Corporate Social Responsibility and The Board of Directors: New Demands, New Opportunities

Article by Kerry D. Moynihan

Not long ago, if you asked the average Fortune 1000 director, the whole concept of Corporate Social Responsibility (CSR) or Corporate Responsibility (CR) would have been deemed the province of wooly-headed tree-huggers with little connection to the core tenets of the uniquely American brand of capitalism that demands the primacy of enhancing shareholder value. That has changed, as the concept and practice of CR has become increasingly mainstream.

This trend goes well beyond the longtime linkage of smaller, niche companies with philosophies and practices that have essentially branded their enterprises, such as Tom’s Toothpaste of Maine’s environmentally friendly and all-natural products or Ben & Jerry’s distributing 5% of its profits to social causes. In the last decade, more of the largest companies have taken up the CR banner as well. Mid-cap companies such as Whole Foods with its organic product emphasis, and The Timberland Company with its active advocacy for community volunteerism and social justice, have done much good, even as the companies’ shareholders have done well.

Indeed, when the CR concept is embraced publicly by market cap behemoths such as Wal-Mart, a favorite target of activists for driving small businesses under and limiting the pay and benefits of its workers so severely that some 40% receive some form of public assistance, and GE, whose business units span such touchy areas as power plants and weapons systems, we must take note. When British Petroleum asks “What’s your global carbon footprint?” and pledges to invest $350 million over five years to reduce carbon dioxide emissions by a million tons annually, we must wonder whether the disciples of Adam Smith and “Bid ‘em up” Bruce Wasserstein have converted to the gospel of Ralph Nader and the Rainforest Alliance.

There are three seemingly simple questions we shall address here. First, should boards be concerned with the issues of CR? Second, can boards have a positive effect? And third, what are the best ways for the board to be involved?

Should Boards be concerned with the issues of CR?

There has certainly been an evolution of thinking on this important question. John Mizroch, the CEO of the World Environment Center in Washington, D.C., a coalition of some 40 of the world’s largest companies, stated, “This is just beginning to affect and infiltrate at the board level in a major way. One of the big issues is to reduce risk and protect goodwill, a significant issue, and not just for the Fortune 500. It is better in the long run to run an ethical company, for both moral and business reasons.”

The National Association of Corporate Directors noted in its 2005 Public Company Governance Survey of directors of U.S. companies that over 80% of respondents agreed that there was a board responsibility to monitor corporate ethical conduct. Yet only 30% of respondents attested to significant board level engagement in Social/Employee issues. These included many typical CR concerns such as: Diversity & Equal Employment (14.8%), Charitable Contributions (14.2%), Local Community Concerns (8.4%), Energy & Environment (8%), Sustainability Reporting (2.4%), and Human Rights (2.2%).

A McKinsey & Company study released in February 2006 surveyed over 4000 executives in 116 countries revealed that only one in six executives thought that profit maximization should be the sole goal of corporations, while the overwhelming majority of 84% felt that profits needed to be balanced with greater, societal good. Only 8% of the respondents attributed their companies’ CR initiatives to “genuine concern,” in other words, purely charitable impulses. However, whatever the motives, corporate behavior and its relationship with corporate board governance is changing, mostly for the better.

Tim Smith, the director of Socially Responsible Investing at Walden Asset Management, and a 25-year veteran of the CSR movement, notes, “The trend is there, but the best practices have not yet been fully described.” We believe that the level of board engagement will, by necessity, increase rapidly, for some of the following reasons.

Liability & Risk– In an era of increased regulation and legal liability, it is plain that to ignore the issues of CR can be downright dangerous to the enterprise. The post-Sarbanes-Oxley environment for business demands that companies pay even more careful attention to their fiscal health and risk controls than in the past. It seems a natural extension that when the environmental and social issues are increasingly linked to the bottom line, boards must exercise the duty of care in this sphere. The dramatic increase in tort liability from the plaintiffs’ bar makes it seem that it is only a matter of time before there are lawsuits that could parallel the decisions against the boards of MCI Worldcom and Enron, where individual directors were held accountable. Why would there not be a similar judgment against directors who stood idly by while the companies they served incurred penalties for polluting the environment, or product liability, or a host of other potential dangers? “Any board that doesn’t have a focus on this issue [of CR] now, will have one soon,” says one Fortune 100 executive.

Brand equity and reputation risk are inextricably linked. Consider the fact that some of the world’s best known brands, including Coca-Cola, American Express, Johnson & Johnson, and Intel are all among those routinely cited by the CSR community, including Business Ethics, for their excellence as corporate citizens. There has been a notable linkage between the high scores for CR and the overall rankings of Fortune’s annual “Most Admired Companies” list. The potential hit to goodwill, which in many cases, particularly in consumer-oriented industries, is a company’s greatest asset, can be enormous. Indeed, potential brand risk is huge; hence Coca-Cola’s concern for climate change issues, which affect water table rates, and the interests of McDonald’s and Kraft for getting involved in issues surrounding adolescent obesity. Companies of this stature cannot afford to be on the wrong side of the big issues, even if they once seemed only tangent or ancillary to the enterprise. Julie Gorte, the Director of Social Research at the Calvert Funds, notes pointedly that “Well governed companies don’t trash the planet and exploit the workers where they do business, then wait for the sheriff to run them out of town!” Today issues once seen as outside the domain of the corporate enterprise can affect the bottom line in a major way.

The Influence of Investors– Perhaps most compelling is the fact that the demands of the institutional investor community, in tandem with nongovernmental organizations (NGOs), are increasingly driving the fiduciary equivalent of the Hippocratic Oath, an agenda of “do no harm” at the least, and enthusiastically fostering a positive, proactive approach. These can often come from multiple and sometimes unexpected angles. For example, energy giant Chevron has attracted its most intense criticism lately not for environmental reasons, but for what its detractors would term collusion with a repressive, corrupt government in Nigeria that has shared little of the benefits of the country’s massive oil revenue with its rapidly expanding population, either in political or economic terms. Exxon Mobil’ s $4 billion investment in a pipeline project in Chad is drawing similar criticism, as the government of that country has changed the terms of its payments, diverting the royalties from the strictly humanitarian uses previously agreed upon.

There has been an increasing recognition that the concerns of a broader class of stakeholders need to be taken into account in assessing corporate behavior. Yet shareholders cannot be ignored, and indeed, may be better served in the long run by enhanced corporate responsibility. The geographic breadth of the McKinsey study and its gap from NACD’s findings seems to underscore the generally acknowledged notion that non-U.S. nationals, particularly Europeans, given their social welfare heritage, regard the role of business as more than just profit maximization. A 2005 study by Mercer Investment Consulting of global institutional investors asked whether Environmental Social & Corporate Governance (ESG) factors would be material to their investment decisions in the next decade and 73% answered yes. Yet 69% of American investors thought they would never be material considerations. Julie Gorte of Calvert notes with some penetration in assessing the apparent discrepancy here, “There are basic economic facts to consider. The U.S. is running a $600 billion annual trade deficit. Therefore, we must run a capital account surplus. Foreign investors, who are providing the capital for that gap for America, will sooner or later demand that U.S. companies adhere to the same standards as their investments in the U.K., the Netherlands, Canada, and so on.”

Therefore, there has to be a CR linkage to the business case. “We don’t say ‘do this’ because we’re do-gooders,” said Conrad MacKerron, Director of the corporate social responsibility program at As You Sow, an organization committed to increasing corporate accountability. “We know that doesn’t wash on Wall Street. We go in and say not only is it the right thing to do, but here’s the business/economic case for it because we want this to be a profitable company.” Further, he said, it is difficult for companies to ignore their largest investors. “They can’t dismiss you or marginalize you as some extreme interest group. We talk about long-term value. In the age of globalization, the most valuable thing these companies have is their brand name. We stress over and over that getting these controversies behind them will help maintain long-term value.”

There is an increasing recognition that sustainability is a key business strategy for the long run. Former Goldman Sachs Asset Management CEO David Blood, who has partnered with former Vice President Al Gore to form a global sustainability fund, Generation Investment Management, noted in a recent speech that such choices are not merely ethical choices, but hard-headed, economic decisions. “We think that [tobacco companies’] selling products that kill their customers is not a sustainable business strategy in the long run! We believe that Costco, which pays its workers better wages and health benefits, will have better service levels and lower employee turnover over time than Wal-Mart, and therefore, is a better investment value.”

Supporting this are studies that compare absolute investment performance of companies that practice enlightened CR policies. No doubt to the surprise of many, returns need not suffer as a result. For example, a comparison between the Russell 1000 and the KLD Research & Analytics Large Cap Social Index (LCS) reveals that for the three years up through September 1, 2005, the KLD LCS outperformed the former by a compound rate of 13.24% to 12.93%. This is all the more significant when one considers the run–up in defense and oil stocks over the last several years in the post-Iraq invasion environment that would logically have contributed more to the Russell Index than the KLD. In other words, doing the right thing is not just good; it’s good business.

Can boards have a positive effect?

Boards can, indubitably, have a positive influence, though many existing CR initiatives have come in response to very public crises. Strange as it may sound, given the historic antipathy between the activist community and the natural resources industries in general, Exxon Mobil has been cited by some for its improvement in corporate citizenship, arguably largely in response to the environmental disaster of the huge oil spill in Alaska of the Exxon Valdez over a decade ago. One NGO head describes the company as “long one of the great skeptics, but now they are truly in the game.” Given the magnitude of the capital commitments necessary, this is a case where one could regard an investment in CR as a concurrent investment in liability control.

Mizroch of the World Environment Center points to the example of Pfizer, long a recognized corporate advocate on healthcare issues, in saying the company, “On the environment, the company went from 0 to 60. The senior leadership in the company averred that they had no issues. They did nothing for a long time, then formed a committee at the board level, which has been very effective. Pfizer has transformed itself into a real global leader.”

Some of the most striking examples of these efforts come from the apparel and footwear industries, a number of whose companies suffered severe public relations disasters. Reebok took its lumps in the press when factories in Pakistan were found to be using child labor in making soccer balls. Nike also suffered negative PR for similar reasons, and apparel makers by the dozen have been criticized for utilizing underage labor, poor working conditions, and uncompetitive (by Western standards) wages. Yet today, these companies are among the finest examples of corrective action and proactive leadership.

Best results are achieved when CR objectives are linked to the business- The Gap and Phillips-Van Heusen were among the very first companies to initiate global reporting initiatives and corporate codes of conduct. “Corporate Social Opportunity,”” or CSO, is the term favored by Marcela Manubens, the head of the latter company’s impassioned efforts, which have been largely focused on human rights leadership. A former auditor and financial executive, she also insists, “The CSO mission must be tied to the business. And CEO commitment is critical to success.” The usual dictum of good governance, “nose in, fingers out” applies here in like measure, since directors should always be acting in concert with senior management. The most effective approaches seem to be when the CR initiatives are linked to the demands of the business.

These points are certainly underscored when we consider the example of Dell Inc., which essentially went from crisis to leadership. Reacting to an NGO onslaught led by the Silicon Valley Toxic Coalition late in 2002, the company realized that it had a major PR and environmental problem. Despite the fact that “We had a donation service to give back older models to schools and communities,” Bryant Hilton of Dell’s Public Affairs group recalls, “no one seemed to know about it.” With the glare of public opinion firmly on Dell, the company’s chairman and largest shareholder, Michael Dell, focused on the issue. Creating a Sustainability Department, led by a respected executive, Dell, with the backing of its directors, engaged with the Socially Responsible Investing (SRI) community, including Calvert and IRRC. The company later worked with IBM, Hewlett-Packard, and its contract manufacturers for the establishment of an industry-wide environmental standard (see www.eicc.info). It essentially took a lesson from the hard experience of the consumer soft goods companies – that it would be cheaper, faster, and more efficient to work together to promulgate a single set of standards.

The Governance & Nominating Committee of the Dell board was briefed repeatedly in 2003 on defining the problem and the creation of a solution, which included the creation of a Sustainability Council comprised of the company’s most senior leadership. The company created a free recycling program for consumers and also established a business-to-business suite of fee-based services that allowed its corporate customers to largely off-load product life cycle concerns. These in turn provided Dell with income to offset the costs of its consumer program.

When asked how to drive system level change, Tod Arbogast, the current Director of Sustainability at Dell, notes the imperative to “Bring the issues into a very senior committee and agree upon standards and metrics. Deep in my bowels, I believe that we drive the change down into the business units and let them take accountability for them. We then meet every quarter for 1.5 to 2 hours with [Chairman] Michael [Dell] and [CEO] Kevin [Rollins]. The business leaders must own these, and ultimately be held accountable by the board.” This approach fostered the capacity to engage with stakeholders on a much broader range of issues than the initial focus on the environment. Since 2004, Dell has pushed forward aggressively on a host of initiatives including the adoption of the Calvert Women’s Principles, formalizing its Code of Conduct, and introducing a Forestry Stewardship Program, and it has won awards for diversity programs, among others.

How are boards addressing the issues of CR?

There are numerous means by which companies and their boards deal with CR. Dell’s Arbogast noted that while his company thinks that they do this well, there is not a monolithic model of success. “CR is emerging; there are so many models in existence.”

There is a clearly a wide variance in how corporations deal with these issues. What and precisely how are the best ways for the board to be involved? Some examples of the “how” include: a dedicated CR officer or other corporate officer such as Chief Risk Officer or General Counsel overseeing the issues; a CR Committee; CR reporting through another board committee such as Risk, Audit, or Governance; or through the focus of a particular member(s) of the board on these issues. The fact that CR-related responsibilities can be so broadly dispersed throughout the enterprise could potentially make it harder to deal with. But it is incumbent on the board to find CR’s most sensible “home,” and then stick to its CR agenda.

According to the McKinsey survey, currently some 56% of the companies’ lead in the CR arena comes from the CEO/Chairman. Public or Corporate Affairs takes the lead in 14% of the companies and the core business divisions or a distinct CR function in roughly 5% each. We may conclude that boards, who are cited as playing the leading role in 10% of the companies, are concerned, but at the same time, desire that management shape direction and policy in ways that are linked to the core business. Indeed, nearly three-quarters of the executives surveyed by McKinsey responded that the senior management, specifically CEOs and Chairmen, those who should be most intimately concerned with and able to affect this linkage, should drive the agenda in CR.

Simply put, the primary role of the corporate board can be boiled down to ensuring three things: 1) The financial health of the enterprise and its shareholders; fiduciary responsibility and risk management. 2) An appropriate process for setting strategy and then stress-testing it. 3) The right executives are in place to accomplish the first two.

In relation to this agenda, boards will increasingly find that the demands of their constituents, both shareholders and stakeholders, will demand more from corporations in the first case, at the interstice of value creation, risk management, and responsibility. CR and the creation and maintenance of shareholder value are no longer severable concerns.

The board must take responsibility for uniting with the executive team to ensure that the second agenda is in place; that the company has a genuine mission, strategy, and ultimately, tactics for the achivement of a CR strategy that is unified with its business strategy. Tying quantifiable business benefits to the CR/Sustainability initiatives are crucial. While boards are increasingly concerned about CR, they desire that senior management shape direction and policy in ways that are linked to the core business.

The risks and the opportunities for corporations and their boards of directors are both great. There is clearly still a yawning gap between mere compliance, a proactive stance, and a higher self-rating for success. The path to reach the ideal, for both shareholders and stakeholders, is still very much in progress, but the companies that walk that path, with a seemingly ever quickening pace, are learning much from the journey.