Modern Corporate Social Responsibilty: A Scrutiny of Two Competing Theories

by Ben on July 24, 2010

The following is a paper I recently wrote for one of my M.B.A classes through the University of Massachusetts Amherst.

Over the last few decades, two competing theories of corporate social responsibility have gained prominence in both the academic and business worlds. The first theory, as defended by Coelho, McClure and Spry (2003), is known as the Shareholder Theory or Stockholder Theory in which all corporate decisions, so long as they are legal and profitable, are made with the shareholders’ interests as the highest priority. The second theory, as defended by Post (2003), is referred to as the Stakeholder Theory, in which corporate decisions are made with equal regard for all immediate stakeholders in the business’s environment including suppliers, customers, employees, management, shareholders, and the local community. This paper analyzes the theories as presented by the authors above, mediates their differences, and offers advice for the modern day corporate executive to assist with her own ethical business decisions.

Corporate executives are coming under an increasing amount of scrutiny over their presumed lack of socially responsible decision making. From the astonishing fall of Enron in 2001, to BP’s current environmental and economic disaster unfolding in the Gulf of Mexico, this decade alone has seen more than its fair share of ethical lapses in leadership and the demand for change is great.

In 1970, economist Milton Friedman published an article for The New York Times Magazine in which he declared “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, which is to say, engages in open and free competition without deception or fraud” (Friedman, 1970). Commonly known as the “Shareholder Theory” or “Stockholder Theory”, Friedman’s paradigm of corporate social responsibility has served as an ethical baseline for multiple generations of business leaders but critics argue it doesn’t go far enough in addressing the realities of the business environment. Consequently, a growing number of individuals from industry and academia are leaning towards the stakeholder theory of social responsibility suggesting that it is a more comprehensive and thoughtful approach to making ethical business decisions. Predictably, the competing schools of thought frequently offer new perspectives on why their particular theory is superior to the other, and how the only way to move the interests of society forward is to adopt one comprehensive model. What follows is a scrutiny of one such debate as featured in the American Journal of Business.

The Argument for the Shareholder Theory
In support of the shareholder theory Coelho, McClure, and Spry (2003) argue that the legal structure upon which corporate entities are established demand that the considerations of management must be in favor of the shareholders’ interests. The authors’ state that “their [the company executives] fiduciary responsibility, within the legal strictures of society and without deception, to husband and increase the wealth that has been entrusted to them by shareholders. All other responsibilities of the firm’s agents must be subordinated to this one.” (Coelho, McClure and Spry 2003).

This “fiduciary duty”, the authors’ argue, is based on the implication that corporations have not only a contractual duty to serve the interests of the shareholder, but also an obligation to serve the shareholder’s interests since they are the owners of the corporation. To further advance their claim of “fiduciary duty”, the authors’ suggest that there is an agency relationship between shareholders and corporate executives in which the financial interests of the shareholders is recognized as first and foremost.

Coelho, McClure and Spry (2003) also point out that the stakeholder theory is too ambiguous and conducive to “managerial corruption” and “chaos”. The authors’ argue that contemporary managers favor the stakeholder theory as it affords them the opportunity to pursue personal causes with corporate resources. Given that executives are presumed to have the best understanding of their company’s business model, the temptation for an executive to invest in a particular cause, at the expense of shareholders, may be too enticing to resist. The authors present a similar reason why contemporary scholars overwhelmingly support the more broadly defined stakeholder theory. They claim that academic institutions have a vested interest in doing so: “Faculty members who champion the view that academia is an institutional stakeholder that corporations have a duty to support are more likely to attract business philanthropy than faculties who eschew the stakeholder doctrine” (Coelho et all, 2003). This theory as presented by the authors is fascinating, but there is no evidence in provided in their paper that supports their claim.

The Argument for the Stakeholder Theory
In his defense of the stakeholder theory, Post (2003) attacks the ethical dimension he claims is lacking when implementing the shareholder theory. “It is my view that management decisions ought to be based upon three different dimensions: economic-Is this profitable?; legal-Is this legal?; and ethical-Is this right?” (Post 2003). Post maintains that being ethical under the shareholder theory means simply abiding by “the rules of the game” (the law), with the rules (the law) being a “reflection of the lowest moral minimums” (Post 2003).

Post (2003) also takes aim at the three “legal underpinnings” Coelho et all cite as the primary reason Friedman’s paradigm is the only ethical basis by which to base ehtical decision in a corporation. First, Post argues that no “contractual obligation” exists or is implied between a shareholder and a corporation. “There is no express contract that the parties sign, since shareholders buy their stock from previous owners, not the corporation. In an initial offering, the only legal document specifying the conditions of the purchase is the prospectus which does not constitute an express contract with management who often remain to be hired in the future” (Post 2003). Second, Post takes issue with the “agency relationship” between a shareholder and a corporation referring to black letter law. According to Post, The Restatement of Agency clearly identifies three key elements for an agency relationship to be valid. “(1) There is consent to the relationship, (2) the agent acts on the principal’s behalf and (3) the principal controls the agent” (Post 2003). Post is quick to point out that “none of these three elements of the agency relationship exist between management and the shareholder group” (Post 2003).

Finally, Post looks at the underlying claim of a shareholder’s “ownership rights” in regards to being the primary beneficiaries of any corporate actions. Post cites examples in which “ownership rights” have been limited by government for the betterment of society. “The theoretical notion of “legal ownership” of private property does not allow unlimited ownership rights and, therefore, does not support the shareholder theory that “legal ownership” of stock alone requires that management consider only the interests of the shareholders” (Post 2003). Post’s statements on ownership rights reminded me of a friend’s recent experience. He owned a parcel of waterfront property on a lake in Maine and was significantly restricted in the improvements he could make on the properly due to local environmental ordinances. Naturally, the ordinances existed for the benefit of society over the “ownership rights” of one individual.

What is an Ethical Manager to Do?
While contemporary scholars, including Post, seems to increasingly focus on the virtues of the stakeholder theory, the modern corporate manager is no less burdened in defining what exactly her strategy should be as she navigates her company through the perilous seas of social responsibility. In an effort to alleviate this burden I would like to interject a few observations of my own to help amalgamate the competing theories of corporate social responsibility as set forth in the two competing papers discussed earlier.

First and foremost, contrary to Post’s assertion, Friedman absolutely embraces an ethical dimension in his doctrine of corporate social responsibility. “That responsibility is to conduct the business in accordance with their [the shareholder’s] desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom” (Friedman 1970). Given Post’s educational background, his failure to recognize the ethical component of Friedman’s paradigm is understandable as he seems to have appointed himself general counsel for proponents of the stakeholder camp. Surprisingly, Coelho et all also failed to recognize Friedman’s ethical component in their sustention of the shareholder theory.

The question remains then, what is does Friedman mean by the “ethical customs of society”? Given this “new” understanding of the shareholder theory as inspired by Friedman (the understanding that Friedman’s principle does indeed provide for an ethical litmus test), the corporate manager has a valuable tool in defining ethical management decisions. She can pursue what she feels is in the best interest of the shareholders so long as she abides by the law, and, so long as the action is “ethical” in the society (or societies) the business is operating. Admittedly, the more complex the societies, the more difficult it will be to define “ethical” in this respect.

To illustrate this point, suppose you managed on an oil rig operating on the Outer Continental Shelf of the Gulf of Mexico. One day, one of your workers approached you to ask if he could purchase a new biodegradable hydraulic oil to use in the installation’s machinery. He points out that in the event of an accident, the hydraulic oil would be less damaging for the environment. The improved oil was 4 times more expensive than conventional hydraulic oil although the total cost was marginal in comparison to the rigs total operating budget. There was no law mandating the use of biodegradable hydraulic oil, but you felt that increase in cost was worth the mitigation of any potential environmental pollution. Under Post’s (2003) or Mackey’s (2005) interpretation of the Shareholder Theory, you would be unethical if you approved the expenditure since you where not pursing the exclusive interests of your shareholders. However, I believe Friedman would have supported the expenditure with the understanding that marginal corporate expenses directly beneficial to the environment are an “ethical custom of society”, even if they are not mandated by law or in the express interests of the shareholders.

Amazingly, Post makes a few admissions in his paper that seem to undermine the main arguments he so passionately makes. First he states “…in the end there is always a tiebreaker that determines the interest to be weighed the most heavily, the long term survival of the company” (Post 2003). Later in his paper Post makes a similar statement “…management makes the final decisions based upon its judgment regarding what is in the best interest for the long term survival of the corporation” (Post 2003). The logical corporate executive should question Post’s premise by asking “since when is the long term survival of a company not in the best interests of a shareholder?” Perhaps Post will attempt to answer this question during the next inevitable evolution of the stakeholder vs. shareholder conundrum.

Having read the works of Friedman (1970, 2005), Post (2003), Coelho et all (2003), Mackay (2005), and Rodgers (2005), it seems that contemporary scholars and business leaders are engaged in a vehement agreement on the big picture of corporate responsibility. When applied as they were originally presented, both the Shareholder Theory and the Stakeholder Theory ethically address the priorities of all immediate stakeholders in the business environment including suppliers, employees, customers, employees, management, and the local communities. Deciding whether or not to go above and beyond the ethical duties of corporate social responsibility, as Whole Foods CEO John Mackey (2005) has so proudly done, is a business decision that relies on the judgment of corporate management. Whole Foods has enjoyed great success establishing themselves within the niche of enhanced corporate social responsibility, but I do not believe an across the board adaptation of this model, as suggested by Mackey (2005), would be sustainable in this business environment.

I believe the ongoing theoretical debate to define the social responsibility of corporate management has hindered the practice of business ethics. The more the sides argue, the more the underlying concepts sound the same. When taken in their full context, the Stakeholder Theory and the Shareholder Theory adequately address the interests of all stakeholders with an ethical regard for the customs of society. The final measure of an ethical business executive is her ability to hold true to the ethical course she has plotted. Knowing what is ethical is one thing, doing what is ethical is quite another.

Coelho, McClure & Spry, The Social Responsibility of Corporate Management:
A Classic Critique, American Journal of Business, Spring 2003: Vol. 18, No. 1.

Friedman, Milton, The Social Responsibility of Business is to Increase its Profits, The New York Times Magazine, Sept. 13, 1970.

Friedman, Mackey & Rodgers, Rethinking the Social Responsibility of Business: A Reason debate featuring Milton Friedman, Whole Foods’ John Mackey, and Cypress Semiconductor’s T.J. Rodgers,, October 2005.

Post, A Response to “The Social Responsibility of Corporate Management:
A Classic Critique, Amercian Journal of Business, Spring 2003: Vol. 18, No. 1.

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