Friday, December 01, 2006

Corporate Social Responsibility: A Necessary Consequence of Market and Legal Failures

The recent passing of Nobel Prize winning economist, Milton Friedman, has provided the opportunity to review some of his ideas that have helped shaped the field of business and economics today. One of his ideas, that “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,” has been frequently commented on in the corporate social responsibility (“CSR”) debate.
Henry Manne, former dean of George Mason University School of Law, reaffirmed Friedman’s views on the topic in a WSJ op-ed. The crux of Dean Manne’s argument rests on his characterization of a business corporation as nothing more than a nexus of private contracts, transactions which invoke private property rights, the unassailable freedom to contract, and the right of immunity from public intervention. Dean Manne laments:

“Any large enterprise, no matter how competitive its industry and no matter how successfully it is fulfilling the public's desires, has a social responsibility--a term that makes mockery of the idea of individual responsibility--to use part of its resources for "public" endeavors…

‘How did this transposition from private to public responsibility come about? After all, even the largest corporation started simply as an idea in someone's head. At first this person hires employees, borrows capital or sells equity, produces goods or service and markets a product. Nothing about any of these purely private and benign arrangements suggests a public interest in the outcome. But then the business begins to grow, family stock holdings become more diffused, additional capital is required and, voilà, another publicly held corporation…

‘But what has happened to implicate public involvement in the management or governance of these enterprises as they grew from a mere idea? Nothing. And if that nothing be multiplied by tens or hundreds or thousands, the product is still zero. So where along the line to enormous size and financial heft has the public-private nexus necessarily changed? True, there are now a large number of complex and specialized private contracts, but every single one of these transactions is based on private property, freedom of contract, and individual risk and reward. If one apple is a fruit, even a billion apples do not become meat.”
The Rebuttal
As a threshold matter, I am not persuaded by the premise of Dean Manne’s arguments, that private contracts and private property are entitled to a shield against government or public intervention. Then again, this is not his premise alone, it is that of the entire University of Chicago Law and Economics tradition, of which both Friedman and Manne are a product of. There is a wealth of literature arguing both sides, so I will waste electrons rehashing old arguments.

More pertinently, Dean Manne's premise that public comapnies consist of a nexus of private contracts that do not invoke the public interest rests of shaky ground. To be fair, Dean Manne acknowledges that there are sometimes arguments under certain circumstances for placing social demands on companies; his criticism is that in today’s debate, CSR advocates are never held to task to assert such justifications, rather, they are taken as a given:

“No arguments, weak as they are, about natural monopoly, market failure, government creation of corporations or the alleged government gifts of limited liability and perpetual existence, are required to justify the demands now regularly placed on business entities. Any large enterprise, no matter how competitive its industry and no matter how successfully it is fulfilling the public's desires, has a social responsibility--a term that makes mockery of the idea of individual responsibility--to use part of its resources for "public" endeavors.”
Externalities and Market Failure
I’m just not sure what there is to “justify.” I take an environmental angle to this deabte: The very axioms of the field of ecological economics lie in the observation that neoclassical economics fails to take into account the finiteness of natural resources and the environment’s capacity to absorb pollution. The result is that a privately generated social cost is borne by the general public. This critique directly implicates every business in primary (resource extraction) and secondary (manufacturing) industry (and indirectly most tertiary and quaternary industries) and thus virtually all business activity. [For an excellent overview of the field of ecological economics, read Ecological Economics: Priciples and Applications, by Hermand Daly and Joshua Farley]

The False Dichotomy of Public versus Private Property
I also will question another of Manne’s assumptions, that if “one apple is a fruit, even a billion apples do not become meat.” My college science background and amateur familiarity of systems theory informs me of the phenomenon of non-linearity, which in basic terms stands for the observation that a whole system can sometime be greater (or less) than the sum of its individual parts. While non-linearity is a mathematical concept, it has far reaching applications to biological systems and climate, among others (indeed in Complexity Theory, the idea of emergence is a direct product of the phenomenon of nonlinearity). But let’s cut the technical mumbo jumbo. My point is that there is something about this legal fiction called corporations that give it such power, the growth and accumulation of which is non-linear.

The perpetual survival of corporations and the limited liability of their shareholders (i.e. shareholders are entitled to all the upside of their investments, but, subject to certain exceptions, their losses are limited only to their investment) are almost ubiquitous of all public corporations. Such (1) immortality and (2) shielded liability, coupled with the (3) capacity for huge appetites (to gobble up corporations bigger themselves through mega mergers), (4) to win the lottery (through an IPO of its shares, and hence expereince an unprecedneted capital infusion), (5) the sleeping around with government (influencing governments through expensive lobbying and election campaign contributions) and (6) the ability to have unlimited children and be at hundreds of places around the globe at once (i.e. as in the case of a multi-national corporation having subsidiaries all over the world)...the list goes on, and if we consider that every itme on the list is accentuated at each step of the economic chain by multiplier effects (which is a concept associated with Kenysian Economics, and hence may be downplayed by laizzes-faire economists like Friedman and Manne), it is now easy to understand that all these factors allow a corporation (and its shareholders) to accumulate wealth and exert powers with such a scale that an individual cannot.

Thus, the growth of corporations are nonlinear, so that at a certain point, the accumulation of private contracts is not merely a quantitative transformation, but qualitative one. In practical terms, it is absurd to argue that the business of huge corporations such as Walmart, Exxon and Microsoft do not implicate the public interest. The growing nexus of private contracts, at a certain point, makes it quasi public. The distinction between private and public rights/property is an artificial straitjacket that is an oversimplification of reality. I cannot think of a day that goes by in which I or any of my friends do not use a product by any of these three companies.

Where the Law Ends
Friedman qualified his rejection of CSR by saying that corporations had to “stays within the rules of the game.” In other words, the behavior of businesses should only be limited by laws and regulations.

But the whole CSR movement arose from the very limitations of law to effectively govern corporate behavior. One only has to read about the daily stories of corporate mismanagement to wonder how much malfeasances go undetected. The best writing that I've seen on the limits of law to control corporate behavior is Christopher Stone’s Where the Law Ends. I wrote a paper in law school, relying heavily on Stone’s writings, discussing among other things the limitations of law in governing corporate environmental behavior. For what it’s worth, I reproduce verbatim the relevant section below.

I am not one of those types of people that Dean Manne characterizes as jealous of the American success story. The concept of the joint-stock corporation is revolutionary concept that has changed civilization forever (for a great overview of the history of the concept of the corporation, read The Company: A Short History of a Revolutionary Idea, by John Micklethwait and Adrian Wooldridge). It has brought enormous wealth to many, but you’d have to brain wash me to convince me that such wealth has been generated free of abuse.
I leave a final thought (or three) for champions of the free market and individual liberty: To the extent, for example, that the public make calls for CSR through consumer boycotts, as individual liberties would allow, shouldn't we respect the will of the "free market"? Taking this further, is it possible that markets exist not only for a company's products and services, but also for a company's reputation? If so, would it be in the best interest of a company to ignore the supply and demand curve of the reputational market?
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Law Paper Excerpt (from J. Wong, "Corporate Environmental Disclosure as a Reflexive Law Approach in Promoting Efficiency in a Marketplace of Morality" (unpublished))

Substantive Law and its Limitations
While U.S. environmental law matured into the most stringent of laws in any regime, they are falling short in promoting the responsibility in corporations that society seeks. One concern is over-deterrence. “Juridification,” meaning the “proliferation of law,”[1] can impose substantial economic costs, including the costs of compliance, reporting and enforcement. An increased reliance on legislation as a social fix inevitably requires a denser network of rules and stiffer penalties. While this may successfully deter bad actors, it can also discourage well-meaning economic actors from engaging in socially productive activities.[2]

Flowing from the problem of juridification is the need for lawmakers at Congressional level to delegate increasing amounts of discretion to administrative agencies to execute the laws, including rulemaking. This delegation raises the concern that legislation becomes separated from democratic procedures to the detriment of the system’s legitimacy.[3] Yet another challenge imposed by juridification is the difficulty for legislatures, agencies and courts to review and harmonize the sheer volume of old environmental laws in the face of new ones that get passed with emerging environmental crises.[4]

Paradoxically, the current legal system is also plagued by under-deterrence. One set of problems revolve around the peculiarities of agency rulemaking and enforcement. Firstly, agency rulemaking processes have become greatly inefficient in the face of serious costs and delays caused by notice and comment procedures.[5] This so-called “ossification” of rulemaking discourages agencies from revisiting any rules they have passed even in light of new circumstances. As a result, the modern administrative agency is unable to keep pace with technological advances and newly emerging information.[6] Secondly, the administration and enforcement of laws incur hefty costs, resulting in lags, gaps, and what Professor Dan Farber describes as “slippage,” where regulators depart from the intent and sometimes letter of statutes in the implementation and enforcement stage.[7]

Moreover, since it is practically impossible for law to control every form of misbehavior; legislation tends to be responsive rather than anticipatory.[8] The result is that much damage is done before any laws are passed to address these wrongs. For example, it is only after much of the air quality in urban America was heavily polluted that the Clean Air Act was passed in 1970, just as it was only after the monumental financial scandals of Enron, Worldcom and others that prompted the enactment of the Sarbanes-Oxley Act in 2002. Command-and-control regulations also have inherent limitations. Rather than promoting high performance, because such regulations only establish minimum standards in the form of bright-line rules, the tendency is for actors to “press their luck, to edge up to the very limits of what they think they can get away with.”[9]

Another set of limitations are typified by the laws’ weaknesses in addressing inherent scientific uncertainties. Environmental performance can be hard to quantify. Ecological systems are multivariate by nature, replete with uncertainties and non-linearities which we are only beginning to understand.[10] In many cases, there is a lack of confidence as to the causes and effects within ecological systems,[11] and there may even be a lack of consensus as to what environmental values or goals we want to advance.[12] Given all this, how can we translate these complexities of science into articulable legal standards? Another dimension to the law-and-science problem is the unsuitability of adjudicatory forums to address “polycentric issues”—“issues characterized not only by their technical complexity, but by their impact on large and diverse groups of people (far beyond the parties immediately represented in court).”[13] Judicial proceedings result in verdicts that are bipolar in nature (resulting in a losing and winning party). Cases involving questions of where to locate a nuclear plant or how large it should be are simply not suited for such adjudication.[14]
[1] Eric W. Orts, Reflexive Environmental Law, 89 Nw. U. L. Rev. 1227, 1239 (1995).
[2] Christopher D. Stone, Corporate Social Responsibility: What it Might Mean, if it were Really to Matter, 71 Iowa L. Rev. 557, 565 (1986). Regulatory costs may also include less obvious social costs such as “the costs of enlarging the role of government while atrophying the moral timbre of the individual citizen.” Id. at 568.
[3] Orts, supra note 3, at 1258. The counterargument to this concern is that it is the democratically elected Executive that appoints heads of agencies, thus providing an indirect form of accountability.
[4] Id. at 1259.
[5] See generally, Thomas O. McGarity, Some Thoughts on “Deossifying” the Rulemaking Process, 41 Duke L. J. 1385, 1387- 1436 (1992) (detailing the onerous procedural and analytical review requirements that have made rulemaking cumbersome and the modern administrative agency unresponsive to society’s problems).
[6] 1436. Cf. Christopher D. Stone, Where the Law Ends 113 (“Corporation are so often moving ahead of the society that at no time will present legal rules... be adequate to provide them with satisfactory standards.”).
[7] Richard B. Stewart, A New Generation of Environmental Regulation, 29 Cap. U. L. Rev. 21, 54 (2001 (citing Daniel A. Farber, Taking Slippage Seriously: Noncompliance and Creative Compliance in Environmental Law, 23 Harv. Envtl. L. Rev. 297 (1999)).
[8] Stone, supra note 8, at 94.
[9] Stone, supra note 4, at 568.
[10] Id. at 99-101.
[11] Cf. Id. at 103-04.
[12] Id. at 97.
[13] Id. at 106 (citing Barry B. Boyer, Alternatives to Administrative Trial-Hearings for Resolving Complex Scientific, Economic, and Social Issues, 71 Mich. L. Rev. 111 (1972)).
[14] Id. at 106 (quoting Maurice Rosenberg, Let’s Everybody Litigate, 50 Texas L. Rev. 1349 (1972)).


At Mon Dec 04, 03:19:00 PM GMT-5 , Blogger Ecopreneur said...

Paul A. King, in a rebuttal comment to Professor Rubinstein's original post supporting Dean Manne's position on Rubinstein's blog "Ideablog", put it well when he said:

Mr. Manne points out “…even a billion apples don’t become meat.” Well, that depends on who eats the apples. If you feed the apples to pigs and cattle, and then we make meat, I would have to take objection to the statement.

For Mr. King's full comments, which discusses among other things energy and reputational externalities, read the first comment to this posting:


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