The dynamics of corporate social responsibilities

THE DYNAMICS OF CORPORATE SOCIAL RESPONSIBILITIES

THE RAOUL WALLENBERG INSTITUTE HUMAN RIGHTS LIBRARY VOLUME 33

THE DYNAMICS OF CORPORATE SOCIAL RESPONSIBILITIES

BY

RADU MARES

THE RAOUL WALLENBERG INSTITUTE HUMAN RIGHTS LIBRARY VOLUME 33

MARTINUS NIJHOFF PUBLISHERS LEIDEN/BOSTON 2008

A C.I.P. record for this book is available from the Library of Congress.

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ISBN 978 90 04 16392 8 Copyright 2008 by Koninklijke Brill NV, Leiden, The Netherlands Koninklijke Brill NV incorporates the imprints Brill, Hotei Publishing, IDC Publishers, Martinus Nijhoff Publishers and VSP. http://www.brill.nl All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, microfilming, recording or otherwise, without written permission from the Publisher. Authorization to photocopy items for internal or personal use is granted by Brill Academic Publishers provided that the appropriate fees are paid directly to The Copyright Clearance Center, 222 Rosewood Drive, Suite 910, Danvers MA 01923, USA. Fees are subject to change.

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CONTENTS ABBREVIATIONS.................................................................................................vii PREFACE ................................................................................................................ix CHAPTER 1 INTRODUCTION............................................................................. 1 1.1. Literature Overview......................................................................................... 4 1.1.1. Law-oriented approaches.......................................................................... 4 1.1.2. CSR approaches........................................................................................ 9 1.2. Critique of current research .......................................................................... 13 1.2.1. Law-oriented approaches........................................................................ 13 1.2.2. CSR approaches...................................................................................... 17 1.3. Matters of approach ...................................................................................... 19 1.4. Disposition of the book .................................................................................. 23 CHAPTER 2 ANCHORING CSR IN COMPANY LAW................................... 27 2.1. Managerial duties of care and loyalty under company laws ......................... 28 2.1.1. Clarification of duty of care through identification of whose interests can be considered ............................................................................................. 31 2.1.2. Clarification of duty of care through judicial review.............................. 40 2.1.3. Clarification of duty of care through other corporate governance mechanisms ...................................................................................................... 52 2.2. Company law: a partial clarification of the duty of care............................... 68 2.2.1. Triple spin-off that company law performs ............................................ 68 2.2.2. Divergent standards ................................................................................ 70 CHAPTER 3 NORMS ADVANCED IN THE CSR DEBATE ........................... 73 3.1. Milton Friedman and his critics .................................................................... 73 3.1.1. Friedman’s views.................................................................................... 76 3.1.2. Stakeholder theory’s response ................................................................ 80 3.1.3. Winning by default? ............................................................................... 86 3.2. The stakeholder norm .................................................................................... 90 CHAPTER 4 THE STAKEHOLDER NORM IN BUSINESS PRACTICE...... 97 4.1. Context of CSR: governance gaps and business responses ........................... 97 4.1.1. Labour .................................................................................................... 98 4.1.2. Natural resources .................................................................................. 100 4.1.3. New markets......................................................................................... 102 4.2. Business case of CSR................................................................................... 106 4.3. Stages of CSR implementation..................................................................... 110 4.3.1. Human rights impact assessments ........................................................ 112 4.3.2. Management systems............................................................................ 114 4.3.3. External audit of performance .............................................................. 139 4.3.4. Social reporting..................................................................................... 143 4.3.5. Assurance of reports ............................................................................. 146 4.4. Pull from market actors ............................................................................... 150 v

Contents 4.5. Scaling-up CSR............................................................................................ 155 4.5.1. Limits of CSR according to sceptics..................................................... 156 4.5.2. Limits of CSR according to proponents ............................................... 159 CHAPTER 5 POLICIES AND LAWS RELEVANT TO CSR......................... 167 5.1. State policies................................................................................................ 169 5.1.1. International level ................................................................................. 169 5.1.2. National level........................................................................................ 176 5.2. Disclosure regulations................................................................................. 177 5.2.1. Narrowly defined disclosures benefiting ‘reasonable investors’ .......... 177 5.2.2. Disclosures in the ‘grey zone’ benefiting multiple audiences .............. 186 5.2.3. ‘Right-to-know’ disclosures benefiting certain stakeholders................ 207 5.3. Laws referring to management systems....................................................... 220 5.3.1. US Sentencing Guidelines .................................................................... 220 5.3.2. US Environmental Protection Agency’s Audit Policy.......................... 226 5.3.3. Other regulations providing incentives for management systems ........ 228 5.3.4. Regulations mandating management systems ...................................... 228 5.4. Tort law ....................................................................................................... 230 5.4.1. Early days for transnational litigation................................................... 230 5.4.2. Legal definition of negligence .............................................................. 234 CHAPTER 6 INCREMENTAL INSTITUTIONALISATION OF CSR REGIME ............................................................................................................... 245 6.1. Making sense of procedural regulations...................................................... 245 6.1.1. Reporting regulations ........................................................................... 245 6.1.2. Regulations referring to management systems ..................................... 250 6.1.3. Negligence under tort law..................................................................... 256 6.1.4. Intermediary variables – understanding decentralised regulatory regimes ........................................................................................................... 261 6.2. Due process considerations in administrative law ...................................... 278 6.3. Observations from regulatory theory .......................................................... 289 6.4. Incremental institutionalisation of CSR regime........................................... 302 6.4.1. Functions and dynamics of regimes...................................................... 303 6.4.2. Specifying positive obligations (‘support’ human rights)..................... 311 CHAPTER 7 CONCLUSIONS ........................................................................... 321 REFERENCES ..................................................................................................... 333 INDEX ................................................................................................................... 367

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ABBREVIATIONS ABI ALI ASB ASIC ATCA BJR BP BPD BR BTC CEO CL CSR EITI EMAS EMS EPA ETI FDI FLA FLO FSC GATT GC GRI ‘Group’ IHRL ILO ISO KP LSE MNE MS NGO NRDC OECD OFR OHCHR RC SAI SEC SG SME SRI ST TNC TRI

Association of British Insurers American Law Institute Accounting Standards Board (UK) Australian Securities & Investments Commission Alien Tort Claims Act (US) business judgment rule British Petroleum Business Partners for Development Business Review (UK) Baku-Tbilisi-Ceyhan chief executive officer company law corporate social responsibilities Extractive Industry Transparency Initiative Eco-Management and Audit Scheme environmental management systems Environmental Protection Agency (US) Ethical Trading Initiative foreign direct investment Fair Labor Association Fairtrade Labelling Organization Forest Stewardship Council General Agreement on Tariffs and Trade Global Compact Global Reporting Initiative Company Law Review Steering Group (UK) international human rights law International Labour Organization International Organization for Standardization Kimberley Process London Stock Exchange multinational enterprise management system non-governmental organisation Natural Resources Defense Council Organisation for Economic Co-operation and Development Operational and Financial Report United Nations High Commissioner for Human Rights Responsible Care Social Accountability International Securities and Exchange Commission (US) Sentencing Guidelines (US) small and medium enterprises socially responsible investment stakeholder theory transnational corporation Toxics Release Inventory vii

Abbreviations UNDP UNEP UNIDO UNOCAL VP WHO WTO

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UN Development Programme UN Environmental Programme UN Industrial Development Organisation Union Oil Company of California Voluntary Principles on Security and Human Rights World Health Organization World Trade Organization

PREFACE The analysis herein proposes that the responsible business practices of leading companies are significant not only as isolated instances of self-regulation but they also contribute to a broader rule-making process which has been underway in the last decade and is aimed at making business more responsive to human rights and environmental concerns. The book highlights the flexibility of existing laws as well as the emergence of new regulations relevant to CSR. As CSR increasingly interacts with public policy, there appear some insufficiently understood effects of CSR that can help us advance toward more systemic solutions in the business and human rights area. By recognising their own roles and responsibilities in the emerging CSR regime, states can, and must, enhance the impact of corporate voluntarism so that responsible practices get diffused more widely and deeply in the business community. The study identifies variables that states can stimulate through a wide range of regulatory options starting with capacity-building measures to policy to hard law. Two audiences might find this analysis useful. Legal experts with an interest in enhancing the protection of human rights in developing countries form the primary audience. International human rights lawyers approaching the new and evolving area of ‘business and human rights’ deem voluntarism as an inherently inadequate response to corporate abuses, especially when compared with ‘hard law’ solutions. This book aims to sidestep a dichotomous understanding of law and CSR, and looks instead at the complex rule-making process in which the voluntary practices of leading companies can facilitate positive regulatory dynamics. The secondary audience is made up of CSR theorists and practitioners; not having a legal background or being necessarily interested in regulatory issues, they might find this study relevant if they ponder on enhancing the impacts of CSR, and on the broader social dynamics that surround the implementation of CSR commitments. For both audiences, a conceptual work of this kind can help one grasp when one defaults too fast toward one CSR extreme (pro or against corporate voluntarism). To the extent that CSR is implemented in a participatory manner and/or communication-based strategies for corporate accountability are adopted, an ability for finer conceptual reasoning will be critical. The book is an updated and revised version of my doctoral dissertation presented at the Faculty of Law, Lund University, Sweden in February 2006. It was titled ‘Institutionalisation of Corporate Social Responsibilities – Synergies between the Practices of Leading Multinational Enterprises and Human Rights Law/Policy’. I must acknowledge a number of colleagues and friends who guided my steps along the way or put a spring in my step. I am indebted to my principal supervisor, Professor Gudmundur Alfredsson. He oriented my efforts while patiently allowing me to find my own voice and shared his contagious optimism. Professor Lars Gorton, my second supervisor, ran through two voluminous drafts with infinite patience and humour; his critical and insightful comments as well as his gentle approach were much appreciated. Conversations with Professor Håkan Hydén were inspiring in finding a way to organize an otherwise heterogeneous material that could have been ‘sliced-up’ in different ways. The long discussions I had with Chris Mathieu have opened my mind to the variety of perspectives on complex organisations while remaining uplifting and thoroughly enjoyable. I would like to further acknowledge Arthur Diakité, Rachel Crossley, Marius Emberland, ix

Preface Neelambar Hatti, Jonas Grimheden, Ulf Linderfalk, Gregor Noll, Habteab Tesfay and the staff at the Prince of Wales International Business Leaders Forum in London where for four months in 2004 and 2005 I was privileged to work. My thanks also to Tim Maldoon and Carin Laurin for their time and effort to turn the manuscript into a book. Finally I am deeply grateful for the financial support provided by the Law Faculty in Lund, the Raoul Wallenberg Institute, the Swedish Institute and the Institutet för Rättsvetenskaplig Forskning (Institute for Legal Science Research). The conditions offered by the Faculty of Law and the Raoul Wallenberg Institute and their staffs were nothing short of outstanding and allowed full concentration on research.

Radu Mares 24 February 2007

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CHAPTER 1 INTRODUCTION Should companies voluntarily contribute to the social good beyond what is legally mandated to them? Some have argued that businesses should only follow the law and the signals of markets. Others have argued that large businesses, due to their significant impacts on society, have in addition a responsibility to protect stakeholders (people affected by corporate activities) and advance the public interest. Arguments for limited, respectively extended, corporate social responsibility (CSR) have been advanced for much of the 20th century ever since large corporations appeared in the US at the turn of this century. As the debate continues and intensifies with the accelerated internationalisation of trade and investment, new CSR issues emerge continuously. A part of the current debate is whether, and if so to what extent, multinational enterprises (MNEs)1 could and should do more to protect human rights in developing countries2 even in the absence of specific legal requirements. This is the subject of the present book. A multitude of CSR issues relevant to human rights have attracted attention in recent years. Thus in labour-intensive industries (e.g. the footwear, clothing and sporting goods industries) there are documented violations of labour rights (e.g. child labour, hindrance of freedom of association, harassment) and poor working conditions (e.g. health and safety violations, excessive overtime and low wages). In extractive industries (e.g. oil and gas, mining) environmental degradation affecting livelihoods is a significant issue, as are the repressive practices of security forces against local communities. Nike and respectively Shell are two well known examples of market leading MNEs that have come since the mid-1990s under constant scrutiny and criticism precisely for their connection to such human rights abuses. The credibility of the global diamond industry came under attack when in the late 1990s it become clear that warlords in some African countries were using revenues from diamonds for armed operations; the connection between diamonds and civil wars was unmistakable. The large pharmaceutical companies have received bad publicity for the manner in which they have protected their patents; the high prices of drugs effectively denying access to life-saving medicines for millions in poor countries. International banks have been confronted for their lending practices in cases involving large infrastructure projects in the Third World; nongovernmental organisations (NGOs) signalled that banks remain oblivious to issues such as forced relocation, indigenous rights and environmental destruction 1

The term ‘multinational enterprises’ (MNEs) will be used interchangeably with ‘transnational corporations’ (TNCs). 2 The focus of this study is on the protection of human rights in ‘developing countries’, ‘poor countries’, ‘Third World’ or ‘Global South’. 1

Chapter 1 associated with the construction of dams and extractive projects. Finally, the bribing of public officials to secure favourable contracts has been another issue high on the CSR agenda; bribery undermines good governance and shortcuts attempts to promote human rights and development. CSR issues have been instrumental in fuelling the heated broader debate on the fairness of globalisation. Confronted with threats to their reputation, and sometimes with social unrest surrounding their operation in the Global South, the most exposed businesses have responded with voluntary initiatives. Corporate codes of conduct stating the corporate policy on various CSR issues have proliferated in the hundreds; some tens of them explicitly refer to the Universal Declaration of Human Rights and various International Labour Organization (ILO) Conventions. Still some other businesses have entered, together with other public and private actors, into so-called ‘partnerships for development’; such partnerships often deal with single issues (e.g. water/sanitation, communications, HIV/AIDS, creation of economic opportunities) and have been legitimised at the World Social Summit at Johannesburg 2002 as a new implementation mechanism for tackling poverty in the South. Thus CSR covers both issues of corporate compliance with legal standards as well as business contributions to development and poverty-reduction. Early in their history corporate voluntary initiatives were mere policy statements with no serious implementation mechanisms and no outside monitoring. To preserve the credibility of such initiatives, some TNCs have accepted to varying degrees some external involvement of NGOs or professional auditors into the implementation of their codes, or have subscribed to collective codes of conduct which set up their own monitoring machinery. Leading businesses have thus responded to widespread expectations on them to effectively implement their own commitments and credibly demonstrate that through CSR reports. States and international governmental organisations (IGOs) have perceived a stake for themselves in this movement surrounding corporate voluntarism. Governments and IGOs have sought to enlist the participation of the business community, often through multistakeholder initiatives. The most prominent example regarding the cooperation with businesses is the UN Global Compact. In brief, states have used their convening power, provided financial support to multistakeholder initiatives dealing with various stages of CSR implementation and have lent crucial political backing and legitimacy to CSR. With localised exceptions, states have not employed the coercive force of law to regulate the human rights impacts of TNCs in the South. The preferred approach so far has been one of cooperation, capacitybuilding and non-binding policy pronouncements. Few jurisdictions have increased transparency around CSR through disclosure regulations. The recent and ongoing developments noted above make the area of ‘business and human rights’ relevant to human rights experts. Nevertheless, for human rights specialists, the twin developments – the global ascendance of influential for-profit actors and their voluntarism – raise a conceptual challenge. Human rights experts are accustomed to look at state actors and binding instruments as the means to protect human rights. However, the legal concepts that would allow human rights 2

Introduction lawyers to comprehend private actors and their voluntarism are still underdeveloped. Numerous questions await more rigorous analysis, especially from a regulatory and policy-making perspective: How to consolidate the gains brought by CSR and how to enhance its impacts? What regulatory avenues can be contemplated to help institutionalise CSR? What are the variables that lawmakers could target? How complex would then the causality between law and corporate behaviour become? How to account for the regulatory dynamics that leading businesses generate? This study takes steps towards answering these questions; at the end, it should have advanced the understanding of the interaction between CSR and law/public policy, and thus help forge a regulatory perspective on CSR. Discussions about the role of business in society use the term ‘CSR’ in two different ways. On the one hand, CSR refers to a managerial strategy through which managers voluntarily (i.e. in the absence of a clear legal command) respond to social expectations and pressures. CSR as ‘voluntarism’ is thus a shortcut for the strategies of proactive businesses following internal calculations about risks and opportunities, calculations that are facilitated by a sense of ethics, social awareness and fresh strategic thinking. On the other hand, CSR highlights fundamental concerns about accountability of corporations to society. In CSR as ‘accountability’, the focus is on corporate responsibilities that lawmakers should define and impose on all companies. The law or other forms of social control should be used to alter corporate behaviour; the respect of certain important standards should not be left to the voluntary decisions of corporate managers. Law does here a twofold job: one, it defines the appropriate level of responsibility (its scope or the limits of corporate responsibilities) to prevent businesses from ‘picking and choosing’ standards, and two, it creates legal incentives for businesses prepared to disregard their responsibilities. This study examines the potential and limitations of CSR as ‘voluntarism’ and draws on legal theory to explain the dynamics towards accountability that CSR may generate. There are various terms in circulation trying to account for the place of business in society: corporate social responsibility (CSR) is the most established, but also corporate citizenship, corporate responsibility, corporate accountability, corporate sustainability or responsible business practices. We use here the term ‘CSR’ for no other reason than because it is a widely recognised term. The priority herein is to understand the implementation of CSR and the dynamics it generates. CSR lacks a universally accepted definition, but a working definition for this study can be the one used by the Dow Jones Sustainability Index. The Index refers to ‘corporate sustainability’ rather than CSR and defines it as “a business approach that creates long-term shareholder value by embracing opportunities and managing risks deriving from economic, environmental and social developments”.3 This definition appropriately accounts for many parameters that will be used throughout this book. 3

Dow Jones Sustainability Indexes, Corporate Sustainability, <www.sustainabilityindexes.com/htmle/sustainability/corpsustainability.html>, visited on 14 February 2007. (emphasis added)

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Chapter 1 1.1. LITERATURE OVERVIEW This section aims to prevent confusion with other research agendas and to grasp some blind spots in current research. It splits literature relevant to ‘business and human rights’ into law-oriented (legalistic) approaches, and CSR (non-legalistic) approaches. The following overview is purely descriptive; the critique emphasising the strengths and drawbacks of each perspective follows in the next section. This disposition – first the description, then the critique – aims to prevent a plunge into polemics that can surround one’s preferred approach before the whole overview is completed. Afterwards and against this background the approach taken in this study will be clarified. 1.1.1. Law-oriented approaches The law-oriented literature has highlighted violations of human rights in developing countries and has proposed several regulatory paths – at national and international levels – to tackle them.4 Arguments have been made for state responsibility for corporate violations of human rights, corporate responsibility and individual responsibility of business executives.

4 See International Council on Human Rights Policy, Beyond Voluntarism – Human Rights and the Developing International Legal Obligations of Companies, Versoix, 2002; D. Kinley and J. Tadaki, ‘From Talk to Walk: The Emergence of Human Rights Responsibilities for Corporations at International Law’, 44:4 Virginia Journal of International Law (2003–2004) pp. 931–1024; International Peace Academy and Fafo, Business and International Crimes: Assessing the Liability of Business Entities for Grave Violations of International Law, 2004, <www.fafo.no/liabilities>; H. Ward, Swedish Partnership for Global Responsibility, Legal Issues in Corporate Citizenship, 2003; S. R. Ratner, ‘Corporations and Human Rights: A Theory of Legal Responsibility’, 111 The Yale Law Journal (December 2001) pp. 443–545; Council of Bars and Law Societies of the European Union, Corporate Social Responsibility and the Role of the Legal Profession – A Guide for European Lawyers Advising on Corporate Social Responsibility Issues, 2003, <www.ccbe.org/doc/En/csr_guidelines_0405_en.pdf>; M. Kamminga, ‘Holding Multinational Corporations Accountable for Human Rights Abuses: A Challenge for the EC’, in P. Alston (ed.), The EU and Human Rights (Oxford University Press, Oxford, 1999) pp. 553–569; MiningWatch Canada, A Policy Framework for the Regulation of Canadian Mining Companies Operating Internationally, 2005, <www.miningwatch.ca/updir/Policy_Framework.pdf>; Extraterritorial Legislation as a Tool to Improve the Accountability of TransnationalCorporations for Human Rights Violations, Seminar of Legal Experts, Catholic University of Louvain and the Free University of Brussels, Brussels, 2006, <www.business-humanrights.org/Documents/Extraterritorial-legislation-to-improveaccountability-legal-experts-seminar-Brussels-summary-report-3-4-Nov-2006.pdf>; International Committee of the Red Cross, Business and International Humanitarian Law: An Introduction to the Rights and Obligations of Business Enterprises under International Humanitarian Law, Geneva, 2006, <www.icrc.org/web/eng/siteeng0.nsf/html/p0882>, visited on 14 February 2007.

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Introduction State responsibility States can be assigned responsibility for their failure to prevent corporate abuses or for failure to offer redress following abuses. Thus liability of corporations could be pursued indirectly by first activating the positive obligations of states to regulate private actors within their jurisdictions. Indeed this is the obligation of states to ‘protect’ human rights, in addition to the obligations to ‘respect’ and ‘support’ human rights (i.e. states not to themselves infringe rights, respectively states to provide aid). Both host and home states can be expected to assume and act on these positive obligations. Host states (i.e. countries where subsidiaries and suppliers operate) already have obligations, under customary and treaty law, to protect human rights from business abuses within their jurisdictions. Home states (i.e. countries where the controlling entity – parent company or buyer company – is headquartered) are currently not under an international legal obligation to regulate controlling entities operating within their jurisdiction and hold them liable for human rights abuses overseas perpetuated by their business partners. Developing countries (host states) have the right and even duty to regulate private actors. Problems arise however as developing countries compete against each other to attract foreign direct investment (FDI). In the process many governments are inclined to relax enforcement of regulations (especially regarding labour rights) and may also use scarce resources to provide additional incentives for foreign investors. This nurtures a downward pressure which detrimentally impacts right-holders. To address the pressures of South-South competition developing countries could sign a treaty containing commitments to regulate certain corporate impacts. A multilateral treaty would tackle the collective action problem and reinforce the human rights protections eroded by economic competition. Developed states (home states) could accept an ‘oversight’ responsibility for the failings of parent companies incorporated in their jurisdictions, failings that contribute to human rights abuses overseas. The responsibility of the home state to regulate the controlling company is important as often strategic decisions are made by parent companies, which escape the jurisdiction of the host state. The responsibility of home states would ensure that host states do not shoulder alone the burden of regulating the impacts of transnational corporate groups. However, even more than in the case of host states, home states are reluctant to undermine their own competitiveness by imposing new obligations (‘red tape’) on their multinationals. To sum up, new treaty provisions would be required to hold states accountable before international monitoring bodies. Recourse to treaty would be able to solve collective action problems which otherwise would place the ratifying state at a competitive disadvantage against other non-ratifying states. The treaty would also clarify the extent of liability of both parent companies and their business partners. Corporate responsibility Various avenues can be conceived to pursue the direct responsibility of companies, rather than the states’ responsibility to ‘protect’ human rights.

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Chapter 1 Developed states could open up their judicial system and allow compensation claims be brought against the parent company for its own wrongdoings or those of their business partners (subsidiaries, contractors, joint venture partners). This would be done by applying the principles of tort law. The UK and the US have witnessed this kind of transnational litigation. UK courts have entertained claims grounded in the law of negligence when the parent company based in the UK culpably failed to prevent violations perpetuated through the activities of its subsidiaries.5 US courts have admitted civil suits brought by foreigners for serious violations of international law perpetuated overseas by a US-based company. The US Alien Tort Claims Act (ATCA) provides the main legal ground at federal level; it reads: “The district courts shall have original jurisdiction of any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States.”6 So far, these suits have not resulted in a judgment on the merits in favour of the plaintiffs; however, few settlements have been reached and also the courts have cleared some procedural hurdles.7 Developed states would pass binding ‘market access’ regulation targeted directly at suppliers from developing countries. For example, a document circulated within the EU notes: “Some argue for a binding regulatory system in which countries would commit themselves to withhold or withdraw registration in their country, and refuse to allow access to their markets, for any enterprise which breached certain social and environmental standards.”8 The strategy aims to prevent goods produced in violation of human rights standards from reaching the markets in the North. This would provide a disincentive for producers that use abusive methods of production. However the so-called ‘social clauses’ that make commercial exchanges conditional upon the fulfilment of some non-commercial considerations have in the past been vulnerable to abuse for political ends. Therefore developing states strongly oppose such conditionalities as disguised protectionism. Under the 5

Lubbe v. Cape Plc [2000] 1 WLR 1545, 2 Lloyd’s L. Rep 383; Connelly v. RTZ [1996] 3 WLR 373; Sithole & Ors v. Thor Chemicals Holdings Ltd & Anor TLR, 15 February 1999; see also R. Meeran, ‘The Unveiling of Transnational Corporations’, in M. K. Addo (ed.), Human Right Standards and the Responsibility of Transnational Corporations (Kluwer Law International, The Hague, 1999) pp. 161–169; R. Meeran, ‘Liability of Multinational Corporations: A Critical Stage in the UK’, in M. Kamminga and S. Zia-Zarifi (eds.), Liability of Multinational Corporations under International Law, (Kluwer Law International, The Hague, 2000) pp. 251–264. 6 Alien Tort Claims Act, 28 USC 1350, 1789. 7 Dozens of cases have been filed in the US courts using the ATCA. Among the companies sued have been Unocal, Royal Dutch Petroleum, Talisman Energy, Chevron, Exxon Mobil and Coca-Cola. For more cases and summaries see International Labor Rights Fund’s website, <www.laborrights.org/projects/corporate/ATCA%20summaries.htm>, visited on 14 February 2007. 8 European Parliament, Committee on Development and Cooperation, Report Accompanying the European Parliament’s Resolution on ‘EU Standards for European Enterprises: Towards a European Code of Conduct, A4-0508/98, 17 December 1998, <www.cleanclothes.org/ codes/howit.htm>, visited on 14 February 2007.

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Introduction current World Trade Organization (WTO) regime states do not have the discretion to adopt social clauses; in 1996 the WTO considered and declined to allow including protections of core labour rights to be included in trade agreements.9 Highly removed from the present realities is the possibility of devising an international regulatory regime where an international body – a court or a committee – is competent to determine culpability and impose liability directly on corporate groups. The United Nations (UN) Norms on the Responsibilities of Transnational Corporations proposed that UN agencies should periodically monitor and verify companies’ compliance with the standards therein.10 Nevertheless, as a result of the debate surrounding the Norms, in 2005 the UN Commission on Human Rights created the position of Special Representative on the issue of human rights and transnational corporations and other business enterprises with the mandate, among others, to clarify standards of corporate responsibility and to elaborate on the role of states in regulating the role of TNCs.11 Professor John Ruggie has been appointed as Special Representative. In the above cases it is state agencies and courts that would enforce the standards of business behaviour. However, public enforcement can be partly or wholly replaced with private enforcement. Enforcement could then be shared with other social actors, be they trade unions or other actors, as in the cases presented below. Another regulatory technique is to enhance corporate transparency through disclosure laws, and to rely on various constituencies to act upon the information. Both home and host states can pass binding regulations demanding disclosure of various kinds of information. For example, the French law mandates social and environmental reports from companies listed on the French stock exchange. Alternatively, lawmakers can target market intermediaries with ‘gatekeeper’ regulations; the most prominent example so far is the UK regulation targeting pension funds and imposing the obligation to disclose the extent to which their investments take into account CSR issues.12 The demands of NGOs for comprehensive regulation of TNCs have recently crystallised on several key points. Besides the already presented calls for disclosure regulations dealing with social and environmental impacts (‘mandatory sustainability reporting’) and access of victims to the courts of home states (‘access 9 World Trade Orgnization, Singapore Ministerial Declaration, adopted on 13 December 1996, WT/MIN(96)/DEC; See also <www.wto.org/english/thewto_e/whatis_e/tif_e/bey5 _e.htm>, visited on 14 February 2007. 10 Commission on Human Rights, Sub-Commission on the Promotion and Protection of Human Rights, Norms on the Responsibilities of Transnational Corporations and Other Business Enterprises with Regard to Human Rights, E/CN.4/Sub.2/2003/12/Rev.2, 26 August 2003, <www.unhchr.ch/huridocda/huridoca.nsf/(Symbol)/E.CN.4.Sub.2.2003.12.Rev.2.En? Opendocument>, visited on 14 February 2007. 11 Commission on Human Rights, Human Rights and Transnational Corporations and Other Business Enterprises, E/CN.4/2005/L.87, 15 April 2005. 12 See infra section 5.2.

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Chapter 1 to justice’), NGOs propose the modification of company laws to expand directors’ duties to include “a specific duty of care for both communities and the environment”.13 There are good reasons for taking an interest in drawing on the protective potential of company law, and CSR proponents have for long time sought to insert corporate responsibilities into company laws. That would arguably assure some default level of accountability when the protections offered by discrete regulations are found to be lacking. Suggestions were made to redefine managerial duties under company laws in a manner that expands the circle of beneficiaries. The means to enforce the broadened duties could be through new powers of a regulatory authority enforcing the duties on behalf of stakeholders through rights of beneficiaries themselves to sue management in courts, or through altering governing structures within the company itself. The latter structural avenue would see stakeholders’ (especially employees) representatives sitting on the board of directors, or, alternatively, independent directors or directors representing the public interest. There is a precedent in the case of ‘co-determination’ laws in Germany which place employee representatives on the governing board of the company. Another structural option is illustrated by an European Community (EC) directive14 which mandates a consultative structure (‘European Works Council’) or, alternatively, a procedure for informing and consulting employees. Employees of ‘Community-scale undertakings’ (i.e. operating in at least two member states) obtain a voice if not a veto in corporate management. The purpose is to allow employees access to the locus of real decision-making in a transnational company, that is, to the ‘controlling undertaking’. A part of those calling for legally binding solutions do not though place too much faith in the regulatory and policing abilities of states. Therefore they emphasise trade union activism and bargaining supported by internationally agreed and legally enforced labour rights as the best solution to work-related abuses. To sum up, the law-oriented proposals argue in principal either for assigning liability to the parent company (or the whole corporate group) for harms inflicted by subsidiaries/contractors, or to impose certain legally-binding procedural requirements (especially social reporting, but also impact assessments, consultation procedures and effective management systems) on the parent that would cover the activities of the whole group. Such provisions are to be included either in an international treaty, or in national laws.

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Corporate Responsibility Coalition (Action Aid, Amnesty International, CAFOD, Christian Aid, The Corner House, Friends of the Earth, Global Witness, New Economics Foundation, Tax Justice Network, WWF), A Big Deal? Corporate Social Responsibility and the Finance Sector in Europe , 2005, p. 2, <www.foe.co.uk/resource/reports/big_deal.pdf>, visited on 14 February 2007. 14 Council Directive 94/45/EC of 22 September 1994 on the Establishment of a European Works Council or a Procedure in Community-scale Undertakings and Community-scale Groups of Undertakings for the Purposes of Informing and Consulting Employees, Official Journal L 254, 30 September 1994, pp. 64–72.

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Introduction Individual responsibility Such an approach would pursue the personal accountability of corporate directors and managers. Criminal liability of business executives is already a possibility under the International Criminal Court regime, but only for the most serious crimes such as genocide, crimes against humanity and war crimes. The most relevant to CSR grounds for criminal liability are to be found in complicity, usually defined as the ‘association or participation in a criminal act’. It was noted that “[t]hree elements must be present in order to find a defendant guilty of complicity under international law: a crime against humanity or war crime must have been committed; the accomplice must contribute in a material (‘direct and substantial’) way to the crime; and there must be an element of intent and/or knowledge, such that the accomplice must have intended that the crime be committed or have been reckless as to its commission”.15 The international criminalisation of transnational bribery is also a precedent that CSR proposals can draw on.16 Following the appointment of Professor Ruggie as UN Special Representative the area of corporate complicity in violations perpetuated by business partners, has received increased attention.17 For harms not amounting to crimes, directors could be held accountable under the law of negligence for culpable acts or omissions in the exercise of their mandate. 1.1.2. CSR approaches CSR writings, often advanced under the umbrella term of ‘stakeholder theory’, can be roughly grouped into three streams: the descriptive, instrumental and normative.18 Descriptive accounts have an information-generating, awareness-raising function; instrumental works are applied capacity-building efforts to improve managerial responsiveness to the social environment; and normative contributions strive for 15

International Peace Academy and Fafo, supra note 4, p. 29. OECD, Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, 1997, Articles 1 and 3, 17 See Exploring Responsibility and Complicity, Business & Human Rights Seminar Report, London, 2005, <www.bhrseminar.org/BusinessHumanRightsSeminarReport2005.pdf>; International Peace Academy and Fafo, supra note 4; EarthRights International, The International Law Standard for Corporate Aiding and Abetting Liability, 2006, <www.earthrights.org/files/Legal%20Docs/UN%20Norms%20ILP/aiding_and_abetting_pape r.pdf>; The International Commission of Jurists launched in 2006 its Expert Legal Panel on Corporate Complicity in International Crimes to clarify when corporations should be held accountable for their involvement in international crimes, <www.icj.org>, visited on 14 February 2007. 18 For overviews of the CSR field and further references, see D. J. Wood, ‘Theory and Integrity in Business and Society’, 39:4 Business & Society (2000) pp. 359–378; A. B. Carroll, ‘Corporate Social Responsibility: Evolution of a Definitional Construct’, 38:3 Business & Society (1999) pp. 268–295; ‘The Toronto Conference: Reflections on Stakeholder Theory’, 33 Business & Society (April 1994) pp. 82–131; W. C. Frederick, ‘From CSR1 to CSR2: The Maturing of Business-and-Society Thought’, originally from 1978, reprinted in 33 Business & Society (August 1994) pp. 150–164. 16

9

Chapter 1 clarity of the responsibilities a company should have (i.e. the scope of CSR) and/or advance alternative models of the firm. The separation between the three streams of stakeholder theory is made here for clarification purposes only. Instrumental accounts can have a descriptive empirical segment (either case studies or mere illustrations). Descriptive accounts often conclude with prescriptions for businesses and regulators. Normative accounts often are backed with illustrations of responsible business practice. Despite this blend of the three streams, the centre of gravity in each case lies in one of the three areas. Models of responsible business behaviour can be proposed directly to corporate management for voluntary implementation. In addition, but not necessarily, they can be advanced to public policymakers as a conceptual base for new regulations. In the first case, the interest of CSR writers would lie with the development of management tools or with enhancing the capacity for moral reflection on the part of managers. In the second case, works particularly in the field of corporate governance target regulators with alternative models of the firm. The descriptive CSR Case studies highlighting the human rights impacts of business activity (mainly TNCs) have raised the awareness of corporations to emerging CSR risks, and also of society to the serious negative impacts of business activity and trade in developing countries.19 Some case studies record corporate abuses. Others illustrate ‘win-win’ situations in which a business successfully advances both profitability and social responsibility; such studies highlight new corporate strategies to manage the social environment. Large corporations operate in an increasingly complex social environment. As many large corporations became transnational, risks to corporate operations and reputations could not be discarded anymore, as Shell’s experiences (Nigeria and Brent Spar) illustrate. Descriptive accounts of the corporate social environment help identify and describe new actors, and new issues, that pose nontraditional risks to business. Other empirical studies not dealing specifically with human rights but more generally with CSR purport to reveal a correlation between CSR and financial 19

Human Rights Watch, The Price of Oil – Corporate Responsibility and Human Rights Violations in Nigeria’s Oil Producing Communities, New York, 1999, <www.hrw.org/reports/1999/nigeria>; I. Mamic, International Labour Organization, Business and Code of Conduct Implementation – How Firms Use Management Systems for Social Performance, 2003, <www.ilo.org/images/empent/static/mcc/download/supply_chain.pdf>, visited on 14 February 2007; Global Witness and Partnership Africa Canada, The Key to Kimberley – Internal Diamond Controls – Seven Case Studies, 2004; California Global Corporate Accountability Project (Natural Heritage Institute, Nautilus Institute for Security and Sustainable Development, and Human Rights Advocates), Beyond Good Deeds: Case Studies and a New Policy Agenda for Corporate Accountability, Berkley, 2002; R. Sullivan (ed.), Business and Human Rights – Dilemmas and Solutions (Greenleaf, Sheffield, 2003); E. Schrage, Promoting International Worker Rights Through Private Voluntary Initiatives: Public Relations or Public Policy, University of Iowa Center for Human Rights, 2004.

10

Introduction performance.20 Many such statistical studies are motivated to establish the existence of a ‘win-win’ in which both profitability and responsibility are advanced. A link to the financial bottom-line is crucial for starting discussions with business executives that see CSR as antithetical to business objectives. It fulfils the vital task of demonstrating the existence of practical possibilities that have escaped attention before. Once such possibilities are demonstrated: instrumental and normative streams of CSR analysis can take over. The instrumental CSR Instrumental accounts of CSR complement descriptive accounts to build a compelling business case of CSR. Instrumental approaches have an ‘engineering’ orientation; they propose deliberate direct changes in corporate structures and procedures able to deliver CSR. A sizable part of such research is professional research commissioned for multistakeholder CSR fora in which businesses, public policy-makers, NGOs and experts participate. Such fora exist to develop the management tools indispensable to identify, manage and communicate corporate social impacts. Sustained efforts along these lines have only been made in the last ten years. A human rights compliance assessment with 1000 indicators has recently been proposed by the Danish Institute for Human Rights; it aims to help businesses understand human rights risks and weak spots in their performance.21 A multitude of templates assist companies to integrate CSR considerations into their management processes: the Sigma guidelines for businesses22 and the FORGE guidelines on CSR for the financial services sector23 (both in the UK), and, still under development, the International Organization for Standardization (ISO) Guidance on CSR (ISO 26000). Further, the Global Reporting Initiative aims to standardise the way that businesses report their economic, social and environmental impacts.24 The auditing industry and NGOs develop auditing standards for CSR; corporate performance could then be audited and corporate claims (reports) ‘assured’, and gain thus in credibility. The Institute of Social and Ethical AccountAbility (UK) has developed

20 M. Tsoutsoura, Corporate Social Responsibility and Financial Performance, Berkeley, California, 2004, <www.haas.berkeley.edu/responsiblebusiness/documents/FinalPaperonCSR _PDFII.pdf>, visited on 14 February 2007; M. Orlitzky et al., ‘Corporate Social and Financial Performance: A Meta-analysis’, 24 Organization Studies (May-June 2003) pp. 403–441. 21 Danish Institute for Human Rights, Human Rights & Business Project, <www.humanrights business.org>, visited on 14 February 2007. 22 Sigma Project, The Sigma Guidelines, Putting Sustainable Development Into Practice – A Guide For Organisations, 2003. 23 FORGE, Guidance on Corporate Social Responsibility Management and Reporting for the Financial Services Sector, 2002, <www.bba.org.uk/bba/jsp/polopoly.jsp?d=123&a=728>, visited on 14 February 2007. 24 Global Reporting Initiative, Sustainability Reporting Guidelines v3 (“G3”), 2006, <www.globalreporting.org/Services/ResearchLibrary/GRIPublications>, visited on 14 February 2007.

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Chapter 1 the AA1000 series for this purpose.25 Toolkits dealing with multistakeholder collaborations have also been prepared to help business collaborate with other social actors.26 With few exceptions, most of these instruments have a wider reach than human rights and tend to cover both the social and environmental aspects of corporate performance. This new and worthwhile development in technical capacity building complements a much older effort in capacity-building. Back in the 1970s in the US, ethicists noted that the business school curricula ill-prepared managers with the conceptual tools necessary to enable moral reasoning in difficult business situations. Therefore business ethicists have worked on training managers on ethics-related issues arising in business operations; it was said that the fundamental difficulty raised by CSR “is simply that a mind attuned to the market place acquires an almost trained insensitivity to non-market considerations”.27 The normative CSR The descriptive and instrumental streams of CSR literature offer useful managerial tools for scanning and managing the business environment. Despite their merits from a stakeholder theory perspective, the two streams do not confront business structures and systemic market pressures that run counter to stakeholder concerns. This is the case with, for example, the profit-maximisation norm enforced by ‘impatient’ capital markets, or the organisation of some supply chains in labourintensive industries (resulting in pressures on suppliers to cut corners). The normative stream of CSR tackles such structural issues head on. Normative ethicists start by evaluating the classical model of corporation, which prioritises the interests of shareholders, as morally bankrupt. As Donaldson and Preston wrote, “[t]he plain truth is that the most prominent alternative to the stakeholder theory (i.e., the ‘management serving the shareowners’ theory) is morally untenable”.28 At the same time, as a matter of law and business reality, directors and management that run the company have a margin of discretion. If this discretion exists, and the people that run large corporations are obviously capable to use moral reasoning, then presumably a more morally tenable model of the corporation can be advanced. This is especially necessary for large businesses. The ‘stakeholder corporation’ should balance the interests of all its stakeholders; 25

The Institute of Social and Ethical AccountAbility, AA1000 Series, <www.accountability.org.uk/aa1000/default.asp>, visited on 14 February 2007. 26 Business Partners for Development, <www.bpdweb.com/index.htm>, visited on 14 February 2007; Copenhagen Centre, Partnership Matters – Current Issues in Cross-Sector Collaboration, Issue 1, 2003, ; International Business Leaders Forum, Partnership Matters – Current Issues in Cross-Sector Collaboration, Issue 2, 2004, , visited on 14 February 2007. 27 H. L. Johnson, Disclosure of Corporate Social Performance: Survey, Evaluation and Prospects (Praeger, New York, 1979) p. 116. 28 T. Donaldson and L. E. Preston, ‘The Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications’, 20:1 Academy of Management Review (1995) pp. 65–91.

12

Introduction environmental and social matters would not be trumped (severely discounted) by the blind (short-sighted) pursuit of the pecuniary interests of shareholders. The corporate institution must be subjected to moral evaluation, and businesses should behave like moral agents/actors. Normative CSR leaves it up to enlightened managers to voluntarily follow the tenets of the stakeholder corporation and/or to lawmakers uniquely positioned to change the ‘rules of the game’. The normative stakeholder theory has sometimes been advanced in the US and the UK in debates for the revision of company law and corporate governance regime. But another part of stakeholder theory is applications of theories of justice, exercises in moral imagination not related to company law. Chapter 3 will analyse in more depth such normative proposals. Normative works dealing specifically with human rights and business have not articulated a comprehensive model of the firm but seem sometimes content to draw for philosophical support on the existent works of normative ethicists as an alternative to shareholder-oriented theories of the firm. Otherwise, in order to identify and specify in more detail the human rights responsibilities for corporations, appeal has been made to the standards developed in international human rights treaties and other instruments. 1.2. CRITIQUE OF CURRENT RESEARCH This section assesses critically, but briefly, the strengths and weaknesses of the CSR approaches previously described. 1.2.1. Law-oriented approaches The priority of approaches focused on state responsibility is the drawing up of new international treaties or the reinterpretation of current treaties to enlarge state responsibility for corporate abuses. International law is clear on the legal obligations of host states to ‘protect’ human rights, that is, to offer protection against abuses perpetuated by private actors. However, a responsibility of home states to protect human rights overseas by regulating parent companies incorporated in their jurisdictions is not yet recognised under current international law. There have been arguments made otherwise. Thus Clapham would, for example, assign responsibility to the US for failure to legislate in a situation like the 1984 Bhopal accident in India which recorded thousands of dead following a poisonous leak from an industrial plant.29 The main interest of this study however is not on state responsibility under international law, for reasons, among others, that the negotiation of a comprehensive international treaty on corporate responsibilities is a cumbersome process likely to stretch over decades. In the meantime a lot can be learned about law and responsible business practices by focusing on regulation at national level, and on how law/policy interacts with CSR, at national and international levels, to shape corporate behaviour.

29

A. Clapham, Human Rights in the Private Sphere (Clarendon Press, Oxford, 1993) p. 348.

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Chapter 1 Personal responsibility of corporate executives can be sought through both criminal and civil law methods. The criminal liability of private actors under international law, including the individual responsibility of business executives, is a rapidly developing area in international law exemplified by the International Criminal Court regime and by the law of transnational bribery. In the corporate accountability area, human rights experts are concentrating now their efforts on identifying standards of corporate complicity by drawing on national laws and the jurisprudence of international criminal tribunals. However, criminalising directorial misbehaviour is likely to remain limited to most extreme cases and apply only to a narrow range of CSR issues. Seeking the deterrence of business executives through civil liability for their negligent acts and omissions has also obstacles to overcome: the constitutive articles of companies, insurance policies and also state regulations make possible for management to have the company itself pay compensation to third parties following acts of managerial negligence. Regulators approach cautiously this area of director liability for negligence, as exemplified by British policymakers: “The law on directors’ liability needs to strike a careful balance: on the one hand, the law must be firm and robust to deal fairly with cases where something has gone wrong, as a result of either negligence or of dishonesty; on the other, Britain needs a diverse pool of high-quality individuals willing to assume the role of company director, and a willingness by directors to take informed and rational risks.”30 This means that efforts to advance CSR at this juncture will run counter to strong dynamics present in most systems of corporate governance. Among the three levels of responsibility that a legalistic approach could elaborate, this book concentrates on the corporate responsibility level, not state or individual responsibility. It is at this level that numerous and interesting developments currently take place. Law-oriented literature reveals a clear focus on ensuring corporate liability through binding regulations. The proposals draw on rational choice analysis that is particularly able to highlight important dynamics surrounding corporate activity. Such analysis proposes that self-interest is a powerful motivator that should not be obscured, especially when dealing with profitmaking entities that are subject to the competitive pressures of markets. In support of tort law solutions, it was observed that “[c]alm, calculating manufacturers are particularly attractive targets for punitive damage awards, not because they are more evil than other injurers or because they are wealthier, but because they are more deterrable. Moreover, because manufacturers calculate, it is especially important to send them the correct signal.”31 This regulatory approach maintains that the judicial system is uniquely able to bring a perpetuator of serious violations of human rights to justice; also harsh financial sanctions have a deterrent effect on other corporations. Thus this approach offers reparations to victims and can also prevent 30

Department of Trade and Industry, Company Law Reform, White Paper 2005, p. 23, <www.dti.gov.uk/bbf/co-act-2006/white-paper/page22800.html>, visited on 14 February 2007. 31 N. K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics, and Public Policy (University of Chicago Press, Chicago, 1994) p. 189.

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Introduction further violations by other corporations: “Damages are a money payment to compensate the victim, that is to say, to restore him, so far as money can, to the position he would have been in if the wrong complained of had not been committed. Damages also serve the aim of preventing harm.”32 The logic employed, one of pure deterrence, offers conceptual clarity: the incentives are clearly specified and the mechanisms of accountability are formalised. For analytical purposes, a deterrent approach offers a direct causality between law and corporate behaviour. There are also downsides of this approach. By relying so heavily on international treaties and on national regulation, law-oriented approaches depend decisively on state action. Host states have often fallen short of properly regulating business impacts, and particularly enforcing these regulations. These states have, often for good reasons, seen proposals to integrate social and environmental issues with international trade as disguised protectionism, as politically motivated efforts made by rich countries and their trade unions to shelter own industries and work forces from foreign competition. Home states, where the parent company is based, may be disinclined to rigorously regulate it when the harms are not directly caused by the parent company and the place of abuses is in other jurisdictions and so geographically remote. These dynamics make the enactment of strong deterrent legal frameworks particularly difficult. More narrowly defined regulatory proposals have higher chances of success as, for example, the treaties on bribery or the regulation of diamond trade, at international level, and laws imposing obligations to report on social and environmental impacts, at national level. Less successful have been more comprehensive regulatory efforts such as the UN Norms on the Responsibilities of Transnational Corporations, at international level, and the reform of company laws, at national level. Lawmakers have difficulties in regulating TNCs which “constitute a new form of enterprise organisation where a plurality of separate legal entities are submitted to unitary economic direction. The central and enigmatic feature of such corporate phenomenon has thus been identified … with the tension or contradiction between diversity (multiplicity of legal entities) and unity (unity of economic entity)”.33 A legal obstacle to the liability of MNEs is the principle of legal separation of companies. To overcome it arguments have been made either for ‘group liability’ (the doctrine of ‘enterprise liability’) which makes the parent company automatically responsible for the subsidiary’s behaviour, or for ‘direct liability’ of the parent company for its own failings that resulted in harm overseas. In the latter case, liability is assigned to the parent either for acts of commission as in the export of dangerous technology to subsidiaries, or for acts of omission as in failure to keep informed about subsidiaries’ activities and exercise oversight. Group liability is a negation of the principle of legal separation, while direct liability is compatible with 32

European Group on Tort Law, Principles of European Tort Law, Article 10:101, 2005, <www.egtl.org/principles/index.htm>, visited on 14 February 2007. 33 J. E. Antunes, Liability of Corporate Groups – Autonomy and Control in Parent-Subsidiary Relationships in US, German and EU Law (Kluwer Law and Taxation Publishers, Deventer, 1994) p. 489.

15

Chapter 1 that principle as it sanctions only own wrongdoing. Muchlinski shows that the enterprise entity doctrine recognises the corporate group as a distinct form of business association. In keeping with this doctrine some a priori judgments should be made either toward the establishment of a supranational incorporation, or a presumption of control by the parent over the subsidiary.34 Muchlinski appreciates that the advantages of limited liability offered by the doctrine of corporate separation provides strong reasons for its retention, and an abandonment of this traditional approach to group liability is unlikely.35 The UK litigation mentioned previously applies the principles of direct liability. Deterrence itself can offer only a partial explanation to regulatory proposals focusing on structures and procedures. This avenue of legislative action departs from a ‘pure deterrence’ reasoning (i.e. deterrence achieved through state regulation and enforcement) as it does not prescribe (final) outcomes and does not assign liability for not meeting them. The law instead specifies only certain means (structures and procedures) to be employed. Procedural regulation crucially depends on the private use of these processes or structures in order to achieve law’s goals. One could refer, as examples, to: collective bargaining; legal requirements for consultation or for environmental impact assessments; a legal obligation to release a CSR report or to have its contents independently verified. It is apparent that such regulatory strategies are based on a different mechanism of influence which include deterrence (through public and private enforcement), but is not limited to it. Corporate voluntarism and various state policies (even if not binding in nature) suddenly appear relevant for understanding the operation of law because they can affect other processes of negotiation, clarification and innovation. All such mandatory procedures would empower stakeholders to negotiate with the business (subsidiary and/or parent company) the scope of its responsibilities. Understanding how law operates in these situations is particularly important when discussing the positive responsibility of the parent company to exercise oversight over its business partners. The final objective of law – obtaining the oversight of parent company – would be specified through negotiation and innovation in how to balance competing interests. Solving the complexity raised by how to specify positive obligations cannot be done solely through legislative fiat. In these circumstances it appears that an emphasis on ‘pure’ deterrence can easily overstate the distinction mandatory-voluntary. While it is true that there cannot be legal liability without binding regulation (or contracts), there are hybrid regulatory frameworks that combine state regulation with private regulation and private enforcement that can provide various degrees of accountability. A deterrent framework cannot account for the developments of the last ten years in the business and human rights area. This is problematic because much of what currently happens in the area of business and human rights does not involve state action; and much of what states do is not of a regulatory type. More broadly, lawmakers in developed countries increasingly rely on private enforcement due to 34

P. T. Muchlinski, Multinational Enterprises and the Law (Blackwell, Massachusetts, 1995) pp. 329–332. 35 Ibid., p. 329.

16

Introduction budgetary constraints and international competitiveness pressures; they design regulatory mixes to mobilise and oversee the regulatory potential of private actors. Therefore, a purely deterrent approach remains aloof of a multitude of policy and corporate developments. Thus the approach exclusively grounded in deterrence also precludes an evolutionary analysis of various CSR initiatives currently underway. Without this temporal dimension introduced by evolutionary reasoning, voluntary initiatives cannot overcome their condition,36 and therefore appear completely inappropriate to provide a systemic solution to CSR concerns. The possible interactions between voluntarism and public policy can however help lawmakers to advance toward systemic solutions in the area of business and human rights. Finally, the deterrence framework cannot properly accommodate leading businesses. Such companies do more than respect human rights in their operations; they develop standards, methods and tools to manage and communicate CSR. In the process they collaborate with stakeholders. The accumulation and availability of this CSR experience may make less defensible the position of less proactive companies which remain outside the CSR regime or free ride from within. By building capacity to handle CSR in various social actors, leading businesses may trigger important regulatory dynamics. Therefore, from a perspective that accounts for the influence exercised by proactive companies, the narrow angle of deterrence concentrating solely on laggards can be criticised. With regard to the entire range of corporate behaviours, deterrence limits itself to wrongdoers and does not account for major new developments triggered by leading TNCs. The impacts of the latter’s behaviour cannot be grasped. This critique of the predominant regulatory approach advanced by human rights proponents serves to highlight the gap in legal analysis; it also gives a rough direction of how this study will be developed. Now the discussion turns to some blind spots left by non-legalistic CSR approaches. This will also show the complementarity of this study with some CSR approaches. 1.2.2. CSR approaches Studies of the link between CSR and financial performance often aim to establish compatibility between responsible business behaviour and profitability. However, the more ambitious attempt to establish causality has not been successful: it is not clear whether CSR contributes to enhanced financial performance, or if it is profitability that generates the resources needed to implement CSR. It is said that such studies showing a positive relation between CSR and the financial bottom line may establish a correlation, but not causation. In addition, such studies in themselves are not meant to provide explanation or guidance on how to promote simultaneously both CSR and profitability. For that purpose, case studies are a useful complement as they may show how a certain experience unfolded.

36 Business self-regulation is notoriously affected by the ‘free-rider’ syndrome and assurance problems.

17

Chapter 1 The findings of case studies bring indispensable evidence on ‘what’ and ‘how’ questions. In the business and human rights area most case studies can be described as ‘thick descriptions’. This may be sufficient and serves important practical purposes, but findings often remained localised to particular contexts. However, better theory is needed to make sensible generalisations to other contexts. As Yin shows, one does not generalise to other case studies but one generalises to theory; theory becomes the vehicle for examining other cases.37 Case studies are thus not expected to inform directly other CSR contexts that are likely to differ significantly. Empirical research advances only when it is accompanied by theory and logical inquiry and not when treated as a mechanistic or data collection endeavour.38 Unfortunately, the theories that deal with possible ways of approaching the area of ‘business and human rights’ are still underdeveloped. Also better theory could shape the design of future case studies to obtain even more insightful evaluations of CSR. As a difference from descriptive approaches the instrumental stream of CSR research aims to build managerial capacity to implement CSR. We have distinguished between the capacity for moral reasoning and the more technical capacity to implement CSR. Business ethicists have emphasised the importance of moral reasoning especially as corporate decisions having a substantial social impact are ultimately taken by individuals capable of moral reasoning. Nevertheless, moral sensitivity needs to be doubled by managerial tools for identifying, measuring, managing, verifying and reporting their economic, social and environmental performance. The creation and on-going evolution of this significant infrastructure – composed of intermediary organisations and networks and managerial templates for CSR – is a development of the last five to ten years whose importance cannot be overemphasised. Chapter 4 looks more closely at this body of work. Both these efforts in capacity-building deliver indispensable managerial capacity, but positive outcomes may still be delayed or remain limited to a few ‘good corporate citizens’. It was left to normative stakeholder theories to embed CSR in a coherent understanding of the regulatory, market and social dynamics surrounding the corporation. As will be shown in chapter 3, normativists downplayed these dynamics and concentrated on developing a moral philosophy-inspired discourse. In fairness, normative stakeholder theories worked to define the foundations and scope of corporate responsibilities in a more hostile context: the ‘greed is good’ corporate climate of the late 1970s and 1980s in the US. Nowadays CSR is significantly more accepted in business circles, and their willingness to cooperate is clearly higher; these CSR practices and the variety of actors involved in CSR were simply not existent decades ago. In addition, CSR practitioners, after ten years of CSR at international level, have become more explicit about the need to make the impacts of CSR more sustainable and to scale them up. This puts a premium on normative works that strive to account for the aforementioned dynamics and articulate scalingup mechanisms. 37

R. K. Yin, Case Study Research: Design and Methods, third ed. (Sage Publications, Thousand Oaks, 2003) p. 38. 38 Ibid.

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Introduction There are direct implications for the business and human rights area, which does not have to import uncritically the normative constructs of stakeholder theory. Appreciation for previous modes of reasoning does not have to hold us blind to new realities and fresh opportunities to find answers to old problems. Despite the efforts of stakeholder theories there is still a way to go until the scope of CSR is satisfactorily defined, that is, the limits of corporate responsibilities. In the area of human rights this definition needs to be done without obscuring the social role of companies and the relationship between corporate responsibilities and state responsibilities.39 New models cannot discount the institutional pressures generated by markets and globalisation that reinforce the standing of shareholders in the economy of the firm.40 Chapters 2 and 3 will further analyse these aspects. A better capacity to assess the dynamics in the social environment is helpful for understanding the full range of effects of CSR and its future evolution. The hope is that this approach will provide a new impetus to bring sceptical companies on board and enhance the cooperative disposition of stakeholders. In this way normative stakeholder theory can truly complement and reinforce the instrumental stream of CSR work. 1.3. MATTERS OF APPROACH This study discusses the responsibilities of TNCs,41 more precisely, the responsibilities of the controlling entity, which will often be the parent company in

39

See J. Ruggie, Response to Fédération internationale des ligues des droits de l’Homme, 20 March 2006, <www.reports-and-materials.org/Ruggie-response-to-FIDH-20-Mar-2006.pdf>, visited on 14 February 2007. 40 M. T. Jones, ‘Missing the Forest for the Trees – A Critique of the Social Responsibility Concept and Discourse’, 35 Business & Society (March 1996) pp. 1–27; T. Mitchell et al., ‘Toward a Theory of Stakeholder Identification and Salience: Defining the Principle of Who and What Really Counts’, 22 Academy of Management Review (October 1997) pp. 853–886; A. Stark, ‘What’s the Matter With Business Ethics?’, Harvard Business Review (May/June 1993) pp. 38–48. 41 The definition of multinational enterprises used herein is broader than usual and includes not only ownership links (i.e. parent-subsidiary) but also other links that allow a degree of control or influence be exercised (i.e. buyer-contractor). As the OECD Guidelines read, MNEs “usually comprise companies or other entities established in more than one country and so linked that they may co-ordinate their operations in various ways. While one or more of these entities may be able to exercise a significant influence over the activities of others, their degree of autonomy within the enterprise may vary widely from one multinational enterprise to another... the different entities are expected to co-operate and to assist one another to facilitate observance of the Guidelines.” Organisation for Economic Co-Operation and Development, OECD Guidelines for Multinational Enterprises, adopted 21 June 1976, revised 27 June 2000, <www.oecd.org/document/28/0,2340,en_2649_34889_2397532 _1_1_1_1,00.html>. See also International Labour Organization, Tripartite Declaration of Principles Concerning Multinational Enterprises and Social Policy, adopted by the Governing Body of the International Labour Office in 1977, amended 2006, para. 6,

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Chapter 1 the North or a large subsidiary in the South. In the following chapters the emphasis is on how the responsible business practices of leading companies within the CSR regime clarify and operationalise CSR, and how states, through law and policy, can reinforce the emerging CSR regime and contribute to the institutionalisation of CSR. Historically CSR has developed in a mode characterised by voluntarism, decentralised non-hierarchical enforcement, pressure of the public opinion mobilised by advocacy groups and facilitative state action. Concepts of rights, duties, the binding nature of instruments and centralised settings to regulate and enforce are not automatically applicable to CSR. This mismatch between legal concepts and social reality is manifest in the difficulty of the legal theory to account for CSR practices. Conversely, the difficulty is also present for business executives and CSR theorists to relate corporate voluntarism to law and state actors. The legal and business systems have thus difficulties of communication when it comes to CSR. As shown above an important implication of this study should lie with challenging widely held perceptions that CSR and regulation are mutually exclusive. This study does not search for static maps based on highly rigorous classifications, but examines the subtle variations in concepts that open an evolutionary path toward accountability on which businesses may move or not depending on the specifics of each context. This research will increase analytical sensitivity by defining the main concepts, where possible, as continuums instead of striving for categorical delimitations. For example, leading TNCs can be positioned on a continuum ranging from ambivalent/aspiring TNCs to decidedly committed TNCs: the gap between altruistic and self-interested behaviour can be narrowed by referring to enlightened self-interest (a longer term and more inclusive type of self-interest). Different regulatory strategies – enabling or mandatory – can be examined in terms of opt-out procedures: the more elaborate and costly the opt-out procedures, the closer the rules are to being, in effect, mandatory. Finally CSR standardisation or benchmarking can be examined along a continuum ranging from guiding problem solving to accountability for reaching targets. This research takes a step back to grasp the paths and trends in the larger picture. Instead of striving for clear-cut ideal categorisations, the argument herein deliberately leaves place for social choice, struggle and contrary arguments. Such a theoretical stance is humble, but makes it more likely for this study to be a useful complement to more applied approaches to CSR and human rights protection. Conceptual treatments as herein cannot obscure the initial understanding that practical solutions need compromises and innovation. As Amartya Sen observed, insistence on completeness of judgements of justice over every possible choice is an enemy of practical social action, while the overuse of the concept of justice reduces the force of the idea.42 Instead the aim here is to identify concepts compatible with both the regulatory and business systems. For purposes of my study, the threshold in developing these border constructs is not perfect alignment, but mere compatibility. <www.ilo.org/public/english/employment/multi/download/declaration2006.pdf>, visited on 14 February 2007. 42 A. Sen, Development as Freedom (Oxford University Press, Oxford, 1999) pp. 253–254.

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Introduction The final goal is, on one hand, to highlight ideas that affect CSR but have outlived their usefulness, and on the other hand, to enrich and clarify the CSR ideas by importing ‘wisdom’ from jurisprudence and regulatory theory. Sensitivity to context is essential. Some regulatory theorists refer to the need to design policies fit to the ‘regulatory space’. This requires proponents to understand business and societal dynamics that can impact on law’s effectiveness. Such attention to context gives to the present study a functionalist orientation. It has been shown in the international law context that functionalism emphasises the need for problem-solving, confronts problems of great complexity with minimal dependency on legal abstractions and doctrines that lack operational utility in the context of those problems; it replaces analogies with functionally specific concepts, techniques and institutions.43 Formalism appears less attractive for the area of business and human rights at this early stage of its evolution; instead of limiting the field of inquiry solely to legally binding instruments, an orientation grounded in functionalism could account for both state and corporate policies, even if they have not the binding nature of law or contract. Their utility in enhancing the protection of human rights would be judged in context. The normative orientation of this study lies with the human rights standards developed in international law instruments. Human rights are legitimised interests that the international community has recognised in the last half century for every human being and are accompanied by legally binding obligations on states. Following Drahos, one can “assume that the current set of human rights recognised in international law serve as an adequate description of those interests that individuals all over the world wish to have protected from interference or promoted”.44 This study also looks at CSR from a human rights angle. It is important when dealing with CSR and human rights to account for established actors (states, trade unions and other non-governmental bodies) and to reinforce their capacity to discharge own responsibilities towards good governance. This study breaks with the tendency to view CSR and regulation as two independent parallel channels to advance human rights; instead it deliberately connects CSR with public policy and state actors, which are the obligation-holders under international human rights law. The practices of leading businesses create opportunities for policy makers to regulate or devise innovative governance arrangements that can, in turn, pressure other companies to emulate good business practices. As Ruggie noted, “[o]ne line of constructivist research seeks to identify, inventory and specify the consequences of innovative micro-practices. This approach is most productive when linked up with

43

D. Johnston, ‘Functionalism in the Theory of International Law’, 26 Canadian Yearbook of International law (July 1988) pp. 55–56. 44 P. Drahos, ‘The Right to Food, Health and Intellectual Property in the Era of “Biogopolies”’, in S. Bottomley and D. Kinley (eds.), Commercial Law and Human Rights (Ashgate, Aldershot, 2002) p. 215.

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Chapter 1 macro-structures, to determine which microagents are potentially transformative agents”.45 Articulating standards for CSR management and creating supporting infrastructure (organisations and networks) makes it possible for businesses to implement and demonstrate CSR. The next step for CSR is to scale-up this infrastructure, to enhance its impacts. By adopting a legal angle the present study begins to analyse the interaction between CSR and law/public policy as a scale-up mechanism. Critics of CSR, both from business and from the civil society, have discussed the relationship between CSR and regulation. Both consider that CSR triggers unwelcome regulatory dynamics. The long-standing business objection to CSR sees it as a step on a slippery slope towards intrusive regulation that impedes the creation of wealth through market mechanisms. Sceptics from civil society assert that CSR displaces regulation (de-regulation) and is too weak to change profitdriven corporate behaviour. By comparison with these two viewpoints, theories that look at constructive interactions between CSR and public policy, at the dynamics for transparency and participation CSR may generate, are less developed. There is an uncharted area where CSR may facilitate sensible regulation, as opposed to deregulation or intrusive regulation. The interaction between law and corporate voluntarism is a complex one. Better understanding it is an effort in capacitybuilding that complements the two aforementioned instrumental efforts aimed at building technical capacity to implement CSR and capacity for moral reasoning. The business case of CSR usually links TNCs with human rights through ‘winwin’ reasoning, but at a certain point there is a conflict. This point is bound to be reached and cannot be disguised through ‘win-win’ rhetoric, especially when one expects a significant and sustainable contribution from business to tackle the numerous human rights problems of the Third World. Where exactly this point is placed is a matter of persuasion and bargaining in each specific context with a look at available alternatives, not a matter of normative or technocratic pre-determination. Still, the point can be sensibly pushed further with an empirically-informed redefinition of self-interest, of poverty, of implementation mechanisms, of the roles of various actors, etc. The interest of this study is to frame CSR in a manner compatible with current business institutions and dynamics, and to be alert to the possibilities for incremental change and evolution toward economic and political arrangements favourable to human rights goals. Karl Popper has ably articulated this orientation. He agreed that many social problems are pressing; one should not rest content with interpreting the world but should strive to contribute to its transformation. It is easier to reach agreement on how to identify and eliminate poverty than to agree on an ideal form of social life. The strategy is to work toward the objective through direct means and not indirectly by conceiving and following a remote ideal.46 45

J. G. Ruggie, Constructing the World Polity: Essays on International Institutionalism (Routledge, London, 1998) p. 27. 46 K. Popper, Conjectures and Refutations: the Growth of Scientific Knowledge (Routledge, London, 2002) pp. 337, 361.

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Introduction 1.4. DISPOSITION OF THE BOOK An analysis of the relationship ‘multinational business – human rights’ can start from either the business end or the human rights law end. This study begins with a discussion of company law and corporate governance. This choice is made in order to anchor the subsequent CSR argument more solidly in business and legal realities and acquire maximum compatibility with them. Chapter 2 presents the legal duties corporate directors have under company laws and also their enforcement through courts of law and corporate governance mechanisms. The discussion will highlight the way that this body of regulations has dealt with stakeholders’ interests. The analysis covers legal formulations employed in the US, British, French and German systems, but concentrates on the US and British ones: On one hand they emphasise the role of shareholders in the economy of the firm, a role that is growing increasingly important in other developed corporate governance systems. This is a timely emphasis as both pro- and con-CSR writings have often obscured or misrepresented the standing of shareholders. On the other hand, the case law and theory regarding managerial duties is best developed in these two jurisdictions. Further insights are derived from the British reform of company law under way since late 1990s; it serves as an excellent example of lawmakers clarifying the established duties of directors and in the same time creating an opening for stakeholders’ interests to be taken into account. Company laws lay down a duty of care on corporate managers in their pursuit of business success. In discharging their duties directors may come to adopt a longerterm perspective and a more stakeholder-inclusive manner; the result is obviously an increase in complexity for managers. Chapter 3 picks up where the company law discussion ended: how did CSR writings – both arguments in favour of or against CSR – assist managers in tackling the complexity of their profit-making mandate? We look at the norms or belief systems that pro- and con- CSR arguments have promoted. While company laws lay down a managerial duty of care, it can be rendered meaningless if the norms that guide managerial decision-making are incompatible with policy aims such as long-term profitability of business and reduced frictions between shareholders’ and stakeholders’ interests (British law being most explicit in this regard). Without looking at managerial norms the effectiveness of the duty of care provided in company laws cannot be understood. In the corner that dismisses CSR we use Milton Friedman’s writings; he is the most resilient critic of CSR. In the other corner are contributors to stakeholder theory who for long and with uncertain success have answered Friedman’s critique. We disaggregate the arguments along three levels in search of valid points and blind spots generated by this lasting debate. The results are compared with the approach that seems to guide leading businesses active in the CSR area. This chapter draws on business ethics and stakeholder theory, which have been mostly developed in the US. As the analysis so far will have found that neither of the two traditional ways of supporting or dismissing CSR properly account for legal realities and recent CSR 23

Chapter 1 developments, chapter 4 provides a descriptive account of what leading businesses do regarding CSR and how the experience of some businesses redefine what reasonable care entails. The last ten years have witnessed an important process of standard-setting and creation of supporting CSR infrastructure. This massive and ongoing effort in capacity building creates new means for businesses to pursue commercial success while taking stakeholders’ interests into account; evolving business practice challenges the simplifications managers used in the past for dealing with their stakeholders. The emphasis in chapter 4 is not on individual business practices but on multistakeholder fora where business actors, civil society groups and governments cooperate to develop shared understandings and tools to manage CSR. The materials used in this chapter are instruments of relevant organisations active in the field and writings of CSR specialists with first hand experience in the implementation of CSR. There is a ‘grey zone’ where corporate and stakeholders’ interests overlap, instances where responsible business practices can contribute to a corporation’s success. Previous chapters highlighted some forces that operate in this grey zone: the legal duty of care that company law imposes on directors (chapter 2), the norms proposed by pro- and con- CSR theories (chapter 3) and the emerging good practices of leading businesses and their stakeholders (chapter 4). Nevertheless, policymaking in the ‘grey zone’ is a relatively new area for regulators. In addition to soft law and policy measures, the law can play here a stronger role, and to that end chapter 5 presents a selection of regulations that do not make CSR redundant, but complement it. In other words there is hard law that does not eliminate managerial discretion, but instead guides it. The aim here is to document this complementarity between law and the managerial discretion on which CSR is built. We screen out pure deterrence approaches where states both lay down the end result and provide the enforcement. Instead we look for combinations of private and public codification and enforcement. We examine instruments that either directly deal with ‘business and human rights’, or could serve as models for future regulations in this area. Examples of such strategies come from corporate governance, environmental protection, criminal law and most recently from regulations dealing with corporate social impacts (especially on employees). The overview covers most jurisdictions that have been active in this new area: the UK, France, Germany, Belgium, Sweden, South Africa and Australia. Otherwise, regulations dealing with corporate governance are selected from the UK and the US. Chapter 6 follows that descriptive account with an explanation of the aforementioned regulations. The complex causality between state action (law and policy) and corporate behaviour is highlighted. As a difference from pure deterrence models where the causality is straightforward, in our case there are some important variables that intermediate between law and business behaviour. Through their CSR practices, leading businesses have already impacted on these variables. States can capitalise on this development and further stimulate the variables through both law and soft law, and capacity-building strategies. Working within the emerging regulatory regime of CSR puts a premium on understanding the context where CSR 24

Introduction and law co-evolve (regulatory space), on the regulatory potential of public and private actors and the norms/rules they apply. Explanations are then placed in a broader context provided by regulatory theory and administrative law. The argument now reaches the human rights end of the ‘business – human rights’ relationship. We highlight the guiding and constraining functions of a regime, and the interaction between corporate voluntarism and law/policy that can happen around those two functions. The state-centred understanding of international law and international relations needs a slight adjustment to account for non-state actors and the regulatory dynamics their practices generate.

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CHAPTER 2 ANCHORING CSR IN COMPANY LAW Why is an analysis of company law (CL) and corporate governance systems necessary? Many CSR arguments have fallen on deaf ears due to a perception that the pursuit of stakeholders’ interests clashes with managerial duties under CL and with the prominent role of shareholders under CL. In this chapter we look to what extent this perception is justified. The following main questions are raised here: What are the managerial duties under company law? Whose interests do these duties protect? How are these managerial duties enforced? To what extent does CSR require a fundamental overhaul of CL? If lawmakers are to regulate companies is CL the proper place for regulatory intervention or should corporate accountability be obtained by strengthening other discrete regulatory areas (e.g. regulations of health and safety, labour rights, environmental protection, etc.) closer to the problem-issue motivating CSR? Corporate managers47 are subject to a broad array of regulations. In running the company they have to obey company law and specific regulations (e.g. tax, anticompetition, tort laws, the above-mentioned regulations, and many others), and also observe the company’s constitution and internal company legislation. Company laws in various jurisdictions require directors to operate companies for the benefit of shareholders: “this obligation is reflected in the powers of shareholders to hold directors to account, which include powers of appointment, dismissal and indeed control of the company constitution”.48 It is up to the company, or to shareholders suing on behalf of the company, to enforce these duties. It should not be deduced from this simplified legal picture that CL imposes legal duties enforceable in courts of law that bind management to follow the whims of most mercantilist shareholders with complete disregard of stakeholders’ interests. This chapter highlights the complexities encountered by CL in steering directors to pursue corporate success. Corporate management is expected under CL to discharge its mandate with care and with loyalty (without self-dealing or conflicts of interest). These two aspects are present in most CL systems. Legal provisions of some important Western systems (mainly the US and the UK, but also France and Germany) will be compared to understand better some recurrent concerns of lawmakers. At the same time managerial accountability is obtained not only through judicial enforcement of these duties, but also to a significant extent by shareholders helping themselves in other 47

The terms ‘directors’, ‘managers’ and ‘business executives’ are used interchangeably unless distinctions are required by the context. 48 Company Law Review Steering Group, Modern Company Law for a Competitive Economy – Developing the Framework, para. 2.7, <www.dti.gov.uk/bbf/co-act-2006/clr-review/page 22794.html>, visited on 14 February 2007. 27

Chapter 2 arenas. Such self-help can use several channels such as the power to elect the board of directors, the influence that comes with large size (institutional shareholders) and market valuations (market indicators such as share price). Therefore the enforcement of managerial duties cannot be understood without comprehending the larger corporate governance context. Both legal issues of CL and wider non-legal aspects of corporate governance will be discussed in this chapter. The following sections present two main issues: how do CL systems clarify managerial duties, with a special emphasis on the duty of care, and what implications does a CL analysis carry for CSR argumentation? 2.1. MANAGERIAL DUTIES OF CARE AND LOYALTY UNDER COMPANY LAWS A concise statement of managerial duties is found in the Organisation for Economic Co-operation and Development (OECD) Principles of Corporate Governance under the heading ‘The Responsibilities of the Board’: “Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders.”49 The analysis of managerial duties follows US jurisprudence, as this is best developed and can highlight more general concerns of company laws elsewhere, and British regulations, as the UK has just finished a major reform of its company law and in the process has dealt explicitly with many issues of relevance here. Eisenberg observes that “[t]he duty of care of corporate directors and officers is a special case of the duty of care imposed throughout the law under the general heading of negligence … if a person assumes a role whose performance involves the risk of injury to others, he is under a duty to perform that role carefully and is subject to blame if he fails to do so”.50 Brudney concisely presents the main elements of the duty of care which requires “some level of attentiveness, some process for (and actual) acquisition or possession of relevant information, some reasoned deliberation in performing services, and exercise of some conscious (but virtually unrestricted) judgment about acceptable levels of return per unit of risk or other measure of enhancing stockholder well-being”.51 The judiciary will not review managerial care unless plaintiffs (shareholders) substantiate that managers were grossly negligent, not merely ordinarily negligent. This higher threshold of negligence exists either explicitly in laws (the ‘business judgment rule’ (BJR) doctrine in some common law systems) or as a matter of judicial self-restraint. The OECD notes: “In nearly all jurisdictions, the duty of care does not extend to errors of business judgement so long as board members are not 49

OECD, OECD Principles of Corporate Governance, 2004, Section VI.A, <www.oecd.org/ dataoecd/32/18/31557724.pdf>, visited on 14 February 2007. (emphasis added) 50 M. A. Eisenberg, ‘The Divergence of Standards of Conduct and Standards of Review in Corporate Law’, 62 Fordham Law Review (1993) p. 439. 51 V. Brudney, ‘Contract and Fiduciary Duty in Corporate Law’, 38 Boston College Law Review (July 1997) p. 599.

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Anchoring CSR in company law grossly negligent…”.52 In the UK it was noted that “our courts have shown a proper reluctance to enter into the merits of commercial decisions”.53 In all developed economies, courts are unwilling to second-guess management, especially in substantive business decisions. Main reasons are that regulators do not want to inhibit necessary risk-taking in business by strengthening managerial liability for cases where risky decisions failed to pay off, and courts regard themselves as not competent to review business decisions. For the judiciary to routinely specify the concrete level of care for each case would put courts in a situation close to making commercial decisions themselves. Courts consider that they do not have the special expertise or the mandate (legitimacy) to assess the wisdom of risky commercial decisions: “One of the important reasons for the existence of the business judgment rule is the institutional incompetence of courts to pass upon the wisdom of business decisions.”54 The business judgment rule “generally protects from substantive review for wisdom”.55 The rule operates in two basic contexts: to protect a business decision from attack (transactional justification cases), and to protect individual directors from monetary liability (personal liability cases). A more detailed discussion of the precise standards of negligence follows later. Directors and officers are under a duty of loyalty that forbids self-dealing. They cannot divert to themselves a business opportunity that belongs to the corporation with which they are associated. In other words a director of the corporation has an obligation to not compete against the corporation. Exceptions are defined in each jurisdiction, but they do not have relevance for the present CSR discussion. Courts scrutinise aspects of loyalty (managerial self-dealing) more severely than matters of due care. However, conflicts of interest can come in many forms. Directors can pursue not only their own pecuniary interest, but also seek nonpecuniary gains or even aim to improperly benefit third parties. One US case has explicitly dealt with the diversity of managerial motivations. The Court in RJR Nabisco, Inc. Shareholders Litigation56 stated: “Greed is not the only human emotion that can pull one from the path of propriety; so might hatred, lust, envy, revenge, or, as is here alleged, shame or pride. Indeed any human emotion may cause a director to place his own interests, preferences or appetites before the welfare of the corporation.”57 Shareholders had attacked a decision of directors to accept a tender offer on grounds that a committee of directors was “not motivated to try to achieve the best available transaction for the benefit of the shareholders, but was inappropriately motivated to repudiate, and more importantly, 52

OECD, supra note 49, p. 59. Company Law Review Steering Group, supra note 48, para. 3.70. 54 Freedman v. Restaurant Associates Industries, Inc., quoted in D. G. Smith, ‘Chancellor Allen and the Fundamental Question’, 21 Seattle University Law Review (Winter 1998) p. 594. 55 Re J.P. Stevens & Co., Inc. Shareholders Litigation, quoted in Smith, ibid. 56 In re RJR Nabisco, Inc. Shareholders Litigation, 1989 WL 7036 (Del.Ch.), (14 Del. J. Corp. L. 1132). 57 Ibid., p. 1159. (emphasis added) 53

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Chapter 2 to be seen publicly as repudiating the Company’s management”.58 There was public dismay caused by the self-enrichment actions of the chief executive officer (CEO) trying to buy the corporation for himself on the cheap. The committee of directors deciding on tender offers did not aim for the highest priced offer, but were said to parade as righteous, independent directors, free of influence from a grasping CEO. US courts have considered only pecuniary self-dealing transactions as duty of loyalty issues: “Aside from the takeover cases, which consider the general motive of entrenchment in office, the issue has always been the potential divergence between the pecuniary interests of the insider and that of the corporation and the shareholders.”59 If courts reviewed the entire spectrum of non-pecuniary interests that managers can pursue, the resulting extensive interpretation of managerial selfinterest would colonise vast territory of managerial discretion in making business judgements (risky commercial decisions). It would overlook all considerations that have lead to judicial restraint in the case of the duty of care. Eisenberg explains: “For corporate-law purposes … it is desirable to define interestedness in a bounded manner, to include only financial and close familial relationships, because a corporate-law definition that turned on objectivity or impartiality would seriously diminish the protection afforded by the business judgment rule. The business-judgment rule protects only directors who are defined as disinterested… In practice, therefore, for corporate-law purposes interestedness is defined in a bounded way, to include only certain kinds of interestedness.”60

A narrow definition of managerial self-interest limited to pecuniary gains is thus warranted because self-dealing removes the protection of the business judgment rule. This has to do not with the concept of self-interest itself (in which CSR could certainly be included as a possible non-pecuniary preference of conscientious directors); it has to do with the (un)willingness of courts to scrutinise business decisions on the merits. Sometimes satisfying the interests of stakeholders (employees or consumers) is the best way towards business success; other times it is not. But courts refrain from analysing what is the best way to success as long as managers remain within the limits of the law. These considerations of judicial policy are relevant to CSR discussions. It is important to understand that CSR enters CL not through the door of the duty of loyalty. Critics of CSR charge that directors use company money, not their own, to support pet causes and obtain public recognition by parading as responsible leaders. This would indeed appear to be self-interested, ‘disloyal’ behaviour, but for courts applying CL there is no pecuniary interest involved and therefore such cases would receive the deferential treatment applied to ordinary business decisions. In the architecture of CL, CSR is an issue pertaining to the duty of care, to be enforced 58

Ibid., p. 1138, 1139. F. S. Kahn, ‘Legislatures, Courts and the SEC: Reflections on Silence and Power in Corporate and Securities Law’, 41 New York Law School Law Review (1997) p. 1125. 60 Eisenberg, supra note 50, p. 452. (emphasis added) 59

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Anchoring CSR in company law accordingly. Therefore from now on the analysis concentrates only on the duty of care: both judicial and non-judicial mechanisms to obtain higher levels of managerial care will be considered. 2.1.1. Clarification of duty of care through identification of whose interests can be considered There has for long been a perception that CL orients managerial decision-making towards the interests of shareholders alone. As a remedy, some CSR writers have proposed indeed that CL should protect stakeholders’ interests in addition to those of shareholders. The confusion surrounding this area is in urgent need of clarification. Indeed, in the UK, the Company Law Review Steering Group noted: “we do not accept that there is anything in the present law of directors’ duties which requires them to take an unduly narrow or short-term view of their functions… There is nevertheless considerable evidence that the effect of the law is not well recognised and understood.”61 The following overview of various company law systems presents references made to shareholders, as beneficiaries of managerial duties, but also draws attention to the qualified formulations of shareholders’ interests as well as to express mentions being made to stakeholders. The OECD Principles of Corporate Governance deal with the responsibilities of the board as following: “Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders.”62 What are then the ‘interests of the corporation’ itself? They need definition. The Millstein Report, on which the Principles are based, wrote about the objective of companies: “Generating economic profit so as to enhance shareholder value in the long term, by competing effectively, is the primary objective of corporations in market economies. Corporate governance must acknowledge this objective while simultaneously fulfilling broader economic, social and other national objectives. This multiplicity of functions is complex but necessary to the perpetuation of the corporation and the market system.”63

The UK system has little tolerance for the concept of ‘company’s interest’, deemed unnecessary and troublesome. The duties of directors under UK case law require directors to manage the undertaking for the benefit of the company. 61 Company Law Review Steering Group, Modern Company Law for a Competitive Economy – The Strategic Framework, 1999, paras. 5.1.19–5.1.20, <www.dti.gov.uk/bbf/co-act-2006/ clr-review/page22794.html>, visited on 14 February 2007. 62 OECD, supra note 49. (emphasis added) 63 Business Sector Advisory Group on Corporate Governance, Corporate Governance: Improving Competitiveness and Access to Capital in Global Markets: A Report to the OECD (OECD, 1998) pp. 30,31. (emphasis added)

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Chapter 2 “That benefit is defined by case law as the interest of members present and future… The reference to future members causes some difficulty; there is little sense in imposing a duty in favour of a class which is unidentifiable and unable to enforce it. But, once it is recognised that the interest of members at any time consists of an interest in the value of the enterprise as a revenue generating entity in the future, including the medium and longer term, this problem largely disappears…”64

The UK Company Law Review Steering Group considered an “obligation of each director to act to serve the purposes of the company as laid down in the constitution and as set for it by its members collectively: that is, it sets as the basic goal for directors the success of the company in the collective best interests of shareholders”.65 Similarly when it comes to pursuing a derivative action,66 the collective interests of shareholders are to guide directors: this “is an issue which should be determined by reference to the collective interests of members within the structure of the company designed to identify and secure them, rather than their individual interests”.67 The recently adopted Companies Act 2006 lays down the ‘duty to promote the success of the company’: “(1) A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to— (a) the likely consequences of any decision in the long term, (b) the interests of the company’s employees, (c) the need to foster the company’s business relationships with suppliers, customers and others, (d) the impact of the company’s operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company.”68

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Company Law Review Steering Group, supra note 61, para. 5.1.18. (emphasis added) Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Final Report, 2001, para. 3.8, <www.dti.gov.uk/bbf/co-act-2006/clr-review/page 22794.html>, visited on 14 February 2007. (emphasis added) 66 “Derivative actions are the route by which shareholders, usually minority shareholders, are able to enforce the company’s rights where directors have breached their duties, (since in these circumstances it is unlikely that the directors, who usually act on behalf of the company, will want to take action).” Department of Trade and Industry, supra note 30, para. 3.4. 67 Company Law Review Steering Group, supra note 48, para. 3.79. 68 Companies Act 2006, UK, 2006, Article 172, <www.opsi.gov.uk/ACTS/acts2006/ukpga _20060046_en.pdf>. 65

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Anchoring CSR in company law The US system displays less concern with employing the term ‘company’s interest’ although it is obviously a misnomer, as everybody understands the interests of shareholders by that. This can be attributed to the dominance of an economic paradigm over company law. The Model Business Corporation Act require a director to act “in a manner [the director] reasonably believes to be in the best interests of the corporation”.69 Furthermore, Smith notes, most states with statutory statements of the managerial duties require that a director perform his or her duties in a manner that he or she reasonably believes to be in the best interests of the corporation. “‘The best interests of the corporation’ are generally understood to coincide with the best long-term interests of the shareholders.”70 The American Law Institute (ALI) Principles of Corporate Governance state: “A director or officer has a duty to the corporation to perform the director’s or officer’s functions … in a manner that he or she reasonably believes to be in the best interests of the corporation…”71 What are the ‘interests of the corporation’ itself? The American Law Institute specifies the company’s objective in an unusually explicit way. It combines strong references to profitability with ethical considerations. Thus the “corporation should have as its objective the conduct of business activities with a view to enhancing corporate profit and shareholder gain … [C]orporations are generally entitled, and indeed obligated, to seek to maximize their wealth for the benefit of their shareholders.”72 Expanding beyond the interests of shareholders, the ALI provides that “(e)ven if corporate profit and shareholder gain are not thereby enhanced, the corporation, in the conduct of its business: (1) Is obliged, to the same extent as a natural person, to act within the boundaries set by law; (2) May take into account ethical considerations that are reasonably regarded as appropriate to the responsible conduct of business; and (3) May devote a reasonable amount of resources to public welfare, humanitarian, educational, and philanthropic purposes.”73

Under Delaware law, directors have a general duty to act with care and in the best interests of the corporation and its stockholders.74 69

Model Business Corporation Act ann., 1996, para. 8.30(a). D. G. Smith, ‘The Shareholder Primacy Norm’, 23 Journal of Corporation Law (Winter 1998) p. 285, <papers.ssrn.com/sol3/papers.cfm?abstract_id=10571>, visited on 14 February 2007. (emphasis added) 71 American Law Institute, Principles of Corporate Governance: Analysis and Recommendations, (American Law Institute Publishers, St. Paul, Minn., 1994), section 4.01(a). (emphasis added) 72 Ibid., section 2.01(a). (emphasis added) 73 Ibid., section 2.01(b). 74 “[D]irectors are charged with an unyielding fiduciary duty to protect the interests of the corporation and to act in the best interests of its shareholders.” Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 360 (Del. 1993); “In discharging [duties to manage business and affairs of 70

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Chapter 2 Pennsylvania’s Act 36/1990 contains an exceptional formulation: managers are not required “to regard any corporate interest or the interests of any particular group … as a dominant or controlling interest or factor” as long as the action serves the best interest of the corporation.75 French law is the most doctrinally committed to enforcing the concept of ‘company’s interest’. The law defines managerial duties as following: “In his business relations with other partners, and in the absence of any statutory definition of his powers, the manager may undertake all managerial decisions in the interest of the company.” 76 Also “[i]n dealings between partners, the manager may undertake all acts of management which the interest of the company requires”.77 In France the interest of the company takes precedence over group interests. The Vienot Report I also comments on the representation of interest-groups and expertise on corporate boards. It affirms “its attachment to the traditional principles or French law and practice. However it is made up, and whoever its members may be, the board of directors collectively represents all company shareholders, and is not the sum of conflicting interests. It must carry out its duties in the interests of the company and if it fails to do so, its members are jointly and severally liable. Similarly, whatever the status or expertise of individual board members, they must consider themselves representatives of all shareholders and behave as such, and are personally liable if they fail to do so. The board of directors of a listed company must be particularly vigilant in applying these principles, bearing in mind the need for its membership to win the confidence of markets, as well as the specific features of its shareholder base… Some have suggested that board members should include representatives of certain interest groups but the Committee believes that a move in this direction would not be desirable. The result could well be to make the board a focus for conflicts between such groups instead of collectively representing the interests of all shareholders as it is supposed to. Moreover, the presence of independent directors should suffice to ensure that all legitimate interests are taken into account… once directors are appointed, it is their duty to represent all the shareholders and to act in the sole interest of the company.”78

a corporation,] directors owe fiduciary duties of care and loyalty to the corporation and its shareholders.” Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 179 (Del. 1986). 75 R. Monks and N. Minow, Corporate governance, second ed. (Blackwell Publishers, Oxford, 2001) p. 78. 76 Article 13 of the 1966 Company Law as translated in C. Alcouffe, ‘Judges and CEOs: French Aspects of Corporate Governance’, 9:2 European Journal of Law and Economics (2000) p. 133. (emphasis added) 77 Article 1848 of the Civil Code, ibid., p. 133. 78 Viénot I Report, The Boards of Directors of Listed Companies in France, 1995, p. 12–14. <www.ecgi.org/codes/documents/vienot1_en.pdf>, visited on 14 February 2007. (emphasis added)

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Anchoring CSR in company law As in the OECD and US cases, French law needs to go on and define the ‘interest of the company’ itself. The Civil Code defines the objective of the company in relation to the common interest of shareholders: the ‘company contract’ should have as its main objective the common interest of the company members.79 The Vienot Report I observes: “The interest of the company may be understood as the over-riding claim of the company considered as a separate economic agent, pursuing its own objectives which are distinct from those of shareholders, employees, creditors including the internal revenue authorities, suppliers and customers. It nonetheless represents the common interest of all of these persons, which is for the company to remain in business and prosper. The Committee thus believes that directors should at all times be concerned solely to promote the interests of the company.”80

In Germany, corporations have a ‘management board’ running the day-to-day operations, and a ‘supervisory board’ where employees can appoint up to a half of the board members. Under the German Stock Corporation Act, the management board is bound by corporate interest, company policy and the group’s guidelines as well as the basic principles of proper management.81 The German Corporate Governance Code, which has been referred to in the Stock Corporation Act,82 deals with managerial tasks and responsibilities: “The Management Board is responsible for independently managing the enterprise. In doing so, it is obliged to act in the enterprise’s best interests and undertakes to increase the sustainable value of the enterprise.” 83 Regarding the Supervisory Board the Code writes: “The representatives elected by the shareholders and the representatives of the employees are equally obliged to act in the enterprise’s best interests.”84 Birk observed that although German law institutionalises employee participation on the board it “cannot be directly deduced from this concept to what extent the employee’s interests are to be taken into account”.85 The Dutch system also seems tilted toward the ‘interests of the company’:

79

Alcouffe, supra note 76, Article 1833 of the The Civil Code, p. 130. Viénot I Report, supra note 78, p. 7. (emphasis added) 81 Article 77 of the German Stock Corporation Act (AktG), referred to in German Panel on Corporate Governance, Corporate Governance Rules for Quoted German Companies, 2000, p. 3, <www.ecgi.org/codes/documents/code0700e.pdf>, visited on 14 February 2007. 82 Article 161 of the Stock Corporation Act, amended by the Transparency and Disclosure Law, in force July 2002. 83 Government Commission, German Corporate Governance Code, 2003, para. 4.1.1, <www.corporate-governance-code.de/index-e.html>, visited on 14 February 2007. (emphasis added) 84 Ibid., p. 1. (emphasis added) 85 R. Birk, ‘Germany’, in A. R. Pinto and G. Visentini (eds.), The Legal Basis of Corporate Governance in Publicly Held Corporations: A Comparative Approach (Kluwer, The Hague/London, 1998) pp. 68, 69. 80

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Chapter 2 “For many years the prime idea behind the Dutch corporation was not so much the maximization of shareholder value, but basically to continue its own existence. … Dutch corporations are not based on maximization of short-term profits for the benefit of shareholders, but rather the main concern is a sustainable, stable, and continuous growth … A stable corporation promotes a stable tax base, in turn, making the social security and welfare programs more stable.”86

This overview shows how company laws and corporate governance instruments refer to the beneficiary of managerial duties. The interests of shareholders are either qualified with varying terms or replaced by the ‘interest of the company’. Laws thus either qualify the interests of shareholders with differing adjectives (‘collective’, ‘long-term’ or ‘common’ interests of shareholders) or introduce the concept of the ‘company’s interest’. In the same time, CL often makes explicit reference to the interests of stakeholders: employees, creditors including the internal revenue authorities, suppliers and customers, the community and the environment, even the market system. From this presentation it appears that both proponents of changes in CL and sceptics of CSR that emphasise the standing of shareholders in the CL architecture do not however account for the true extent to which CL favours the continued existence of the company when this clashes with shareholder wishes. The ‘success of the business’ appears as the organising concept with which CL approaches the variety of competing interests converging on the corporation. A look at two areas of US case law illustrates to what extent CL has overridden some of its own important concerns in order to protect the ‘success of the business’. These concerns of CL refer to the necessity for undivided loyalties (the ‘duty of loyalty’ context) and respectively to the property rights that shareholders have over their stock (the ‘take-over’ context). Traditionally CL in common law countries has seen the relationship management-shareholders as a fiduciary one.87 Brudney shows that from its origins in the law of trusts, the fiduciary obligation of loyalty has entailed the exclusive benefit principle: “To assure such exclusive service, the fiduciary is to refrain from engaging in any transaction with the trust’s or principal’s assets … from which he might either gain for himself or harm the beneficiary … The exclusive benefit principle and its prophylactic implementation impose the costs of over-prohibition on the beneficiary, the fiduciary and society. 86 W. van den Muijsenbergh, ‘Corporate Governance: The Dutch Experience’, 16 Transnational Lawyer (Fall 2002) p. 65. (emphasis added) 87 Civil law jurisdictions do not recognise fiduciary duties as such, those duties being a product of the common law, but refer to obligations that in many circumstances give rise to equivalent duties. Freshfields Bruckhaus Deringer, UNEP and Finance Initiative, A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment, 2005, p. 10, <www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf>, visited on 14 February 2007.

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Anchoring CSR in company law Transactions that might be beneficial to all may be required to be foregone in order to ensure that the beneficiary receives the full benefits of the fiduciary’s services.”88

To take out these costs of over-prohibition, economists have advanced a contractarian perspective that aims to provide additional incentives for managers to pursue wealth-maximisation. The premise is that “the law, which cannot force managers or controllers to engage in wealth-maximizing behavior for the enterprise, should at least not get in the way by restricting their self-appropriative behavior”.89 The fiduciary duty of loyalty is “a significant obstacle to that maximizing goal, particularly as it prophylactically precludes transactions that might maximize – or at least make – gains for the enterprise. The classic fiduciary duty is also said to dampen the incentives of decision-makers by denying them the rewards from selfaggrandizing behavior that they think necessary, in addition to the rewards for which they expressly contract.”90 A reform along contractarian lines authorises the power to self-deal which may derive from the beneficiary freely giving its informed express consent, or from the easy imputation of consent by stockholders. The fiduciary relationship appears as simply a species of contract. Fiduciary duties are merely default rules to reduce the costs associated with providing the fiduciary with incomplete instructions. Parties are free to depart from them by contracting instead.91 Courts in the US have shifted their position regarding the duty of loyalty and eroded the protection shareholders used to get from the exclusive benefit principle. “Over the course of the last century, although the conditions underlying the historic application of the exclusive benefit principle and its prophylactic implementation in the corporate context have not changed materially, the principle has been abandoned, notwithstanding the continued characterization of management’s relationship and obligations to the enterprise and its stockholders as fiduciary. As the legal doctrine has evolved, the restrictions on managerial conduct no longer prophylactically forbid self-aggrandizing behavior … Legislation that authorizes management to take into account the interests of other stakeholders qualifies the scope of the exclusive benefit principle … Notwithstanding occasional pious allusions to the exclusive benefit principle in opinions, the surviving body of corporate fiduciary doctrine has lost that principle’s normative underpinning … Whatever the reasons for relaxing the restrictions on management’s appropriative behavior, a curtain of fiduciary discourse still screens the loosened strictures. The

88

Brudney, supra note 51, p. 603. Ibid., p. 623. 90 Ibid. 91 Ibid., p. 605. 89

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Chapter 2 fiduciary rhetoric of courts may have an impact on investors’ expectations; but these expectations are hardly fulfilled.”92

Thus the goal of wealth-creation has split shareholder-oriented theories in two camps: one has prophylactically prioritised undivided loyalty despite immediate losses in efficiency; the other has accepted self-dealing (divided loyalties) for the sake of wealth-maximisation. The latter trades off shareholders’ rights in the pursuit of efficient wealth creation; the former sees shareholders’ rights as sacrosanct. US courts have moved toward the latter view. There has appeared a gap in CL, at least in the US, between the rhetoric surrounding shareholders’ rights and the reality of their judicial protection. In this context, the ‘success of the business’ (efficient wealth creation) has asserted itself over the rights of shareholders under CL, and reaffirmed its prominence in the CL architecture. In the takeover context, the shareholder is not waiting for a dividend to be distributed by management, but prefers to sell his/her stock for a price higher than the market price. Here s/he exercises not a qualified right to participate in the profits of the company, but a property right over shares. In a hostile cash tender offer it is possible that the vast majority of a target company’s shareholders want to accept the tender offer. US laws have tended to side with directors to the detriment of shareholders either through case law as in Delaware or through passing new laws. It is necessary to briefly recount the historical context. In the 1980s, the ‘market for corporate control’ has become the principal mechanism for reigning in managerial power. If a company appeared to be poorly managed, corporate ‘raiders’ could be willing to buy enough shares to acquire control over the target company, reorganise it more efficiently and eventually sell it profitably. Raiders are defined as an individual or organisation that tries to take over a company by initiating a hostile takeover bid. Hostile takeovers go against the wishes of the target company’s management. Markets thus curtail managerial discretion from outside of the corporation, not from within as the board of directors does. However, the benefits of this form of control came at the price of social disruption and of endangering the longer-term economic value of some businesses. Consequently, many US states passed so called ‘constituency statutes’. They allow managers, “in considering the best interests of the corporation, to consider the effects of any action upon employees, suppliers, and customers of the corporation, communities in which offices or other establishments of the corporation are located, and all other pertinent factors”.93 The purpose is to provide managers with a stronger legal basis to pursue the long-term interests of the company through anti-takeover defences. Such laws explicitly trumped the short-term interests of shareholders, which would be tapped by raiders offering premium prices for shares. Incumbent management could invoke the interests of stakeholders (e.g. workers, communities, various market actors), the long-term interest of the corporation itself and the public interest in wealthgenerating corporate activities. 92 93

Ibid., p. 617. (emphasis added) Smith, supra note 70, p. 289.

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Anchoring CSR in company law Delaware has ruled on the disruptive effects of takeover not through new laws but through judge-made law. Commenting on the 1986 Revlon case94 and subsequent jurisprudence, Smith identifies three important alterations of directors’ duties in a takeover situation. First, following the Revlon case, the board of directors has to obtain “the highest price for the benefit of the stockholders”; the board must focus on maximising the current value of shares held by common stockholders. Normally, a board of directors is allowed to sacrifice current value in pursuit of future value. Second, the other duty imposed by Revlon is the duty to “fully consider alternative transactions offered by any responsible buyer”. In other contexts, a board is empowered to ‘just say no’ to proffered transactions. Third, the standard of review of Revlon claims is more searching than for other applications of the business judgment rule.95 In Paramount Communications, Inc. v. Time, Inc.96 the Delaware Supreme Court expressed the view that corporate directors, if they act in pursuit of some vision of the corporation’s long-term welfare, may take action that precludes shareholders from accepting an immediate high-premium offer for their shares. Delaware does not have a ‘constituency statute’; so its courts settled for a case-bycase approach. However, the Delaware Supreme Court reinterpreted case law along lines similar to the reasoning of constituency statutes. Smith refers to the Macmillan case97 which subtly reinterpreted the Revlon case: “In Macmillan the court’s emphasis on the ‘best interests of the stockholders’ and on the ‘highest value reasonably attainable’ suggests a subtle shift away from the ‘best price’ or sale ‘to the highest bidder’ that was required by Revlon. Indeed, the court in Macmillan defined the board’s Revlon duties as follows: ‘The proper objective of Macmillan’s fiduciaries was to obtain the highest price reasonably available for the company, provided it was offered by a reputable and responsible bidder’.”98

Factors that a board might consider, according to the Court, in determining whether the bidder is reputable and responsible, include not only the adequacy and terms of the offer, but also “the impact of both the bid and the potential acquisition on other constituencies, provided that it bears some reasonable relationship to general shareholder interests”, and “the bidders identity, prior background, and other business venture experiences”.99 Thus, in the take over context, the US law prioritises the welfare of the company as a going concern over the wishes of shareholders to obtain the highest 94

Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). Smith, supra note 54, p. 602. 96 Paramount Communications, Inc. v. Time, Inc., [1989 Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 94, 514 (Del.Ch. July 14, 1989), aff’d, 571 A.2d 1140 (Del.1990). 97 Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261 (Del. 1989). 98 Smith, supra note 54, p. 586. 99 Ibid., p. 587. 95

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Chapter 2 price for their shares. CL in this case elevated the long-term interest of the business above the very property rights that shareholders have. The analysis in this section brings clarity on the issue of how CL defines the duty of care in regard to the interests corporate management should take into account. Although CL is commonly associated with the rights and interests of shareholders the picture is more complex. It is certain that CL does not instruct directors to disregard the interests of stakeholders but the contrary. Policymakers in the UK felt necessary to set the record straight when they wrote: “The concern is that current arrangements lead to directors neglecting the long term, often under (actual or perceived) misguided pressure from shareholders.”100 Through the statutory clarification of the managerial duty of care, lawmakers aim at “clarifying the law, to ensure recognition of a proper long term perspective and inclusive approach to business relationships”.101 In a restatement of directors’ duties, the UK Company Law Review Steering Group, following a broad consultation process, laid out its vision: “[T]he obligation of each director [is] to act to serve the purposes of the company as laid down in the constitution and as set for it by its members collectively: that is, it sets as the basic goal for directors the success of the company in the collective best interests of shareholders. But it also requires them to recognise, as the circumstances require, the company’s need to foster relationships with its employees, customers and suppliers, its need to maintain its business reputation, and its need to consider the company’s impact on the community and the working environment.”102

The American Bar Association’s Committee on Corporate Laws noted on similar lines: “Directors have fiduciary responsibilities to shareholders which, while allowing directors to give consideration to the interests of others, compel them to find some reasonable relationship to the long-term interests of shareholders when so doing.”103 2.1.2. Clarification of duty of care through judicial review We can ease in by noting first two US cases involving managerial decisions justified in CSR terms. Minority shareholders contested the good faith of management in allocating corporate resources for seemingly CSR-type purposes. After that the analysis will cover the evolution of judicial review towards more stringent specifications of the duty of care.

100

Company Law Review Steering Group, supra note 48, para. 3.54. Ibid., para. 2.14. (emphasis added) 102 Company Law Review Steering Group, supra note 65, para. 3.8. (emphasis added) 103 Committee on Corporate Laws, ABA, ‘Other Constituencies Statutes: Potential for Confusion’, 45 Business Lawyer (1990) p. 2261. (emphasis added) 101

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Anchoring CSR in company law In Dodge v. Ford Motor Co (1919),104 the Dodge brothers, minority shareholders owning ten per cent of the stock, challenged Henry Ford (owning 58 per cent of the stock) in courts because he proclaimed that future dividends would be limited to five per cent monthly while the remaining profits would be used for business expansion, and also “to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes”.105 The Court was asked to rule on two distinct decisions justified by Ford in CSR terms: first, the decision to use corporate funds for CSR purposes; second, the decision to expand the business by building a new plant. Regarding the first issue – the motives alluding to CSR – the Court indicated that the motives of Ford in keeping so much money in the corporation for expansion and security were to benefit the public generally and spread the profits out by means of more jobs, etc. The Court found that management has breached their good faith duty by not pursuing shareholders’ interests, that is, by not distributing significant dividends in a time of extreme prosperity for the Ford company. The Court stated: “There should be no confusion … of the duties which Mr. Ford conceives that he and the stockholders owe to the general public and the duties which in law he and his codirectors owe to protesting, minority stockholders. A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end and does not extend to a change in the end itself, to the reduction of profits or to the nondistribution of profits among stockholders in order to devote them to other purposes.”106

Regarding the second decision – to expand the business – the Court refused to interfere, in stark contrast with its ruling on the motivational aspects: “We are not, however, persuaded that we should interfere with the proposed expansion of the business of the Ford Motor Company. In view of the fact that the selling price of products may be increased at any time, the ultimate results of the larger business cannot be certainly estimated. The judges are not business experts. It is recognized that plans must often be made for a long future, for expected competition, for a continuing as well as an immediately profitable venture. We are not satisfied that the alleged motives of the directors, in so far as they are reflected in the conduct of business, menace the interests of the shareholders.”107

In this case the Court delineated the powers of management. On one hand it reaffirmed the discretion management has to pursue a business strategy by choosing 104

Dodge v. Ford Motor Co., 204 Mich. 459, 170 N.W. 668 (1919). Ibid., p. 468. 106 Ibid., p. 507. 107 Ibid., pp. 507–508. 105

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Chapter 2 whatever legal means necessary, including by embracing CSR considerations. This discretion is substantial, as courts will not assume the role of business experts in assessing means. On the other hand, this discretion is not unlimited and cannot amount to a change in the revenue-generating orientation of a company. It is an enduring judicial statement to acceptability and limits of CSR-behaviour under CL. The Court summarises the complaint in Shlensky v. Wrigley (1968)108 as follows: “The action was a stockholders’ derivative suit against the directors for negligence and mismanagement. Plaintiff alleges that defendant Wrigley has refused to install lights, not because of interest in the welfare of the corporation but because of his personal opinions ‘that baseball is a ‘daytime sport’ and that the installation of lights and night baseball games will have a deteriorating effect upon the surrounding neighborhood.’ It is alleged that he has admitted that he is not interested in whether the Cubs would benefit financially from such action because of his concern for the neighborhood. Plaintiff also alleges that the other defendant directors knew Wrigley was not motivated by a good faith concern as to the best interests of defendant corporation, but solely by his personal views set forth above. It is charged that the directors are acting for a reason or reasons contrary and wholly unrelated to the business interests of the corporation; that such arbitrary and capricious acts constitute mismanagement and waste of corporate assets, and that the directors have been negligent in failing to exercise reasonable care and prudence in the management of the corporate affairs.”109

The motivation attached to Wrigley’s decisions follows the tenets of CSR and the Court treats the case as a matter of due care and good faith. So the Court has to assess the (ir)rationality of management’s decision, that of not scheduling nighttime games because of its adverse effects on the neighbourhood. The Court tried to assess the rationality through a loss-benefit analysis counting elements such as the following: ƒ

ƒ

108

Adverse effects on the neighbourhood may in turn result in the absence of the club’s patrons at the games (“it appears to us that the effect on the surrounding neighborhood might well be considered by a director who was considering the patrons who would or would not attend the games if the park were in a poor neighborhood”).110 Adverse effects on the neighbourhood may in turn result in lower value of property owned by the company in that neighbourhood (“the long run interest of the corporation in its property value at Wrigley Field might demand all efforts to keep the neighborhood from deteriorating”).111

Shlensky v. Wrigley, 237 N.E.2d 776, Ill.App. 1968, 25 April 1968. Ibid., p. 177. 110 Ibid., pp. 180, 181. 111 Ibid., p. 181. 109

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Anchoring CSR in company law ƒ

ƒ

ƒ ƒ

ƒ

Plaintiff’s allegation that the installation of lights would have resulted in additional revenues for the company (however, “[t]here is no allegation that the night games played by the other nineteen teams enhanced their financial position or that the profits, if any, of those teams were directly related to the number of night games scheduled” ).112 Plaintiff’s allegation that the cost of installation of lights would be recaptured by increased revenues (“[h]owever, no allegation is made that there will be a net benefit to the corporation from such action, considering all increased costs” ).113 Plaintiff’s claim that the losses are due to poor attendance at home games (“[h]owever, it appears … that factors other than attendance affect the net earnings or losses” ).114 Plaintiff’s allegation that every member of the major leagues, other than the Cubs, scheduled substantially all of their home games in 1966 at night. (However “it cannot be said that directors, even those of corporations that are losing money, must follow the lead of the other corporations in the field. Directors are elected for their business capabilities and judgment and the courts cannot require them to forego their judgment because of the decisions of directors of other companies … [M]ere failure to ‘follow the crowd’ is not such a dereliction.”)115 Plaintiff did not adequately address the multitude of factors relevant to the contested business decision (“[t]he record shows that plaintiff did not feel he could allege that the increased revenues would be sufficient to cure the corporate deficit. The only cost plaintiff was at all concerned with was that of installation of lights. No mention was made of operation and maintenance of the lights or other possible increases in operating costs of night games and we cannot speculate as to what other factors might influence the increase or decrease of profits if the Cubs were to play night home games.”)116

The case illuminated how a court will deal with the question: can a CSR-like decision of management (not to play games during night hours because of adverse effects on neighbourhood) be reasonably capable of benefiting the company? There are a multitude of factors that can be relevant in answering this. The assessment of the exercise of managerial powers performed by the Court was thorough and nuanced. The Court was unwilling to censor managerial discretion and sustained that particular business decision. American courts have shown great tolerance for directors to consider the interests of stakeholders in their pursuit of the corporate interest. In the Wrigley case 112

Ibid. Ibid., p. 182. 114 Ibid. 115 Ibid., p. 183. (emphasis added) 116 Ibid., p. 182. 113

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Chapter 2 the Court was satisfied that the CSR-like decisions of the management could be rationalised in terms of business success. It wrote: “By these thoughts we do not mean to say that we have decided that the decision of the directors was a correct one. That is beyond our jurisdiction and ability. We are merely saying that the decision is one properly before directors and the motives alleged in the amended complaint showed no fraud, illegality or conflict of interest in their making of that decision.”117 This reasoning is indicative of the self-restraint courts show when asked to review duty of care aspects. In the US this attitude is encapsulated in the business judgement rule. The discussion of BJR below helps us to understand the more precise standard of care that courts enforce. Courts in the US have defined differently the BJR. Some courts have adopted lax standards that would limit the area of judicial review and thus allow a broader margin of managerial discretion. Others have shown judicial activism and defined more stringent conditions for the BJR to apply, for managerial decisions to be protected from the judicial claims of shareholders. As courts have clarified when they will review managerial decisions, they also increasingly clarified what the duty of care entails. While doctrine and practice agree that BJR is a special standard of culpability in matters involving the duty of care, opinions however diverge to the exact standards contained in the BJR. Nevertheless they all hold that director liability under BJR requires greater fault than ordinary negligence. Gewurtz identifies three main standards developed in the US case law: 1.

2.

3.

The good faith standard. The heart of the matter is whether or not the directors believed that what they were doing was in the best interest of the corporation. Excluded from the courts’ inquiry for the most part is any review of the objective reasonableness of such a belief. This is a largely subjective approach that confers virtually unlimited discretion to management. The gross negligence standard strikes a middle ground between ordinary negligence and the ‘good faith only’ and is applied in Delaware. It offers still very substantial but more limited discretion than above. The process-versus-substance distinction. The American Law Institute’s Principles of Corporate Governance draw a distinction between the level of judicial scrutiny of the directors’ decision itself, and the review of the process that directors used to arrive at the decision. The review of the process of decision-making is tighter than the review of the decision arrived at through that process.118

Gevurtz further notes that 117

Shlensky v. Wrigley, supra note 108, p. 181. F. A. Gevurtz, ‘The Business Judgment Rule: Meaningless Verbiage or Misguided Notion?’, 67 Southern California Law Review (January 1994) pp. 297–303. 118

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Anchoring CSR in company law “views of the business judgment rule … form a continuum rather than precisely defined positions … The cases following a good faith approach illustrate this point. Few unequivocally rule out any review of objective reasonableness. Instead, after proclaiming that directors’ decisions are unassailable in the absence of bad faith, dishonesty, or fraud, such opinions often soften such statements by backpaddling in varying degrees.” 119

An analysis of BJR presents the question to what extent can we expect to see courts actively enforcing the managerial duty of care? So far, it is recalled, courts have rebuffed overreaching shareholders that claimed that CSR-minded managers were in breach of the duty to carefully pursue shareholders’ interests. The inclination of courts to move from subjective (good faith) to objective reasonableness, as Gewutz explains, and the distinction decisionmaking process – decision itself, articulated by the American Law Institute – create an important opening for courts to actively enforce higher care rather than defensively shielding management from shareholder litigation.120 The result is having the court look more closely at the factual issues of the case to see whether management acted with reasonable care. Immediately relevant for CSR purposes, courts could arguably censor directors that stick to outdated business models and remain ignorant of CSR risks and opportunities that actually can affect business success. Company law relies on directors being informed, knowledgeable and diligent. Directors are expected to operationalise that approach through management systems. The OECD notes: “The principle [duty of care] calls for board members to act on a fully informed basis. Good practice takes this to mean that they should be satisfied that key corporate information and compliance systems are fundamentally sound and underpin the key monitoring role of the board advocated by the Principles. In many jurisdictions this meaning is already considered an element of the duty of care, while in others it is required by securities regulation, accounting standards etc.”121

119

Ibid., p. 297. This analysis does not insist on subjective or objective standards of care, but on the distinction process-decision as it is easier for courts to operationalise it. As an example, the UK Companies Act 2006 writes that “[a] director of a company must exercise reasonable care, skill and diligence… that would be exercised by a reasonably diligent person with – (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and (b) the general knowledge, skill and experience that the director has.” Companies Act 2006, supra note 68, Article 174. 121 OECD, supra note 62, p. 59. 120

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Chapter 2 In the US state of Delaware, the Caremark case122 dealt with a facet of the duty of care: the duty to monitor corporate activities. The duty of care contains a duty to “follow up reasonably on information that has been acquired and should raise cause for concern”.123 The stockholders claimed that “Caremark’s directors breached their duty of care by failing adequately to supervise the conduct of Caremark employees, or institute corrective measures, thereby exposing Caremark to fines and liability”.124 The court held that corporate directors have a duty to implement and maintain “reporting systems … that are reasonably designed to provide to senior management and the board itself timely, accurate information sufficient to allow management and the board … to reach informed judgments concerning both the corporation’s compliance with law and its business performance.”125

The Court handled the case as a duty of care issue; the standard of review applied is the ‘business judgement rule’. As the BJR applies only when directors make a decision (passivity is outside the BJR), the Court devised a similarly protective standard based on good faith for situations in which directors have failed to decide. It was acknowledged that “such a test of liability – lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight – is quite high”.126 Furthermore, “where a claim of directorial liability for corporate loss is predicated upon ignorance of liability-creating activities within the corporation … only … an utter failure to attempt to assure a reasonable information and reporting system … will establish the lack of good faith that is a necessary condition to liability”. 127 This language indicates a very high burden that will not be met simply by showing that the reporting system is ineffective.128 The Court arrived at this standard of care by reinterpreting previous case law, which did not take this trenchant position. In 1963, the Delaware Supreme Court held in Graham v. Allis-Chalmers Manufacturing Company: “[A]bsent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists.”129 Graham may be construed to stand for the proposition that directors have no obligation or affirmative duty to implement reporting systems designed to monitor corporate activities.130

122

Caremark International, Inc. Derivative Litigation, 698 A.2d 959, 970 (Del. Ch. 1996). S. F. Funk, ‘In Re Caremark International Inc. Derivative Litigation: Director Behavior, Shareholder Protection, and Corporate Legal Compliance’, 22 Delaware Journal of Corporate Law (1997) p. 311. 124 Caremark International, Inc. Derivative Litigation, supra note 122, p. 964. 125 Ibid., p. 970. 126 Ibid., p 971. (emphasis added) 127 Ibid., (emphasis added) 128 Funk, supra note 123, p. 322. 129 Caremark International, Inc. Derivative Litigation, supra note 122, p. 969. 130 Funk, supra note 123, p. 314. 123

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Anchoring CSR in company law Chancellor Allen’s reinterpretation was done in light of legal developments in company law and in other branches of law. An example of the latter is the US Sentencing Guidelines which offer benefits to corporations that implement an ‘effective’ system of legal compliance,131 the type of monitoring system envisioned in Caremark. Thus Chancellor Allen set forth three important factors to support why he believed the Delaware Supreme Court, in 1996, would agree with his interpretation of Graham. First, he noted the “seriousness with which the corporation law views the role of the corporate board. [Second, he noted] the elementary fact that relevant and timely information is an essential predicate for satisfaction of the board’s supervisory and monitoring role… [Finally,] the United States Sentencing Guidelines, which mandate specific sentence calculations and offer reduced penalties for organizations that have implemented adequate compliance systems, necessitate that reporting systems become standard practice.”132 Another case refers to Graham and qualifies it as following: “[W]hile it is true that a director is not under a duty to ‘install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists,’ … a director does have a duty to be reasonably informed about the company and must make sure that appropriate information and reporting systems are in place so that the Board receives relevant and timely information necessary to satisfy its supervisory and monitoring role. Thus, a claim of directorial liability ‘predicated upon ignorance of liability creating activities within the corporation’ will lie where the plaintiff shows a ‘sustained or systematic failure of a director to exercise reasonable oversight.’”133

An article reviewing the US Sentencing Guidelines refers to developments in company law to conclude that “[i]t has thus become critical for corporate directors to make sure that their organization has implemented effective programs for ‘legal and regulatory compliance’.”134 The author notes: “Citing Caremark, the Fourth Circuit recently ruled in Dellastatious v. Williams that directors can avoid liability in shareholder derivative suits by showing a good faith attempt to create ‘an adequate corporate information-gathering and reporting system.’ The Sixth Circuit held in McCall v. Scott, another derivative suit in the Caremark line, that directors can breach their fiduciary duty if they intentionally or recklessly 131

See infra section 5.3.1. Funk, supra note 123, p. 320. 133 Benjamin v. Kim, 1999 WL 249706 (S.D.N.Y. 1999), quoted in Report of the Ad Hoc Advisory Group on the Organizational Sentencing Guidelines, 2003, p. 32, <www.ussc.gov/ corp/advgrprpt/AG_FINAL.pdf>, visited on 14 February 2007. (emphasis added) 134 D. E. Murphy, ‘The Federal Sentencing Guidelines for Organizations: A Decade of Promoting Compliance and Ethics’, 87 Iowa Law Review (March 2002) p. 714, <www.ussc.gov/corp/Murphy1.pdf>, visited on 14 February 2007. 132

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Chapter 2 disregard ‘red flags’ that should alert them to fraudulent practices within the organization. According to the court in McCall, even ‘[u]nconsidered inaction can be the basis for director liability because … ordinary business decisions … can significantly injure the corporation and make it subject to criminal sanctions.’”135

Also in Delaware, in RJR Nabisco, Inc. Shareholders Litigation, the Court wrote: “[T]o invoke the [business judgment] rule’s protections directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them. Having become so informed they must then act with requisite care in the discharge of their duties.”136 The Court further accounted for the fact that information has costs and concluded that “the amount of information that it is prudent to have before a decision is made is itself a business judgment of the very type that courts are institutionally poorly equipped to make… The risks (costs) associated with getting more information had to be weighed by the Committee against the likely benefits.”137 So the design of the information gathering system is an issue involving business judgment. Managerial discretion is protected here by the BJR. As William T. Allen explained, the duty of care states a “command to be efficient with respect to the acquisition and use of information”.138 The ex ante formulation of the duty of care cannot be otherwise than vague and general. Determining when an optimum amount of information is available for a decision with a time-fuse on it involves estimating the unknown costs associated with getting more info, the possible value that unknown info may bring and the attitude toward risk.139 Investors and directors know that an important part of the utility of the corporate form derives from information efficiencies that centralised decision-making offers. Therefore they have wide discretion to react in a timely way to changing circumstances. This case law shows company law stressing the role of internal management systems. This is facilitated by a distinction made in cases of duty of care between the decision itself and the decision-making process; the latter can be made subject to closer judicial review. The American Law Institute’s Principles of Corporate Governance draw an explicit distinction between the level of judicial scrutiny of the directors’ decision itself, and the review of the process that directors used to arrive at the decision. The review of the process of decision-making is tighter. Veasey comments on the business judgment rule as applied in Delaware:

135

Ibid. (emphasis added) In re RJR Nabisco, Inc. Shareholders Litigation, supra note 56, p. 1164. 137 Ibid., p. 1165. 138 W. T. Allen, ‘The Corporate Director’s Fiduciary Duty of Care and the Business Judgement Rule Under US Corporate Law’, in K. J. Hopt et al. (eds.), Comparative Corporate Governance: The State of the Art and Emerging Research (Oxford University Press, Oxford, 1998), p. 317. 139 Ibid. 136

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Anchoring CSR in company law “Courts do not measure, weigh or quantify directors’ judgments… Due care in the decision making context is process due care only … [T]here is no liability for the substance of a bad business judgment reached in good faith, even if the decision was stupid by hindsight, unless, of course, the decision fails the waste test [‘cannot be attributed to a rational business purpose’] or the decision-making process was materially flawed [‘grossly negligent process that includes the failure to consider all material facts reasonably available’].” 140

This evolution of CL can be observed in other jurisdictions as well.141 British case law also refers to a high threshold in assessment of duty of care. It did so in the context of the delegation of board’s functions which left directors completely unaware of risks. The case Re Barings plc142 showed a company collapsing because of the wrongdoings of a single individual: “the unauthorised and ultimately catastrophic activities of, it appears, one individual (Leeson) that went undetected as a consequence of a failure of management and other internal controls of the most basic kind”.143 The Court took this opportunity to clarify the contents of the duty of care of directors. Thus directors have a duty to be informed and knowledgeable of the company’s business which is compatible with directors delegating their functions down the management chain, but directors retain a residual duty of monitoring and supervision.144 The Court stated in this case: “(1) Directors have, both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company’s business to enable them properly to discharge their duties as directors. (2) While directors are entitled (subject to the company’s articles of association) to delegate particular functions to those below them in the management chain and to trust their competence and integrity to a reasonable extent, the exercise of a power of delegation does not absolve a director from the duty to supervise the discharge of the delegated functions. (3) No rule of universal application can be formulated as to the residual duty of monitoring and supervision referred to in (2) above. The extent of the duty, and the question whether it has been discharged, must depend on 140

E. N. Veasey, OECD, The Role of the Judiciary in Corporate Law, Corporate Governance and Economic Goals, 2000, p. 9, <www.oecd.org/dataoecd/40/5/1857539.pdf>, visited on 14 February 2007. 141 In Italy, the courts do not second-guess the business judgment of directors which owe the company a duty of care (Article 2392, Civil Code). The judge’s review is limited to the decision process and cannot extend to the merits of the actual decision. E. Ruggiero, ‘Italy’, in Pinto and Visentini, supra note 85, pp. 103–105. 142 Re Barings plc (No. 5) [1999] 1 BCLC 433. 143 The report of the Board of Banking Supervision in Singapore, quoted in A. Walters, ‘Directors’ Duties of Care, Skill and Diligence – Case Comment’, Company Lawyer (1999) p. 142. 144 Ibid.

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Chapter 2 the facts of each particular case, including the director’s role in the management of the company.”145

By employing the process-versus-substance distinction, CL lowers the protection offered by BJR and correspondingly increases scrutiny of managerial decisionmaking. As courts have become more assertive in duty of care aspects this could raise the hopes of CSR proponents that see CSR as a duty of care issue. First, there is compatibility between the emphasis placed by CSR proposals on sound management systems able to account for CSR risks and opportunities and the emphasis of CL on informed, diligent decision-making. Second, with the multitude of references to stakeholders there have been proposals to expand the duty of care to stakeholders as well. Then directors could be made answerable on the charge that they do not ‘promote the success of the company’ with sufficient ‘care, skill and diligence’ (to borrow British terminology) as they have disregarded important relations with stakeholders.146 CSR proposals to reinterpret managerial duties aim, of course, to obtain the enforcement potential of CL. They seem to build on the assumption that judicial enforcement has a strong role in ensuring that managers comply with high standards of care. This role of CL can be doubted in light of how courts currently enforce the duty of care; courts exercise self-restraint or apply the explicit business judgement rule. Gewurtz writes: “[T]he bottom line is that remarkably few courts have found directors liable for breaching their duty of care in making a business decision. As a result, the duty of care has provided the shareholders and the corporate entity little protection from the directors making decisions that are harmful to the interests of the shareholders or the corporate entity. Accordingly, it is difficult to see how making employees also the recipients of a duty of care, when enforcement of the duty is limited by the business judgment rule, is significantly going to improve decisions from the standpoint of the employees… My concern is that much of the literature on these issues … fails to consider the limited practical impact of these various corporate law rules, particularly in light of the actual manner in which courts enforce such rules.”147

There can be more ambitious proposals that go beyond giving a right to stakeholders to check on management about how to best to pursue business success. Arguments can be made for complementing business success with another objective making reference to stakeholders. A multiplicity of objectives towards which management 145

Ibid. (emphasis added) The consultation process carried out by the UK Company Law Review Steering Group revealed that supporters of the ‘pluralist approach’ wanted either a power for the Secretary of State to intervene, or a consultative system, with very few favouring giving rights to stakeholders. Company Law Review Steering Group, supra note 48, para. 2.12. 147 F. A. Gevurtz, ‘Getting Real About Corporate Social Responsibility: A Reply to Professor Greenfield’, 35 U.C. Davis Law Review (February 2002) pp. 664–665. 146

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Anchoring CSR in company law care should be oriented would likely enhance further the self-restraint that courts have traditionally shown in duty of care cases. Crespy concurs that a re-specified duty of care would be implemented by the courts under a standard of review likely to be even more deferential and procedural in character than at present.148 In addition, the fundamental orientation toward the company’s success, as shown in the previous section, makes it highly difficult to modify the objective of the corporation. Some laws that attracted attention in corporate governance literature because of mentioning stakeholders have not granted stakeholders any active standing in enforcing managerial duties. The examples come from the US and UK. The Companies Act 2006 clarifies the ‘nature of general duties’ by expressly saying they “are owed by a director of a company to the company”.149 A section of the Companies Act 1985, now overridden, stated explicitly: “(1) The matters to which the directors of a company are to have regard in the performance of their functions include the interests of the company’s employees in general, as well as the interests of its members. (2) Accordingly, the duty imposed by this section on the directors is owed by them to the company (and the company alone) and is enforceable in the same way as any other fiduciary duty owed to a company by its directors.”150

The UK Review Group commented upon this legislation: “Section 309 is arguably a statutory declaration of an enlightened shareholder value duty, requiring that directors consider the interests of employees in reaching a view of what is in the best interests of the company. That this is the effect intended is confirmed by its declaratory character, by ministerial statements in Hansard and by the unusual statutory language emphasising that the duty ‘is owed to the company (and the company alone) and is enforceable in the same way as any other fiduciary duty owed to a company by its directors’ … It is clear that employees have no remedy under the section.”151

The already mentioned ‘constituency statutes’ in many US states authorise directors to weight the interests of nonshareholder constituencies in their decision-making. Stakeholders did not obtain under the new laws corresponding rights or fora to back their claims. Some CSR advocates found in these statutes the legal support for extending directors’ duties toward employees and other stakeholders. However it is apparent that these statutes safeguard discretion for managers – a discretion that they have originally and legally had, but that capital markets have eroded – but have been 148

G. S. Crespi, ‘Redefining the Fiduciary Duties of Corporate Directors in Accordance with the Team Production Model of Corporate Governance’, 36 Creighton Law Review (2003), p. 641. 149 Companies Act 2006, supra note 68, Article 170. 150 Section 309 of the Companies Acts of 1963 to 1990. (emphasis added) 151 Company Law Review Steering Group, supra note 61, para. 5.1.21.

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Chapter 2 ineffective in providing stakeholders with a remedy. The more relevant concept in this equation proves to be not that of (a particular category of) stakeholders’ interest, but the concept of company’s interest or even public interest. The latter includes an interest in safeguarding the productivity of the target company against financial speculation destructive of actual wealth, another interest in protecting those businesses and authorities relying on the target company for contracts and tax revenues, and still another interest in avoiding the social welfare burden entailed by employees loosing their jobs. It appears that the judicial enforcement performed by CL is a sword with one sharp edge only. It enforces its ‘due care’ norm defensively, against overreaching shareholders. The discretion granted deliberately to directors results from the reluctance of courts to interfere with business decisions except for gross negligence and bad faith cases. However, the managerial discretion backed by judicial selfrestraint that protects against shareholder suits also prevents courts actively from compelling directors to act at higher levels of care. Therefore judicial enforcement of the duty of care, including through internal systems that can account for CSR risks and opportunities, is likely to remain marginal. Courts have explained that the design of such systems is a mater of business judgment taken in the light of risks (costs) and likely benefits. CL may have other roles to play regarding the duty of care, as will be discussed shortly, but for CSR proposals the search for other enforcement mechanisms is still needed. This also requires a closer look at broader corporate governance dynamics that surround CL. 2.1.3. Clarification of duty of care through other corporate governance mechanisms Company laws lay down a legal duty of care but how management actually comes to abide by higher standards of care cannot be understood only by examining CL. This section will highlight the manner in which CL relies on non-judicial mechanisms to enforce the precepts of the duty of care. Our incursion in the broader corporate governance system begins by taking a look at the standing of shareholders in this system, that is both the legal rights of shareholders under CL and the mechanisms available to them to protect their interests. A. Standing of shareholders in the corporate governance system The discussion on managerial accountability draws on the previous sections that dealt exclusively with legal duties of loyalty (no self-dealing) and care that usually directors owe to the company. One of the points highlighted there was the selfrestraint that courts manifested in holding directors accountable for negligence. Courts are ill positioned to actively enforce the duty of care. Therefore the enforcement of higher levels of managerial care remains more an issue of shareholder self-help than of litigation. The analysis of shareholders’ standing in corporate governance continues here by referring to the legal rights shareholders have under CL and then to the extra-legal channels shareholders have for advancing their interests.

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Anchoring CSR in company law Shareholders have a bundle of rights, which following the OECD can be split into property rights over the shares and the right to influence the corporation: “Equity investors have certain property rights. For example, an equity share can be bought, sold, or transferred. An equity share also entitles the investor to participate in the profits of the corporation, with liability limited to the amount of the investment. In addition, ownership of an equity share provides a right to information about the corporation and a right to influence the corporation, primarily by participation in general shareholder meetings and by voting.”152

Shareholders’ rights to influence the corporation are specified in company law and internal company statutes. Varying with each jurisdiction, shareholders have rights in relation to the most important decisions in the life of the corporation. Shareholders elect the board of directors (subject to employee rights in certain EU states), have authority to amend the constitutive documents of the company, approve the distribution of dividends, approve the selection of the external auditors, approve the annual accounts, approve new share issues and approve extraordinary transactions such as mergers, acquisitions and takeovers.153 Shareholders adopt the constitutive acts of the company and elect the directors. According to law, directors are to exercise this delegated power carefully and loyally. The discretion that directors have in running the company appears unavoidably as a mere fact of delegation, but is also allocated purposively to them in order to take risks that could increase corporate wealth. It is important to emphasise that discretion is allocated by purpose, and it is not merely an accidental, undesirable fact of life. Brudney refers to the virtues of centralised management which “preclude both officers and directors from being subject to the daily control of stockholders, as a commercial agent in such matters might be. Moreover, the wealth-enhancing function of management implicates taking risks with the assets that are not permitted to a trustee”.154 The OECD notes the same functional necessity: “As a practical matter, however, the corporation cannot be managed by shareholder referendum. The shareholding body is made up of individuals and institutions whose interests, goals, investment horizons and capabilities vary. Moreover, the corporation’s management must be able to take business decisions rapidly. In light of these realities and the

152

OECD, supra note 62, p. 32. Weil, Gotshal & Manges LLP, Comparative Study of Corporate Governance Codes Relevant to the European Union and its Member States, Annex IV ‘Discussion of Individual Corporate Governance Codes Relevant to the European Union and its Member States’, 2002, p. 224, <europa.eu.int/comm/internal_market/company/docs/corpgov/corp-gov-codes-rptpart2_en.pdf>, visited on 14 February 2007. 154 Brudney, supra note 51, p. 612. 153

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Chapter 2 complexity of managing the corporation’s affairs in fast moving and ever changing markets…”155

CL has accounted for the above considerations. In the US, once elected, directors have the legal power to run the company even if the majority of shareholders disapprove. Shareholders can elect different directors at the next annual meeting, or call a special meeting to remove the directors. But once elected directors are ‘fiduciaries’ of the corporation and must look out for all shareholders and the corporation.156 Already in 1908 a UK court wrote: “The directors are not servants to obey directions given by the shareholders as individuals … .”157 Sir Adrian Cadbury wrote that shareholders elect directors and entrust them with control of corporate affairs. From there on directors owe their duty to the company and the recourse of shareholders is to vote a new board in the general meeting. Shareholders are not part owners of the undertaking; they own shares.158 As a difference from ordinary agents, directors have a duty to act consistently with the legal document that created their authority (constitutional documents) and a legal obligation to exercise their honest judgement.159 CL does not impose the regular obligation of an agent to conform to any wish of some shareholder; British law expressly provides that “a director of a company must exercise independent judgment” which is limited only in some circumstances: “This duty is not infringed by his acting (a) in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or (b) in a way authorised by the company’s constitution.”160 Section 2.1.1. dealing with managerial duties has already introduced, through a comparative survey, various CL formulations of shareholders’ interests. Laws thus either qualify the interests of shareholders with differing adjectives (‘collective’, ‘long-term’ or ‘common’ interests of shareholders), or introduce the concept of the ‘company’s interest’. Shareholders’ interests thus suffer a transformation which has an impact on metaphors of agency. From a legal perspective the UK Company Law Review Steering Group explains the transformation of shareholders’ interests once they are pursued in a corporate form: “[A] company is an association of shareholders who have agreed to subordinate their individual interests in the undertaking and to organise their protection in accordance with a set of jointly accepted rules and institutions – the company’s constitution. Shareholders therefore normally assert their rights collectively in accordance with those rules (to the extent 155

OECD, supra note 62, p. 32. A. Pinto, ‘United States’, in Pinto and Visentini (eds.), supra note 85, p. 261. 157 Gramophone and Typewriter Ltd v. Stanley (1908), quoted in Sir Adrian Cadbury, Corporate Governance and Chairmanship: A Personal View (Oxford University Press, Oxford, 2002) p. 41. 158 Ibid., p. 42. 159 Allen, supra note 138, pp. 315, 316. 160 Companies Act 2006, supra note 68, Article 173. 156

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Anchoring CSR in company law that they have not been delegated to directors) and are bound to accept the decisions which emerge.”161

To safeguard the powers of managers against overreaching shareholders CL has stricken a balance and at times has limited the rights of shareholders to influence the corporation. For fears of excessive litigation, CL discourages shareholders from pursuing their wishes through litigation. The Annotations to the OECD Principles of Corporate Governance state: “There is some risk that a legal system, which enables any investor to challenge corporate activity in the courts, can become prone to excessive litigation. Thus, many legal systems have introduced provisions to protect management and board members against litigation abuse in the form of tests for the sufficiency of shareholder complaints, so-called safe harbours for management and board member actions (such as the business judgement rule) as well as safe harbours for the disclosure of information. In the end, a balance must be struck between allowing investors to seek remedies for infringement of ownership rights and avoiding excessive litigation.”162

CL has thus erected procedural hurdles for shareholders initiating derivative actions in courts, similar high hurdles for shareholder resolutions filed with the annual general meeting of shareholders, the boards of directors have been restructured to include independent directors or employee representatives and in takeover situations some US jurisdictions even empowered directors to block shareholders from selling their shares (and exercising their property rights over their shares). Writers have found substantial evidence that company laws are tilted in management’s favour.163 The existence of managerial powers and the limits CL imposes on shareholders’ rights cannot mislead one into obscuring either the prominent standing of shareholders in corporate governance systems or the main non-legal avenues available to them to protect their interests. The globalisation of capital markets has made share capital an increasingly attractive form of financing even for companies that until recently had relied mainly on debt financing (loans from banks). Thus the EC regulation on the European public limited-liability company emphasises the importance of share capital, “that being the form most suited, in terms of both financing and management, to the needs of a company carrying on business on a European scale”.164 In addition, the liberalisation of product and services markets under the WTO regime compels developed states to strengthen the competitiveness and efficiency of their economies and businesses. Furthermore, as Allen observed: 161

Company Law Review Steering Group, supra note 48, para. 4.19. (emphasis added) OECD, supra note 62, p. 41. 163 G. F. Davis and T. A. Thompson, ‘A Social Movement Perspective on Corporate Control’, 39 Administrative Science Quarterly (1994) pp. 141–173. 164 Council Regulation (EC) No. 2157/2001 of 8 October 2001 on the Statute for a European Company (SE), preamble (13). 162

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Chapter 2 “Each of the two dominant social trends that will exert potentially transformative power on corporate governance in the years immediately ahead – the evolution of a truly global economy and the continuing growth, and coming dominance, of institutional shareholders – is more consistent with the property conception of the corporation than with the entity conception … These developments tend to push shareholders, as residual risk bearers, back towards the center of thinking about the enterprise.”165

In this environment the standing of shareholders’ concerns is correspondingly strengthened.166 Shareholders have extra-legal channels for advancing their interests: capital markets, through the impersonal valuations they made, and institutional shareholders, through their large size. In addition, mandatory disclosure of corporate information is a particularly important regulatory strategy in corporate governance;167 policy-makers view favourably disclosure strategies that facilitate shareholder self-help in issues of managerial care. First, in the US and the UK shareholdings have been rather dispersed. Stock markets are said to be ‘liquid’ as it becomes easier for shareholders to buy and sell shares, to enter and exit the market. Historically, shareholdings in other developed economies have not dispersed to the same extent as in the US and UK, with large shareholdings being held by banks, families or the state; correspondingly, stock markets have developed less in Germany, France, Italy or Japan.168 Well functioning stock markets are a powerful mechanism for obtaining managerial accountability and enforcing shareholder wishes. Shareholders can simply sell their stock in protest if dissatisfied with management. The expectations of financial analysts are influential in measuring managerial performance; the failing to meet analysts’ forecasts drives the stock price down and signals to shareholders that management is underperforming. This self-help mechanism finds support from financial transparency laws that facilitate market valuations and enforcement. Second, institutional investors holding large stocks cannot easily sell in bulk; also their leverage with management increases together with the larger size. This combination makes ‘voice’ a more attractive option for institutional shareholders than ‘exit’ from the market. Institutional investors therefore have attempted to engage corporate management and raise their concerns in private meetings or at the 165 W. T. Allen, ‘Our Schizophrenic Conception of the Business Corporation’, 14 Cardozo Law Review (1992) p. 279. 166 For an explanation about how the shareholders-rights movement reasserted a prominent role for shareholders in corporate governance since the 1980s, see Davis and Thompson, supra note 163. 167 See infra sections 5.2.2. and 6.1.1. 168 R. La Porta et al., NBER, Corporate Ownership Around the World, Working Paper No. 6625, 1998, <www.nber.org/papers/w6625>; M. Berndt, Global Differences in Corporate Governance Systems – Theory and Implications for Reforms, Harvard Law and Economics Discussion Paper No. 303 (2000), <papers.ssrn.com/sol3/papers.cfm?abstract_id=255886>, visited on 14 February 2007.

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Anchoring CSR in company law general shareholder meetings. Institutional investors have acted as forces for both quick high returns as well as for longer-term sustainable polices that can accommodate CSR concerns.169 Shareholders also have the power and right under CL to replace directors through ordinary or extraordinary shareholder meetings. Well functioning stock markets, when they are liquid, and institutional investors, because of their size, provide the main opportunities to obtain managerial accountability. Overall, corporate management is subject to the internal control performed by the board of directors and also to the external control exercised by the markets (mainly the capital markets) properly informed on managerial performance as a result of disclosure regulations. Thus the locus of managerial accountability varies with jurisdictions toward the external pole – as in the US and UK with their developed capital markets – or toward the internal pole – as in Germany, France and Japan with their concentrated ownership. A comparison of corporate governance systems explains why CSR debates have developed mainly in the US and the UK. There, shareholders’ influence and oversight over managerial decisions have been weakened by the separation of ownership and control. More precisely, by the fragmentation of ownership into many dispersed shareholdings. Dispersed shareholders have few incentives and possibilities to effectively monitor management, rendering it virtually unaccountable. This shaped both the priorities for company law, as well as CSR arguments about the role of management in society. On one hand, the central concern of company laws in the US and the UK has been the “omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders”.170 Managerial accountability is a top priority here, and not in Germany, France or Italy, where banks, the state or families own the bulk of the stock. These large shareholders control the managers without having to rely on courts or markets. Therefore the jurisprudence on managerial duties is scarce in these jurisdictions and the accountability of directors has not been a priority for CL there. Also CSR arguments find here less fertile ground in discussing the responsibilities of managers and corporations in society as a difference from the US and UK where the existence of a broad managerial discretion stimulated debate about how to exercise it (to benefit shareholders or broader social interests). Indeed most CSR literature is British and especially American. Actually the discussion about the interests of shareholders and their role in corporate governance can be well facilitated by taking a look at the main theories of the firm that have been influential in CL and corporate governance. They can highlight some crucial features and mechanisms of corporate governance. They are all shareholder-friendly theories that see the company as oriented towards economic wealth-generation. In the next chapter a radically different theory of the firm 169

J. P. Hawley and A. T. Williams, The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic (University of Pennsylvania Press, Philadelphia, 2000). 170 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d at 954. (Del. 1985).

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Chapter 2 (‘stakeholder corporation’) will be highlighted because it is sometimes at odds with CL, the primary subject of interest in this chapter. B. Theories of the firm The three theories are: First, the ‘property rights’ view of the firm gives shareholders (‘owners’) a sacrosanct place, and consequently managers should pursue exclusively shareholders’ interests with undivided loyalty. Second, the ‘nexus of contracts’ view of the firm is preoccupied with efficient wealth creation guided by market signals. Third, the ‘productivity’ view is similarly oriented towards wealth creation but argues for management to have the power to sometimes override the signals of markets. We will highlight how each theory conceives the issues of how to deliver accountability of management and what should guide managerial decision-making. This will help placing CL in the broader context of corporate governance systems and highlight the regulatory role of financial markets. The mainstream theories of the firm affirm the primacy of shareholders. Such views come in at least two broad forms: in one shareholder primacy stems from a moral imperative and in the other from the pursuit of efficiency. The ‘property rights’ view of the firm sees shareholders as the owners of the firm. The concern here is with ensuring fairness for shareholders who risk their money by investing in companies. Their rights should not be diluted by claims of other stakeholders who can protect themselves through contracts or laws. Milton Friedman based his famous attack on CSR171 on this ethical conception of shareholders’ rights. The ‘nexus of contracts’ view of the firm does not see shareholders as owners of the firm because the firm is not something that can be owned. Although the nexus of contracts theory rejects the notion of shareholders as owners, characterising them as merely one provider of inputs among many others, it strongly defends their interests through the market mechanism. The firm is a legal fiction constituting a nexus of contractual relations between various resource providers (investors, workers, contractors, consumers, etc). The primary concern lies with efficiency in wealth creation. Shareholders are viewed as residual-risk bearers. This ‘finance model’ of corporate governance dominates the Anglo-American legal, economic and management scholarship.172 Hill notes that “[w]hile the contractual theory deprecates shareholder participatory rights in corporate governance, it resurrects shareholder interests to preeminence, through the guiding principle of ‘profit maximization’”.173 Shareholders are deemed to have “exchanged corporate control for marketability of their shares”. Thus “the hub of shareholder protection should be 171

M. Friedman, ‘A Friedman Doctrine – The Social Responsibility of Business Is to Increase Its Profits’, New York Times Magazine, 13 September 1970, pp. 32, 33 and 122–124. 172 J. Cioffi and S. Cohen, ‘The State, Law and Corporate Governance: The Advantage of Forwardness’, in S. S. Cohen and G. Boyd (eds.), Corporate Governance and Globalization (Edward Elgar, Cheltenham, 2000) p. 315. 173 J. Hill, ‘Visions and Revisions of the Shareholder’, 48 American Journal of Comparative Law (Winter 2000) pp. 61.

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Anchoring CSR in company law located outside the corporation, in ensuring a fair and open market, offering shareholders ease of entry and, crucially, exit”.174 This functional justification of the shareholder primacy norm asserts that allowing other constituents to participate in the control of the firm presents an externality problem because stakeholders would not internalise the risks to the shareholders’ investment. Stakeholders would take risks otherwise regarded as imprudent and use corporate capital as a source of rents. This set of incentives would increase risks, lower expected returns and reduce the amount of equity investment in the aggregate.175 “The utilitarian justification is that this preference is the price paid for strong capital markets, and allocative efficiency and that these benefits are so powerful that they overwhelm the normative benefit of any distributional favoring of current employees over current shareholders. In the long run, the argument goes, employees and other stakeholders are overall better off with fluid and efficient capital markets, managers need a simple metric to follow, and both wealth and, in the end, fairness are maximized by shareholders being the corporation’s residual beneficiary, with the other claimants getting what they want via contract with the corporation. Current employees might be made worse off in some industries, but employees overall will have more opportunities, higher salaries, and better working conditions. Furthermore, a stakeholder measure of managerial accountability could leave managers so much discretion that managers could easily pursue their own agenda, one that might maximize neither shareholder, employee, consumer, nor national wealth, but only their own.”176

The ‘productivity’ view of the firm also aim to ensure the productivity of the business system but reacts to the short-termism of business decisions guided by the shareholder primacy norm, which is enforced by impatient capital markets. Such a perspective purposively parts with a narrow focus on the interests of shareholders. The productivity view has gained currency in the US and the UK since 1970s where the perception was that impatient capital markets shun longer-term investments (e.g. investment in research and development) which made the American economy less competitive than the Japanese and German ones.177 “Our need for productive business enterprise commits us to the entity view … because it is corporate management, with its special organizational skills, that knows how to balance the claims made on the corporation in order to make large scale enterprise productive over the long term. For the common good, those managements cannot be hobbled by 174

Ibid., p. 62. Cioffi and Cohen, supra note 172. 176 M. J. Roe, ‘The Shareholder Wealth Maximization Norm and Industrial Organization’, 149 University of Pennsylvania Law Review (2001) p. 2063, <papers.ssrn.com/sol3/papers.cfm? abstract_id=282703>, visited on 14 February 2007. 177 A. Gamble and G. Kelly, ‘Shareholder Value and the Stakeholder Debate in the UK’, 9 Corporate Governance (April 2001) pp. 110–117. 175

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Chapter 2 a short-sighted orientation geared exclusively to stockholders.”178 More recently, theories of the firm argue that not only shareholders are residual risk-takers, but also that other stakeholders who make firm-specific investments are bearers of risks that are impossible to diversify; the success of business would be inhibited unless these stakeholders gain more say in the control of the company.179 These arguments are consistent with the traditional wealth creation role of the business and focus on a narrow range of stakeholders such as the employees and creditors seen as residual risk takers. Other theories, usually the stakeholder approaches of an instrumental type, further expand the circle of stakeholders on which the success of the company depends. The UK Company Law Review Steering Group referred to this reasoning as the ‘Enlightened Shareholder Value’ approach: “Those who adopt an approach of this kind [Enlightened Shareholder Value] argue that the ultimate objective of companies as currently enshrined in law – ie to generate maximum value for shareholders – is in principle the best means also of securing overall prosperity and welfare. Many who take this view point out as well, however, that … exclusive focus on the short-term financial bottom line, in the erroneous belief that this equates to shareholder value, will often be incompatible with the cultivation of co-operative relationships, which are likely to involve shortterm costs but to bring greater benefits in the longer term. Thus the law as currently expressed and understood fails to deliver the necessary inclusive approach.” 180

For the ‘property rights’ and the ‘nexus of contracts’ views of the firm, shareholders, because of their investments made, appear as best at controlling that the company operates efficiently and delivers competitive returns. Shareholders as owners, respectively as residual-risk bearers, are ideally positioned to control management. The review of UK company law reaffirms this role of shareholders: “Shareholders focus on wealth creation and are … very suited to act as ‘watchdog’ not only on their own behalf, but also, in normal circumstances, on behalf of other stakeholders.”181 The corresponding managerial duties laid down by CL are either oriented exclusively towards the interests of shareholders, as ‘owners’, or are a rather unimportant, almost irrelevant concept – according to the nexus of contracts view. In the latter case market discipline will much better fulfil the function assumed by managerial duties; markets are more effective enforcers of shareholders’ interests than boards of directors or courts of law could ever be.

178

Allen, supra note 165, p. 272. Crespi, supra note 148, pp. 623–642. 180 Company Law Review Steering Group, supra note 61, para. 5.1.12. 181 High Level Group of Company Law Experts, Report of the High Level Group of Company Law Experts on a Modern Regulatory Framework for Company Law in Europe, Brussels, 2002, p. 47, <www.ec.europa.eu/internal_market/company/docs/modern/report_en.pdf>, visited on 14 February 2007. 179

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Anchoring CSR in company law The overriding concern of the ‘property rights’ and the ‘nexus of contracts’ views of the firm lies with the opportunities for self-dealing that managers encounter while running companies, and with how to limit such opportunities. Managerial selfdealing negatively affects both shareholders’ interests and the efficient creation of wealth in society. Managers can extract too many private benefits, for example, business opportunities belonging to the company, leisure, entrenchment, empire building and pet projects. Allowing for multiple loyalties, as proposed by some stakeholder theories, creates broad opportunities for managers to abuse their discretion. The UK Company Law Review Steering Group has considered and resisted orienting managerial duties toward a balance of stakeholders’ interests, and the public interest. Their objection rests on the effect these formulations (dropping the reference to shareholders or referring to stakeholders) would have. They would “create an undisciplined and unlimited power” for directors with no practicable means to enforce such a reformulated duty.182 Increasing managerial discretion would be undesirable. Thus a managerial power to consider stakeholders widens discretion for managers; a managerial duty to consider stakeholders creates discretion for courts leading to a judiciary management of companies.183 A reformulation of CL bringing non-pecuniary interests of shareholders besides the wealth-making interests of shareholders confuses the benchmark on which managerial performance is measured. An ambiguous benchmark makes it difficult for stock markets to value businesses and thus to hold managers accountable. A pluralistic norm serving multiple constituencies throws away the criterion of valueseeking and its enforcement by markets.184 In the same vein, “the fiduciary norm which instructs the agent to act solely for the principal, is one of the coping mechanisms for the principal to economise on specification and policing costs.”185 Veasey explained the position of the Delaware judiciary: “Although the interests of stakeholders other than stockholders may be considered by the board according to some Delaware caselaw dicta, it is clear under the holdings of Delaware judicial decisions that the interest of the stockholders is paramount… [T]he singular focus on stockholder interests avoids diffusing the accountability of the board. Thus, Delaware does not give the board unfettered discretion that could be rationalized under the ‘other constituency’ regime because almost any action could be

182

Company Law Review Steering Group, Modern Company Law for a Competitive Economy – Completing the Structure, 2000, p. 34, <www.dti.gov.uk/bbf/co-act-2006/clrreview/page22794.html>, visited on 14 February 2007. 183 Ibid. 184 M. C. Jensen, ‘Value Maximization, Stakeholder Theory, and the Corporate Objective Function’, 14 Journal of Applied Corporate Finance (Fall 2001) pp. 8–21, <papers.ssrn.com/ sol3/papers.cfm?abstract_id=220671>, visited on 14 February 2007. 185 B. M. Mitnick, ‘The Theory of Agency and Organizational Analysis’, in N. E. Bowie and R. E. Freeman (eds.), Ethics and Agency Theory: An Introduction (Oxford University Press, New York, 1992) p. 91. (emphasis added)

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Chapter 2 justified or rationalized as being in the interest of one or more of these outside groups.”186

A clear benchmark makes it possible for market mechanisms to exert control and enforce shareholders’ expectations. Markets occupy a prominent role in both shareholder-oriented models as an essential controlling mechanism limiting the discretion of management. The market for corporate control was intensively active in the US in the 1980s, with hostile takeovers seen as the ultimate disciplinary mechanism against underperforming managements. Aside from the drastic measure of hostile takeovers, the mere existence of liquid capital markets where shareholders can easily sell and acquire stock can bring management to account. It was noted that “[d]ispersed shareholder ownership elevates exit over voice as the mechanism by which shareholders can call management to account. Given the deep liquidity of the London stock exchange, the threat of shareholder exit is a meaningful one.”187 In addition to market control considerations, the property rights view of the firm, which sees shareholders as owners of the firm, resist conceptions that managerial duties could be owed to other constituencies than shareholders; the duties are ‘fiduciary’, based on trust and can be owed solely to the shareholders. The ‘productivity’ view of the firm rely on managerial discretion to better account for, and manage, the multitude of factors that affect corporate success and/or social welfare. Contrary to strictly shareholder-oriented views, the discretion of management is not necessarily a great problem (of accountability), but a potential solution (to productivity and fairness problems). This implicitly discounts the enforcement role of markets. In fact, the focus is not on market discipline but on market impatience; markets are part of the problem rather than the solution. Markets, especially financial markets that facilitate ever increasing and quicker returns on investment, came to be perceived as inimical to both business productivity (competitiveness) and to fairness considerations in society. There is a different emphasis on the various forces active in the corporate governance system – directors, markets and the state. On one side, mainstream economic theories give primacy to markets (decentralised and impersonal mechanisms) while regarding with suspicion state intervention and rejecting the capacity of directors for selfdiscipline. On the other side, ‘productivity’ views regard financial markets as potentially destructive to real wealth creation, while relying on wisely exercised managerial discretion (bureaucracies) and state regulation. Williamson noted that economists have a “long tradition of working out of spontaneous rather than intentional mechanisms” of which the ‘invisible hand’ of Adam Smith is a prime example.188 They regard with suspicion state policies that overrule market signals and, more generally, the wishes expressed by individuals through spontaneous social 186

Veasey, supra note 140, p. 6. S. Deakin, ‘Squaring the Circle? Shareholder Value and Corporate Social Responsibility in the U.K.’, 70 George Washington Law Review (October/December 2002) p. 978. 188 O. E. Williamson, Human Actors and Economic Organization, 1998, p. 11, <www.isnie.org/ISNIE98/OEWilliamson.doc>, visited on 14 February 2007. 187

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Anchoring CSR in company law exchanges. CSR appears as a form of social engineering that deeply clashes with market valuations, which in addition does not have the political legitimacy that the state and the law might have. The ‘property rights’ and especially the ‘nexus of contracts’ view of the firm see in markets not only the main controlling mechanisms of managerial discretion but would also rely on market signals to facilitate managerial decision-making. For economists, markets are the principal protective mechanism of shareholders (accountability), as well as the main source of information and guidance for managers (decision-making). Markets appear as large machines for gathering, processing and translating information into a price that reflects underlying economic values. It was noted that shareholder-oriented models offer shareholder value maximisation as a guidance for decision-making provided by markets. The assumption is for strong market efficiency whereby optimality in the long run is simply the result of a series of optimal short-run decisions.189 The ‘efficient market’ hypothesis comes in three forms: weak (prices reflect past movements of equity), semi-strong (prices reflect public information) and strong (prices reflect all public and private information). 190 For ‘nexus of contracts’ theories companies are seen as resembling markets allocating resources at arms-length rather than institutions, hierarchical organisations. Managing, usually described as a hierarchical exercise, is really a continuous process of negotiation of successive contracts. This has created a way around management hierarchies and succeeded in opening the interior of the firm to neoclassical microeconomics analysis. Thus economists could “discuss organizations while remaining within the traditions of their discipline and without sullying their hands with ‘engineering’”.191 In effect, “the neoclassical picture denies altogether the existence of the management power on which lawyers and legal academics have long focused their analysis of corporate law”.192 Managers are instead expected to follow markets’ signals. However, there is information that markets have not acquired or processed. As Stone wrote, “[t]he opponent of voluntarism [of discretion exercised by management] … is likely to begin by extolling the presumptive capacity of ‘market signals’ to correctly indicate social preferences. All but the most dogmatic anti[-CSR] concedes that the signals may be misleading and may require overriding in certain circumstances.”193

189

A. Sundaran et al., ‘The Corporate Objective Revisited’, 15:3 Organizations Science (2004) p. 358. 190 Hawley and Williams, supra note 169, p. 191. 191 W. W. Bratton, Jr., ‘The “Nexus of Contracts” Corporation: A Critical Appraisal’, 74 Cornell Law Review (March 1989) p. 417. 192 Ibid., p. 420. 193 On aspects that will be discussed in later chapters, the author continues: “But the anti maintains that it is for public representatives, accountable to the general electorate, to decide when and how to override the market signals, and not for the managers of private firms, whose training, expertise, and accountability is nonpolitical.” C. D. Stone, ‘Corporate Social

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Chapter 2 An important clash occurs here between shareholder and stakeholder views on the firm. Allen observed: “In claiming that management’s unique expertise enables it to maximize corporate performance, and that its expert judgments about long-term value creation are more dependable than market valuations reflecting investor decisions, this … view directly challenges the premise of many economist critics that markets in widely traded securities value future prospects more dependably than does internal management.”194 One could now ask: so, in the end, for whose benefit …? The overwhelmingly dominant theoretical perspective applied in corporate governance is agency theory.195 CSR discussions in the CL context commonly asked: ‘for whose benefit are those in control of a corporation supposed to act?’ The question goes back as far as the 1930s when Professors Dodd of Harvard Law School and Berle of Columbia Law School started to debate the question ‘for whom are corporate managers trustees?’196 Then, Professor Berle argued that managerial powers are held in trust for stockholders as sole beneficiaries of the corporate enterprise, while Professor Dodd argued that these powers were held in trust for the entire community. For shareholder-oriented theories inspired by economics the firm is a legal fiction and is conceived in contractarian terms in line with the methodological individualism traditionally favoured in economics. The “corporation tends to disappear, transformed from a substantial institution into just a relatively stable corner of the market in which autonomous property owners freely contract”.197 Speaking of the ‘interest of the company’ is nonsense and could never be different from shareholder value maximisation. For the ‘property rights’ view of the firm there is an additional ethical command to pursue solely the interests of shareholders. For authors animated by concerns to reduce managerial discretion (improve managerial accountability), references to company’s interests are ‘schizophrenic’. Fanto clearly summarises the argument in the French context: “From an agency perspective of countering management power, this justification for decision-making simply invites managers to ‘divide and conquer’: rather than serving company interests (whatever they are), executives can play various company constituents (e.g. creditors, employees, shareholders) off against one another to maintain their own primacy.”198 Management “no longer checked by State controls and increasingly Responsibility: What It Might Mean, if It Were Really to Matter’, 71 Iowa Law Review (January 1986) p. 566. 194 Allen, supra note 178. 195 C. M. Daily et al., ‘Corporate Governance: Decades of Dialogue and Data’, 28:3 Academy of Management Review (2003) pp. 371–382 196 A. A. Berle, ‘Corporate Powers as Powers in Trust’, 44 Harvard Law Review (1931) p. 1049; E. M. Dodd, ‘For Whom Are Corporate Managers Trustees?’, 45 Harvard Law Review (1932) p. 1145; A. A. Berle, ‘For Whom Corporate Managers Are Trustees: A Note’, 45 Harvard Law Review (1932) p. 1365. 197 Allen, supra note 178, p. 265. 198 J. Fanto, ‘France’, in Pinto and Visentini (eds.), supra note 85, pp. 48, 49.

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Anchoring CSR in company law operating in market capitalism, can now use the ‘interet social’ strategically to pursue their own interests, generally at the shareholders’ expense”.199 The debate in France about corporate governance has involved the ‘company’s interest’ concept. There it was observed that “surrounding the prime interest of the company is the fine web of the interest of society as a whole”.200 Thus an emphasis on company’s interest brings a wealth creating entity a step closer to public interest which is susceptible to manipulation and abuse. Alcouffe shows that the notion of the interest of the company itself has been used with different meanings and intentions. Thus judges refer to it mainly to guarantee the continuity of the firm, especially when the latter faces economic difficulties. CEOs refer to it to keep a free hand in managing the company. Shareholders see the notion as ambiguous and mostly used against their own interest.201 There has been preoccupation with the value of having a single-minded focus on shareholders and blindly relying on the capacity of markets to provide guidance. Some writers (the ‘productivity’ view of the firm) are troubled by the framing effects that such a focus generate, with negative effects on sustainable wealth creation; others (instrumental stakeholder theory) concerned more with social justice than with economic wealth think that business success and stakeholders’ interests could be (partly) reconciled by improving managerial practices. Both these approaches concerned with improving managerial decision-making find the question ‘for whose benefit are those in control of a corporation supposed to act?’ ill-posed altogether. Those concerned with the practicalities of decision-making tend to find most relevant other concepts. These are exactly those that the analysis of CL in this chapter has highlighted: the qualified interests of shareholders and/or the company’s success/interest. These are intermediary concepts that have been rejected by economic models of agency because of ‘distorting’ the direct link investormanagement; similarly stakeholder theories have neglected or misrepresented them. However various writers have struggled to account for and specify these intermediary concepts. Leader and Dine use established company law concepts to account for the transformation of shareholders’ interests. They distinguish between derivative and personal interests. The authors argue that the question ‘whose interests should be served’ raises a false dilemma if it asks for choice between classes of individuals. The relationship between the interests of shareholders and corporate performance are linked in two ways: derivatively (damage to the company) and personally (damage done by the company to shareholders). The company should satisfy shareholder’s derivative, not personal interests. As a side constraint, it must not abuse those personal interests, but that is not its very reason for existence. “Indeed, the success of the company depends on satisfying a varying mix of wants among

199

Ibid., p. 50. Alcouffe, supra note 76, pp. 134, 135. 201 Ibid., p. 127. 200

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Chapter 2 these groups at any given moment…”202 The authors further note: “[T]he conception of the company as a set of constituencies is partly right: no single group can be allowed to dominate the allocation of the company’s resources if it is to function successfully. On the other hand, it is wrong to see the company as a ‘community’ … That view fails to appreciate how there will inevitably be tensions … between personal and derivative interests within the enterprise.”203 Rolf Birk, commenting on the German system of corporate governance, understands the interest of the corporation in a procedural rather than a substantive sense. He notes that the material content of the ‘interest of the corporation’ is vague: it aims at “securing the existence, the inner stability and success of the corporation in the market”.204 The concept is however a variable and dynamic notion: “[T]he interest of the corporation does not set forth an order of priority of the interests to be taken into account, but rather fixes rules of conduct related to the corporation such as rational discussion of conflicts and a cooperative managerial behaviour. Hence the interest of the corporation can be understood in a ‘procedural’ rather than in a substantive sense.”205 German law institutionalises employee participation on the board; however it “cannot be directly deduced from this concept to what extent the employee’s interests are to be taken into account”.206 Teubner considers that Berle and Dodd207 posed the wrong question by searching for social groups. Instead of an ‘interest group approach’ he proposes a ‘functional approach’ as more able for selecting and weighting social interests.208 Teubner emphasises the orientation of the firm towards efficient wealth creation. By careful wording Teubner hints that his approach is superior for ‘selecting’ and ‘weighting’ interests, while tacitly leaving the ‘identifying’ of interests to other approaches, such as stakeholder approaches working as an environment-scanning technique. How effective a system CL is in pressing for higher managerial care and especially for maintaining managerial accountability remains to be seen. CL itself relies on markets and shareholder self-help to reign in abuses of managerial discretion. Something clear can still be said about those arguments that draw on CL to either disregard CSR out of hand or to promote CSR. Both these arguments have searched for intuitive, easy-to-define concepts, towards which to orient managerial duties and in the process they obscured intermediary concepts at the foundation of CL. The analysis in this chapter makes it clear that CL introduces some intermediary 202

S. Leader and J. Dine, ‘The United Kingdom’, in Pinto and Visentini (eds.), supra note 85, pp. 248, 249. 203 Ibid., p. 250. 204 Birk, supra note 85, p. 68. 205 Ibid., p. 69. 206 Ibid. 207 See supra note 196. 208 G. Teubner, ‘Corporate Fiduciary Duties and Their Beneficiaries’, in K. J. Hopt and G. Teubner (eds.), Corporate Governance and Directors’ Liabilities (W. de Gruyter, Berlin/New York, 1985) pp. 150, 151.

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Anchoring CSR in company law concepts between shareholders (principal) and directors (agent) – the qualified interests of shareholders and/or the company’s interest – and that the agency metaphor deliberately disregards these intermediary concepts. Both critics and supporters of CSR have framed it as a matter of divided loyalties (to shareholders, respectively to stakeholders). However company laws in the area of the duty of care can hardly be understood in term of loyalties. Difficulties are unavoidable even if shareholders are the principals and managers their agents; business executives pointed to the heterogeneous nature of shareholders’ interests. For example, Sir Adrian Cadbury noted that “interests differ among shareholders. Some are more concerned with trading in a company’s shares than in holding them; others will differ over the relative importance which they attach to dividends and to capital appreciation. Shareholders are not a homogenous group with a common set of interests, as chairmen soon discover.” 209 It is apparent that management already has some kind of split loyalty: it has to pursue the interest of the business as a going concern (as a wealth-generating entity) while in the same time satisfying the expectations of shareholders for competitive returns (as an entity able to attract market investments). CL has conceptually sided with the management and favours the interests of business as a going concern, but corporate governance systems to which CL belong have increasingly emphasised the importance of shareholders and stock markets. Labelling directors as agents of shareholders cannot be allowed to obscure the complexity of the decision-making process that directors face in business life. Other ways to obtain simplification of that complexity may need to be found; the more compatible they are with agency model’s concerns for accountability and with the working of markets, the better. Policymakers in the UK have recognised the necessity to clarify managerial duties under CL and help markets develop wider criteria (including CSR) linked to business success in a complex economy. The British strategy requires companies to disclose information on a wider range of material risks to business, not only financial data.210 The Company Law Review Steering Group writes about the “pivotal role [of increased transparency] in improving understanding of business performance and prospects, as well as promoting accountability and encouraging responsiveness and high standards of business practice”.211 This is a modality to sustainably create shareholder value and also to promote stakeholders’ interests though “freedom of contract and exchange in the broadest sense”.212 The concerns advanced by agency perspectives cannot be dismissed; they highlight the essential issue of the accountability of management. This is at the heart of CL; it was noted that “[in] nearly all modern governance research governance mechanisms are conceptualized as deterrents to managerial self-interest”.213 But there is another side of the CL coin. To what extent does the agency model assist 209

Cadbury, supra note 157, pp. 42, 43. Companies Act 2006, supra note 68, Article 417. 211 Company Law Review Steering Group, supra note 65, para. 3.32. (emphasis added) 212 Company Law Review Steering Group, supra note 61, para. 2.22. 213 Daily, supra note 195. 210

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Chapter 2 managers struggling to discharge their duty of care under CL and enhance the success of their business, as a difference from that of the economy as a whole, in unsettled issues, such as when dealing with CSR risks and opportunities? To what extent can agency reasoning aid managers obeying the duty to exercise judgement under CL when managers grow aware of the negative externalities their business may produce and backfire on their own company? 2.2. COMPANY LAW: A PARTIAL CLARIFICATION OF THE DUTY OF CARE The tension that permeates CL in the area of the duty of care has become clear by now. The analysis below highlights the way in which CL spins off certain of its prerogatives into the wider corporate governance system. Then we boil down the norm that CL seems to advance as a reference for CSR-supportive arguments. 2.2.1. Triple spin-off that company law performs There are some important dynamics that a CSR argument needs to take into account. First, CL tends to concentrate on wealth creation and to spin-off distributional issues. While economists support this tendency, CSR proponents try to reverse it and build CSR protections within CL. Second, in CL the judiciary tends to enforce the prohibition of self-dealing (duty of loyalty) and to spin-off enforcement of aspects of due care. While economists emphasise the controlling function of the market and downplay judicial enforcement, some CSR advocates have long sought a change in the managerial duties in CL and to enrol judicial enforcement. However, the current managerial duty of care is weakly enforced by CL; not only is the present duty of care not a legal obstacle to CSR, but mentioning stakeholders’ interests in legal definitions of managerial duties may not be effective because CL cannot anyhow deliver the judicial enforcement sought after. Third, CL also spins-off the specification of what due care entails in concrete contexts. Economists have relied on the signals sent by markets as the best assessment of managerial due care being exercised or not, while most CSR proponents have fought to include a mention of stakeholders’ interests in legal definitions of managerial duties assuming that this will somehow automatically lead to higher managerial care. Below I expand on this triple spin-off that CL performs. First, regarding distributional issues, the overwhelming concern of company law is for wealth creation. The EU positions CL within an increasingly explicit and assertive paradigm of wealth creation and competitiveness: “Company law should primarily concentrate on the efficiency and competitiveness of business … Company law should provide a flexible framework for competitive business. Using company law for other regulatory purposes may lead to an undesirable tightening of rules … there is a tendency to use the traditional field of company law to achieve all sorts of other regulatory purposes, for example to combat tax fraud. … This development leads to quite the opposite of company law as a

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Anchoring CSR in company law framework for competitive business: more compulsory rules, heavier monitoring and enforcement regimes and slower, more cumbersome and burdensome procedures for all … [Other regulatory purposes] should be achieved through specific law enforcement instruments outside company law, and should not be allowed to hinder the development and use of efficient company law structures and systems.”214

The reform of British company law currently under way operates in a likeminded wealth creation paradigm: “We would stress in this context that we interpret our terms of reference as requiring us to propose reforms which promote a competitive economy by facilitating the operations of companies so as to maximise wealth and welfare as a whole. We have not regarded it as our function to make proposals as to how such benefits should be shared or allocated between different participants in the economy, on grounds of fairness, social justice or any similar criteria.”215

The US commentators note that the US public corporation law manifests a similar indifference to distributional issues.216 Thus company law shuns distributional issues from its purview in most jurisdictions with the exception of a handful of countries – Germany, Netherlands – that use ‘co-determination’ to build employees’ representation in the corporate governing structure; Germany however is currently scaling down its long established co-determination system.217 Most systems tend to relegate solutions to distributional issues to other branches of law such as labour law, tort law, environmental law, tax law and so on. Because CL has a tendency to spin off distributional issues, including CSR, one of the challenges encountered by CSR arguments directed at CL is to show why CL is the right arena for legal alterations, and not the specialised legal fields closer to the problem-issue motivating CSR. Arguably this would be less of a problem if CSR proposals strove more insistently for compatibility with CL’s basics, which has seldom been the case. A way to address this fundamental objection is to relate CSR to CL’s guiding concept, the intermediary concept of ‘business success’ (the interest of the company as a going concern), and to refocus from debating ‘loyalty’ to various beneficiaries towards positioning the implementation of CSR as an issue of reasonable care owed to the company. In its defence, CSR is a relevant issue for CL to a larger extent than it is for other legal fields because it guides the broad discretion that managers have whenever they are not guided by specific laws or shareholders’ instructions. It is true that less ambitious proposals to alter corporate behaviour could pursue discrete reforms in other legal fields closer to the problem. 214

High Level Group of Company Law Experts, supra note 182, p. 36. Company Law Review Steering Group, supra note 61, para. 2.5. 216 T. A. Smith, ‘The Efficient Norm for Corporate Law: A Neotraditional Interpretation of Fiduciary Duty’, 98 Michigan Law Review (October 1999) p. 248. 217 H. Williamson, ‘Shake-Up Looms for German Workers’ Board Role’, Financial Times, 5 April 2005. 215

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Chapter 2 But, in an important sense, CSR does not necessarily seek to overhaul CL. CSR can merely aim to correct some misguided belief systems grounded in the agency metaphor that misrepresents the managerial decision-making process and that could impede the very wealth creation objective of CL. Thus CSR helps contesting simplistic views of loyalty to shareholders’ interests that disregarded the cornerstone of CL: the interest/success of the business entity. Second, the enforcement aspects related to the duty of care leads one to move beyond analysing judicial enforcement and legalistic strategies only. The discussion herein about company law, and its enforcement potential, did not obscure the manner in which CL deliberately relies on other legal and non-legal forces that impact on how corporations are governed. In advancing the duty of care, CL relies on wider corporate governance mechanisms (especially markets), on shareholder self-help, on soft law approaches, backed by disclosure regulations,218 as a first line of enforcement. An understanding of the enforcement of the duty of care in corporate governance regimes informs about where feasible regulatory solutions to CSR lie in the current economic-political climate. The spin-off of enforcement performed by CL requires an analysis of the causality between the objectives of law (expressed herein in the managerial duty of care articulated in CL) and corporate behaviour.219 This focuses analysis on the regulatory potential of public and private actors, and the norms/rules they apply. As the OECD noted, the “corporate governance framework typically comprises elements of legislation, regulation, selfregulatory arrangements, voluntary commitments and business practices that are the result of a country’s specific circumstances, history and tradition”.220 In light of this, attention should be given to both the context where CSR and law co-evolve (‘regulatory space‘) and the regulatory strategies that states can employ (‘regulatory mixes’). Regulatory interventions in support of CSR are bound to use all these forms and can be included in an array of legal domains that regulate corporate governance, such as company law, securities regulation, accounting and auditing standards. Third, the specification efforts of CL related to the duty of care tell mangers what to strive for, but not how to do that except to do it with ‘care’. Courts could clarify no more than that managers are expected to perform in an informed manner, attentively, skilfully and by employing rigorous processes. It appears then that legal duties (of care) are accompanied by a norm that provides guidance to managers with how to approach complexity and how to reduce it to manageable dimensions. This norm occupies an essential intermediary position between law’s objectives and corporate behaviour. 2.2.2. Divergent standards Courts in various jurisdictions have consistently held that managers are free to pursue corporate success by taking a long-term perspective that can include 218

See infra sections 5.2.1. and 5.2.2. See infra section 6.1.4. 220 OECD, supra note 62, p. 29. 219

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Anchoring CSR in company law stakeholders’ interests. Courts have exercised self-restraint in assessing the wisdom of managerial decisions or the care with which they were made. This judicial restraint generates confusion regarding what signal CL really sends regarding the duty of care: on one hand, CL says that directors should act with care and skill; on another hand, courts will hear shareholders only if they hint that directors were grossly negligent, not ordinarily negligent. When directors are merely negligent shareholders have no judicial remedy; in these cases the legal duty has no sanction. This is an embarrassment for CL and seeds confusion on what standard of care CL really advances. Some authors referred to this puzzling situation as the divergence between ‘standards of conduct’ and ‘standards of review’ (liability): company law presents a distinct case where law mandates standards for the directors’ conduct that are higher than the standards that courts use for adjudicating related disputes. This happens precisely in the duty of care area which is central to CSR discussions. As Eisenberg explains, standards of conduct and review diverge most dramatically in respect of due care, less so in respect of self-dealing (duty of loyalty).221 What accounts for this divergence of standards that breeds confusion? William T. Allen tries to answer this question by zooming out of corporate law and analysing the broader context where CL has to play its role. The duty of care as formulated and enforced is subject to two cross-cutting efficiency effects. On one hand, law tries to accomplish a positive effect – the standard states a “command to be efficient with respect to the acquisition and use of information”.222 On the other hand, law tries to prevent a negative effect; indeed the pursuit of directors’ liability generates personal risks which would impede rational risk assumption and therefore impede wealth creation. This results in a divergence of the standard of care and that of liability. Some lawyers seem sceptical of the practical value that the duty of care under CL has. Brudney for example writes: “[I]n the case of investor-owned publicly held corporations, the principal normative concern for the law and lawyers over the years has been with the loyalty aspect of management’s (including directors’) and controlling stockholders’ fiduciary obligations. That emphasis on loyalty reflects substantial doubt that the ‘care’ obligation entails a useful norm of behavior.”223 Other lawyers take a second look at the duty of care. Eisenberg, who first conceptualised the divergence of standards in CL, refers to the expressive and clarifying functions of law. These functions impact social norms and roles. He writes: “Although legal standards of conduct are characteristically accompanied by liability rules or other enforcement regimes, even a legal standard of conduct that is unaccompanied by such a regime may be effective because of its impact on social norms.”224 Thus law indirectly affects corporate behaviour by first making an impact 221

Eisenberg, supra note 50, p. 465. Allen, supra note 138, pp. 317, 318. 223 Brudney, supra note 51, p. 599. 224 M. A. Eisenberg, ‘Corporate Law and Social Norms’, 99 Columbia Law Review (June 1999) p. 1269. 222

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Chapter 2 on norms. This explanation referring to ‘norms’ points to the necessity to understand broader legal and non-legal dynamics mediating between law and corporate behaviour. Such divergence of standards complicates the causality between formal state regulation and corporate behaviour; the neat simplicity of deterrence theory is not available in the area of due care. CL advances important pointers regarding the duty of care. The main elements of the norm is to orient managerial loyalty solely toward the interest/success of the company itself as a wealth-creating entity, to refer to the necessity to take a longerterm perspective of business success, to take an inclusive view of the relationships (with stakeholders) that can affect business success and install sound processes for decision-making to enable directors to discharge their duties in an informed and attentive manner. It is then a matter of independent business judgement on how to approach complexity in each specific context. By clarifying the contents of the duty of care, CL could only go that far in specifying how managers should approach and simplify complexity. The next chapter continues with an analysis of the norms and belief systems that pro- and con- CSR theories have proposed to managers as a way to approach complexity in their environment.

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CHAPTER 3 NORMS ADVANCED IN THE CSR DEBATE The previous chapter has analysed the relationship between management and shareholders from a company law perspective. CSR debates have elaborated on this relationship but also asked broader questions: What is the role of large businesses in society? What should managers concretely do when confronted with instances of injustice linked to their company’s activities? Thus this chapter continues the comparison of theories of the firm done in chapter 2 in the context of company law; now we rely on other types of considerations that CSR debates have brought up. The purpose here will be to deconstruct pro- and con-CSR CSR arguments because they seem to be in fact ‘packages’ whose elements are held together in a questionable manner. For this purpose I identify three levels on which CSR arguments develop. The analysis is driven by a concern that ‘contaminations’ among these levels seem to have taken place in both camps of the CSR debate. Highlighting this issue will hopefully make it easier to cut through the dense rhetoric and normative positions, and step closer to genuine dilemmas and practicable solutions. In the end the reader who feels attached to one element in the package may find that s/he may not necessarily have to ‘buy’ the whole package. 3.1. MILTON FRIEDMAN AND HIS CRITICS Probably the most articulate voice against CSR remains that of the economist Milton Friedman; his 1970 article225 contains the key objections to CSR which will be presented below. Critics of CSR still rehearse the same basic insights 35 years later and have hardly added anything new.226 I rely on this article also because it attracted countless responses from business ethicists. Even very recent works on business and human rights in developing countries (international CSR) often start by disagreeing with Friedman. Friedman though raised important issues that were left without an appropriate answer. As the responses to Friedman’s article are heterogonous I will present what I perceive are the crucial points where pro-CSR literature has concentrated, as well as the points on which it did not mount a sustained response. The following critique is done from a specific perspective taken by this study, which focuses on the situation of human rights in developing countries and the role of the parent company (or MNE group) regarding the operations of its subsidiaries/contractors. What is primarily targeted here is the temptation of current writers in the business and human rights area, both pro- and con-CSR, to rely 225

Friedman, supra note 172. See for example ‘The Good Company – A Sceptical Look at Corporate Social Responsibility’, The Economist, 22 January 2005. 226

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Chapter 3 uncritically on arguments that could carry important lessons, but were advanced in a different context (in the US) in different times (over the last 30 to 40 years). Proand con-CSR models have often accounted insufficiently for important dynamics and considerations. Using them as a base to perpetuate advices to managerial decision-making that have outlived their usefulness makes it more difficult to account for important recent developments (in management and public governance) and to come closer to viable solutions to pressing human rights problems. We begin by briefly introducing each level of analysis. The three levels are the following: (1) the role of the large business in society; (2) the duties of management; and (3) the norm managers should use to approach complexity. Later sections will present how proponents and sceptics of CSR have conducted their analysis at each level. Level 2 in this analysis has been dealt with in chapter 2 from a corporate governance perspective. Friedman’s argument belongs to the ‘property rights’ view of the firm that sees shareholders as the ‘owners’ of the company and draws on markets, which guide managerial decisions, limits managerial discretion and hold them accountable to shareholders. To avoid unnecessary duplication only some of Friedman’s own words will be added here with a more detailed presentation of the response from stakeholder theory. The next two levels of analysis bracket level 2 ‘upwards’ and ‘downwards’. Thus level 1 zooms out to discuss views about the role of business in society. Level 3 in turn zooms in to hint to the intricacies of managerial decision-making. An analysis at level 1 – role of large businesses in society – refers to the necessity for role separation. This necessity arises from concerns with efficient wealth creation and with the legitimacy of corporate power. I will take them in turn. A division of labour needs to exist in society; specialised subsystems are then able to fulfil their respective functions more efficiently. Such specialisation would entail, by definition, that one could pursue its respective mandate without having to concern himself with the fulfilment of other functional roles. Thus efficiency gains from the division of labour result precisely from the deliberate disregard of other works pursued simultaneously. Then organisations should not expand beyond primary tasks: “[I]f each individual and organization seeks to accomplish in the most efficient manner the highest-valued specific tasks of which he (it) is capable, the value of the total product of society will be as great as possible.”227 CSR arguments have mainly been advanced with large businesses in mind because with large size comes commensurate economic, social and environmental impacts. CSR basically proposes that these large business groups should have responsibilities that go beyond wealth generation towards a fairer distribution of risks, losses and gains of corporate activity among stakeholders. There is a potential contradiction of CSR with this important principle of role separation and efficient social organisation. Indeed CSR advances proposals that go against this trend: 227

L. E. Preston and J. E. Post, Private Management and Public Policy: The Principle of Public Responsibility (Englewood Cliffs, N.J., 1975) p. 31.

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Norms advanced in the CSR debate monofunctional systems become multifunctional. Structural-functionalism suggests that as societies modernise and complexity increases, their subsystems differentiate and multifunctional system structures are replaced by single function systems. CSR blurs this division of labour by resurrecting the question: what is the role, or the roles, of the business system in society? March and Olsen have insightfully remarked a characteristic of institutions in general that is pertinent to our discussion about role separation. They noted that a central anomaly of institutions is that they increase capability by reducing comprehensiveness; politics is uncoupled from administration; various parts of administration are uncoupled from each other. “As a result of these various forms of simplifications, political institutions are simultaneously an affront to our sense of comprehensive rationality and a primary instrument for approximating it. The uncouplings are justified not by a judgment that the aspects are independent but by the assumption that the errors introduced by treating them independently are less than the errors introduced by trying (and failing) to treat them as interdependent.”228

The role of businesses (of corporate managers) in society has been discussed since Berle and Means wrote in the 1930s about the separation of ownership and control in large corporations. The perception was that the management of large corporations in the US has escaped any significant oversight by shareholders and acquired significant discretion. This ascendance of managers as a professional group was recorded as the ‘managerial revolution’, and the question was whether to orient this managerial discretion toward broader social goals or toward narrow profit-making. Thus CSR writings have built on the existence, in fact and in law, of managerial discretion in how to allocate corporate resources and attempted to steer the managerial power to mediate among conflicting social interests. An analysis at level 3 – the norm managers should use to approach complexity – should provide guidance to managers with how to fulfil their role, how to approach complexity and how to reduce it to manageable dimensions. Managerial duties under company laws tell mangers what to strive for – the interest/success of the company – but not how to do that except to do it with no self-dealing and with ‘care’. It is not possible for lawmakers to define ex ante what reasonable care entails in each context; courts are also limited in their ex post review assessing whether due care was exercised or not. It fell then on others – both pro- and con-CSR theories – to propose a guiding norm. For present purposes, a norm can be defined as a set of attitudes, beliefs and guidance for how to approach complexity. Following Talley, a norm can be seen as a “tendency for individuals to adopt a particular strategy or pattern of behavior within a broader social context”.229 This study takes a 228 J. G. March and J. P. Olsen, Rediscovering Institutions: The Organizational Basis of Politics (Free Press, New York, 1989) p. 17. (emphasis added) 229 E. Talley, ‘Disclosure Norms’, 149 University of Pennsylvania Law Review (June 2001) p. 2011.

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Chapter 3 behavioural view of norms as “commonly shared practices that people tend to pursue even though legal rules alone do not compel them to do so”230 rather than the moral view of norms, which conceives a norm as a moral imperative that is independent of individual preferences. The exposition of various theories of the firm in chapter 2 revealed the clash between the mainstream theories of the firm and the ‘productivity’ view. The former instructed managers to follow the law and (financial) market signals; the latter cautioned that market signals could not replace completely the role of managerial judgment in longer-term planning, drawing thus attention to market failures. CSR goes further to propose that a sense of responsibility is indispensable for making economically- and morally-sound business decisions in complex situations. CSR would raise the question: what will provide guidance to managers when following certain social and environmental negative impacts of business market signals aren’t there, laws are also inadequate, but damage to reputation and other liabilities may be forthcoming? How does the manager simplify complexity in such a business environment? Limiting your attention only to the law and market signals will surely not provide the answer. 3.1.1. Friedman’s views Friedman offered the following definition of CSR: “[T]here is 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.”231 I will follow the three levels of analysis identified in the beginning to present Friedman’s argument. Friedman starts his analysis with the relationship between management and shareholders (level 2). Shareholders are the ‘owners’ of the business and managers are their agents. Friedman examines an agency relationship and identifies the mandate that binds business executives: in opposition with the non-profit social corporation, their mandate is “to make as much money as possible while conforming to the basic rules of society, both those embodied in law and those embodied in ethical custom”.232 Thus the interests and wishes of owners are deduced from the legal process of incorporating a for-profit entity. Friedman appears to conceive the agency relationship from three perspectives: moral, legal and functional. From a legal viewpoint the agency relationship he sees between shareholders and managers does not hold. His argument has however never been meant as a legalistic one: he mainly emphasises the moral right of shareholders who invest their money, and the function that markets have in protecting shareholders’ interests and sanctioning managers abusing their discretion.

230

Ibid., p. 1962. Friedman, supra note 172, p. 126. 232 Ibid., p. 33. 231

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Norms advanced in the CSR debate Friedman applies his reasoning to both managers and union leaders, which at that time in the US were expected to show restraint in their labour grievances that could increase inflation. He considered that the CSR doctrine by definition asked corporate executives, as well as labour leaders, to accept social responsibilities that go beyond the interest of their members. As to level 1, the key characterisation of CSR is that managers that allocate scarce corporate resources in order to satisfy stakeholders’ claims would in fact impose a tax on shareholders, employees and customers. But it is the province of democratic representative governments to impose taxes and allocate their proceeds. If CSR were given course, democratic procedures would be bypassed in determining a fundamental political issue such as redistribution. That deprives CSR of legitimacy. The way to go instead of imposing social responsibilities on business executives, Friedman proposed, is to accept that “it is the responsibility of the rest of us to establish a framework of law…”233 so that the invisible hand can operate. Friedman thus insists on the functional separation of roles in a democratic society, but this is insufficient to understand his views on the roles of law and government. The emphasis on role separation could in itself reinforce the role of political institutions in distributive matters. However Friedman subscribes to a libertarian philosophy on which Robert Ayres commented: “It is argued that businesses exist only to make profits for their owners (stockholders) and that any diversion of managerial effort in other directions is actually a breach of fiduciary responsibility. It is also argued that, if there are environmental problems resulting from the profit-making activities of business, the resulting problems should be dealt with by tort law, meaning that parties suffering damages should sue the parties causing those damages ... Ultimately, it is the government that sets the rules under which companies operate and compete. Unfortunately, many of those who argue vociferously that the business of business is only to make profits – and there are a lot in the financial world – also argue, in the same breath, that there is too much government and too much regulation and that the ‘free market’, left to its own devices, would take care of any environmental problems. I think they are wrong.”234

Indeed, Friedman’s overriding concern is to safeguard the free-market system, threatened by private and public concentrations of power (monopolies and governments). Friedman says: “The existence of a free market does not of course eliminate the need for government. On the contrary, government is essential both as a forum for determining the ‘rules of the game’ and as an umpire to interpret and enforce the rules decided on. What the market does is to reduce the range 233 M. Friedman, Capitalism and Freedom (University of Chicago Press, Chicago, 1962) pp. 133, 34. 234 R. Ayres, ‘What is the business of business?’, International Herald Tribune, 4 June 2002, p. 9.

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Chapter 3 of issues that must be decided through political means, and thereby to minimize the extent to which government need participate directly in the game.”235

In that regard it was observed: “What galls Friedman the most is the idea that some people should employ the apparatus of state power to remake the world to their own liking, usually by regulating profit endeavors and taxing some to spend on others. While he differs from pure libertarian economists by accepting the state as a protector of private property, persons and contracts and as a preserver of free competition, Friedman delights in discovering ways in which the free market can solve problems which many feel are within the province of government.” 236

Friedman is concerned that acceptance of CSR, and the managerial discretion it entails, is the first step on a slippery slope. If the private tax raising that CSR is deemed to be is allowed then for the sake of ensuring accountability and the supremacy of democratic state institutions the political machinery should check such tax raising. This would however mean to adopt the socialist view that political mechanisms, not market ones, are the appropriate way to allocate scarce resources in a society. Because CSR is likely to shift the balance between state and markets, Friedman concluded that CSR is a ‘fundamentally subversive doctrine’. Hayek refers approvingly to Friedman and similarly argues that pursuing idealistic aims present the danger of corporations acquiring real and uncontrollable power. Such power cannot be left to private managers but would be made subject to increasing public control: “The argument against specific interference of government in the conduct of business corporations rests on the assumption that they are constrained to use their resources for a specific purpose.” 237 Monks and Minow also note that legitimacy of corporate power requires that it be “limited to business and not extend to the trade-offs necessary to balance competing social goals”.238 Friedman’s argumentation reaches the norm level (level 3) where he has a prescription for business executives. They should be guided by the signals sent by markets and law, and should stay aloof of CSR concerns and distributional issues. This norm is derived from a range of ‘positives’: managers to act toward the interests of the ‘owners’, to pursue their profit-maximising mandate within the rules of the game, companies to stick to their legitimate role in a functionally differentiated democratic society and markets know best how to allocate scarce resources. Thus Friedman’s norm is derived directly from the insights articulated on 235

Friedman, supra note 233, p. 15. M. Friedman, ‘Milton Friedman Responds: A Business and Society Review Interview’, 1:1 Business and Society (1972), p. 6. 237 F.A. Hayek, ‘The Corporation in a Democratic Society: In Whose Interest Ought It and Will It Be Run?’, in H. I. Ansoff (ed.), Business Strategy: Selected Readings (Penguin books, Harmondsworth, 1969) p. 231. 238 Monks and Minow, supra note 75, p. 72. 236

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Norms advanced in the CSR debate the previous two levels. But there is more. Friedman also backed his norm with a series of ‘negatives’. These have to do with the managers’ lack of expertise for dealing with complex macroeconomic and social issues, the immorality of fraudulent CSR rhetoric and the possible perverse effects that result from businesses adopting CSR strategies. First, business managers lack the expertise to deal with complex macroeconomic issues, not to mention dealing with social issues. Second, Friedman does note the arguments of advocates who showed the benefits to the company resulting from CSR strategies (e.g. desirable employees, less sabotages, other worthwhile effects). Friedman agrees that “in the present climate of opinion with its widespread aversion to ‘capitalism’, ‘profits’, ‘the soulless corporation’, [CSR] is one way for a corporation to generate goodwill as a by-product of expenditures that are entirely justified in its own self-interest”.239 Later he would comment more explicitly that if an energy company can demonstrate that the controversy surrounding the release of industrial effluents makes it difficult to recruit and retain employees, or offers the prospect of adverse publicity or litigation, then voluntary reduction or clean-up of the effluent makes business sense.240 Although Friedman agrees that such strategies can benefit the firm, he deems them hypocritical windowdressing activities approaching fraud. If CSR paid back then only hypocrites would call it ‘CSR’ as it would in fact be pure business self-interest. However CSR’s benefits to the company must pay back ‘dollar for dollar’, which imposes a quantitative threshold on CSR expenditures that can hardly be passed by CSR proponents: “It may very well be in the self-interest of that corporation to spend money on improving conditions in that community. That may be the cheapest way it can improve the quality of the labor it attracts. The crucial question for a corporation is not whether some action is in the interest of the corporation, but whether it is enough in its interest to justify the money spent … But the corporation isn’t exercising a social responsibility. The executive is performing the job he was hired for.”241

On a later occasion Friedman described oil companies’ television ads as ‘turning his stomach’ for making it seem that their purpose was to preserve the environment. However, he noted that he would probably sue if they did not engage in such ‘nonsense’ because otherwise they would endanger their competitiveness: Friedman makes the point that companies must profess social responsibility to appeal to the public at large, keep regulators at bay, and thus ensure profits.”242

239

Friedman, supra note 172, p. 124 Friedman referred to in J. Entine, The Odwalla Affair – Reassessing Corporate Social Responsibility, January/February 1999, <www.jonentine.com/articles/odwalla.htm>, visited on 14 February 2007. 241 Friedman, supra note 236, p. 7. 242 Entine, supra note 240. 240

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Chapter 3 Third, Friedman considers that adopting CSR strategies to please vocal constituencies can have unintended effects. CSR rhetoric may gain business benefits in the short run, but may also strengthen the prevalent view that profit-making is wicked/immoral and needs be controlled by external forces, that is, the iron fist of government bureaucrats. The norm boils down to Friedman advising business executives to solely obey the law and listen to the signals of the market. Managers should respond to CSR expectations only if the business case is obvious. This is what Friedman arguably hinted at when he referred to the ‘ethical custom’ that managers should respect in addition to the law; though he never elaborated on what ethical custom is. Otherwise the norm hardly leaves space for managers even to inform themselves of, and understand, CSR risks. CSR expenses must pay back ‘dollar for dollar’, according to Friedman. In this view, as Ayres wrote, “any diversion of managerial effort in other directions is actually a breach of fiduciary responsibility”.243 3.1.2. Stakeholder theory’s response The literature on business ethics/stakeholder theory is immense and heterogeneous. The purpose here is not to present a comprehensive catalogue of the responses triggered by Friedman’s challenging article; I will simply limit myself to showing some broad tendencies manifested by stakeholder theory on each of the three levels of analysis. Stakeholder theorists observe the discretion that management of large companies has when ownership is dispersed; also they account for the complexity of modern business environment where business success depends on motivated employees, satisfied consumers, institutional investors with a long-term investment horison, trusting regulators, etc. Thus the prominent role granted to stockholders by shareholder-oriented theories inadequately mirrors business reality in present days;244 it also cannot satisfactorily be justified in moral terms. Regarding the issue of managerial duties, which in mainstream theories covers the relationship between managers and shareholders (level 2), stakeholder theory is concerned primarily with finding a way to elevate the interests of other stakeholders. Large businesses should heed not only signals sent by markets and law, but also their moral responsibilities and expectations of society. While for Friedman managers are, legally and morally, the agents of shareholders and should therefore act solely on their behalf, ethicists would correctly show that, under CL, managers are not the agents of shareholders and have a legally sanctioned discretion to exercise their ‘business judgment’. Therefore seeing shareholders as the owners of the company provides a false justification for orienting managerial duties solely toward the shareholders’ interests. Such arguments have often accounted for the central role that CL allocates to the corporation towards which managerial duties are 243

Ayres, supra note 234. R.E. Freeman, Strategic Management – A Stakeholder Approach (Pitman, Boston/London, 1984). 244

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Norms advanced in the CSR debate oriented. However, to the extent that stakeholder theories have referred to the ‘company’s interest’ or its success, the tendency has been to see the company as a social entity rather than simply a commercial entity. Then the concept of ‘company’s interest’ in a commercial sense is either stretched to overlap with the public good, or subordinated to other concepts (public good or stakeholders’ interests). The company is portrayed as a social entity distinct from the interests of shareholders and in which the public (or stakeholders) impacted by corporate activities has a stake. This entity view of the firm has surfaced in the US at the turn of the 20th century against a certain economic and social background. Allen notes: “The evolution of these large entities and the impact of German philosophy on American scholarship triggered an outburst of scholarly writing on the nature of the corporation… National securities markets emerged and stockholders gradually came to look less like flesh and blood owners and more like investors who could slip in or out of a particular stock almost costlessly. These new giant business corporations came to seem to some people like independent entities, with purposes, duties, and loyalties of their own; purposes that might diverge in some respect from shareholder wealth maximization … [T]he corporation is not strictly private; it is tinged with a public purpose… [The] corporate purpose can be seen as including the advancement of the general welfare.”245

Friedman identified the mandate of management as one of profitability which soon becomes profit-maximisation because of the constraints imposed by efficient financial markets. Normative stakeholder theory, to which the UK Company Law Review Steering Group referred to as the ‘pluralist’ approach, “argue[s] that the ultimate objective of maximising shareholder value will not achieve maximum prosperity and welfare. … [A] company [should be] required to serve a wider range of interests, not subordinate to, or as a means of achieving, shareholder value (as envisaged in the enlightened shareholder value view), but as valid in their own right.”246 Stakeholder-oriented perspectives reject any primacy accorded to shareholders. “Surely contributors of capital (stockholders and bondholders) must be assured a rate of return sufficient to induce them to contribute their capital to the enterprise. But the corporation has other purposes of perhaps equal dignity: the satisfaction of consumer wants, the provision of meaningful employment opportunities, and the making of a contribution to the public life of its communities.”247 In the end, normative ethicists object either to profitability or to profit-maximisation as the ultimate goal of business; they

245

Allen, supra note 179, p. 265. Ibid., 5.1.13. 247 Allen, supra note 179, p. 271. 246

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Chapter 3 ƒ ƒ ƒ

offered taxonomies that include profitability but offered no criteria of how to make trade-offs among various categories,248 trumped profitability with the weight of pressing moral concerns, avoided profitability with the understanding that making CSR arguments in a vocabulary using profitability-related concepts would automatically deemphasise moral considerations.

In stakeholder theories, shareholders lose their central position in the economy of the firm. They are just one among many stakeholders whose interests management must consider and balance. Normativists challenge Friedman who saw management as owing a moral duty to shareholders who entrusted management to act on their behalf. Ethicists argued that, on the contrary, managers should be seen as ‘agents’ not of shareholders, but as agents in a different meaning: ƒ Agents of all stakeholders, not merely shareholders, because they are all 249 affected by or can affect the corporation, ƒ Agents of the corporation, but the corporation should maximise social welfare instead of its own wealth (profitability), ƒ Moral agents instead of agents obeying the will of their principal(s). In other words – agents of change. Agents in this sense have free will and managers are bound by moral duties as much as any other moral agents. Normative stakeholder models suggest a managerial role informed by ‘multiple loyalties’ over the strong objections of shareholder-oriented models based on the agency (fiduciary) principle of ‘undivided loyalty’. The board of directors’ duties should “extend beyond assuring investors a fair return, to include a duty of loyalty, in some sense, to all those interested in or affected by the corporation … [C]orporations as independent social actors … do not simply owe contract or other legal duties to those affected by its operation, but owe loyalty in some measure to all such persons as well.”250 In such situations the agency metaphor soon loses its analytical usefulness: it does not take one very far towards accountability once multiple principals are present (managers acquire split loyalties to conflicting interests), or when the preoccupation to keep agency costs (i.e. specification and monitoring costs incurred by the principal) down is not a major concern. Other fundaments such as ‘social contracts’, deontology, rights-based theories, etc. are more useful than principal-agent reasoning to advance broader managerial and corporate accountability to stakeholders and society. Stakeholder theories aim to enshrine stakeholders as beneficiaries of managerial duties. If corporate management were loyal to stakeholders, the resulting duty of care would require management to handle with due care stakeholders’ interests. That would require 248

A. B. Caroll, ‘The Pyramid of Corporate Social Responsibility: Towards the Moral Management of Organizational Stakeholders’, 34:4 Business Horizons (1991) pp. 39–48. 249 Freeman, supra note 245. 250 Ibid., p. 271.

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Norms advanced in the CSR debate directors to both identify better stakeholders’ interests as well as to weigh them heavier while pursuing the wealth-creation goal. Loyalty to stakeholders’ interests would allow directors to distribute risks differently in their business decisions (e.g. turning down business opportunities harmful to some stakeholders, set up protective managerial systems, invest in safer or less polluting technologies, etc.). Multiple loyalties would also require management to provide shareholders with reasonable returns only, not necessarily competitive returns; a part of profits could be used to satisfy the other loyalty recipients. Friedman was preoccupied by the potential to abuse the managerial discretion that CSR creates, and with ways to ensure managerial accountability. By employing agency reasoning, he sought to diminish managerial discretion by orienting it toward a clearly measurable, unique goal (profitability) that markets can enforce. In response, CSR supporters concerned with capital markets that generate short-term pressures and inhibit responsible managerial behaviour have severely downplayed the role of the markets in their models of the firm. In their pursuit for corporate accountability, normative stakeholder theories have posited the enforcement of (wider) managerial responsibilities either with the state (courts and regulatory agencies) or with the self-discipline of managers themselves (or board of directors) guided by moral imperatives. If managerial accountability toward shareholders is secondary, then what counts for stakeholder analysis is either accountability toward all stakeholders (normative stakeholder theory) or guidance for managerial decision-making (instrumental stakeholder theory). Here stakeholder theory has split into two branches, as explained in chapter 1. The normative branch aims to design a new model of the firm with revised managerial duties oriented towards stakeholders, and is concerned with matters of corporate accountability (to whom, how broad, according to what principles, etc.). The instrumental branch does not challenge the basics of the shareholder-oriented model of the firm, and sets up to help management in their decision-making with better tools and systems in order to be more responsive to pressing social issues. The discussion at the norm level (level 3) kicks in as one asks: how to manage with a longer-term perspective (instrumental stakeholder theory – ‘instrumental ST’) or with a moral attitude that treats all stakeholders fairly (applied business ethics)? The stakeholder norm roughly proposes that managers need to identify stakeholders and then to somehow balance their interests. Instrumental ST has developed an environmental scanning technique to identify threats and opportunities in an increasingly complex environment. Actually the strategic planning literature has first used the term ‘stakeholder’ in relation to information systems: as planning moves from reactive to proactive strategy formulation, the need for ‘environmental scanning’ increases.251 Freeman originally used the stakeholder concept as “an intelligence gathering mechanism to more accurately predict environmental

251

Ibid., p. 34.

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Chapter 3 opportunities and threats”.252 Alert managers confronted with pressing risks in their environment found it non-contentious to adopt the stakeholder norm; they followed Freeman who proposed that managers should identify the concerns of their stakeholders defined as groups affected by or that affect the business. Business ethics and instrumental ST have contributed substantially at the norm level by building capacity for moral reasoning, respectively building technical capacity. Friedman opposed CSR as a hypocritical exercise bordering on fraud that would backfire in the long term. Thus Friedman saw CSR as only superficially rational from a business standpoint; therefore he stopped short of rationalising CSR in terms of organisational utility. His norm also suggested to managers to stay aloof of CSR issues, not to make efforts to rationalise them. Normative stakeholder theory has followed Friedman in his disregard for rationalisation attempts because the structural obstacles to CSR seem insurmountable and need to be dealt with first. It offers a vision of a moral company, but barely helps managers operating in competitive markets with a norm to simplify complexity. In contrast instrumental ST considers that the rationalisation of CSR – aligning CSR means with profitability/organisational goals – is key to reconciling business and societal needs. It has concentrated precisely on offering guidance to managers in how to deal with their social environment. Friedman disputed that the proper locus of responsibility could be an artificial person, but only the people operating it; even so, such individuals are ill-suited for the task at hand because they lack expertise. Business ethicists working in a more applied stream concurred with Friedman in locating moral responsibility at individual (manager) level and offered their advice on this basis. They have stimulated exercises of moral reasoning applied to concrete business contexts (e.g. conflicts of interest, bribery, whistle-blowing, etc.) and generated numerous training materials. As a result, the work of ethicists in this area has played a crucial role in raising the awareness of managers to social concerns and their ability to reason ‘out of the box’. Correct identification of issues is a necessary first step in managing them properly. Thus business ethicists deliberately worked solely at the norm level; there they made a contribution to building managerial expertise, but not necessarily to rationalising CSR. For the latter, they offered intuitive arguments under the umbrella term of ‘enlightened self-interest’; however, to go beyond rhetoric and illustration more technical capacity was needed. Stakeholder theorists of an instrumental mind followed business ethicists in meeting managers where they were. They all agree with Friedman in his assessment that managers lack the necessary expertise to manage CSR. Instrumental ST realises that not only moral expertise is what managers lack, but also, once awareness is built, proper managerial tolls to implement and communicate CSR. Researchers belonging to the ‘corporate responsiveness’ stream – a response to the overly moralistic treatment provided by the ‘corporate responsibility’ stream’253 – started in 252 253

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Ibid., p. 35. Frederick, supra note 18.

Norms advanced in the CSR debate the 1970s in the US to develop the tools that the rationalisation of CSR requires; therefore they replaced the moral lenses used by Friedman and normative ST with the technocrat’s lenses. Then crucial questions related to the CSR process could be raised: what stakeholder issues could affect firms, how could they be managed, with whom could business collaborate to solve the issues and safeguard its own interests, how much and what kind of resources business could contribute, for how long business needs to stay involved with an issue before other actors can take over? Multistakeholder fora have started in the last ten years to address these issues