LPC Solicitors

Good Corporate Governance: Balancing Financial Responsibility with Social Responsibility

What is Good Corporate Governance?

Corporate governance refers to the way in which companies are governed. It is concerned with practices and procedures for trying to ensure that a company is run to enable it fulfill its mission and goals whilst having cognizance of the interest of various stakeholders of the company. A major goal of companies will usually include maximization of returns on investments to its owners (shareholders), the achievement of which should not be without regard to the interests of other stakeholder groups or individuals (those with an interest in what the company does). This involves, for example, the obligation on the company to behave in an ethical way in compliance with relevant laws and regulations. Stakeholder groups of a company include its shareholders, employees, customers, creditors, suppliers, government and the general public.¹

Good corporate governance practices require the Directors, who have responsibility for governance of companies, to be active and committed in approaching their important task with robust knowledge of what this entails. It necessitates that while directors should focus on performing their key roles of strategic oversight, financial & performance monitoring and accountability to shareholders, directors also have a concurrent responsibility to ensure that the interests of other stakeholders are recognized and given due attention. For example, it would be unethical and irresponsible of a manufacturing company to discharge harmful waste from its manufacturing operations into the environment because of the increased costs associated with making the waste less harmful, although such costs will generally diminish the returns due to the shareholders.

This paper considers the nexus between corporate governance and social responsibility as well as the key challenges faced by companies in their efforts to achieve socially responsible behavior without sacrificing profitability and ultimately reducing shareholders’ returns. This will include a brief study of successful social responsibility within profitable Nigerian Companies and essential recommendations to improve the participation of companies in furthering societal progress.

 

1.  Corporate Governance and Corporate Social Responsibility

 

Corporate Governance is ensuring that an organization is run in a responsible manner by ensuring accountability, transparency and compliance with due regard to its key stakeholders. It is the whole set of legal, cultural, and institutional arrangements that determine what publicly traded corporations can do, who controls them, how that control is exercised, and how the risks and returns from the activities they undertake are allocated.² One approach to achieving a system of best practice in corporate governance is to establish laws and other regulations for corporate governance that companies must comply with, as exemplified by the adoption of the Sarbanes-Oxley Act of 2002 in the United States of America. A second approach is to establish voluntary principles and guidelines, and invite (or expect) companies to comply with them, for example the United Kingdom Corporate Governance Code.

In Nigeria, public listed companies are required to comply with laws and regulatory disclosure rules including the Code of Corporate Governance of the Securities and Exchange Commission (SEC Code) and Listing Rules of the Nigerian Stock Exchange (NSE) (Listing Rules). In Addition, the Companies and Allied Matters Act (CAMA) 2004 includes as a statutory duty of directors, a requirement to promote the success of the company. A director when making a decision is required to act in the best interests of the company at all times and consider, in good faith, how that decision will promote the success of the company for the benefit of its members as a whole.³ Whilst there is no direct requirement under the company laws of Nigeria for companies to engage in CSR, directors are required to have some regard for CSR issues, and to take an enlightened approach to governance in fulfilling their statutory duties towards the company’s employees, suppliers and customers, the community and environment as well as maintaining a reputation for high standards of conduct.⁴

 

2.  Financial Responsibility of the Company

According to Milton Friedman, “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it engages in open and free competition, without deception or fraud.”⁵ The core financial responsibility of a company is to pursue profits, as such, companies must operate in a way that will enable them make sufficient financial returns to their shareholders. Whilst the Shareholder Approach to corporate governance favors the view that the objective of the company should be the maximization of shareholder wealth, the Enlightened Shareholder Approach recognizes that companies have certain obligations to stakeholder groups other than the shareholders.

Furthermore, the matters to which the directors of a company are to have regard in the performance of their functions include the interest of the company’s employees in general. ⁶ As such, directors have a duty under law to safeguard the welfare of the company’s employees and this financial responsibility of the company to its employees includes the payment of fair wages and contributions towards a pension program.

 

3.  Corporate Social Responsibility of the Company

Good corporate governance practice cannot be realized without effective Corporate Social Responsibility (CSR) objectives. The concept of CSR refers to the integration of ethical values with business operations in companies and can be understood in terms of a company’s obligation to act as a corporate citizen by pursuing its financial objectives whilst recognizing at the same time, its wider obligations to the environment in which it functions. These socially-responsible objectives may vary in different companies, according to the size of the company, the nature of its operations and products or services, amongst other factors. In addition, many investors are guided by a sense of moral duty and are not solely interested in the maximization of shareholders’ wealth but also in the maximization of stakeholders’ wealth. Such investors will expect companies to have regard for social and environmental issues including efforts on environmental friendliness, social issues and ethical behavior by the company thus, social and environmental issues can affect the reputation, sales, profits and share price of a company.⁷

The existence of CSR today is the result of long-standing social pressure on businesses to try to be more responsible for environmental harms, social harms and labor issues created through their operations.⁸ Attention towards CSR began as a result of a growing public concern for the negative impacts businesses were having on the community and environment, and the sustained protests forced companies to address these concerns or risk losing its customers.⁹

The way organizations perceive social responsibility remains a subject of debate in both the academic world and in practice – whilst some organizations associate social responsibility with burdens and restrictions that threaten profitability, others see it as an opportunity to develop sustainable solutions that not only benefit the company but also ensure a positive impact on society, economic development and the environment.¹⁰

 

4. Milton Friedman vs. Adam Smith – Profit Responsibility and Corporate Social Responsibility

“There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say engages in open and free competition without deception or fraud.”¹¹

According to Milton Friedman, firms should only be interested in profits; he challenges the idea that firm’s should be involved in promoting social ends such as providing employment, diminishing pollution, and eliminating discrimination, and asserts that a firm’s only “social

responsibility” is to be profit-seeking. Friedman further articulates that a corporation is nothing but a legal entity and therefore lacks the “conscience” to incorporate social initiatives into its business model. In line with this theory, it would make no sense to claim that a firm has any “responsibilities” much less moral ones rather, attention ought to focus more on the corporate executives who are human and who have a direct responsibility towards their employers (the shareholders and owners of a company) to conduct business in accordance with their desires, which generally is to make as much profit as possible.¹²

Hence, CSR is perceived as a business cost and subsequent cause for decrease in company profits and this is in direct conflict with the principal-agent theory.¹³ Friedman explains that by adopting “social responsibility”, the corporate executive shirks his only duty and spends everyone’s money but his own, undermining the principal-agent theory. Insofar as his actions, in accord with “social responsibility” reduce returns to shareholders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customers’ money. Insofar as his actions lower the wages of employees, he is spending their money.¹⁴

Following from the above, Friedman’s arguments and similar ones¹⁵ have shaped one side of the CSR debate, that CSR movements hinder profit maximization and are an inefficient allocation of time and resources under the assumption that firms are most productive and useful to society as wealth generating entities. For this cohort of thinkers, firms that choose to practice CSR perform worse financially than firms that do not concern themselves with explicitly addressing public interests.¹⁶ However, some believe that there is no effect on

 

References

1. Brian Coyle, Corporate Governance (5^th edn, ICSA 2015).
2. Margaret Blair, Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century(Taylor & Francis Ltd 1995).
3. CAMA, Cap. C20, LFN, 2004, s 279(3).
4. Companies and Allied Matters Act 2004.
5. Milton Friedman, Capitalism and Freedom(UCP 1962) 133. 
6. CAMA, Cap. C20, LFN, 2004, s 279(4).
7. Brian Coyle, Corporate Governance(5^th edn, ICSA 2015).
8. Mark Kramer, “Corporate Social Responsibility” Interview by Paul Michelman and Cathy Olofson, HarvardBusiness Review (21 December 2006) <https://hbr.org/ideacast/2006/12/harvard-business-ideacast-22-c.html> accessed 19 October, 2016.
9. Thuy Tran, “Corporate Social Responsibility and Profits: A Tradeoff or a Balance?” (CCDRL 2015).
10. Emma Meurs, “Balancing Economic, Social and Natural Capital: The Contribution of Corporate Social
11. Responsibility and the Role of Greenpeace in Creating Balance” <http://purl.utwente.nl/essays/61810> accessed October, 2016.
12. Milton Friedman, “The Social Responsibility of Business is to Increase Its Profits” The New York Times13 September 1970.
13. The agency relationship is defined by Jensen and Meckling as a form of contract between a company’s owners and its managers, where the owners (as principal) appoint an agent (the managers) to mange the company on their behalf. As part of this arrangement, the owners must delegate decision-making authority to the management.
14. Milton Friedman, “The Social Responsibility of Business is to Increase Its Profits” The New York Times13 September 1970.
15. Arthur Laffer, Andrew Coors, Wayne Winegarden, Does Corporate Social Responsibility Enhance BusinessProfitability? (Laffer Associates 2011); It is argued that participating in social impact programs will detract from the profit making potential of any company.
16. David Vogel “CSR Doesn’t Pay” Forbes16 October 2008; Starbucks and Whole Foods are cited as examples of corporations with poor financial performances despite being CSR role models for other companies because of their continued commitment towards the production of socially conscious goods.