Principles Do Pay; Wanted: A Thomas Aquinas of the business world

Companies can’t succeed in a society that fails.

That expression nicely captured the message at Geoffrey Heal’s talk yesterday at the Carnegie Council's Global Policy Innovations program on his new book When Principles Pay: Corporate Social Responsibility and the Bottom Line. Heal, a professor at Columbia Business School, credits the phrase to a friend of his.

Does it really pay to be ethical? Do principles pay, as the book’s title suggests? Not only does Heal touch on CSR’s manifestations from Adam Smith to Starbucks in an elegant sweep, he makes an argument that principles do pay, pointing to philosophical, empirical, and anecdotal evidence.

In the book, Heal sets the philosophical stage. Adam Smith, he reminds us, argued in 1776 that if everyone acts in his or her own interest, society would benefit—the concept known as the invisible hand. From Heal's book:

He was arguing against do-gooders and in favor of self-interested behavior, at first sight a strange position for a moral philosopher. What was counterintuitive is the claim that self-interested behavior by each individual in society is good for society as a whole—‘By pursuing his own interest he frequently promotes that of society.’

The invisible hand has two problems, however. One was less relevant in Smith’s day. That is the issue of external costs. Private costs are those paid by the person carrying out an action. In the case of driving a car, those would be the cost of gas and insurance, notes Heal. Meanwhile, the external costs are those that everyone pays, in pollution, climate change, and congestion, for one person using a car. The same applies to the operation of a company. Some costs are borne by the company while others are borne by society.

The second is fairness. Fairness may sound removed from modern economics. But Heal reminds us that it is not. Just as some measures in the name of efficiency could be inhumane, Heal points out that insider trading and favoritism are not condoned in the ethics of our modern capitalism, whether we think about it that way or not. Similarly, as Heal put it yesterday, is it fair to pay someone a dollar a day even if that is the market clearing wage?

Since the birth of the corporation, these organizations have somewhat lost their way. We might need a Thomas Aquinas, Martin Luther, or Nagarjuna of the business world to come around and remind us that corporations should be run for the good of society—the second part of Smith’s invisible hand formulation: …promotes that (interest) of society. Shouldn’t we recall that promoting society’s interest was the original goal of corporations?

Heal responded that companies’ interpretations of their role in society has fluctuated over the years. The last time we had a wave of corporate responsibility was at the end of the 19th Century. People such as Henry Ford tried to strengthen the welfare of employees by paying them higher wages. Indecently, Ford was sued for this policy by the Dodge brothers, who went on to found the eponymous car company. They sued on the grounds that Ford’s obligation was to shareholders, not employees. The Dodges won that suit. And, as Heal put it, corporate responsibility went out of style.

But a sense of corporate responsibility has returned. This awareness is partly due to an increased awareness of the interdependence of global problems like climate change, Heal surmised yesterday. As we sometimes put it at the Carnegie Council, the awareness of other cultures and global problems, through modern communications, is fostering an ethical moment in history whereby people are more conscious of the effects of their actions.

While companies have always had social and environmental impacts, how can we explain the integration of these factors in corporate decision-making? Heal cites four factors. First, with their privatization efforts, the Reagan and Thatcher administrations gave more power to companies in areas that were traditionally managed by the state.

Second, the globalization of business has forced managers to examine their ethical obligations in foreign markets or operations. Third, the rise of nongovernmental organizations (NGOs) and consumer activism (in the form of boycotts) has required companies to reduce their social footprints. The famous campaign in 1997 against Nike’s use of child labor is often credited for causing that company’s about-face on labor rights.

Fourth, the growth of socially responsible investment (SRI) funds have put more power in investors’ hands to shape the kind of society they want to see. It is sometimes said that if everyone owned more of the economy, more ethical decisions would be made. Heal noted that the university endowment that he advises has its own set of social principles and estimated that a quarter of all the money in the stock market is for ethical causes.

One consequence of these developments is that businesses are now “over complying.” Heal gave several examples: BP publicly accepted the role of greenhouse gases in global warming in 1997, long before it was common wisdom and much to the dismay of BP’s oil industry competitors. Another was the decision of Citibank, Barclay’s, ABM Amro, and West LB (“the gang of four”) to come together and establish the Equator Principles for project finance.

Heal gave quantitative and qualitative evidence for the argument that principles do pay. One area was in human resources. Starbucks saves millions of dollars a year by retaining their employees longer (50 percent turnover) than the industry average. Another point was that an analysis of the EPA’s Toxics Release Inventory and stock prices shows that the more a business pollutes the more its stock price tends to fall. Finally, Heal mentioned that Goldman Sachs has indicated that social and environmental impact data are valuable for stock picking.

One of the final questions at the talk was about the development of a peace index (the Global Peace Index in 2008 ranked Iraq last). I was thinking that Andrew Carnegie would have loved this question. Heal remarked that there is certainly a very strong business case for peace. Only a handful of companies can actually benefit from war. But the question is: Which issues do businesses have control over? While businesses have a lot of sway over global equity and pollution, it is the politicians who wage war.