its responsibilities to the entire community. The corporations of the future must be those that are semi-public servants, serving the public, with ownership widespread among the public, and with labor so fairly treated that it will look upon the corporation as its friend.28 In the view of many observers, it was the separation of ownership and control—first noted at the turn of the twentieth century and subsequently documented by Berle and Means in 1932—that made it both possible and necessary for business leaders to behave more responsibly. As Walter Lippmann put it in his 1914 book Drift and Mastery, “The cultural basis of property is radically altered. . . . The men connected with these essential properties cannot escape the fact that they are expected to act increasingly like public officials. . . . Big businessmen who are at all intelligent recognize this. They are talking more and more about their ‘responsibilities,’ their ‘stewardship.’”29 This change in the pattern of corporate ownership meant that professional managers and owners had different priorities. Unlike owners, managers were in a position “to balance the claims of the firm’s “stockholders, consumers and the public in general.”30 Freed from the pressure to earn as much money as possible for their shareholders, managers could use corporate resources to pursue a variety of goals—essentially making companies into “multipurpose social institutions.”31 This firm, popularly depicted in Galbraith’s New Industrial State, could “afford” to engage or support programs or policies that were unrelated or only tangentially linked to its business objectives since its market position was relatively stable, and equally important, its shareholders were relatively passive. Its managers might not always, or even often, have acted like “public officials,” judiciously and responsibly balancing the claims of is there a business case for virtue? 25 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. the firm’s many stakeholders, only one of whom was its shareholders, but in principle they were in a position to do so. And in fact, many adopted highly paternalistic labor policies, provided job security for their whitecollar employees and generous benefits for their blue-collar employees, and made substantial philanthropic contributions. For better or worse, the world in which these corporations existed has disappeared in the United States and increasingly in Europe as well. Thanks to increased domestic and international competition, threats of hostile takeovers, the concentration of ownership in the hands of institutional investors, and changes in the basis of executive compensation, the creation of shareholder value has become a central objective of managers. Their personal wealth and continued employment as well as the survival of their firms now depend on their ability to shape and meet the expectations of financial markets. Accordingly, “the freedom of top executives to pursue corporate goals unrelated to the bottom line has been circumscribed. ... Managerial capitalism tolerated a host of company objectives besides shareholder value. Investor capitalism does not.”32 In a sense, managers now have little choice but to follow Friedman’s dictum: they must strive to maximize shareholder value. Ironically, one might have thought that these changes in both management incentives and the competitive environment would have led to the conclusion that it has become much more difficult for firms to act responsibly. Instead it has led to a shift in the rationale for corporate responsibility. Now the main justification for corporate responsibility is its contribution to the bottom line. While criticizing Friedman’s article remains de rigueurin virtually every book and article on corporate responsibility, many contemporary advocates of CSR have implicitly accepted Friedman’s position that the primary responsibility of companies is to create wealth for their shareholders. But they have added a twist: in order for companies to do so, they must now act virtuously. The New Embrace of Money and Morals The contemporary importance of the business case for CSR is linked to a second development: the popular embrace of business and the values of moneymaking. The movement for corporate responsibility of the 1960s and 1970s took place during a period of considerable hostility to business. Indeed, companies began to talk more about their social responsibilities during the late 1960s and early 1970s in part as a response to the disen 26 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. chantment expressed by many college students and graduates with business values. Fortune noted in 1966 that “the prejudice against business is undeniable, and permeates the country’s highest-ranking colleges.”33 A student at the Harvard Business School admitted, “If people are really interested in tackling social problems, they will have nothing to do with business.”34 A 1967 survey of college students reported that 61 percent found “their fellow students to be indifferent or hostile toward working in industry.”35 During the second half of the 1960s, enrollment in business schools increased only one-third as fast as total college enrollment.36 The current revival of interest in corporate responsibility began in a somewhat different cultural and social context. While surveys continue to report widespread hostility to and suspicion of business, the 1990s were also a decade when many of America’s and Europe’s “best and brightest” became attracted to business careers. Successful entrepreneurs became admired and respected, and the growth of Silicon Valley became a focus of national pride in the United States and envy in other countries. “Making money” became more respectable, popular interest in business grew, and not coincidentally, business school enrollment soared in both the United States and Europe. Still, some of the people who enrolled in business schools or began to work for or start companies also cared about social and environmental concerns. And many were highly critical of corporate social and environmental practices. How could their interest in business—and making money—and their social values be reconciled? The business case for corporate responsibility provided an answer. Like investors in socially responsible mutual funds, they did not have to abandon their values to become prosperous. On the contrary: they could simultaneously become financially secure and make the world a better place. Indeed, they could now become prosperous by making the world a better place. One strain of the contemporary movement for corporate responsibility links the “counterculture” values of the 1960s with those of the “decade of greed,” as the 1980s came to be known. This vision appeals not only to those who came of age during the 1990s, but also to those a decade or two older who were influenced by the values revolution of the 1960s and 1970s, in some cases belatedly. Many of the latter individuals now hold positions of leadership in corporations. They too want to believe that there is a business case for corporate responsibility since it enables them to link their personal values with their responsibilities as managers. And it is the baby-boomer generation, many of whose members have is there a business case for virtue? 27 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. become relatively affluent but still hold liberal social values, who are the major individual investors in socially responsible mutual funds.37 These investors care about social values, but they also want to protect the value of their savings. The emergence of “companies with a conscience” represents a particularly vivid expression of the contemporary reconciliation of social values and the business system. These are companies whose vision of social responsibility was integral to their business strategies from the outset. They were formed by individuals with strong personal social commitments who regarded their businesses both as vehicles to make money and as a means to improve society. Among those that became widely known and celebrated are the Body Shop, Seventh Generation, Domini, Esprit, Celestial Seasonings, Stonyfield Farm, Tom’s of Maine, Ben and Jerry’s, and Patagonia. As Ben Cohen, one of the founders of Ben and Jerry’s, put it: “We are in the process of creating . . . a business climate in which the right way to go about solving social problems is by founding and maintaining and sustaining a socially responsible business.” Anita Roddick, the founder of the Body Shop, acknowledged, “I think a lot of us would have slit our wrists if we ever thought we’d be part of corporate America or England.” Likewise, many of the individuals who established socially responsible funds and research services, such as Peter Kinder and Amy Domini, had political as well as financial motivations: they wanted to use SRI to bring about social change by improving business practices, as well as create successful businesses.38 In 2000 Goldman Sachs began funding a national—subsequently international—business competition in which business students and recent MBAs develop business plans that are judged on how well they meet both social and financial criteria. The most promising plans are often funded. Many business schools now offer courses in social entrepreneurship—in effect teaching MBA students how to form and secure funding for future Ben and Jerry’s. One of the largest American MBA student organizations is Net Impact. Its well-attended annual conventions feature inspirational speeches by business leaders—entrepreneurs and professional managers— who personify both the financial benefits of corporate responsibility and the social contributions of successful firms. In Britain, First Tuesday, which formerly functioned as a “dating agency” for dot.com entrepreneurs and venture capitalists, now hosts meetings that bring together entrepreneurs with sustainable ideas and investors with environmental concerns, with the goal of building a “global sustainability business network.”39 28 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. In short, the increasing influence of the business case for CSR reflects changes in the nature of business competition and changes in beliefs about the potential social role of business. It is both widely believed and influential. But what is the evidence that such a business case exists? Putting the Business Case to the Test An extensive body of academic research examines the relationship between corporate responsibility and profitability.40 A detailed examination of this large and still growing literature is beyond the scope of this book. But its central conclusion can be easily summarized: at best, it is inconclusive. What the Studies Show While many studies report a positive relationship between ethics and profits, some find a negative relationship, and still others find the relationship to be either neutral or mixed. These results hold both for those studies that use financial performance to explain social performance and for those in which the causal relationship is reversed. Equivocal results also characterize those studies that assess a wide variety of measures of corporate social responsibility as well as those that focus on specific areas such as environmental performance, corporate philanthropy, and community relations. In the area of environmental performance, one study found a moderate positive relationship between levels of emissions reduction between 1988 and 1989 and the financial performance for firms involved in manufacturing, mining, and production, though the direction of causality was not clear.41 Another study reports a strong positive relationship between the financial performance of large manufacturing and mining firms and their adherence to relatively stringent uniform global environmental standards, though such firms may perform better just because they are better managed.42 A third study reports a positive relationship between financial performance and various dimensions of environmental performance based on ratings by the Franklin Research and Development Corporation. This relationship was especially strong for firms in high-growth industries.43 But reviews of a broader range of research suggest that environmentally responsible behavior does not raise firm performance: is there a business case for virtue? 29 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. Researchers have yet to demonstrate that environmental expenditures improve firm profitability in a structural way, and that it is not a matter of reverse causality, where profitable firms can afford to invest in environmental performance. A more likely explanation of the research to date [which demonstrates a positive relationship between environmental and financial performance] is that various omitted variables affecting both environmental and financial performance are responsible for the apparent statistical relationship.44 Research that relates measures of corporate environmental performance to measures of financial performance suffers from several shortcomings. Few studies attempt to explain how better environmental strategies have changed financial analysts’ views of a firm’s future earnings. Among those studies that compare the portfolios of environmental leaders and laggards, virtually none correct for differences in risk other than environmental performance. These studies also do not address the issue of causation. It is as likely that more profitable firms are able to devote more resources to environmental protection as it is that such firms are more profitable because they have adopted better environmental practices.45 It is also possible that good environmental performance is a proxy for management quality. It is hard to draw broad conclusions about the relationship between CSR and profits because the studies often measure different things. In the ninety-five studies summarized by Margolis and Walsh, financial performance is measured in seventy different ways: these studies employ forty-nine different accounting measures, twelve different market measures, five measures that mix accounting and market indicators, and four other measures of outcome performance.46 Accounting measures are usually used as indications of prior financial performance for studies that seek to explain the impact of CSR on financial performance, while market measures are usually employed to assess future performance when financial performance is used to explain CSR.47 Measurements of corporate social performance also vary widely.48 In ninety-five studies, twenty-seven different data sources were used. These range from multidimensional screening criteria, surveys, conduct in South Africa (which has since become irrelevant), organizational programs and practices, disclosure, money spent, environmental performance, and reputation. The most frequently used are environmental practices, followed by omnibus measures such as the Fortune reputation rankings and the indexes of Kinder Lyderberg Domini (KLD) Research & Analytics. 30 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. Not only does the diversity of these measures make drawing conclusions from this literature difficult, but there is considerable debate about the validity of some of them. For example, one of the most commonly employed measures of CSR is based on Fortune’s annual reputational survey of America’s most admired corporations. One of the attributes rated by Fortune is a “company’s responsibility to the community and the environment.” However its raw scores appear to be heavily influenced by a company’s previous financial performance, which means that any relationship between it and corporate profitability is tautological. In addition, the surveys on which the rankings are based poll only industry executives and market analysts.49 The most exhaustive and widely used measure of CSR is KLD’s extensive database of 400 mainly U.S. companies. KLD evaluates five different measures of corporate performance: community relations, diversity, employee relations, natural environment, and product safety and quality. The rankings rely on publicly available data such as information supplied to tax and regulatory agencies, newspapers, and magazines, and on company reports, supplemented by surveys of the 400 firms. Companies also have the opportunity to review KLD’s assessments before they are released. However, KLD does not reveal its basis for weighing each screening category in determining a firm’s overall CSR ranking. Many of its rankings are subjective; few are based on quantitative measures. In many instances the data on which ratings are based are incomplete, particularly with respect to the non-U.S. operations of the companies in its database. Studies that employ a narrower range of criteria capture only some of the policies usually associated with corporate responsibility, while those that employ a broader range are unable to identify which policies might be affecting financial performance. And it is not uncommon for firms to exhibit more virtuous performance in some areas than in others. Even within a relatively narrow category such as environmental performance, measures can be inconsistent with one another. Thus how should a firm’s environmental responsibilities be assessed if it has relatively low emissions, but a poor record of compliance and a weak environmental management system?50 Virtually every measure employed has been subject to substantial criticism: no consensus has emerged as to how either environmental responsibility or corporate responsibility more generally can or should be measured. Any effort to explain a firm’s financial performance must also control for other antecedent factors. But not all studies adequately do so. For is there a business case for virtue? 31 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. example, McWilliams and Siegel, in reexamining the conclusions of a study that strongly linked corporate social and financial performance, found that “when R&D intensity is included in the equation, CSP (corporate social performance) is shown to have a neutral effect on profitability,” since firms that actively engage in CSR also tend to make strategic investments in R&D.51 Some studies employ no control variables, which means that any relationship they find may be spurious. In all, nearly fifty different control variables have been used by different scholars. Industry, size, and risk are employed most frequently, but most control variables have been used only once. This also increases the difficulty of identifying the relative contribution of social performance to financial performance.52 Equally important, correlations drawn from surveys and other crosssectional data cannot establish the direction of causality. It is just as likely that more successful firms are more responsible than others as it is that more responsible firms are more successful than others. For example, if firms identified as “good places to work” are more profitable, this may be because they can afford to treat their employees well, not because their labor policies increase shareholder value. Moreover, correlations between social and financial performance may reflect the fact that well-managed firms are also better at managing CSR, making it difficult to discern whether or to what extent they are more profitable because they are more responsible. The dozen literature reviews published between 1979 and 1999 identify nearly fifty shortcomings of the broader body of research. They agree that the connection between CSR and financial performance has not been established and that neither academics nor practitioners should rely on the research results because they are noncomparable.53 Summarizing both their own analysis and these studies, Margolis and Walsh concur: The clear signal that emerges from thirty years of academic research—indicating that a positive relationship exists between social performance and financial performance—must be treated with caution. Serious methodological concerns have been raised about many of the studies and about efforts to aggregate results. ... Questions arise about the connection between the underlying CSP [corporate social performance] construct and efforts to measure it; the validity of the measures used to assess social performance; the diversity of measures used to assess financial performance; and the direc 32 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. tion and mechanisms of causation; given the heavy reliance on correlation analyses and contemporaneous financial and social performance data.54 It is thus difficult to know what to make of the claim that “those hoping for a positive or neutral impact of social performance on financial performance can feel some satisfaction, because the vast majority of studies support the idea that, at the very least, good social performance does not lead to poor financial performance.”55 If this is true, it might reflect the fact that corporate responsibility is not sufficiently costly to affect earnings. Or it might be attributable to the fact that many corporate CSR expenditures are discretionary and therefore more likely to be made by more profitable firms. But although CSR may not make firms any less profitable, it is possible that some more responsible firms might be even more profitable if they were less responsible. Putting CSR in Its Place Studies of the links between social responsibility and profitability continue to be published and are becoming increasingly sophisticated. It is possible that future research will confirm the validity of the several studies that have posited positive causal relationships between the two. However, the effort to demonstrate through statistical analyses that corporate responsibility pays may be not only fruitless, but also pointless and unnecessary, because such studies purport to hold corporate responsibility to a standard to which no other business activity is subject. For example, it is highly unlikely that there is a positive correlation between advertising expenditures and corporate profitability; some profitable firms spend little on advertising, and many advertising expenditures produce disappointing results. Yet no one would dispute that there is a business case for advertising. But just as firms that spend more on marketing are not necessarily more profitable than those that spend less, there is no reason to expect more responsible firms to outperform less responsible ones. In other words, the risks associated with CSR are no different than those associated with any other business strategy; sometimes investments in CSR make business sense and sometimes they do not. Why should we expect investments in CSR to consistently create shareholder value when virtually no other business investments or strategies do so? is there a business case for virtue? 33 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. It is not necessary to find a positive statistical relationship between CSR and profits to claim that some firms may benefit financially from being more responsible or suffer from being irresponsible. This is certainly true. Such a claim, however, does not satisfy CSR advocates. The reason they have placed so much importance on “proving” that CSR pays is because they want to demonstrate, first, that behaving more responsibly is in the self-interest of all firms, and second, that CSR always makes business sense. Were they able to satisfactorily do either or both, then presumably all firms would begin to behave more responsibly so that they too could become more profitable.56 But even if it were possible to convincingly demonstrate a positive causal link between CSR and business financial performance, it is unclear what this would prove. If some firms are actually more profitable because they are more responsible, it does not necessarily follow that their less responsible competitors would be more profitable if they were more responsible. It is equally possible that the market niche for relatively responsible firms is limited and that they would be better off continuing to pursue a less responsible strategy. And a link between responsibility and profitability does not necessarily mean that firms would be even more profitable if they were more responsible, since there may be declining returns for behaving more responsibly. In fact, if all firms behaved responsibly—which presumably is the goal of the CSR movement—then at least some of the advantages a firm receives from being more responsible than its competitors would disappear, and thus, ironically, future studies of the links between CSR and profits would find no statistically significant relationship. Moreover, if CSR were actually a significant source of competitive advantage, then it might logically be in the interest of more responsible firms to discourage their competitors from following their example. After all, a firm that has developed a profitable new product does not want its competitors to imitate it, or even learn from its example. But in the case of CSR the opposite is true: rather than seek to protect their “first mover” advantages, these firms frequently encourage their less responsible competitors to emulate their behavior.57 Hence the popularity of industry codes of conduct in business sectors that are under public pressure to improve their social performance. This suggests that more virtuous firms are frequently not able to capture the financial benefits of their more responsible behavior. Instead of being defined as a necessary condition for business success, corporate responsibility is better understood as one dimension of corpo 34 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. rate strategy. Corporations pursue a wide variety of strategies: some are highly diversified, others are specialized; some invest heavily in research and development, others focus on marketing; some pay relatively high wages, others pay close to the minimum wage; some are global, others focus on national or local markets. CSR is no different: firms have chosen and will continue to choose different levels of corporate responsibility, depending upon the risks and opportunities they face. There is no reason to expect a convergence of CSR strategies, any more than companies can be expected to converge on any other strategy. That said, it is of course possible that the baseline or benchmark for corporate behavior could steadily improve. But correlations of responsibility and profitability will not tell us whether this is occurring. Taking a Second Look at CSR: Socially Responsible Investment The validity of the business case for virtue can also be explored through the financial performance of socially responsible mutual funds. The results of this analysis reveal that socially responsible funds and indexes perform no better or worse than those of any other kind of fund or stock index. The three most widely used ethical fund indexes are the Domini 400 Social Index, which is based on the research of KLD discussed above; the Dow Jones Sustainability World Index (DJSI World); and the FTSE4Good Index. In addition to using positive screens, the Domini uses negative screens based on military contracting, the manufacture of alcohol or tobacco products, revenues from gaming products or services, and the ownership of nuclear power plants. DJSI World, which was established in 1999 by the Sustainability Asset Management Group, a Swiss company, in cooperation with Dow Jones Indexes, tracks the performance of the top 10 percent of leading sustainability firms in each industry group. The FTSE4Good Index includes firms that meet its criteria on social, environmental, and human rights issues and excludes tobacco, arms manufacturers, and firms that produce nuclear power or uranium. The Performance of Socially Responsible Funds Between May 1, 1990, and June 30, 2004, KLD’s Domini 400 Social Index, which is used as the basis for selecting the Domini Social Equity Fund (the fourth largest social fund with $1.2 billion under management), returned $5.40 for each dollar invested, while the S&P 500 returned is there a business case for virtue? 35 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. $4.60. But this difference is largely attributable to the industries in which the fund invested; there was no evidence of a “social” factor.58 For its part, the FTSE4Good has closely tracked the performance of the FTSE All Share Index since 2000. The DJSI World has performed more poorly than the benchmark Dow Jones Global Index since its inception in 1999, but much of this difference can be traced to the relative size of the two indexes. The DJSI World consists of only 250 companies, while the DJ Global comprises 5,029, making the former much less diversified and therefore more susceptible to changes in the market valuation of any one firm. It is also overweighted in large-capitalization stocks and growth companies, and it adds and deletes companies more frequently than do most indexes: in 2002 it replaced more than seventy companies, nearly one-quarter of its portfolio. Although the performance of the DJSI World index is often taken as evidence for or against the financial case for SRI, the lack of comparability between it and the DJ Global Index renders any such assessment problematic. Alois Flatz, its former research director, cautions: “It is premature to draw definitive conclusions regarding the business case for sustainability. . . . A much longer time frame is needed to attribute index or fund performance to particular sustainability criteria or strategies.59 As in the case of the Domini Social 400 and DJSI World, much of the relative performance of SRI mutual funds and indexes is affected by the performance of the industries in which their investments are concentrated.60 For this reason, in some years they have outperformed their mainstream counterparts and in other years have lagged behind them. For example, during the latter part of the 1990s, many social funds showed relatively strong returns due to their heavy exposure in financials, “clean” technology, health care, media, and communications. But their performance was then negatively affected when the value of many of these firms declined. In addition, social investors are not free from the fads that affect all other investors.61 In Britain during the late 1980s there was considerable excitement about the financial prospects of “green” companies, and a “green index” of thirty companies involved in environmental services increased in value from 100 to 147 in just five months. This green euphoria, however, could not be sustained, and over the next five years the index steadily underperformed the FTSE All Share Index. A similar development occurred in the United States, where the fifty worst mutual funds listed by the Wall Street Journal in 1993 contained a number of environmental funds, most of them involved in environmental remediation. 36 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. More recently, a study by researchers at Erasmus University found that firms selected by the New York investment firm Innovest on the basis of their “eco-efficiency” commanded an impressive 6 percent premium over their “worst-in-class” counterparts between 1995 and 2002; and State Street Global Advisors reported in 2004 that Innovest’s eco-efficient companies had outperformed the S&P as a whole by roughly 7 percent compounded annually. State Street plans to launch a fund based on the Innovest strategy.62 It remains to be seen how successful this investment strategy will prove. The performance of specific ethical funds has varied as widely as that of any other kind of fund. For example, the well-managed Parnassus Fund outperformed the S&P 500 from 1998 through 2002; the Calvert Fund trailed the S&P by a substantial margin every year between 1993 and 1998, though its performance improved after it hired a new manager. 63 During the five years before July 31, 2004, the annual return of the ten largest socially responsible mutual funds reported in the Social Investment Forum ranged from 24.68 percent (Bridgeway Ultra Small Company Tax Advantage), 7.85 percent (Ariel Appreciation), and 7.58 (Parnassus Equity Income), on one hand, to 2.44 percent (Pax World Balanced), .05 percent (Calvert Social Investment Balanced A), and –7.30 percent (Dreyfus Premier Third Century), on the other. While there continues to be debate over whether the use of negative screens by virtually all SRI funds increases risk or lowers returns (or both), or alternatively, whether socially screened investments are less volatile and result in higher returns, the consensus of the more than 100 studies of social investment funds and their strategies is that the risk-adjusted returns of a carefully constructed socially screened portfolio is zero.64 In other words, share returns are neither harmed nor helped by including social criteria in stock selection. This explains why SRI investment vehicles have recently grown in popularity in both the United States and Europe: there appears to be little cost associated with making such investments. But it also undermines the frequent claim that more responsible firms, at least as assessed by SRI fund managers and researchers, perform better. It also explains why the funds that manage 98 percent of investments in mutual funds in the United States continue to pursue other investment strategies, none of which is necessarily any better or worse. Ironically, if more socially responsible firms did systematically perform better, we would expect all fund managers to heavily weight their portfolios with those firms’ securities. This would both erase all differences in is there a business case for virtue? 37 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. financial performance between socially responsible and “normal” funds and raise the price of the shares of more responsible firms so as to reduce the return from future purchases of them. Still, if the financial markets undervalue corporate social performance, then more responsible investors might in principle be able to earn higher returns when the financial consequences of responsible or irresponsible behavior eventually affected earnings. But there is no persuasive evidence that the market does so. Some advocates of SRI continue to claim that socially informed investment funds will perform better because their managers are more aware of the significance of corporate social and environmental policies on longterm financial performance.65 As one environmental foundation writes: “We believe that we are once again on the cusp of redefining the responsibilities of a prudent fiduciary—this time to recognize that improving environmental performance is a primary pathway to increasing shareholder value.”66 Its claim is that, as an environmentally conscious investor, it possesses insights into the long-term financial benefits of corporate environmental efforts, which more conventional investors have overlooked. That such claims have not yet been validated does not mean that they never will be. But there is reason to be skeptical. For this claim cannot rest on an investor’s ability to accurately measure current corporate environmental practices. It must be based on an ability to predict future corporate environmental practices, or more precisely, the relationships between current and future corporate environmental practices and between those practices and current and future environmental pressures and opportunities. But how can anyone know which environmental issues will become politically salient or whether a firm that has successfully addressed environmental issues in the past will also manage them well in the future? Such uncertainties about future financial performance are no different from those that confront any investment strategy. In this context it is worth recalling that the social investment community was no more able than any other investors to identify the failures of corporate governance that created such massive shareholder losses at the beginning of the twenty-first century. Enron, WorldCom, Adelphia, and Healthcare were all widely held by SRI funds. Enron was widely respected for its CSR: it was ranked one of the 100 best companies to work for; received several environmental awards; issued a triple-bottom-line report; established a social responsibility task force; developed codes of conduct covering security, corruption, and human rights; supported progressive climate change policies; and was known for its generous philanthropic 38 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. contributions. These practices, which led a number of SRI funds to include Enron in their portfolios, did not make Enron a sound investment. And Shell, whose environmental and human rights initiatives led it to be included in many SRI portfolios, also did not turn out to be a prudent investment when in 2004 it was revealed to have falsified the amount of its oil reserves. The Dubious Claims for Socially Responsible Investing Implicit in the very existence of SRI is the claim that it is possible to identify which firms are more or less responsible. Not only is this claim questionable, but the selection criteria employed by SRI fund managers and researchers can be criticized on several grounds. First, questions have been raised about both the information that fund managers rely on to make investment decisions and the consistency of the criteria they employ. According to a study of eight of the most prominent funds, “Sources of social information used varied widely from fund to fund with data provided by firms themselves being the most frequently used.”67 While all investors depend heavily on corporate self-reporting, the shortcomings of corporate financial reporting pale when compared with those of corporate voluntary disclosures of nonfinancial performance, in part because, with one rare exception (discussed in chapter 4), there have been no legal penalties for providing incomplete or misleading information. Another common source of data, articles in the business and popular press, may reflect the effectiveness of a firm’s public relations, or that of its critics, rather than its actual behavior. Moreover, many SRI fund managers use screening methodologies that are proprietary and thus they cannot reveal why a particular firm is excluded or included. A second criticism focuses on the criteria employed by SRI funds to determine corporate “irresponsibility.”68 Tobacco and alcohol are the two negative screens American funds use most often. The reasons for the former are relatively straightforward, but the latter is more problematic: why should a firm automatically be considered irresponsible because it produces or distributes wine, a product that shareholders in ethical mutual funds are as likely to enjoy as any other group of investors? More substantively, many funds restrict or prohibit investments in firms that produce military equipment or nuclear power. But should such firms be considered “irresponsible” in light of the fact that the former may contribute to legitimate national security needs and the latter may contribute is there a business case for virtue? 39 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. to reducing carbon emissions? Despite all their claims to be on the cutting edge of changing public expectations of business, no fund has relaxed its exclusion of military contractors since September 11. SRI has also been criticized for being too inclusive. According to a survey of more than 600 SRI funds, by Paul Hawken, more than 90 percent of Fortune 500 companies are included in at least one SRI portfolio. Hawken argues that the selection criteria employed by many social funds allows virtually any publicly held firm to be considered responsible. The most widely held firm by socially responsible investment funds is Microsoft, a firm that Hawken criticizes for “its ruthless, take-noprisoners management tactics,” as well as for antitrust violations in both the United States and Europe. (According to Calvert, “aside from its [Microsoft’s] legal troubles, the company has a number of exemplary practices with respect to workplace issues, international operations and human rights.”)69 Hawken is also critical of the social and ethical practices of other firms that feature prominently in SRI portfolios, including WalMart (held by thirty-three SRI funds), Halliburton (held by twenty-three funds), and ExxonMobil (held by forty funds). Finally, the emphasis many funds place on competitive rates of return renders problematic a critical raison d’être of social investment, namely that social responsibility pays. These funds typically apply their social attributes or yardsticks only after firms have been screened by normal financial criteria. The result may be the exclusion of investments in firms whose social performance is outstanding or highly innovative, but whose financial prospects are uncertain or modest. An innovative or pioneering firm that has chosen to sacrifice short-term profits in the pursuit of social goals thus might not be owned by many socially responsible funds. This may be counterproductive from the perspective of promoting more responsible corporate behavior, and it also calls into question the popular claim that being more responsible can and should make a firm a better investment. These criticisms suggest that even if SRI funds were to consistently outperform nonsocially screened portfolios (which there is little evidence that they do), it is unclear what this would prove about the relationship between corporate responsibility and profitability. Are Virtuous Firms Built to Last? CSR advocates assert that while CSR may not affect short-term earnings or share performance, in the long run the more responsible firms will 40 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. perform better. One way of investigating this assertion is to examine the social performance of companies that have performed extremely well financially over an extended period of time. Consider, for example, the U.S.-based firms included in the 1994 bestseller Built to Last on the basis of their having attained “extraordinary long-term performance.” According to its authors, James Collins and Jerry Porras, these firms are “more than successful. They are more than enduring. In most cases, they are the best of the best in their industries, and have been that way for decades.”70 The firms that meet their criteria are 3M, American Express, Boeing, Citicorp, Ford, General Electric, HewlettPackard, IBM, Johnson & Johnson, Marriott, Merck, Motorola, Nordstrom, Philip Morris, Procter & Gamble, Sony, Wal-Mart, and Walt Disney. To this list of distinguished financial performers we can add the companies featured in the sequel Good to Great published in 2001, whose cumulative stock return was 6.9 times that of the market as a whole. These firms are Abbott, Circuit City, Fannie Mae, Gillette, KimberlyClark, Kroger, Nucor, Philip Morris, Pitney Bowes, Walgreens, and Wells Fargo. Some of these twenty-eight firms do enjoy reputations for exhibiting above average levels of CSR on some dimensions, including American Express, 3M, Hewlett-Packard, IBM, Johnson & Johnson, Citicorp, and Merck. And it is possible that their social responsibility has contributed to their above average financial performance during the time frame considered in the two best-sellers, though it is unlikely to have been critical to it. But no one would confuse all or even most of these companies with firms that are also leaders on many dimensions of CSR. (Note that the only company featured in both studies is Philip Morris.) It is true that these firms have been built around values, visions, and goals other than profit maximization, and, according to Collins and Porras, these factors have contributed to their financial success. But only in a few instances do these values have anything to do with social responsibility. Social responsibility and irresponsibility may well matter, but their impact on the long-term financial performance of companies is typically dwarfed by a host of other factors. Particular firms succeed or fail for many reasons, but exemplary or irresponsible social or environmental performance is rarely among them. And there is no evidence that the relative importance of CSR to financial success is increasing for most or even many companies. For all the claims that being responsible is a necessary condition for long-term business success, what is striking is how is there a business case for virtue? 41 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. few responsible firms have been “built to last.” There are certainly firms that have been both relatively profitable and responsible over more than one or two decades, but the list is not long. More important, it does not appear to be growing. It is of course possible that in ten years the number of financially successful “responsible” companies will be much larger. But the historical record to date gives few grounds for such optimism. During the 1970s, lists of the most socially responsible firms would have included Atlantic Richfield, Control Data, Cummins Engine, DaytonHudson, Levi Strauss, and Polaroid.71 Polaroid filed for bankruptcy in 2001. In 1992, Control Data, faced with losses that at one point totaled more than $1 billion, was divided into two companies; its CSR practices are no longer distinctive. Dayton-Hudson barely survived a hostile takeover in the 1980s, and Levi Strauss’s sales have been declining since the mid-1990s, forcing it to abandon its prior commitment to source some of its products from domestic manufacturers. Cummins Engine has survived—and prospered—but competitive pressures have forced it to abandon many of its highly paternalistic employment policies and the community contributions that made it socially distinctive. In 1999, Atlantic Richfield was acquired by British Petroleum as part of a general consolidation of the oil industry. Merck, a firm widely recognized for its decision in the 1980s to develop and distribute without charge a drug for river blindness and more recently for its work with the Gates Foundation to make AIDS drugs available in Botswana, began experiencing declining profits and an underperforming stock price after 2000, leading some analysts to question the continued validity of George Merck’s celebrated 1950 credo: “Medicine is for the people. It is not for the profits. The profits follow.”72 (The firm’s financial difficulties predated but were exacerbated by its withdrawal of the painkiller Vioxx from the market in late 2004.) The retailer Marks & Spencer (M&S) has long enjoyed a reputation as one of Britain’s most virtuous companies. It has been a highly benevolent employer and for many years had a policy of selling only British-made goods. In July 2004 Business in the Community, a prominent British NGO, named M&S company of the year for putting responsible business practices at the heart of its strategy and for producing “measurable, outstanding positive impacts on society.”73 The Dow Jones Sustainability World Index rated M&S “the most sustainable retailer in the world” in 2002 and 2003, and a survey of worldwide labor standards carried out by Insight Investments and Accountability gave the firm its top ranking.74 But 42 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. in the same month it received its CSR award, M&S attracted a hostile takeover bid made possible by the firm’s recent poor earnings and poorly performing share price.75 Although the investor attempting to take over M&S had promised to continue the firm’s progressive policies, and the takeover bid was ultimately unsuccessful, the juxtaposition of these two events prompted a column in the Financial Times, which noted: The battle for CSR has to be won in an environment more hostile than many of its proponents appreciate. . . . CSR is best seen as the management of risk, as the avoidance of damages to the company’s reputation. But it is no substitute for the avoidance of the larger risk: that consumers may go elsewhere because the company’s offering is not good enough. As models we need companies whose risk management has made them commercially successful. CSR is only as sustainable as the companies that practice it.76 Another journalist concluded that M&S showed that “being a good corporate citizen has nothing to do with being profitable,” an appraisal apparently confirmed by a contemporary survey of London financial analysts, which found “that they placed most corporate responsibility issues well down their list of company concerns.”77 Competitive pressures have also forced M&S to abandon its “buy British” policy. During the late 1990s, Chiquita Brands International (an outgrowth of the United Fruit Company), which produces a quarter of the world’s bananas and is the largest agricultural employer in Latin America, implemented a highly innovative program aimed at improving the environmental practices of its growers in Central America; more than 79 percent of its independent suppliers have been certified by the Rainforest Alliance. The funds spent by the company to bring its farms up to the Rainforest Alliance’s environmental standards have resulted in considerable cost savings by reducing pesticide use and recycling the wooden pallets used to transport the fruit. Nonetheless the firm was forced to declare bankruptcy in November 2001.78 Some of the recent generation of ethical business “icons” have not fared any better. Both the Body Shop International and Ben & Jerry’s had strong financial results for several years. Yet both began to experience financial difficulties in the late 1990s. Pressures from investors relegated founder Anita Roddick to an advisory nonexecutive role at the Body Shop, and in 2000, Ben and Jerry’s, faced with a highly undervalued share price and declining profits due to a series of management failures, was is there a business case for virtue? 43 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. taken over by Unilever. The carpet manufacturer Interface, whose chief executive, Ray Anderson, was called “the green CEO” and whose environmental practices have been described as “leading the way to the next frontier of industrial ecology,” has been unprofitable since 2000.79 In 2001 it consolidated its services operations, exited the broadloom market in Europe, and cut about 10 percent of its workforce, making further cuts the following two years. Notwithstanding Hewlett-Packard’s widely applauded CSR initiatives under CEO Carly Fiorina, the firm’s disappointing financial performance forced her resignation in 2004. The more responsible firms, no less than the less responsible ones, must survive in highly competitive markets. Consumers can choose to purchase pharmaceutical products, household products, ice cream, herbal tea, clothes, jeans, computers, or body care products from many companies. Socially responsible firms, like all other firms, are subject to the vagaries of shifting consumer preferences and poor management. And when such firms find themselves in financial difficulty, many of their distinctive CSR practices can become more difficult to sustain. The less-than-strong financial performance of many firms with strong CSR reputations hardly suggests that such firms represent the wave of the future. Rather it says that while the business system has a place for socially responsible firms, this place is at least as precarious and unstable as for any other kind of firm. The market for social responsibility is dynamic. Some companies with strong CSR reputations are prospering (for example, Patagonia, Seventh Generation, Starbucks, Stonyfield Farm, Ikea, BP), while others are not (Levi Strauss, Merck, M&S, HP, Interface, Shell); still others perform well financially but have become less socially distinctive (Cummins Engine). At the same time, new relatively responsible firms continue to emerge, some of which will be financially successful and some of which will not. Proponents of CSR tend to view the dynamics of responsible business in evolutionary terms. Since they assume that only the most responsible firms can or will survive in the long run, they believe that over time there will be more responsible firms and fewer irresponsible ones—a kind of survival of the virtuous. However the dynamics of corporate responsibility are better understood in ecological terms. There is a market or ecological niche for the relatively responsible firms. But there is also a market or ecological niche for less virtuous ones. And the size of the former does not appear to be increasing relative to the latter. 44 is there a business case for virtue? Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved. Conclusion The belief that corporate virtue pays is both attractive and influential. It appeals to those who wish to encourage firms to become more responsible as well as to those who want to manage, and work and invest in, virtuous enterprises. It is also an important component of the business model of the SRI industry and informs much popular and academic writing on CSR. And it reflects the business reality that firms are under pressure to satisfy the financial markets by producing strong earnings. Unfortunately, a review of the evidence, including academic studies of the relationship between profitability and responsibility and the relative performance of SRI, finds little support for the claim that more responsible firms are more profitable. But this does not mean that there is no business case for virtue. It is rather to suggest that any such claim must be more nuanced. CSR does make business sense for some firms in specific circumstances. Exploring those circumstances in more detail is the focus of the next chapter. is there a business case for virtue? 45 Vogel, D 2006, Market for Virtue, Brookings Institution Press, Washington. Available from: ProQuest Ebook Central. [27 March 2017]. Created from unsw on 2017-03-27 04:09:12. Copyright © 2006. Brookings Institution Press. All rights reserved.