Socially Responsible Investing: The Balance of Shareholder and Stakeholder Needs - dummies

Socially Responsible Investing: The Balance of Shareholder and Stakeholder Needs

By Consumer Dummies

A business can’t be socially responsible unless it can make the business case that being socially responsible is good for the bottom line. Legally, corporations are managed for the benefit of their shareholders. In the United States, corporate managers have a fiduciary responsibility to maximize shareholder value while complying with other laws. Some managers interpret that to mean that even the teensiest bit of philanthropy is wrong because it hurts shareholders. Others argue that behaving responsibly benefits shareholders.

Maximize shareholder value

The key responsibility of a company is to maximize wealth for its owners, the shareholders. This mandate isn’t as mercenary as it may seem. Usually, what makes shareholders happy makes everyone else happy, too: good products or services that customers gladly pay for, employees who run the company efficiently, and so on. Also, a well-run business can generate profits for shareholders long into the future. But some potential pitfalls in maximizing shareholder value exist:

  • Cutting corners: Sometimes management’s desire to get paid well while keeping pesky shareholders off its back leads to cut corners and even outright fraud. This short-term thinking can destroy a business.

  • Neglecting customer service: Customer service is an ongoing expense that creates long-term value. A company with a short-term perspective can boost its profits in the short run by cutting back on customer service, which may make the short-term shareholders happy, but all the annoyed customers will go elsewhere, harming long-term shareholders.

The key debate about socially responsible behavior by corporations is whether it’s good or bad for shareholder wealth. Investments in good governance, clean technology, or sustainable economic development may take years to pay off, even if the payoff will be spectacular. Not all shareholders are patient enough to wait, and some may push the company to give up the project.

Remember stakeholder value

Stakeholders are not shareholders. They’re all the other people who contribute to the success or failure of the corporation: employees, vendors, customers, members of the community where the company has facilities, regulators, and so on.

In the short run, corporations can maximize shareholder value without even thinking about the other stakeholders, but it can’t do so in the long run. A company that wants to maximize shareholder value for years to come needs to think about its stakeholders — how it recruits workers, retains employees, and works with the community at large.

Although companies have a fiduciary obligation to maximize shareholder value, they use more than just shareholder capital to make the business possible. They need other inputs to operate: roads, communities, an educated work force, and so on, as well as key inputs that belong to no one but affect everyone, such as air, water, and soil.

Externality is the term economists use to describe the effects that a business has on things that are outside the price of the goods or services it sells. For example, if a business pollutes the water, there’s a cost to the world, but this cost isn’t included in the price of the product. That’s a negative externality. Externalities can be positive, too. For example, maybe the company sponsors the local symphony as a way of marketing to its target customers, but all music lovers benefit from the donation.

Unite shareholders and stakeholders with the triple bottom line

Because a company’s management team has the responsibility to maximize shareholder value, it can’t pursue any projects that benefit stakeholders unless it can show that these will ultimately pay off for the shareholders. Still, a company that plans to stay in business for a long time needs to keep other stakeholders happy.

The triple bottom line, popularized by a book of the same name by Andrew Savitz and Karl Weber, asks companies to account for how their operations and strategies affect people, the planet, and profits. The goal is to get companies thinking about how they will generate profits over the long haul by protecting important inputs.

  • The people: Companies are accountable to the people they touch: employees, customers, contractors, and residents in the communities surrounding their facilities. Paying attention to — and keeping track of — how they are treated leads the company to do the right thing for its stakeholders and shareholders alike.

    An organization’s reputation is built on how it treats the people it deals with, no matter who they are or what they do.

  • The planet: This component of the triple bottom line looks at how a company’s activities affect the environment. A company’s environmental responsibility derives from how a product is sourced, manufactured, and moved to market, but it’s also affected by what the company does at headquarters and how it works with its contractors. (No fair claiming to be clean while outsourcing your manufacturing to a contractor in a country with no environmental laws.)

  • The profit: Without profits, the business will close, an event that harms the employees who need jobs, the customers who need what the company provides, and the government that relies on it for taxes. Ideally, the short-term profits will allow the company to afford its investments in people and planet, while those sustainability investments will pay off in long-term profits for the smart, socially responsible shareholders.

A U.K. organization, AccountAbility, has drawn up standards similar to Generally Accepted Accounting Principles (GAAP; the rules that govern accounting in the United States) to help companies report their social and sustainable activities. Many global companies use them now, and the hope is that more will soon adopt the standards to help investors and others understand the effects of business activities.