For a time, good corporate governance and socially responsible investment (SRI) had little to do with each other. The growing activism of institutional shareholders, however, has made SRI – along with what this author calls the economics of reputation, and the recognition that CSR must be encouraged – one of the drivers behind the widespread willingness to assume greater corporate social responsibility.

Two popular misconceptions abound about corporate governance, that it is about resolving the problems created by one or two “rotten apples” such as Enron and WorldCom, and that it is a legalistic subject of interest only to businessmen. Neither is correct. There is, in fact, increasing public concern about corporate governance around the world. For example, Korea’s reforming Prime Minister, Roh Moo Hyun, took office in February 2003 pledging to put better corporate governance of the country’s giant chaebol conglomerates high on his list of governmental priorities. Also, improving corporate governance is being discussed at the highest political levels in the European Union, Tokyo, and Hong Kong.

Nevertheless, it is probably correct to state that the subject has been given the greatest airing in the Anglo-Saxon word. This is hardly surprising, as the sudden and unexpected collapse of a large public company resulting from corruption or incompetence is surely the most prominent example of corporate governance failure. Such corporate failure, and the consequent public outcry it brings, is most evident in the United States, in the wake of the causes celebres referred to earlier.

The British financial press tends to take a rather complacent view of corporate governance in the UK, but recent years have seen a number of former FTSE 100 constituent members come upon hard times: British Energy; Cable & Wireless; Independent Insurance, Marconi; and Railtrack. It is true that Independent Insurance is the only member of this list that seems to have suffered from Enron-style corruption, with the rest the victims of weak management. However, the result for shareholders has been the same — a decline, and in some cases, an evaporation, in the value of their shares. During 2001, the Australian business community and the political establishment was rocked by the sudden failure of three large companies: HIH, Ansett, and One.Tel. Australian regulators and business people subsequently criticized weak corporate governance as a key factor in the demise of these companies

Canadian business comes out relatively well in this dismal list, although we should not ignore the travails of Nortel Networks, whose market capitalization has fallen from over one third of the total market capitalization of the Toronto Stock Exchange to less than three percent, with thousands of job losses along the way.

However, there is growing public indignation over what many observers would call the real scandal of corporate governance — the way executives of many large companies have abused their position to transfer significant amounts of shareholders’ wealth to themselves. Not all large companies have of course behaved like this, but such “corporate malfeasance,” to use Alan Greenspan’s terminology, has left a residue of suspicion about business among the public and politicians alike. It may be worth recalling that at this level, concern about corporate governance is no more than an “agency problem” identified as such by Adam Smith as far back as 1776. Smith noted that a corporate system based upon limited companies separates the owners and managers of a business. It is a system that has worked well, on balance; but without effective checks and balances it can facilitate an Enron-type scandal.

Corporate governance first really emerged as a significant issue in its own right in the UK in the early 1990s, as a result of a number of corporate scandals, most noticeably in companies linked to the late Robert Maxwell. This series of events prodded the UK government to convene a substantial review of corporate governance – the 1992 Cadbury Committee. The Cadbury Committee defined corporate governance as: “The system by which companies are directed and controlled.” Personally, I liked John McCallum’s definition in a recent Ivey Business Journal: “Governance is the organizational machinery through which principals assure that their assets are administered to their satisfaction.”

Certainly there need to be mechanisms to limit the all-powerful chief executive of the type that has become commonplace in North America. Back in 1992, the Cadbury Committee recommended that the posts of chief executive and chairman should be separate, and that there should be a significant number of independent non-executive directors. Its other recommendations called for audit and remuneration committees; it also advocated that institutional investors should use the voting rights attached to the shares that they own. Of course external investors need to possess voting shares in order to assert such rights. In the UK, virtually all public companies now have only one class of shares with full voting rights, and European countries such as Switzerland and Sweden have made significant moves in this direction. Indeed, this is one area where Canadian and American corporate governance looks rather outdated and in need of repair, given the fairly wide prevalence of insiders owning ‘A’ (voting) and the public ‘B’ (non-voting) shares.

In the remainder of this article, I intend to move on from what we may describe as the narrow view of corporate governance, i.e. one limited to considerations of board composition and functioning, to try and convince the reader that the whole agenda of corporate governance is broadening out. In particular, I would argue that the subject of corporate social responsibility includes the technicalities of corporate governance but goes far beyond them.

Corporate social responsibility: More than just good governance

It is probably timely at this point to define what I mean by “corporate social responsibility.” Here it describes the reality that companies are increasingly being judged not just by the products and profits they make, but also by how these profits are made. Campaigning groups often express fears that corporate social responsibility is just another form of spin, “greenwash” or public relations. After all, most companies have some kind of mission statement describing themselves as good corporate citizens. Enron and WorldCom certainly did! It is important to stress, however, that this definition is limited to the societal and environmental constraints on a company’s core function to maximize profit. We must exclude the wooly claims of the stakeholder theorists who assert that business has unlimited responsibilities to an infinite number of claimants. Likewise we must also reject the thesis of some economists that the whole idea of corporate social responsibility (CSR) is fundamentally misconceived, and in Milton Friedman’s words, ‘that the only social responsibility of business is to maximize its profits’. (Enron and Arthur Andersen certainly maximized reported profits.)

Friedman’s error, repeated by numerous authors since, lies in the erroneous assumption that CSR is equivalent to corporate philanthropy. They are quite right to argue that companies should not give shareholders’ money away. Corporate social responsibility is not an invitation for companies to take over charitable functions better left to foundations and publicly elected bodies. In economic terms it is a constraint on business activity, which must be integrated into management decision-making in order to maximize long-term profits. To repeat, CSR simply means that companies should carry out their core function of making profits by the provision of goods and services — but, and this is crucial, by doing so in a socially responsible way. Some people may feel that the above argument is rather theoretical, so let me put some meat on the bones. Corporate social responsibility includes issues such as a company’s general business practices, executive pay levels, global practices on health and safety, policy towards bribery and other practices. It also includes policies towards trade unions, and working conditions of overseas suppliers.

 The drivers of corporate social responsibility

There are three main drivers that promote greater corporate social responsibility.

1. The first may be summed up as the economics of reputation. This is a well-known consequence of the global information revolution. Corporate added value increasingly consists of intangible items such as brand image; companies perceived to be behaving badly with regard to the environment or human rights standards may be hit by falling sales. This is particularly true for consumer products companies operating in the field of fashion textiles and sportswear. In the U.S., for example, both Gap and Nike found their sales and profits growth were badly hit by consumer boycotts.

2. The second driver behind increased interest in corporate social responsibility is the rapid growth of socially responsible investment funds (SRI), which quite legitimately use their shareholder ownership rights to push for corporate social responsibility. (This process is documented in my new book Socially Responsible Investment — A Global Revolution.) Table One below shows the quite extraordinary growth in the investment universe of UK SRI funds, which increased by a factor of ten in the four years from 1997 to 2001. SRI truly moved from fringe to mainstream in Britain during this period, the catalyst being the decision by the UK government to introduce legislation requiring pension funds to report on SRI issues. Table Two demonstrates the sheer size of socially responsible investment funds around the world.


3. It must be admitted that until recently there has been negligible overlap between corporate governance and socially responsible investment. (One of the first people to advocate such a link was the author in his earlier book on SRI, The Ethical Investor, 1995.) What has changed is the growing adoption by large pension fund investors of SRI shareholder activism, i.e. the use of their voting rights as shareholders to press for good CSR practice. This in turn reflects the third driver of change, a growing political consensus among the Anglo-Saxon political establishment that CSR must be encouraged. This can be seen in the ethics and whistle-blowing clauses of the U.S. Sarbanes-Oxley Act, in the UK and Australian legislation to encourage SRI and shareholder voting, and lastly, but not least, the recent amendments to the Canadian Business Corporations Act, which now permit shareholder activism. Let me expand upon the latter a little.

Shareholder activism changes the agenda

CSR shareholder resolutions have become common in the U.S. over the last 30 years. They are generally known as “social proxies” but are virtually unknown in Canada. The reason for this was a court decision in 1987 that ruled that a shareholder resolution criticizing Massey-Ferguson for its involvement in South Africa contravened the Canada Business Corporations Act (CBCA). The 1990s saw growing pressure on the Canadian government to update the CBCA. For example, recall the campaign led by the Task Force on Corporate Responsibility aimed at getting Talisman Oil to cease operations in the Sudan because of concerns over human rights abuses occurring in the country. With great difficulty, TCCR managed to file a shareholder resolution in 2000 backed by major investment institutions such as the Ontario Teachers’ Pension Plan Board, the Ontario Municipal Employees Retirement Board, and the Caisse de Depot de Quebec. This obtained the support of 27 percent of the company’s shareholders, the highest level of support ever seen for a social resolution. Finally, in November 2001, the federal government issued new regulations governing the CBCA that, in essence, make the Canadian rules similar to those in the United States.

Over time, U.S. shareholder activism has developed a recognised code of procedure. Informal dialogue with corporate executives informs them of institutional investors’ SRI concerns. Often, the mere existence of such a resolution is enough to concentrate executives’ minds, and the matter is then settled, with the resolution being amicably withdrawn by its sponsors before the company’s annual general meeting. By the 1990s, many social resolutions were receiving10-25 percent of the vote, pressurising corporate executives to respond positively. Church investors, led by the Interfaith Center on Corporate Responsibility (ICCR), have been in the vanguard of the process. Of the 261 shareholder resolutions filed in 2001, nearly half, 135 in total, were filed by ICCR.

In the UK and Canada, where social resolutions are relatively new, company executives often seem to regard them as an unwarranted interference in a company’s affairs. (Such suspicions may be justified when they are filed by a single-agenda group.) However, SRI resolutions can function as a feedback mechanism alerting senior management to potential problems lying ahead, thus illustrating the linkages between SRI and CSR. When U.S. institutions started filing social proxies in the early 1970s, the atmosphere was often highly charged and adversarial. By the 1990s things had changed through what Tim Smith, the long-standing head of ICCR, called “a process of maturation.” In other words, each side of the process recognized that the other had something of value to offer — that the objective of the exercise was to benefit the corporation by improving its behaviour, not to damage it. In Smith’s words:

‘Today, a generation of parties to these negotiations has become accustomed to the idea that the interests involved are not mutually exclusive but are often complementary. In fact, this is what the corporate social responsibility movement has contended from the beginning. A “maturation” process is taking place on both sides. Increasingly, investors are recognising and affirming the constructive role of social investors such as the churches to raise and work though issues that must be of concern to the corporation.’

 Not everyone will agree that corporate governance is really just one aspect of SRI. In the UK, many commentators cling to an outmoded legalistic and technical interpretation of corporate governance, although this is less true in the U.S., owing to the prevalence of shareholder activism. As a practical matter of fact, SRI and corporate governance are certainly converging. Corporate governance research providers such as PIRC and NAPF in the UK, and IRRC in the U.S., have invested significant resources in expanding their SRI research capability, while SRI specialists such as EIRIS now monitor corporate governance. I asked Bob Monks, one of America’s leading experts on corporate governance, about this trend. Monks is a pioneer of shareholder activism, and he certainly sees a growing overlap between corporate governance and SRI: “It’s true that this is a relatively new area for me in the context of my writing,” he said. “In fact, it was Peter Drucker who convinced me just a couple of years ago that corporate governance was essentially just one aspect of investment. However, questions of business ethics have always concerned me.”

A similar reinterpretation of corporate governance, this time from a Swiss point of view, was given by Reto Ringger, Chief Executive of Sustainable Asset Management (SAM), in the spring of 2001: “In the 21st century, it will no longer be possible to measure corporate governance solely in terms of financial success and consumer satisfaction. Instead, the successful firm will have to pay more attention to, and balance the demands of society at large and the environment…Growing demand for ecologically, socially and ethically sound products and services is likely to force companies to target their activities, as well as products and services, accordingly. This is undoubtedly part of the new reality of corporate governance that companies must address.”

Companies have to decide whether they are taking corporate social responsibility seriously or not. It seems to me that the current status of CSR is rather like that of total quality management in the 1980s. At that time, Western companies thought it was a matter of sampling at the end of the production process. They lost significant market share to Japanese companies who practised total quality management, i.e. the integration of quality management right from the design stage at the beginning of the production process through manufacture and assembly.

I can understand the concerns of overworked and harassed business executives who worry that the CSR agenda is just one more burden placed upon them. But remember, your CSR concerns should be limited to the way you do business, and ultimately will differentiate your company from its competitors. It is up to you whether this is a positive or a negative. Let me conclude by stating that the subject of corporate social responsibility is not going to go away, and certainly, wishful thinking will not make it do so. It is just one more challenge that the successful business leaders of the new millennium will need to address.