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4-1.2: Corporate Social Responsibility
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From the course by University of Illinois at Urbana-Champaign
Corporate Strategy
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University of Illinois at Urbana-Champaign
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Course 6 of 7 in the Specialization Strategic Leadership and Management
From the lesson
Module 4: Corporate Governance
This module focuses first on the characteristics of public firms. Second, it considers stakeholder impact analysis and corporate social responsibility. Third, it emphasizes corporate governance and the mitigation of agency problems.
Meet the Instructors
Joe MahoneyProfessor of Business Administration
University of Illinois, Urbana-Champaign College of Business Department of Business Administration
[SOUND]
Okay, for this video we'll start with
discussing the pyramid of corporate social responsibility.
Of course throughout this course, we've talked about, gaining and
sustaining competitive advantages, and that's the responsibility of the managers.
But the managers' responsibilities are much more than just the economic
responsibilities.
Clearly they also have legal responsibilities.
They have laws and regulations in place.
And they have to make sure that they stay within the guidelines of those rules,
and that also for the protection of the economic interest of the company as well.
Beyond that, there's also the ethical responsibilities of doing what is right,
just, and fair.
There's a very famous categorization scheme of knowledge
by a person named Bloom, and Bloom had this taxonomy of knowledge.
At the first level is the level of description.
That's do you understand the material, and
can you show that you have competence in the material?
In many ways what we're doing
in learning this material is that fundamental level of knowledge.
Going beyond that,
you can also keep taking it up to the next level of analysis.
Can you take knowledge and take it apart and look at its individual parts?
The next level is, can you take that and put a synthesis and put it back together?
As an example I would say when I was about ten years old I got a very fascinated with
my parents' phone.
So I was very analytical, and I took the phone all apart.
But I found out at the time I was ten, I wasn't very good at synthesis because I
couldn't put it back together the way it was when I originally started.
Now beyond that the next level is application.
Can you take the knowledge that you had and apply it to a new situation?
So that really shows a deep understanding.
And what made me think of Bloom's Taxonomy is actually ethical responsibilities is
what Bloom would call the highest level in his taxonomy.
And that is when a student starts to not ask the question, am I doing this right?
And they start to ask the question, am I doing the right thing?
Then that's what Bloom regards as a very high level of education at that point when
you start to habitually think that way.
And at the highest level is even beyond doing the right thing within
the organization itself, is there a question of are you doing the right thing
for others beyond the corporation?
Is the organization a corporate citizen not only to the corporation itself,
but is it a corporate citizen to the world beyond the boundaries of that corporation?
Your question then goes to a comment by Milton Friedman, a famous economist,
Nobel prize winning economist from the University of Chicago.
Who stated that the only social responsibility of business is to
increase profits so long as it stays within the rules of the game.
So the questions is,
are philanthropic responsibilities part of the public corporation's responsibility,
or is its only corporate responsibility to increase profits?
Please reflect on this question and
post your response in the discussions for this video, thank you.
So Milton Friedman circa 1962 noted the social responsibility of
business is to increase profits, and this part often is left out of the quote,
so long as it stays within the rules of the game.
So he does have an ethical aspect to it, but
just staying within the legal boundaries and making profits.
And so, in some sense in our pyramid, it's really mostly the first two levels,
the economic responsibility, the legal responsibility.
So the issue then is for
today's businesses it tends to be more than just making profit.
So the question is, does corporate social responsibility,
or CSR, help build competitive advantage?
And then the answer also might depend on where you do business.
So for example United Arab Emirates, Japan,
and India are less interested in corporate social responsibility.
While other countries like China, Brazil, and
especially Germany are more interested in CSR.
Here's an example here of kind of a recent survey done and
asked the question about whether you agree or
not that the social responsibility of business is to increase profits, which is
at least some would agree that there's a social responsibility of business.
So, United Arab Emirates is at one extreme, focusing mostly on profits.
But you have other companies to the right of the US, such as China,
Brazil, Germany, Italy, and Spain.
With Spain being the most social responsibility oriented managers on
average, and
United Arab Emirates being at the other extreme in the variance in this figure.
So corporate social responsibility then can also be considered in terms of
a value creation framework.
And that framework would consider the following.
What's your customer base and how are you bringing in non-consumers?
Expanding the internal firm's value chains by including more non-traditional
partners, and focusing on creating new regional clusters.
So in other words generating a larger base for the reach of the, or
sometimes called the footprint of the organization.
So some companies actually try to reconcile the shareholder and
stakeholder view.
A company like General Electric, for example, recognizes explicitly a desire
for convergence between shareholder and stakeholder perspectives.
That is, looking for actions that are win-wins for
both the shareholders and other stakeholders.
So there's a whole empirical literature on this.
And in general, the findings are that firms that tend to do well financially,
they also do well by having some attention to corporate social responsibility.
Now, the question is whether they're intrinsically motivated to do that or
whether they're extrinsically and
instrumentally doing it just because they know it helps their bottom line.
But in some ways the answer to that question is not essential for
the observation that companies, whatever their motives, that
have corporate social responsibility tend to have better financial bottom lines.
To finish up this particular video we'll look at issues of corporate governance.
You've heard this term probably a lot throughout the course.
Here let's formally define it.
The corporate governance represents the relationships among the stakeholders that
is used to determine and control the strategic direction and
performance of the organization.
I referred to it also earlier as thinking about it as the rules of the game within
the corporation itself.
What are the responsibilities and duties of the board of directors and
the managers, so forth?
The other aspect is what are called agency costs.
And agency costs are that the principal is the one paying to have something done, and
the agent is the one who does it.
And the question is, will the agent act in the interest of the principal?
We talked a little bit earlier about the separation of ownership and control.
So there the agent is the manager, and the principal is the shareholders.
And will the manager act in the best interest of the shareholder?
When they do not, that's referred to as agency costs.
So how do you reduce the agency cost?
That is, how do you get the agent to actually act in the way that the person
who's paying wants them to act?
And so there are a few ways to do that.
One is to provide the agent with more incentives, and so
that will be incentive cost.
Another is the principal can monitor the agent's behavior more, and so
that would be monitoring cost.
There can be penalties for non-compliance, and
that's referred to as the enforcement cost.
So let's take an example of a franchiser and a franchisee.
The franchiser of McDonald's is the principal, and
the franchisee of the particular McDonald's store that you may attend is
the owner of that particular store is the franchisee.
Now the question is,
how do you get the franchisee to act in the benefit of the whole system?
Because if the franchisee does not, it will not only hurt that particular
restaurant, it may hurt the entire brand name of McDonald's.
If a customer has a bad experience in that one restaurant,
it may affect the whole system and word of mouth with other people.
Now in the era of social media, the need for
control of quality is even greater than ever.
So McDonald's will use a mix of incentives, monitoring, and enforcement
within their franchise contract as way to try and get better performance.
All of those costs that McDonald's incur
in that franchiser-franchisee relationship are called agency costs.
Now there are difference corporate governance mechanisms that can be used,
and we'll talk more in our final video about some of these mechanisms.
But just for now,
the different ways that the corporation tries to minimize the cost,
they're referred to here as mechanisms, to direct and control the firm.
The objective of these mechanisms are to ensure the pursuit of the strategic goals
of the company.
That is, they want to do certain things, how are they going to implement and
get what they want?
And in particular and specifically, we're addressing the principal agent problem.
How do you minimize the agency cost?
How do you minimize the sum of the monitoring cost,
the enforcement cost, and incentive cost within the organization?
So at its larger level what we're talking about is if you have really good corporate
governance, you're less likely to have accounting scandals like we had at Enron,
less likely to have global financial crises.
And then also so Bernie Madoff was very well known for, or
infamous I guess more than famous, for having a Ponzi scheme or a scheme that was
kind of a pyramid scheme of taking some money to pay others to pay others.
But you never really have enough money to cover, and
your debt keeps getting worse as you go along.
So that's kind of a severe kind of agency problem.
In that example,
Bernie Madoff was just trusted by all the principals who gave Bernie Madoff money.
No one was checking the books, no one was monitoring him.
And so that really gave him a lot of leeway for egregious behavior.
So all of this is then,
the central concept at an abstract level is that of asymmetric information.
That is Bernie Madoff has all the information and
doesn't give any of it out.
No one's monitoring him.
And then he takes advantage of that asymmetric information.
Another example of asymmetric information is those who buy and
sell stock who get inside knowledge within a company.
So it's not really a fair playing field for buying and selling of stock.
And there's insider information at some point what would be defined as
illegal activity.
And if a person is caught buying and
selling with insider information, then have they have severe penalties for that.
Finally, to finish up this section, we have, once again,
we've been using the term agency theory a lot.
So agency theory then views the firm as a nexus, that is,
a bundle of legal contracts.
So the employees have legal rights.
The customers,
when they buy a product, have legal rights for having certain expectations.
If you buy a ladder and the ladder collapses and you get harmed,
you may have a strong recourse from the firm for compensation and so forth.
So there's relationships and
thought of as contractual relationships among all the stakeholders of the firm.
Some are explicit contracts, and some are implicit contracts.
But the law will treat them all as types of contracts that have
their own sets of responsibilities and obligations.
When we talked about asymmetric information problems,
there's two types of agency problems in particular.
And one is called the adverse selection problem.
And the other is the moral hazard problem.
Within the context of the employment relationship, an adverse selection
problem is perhaps someone misrepresents their abilities to the employer.
So they're asking, are you an architect?
And the person says, yes I'm an architect.
And they start, and then later on it's discovered they don't actually have
an architectural degree, that would be a misrepresentation.
The other type of thing that could happen is once you're,
even if you are an architect, once on the job if there's any kind of slacking or
shirking or not putting in very much effort,
then that is referred to as a moral hazard problem.
So those will be two of the challenges.
When we finish up on our last video, we're talking about mechanisms to reduce
asymmetric information and agency problems and
in particular reducing these adverse selection and moral hazard problems.
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