Legislating corporate social responsibility

Legislating Corporate Social Responsibility

Thomas A. Hemphill

T he proper role of the corporation in evaluating the efficacy of American society has re-emerged as a this and other proposals, a topic of national political debate. In a more fundamental ques-

speech last year at George Washington Univer- tion needs to be ad- sity’s School of Business and Public Management dressed: What is this con- in Washington, D.C., Secretary of Labor Robert cept of corporate social Reich called for a “new corporate citizenship” responsibility? making firms responsible for the social costs and benefits of economic change. As an economic Defining Corporate incentive to encourage corporations to be more Social Responsibility employee-sensitive, he suggested a reduction, or elimination, of corporate taxes for qualifying Nobel Prize-winning firms. A qualifying firm, said Reich, would be one economist Milton Fried- that contributes 2 percent or more of total pay- man, in a widely refer- rolls to upgrading general skills and provides enced 1970 New York decent pension and health benefits, profit sharing, Times Magazine article, layoff training, and outplacement. As a market offered perhaps the most disincentive to less employee-sensitive corporate famous definition of corporate social responsibil- behavior, Reich suggested that firms that failed in ity. According to Friedman, the responsibility of a their responsibility to maintain jobs should pay corporation is “to conduct the business in accor- extra taxes. The Secretary even discussed creating dance with [owners’ or shareholders] desires, a “corporate hall of shame” for the most egre- which generally will be to make as much money gious socially irresponsible companies. as possible while conforming to the basic rules of

In Congress, Senate Democrat Edward M. society, both those embodied in law and those Kennedy, using a “carrot-and-stick” approach, embodied in ethical custom.” This definition is called for tax incentives to be offered to corpora- based on the economic concept of market value tions creating and preserving American jobs, and maximization that underpins shareholder capital- tax assessments and other penalties for compa- ism. Critics of shareholder capitalism regularly nies closing U.S. plants and moving production use Friedman’s definition as the example of a facilities offshore. The Massachusetts senator also limited view of corporate responsibility. suggested possible legislation requiring firms to A contrasting view is offered by the Business file formal reports on their social responsibility Roundtable, an organization that examines public efforts and giving those sensitive to employee policy issues related to the economy and develops needs preferences in federal contracting. positions on these issues. In 1981, the Roundtable

Congressional Democrats have chosen a issued a “Statement on Corporate Responsibility” more comprehensive strategy than the proposals calling for business to “serve the public interest offered by Senator Kennedy. A Senate task force as well as private profit.” Known as stakeholder is floating a legislative policy proposal that would capitalism, this view holds that the corporation offer corporations a variety of economic incen- should balance the legitimate claims of all seven tives for implementing business policies that ex- constituent groups that have an interest (“stake”) hibit a heightened concern for the well-being of in or relationship with the firm: customers, em- employees, communities, and society. But before ployees, financiers, suppliers, communities, soci-

Legislating Corporate Social Responsibility 53

ety at large, and shareholders. Customers, according to the Roundtable, have a primary claim on the attention of corporate management. Share- holders, however, are viewed as providing risk capital. This approach differs sharply with the Friedman definition of shareholders as the princi- pals who are the primary beneficiaries of market value maximization.

Corporate social responsibility, then, has wide variations in its definition. The variations are based on the extent to which a firm stretches its acceptance of responsibilities beyond its primary role as an economic institution to include social duties. On one hand, a limited, efficiency view of corporate social responsibility is the stockholder model espoused by Friedman; on the other hand, the stakeholder model of the Busi- ness Roundtable represents a wider, systemic view of the economic and social responsibilities of the corporation.

A Public Policy Proposal: The A-Corp

In February 1995, a task force of Senate Demo- crats was charged by Senate Minority Leader Tom Daschle (D-SD) to develop a set of public policy proposals to “help America’s working families.” A year later the task force, chaired by Senator Jeff Bingaman (D-NM), presented to a forum of Sen-

ate Democrats the detailed legislative plan. It would pro- vide incentives for corporations to be- have more “respon- sibly toward their employees, their communities, and the country as a whole.” The proposal was based on the belief that to compete in a highly competitive, global

economy, businesses and employees need to be allies to successfully execute corporate strategies. To accomplish this goal, the task force proposed a comprehensive set of economic incentives with which a qualifying “Business Allied with Amer- ica’s Working Families,” or “A-Corp,” could avail itself. These incentives would include favorable tax, regulatory, and government contract preferences.

To qualify as an A-Corp, a business would be evaluated annually by the federal government on the following criteria:

l contributing an amount equal to at least 3 percent of payroll to a pension plan;

l devoting an amount equal to at least 2 percent of payroll to employee training or education;

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l offering and paying at least half the cost of a health care plan to all its American employees;

l operating a profit-sharing, gain-sharing, or stock plan for its American workers in which 50 percent or more of them participate;

l ensuring that the total compensation of the highest paid employee is no greater than 50 times the compensation of the lowest paid, full-time employee;

l ensuring that at least 50 percent of all new investment in R&D occurs in the United States, and that at least 90 percent of all new investment in plant, equipment, and employment used to produce goods consumed in the United States is directed here; and

l maintaining an above-average occupational safety and environmental compliance record.

The benefits accruing to an A-Corp would be substantial. Businesses that qualified would be assessed a significantly lower corporate income tax rate (say, 11 percent) than a non-qualifying business (say, 18 percent). Regulatory relief for a qualified A-Corp would include speedier federal agency review and decision-making, participation in voluntary compliance programs, and access to newly created “safe-harbor” exemptions from certain regulatory requirements. Qualified A- Corps would also be entitled to a strong prefer- ence (10 percent cost advantage, set-asides, and so on> when competing for federal government contracts, awards, and other programs in which businesses are allowed to participate.

To encourage corporate long-term investment in employees and discourage the enormous pressure brought to bear on American business to produce short-term profits, the task force proposes creating a disincentive for the “churning” of securities by levying a tax of less than 0.5 percent on the sale of securities purchased within a two-year period. The securities would include corporate stocks and bonds, Treasury bills and bonds, futures, options, and swaps of currency, interest rates, or assets. The rate of tax assessed when a security is sold would be prorated in six- month increments, with the highest rates applied in the first six months and lowest rates applied in the last six months. Proceeds of the tax would be dedicated to an “A-Fund,” which would offer deductions for higher education and skill training, tax credits for dependent children, and money for work force training, educational goals and standards, technological R&D, and export promotion.

The task force proposal contains qualifying provisions that closely resemble business and public policy goals suggested by Labor Secretary Robert Reich. Reich characterized the task force’s product as “a very interesting proposal”; the White House’s response to it was restrained. Ac- cording to Laura Tyson, chief economic adviser,

Business Horizons / March-April 1997

President Clinton’s approach is to use the office of the presidency to challenge American businesses to be good corporate citizens, not legislate their behavior. With that philosophy in mind, President Clinton delivered a March 1996 speech at Xavier University in Cincinnati, Ohio in which he cited United Technologies, Harley-Davidson, Starbucks, Procter & Gamble, Motorola, Harman International, and Xerox as firms that have insti- tuted socially responsible policies that should be emulated by other companies.

In May 1996, President Clinton sponsored the White House Conference on Corporate Citizen- ship held at Georgetown University in Washing- ton. Panelists representing some 60 major corporations and small businesses discussed examples of good corporate responsibility policies toward American workers and communities. The Confer- ence revolved around what Clinton characterized as the “five principles of corporate citizenship”: 1) a family-friendly workplace; 2) health and retirement security; 3) a safe and secure workplace; 4) employee education and training; and 5) a workplace partnership between employer and employees. The President also announced the creation of the “Ron Brown Corporate Citi- zenship Award,” in honor of the late Secretary of Commerce, to be presented annually by the President to a company best exemplifying these principles.

The Best Intentions/The Wrong Solution

The Bingaman proposal focuses on corporate social responsibility toward one internal stakeholder of the company: the employee. Senator Bingaman proposes using voluntary economic incentives (and one voluntary financial market disincentive) to alter corporate behavior toward employee pension plans and health benefits, education and training, salary structure and profit sharing, occupational safety and health, and R&D and capital investment. But is this the appropriate form of social responsibility to encourage in an economy going through structural transformation? No, and for several reasons.

The Bingaman proposal offers a reduced corporate income tax rate for the A-Corp. Accord- ing to the definition of “corporate welfare” offered by the libertarian Cato Institute, a public policy “think tank” in Washington, such a prefer- ence would be considered a loophole in the tax code carved out solely for the benefit of a particular company or industry, In the Bingaman proposal, the reduced corporate income tax rate would be targeted to a particular class of business. And regulatory and federal government procure- ment preferences-both forms of discriminatory “market distortions”-would be viewed unfavor- ably by firms unable to avail themselves. How-

ever, the Clinton administration might support this tax subsidy approach; it is not opposed to all corporate subsidies, only those not serving a “broader public benefit” or passing a rigorous cost-benefit analysis.

The reduced level of actual federal corporate income taxes paid by corporations today means that the reduced tax rate offered to an A-Corp is a less effective economic incentive for encouraging socially responsible behavior. To support this con- tention, the share of total federal taxes paid by corporations has diminished from over 37 percent in 1957 to less than 12 percent in 1995. In addition, with the corporate tax rate further reduced under the Bingaman proposal, the average taxpayer would be held responsible for filling the federal tax revenue vacuum.

What corporations will qualify as an A-Corp under this proposal? Those companies that are presently meeting or can easily adjust their business operations to meet the qualifying criteria. Smaller firms lacking the financial resources to qualify will simply be placed in an even more adverse competitive position in their industries. Because of its comprehensive qualifying criteria, this proposal’s negative impact on small businesses and entrepreneurs unable to meet the financial demands of inclusion could be particu- larly harsh. This, in turn, could reduce hiring in the sector of the American economy responsible for generating up to 90 percent of new employment. The end result? Companies presently operating as socially responsible organizations will be the recipients of “windfall” economic incentives.

Implementing this A-Corp proposal will also require an expanded federal bureaucracy to review the thousands of annual corporate applica- tions submitted for review. With both Congres- sional Democrats and Republicans agreeing on a reduction in the size of the federal government, and the Clinton administration trumpeting a reduction of nearly 250,000 federal employees on its watch, it is highly unlikely that such a bureau- cratic expansion would be viewed favorably by the powers that be.

How based in reality are the qualifying criteria used in the Bingaman proposal? Consider compensation as an example. The ratio of the highest paid to lowest paid employee can be no more than 5O:l. But according to Graef S. Crystal, an internationally renowned compensation ex- pert, the ratio of the pay of a typical U.S. CEO to


that of a typical employee (and not the lowest paid one> is 12O:l. The average salary and bonus paid to CEOs of the nation’s largest corporations rose 15 percent in 1995 to more than $2 million. But for the nation’s work force, wages and benefits barely kept up with inflation last year at 2.8 percent. Compensation ratios presented by Crys- tal for the U.K. (33:1), Germany (21:1), and Japan

(l&l) would prob- ably qualify under the Bingaman proposal even if ad- justed for the lowest paid employee. But reducing U.S. CEO and senior- level management salaries by more than 60 percent, on average, would appear to be a Draconian re-

sponse to qualify as an A-Corp. A more realistic measure would be to concentrate the qualifying criteria on a comparison of the average employee wage in the applying company compared to a reasonable living wage standard.

Once this corporate social responsibility proposal is introduced as legislation, a political Pan- dora’s box will be flung open. Committee hear- ings will be immersed in endless controversy over public policy questions: Are the proposed qualifying criteria the most appropriate? Are the quan- titative “hurdles” attached to each criteria repre- sentative? What about adding other socially responsible criteria to qualify as an A-Corp, such as environmental protection or employee diversity? After this proposal is codified, will flexibility to adjust the qualifying criteria to reflect changing societal priorities and expanding knowledge be lost because of the time-consuming difficulty to amend legislation? A political quagmire awaits this proposal in the halls of Congress.

Finally, the less than 0.5 percent disincentive tax to discourage rapid turnover of securities is a solution in search of a problem. According to the task force report, the purpose of the tax is to encourage well-informed investments in corporate securities followed by sustained support of the securities over some reasonable investment time period. This purpose assumes that capital markets are not currently functioning in a SOCtilly

efficient manner and that investors are not making informed decisions when buying and selling securities. Such a value judgment, however, is not shared by most participants in financial markets, who are responsible for exerting market discipline through their buy-and-sell decisions. So small a tax likely would not have much market-distorting impact on investors’ decisions to sell. If it did, it

would be counterproductive to the primary purpose of the proposal: to generate new sources of tax revenue to support proposed education tax deductions, tax credits for dependent children, and federal government “corporate welfare” programs aimed at export promotion.

Neither the libertarian view espoused by Friedman nor the comprehensive, government intervention approach of the A-Corp offered by Senate Democrats has political viability in Wash- ington’s current political environment. Establish- ing rigid legislative criteria of what is socially responsible corporate behavior, as in the Binga- man proposal, has a multitude of economic and political weaknesses that may do greater harm than good. Corporate social responsibility can be accomplished through a more ideologically “flexible” approach incorporating a variety of business and public policy instruments. This flexible ap- preach-ne that emphasizes targeted legislative inducements-is cognizant of the effect of market distortion on the economy, encourages corporate innovation, is employee empowering, and hdS

the potential to offer more effective assistance to corporations, workers, and society.

A Revised Social Contract

The contract between business and society has evolved from the traditional view (Friedman’s minimalist view)-that economic growth was the source of all progress, social and economic-to one holding forth an organizational imperative to work for social as well as economic improvement (the stakeholder view). This latter, expanded meaning of corporate social responsibility included an implicit, informal social contract between the corporation and its employees. Em- ployee obligations included satisfactory atten- dance, acceptable levels of effort, and loyalty; employer obligations included “fair” (competitive) pay and fringe benefits, advancement based on seniority and merit, and job security. But according to Chilton and Orlando (19961, this informal social contract between employers and employees is now breaking apart under the stress of economic transformation.

Economic analysts have identified a coterie of factors responsible for the restructuring of the American economy:

l The information age has allowed computer technology (“capital”) to become an efficient substitute for labor.

l Widespread economic deregulation in the 1980s has enhanced domestic competition among many American industries.

l Global competition from increasingly com- petent foreign adversaries coupled with the con- tinued relaxation of trade barriers has intensified market pressure on American corporations.

56 Business Horizons / March-April 1997

l A strong U.S. currency in the 1980s allowed foreign firms to expand product market share domestically.

l The immigrant work force, both legal and undocumented, have increased the available labor supply.

l Contracting and outsourcing the work force has eliminated many full-time jobs.

l Pressures exerted by institutional shareholders to maximize short-term return and profitability as the primary, if not sole, objective of the firm have emasculated other stakeholder interests.

A revised social contract between management and employees needs both specific legislative remedies and innovative corporate investment in employee well-being. To accomplish this immensely important goal, the following business and public policy strategies are offered to guide the national debate.

1. Portable health care and pension benefits. The reality of the American labor market is that employees now move from company to company to improve their economic standing. This practice has become universally accepted and reflects a growing identification by white- collar workers with their profession, rather than with one organization. Federal health care legislation recently signed into law allows workers to maintain health insurance coverage if they change or lose their jobs and effectively bars insurance companies from denying coverage to people who have pre-existing coverage. Al- though the legislation requires companies to offer the same access to coverage for people with pre- existing conditions that they offer to the general public, it does not set price limits on individual policies or guarantees that premiums will be affordable. This flaw needs to be addressed through supplementary legislation, or effective health care portability will still continue to be limited for many workers.

Another innovative approach to reintroduc- ing market forces to health care is the Medical Savings Account (MSA).* The MSA is essentially a combination of a catastrophic plan with a high deductible and an employer-provided account for first-dollar health expenses. The advantages to this approach are that employees are careful about spending their own money, so employee expenses for health insurance are reduced and the cost of administering an MSA should be con- siderably lower than with a traditional plan. The federal health care portability legislation contains a provision allowing small businesses or the self- employed to establish MSAs. Experiences with this limited use of MSAs, it is hoped, will verify

*Editor’s note: For an in-depth exploration of MSAs, see Bond, Heshizer, and Hn’vnak’s article on them in the July-August 19% issue of BH.

the efficacy of this approach and allow for legislative expansion to the rest of the economy.

Pension portability haslyet to be addressed legislatively. Current pension vestment in the private sector is five years; in the public sector, it is ten years. Increased flexibility is needed to allow pensions to be carried from company to company with a shorter time frame for vesting. Last September the Clinton administration announced two steps the U.S. Department of the Treasury would take administratively to enhance pension portability. The first initiative removes barriers to workers rolling retirement savings into the pension plans of new employers. The second measure allows departing or retiring workers who choose to leave their 401(k) or other savings plan with the employer to have some investment choice other than money market funds.

2. Employee education, retraining, and family assistance. Employees need to take, and are increasingly accepting, greater responsibility for their own futures. Individual education accounts, with match- ing contributions by $0#Yc#~ cW?;tvacf employers (who are then eligible for federal tax credits), can be used by employees for lifetime learn- r ing experiences. The federal government can further encourage formal learning experiences by liberalizing the present personal-mcome tax deductibility of a range of graduate and postgraduate certificate programs in management, engineering, and applied sciences.

Results of a recent American Management Association survey of 1,003 large and mid-sized corporations showed that companies that increased their training budgets after announcing layoffs were twice as likely to report profits and productivity as the firms that did not invest more in training. Among those that expanded training (which included General Electric, Xerox, NYNEX, Anheuser-Busch, Motorola, and Arthur Andersen), an impressive 79 percent improved long-term profits and 70 percent raised productivity.

Strengthening families is another area of concern for employees. Family-related problems can adversely affect absenteeism, job turnover, and productivity on the job. AT&T, whose management has been demonized in the media for its massive layoffs, is a model for offering employees a menu of programs that address their family concerns: child and elder care resource referral services, leaves of absence for newborns and the newly adopted, and time off for family care.


3. Compensation and capital markets. Executive compensation has been a contentious issue in the new era of corporate “downsizing.” Should the compensation ratio between the highest paid and lowest paid employee exceed a 5O:l ratio? CEO compensation is managed through the corporate governance mechanism of the firm. Therefore, the decision on a compensation pack- age should continue to reside with the board of directors, One suggested federal government disincentive to discourage “exorbitant” CEO compensation packages could involve eliminating the tax deductibility of executive salaries above the Bingaman proposed “50” multiplier.

Capital markets, in the form of institutional investors, have placed intense pressure on corporations to show short-term stock appreciation and profitability. Unfortunately, when there are layoff announcements, stock prices often surge-at least for the short term. But according to a seven- year study of 25 large corporations published in 1995 by University of Colorado-Denver professors Wayne Cascio and James R. Morris (Lalli 1996), the average downsized company’s stock was up only 4.7 percent after three years, compared with a typical 34.3 percent increase for similar companies in the same field that did not reduce Staff to the same extent. The federal government could offer an incentive to encourage a longer-term market orientation in the form of a capital gains tax reduction. The financial market disincentive of a “nuisance” tax on short-term turnover of securities, if adopted, would need to be set higher than the Bingaman proposal to act as an effective deterrent.

A merican corporate management must recognize the real threats emerging from an increasingly angry middle class

that is seeing the “American Dream” slipping away in a sea of layoff notices. Market-distorting incentive and punitive legislation has ominously appeared on the public issue radar screen. The public images of many corporations have been tarnished by repeated announcements of massive layoffs and subsequent CEO bonuses for improv- ing the financial positions of their firms-at workers’ expense. This negative public percep- tion of singularly profit-motivated corporations is daily registering with more managers, directors, and stockholders.

The narrow definition of corporate social responsibility offered by Milton Friedman is no longer feasible. A business philosophy recogniz- ing the importance of stakeholders, especially employees and local communities, is necessary for the long-term economic success of the mod- ern corporation in American society. But it is also

an axiom that a firm must be fiscally responsible--competitive at producing its products and services-if it is to be socially responsible. In conjunction with specifically targeted federal legislation, each corporation must have the flexibility to choose the best combination of socially responsible policies for its workers based on employee needs and competitive conditions in the industry and the global economy. Choosing the right path of corporate social responsibility is no longer an option. It has become a moral, economic, and political necessity. 0

References

Senator Jeff Bingaman, “Scrambling To Pay The Bills: Building Allies For America’s Working Families,” Full Report, February 28, 1996.

Business Roundtable, “Statement on Corporate Respon- sibility,” New York, October 1981.

Kenneth Chilton and Michael Orlando, “A New Social Contract For The American Worker,” Business And Society Review, Winter 1996, pp. 23-26.

Graef S. Crystal, In Search Of Excess: 7&e Overcompen- sation OfAmerican Executives (New York: W.W. Norton and Co., 1991).

David Fischer and Kevin Whitelaw, “A New Way To Shine Up Corporate Profits,” U.S. News G World Report, April 15, 1996, pp. 54-55.

Milton Friedman, “The Social Responsibility Of Busi- ness Is To Increase Its Profits,” New York Times Maga- zine, September 13, 1970, pp. 32+.

Keith H. Hammonds, Wendy Zellner, and Richard Melcher, “Writing A New Social Contract,” Business Week, March 1, 1996, pp. 60-61.

Frank Lalli, “Why You Should Invest In Companies That Invest In Their Workers,” Money, March 1996, p. 11.

“Legislating Responsibility,” Harper’s, May 1996, p. 45.

Steven D. Lydenberg, Ron Carey, John McClaughry, Rosabeth Moss Kanter, and George Daly, “Can Corpo- rate Social Responsibility Be Legislated?” Business And Society Review, Winter 1996, pp. 4-10.

Bill Saporito, “Good For The Bottom Line,” Time, May 20, 1996, pp. 40-42.

Thomas A. Hemphill is a fiscal officer for the New Jersey Department of Envlron- mental Protection in Trenton, New Jersey.

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Legislating corporate social responsibility