New proof that good ethics is good business

In a simpler economic time, the tangible rewards to oneself from doing good for others were fairly self-evident. A memorable articulation of this (from a chronicler of Eskimo life who is quoted in Robert Wright’s book  Nonzero: the Logic of Human Destiny): “’the best place for [an Eskimo] to store his surplus is in someone’s else’s stomach.’”  But as we have  progressed from hunter-gatherer societies – where it was clear that sharing food today could lead to life-saving reciprocation tomorrow – to the modern world of complex capital markets more is now required to make the economic case for helping others.

That need, as described in a post earlier this year,  arises in part “because of the enduring  influence of a free-market critique of business ethics associated with Milton Friedman’s 1970 article ‘The Social Responsibility of Business is to Increase Profits.’   While I do not agree with his view, I understand its appeal:  it has the virtue of simplicity – and hence being easy to apply; and, particularly with respect to public companies – where managers act as stewards of other people’s money – it can certainly be seen as fairness based.” Indeed, Friedman’s critique has special relevance to the COI Blog, as it suggests that managers acting in a socially responsible way may in fact constitute a conflict of interest vis a vis their shareholders.

However, like many business ethics issues generally and COI issues in particular, resolving this one is less a matter of drawing from philosophy than social science, as Friedman’s view is based largely on an essentially zero-sum notion that a company’s acting ethically tends to disadvantage its shareholders economically.  But, what if that premise were factually questionable? Indeed, as also noted in the above-referenced prior post, a then just-published study – looking at promoting integrity values, a different but related aspect of business ethics than corporate social responsibility (“CSR”) – had helped to show that “’high levels of perceived integrity are positively correlated with good outcomes, in terms of higher productivity, profitability, better industrial relations, and higher level of attractiveness to prospective job applicants,’” thereby undermining at least partly the view that good ethics is bad for business. Still, given how complex, contentious and consequential it is, this issue calls out for more research.

So, it is good news that another study – this one focused on CSR itself – has recently been added to the relevant literature in this area: “Socially Responsible Firms,” which is published by the European Corporate Governance Institute (ECGI) and authored by Allen Ferrell of Harvard University and ECGI, Hao Liang  of Tilburg University and Luc Renneboog of Tilburg University and ECGI .  It is available on SSRN  and a summary of it can be found on the Harvard Law School Forum on Corporate Governance and Financial Regulation.

As noted in that summary, the authors’ focus was on the area of agency and particularly the Friedman-inspired critique that “socially responsible firms tend to suffer from agency problems which enable managers to engage in CSR that benefits themselves at the expense of shareholders.  Furthermore [the critique posits] managers engaged in time-consuming CSR activities may lose focus on their core managerial responsibilities… Overall, according to the agency view, CSR is generally not in the interests of shareholders.” Using “a rich and partly proprietary CSR dataset with global coverage across a large number of countries and covering thousands of the largest global companies, [the study’s authors] test [both this agency view and its opposite – which argues that CSR in fact is value enhancing for companies] by examining whether traditional corporate finance proxies for firm agency problems, such as capital spending cash flows, dividend payouts and leverage, are associated with increased CSR. [They also test] the relationship between CSR and managerial pay-for-performance.”

As noted in the Harvard blog summary, the findings from this research help support the notion that good ethics – in this particular instance, CSR – is good business: “We do not find empirical evidence that CSR is associated with ex ante agency concerns, such as abundance of cash and a weak connection between managerial pay and corporate performance. Rather, higher CSR performance is closely related to tighter cash—usually a proxy for better-disciplined managerial practice in the traditional corporate finance literature … and higher pay-for-performance sensitivity. In addition, firms in countries with better legal protection on shareholder rights receive higher CSR ratings…. Finally, we find that CSR can counterbalance the negative effects of managerial entrenchment, and lead to higher shareholder value…”

So, definitely more complicated than the adage about filling Eskimo tummies, but the bottom line is that these and other results of their research “suggest that good governance is associated with higher CSR, and that a firm’s CSR practice is consistent with shareholder wealth maximization.” While no one study could ever definitively make the case for strong CSR or other aspects of good business ethics (just as no one study could never disprove such a case), the work of Ferrell and his colleagues should enhance the comfort that managers and boards of directors feel in moving in this direction.


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