Stephen M. Bainbridge

UCLA School of Law

Corporate Social Responsibility

The Policy Debate

“To qualify as socially responsible

corporate action, a business expenditure

or activity:

1. must be one for which the marginal

returns to the corporation are less

than the returns available from some

alternative expenditure,

2. must be purely voluntary, and

3. must be an actual corporate

expenditure rather than a conduit for

individual largesse.” Henry G. Manne (May 10, 1928 -

January 17, 2015) was an American

lawyer, writer and legal academic,

considered a founder of the law and

economics discipline.

What is corporate social responsibility?

Corporate directors and officers should consider not only the interests of the shareholders, but also recognize obligations to the community, to their workers, and to consumers

Why?

• Society allows corporations to become legal entities because they serve a purpose for the community and are not just a vehicle for financial gain by the shareholders.

• Social responsibility ultimately benefits shareholders.

– E.g., employee satisfaction leads to greater productivity and ultimately increased profits.

• Public opinion demanded social responsibility and the law must adapt to it.

E. Merrick Dodd (1918-1951) was

successively on the law faculties of

Washington & Lee, Nebraska, Chicago,

and, after 1928, Harvard University. He

wrote numerous and highly regarded law

review articles on corporations and

corporate finance. Dodd and his wife

died in an automobile accident in 1951.

E. Merrick Dodd, Jr., For Whom Are Corporate Managers

Trustees?, 45 Harv. L. Rev. 1145 (1932)

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Can it be true CSR if public opinions demands it?

Dodd said he “believes that public

opinion, which ultimately makes law, has

made and is today making substantial

strides in the direction of a view of the

business corporation as an economic

institution which has a social service as

well as a profit-making function, that this

view has already had some effect upon

legal theory, and that it is likely to have a

greatly increased effect upon the latter in

the near future.”

“Recent economic events suggest that

the day may not be far distant when

public opinion will demand a much

greater degree of protection to the

worker.”

Manne:

• “To qualify as socially responsible

corporate action, a business

expenditure or activity:

2. must be purely voluntary ….”

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Managers of a corporation should regard themselves as trustees of the investments made by the shareholders.

All powers given directors and officers therefore are to be used for the benefit of the shareholders.

Why?

• Managers who are responsible to everyone are responsible to no one.

– “The claims upon the assembled industrial wealth and funneled industrial income which managements are then likely to enforce (they have no need to urge) are their own.”

• Rights of shareholders as owners:

– “Either you have a system based on individual ownership of property or you do not.”

Berle was “a lawyer, educator, author, and

U.S. diplomat. He was the author of The

Modern Corporation and Private Property, a

groundbreaking work on corporate

governance, and an important member of

U.S. President Franklin Roosevelt's ‘Brain

Trust’.”

A. A. Berle, Jr., For Whom Corporate Managers Are Trustees: A

Note, 45 Harv. L. Rev. 1365 (1932)

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Dodd A.P. Smith Mfg. Co. v. Barlow, 98 A.2d 581 (NJ 1953)

“… public opinion, which ultimately makes law, has

made and is today making substantial strides in the

direction of a view of the business corporation as an

economic institution which has a social service as

well as a profit-making function …”

“The view that those who manage our business

corporations should concern themselves with the

interests of employees, consumers, and the general

public, as well as of the stockholders, is thus

advanced today by persons whose position in the

business world is such as to give them great power of

influencing both business opinion and public opinion

generally.”

“The only way to defend capitalism is through

leadership which accepts social responsibility and

meets the sound needs of the great majority of our

people.”

“Control of economic wealth has passed largely from

individual entrepreneurs to dominating corporations,

and calls upon the corporations for reasonable

philanthropic donations have come to be made with

increased public support.”

“ … just as the conditions prevailing when

corporations were originally created required that they

serve public as well as private interests, modern

conditions require that corporations acknowledge and

discharge social as well as private responsibilities as

members of the communities within which they

operate …”

“… corporations … now recognize that we are faced

with other, though nonetheless vicious, threats from

abroad which must be withstood without impairing the

vigor of our democratic institutions at home ….”

Dodd’s Influence

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“There is one and only one social

responsibility of business–to 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”

Milton Friedman (July 31, 1912 –

November 16, 2006) was an American

economist, statistician and writer who

taught at the University of Chicago for more

than three decades. He received the 1976

Nobel Memorial Prize in Economic

Sciences for his research on consumption

analysis, monetary history and theory and

the complexity of stabilization policy.

Milton Friedman, The Social Responsibility of Business is to

Increase its Profits, N.Y. Times Mag., Sept. 13, 1970

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“In a free-enterprise, private-property system, a corporate executive is an

employee of the owners of the business.

“He has direct responsibility to his employers.

“That responsibility is to conduct the business in accordance with their desires,

which generally will be to make as much money as possible while conforming

to the basic rules of the society, both those embodied in law and those

embodied in ethical custom.”

Friedman’s core argument

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Social responsibility

spends other

people’s money

Managers are not

elected experts

on social policy

CSR = socialism

Friedman’s case elaborated

A manager who spends money on socially responsible activities:

• Spends stockholders dividend

• Spends employees wages

• Spends customers money

“He becomes in effect a public employee, a civil servant, even though he remains in name an

employee of a private enterprise. … If they are to be civil servants, then they must be elected

through a political process.”

“… the doctrine of ‘social responsibility’ involves the acceptance of the socialist view that

political mechanisms, not market mechanisms, are the appropriate way to determine the

allocation of scarce resources to alternative uses.

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Friedman says that businesses are obliged to follow laws, rules, and regulations.

• Note: Some of these may incorporate social ends.

Friedman also says that businesses should adhere to generally accepted social

standards and expectations.

• He points out that if a corporation operates in violation of the moral standards and

expectations that are generally accepted in its society, it runs the risk of losing

business, which, of course, would decrease profit.

Friedman also recognizes that a short-term focus can undermine long-term gains

• Is there a real difference between corporate social responsibility and sustainable profit

maximization?

– “To qualify as socially responsible corporate action, a business expenditure or

activity:

1. must be one for which the marginal returns to the corporation are less than the

returns available from some alternative expenditure,

Does Friedman recognize any limits on pursuit of profit?

Edward, First Baron Thurlow

(1731-1806):

"Did you ever expect

a corporation to have

a conscience, when it

has no soul to be

damned, and no body

to be kicked?”

Is a manager really the agent of the individuals who own the

corporation?

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Private Property Model Nexus of Contracts Model

Private property and the corporation:

Is the corporation a thing capable of being owned?

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Board of Directors

Sha

re p

rice

info

rmat

ion

Quarterly rep

orts

Vo

tin

gp

ow

er

Dir

ect

co

nsu

ltati

on

Dividends

Corporation(management and

physical capital)

LendersEmployees

CustomersCustomers

Interest payments(market rates)

Suppliers

Labour

Inputs

Supervisory power

Board of Directors

Securities markets

SHAREHOLDERS

Vo

tin

gp

ow

er

Dir

ect

co

nsu

ltati

on

Corporation(management and

physical capital)

LendersEmployees

CustomersCustomer

Dept capitalWages

(market rates)

SuppliersNational &

Local

Government

TA

XE

S

PU

BLIC

GO

OD

S

Market price

Goods &

Services

Mar

ket P

rice

Institutional

Investors

Adapted from: M. Blair, Ownership and Control (1995)

Ownership

Control

Statement Implications

“A corporation is just a nexus of

contracts, subject to rearrangement

in many ways.”• Central States, Southeast and Southwest Areas

Pension Fund v. Sherwin-Williams Co., 71 F.3d

1338, 1341 (7th Cir. 1995)

Nexus of contracts theory visualizes the

firm not as an entity, but as an

aggregate of various inputs acting

together to produce goods or services. • The firm is seen as simply a legal fiction

representing the complex set of contractual

relationships between these inputs.

• In other words, the firm is treated not as a thing,

but rather as a nexus or web of explicit and

implicit contracts establishing rights and

obligations among the various inputs making up

the firm.

Nexus of contracts model allows

(requires) us to rethink intra-

corporate relationships• Ownership not meaningful concept in

contractarian theory

• Hence, control rights do not follow per se from

ownership of equity claims

Corporate Property Rights are

different from personal property.• Stockholder of a corporation have limited liability

for actions of their corporations.

• They have no direct rights of access/control.

The nexus of contracts model

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Green:

• “Eventually, we would expect the

elaboration of a body of law

establishing a slate of varied priorities

for corporate management. Within this

framework, shareholders would be

one stakeholder group among others.

Normally they would be regarded as

primus inter pares in the sense that

they have priority in day-to-day fiscal

decision-making. But their interests

might be explicitly subordinated in

cases in which certain kinds of serious

inconveniences or harms threaten

other stakeholders.”

Absent shareholder wealth maximization

norm, board lacks a determinate metric

for assessing options

Berle:

• “you cannot abandon emphasis on ‘the view that business corporations exist for the sole purpose of making profits for their stockholders’ until such time as you are prepared to offer a clear and reasonably enforceable scheme of responsibilities to someone else.”

Is Friedman right anyway?

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Is Friedman right anyway?

Absent clear standards, directors will be

tempted to pursue their own self-interest

Berle:

• Managers who are responsible to everyone are responsible to no one.

– “The claims upon the assembled industrial wealth and funneled industrial income which managements are then likely to enforce (they have no need to urge) are their own.”

Friedman:

• Managers would have no idea what to do.

– They have only their private beliefs, which is not at all the same thing as genuine social purpose.

– Moreover, each manager would have too small a view to expect his or her beliefs to be correct.

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Shareholders more vulnerable to board misconduct, but interest is less contractible

• Assume a solvent corporation able to pay its debts and other obligations (especially employee salaries) as they come due in the ordinary course of business.

• Further assume that the corporation has substantial free cash flow—i.e., cash flows in excess of the positive net present value investments available to the corporation.

• If the directors siphon some portion of the corporation’s free cash flow into their own pockets, shareholders are clearly hurt, because the value of the residual claim has been impaired.

• Yet, in this case, there is no readily apparent injury to the value of the fixed claim of all other corporate constituents.

All corporate contracts are incomplete,

but shareholder-board contract

especially gappy

• Fiduciary duties fill those gaps

Most stakeholder interests are relatively

more contractible

• “Arrangements . . . thoroughly

negotiated and massively

documented” (Katz v. Oak Indus.)

General welfare and special interest

legislation

Is Friedman right anyway?

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1.

2.

3.

Discussion questions

Friedman’s essay implicitly suggests a distinction between corporate

social responsibility and corporate stakeholder theory. Can you

describe that distinction? Why might that distinction matter?

Is Friedman correct that a legal person—what he calls an “artificial”

person—cannot have responsibilities? In other words, do only people

have responsibilities?

Why is appropriate for an individual to act responsibly but not

corporate directors, managers, or shareholders?

• Should managers have to check their ethics at the office door?

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