Rebuilding Corporate Leadership: How Directors Can Link Long-Term Performance with Public Goals

Committee for A Statement by the Economic Development Research and Policy Committee of the 2000 L Street N.W. Committee for Economic Development Suite 700 Washington, D.C. 20036 202-296-5860 Main Number 202-223-0776 Fax 1-800-676-7353 www.ced.org Rebuilding Corporate Leadership: How Directors Can Link Long-Term Performance with Public Goals

A Statement by the Research and Policy Committee of the Committee for Economic Development Rebuilding Corporate Leadership: How Directors Can Link Long-Term Performance with Public Goals

Includes bibliographic references

ISBN: 0-87186-184-5

First printing in bound-book form: 2009

Printed in the United States of America

COMMITTEE FOR ECONOMIC DEVELOPMENT

2000 L Street, N.W., Suite 700, Washington, D.C., 20036

(202)-296-5860

www.ced.org

ii Contents

PREFACE BY THE CED RESEARCH AND POLICY COMMITTEE ...... xi

EXECUTIVE SUMMARY ...... 1

I. INTRODUCTION ...... 7 a. Th e Context of Recent Events ...... 7 b. Th e Corporation and Society are Interdependent ...... 8 c. Th e New Corporate Engagement ...... 9 d. Th e Urgency of Action ...... 11 e. Plan of Th is Study ...... 11

II. INITIATIVES AND RESPONSES TO SHAREHOLDER AND SOCIETAL CONCERNS ...... 13 a. Long-term Shareholders’ Interests Converge with Societal Interests...... 13 b. Shareholders and Other Corporate Constituents May Work Together to Pursue Non-Financial Objectives...... 17 c. Other Demands of Corporate Constituents ...... 19 d. Corporations Have Responded, but Most are Behind the Curve ...... 20 e. Financial Analysts and Investors Use Social Information to Evaluate Company Performance ...... 21

III. BOARDS CAN PROVIDE LEADERSHIP ...... 25 a. Meeting Shareholder and Public Goals ...... 25 b. Choosing the Right Leadership ...... 29 c. Having the Right Plan: Company Codes, Value Statements, and Strategic Plans ...... 30 d. Honesty in Reporting and Enhanced Communication ...... 32

IV. THE INTERSECTION OF CORPORATE STRATEGY AND SOCIETAL CONCERNS IN PRACTICE ...... 35 a. Corporations and the Environment: Many Businesses are Trying to Incorporate Climate Change into Corporate Strategy ...... 35 b. BP and ExxonMobil ...... 36 c. Corporations and Human Rights ...... 39 d. A Role for Directors in Considering Corporate Strategy and Societal Concerns ...... 42

V. TWO CRITICAL ISSUES: PRIVATELY HELD CORPORATIONS; THE ROLE OF GOVERNMENT ...... 43 A. Issue 1: Corporations Owned by Private Equity Companies Face Many Similar Market Pressures but Diﬀ erent Corporate Governance Requirements ...... 43 B. Issue 2: What are the Proper Roles and Responsibilities of Government, Business, and Non-Proﬁ ts with Regard to Societal Concerns ...... 46 continued iii contents continued

VI. CONCLUSION ...... 53

MEMORANDA OF COMMENT, RESERVATION OR DISSENT ...... 55

APPENDIX—ENVIRONMENTAL, SOCIAL, AND GOVERNANCE ORGANIZATIONS ...... 57

ENDNOTES ...... 63

BOXES 1. Deﬁ ned-Beneﬁ t Pension Funds Contribute to the Problem ...... 14 2. Th e Hermes Principles ...... 16 3. Th e Ten Principles of the UN Global Compact ...... 22 4. Examples of Corporate Reporting on Compensation Tied to Societal Concerns ...... 29 5. Th e Johnson & Johnson Credo ...... 31 6. Findings of Modernizing Government Regulations ...... 50

iv CED Research and Policy Committee

Chairmen KATHLEEN COOPER RODERICK M. HILLS , ESQ. Senior Fellow Chairman PATRICK W. GROSS Southern Methodist University Hills Stern & Morley LLP Chairman Th e Lovell Group W. BOWMAN CUTTER EDWARD A. KANGAS Managing Director Chairman and Chief Executive Oﬃ cer WILLIAM W. LEWIS Warburg Pincus LLC (Retired) Director Emeritus, McKinsey Global Deloitte Touche Tohmatsu Institute KENNETH W. DAM McKinsey & Company, Inc. Max Pam Professor Emeritus of American JOSEPH E. KASPUTYS & Foreign Law & Senior Lecturer, Chairman, President and Chief Executive University of Chicago Law School Oﬃ cer Members Th e University of Chicago Global Insight, Inc. IAN ARNOF RICHARD H. DAVIS CHARLES E.M. KOLB Chairman Partner President Arnof Family Foundation Davis Manafort, Inc. Committee for Economic Development

ALAN BELZER RICHARD J. DAVIS BRUCE K. MACLAURY President & Chief Operating Offi cer Senior Partner President Emeritus (Retired) Weil, Gotshal & Manges LLP Th e Brookings Institution Allied Signal WILLIAM H. DONALDSON WILLIAM MCDONOUGH LEE C. BOLLINGER Chairman Vice Chairman and Special Advisor to the President Donaldson Enterprises Chairman Columbia University Merrill Lynch & Co., Inc. FRANK P. DOYLE ROY J. BOSTOCK Executive Vice President (Retired) LENNY MENDONCA Chairman General Electric Company Chairman, McKinsey Global Institute Sealedge Investments, LLC McKinsey & Company, Inc. MATTHEW FINK JOHN BRADEMAS President (Retired) ALFRED T. MOCKETT President Emeritus Investment Company Institute Chairman & CEO New York University Corinthian Capital LLC. EDMUND B. FITZGERALD BETH BROOKE Managing Director NICHOLAS G. MOORE Global Vice Chair - Public Policy, Woodmont Associates Director Sustainability and Stakeholder Bechtel Group, Inc. Engagement PATRICK FORD Ernst & Young LLP President and Chief Executive Offi cer, U.S. DONNA S. MOREA Burson-Marsteller President, U.S. Operations & India DONALD R. CALDWELL CGI Chairman & Chief Executive Offi cer HARRY FREEMAN Cross Atlantic Capital Partners Chairman M. MICHEL ORBAN Th e Mark Twain Institute Partner DAVID A. CAPUTO RRE Ventures President CONO R. FUSCO Pace University Managing Partner (Retired) STEFFEN E. PALKO Grant Th ornton Retired President GERHARD CASPER XTO Energy Inc. President Emeritus and Professor GERALD GREENWALD Stanford University Chairman CAROL J. PARRY Greenbriar Equity Group President MICHAEL CHESSER Corporate Social Responsibility Chairman & CEO BARBARA B. GROGAN Associates Great Plains Energy Services Chairman Emeritus Western Industrial Contractors CAROLYN CHIN Chairman and Chief Executive Offi cer Cebiz/Singlepoint

v CED Research and Policy Committee

DONALD K. PETERSON GEORGE E. RUPP MATTHEW J. STOVER Chairman and Chief Executive Offi cer President Chairman (Retired) International Rescue Committee LKM Ventures, LLC Avaya Inc. JOHN C. SICILIANO VAUGHN O. VENNERBERG NED REGAN Senior Managing Director and CEO, Senior Vice President and Chief of Staff Professor Investment Boutiques XTO Energy Inc. Th e City University of New York New Your Life Investment Management JOSH S. WESTON DANIEL ROSE SARAH G. SMITH Honorary Chairman Chairman Chief Accounting Offi cer Automatic Data Processing, Inc. Rose Associates, Inc. Goldman Sachs Group Inc. JOHN P. WHITE LANDON H. ROWLAND PAULA STERN Lecturer in Public Policy, Kennedy School of Chairman Chairwoman Management Ever Glades Financial Th e Stern Group, Inc. Harvard University

vi CED Corporate Governance Subcomittee

Chairman: ROBERT COLSON JOHN LIFTIN Partner - Institutional Acceptance General Counsel WILLIAM H. DONALDSON Grant Th ornton D. E. Shaw & Co., L.P. Chairman Donaldson Enterprises STEPHEN A. CRANE LI LU Chairman President Insurance and Reinsurance Strategies Himalaya Management LLC President MAUREEN ERRITY SAMUEL LYNN CHARLES E.M. KOLB Director Center For Corporate Governance Deputy Director of Accounting Policy President Deloitte LLP Goldman Sachs Group Inc. Committee for Economic Development MARGARET FORAN COLETTE MAHONEY Executive Vice President, General Counsel President Emeritus and Corporate Secretary Marymount Manhattan College Subcommittee Members: Sara Lee Corporation IRA M. MILLSTEIN DEBORAH HICKS BAILEY PATRICK FORD Senior Partner Chairman and CEO President and Chief Executive Oﬃ cer, U.S. Weil, Gotshal & Manges LLP Solon Group, Inc. Burson-Marsteller DONALD K. PETERSON LYDIA I BEEBE CONO R. FUSCO Chairman and Chief Executive Oﬃ cer Corporate Secretary Managing Partner (Retired) (Retired) Chevron Corporation Grant Th ornton Avaya Inc.

PETER A. BENOLIEL ALBERT H. GARNER MARK PREISINGER Chairman Emeritus Managing Director Vice President, World Wide Public Aff airs Quaker Chemical Corporation Lazard Freres & Co. LLC & Communications Th e Coca-Cola Company JOHN BRADEMAS ALAN B. GILMAN President Emeritus Chairman NED REGAN New York University Th e Steak n Shake Company Professor Th e City University of New York RANDY J. BRAUD PATRICK W. GROSS U.S. Country Controller Chairman LANDON H. ROWLAND Shell Oil Company Th e Lovell Group Chairman Ever Glades Financial CATHERINE BROMILOW ADAM J. GUTSTEIN Partner Chief Executive Offi cer and President JOHN C. SICILIANO PricewaterhouseCoopers LLP Diamond Management & Technology Senior Managing Director and CEO, BETH BROOKE Consultants, Inc. Investment Boutiques New York Life Investment Management Global Vice Chair - Public Policy, HOLLIS W. HART Sustainability and Stakeholder Director of International Operations SARAH G. SMITH Engagement Citi Chief Accounting Offi cer Ernst & Young LLP Goldman Sachs Group Inc. G. PENN HOLSENBECK HYEWON CHOI Vice President and Corporate Secretary SARAH B. TESLIK Vice President and Head of Corporate Philip Morris International Sr. Vice President, Policy and Governance Governance Apache Corporation TIAA-CREF ROSEMARY M. KENNEY Director, Corporate Governance & VAUGHN O. VENNERBERG MARTIN COHEN Communications Senior Executive Vice President and Chief Managing Director Pfi zer Inc of Staff Morgan Stanley XTO Energy Inc.

vii CED Corporate Governance Subcomittee

FRANK VOGL President Guests: Project Director: Vogl Communications CHRISTOPHER A. BUTNER ELLIOT SCHWARTZ JOHN C. WILCOX Assistant Secretary & Managing Counsel, Vice President & Director of Economic Chairman Securities/Corporate Governance Studies Sodali Ltd. Chevron Corporation Committee for Economic Development

HAROLD M. WILLIAMS MICHAEL CLAES President Emeritus Managing Director, Corporate Practice Getty Trust Burson-Marsteller Project Associate:

H. LAKE WISE ROBERT H. HERZ CHARLES JOHNSON Executive Vice President and Chief Legal Chairman Research Associate Oﬃ cer Financial Accounting Standards Board Committee for Economic Development Daiwa Securities America Inc. (FASB)

JUDITH SAMUELSON Executive Director, Business and Society Program Th e Aspen Institute

Please Note: Italicized names indicate CED Trustees

viii Please Note: Italicized names indicate CED Trustees Responsibility For CED Statements On National Policy

Th e Committee for Economic Development is an proposals; its purpose is to urge careful consideration independent research and policy organization of over of the objectives set forth in this statement and of the 200 business leaders and educators. CED is non- best means of accomplishing those objectives. profi t, non-partisan, and non-political. Its purpose is Each statement is preceded by extensive discussions, to propose policies that bring about steady economic meetings, and exchange of memoranda. Th e research growth at high employment and reasonably stable is undertaken by a subcommittee, assisted by advisors prices, increased productivity and living standards, chosen for their competence in the fi eld under study. greater and more equal opportunity for every citizen, and an improved quality of life for all. Th e full Research and Policy Committee participates in the drafting of recommendations. Likewise, the All CED policy recommendations must have the trustees on the drafting subcommittee vote to approve approval of trustees on the Research and Policy or disapprove a policy statement, and they share with Committee. Th is committee is directed under the the Research and Policy Committee the privilege of bylaws, which emphasize that “all research is to be submitting individual comments for publication. thoroughly objective in character, and the approach in each instance is to be from the standpoint of the Th e recommendations presented herein are those of the general welfare and not from that of any special politi- trustee members of the Research and Policy Committee cal or economic group.” Th e committee is aided by a and the responsible subcommittee. Th ey are not necessarily Research Advisory Board of leading social scientists endorsed by other trustees or by non-trustee subcommittee and by a small permanent professional staff . members, advisors, contributors, staff members, or others associated with CED. Th e Research and Policy Committee does not attempt to pass judgment on any pending specifi c legislative

Preface

CED’s interest in the interaction and interdependence Th is report and our two previous reports taken of business and society and the development of more together give a comprehensive and up-to-date survey socially conscious corporate leaders started with of the potential contributions of boards of directors to its founding in 1942. CED policy statements on improving overall corporate performance. Empowered corporate governance issues since 2006 have analyzed boards can ensure that corporate strategy builds lasting fi rst, how corporations could regain the public’s trust value by addressing key shareholder and societal con- in the wake of corporate scandals and compensation cerns. In our view, directors could do more with their unrelated to performance, and second, how corporate current authority to motivate managements to greater directors could promote the long-term enduring quali- innovation, and to support managements in fi nding ties of their enterprises rather than give in to fi nancial long-term value solutions to the numerous economic market “short-termism.” and societal pressures they face. Th is report examines how these eff orts to build public Acknowledgements trust and long-term value have coalesced to encourage many large, global corporations to pay greater attention We are grateful for the time, eff orts, and care that CED to their longer-term interests by striking a balance Trustees and other participants in the Subcommittee between short-term commercial pursuits and such on Corporate Governance and Capital Markets put societal concerns as the environment, labor standards, into the development of this statement. and human rights. Many companies have also found ways to turn such concerns as the eff ects of climate Special thanks go to the subcommittee chair, William change and other environmental damage into profi table H. Donaldson, chairman and CEO of Donaldson commercial opportunities. Th is report also explores Enterprises, for his guidance and leadership. We how all corporate boards could take a more active part are also indebted to Elliot Schwartz, Vice President in considering such issues and improving the reporting and Director of Economic Studies at CED, and Joe of fi nancial and non-fi nancial measures of corporate Minarik, CED’s Senior Vice President and Director performance broadly conceived. of Research. Th anks are also due to Charles Johnson for research assistance, including the drafting of case Th e recommendations of this report are off ered to studies in Chapters 4 and 5. stimulate debate within the corporate community. Our intent is not to call for specifi c change but to encourage corporate leaders to contemplate our recommendations and adapt them to their unique circumstances. In accord with this purpose, companies identifi ed in illustrative case studies in Chapters 4 and 5 were asked if they wanted to correct any factual errors or provide a short statement or comment related to the issues. ExxonMobil Corporation’s statement can be found at the end of this report (page 55) and in footnotes on pages 37-39. We are grateful to ExxonMobil for their cooperation.

Rebuilding Corporate Leadership: How Directors Can Link Long-Term Performance with Public Goals

Executive Summary

Th e fi nancial crisis, which became evident in encouraging enlightened statesmanship in accounting, September 2008, transformed U.S. fi nancial markets corporate governance, other board and management and provided a painful reminder of the confl ict that can practices, and, as important, the strategic thinking occur between private-sector actions and public goals. of corporate leaders. Public corporations are the A root cause of the crisis was the excessive risk taken driving force of the U.S economy. Th ey are the core by almost all market participants—corporate execu- of a system unsurpassed in creating jobs, income, and tives, money managers, rating agencies, investment wealth, and in delivering a wide choice of goods and intermediaries, bankers, and investors—to achieve services. Corporate leaders should understand it is in short-term results that temporarily benefi ted their their self interest to engage responsibly with the society businesses and themselves at the expense of their own around them. Th ey must fi nd an appropriate balance long-term interests and those of their shareholders, between generating short-term profi ts and building for employees, other linked businesses, and the nation as a the future, because sustainable profi ts come only from whole. Of course, government regulators, some home long-term investment and strategy. buyers, and others who overextended credit purchases Th is statement is meant to promote discussion; its recom- also share responsibility. mendations are advisory. We encourage corporate leaders Although the crisis started in the fi nancial services to put the long-term health of their enterprises at the sector, our focus in this report is not on fi nancial forefront of their numerous priorities, by paying greater services or capital markets as such. Our focus is on attention to how their business strategies interact with corporate governance and the vital role directors can the societal environment that shapes their corporations’ play in mitigating the types of pressures that created long-term performance and sustainability. Aligning the the crisis. “Rebuilding Corporate Leadership” is best interests of the corporation and its shareholders with the understood in the context of our previous reports on long-term interests of society will generate vibrant and regaining public trust in the wake of Enron and other successful entities that will help to regain the public's trust. scandals and how corporate directors could promote Our focus is on the potential contributions boards of the enduring qualities of their enterprises.* directors can make to improve corporate strategy and It is clear to us that the underlying patterns of behav- long-term performance. Directors generally have been ior—rooted in short-sighted and self interested behav- reluctant overseers of their corporations. Before the iors—exist across all industries. A well-functioning corporate scandals associated with Enron, WorldCom, board can govern the corporation and its management and others, directors too frequently deferred to “imperi- by supporting a CEO who is doing the right thing for al CEOs.” Th e Sarbanes-Oxley Act and other reforms the sustainability of the business, while checking the put greater emphasis on the responsibility of indepen- excesses and other mistakes of one who is overly short dent directors to counter the CEO’s inherent power. sighted, self interested, or confl icted. But many directors have interpreted those reforms solely in terms of fi duciary loyalty to shareholders and, Starting in 2002, the CED Subcommittee on consequently, to the maximization of short-term share Corporate Governance and Capital Markets has met value, despite the diversity of shareholder interests and to propose ways by which to restore confi dence and the transitory membership of that group. For many trust in American corporations and their leaders by

* Private Enterprise, Public Trust: Th e State of Corporate Governance After Sarbanes-Oxley; and Built to Last: Focusing Corporations on Long-Term Performance

1 directors, the daily share price has come to represent other as partners, not adversaries. Th eir actions the success or failure of a board’s ability to represent and public communications should recognize their shareholders’ interests. But shareholders will not interdependence and shared goals. prosper long when other groups linked to the health of the corporation—broadly, society—do not also thrive. Recommendations

Directors have a legal obligation and duty to address Th is report is addressed primarily to America’s corpo- the long-term performance of the corporation. rate directors. Individual directors and the boards they Directors’ fi duciary duties include broader societal compose can make an enormous diff erence by motivat- concerns that affi rmatively aff ect the corporation’s ing management to identify and execute long-term performance and long-term sustainability. To meet value solutions to the economic and social pressures that duty, directors must consider the concerns of their businesses face. all—not just current shareholders, managers, or other powerful constituents—who are in a position In summary, our major recommendations are as to aff ect a company’s long-term performance. In follows: today’s environment, boards must know that they are • Th e board of directors has ultimate responsibil- empowered to reject actions that produce only short- ity for the performance of the corporation. term fi nancial results at the expense of the long-term Directors have an obligation to act as stewards interests of the corporation. Compensation policies, of the corporation’s long-term economic health. for example, should not be designed to promote Th ey should widen the purview of their delibera- purely short-term share price enhancement. tions to give weight to societal issues that impact Many corporate leaders—directors and CEOs—have the fi rm’s longer-term performance. (p. 26) found that a principled, long-term view fosters greater • Our basic recommendation with regard to appreciation of the interdependence between the societal issues is not a “one-size-fi ts-all” solu- corporation and the society in which it operates. Th ese tion. As each corporation is unique, each will individuals are leading the development of business have unique societal issues that may impact strategies that take account of societal challenges as a its performance. Th ese should be the board’s means to ensure their corporations’ and society’s long- concern. Our recommendation is simply that term prosperity. Although many boards remain behind boards should play an active role in encouraging the curve, a number of forward-thinking directors seem company management to evaluate the options willing if not eager to consider shareholder resolutions available and to decide explicitly what it ought that encourage action to abate climate change, disclose to do, based on sound business grounds that environmental risks, or incorporate human rights best incorporate a longer-term view. Once a decision practices. As important, some are speaking out to urge has been made and justifi ed, the board should U.S. political leaders to repair their broken systems so monitor implementation and continue to evalu- they can begin to solve long-term societal problems ate the company’s strategy on the basis of long- that hamper business as well as society’s other con- term costs and long-term benefi ts. (p. 32) stituents. But too few business or political leaders are following these paths, and talk about business and • Directors regularly should consider how the society interaction far outpaces action. company plans, manages, and communicates its interaction with society. Th e board should Our central conclusion is that corporate boards insist that management report regularly to it and the leaders they select must integrate relevant and to the public on non-fi nancial performance, societal concerns, such as environmental and human including social performance.* To institutional- rights considerations, into corporate strategy to ize the process, the board may want to establish strengthen long-term competitiveness and the a special committee or empower its governance sustainability of both the corporation and the society committee to take responsibility for oversight. in which it exists. A successful framework requires Th at committee should report to the full board that societal and business leaders view and treat each and appear regularly on its agenda. (p. 28)

2 • Directors should recognize the value of corpo- tion views the role of business solely as the maximi- rate communication with shareholders and the zation of profi ts. While those engaged in business public on issues that bear on the company’s repu- understand the good that comes from the profi t motive, tation and brand value, even when such commu- many in the public and in politics see the pursuit of nication may not be required by regulation or fi t profi t as feeding individual greed at the expense of neatly into fi nancial disclosure formats. Boards society. Th ey perceive private and public interests to be that have a non-executive chair or lead director engaged in a zero-sum contest for resources and power. may want to consider a communications role for Th e recent turmoil and government intervention in that person on such issues and topics. (p. 32) fi nancial markets has exacerbated these perceptions. • Directors should promote honesty in reporting Our preferred framework recognizes that the interests not only on fi nancial results and other non- of society and business are not mutually exclusive: they fi nancial aspects of their company’s operations, are interdependent; their goals are linked; and they but also on the risks, opportunities and results should be seen in positive-sum terms. Our society of its social interactions. Such reporting should depends on corporations to innovate and invest, show how the company evaluates the long-term thereby improving living standards, creating jobs and impact of potential costs and benefi ts. But aside wealth, and providing social goods. Corporations, too, from mandated environmental and labor report- depend on society. At the most fundamental level, ing to government regulatory agencies, corporate society establishes and secures property rights and “sustainability” reporting should remain within provides the environment in which businesses can the purview and at the discretion of individual exist. An excellent and equitable education system companies (as they exercise their responsibility is needed to provide a productive and innovative for honest and full communication with share- workforce. Intelligent policies towards land, water, holders). Directors should use their authority to energy, transportation, communication, health care, and help their companies fi nd a fi rm-specifi c way to other concerns are needed to sustain the environment, communicate eff ectively with shareholders and improve commerce, and maintain a vibrant society. An the public—through the regular annual report eff ective and equitable system of justice keeps all parties to shareholders, in a separate public report, or in productively engaged in the pursuit of the common some other way. (pp. 33-34) good and protects property and other economic rights. It is without question in each corporation’s interest to • Th e CEO is mainly responsible for carrying sustain the society in which it operates. out the board’s directions. When choosing a CEO, the board’s selection committee should We recognize that there are practical limits to any be mindful of the role that person will play in corporation’s ability to fulfi ll societal needs—individual setting the tone and direction of the company companies cannot do everything. Neither can they with regard to ethics, integrity, and engagement ignore their profi t-making responsibilities. Surely with shareholders and other interested parties. government must play a prominent role in setting Boards should tie a portion of CEO and senior the public agenda and rules of fair competition that management’s performance compensation to support, rather than undermine, far-sighted business metrics based on the corporation’s performance statesmanship (as discussed below). on such concerns. (pp. 28 and 29) Yet, failure of corporations to shift to an approach— based on substance, not image—that recognizes their Interdependence of Business and Society interdependence with the societies around them will Th e current paradigm that shapes the way that many further increase public cynicism toward business, erode business and political leaders and the general public society’s already diminished trust in, and support of, think about the relationship between business and corporations and their leadership, and invite more bur- society is overly narrow and oppositional. Th is conven- densome regulation. Such results are in the interests of

* Of course, these need not be the same reports, but public reporting must be truthful and easily understood.

3 neither business nor society. Society overall is already cannot aff ord to ignore that social environment. Nor poorer and less able to address its needs because can they ignore the welfare of key groups, such as business has not been suffi ciently engaged in helping to employees, whose interests bear on the wealth-creating fi nd solutions to problems culminating in the late-2008 potential of the corporation. fi nancial crisis. Business risks losing its “license to operate,” imperils its access to needed physical, human, Additional Considerations and fi nancial resources, and invites ever greater scrutiny and more stringent regulation through excessive atten- In the course of our deliberations, we examined several tion to short-term self interest. related critical issues. First, we examined some practical cases where corpora- The Role of the Board of Directors tions have had to confront directly environmental and human rights issues. Th e examples we analyze, in the oil Boards should spend more productive time considering industry with respect to climate change and in internet long-term sustainability, which means fi nding practical technologies with respect to human rights, illustrate ways—through production, research and development, the diffi cult problems companies face and the types investment, marketing, communications, human re- of responses they have developed. Th ese examples sources development, and other processes—of carrying demonstrate that companies cannot avoid confronting out a strategy that includes the interaction between the hard questions regarding environmental, human rights, corporation and society. and other societal concerns, and that no one answer fi ts Many directors are uncertain about the validity of every circumstance. Whether decisions are made after societal and other non-shareholder concerns and how considerable deliberation or in the heat of a moment, such concerns interact with corporate performance. business decisions that intersect with societal interests But recent research indicates that how a corpora- can reverberate in unexpected ways. Th e importance tion engages societal issues is a signifi cant factor in a of such decisions both to the society in which a company’s performance. Investors and analysts are business operates and to the business itself should increasingly using such evaluations to allocate capital. command the attention of corporate directors. Th at does not mean that other corporate constituents Next, we addressed the question of whether privately held any more than shareholders should determine company corporations that are owned by private equity companies policies; that social considerations should trump face the same societal pressures as their publicly held hard-headed business analysis; or that the corpora- counterparts. We found, unsurprisingly, that the tion should be viewed as an arm of government or an actions of private fi rms are subject to the same market instrument of social policy. It does mean, however, forces and bound by the same social considerations that boards must pay greater attention to how societal (including government regulation) as large, public concerns aff ect the corporation while continuing to corporations. Of course, private-equity-owned fi rms keep an eye on traditional fi nancial criteria. diff er from public corporations on a number of ac- Boards are uniquely positioned to make sure that the counts: disclosures, access to funding, executive com- long-term interests of the corporation are not lost pensation, shareholder/ownership rights, and investors’ or sacrifi ced to the pressures of daily business activ- liquidity, to name a few. But these diff erences neither ity. Successful boards will help the CEO to balance protect private fi rms from market competition nor free short-term and long-term goals. Boards can serve as a them from exposure to societal concerns. In fact, like buff er between the CEO and market forces that make their public counterparts, market forces, pressure from unhealthy short-term practices diffi cult to resist. Th ey non-governmental organizations, and “enlightened self should support—and protect—CEOs and other senior interest” work to nudge some of these private fi rms managers who take the long-term view. toward a more operational and sustained integration of social issues with company strategy. Others, of course, Because each corporation has a stake in the health and remain resistant to change or fl y under the radar of welfare of the society in which it operates, its directors social monitors.

4 We conclude that both publicly held and private- addressed the problem of Washington’s broken policy equity-owned businesses must become more adept process.* Our conclusion and recommendation, at incorporating societal concerns into strategic adapted from that analysis, is that political leaders frameworks and business plans. For private fi rms, should understand the costs they impose on busi- which currently are not compelled to disclose as much ness and society at large if they do not take action information as public fi rms, greater voluntary disclo- to improve political governance and policymaking. sure of their activities might serve as a starting point. Th ey need seriously to address reforms in ethics, lobbying, redistricting, earmarks, and other legisla- Finally, what is the proper division of responsibility tive procedures and executive practices to break the between business and government? Shouldn’t govern- logjam holding back policy reforms in substantive ments take primary responsibility for addressing societal areas such as global climate change. concerns? We also reiterate conclusions and recommendations Government plays many economic roles in market from CED’s previous policy statement on government capitalist systems. Among them are: promotion of regulation.† Th at analysis pointed to what some now macroeconomic growth and stability; maintenance term “smart regulation,” which draws from an array of social equity in the distribution of income; and of ideas linked to performance-and principles-based regulation of market competition. Most relevant to the regulation. Smart regulation seeks to strike an appro- issues addressed in this report, governments generally priate balance between fl exibility and effi ciency, relying supplement markets by providing public goods and more on markets than on commands. compelling private entities to account for the costs they impose on society—the two primary concerns that Conclusion corporations are increasingly called upon to address. Clearly, government must establish and enforce social CED was founded by a group of business statesmen policies in these areas. Normally, the business role who had strong views on the direction of public policy is to obey local laws and regulations. But laws and and the role of the business community in helping to regulations typically set minimum standards. Many advance our society as a whole. A key, if not critical, businesses, especially global corporations, often exceed contribution of the business community to overcom- these minimum standards. In advanced economies, ing societal problems may lie not only in individual like the United States, the pressure to exceed regula- corporate policies but in business statesmanship—the tory minimums is strongest when it appears that willingness of business leaders to speak out on pressing government policies lag behind societal attitudes. For public concerns, such as unsustainable cost increases example, U.S. environmental policy, to many observers, in federal entitlement programs, the lack of universal has not caught up with societal concerns about the health care, environmental damage from climate risks of climate change. change, and the threat to human rights. In the U.S. context, a lack of trust in political institu- It is not an either-or choice. U.S. business leaders tions undermines social progress and shifts public should consider both how their business strategies demands from political leaders to business leaders. A interact with societal issues and how they personally better outcome would be one where political institu- can make a diff erence by supporting sound public tions could be relied upon to address intelligently policies that address society’s key concerns. public concerns and close the gap between social expectations and government policies. Elsewhere, CED has

* “Washington Is Broken” So What Are You Going To Do About It? † Modernizing Government Regulation: Th e Need for Action

Chapter I: Introduction

Public, for-profi t corporations perform a highly impor- consumers and producers. Producers face greater legal tant societal function—they create jobs that provide and market constraints because consumers and citizens income and wealth to elevate living standards better are more sensitive to how things are produced—the than any other known mechanism. But CEOs and conditions under which workers labor, the types of corporate directors increasingly face myriad additional chemicals and materials used, and even the method demands to extend their success to other areas of of production. As important, the seeming inability societal concern. Shareholders, regulators, government of political systems, in the United States and virtually agencies of all types, consumers, employees, non-profi t everywhere else, to address these concerns meaningfully organizations, ratings agencies, and other constituen- creates social conditions that impede economic growth cies expect CEOs and directors to do much more than generally and make business decisions much more take (prudent) risks to grow profi ts and act within legal diffi cult for individual fi rms. constraints. Rather, they expect ethical behavior and Th is study examines: transparent operations that respect environmental, societal and corporate governance concerns, and a host of • How these conditions, as refl ected by the various other fi nancial and non-fi nancial objectives. Balancing demands of shareholders and others, aff ect corpo- these expectations has never been easy. In recent years, rate strategy; excessive compensation, exorbitant severance payments, and other forms of short-sighted and self-interested • What actions corporate directors could take to behavior have poisoned the public’s opinion of business promote the identifi cation and inclusion of societal and business leaders. Th e fi nancial crisis of 2008 has concerns into core business strategies, consistent further lowered the public’s regard of business. with the goal of maximizing long-term value; One of the great strengths of the corporation and of • Whether constituency demands and societal successful corporate leaders has been the ability to concerns aff ect public and private corporations adapt to ever-changing circumstances. Today, as cor- diff erently; and porations become more global and increasingly operate • Where the limits may be between private, volun- in geographic areas with diff erent, often confl icting tary actions of corporations and the responsibilities legal regimes and social norms, demands of corporate of governments. constituencies—transmitted through resource (capital and labor) and fi nal-product markets, government The Context of Recent Events regulation, and public forums—motivate more than ever corporate leaders to consider these pressures and In fall 2008, fi nancial markets in the United States embrace public goals to bring the forces of corporate and other parts of the world fell into a crisis that saw enterprise to bear on public problems. in quick succession the collapse of some of the nation’s top fi nancial institutions and an unprecedented Th e problems faced by society—whether local, $700 billion appropriation designed to stabilize credit national, or global—also necessarily confront busi- markets and recapitalize remaining fi nancial institu- nesses, which exist within and are part of society. tions. Environmental problems throughout the world aff ect living standards and constrain activities once taken for Th e crisis is a painful reminder of the confl ict that can granted. Th e increasing scarcity of critical resources, occur between private-sector actions and public goals. such as clean water and energy, limit choices for both A root cause of the fi nancial crisis was the excessive risk

7 taken by almost all market participants—corporate ex- The Corporation and Society are ecutives, money managers, rating agencies, investment Interdependent intermediaries, bankers, and investors—to achieve short-term results that temporarily benefi ted their Historically, corporations were privately organized and publicly chartered to both grow the value of sharehold- businesses and themselves at the expense of their own 1 long-term interests and those of their shareholders, ers’ investments and advance the public good. In the 16th and 17th centuries, “chartered companies” employees, other linked businesses, and the nation as a were created by monarchs largely to explore and whole. Actions by public offi cials charged with regulat- open the resources of the New World. And the early ing private-sector conduct, particularly in the fi nancial American colonies empowered chartered corpora- sector, also played a signifi cant role in the crisis. tions to build critical infrastructure, including roads, Th is “short-termism” took diff erent forms in diff erent canals, and banks. It wasn’t until 1830 that the state parts of the economy, but it was pervasive. In fi nancial of Massachusetts fi rst allowed companies the privilege services, excessive leverage and a classic mismatch of limited liability, a hallmark of the corporate form, between short-term liabilities and long-term invest- without being engaged in public works. And, in 1837 ments were at the core of problems obscured by a Connecticut became the fi rst to allow companies to be blizzard of complex fi nancial paper. In housing, myopic incorporated without a special legislative act. Even greed of borrowers and lenders created bad loans that then, legislatures often revoked charters from corpora- could be justifi ed only by looking beyond the very tions that failed to fulfi ll their public responsibilities.2 short-term through rose-colored glasses. Elsewhere, But the conventional view of the modern corporation in manufacturing for example, many fi rms focused is that it must operate primarily (some would say more on their quarterly earnings-per-share number solely) in the interests of its shareholders. Nearly a than they did on investing in research and development half century ago Milton Friedman claimed “there is but (R&D) and worker training, which underlie long-term one and only one social responsibility of business—to performance. use its resources and engage in activities designed to Although the crisis has been centered in fi nancial increase its profi ts so long as it stays within the rules services, our focus in this report is not on that sector or of the game.”3 More recently, that view has been on capital markets as such. Our focus is on corporate challenged by scholars and practitioners who have governance and the vital role directors can play in examined the role of the board with regard to a broader mitigating the types of pressures that created the crisis. set of corporate constituents and concluded that they It is clear to us that the underlying patterns—rooted too merit consideration. We take up this issue in more in short-sighted and self interested behaviors—exist detail in discussing the role of boards of directors in across all industries. A well-functioning board can Chapter 3. govern the corporation and its management by sup- Recent turmoil in fi nancial markets and the downturn porting and protecting a CEO who is doing the right in business generally have soured public perceptions of thing for the sustainability of the business, while business and business leaders. Corporations are under checking the excesses and other mistakes of one who is increased pressure to rebalance public and private overly short-sighted, self-interested, or confl icted. goals, as the public demands tangible results beyond Recovery from this crisis will continue to dominate the corporations’ direct (though temporarily declining) economic decision making for some period of years. contributions to personal income and wealth. Some We do not, however, want to lose sight of longer-term shareholders are among those demanding “more,” by forces that also will shape the business environment. agitating for greater consideration of environmental, It is vitally important that as a society, and as business human rights, and other societal issues. Although such leaders, we work to fi x both short-term and long-term demands have been greatest on large, global corpora- problems. tions, the underlying trends make it likely that even relatively smaller-sized companies, and non-corporate businesses, will feel the same pressures if they have not yet.

8 Various constituencies, often working through non- politicians, NGO leaders, the media, and others adopt profi ts or non-governmental organizations (NGOs), this framework to demonize “Corporate America” and make similar demands. Many NGOs actively advocate link caricatures of greedy businessmen to stir cynicism higher standards of corporate behavior with respect to within the general public. Th is framework colors environmental and human rights issues. Other NGOs and shapes perceptions about the relationship of the attempt to hold corporations accountable by leveraging corporation to society at both board tables and kitchen the Internet and other media sources to expose what tables. they see as sub-standard labor practices, abuses of In reality, the interests of society and the business com- human rights, pollution of local waterways, violations munity are not mutually exclusive, but interdependent, of government health and safety standards, and the like. and their goals are interlinked. Our society depends on Of course, governments—local, state, and national— corporations to innovate and invest, thereby improv- have their say, too. Governments everywhere require ing living standards, creating jobs and wealth, and disclosure and reporting of the corporation’s eff ects providing social goods. U.S. corporations are expected on society. Government laws and regulations often to provide a signifi cant portion of the social safety- mandate the achievement of certain societal objectives net (health insurance and retirement income) often running the gamut from standard fi nancial disclosures provided elsewhere by governments. Corporations to employment practices to environmental standards. also depend on society, and it is in each corporation’s Other times, governments may impact businesses by interest to sustain the society in which it operates. An doing too little to meet societal goals directly, thereby excellent and equitable education system is needed to increasing public pressure on, and often the commercial provide a productive and innovative workforce. Health need for, corporations to fi ll the gap. In some less de- care that is accessible, aff ordable, and based on medical veloped countries, where governmental authority exists best practices is necessary to ensure a healthy society in name only, multinational corporations frequently and productive workers. An eff ective and equitable carry the burden of providing basic services usually system of justice keeps all parties productively engaged supplied by governments. Even in the United States, in the pursuit of the common good. Th e production of corporations often must provide workers with remedial safe, high-quality goods and adherence to labor practic- education services, roads for transportation, and other es that meet high ethical standards allows corporations infrastructure improvements. to minimize the cost of accidents, attenuate concerns over the threat of litigation, and enhance the value of At the same time, other voices, mostly from the their brand. In these circumstances, consumers and business community, are questioning how much of workers become more attracted to the company and the corporation’s resources it can aff ord to devote to invested in its success. Th e effi cient use of land, water, societal issues that, however worthy, do not add to this energy and other resources is needed to both sustain quarter’s or even this year’s bottom line. Where is the the environment and lower overall costs. But, there are line between private and public responsibilities? And limits to what each individual corporation can aff ord to what calculus can guide the corporation’s decision do on its own. making? To an extent, how the public and business think about The New Corporate Engagement each other and their relationship has consequences for the achievement of their separate and mutual Th e social role of business and the question of how goals. Th e conventional (Friedman) framework, cited businesses can best fulfi ll that role have been the above, strongly implies that society and business stand subject of many books and articles dating back to the opposed to one another; any benefi t to business comes inception of capitalism and to the work of its leading at the expense of society and vice versa. It refl ects proponent, Adam Smith. Th e Depression of the 1930s a zero-sum game where private and public interests broke the implicit social contract that had supported are understood to be mutually exclusive ends. Often prior business expansion and touched off a fi erce public

9 debate on the role of the corporation and its relation- Scholars, practitioners, and other analysts have begun ship to society—a debate that culminated in the New to reexamine both why and how businesses engage in Deal.4 In the last quarter of the twentieth century, the social arena. A 2008 report of the news magazine, “corporate social responsibility” (CSR) became a vogue Th e Economist, concluded that the CSR label is unhelp- term, as businesses began to respond to social pressures ful to understanding the subject because the range by initiating CSR programs and appointing CSR of activities coming under its umbrella is vast and offi cers to demonstrate corporate concern with social third-generation corporate responsibility activities are causes. Over time, CSR programs have developed from becoming too important to global companies to catego- a focus fi rst on philanthropy (what might be called rize them separately from other corporate activities.7 “fi rst-generation” CSR), then on public relations (the Th e conclusion of an infl uential analysis published in “second-generation”), and now increasingly on product 2006 resonates with our own observations: development (“third-generation” CSR). Integrating business and social needs takes Like many others who recently have examined this more than good intentions and strong leader- topic, we do not favor CSR as a term of art. 5 Some ship. It requires adjustments in organization, hold the perception, whether fair or not, that CSR reporting relationships, and incentives. Few activities tend to originate outside the fi rm and mar- companies have engaged operating management ginalize social concerns, despite the intent to give them in processes that identify and prioritize social greater prominence. Our focus in this statement is dif- issues based on their salience to business opera- ferent: we are concerned with the interdependence of tions and their importance to the company’s business and society, and on how corporations should competitive context. Even fewer have unifi ed anticipate and incorporate social factors into long-term their philanthropy with the management of the strategies and objectives. Th e 2002 report of the Aspen CSR eff orts, much less sought to embed a social Institute used the term “social impact management” dimension into their core value proposition. to describe this intersection, and interdependency, of Doing these things requires a far diff erent ap- business practice and wider societal concerns. Within proach to both CSR and philanthropy than the such a framework, CSR activities and programs as one prevalent today. Companies must shift from sometimes narrowly construed may count among the a fragmented, defensive posture to an integrated, ways corporations react to social demands, but they do affi rmative approach. Th e focus must move away not by themselves capture this wider fi eld of interest. from an emphasis on image to an emphasis on A common critique of mostly fi rst- and second- substance.8 (Emphasis added.) generation corporate social responsibility programs is Th e view that pits society and business at odds with that charitable donations and other narrowly focused one another is self-defeating. Certainly, there are prac- CSR-related projects serve only as short-term, cosmetic tical limits to any corporation’s ability to fulfi ll societal solutions to systemic problems, and as vehicles for needs—it cannot do everything. And, there will be public-relations campaigns intended to placate activist occasions when confl icts will occur. Nevertheless, NGOs.6 Th is view holds that while the rhetoric of the zero-sum view is a losing proposition. Practically CSR appears well-intentioned, many corporations applied, it often moves corporations either to fi ght civil are failing to translate rhetorical commitments to society groups or to try to mollify them with ineff ective strategic goals and operations. Th at view does not palliatives. It encourages anti-business groups and imply that companies should end CSR activities, nor opportunist politicians to throw roadblocks in front do we believe that they should. Many CSR programs of nearly every form of business expansion. Th e 2006 achieve excellent results both for the corporation and analysis cited above put it in plain terms: “If either a for society. Most companies will want to continue to business or a society pursues policies that benefi t its fund CSR activities and support volunteer programs, interests at the expense of the other, it will fi nd itself but we believe that they also may want to look deeper on a dangerous path. A temporary gain to one will into their overall interaction with society, as have some undermine the long-term prosperity of both.”9 fi rms—under the banner of CSR or otherwise.

10 The Urgency of Action standards of living of future generations. Common problems demand solutions that transcend tradi- Our central conclusion is that corporate boards tional divides. Business alone cannot solve the world’s and the leaders they select must integrate relevant problems. Neither can government. Neither can civil societal concerns, such as environmental and human society organizations. Th e responsibility to act falls to rights considerations, into corporate strategy to all of us. strengthen long-term competitiveness and the sustainability of both the corporation and the society Th e purpose of this report is to restore confi dence and in which it exists. A successful framework requires trust in American corporations and their leaders by that societal and business leaders view and treat each encouraging enlightened statesmanship in accounting, other as partners, not adversaries. Th eir actions corporate governance, other board and management and public communications should recognize their practices, and, as important, the strategic thinking of interdependence and shared goals. America’s corporate leaders. Th is report urges business leaders to consider the critical importance of societal Failure of corporations to shift to an approach—based concerns to their companies’ long-term sustainability, on substance, not image—that recognizes their inter- and it recommends ways in which corporate direc- dependence with the societies around them will further tors can take a leadership role better to address these erode society’s trust in, and support of, corporations concerns. and their leadership, a group that has fallen to an extraordinarily low level of public esteem—71 percent Plan of This Study of Americans rate the reputation of corporate America as poor.10 Th at result is not in the interests of either In the next chapter we examine what shareholders business or society. Society overall would be poorer and others say they want from global companies, and and less able to address its many needs and concerns we look at how companies have responded. Ample if business is not engaged in helping to fi nd solutions. evidence exists that large, global corporations are Business would also be hobbled, as it risks losing its increasingly attentive to societal issues, especially issues “license to operate,” imperils its access to needed physi- related to the environment. Yet, many have responded cal, fi nancial, and human resources, and invites ever to the challenge defensively, which has done little to greater scrutiny and more stringent regulation. lessen public distrust. Although market forces and the power of “enlightened In Chapter 3 we look at the key leadership role of self interest” are pushing many corporations to address boards of directors and make recommendations these issues, the actions taken thus far are slow, incom- for directors to promote a corporate culture that plete, and overall inadequate. Certainly, many large, recognizes societal interdependence and encourages global enterprises have shown that they understand honest reporting and proactive management of societal the importance of addressing societal issues because concerns facing their companies. they are confronted by them every day in multiple settings. New evidence of their awareness and of Chapter 4 provides some illustrative examples of how their activities surfaces almost daily, especially with these issues have played out in practice. Th ese exam- regard to environmental issues such as climate change. ples off er no pat answers but illustrate the diffi culty of Th e dynamism behind many present day corporate some of the problems faced and the types of solutions citizenship programs is impressive. But even leading that companies have developed. corporations can and should do more, and corporations Chapter 5 examines two diffi cult issues that fall outside outside the Fortune 500 need quickly to become more the bounds of any one corporation’s purview. Th e fi rst aware of their interactions with society and more active is the diff erent regulatory and governance regimes that in addressing them. apply to privately held and publicly held corporations. Failure to address environment, human rights, and How do these diff erences aff ect responses to societal other relevant societal concerns puts our prosperity at issues and the competition between these types of risk because it lowers our standard of living and the companies? Th e second issue is whether the roles and

11 responsibilities of government, business, and non-profi t entities can be clarifi ed in a way that enhances the individual and mutual objectives of all three groups. Can expectations and perceptions be changed to emphasize positive-sum rather than zero-sum outcomes? What steps can governments take? Chapter 6 provides a wrap-up of the issues and draws fi nal conclusions.

12 Chapter 2 Initiatives and Responses to Shareholder and Societal Concerns

In the wake of corporate scandal, fi nancial crisis, reces- operations and strategy. Many of these concerns sion, and increased activism on the part of sharehold- appear in the form of shareholder resolutions. ers, non-governmental organizations, and others, the public is paying increased attention to how businesses Th e Important Role of Pension Funds and other operate, what they do, and how they interact with the Institutional Shareholders broader society—their “authenticity,” as one group has Institutional shareholders—pension, insurance, mutual 11 termed it. Many of the underlying reasons for such funds and others—now hold nearly two-thirds of attention are linked broadly to the role of business in the equity of U.S. corporations. Th at is a signifi cant society rather than specifi cally to the corporation as change from the 1950s, when they held less than about such. But, the larger the business the greater its impact 10 percent.12 Defi ned-benefi t pension funds, which and the more attention paid to it. Most of the largest most often promote social and governance issues and businesses are public corporations, and these corpora- other concerns that aff ect long-term value, account for tions are under the most pressure to contribute actively about half of institutional holdings (one-third of total to the public good. Public corporations have diverse equity). ownership and shares traded in regulated markets. Th ey have unique responsibilities and governance Defi ned-benefi t pension funds must be long-term concerns, and operate under specifi c rules and regula- investors due to the structure of their liabilities, which tions that set them apart from non-corporate forms of demands payments far into the future. Th at is not to business and from privately held corporations. say that pension funds do not pursue short-term gains or trading advantages. In fact, many place a portion of Below, we examine some of the pressures on public their resources with hedge fund and other money man- corporations coming from shareholders and other agers who trade for short-term profi t opportunities. corporate constituencies. In Chapter 5, we look at how (See box 1, page 14) But at their core, such institutions public and private corporations face similar issues yet must pay attention to very long-term fi nancial goals, are treated diff erently in some respects. as the lives of their benefi ciaries extend beyond even a 30-year horizon. In addition, pension funds generally Long-term Shareholders’ Interests are broadly diversifi ed, in many cases indexing their Converge with Societal Interests holdings to refl ect generally the national and international economies. In economic terms, these funds are A public corporation has numerous shareholders with so diversifi ed that they internalize externalities—the varied interests. Th ough the number one interest of all results of actions by one fi rm that fall upon others.13 shareholders is return on investment, specifi c share- Th ey gain not when one company outperforms another holders, in particular those often described as “activist,” by shifting costs or profi ts in a zero-sum fashion, may have additional goals or alternative views on how but when companies expand productivity, engage in best to attain that return. Some hope to increase share positive-sum competition, and contribute broadly to value by promoting such steps as reducing takeover the social good. defenses, raising dividends, or restructuring or selling off corporate units. Others may seek to enhance the Some observers also have pointed out that the corporation’s value by encouraging consideration of benefi cial owners of pension funds—workers and how environmental change, human rights issues, or retirees—have broader interests than just their small other societal concerns might aff ect the company’s fi nancial stake in each of the thousands of companies

13 larger role in corporate fi nance as U.S. companies are Box 1. Defi ned-Benefi t Pension Funds increasingly dependent on foreign capital. Unless Contribute to the Problem current trends are reversed, it seems likely that foreign investors will nudge U.S. corporations to pay greater It seems common sense that defi ned-benefi t attention to societal issues. pension plans, which carry liabilities to pay benefi ciaries long into the future, should demonstrate Capital infl ows to the United States amounted to an interest in the long-term value of their holdings. nearly 7 percent of GDP in 2006 and 5.3 percent But many such plans allocate a portion of their in 2007. Infl ows of foreign capital are forecast to * portfolio to hedge funds and other asset managers continue at signifi cant levels into the future. A large who pursue short-term strategies for quick returns. portion of patient equity capital is supplied by inves- Like their corporate counterparts, pension fund tors in advanced economies of Europe, plus Japan managers and the asset managers they employ and Australia. Some, too, comes increasingly from typically are evaluated and compensated based on sovereign wealth funds in China and the oil-exporting quarterly fi nancial results rather than on long- nations of the Middle East. Many pension funds term performance. Th e consequent pressure for and other institutional investors in the former group short-term performance has a strong eff ect on asset of countries, more than the latter, are known to have managers’ incentives and makes it more diffi cult for strong feelings about the social role of corporations in corporate decision makers to take a longer-term which they invest. Th e latter group might be presumed view. not to care as strongly about meeting societal goals, but these funds tend to be relatively passive investors. It is particularly striking that corporate defi ned- benefi t pension plans act in the same short-termist Some recent international reports, associated with the manner as public pension plans and union plans. United Nations Environmental Program (UNEP) By placing their assets with hedge fund managers, (discussed below), have focused on the fi duciary duty fi duciaries of corporate pension plans—including of investment managers to assess how companies the corporation’s directors—take the risk that their handle environmental, social and governance (ESG) assets will be employed in ways that undercut the issues—a term rapidly replacing ‘CSR’ in discussions 14 corporation’s ability to engage in a long-term strat- of corporate social performance. Th e UNEP reports egy. Th e self-defeating nature of such placements conclude that ESG issues can aff ect corporate (and seems to go unnoticed by corporate directors. portfolio) performance, and therefore investors ought to give appropriate weight to them. Th at conclusion likely will add to shareholder pressure for action and, by some accounts, could create a more explicit duty for whose shares the pension fund holds. For example, corporate boards to review these issues as well. a pension-earning worker would not benefi t if the company he works for, and whose shares he holds What do activist funds say they want? through his pension fund, pollutes his community lake. Activist pension funds probably account for no more At a minimum, such confl icting interests make it dif- than 10 percent of total U.S. equity, but they have fi cult for pension fund fi duciaries to represent the full a substantial eff ect on the companies they own and economic interests of their ultimate benefi ciaries when on markets generally.15 Such funds seek to improve focusing exclusively on fi nancial returns. Many pension the performance of their investments by promoting fi duciaries, therefore, seek to go beyond such a narrow changes in corporate governance practices and aligning measure of wellbeing. their shareholder votes with their point of view. Th eir An additional source of pressure on public corpora- objectives tend to focus on four areas: board indepen- tions comes from foreign shareholders, who play a dence, minimization of takeover defenses, tying executive compensation to performance while restraining its

* In part, this increased dependency on foreign capital is driven by a historically low saving rate in the United States matched by extraordinarily high saving in the rest of the world. In part, too, the United States has been and remains an attractive location for investors to place their capital.

14 growth, and asserting the prerogatives of shareholders, invest, and with society overall. A document that as “owners,” to have a say in the corporation’s aff airs. closely mirrors CED’s concerns in the current context is “Th e Hermes Principles,” published by the UK-based Such concerns have led many of these funds, their Hermes Investment Fund, which invests on behalf of associations (the Council of Institutional Investors and UK pension funds, insurance companies, government the International Corporate Governance Network), entities and fi nancial institutions, as well as charities advisors (RiskMetrics’ ISS Governance Services, Glass, and endowments.18 In its own words, the Hermes Lewis & Co., and Proxy Governance), and others Principles attempt to address a simple question: “What (among them the American Bar Association, Business should owners expect from UK public companies Roundtable, National Association of Corporate and what should these companies expect from their Directors) to develop and publish principles, standards, owners?”19 Th e answers appear to be as applicable to and other guidelines by which to judge and prod the U.S. companies as to those in the United Kingdom, behavior of public corporations. Th e law fi rm Weil, and Hermes, along with others, has actively sought to Gotshal & Manges has identifi ed and summarized over hold U.S. companies to the same standard. (See box 2, 30 distinct governance objectives of some of the major page 16.) guidelines and codes published by pension funds, business associations, and others.16 Other institutional investors hold similar expectations of how corporations should operate. TIAA-CREF, Interactions between pension funds and the corpora- for example, in 2007 published the fi fth edition of its tions whose shares they hold can be complicated and “Policy Statement on Corporate Governance,” in which testy. Th e CtW Investment Group (CtW-IG), for it spelled out its interests as a long-term investor. Th e example, is a part of the Change to Win (CtW) coali- following excerpt summarizes, without the detail, much tion of unions.* Members of CtW affi liates participate of the contents of the statement: in public and Taft-Hartley pension funds claiming about $1.5 trillion in assets. Th e CtW Investment In keeping with our mission and fi duciary duty, Group was founded in February 2006. Its self- TIAA-CREF continues to establish policies described mission is to defend the interests of pension and engage with companies on governance, funds sponsored by CtW affi liates and other interested environmental, social and performance issues. groups “by organizing workers’ capital into an eff ec- We believe that, consistent with their business tive voice for corporate accountability and retirement judgment, companies and boards should: security.”17 Under this banner, short-term interests can (i) pay careful attention to their governance, create hostile interactions between the funds and the environmental and social practices; (ii) analyze companies whose shares they hold. the strategic impact of these issues on their business; and (iii) fully disclose their policies For the 2008 proxy season, for example, the CtW and decisions to shareholders. We expect Investment Group strategy was to oppose the re- boards and managers to engage constructively election of corporate directors who could be connected with us and other shareholders concerned to the sub-prime mortgage crisis. CtW-IG said it about these issues. would cast shareholder votes against directors at major U.S. banks who “fail to provide a compelling response” TIAA-CREF recognizes that corporate gov- to a request to describe what they did to assess their ernance standards must balance two goals — fi rm’s mortgage-related risk and management’s eff orts protecting the interests of shareholders while to control such exposure. respecting the duty of boards and managers to direct and manage the aff airs of the corpora- Short-term considerations aside, the goals of institution. Th e corporate governance policies set tional shareholders ought to be consistent with the forth in this Policy Statement seek to ensure long-term goals of the corporations in which they board and management accountability, sustain

* Th e CtW coalition members are: International Brotherhood of Teamsters (IBT); Laborers’ International Union of North America (LIUNA); Service Employees International Union (SEIU); United Brotherhood of Carpenters and Joiners of America (UBC); United Farm Workers of America (UFW); United Food and Commercial Workers International Union (UFCW); and UNITE HERE.

15 Box 2. The Hermes Principles

“Hermes’ overriding requirement is that companies be run in the long term interest of shareholders. Companies adher- ing to this principle will not only benefi t their shareholders, but also we would argue, the wider economy in which the company and its shareholders participate. We believe a company run in the long term interest of shareholders will need to manage eff ectively relationships with its employees, suppliers and customers, to behave ethically and have regard for the environment and society as a whole. Communication Principle 1 ‘Companies should seek an honest, open and ongoing dialogue with shareholders. Th ey should clearly communicate the plans they are pursuing and the likely fi nancial and wider consequences of those plans. Ideally goals, plans and progress should be discussed in the annual report and accounts.’ Financial Principle 2 ‘Companies should have appropriate measures and systems in place to ensure that they know which activities and competencies contribute most to maximising shareholder value.’ Principle 3 ‘Companies should ensure all investment plans have been honestly and critically tested in terms of their ability to deliver long-term shareholder value.’ Principle 4 ‘Companies should allocate capital for investment by seeking fully and creatively to exploit opportunities for growth within their core businesses rather than seeking unrelated diversifi cation. Th is is particularly true when considering acquisitive growth.’ Principle 5 ‘Companies should have performance evaluation and incentive systems designed cost eff ectively to incentivise managers to deliver long-term shareholder value.’ Principle 6 ‘Companies should have an effi cient capital structure which will minimise the long-term cost of capital.’ Strategic Principle 7 ‘Companies should have and continue to develop coherent strategies for each business unit. Th ese should ideally be expressed in terms of market prospects and of the competitive advantage the business has in exploiting these prospects. Th e company should understand the factors which drive market growth, and the particular strengths which underpin its competitive position.’ Principle 8 ‘Companies should be able to explain why they are the “best parent” of the businesses they run. Where they are not best parent they should be developing plans to resolve the issue.’ Social, ethical and environmental Principle 9 ‘Companies should manage eff ectively relationships with their employees, suppliers and customers and with others who have a legitimate interest in the company’s activities. Companies should behave ethically and have regard for the environment and society as a whole.’ Principle 10 ‘Companies should support voluntary and statutory measures which minimize the externalization of costs to the detriment of society at large.’” Source: Hermes Investment Fund

16 a culture of integrity, contribute to the strength (INCR), an alliance of 60 institutional investors that and continuity of corporate leadership and seeks to promote better understanding of the fi nancial promote the long-term growth and profi tability risks and investment opportunities posed by climate of the business enterprise. At the same time, change. INCR is coordinated by CERES, a coalition these policies are designed to safeguard our of investors and environmental groups “working with rights as shareholders and provide an active and companies and investors to address sustainability vigilant line of defense against fraud, breaches challenges such as global climate change.”22 of integrity and abuses of authority.20 Th e motivations that underpin the shareholder pro- In summary, shareholders are a diverse group with posals range from a straightforward concern for the many individual interests. Institutional sharehold- environment to worry that lack of voluntary action ers focused on long-term performance are raising will lead to mandated, more-burdensome regulatory important issues about fi rms’ governance, strategy, and measures in the near future. Many investors in the execution. Many of these issues are also being pursued United States look at the European cap-and-trade by non-profi t, civil-society organizations, frequently system for greenhouse gas emissions as a harbinger called non-governmental organizations (NGOs). of future action here. Indeed, groups of states across the country are moving to implement regional cap- Shareholders and Other Corporate and-trade systems in the absence of federal action. In Constituencies May Work Together to addition, although the United States is not a signatory Pursue Non-Financial Objectives to the Kyoto Protocol, the possibility of a follow-on agreement with U.S. participation threatens to raise Th e fi ling of shareholder resolutions for inclusion in costs for companies with poor environment practices.23 companies’ annual proxy statements is but one of many For many shareholders, perhaps the majority of those avenues shareholders and others use to exert infl uence off ering these resolutions, impending regulation in the on the corporation. Th e resolutions have the advantage U.S. market and ongoing regulation abroad constitute of being a visible measure of the societal demands on a competitive and material risk that corporations ought public corporations, although much of the interaction to address. with corporations, even with regard to fi led resolutions, takes place behind the scenes. Such resolutions can be For others, the development of new energy-effi cient fi led only by shareholders but many are developed in technologies and products provides a commercial conjunction with other corporate constituent groups opportunity to meet increasingly “green” consumer represented by NGOs. Th us, for example, many of the demand, and should be explored as such. Viewing shareholder resolutions fi led for the 2008 proxy season environmental concerns as an opportunity, many that focused on climate change and the disclosure and institutional investors want corporations to adapt their monitoring of political contributions were promoted by day-to-day operations and value-creation strategies to NGOs. take account of these new challenges and opportunities. For example, three separate 2008 shareholder resolu- Climate Change Resolutions tions requested ExxonMobil to develop specifi c green- Climate change resolutions led among shareholders’ house gas reduction goals, put forth and implement a social proposals, with 54 proposals fi led during the policy for renewable energy research and development, 2008 proxy season focused on this subject. Th at and publish a report on how to lead the development doubles the number fi led two years earlier and sur- of technologies to achieve a more energy independent 24 passes the previous year’s record high of 43 proposals.21 United States. In another instance, a socially active Th e proposals generally requested greater disclosure of non-profi t, the Nathan Cummings Foundation, sub- climate change practices, including information about mitted a shareholder proposal for Standard Pacifi c, one greenhouse gas reduction targets and renewable energy of the largest U.S. homebuilders, to adopt specifi c goals strategies. Many of the resolutions were proposed by to reduce greenhouse gas emissions in both its opera- * 25 members of the Investor Network on Climate Risk tions and its products.

* Th e proposal received 25 percent ‘yes’ votes.

17 Shareholder resolutions are the most visible and According to RiskMetrics, the resolutions follow easily measured actions shareholders are taking. But a template developed by the Center for Political in 2007, a group of institutional investors—mostly Accountability, an NGO that focuses on corporate public pension funds from such states as California, political spending.† As with many such proposals, Florida, Maryland, New York, and New Jersey—led shareholder proposals related to societal issues often by CERES, petitioned the Securities and Exchange come from activist groups rather than from long-term Commission (SEC) to issue interpretative guidance investors. Nevertheless, boards must give any share- that would force corporations to disclose business risks holder proposal due consideration. related to global warming.* In essence, the petition Other issues with substantial shareholder/societal seeks to accomplish through SEC action results similar support include universal health care, homeland to those sought by the individual resolutions discussed security, employment diversity, human rights, and above. product safety. Th ese shareholder resolutions typically Almost always shareholders act on their own behalf via are a component of a broader campaign to focus public resolutions or petitions as noted above. More recently, attention. Many of the individual proposals in areas however, New York’s attorney general, Andrew M. such as health care and human rights in particular Cuomo, added the weight of the state to shareholders’ are sponsored by unions and religious groups that are concerns about climate change when he subpoenaed simultaneously shareholders (through pension funds) several companies seeking to determine if they had and corporate constituents (in their social functions). properly disclosed risks of building new coal-fi red Of course, members of these groups are also likely to power plants. In August 2008, Xcel Corporation, be consumers, workers, and community neighbors of a leading builder of coal-fi red power plants, agreed the companies receiving such proposals. to disclose to shareholders the material risks, such Th e eff ort to promote corporate endorsement of as future lawsuits or the increased costs of potential universal, aff ordable health insurance illustrates regulatory rules that restrict carbon emissions, posed many of the complications and challenges facing by climate change.26 Cuomo remarked that the agree- public corporations. A shareholder proposal asking ment “sets a new industry-wide precedent that will companies to adopt ''principles for comprehensive force companies to disclose the true fi nancial risks health care reform,'' like those devised by the National that climate change poses to their investors. Coal-fi red Institute of Medicine, was submitted to several major power plants can signifi cantly contribute to global U.S. corporations during the 2008 proxy season.29 warming, and investors have the right to know all the Th e SEC, reversing previous policy allowing exclusion associated risks.”27 Th e agreement, the fi rst of its kind, based on infringement of ordinary business opera- will likely establish a precedent that corporations face tions, allowed the proposals to be included in proxy legal recourse if they fail to disclose properly risks materials for shareholders’ votes. Company responses related to climate change, and it may provide a template ranged from acceptance of the principles (GE, Medco for further such agreements. Health), opposition to the principles (Boeing, Reynolds Other Social Resolutions American), to engagement and negotiation with shareholders who proposed the principles (Wal-Mart, After climate change, the leading category of social IBM).‡ Although they arrived at diff erent solutions, issue proposals fi led by shareholders in 2007 dealt each company has had to address such questions as with political contributions, according to an analysis by whether it ought to endorse a contentious public policy the governance rating fi r m R i s k M e t r i c s . 28 Proposals issue not central to its core competency, how such a on political contributions usually ask companies to policy might impact its own operations and perfor- issue semi-annual reports on political contributions mance, and what the impact of its decision would be on and to provide guidelines for making contributions. its shareholders, employees, customers, suppliers, and others.

* In January 2009, the SEC had not acted on the petition. † CED’s Vice President and Director of Business and Government Policy, Mike Petro, is a member of the board of the Center for Political Accountability. ‡ Th e proposal received 7.3 percent ‘yes’ votes from Boeing shareholders. Th e proposal received 0.8 percent ‘yes’ votes from Reynolds American shareholders.

18 Other Demands of Corporate Constituents drivers of trust of a business are, in order: the quality of its products or services; customer service; and Non-shareholders lack a direct voice in corporate overall reputation.33 In this survey, the major drivers matters. As shown above, however, on many issues of reputation are a company’s social and environmental they have been able to form eff ective coalitions with track record and how it treats its employees. Th ese shareholders who share their concerns. Such links are factors are shown to translate into whether individuals not the only means by which corporate constituents say they will: buy a company’s products or recommend can infl uence business decisions, and, of course, there them to others; pay a premium for products or services; should be no presumption that such coalitions always choose to invest, speak or write in support of a com- operate in the best long-term interests of the corpora- pany’s actions; and support or block its plans to locate tion. Labor groups, consumer activists, and advocates in a community. of other causes have carried out eff ective campaigns by bringing market pressure or political pressure to bear Wal-Mart Watch is a prime example of a broad constit- on corporate targets. Such campaigns are aided by uency-based campaign meant to challenge a company’s inexpensive and ubiquitous communications technol- reputation and its ability to carry out company plans ogy, notably the Internet. As one analysis put it, “Th e and policies. Wal-Mart Watch is a project of the Internet has already triggered lasting change in the Center for Community & Corporate Ethics, whose structures of industries and the ways businesses create board includes leaders of the Service Employees value. Today, ubiquitous connectivity is creating new International Union (SEIU), the National Partnership relationships among businesses, customers, employees for Women & Families, Common Cause, and the and partners. People now have access to massive Sierra Club. It began in spring 2005 as a nationwide amounts of information—and opinions—about public education campaign to, in its words, “challenge products and company practices. Th is information is the world’s largest retailer, Wal-Mart, to become a available in every part of the globe, every minute of better employer, neighbor, and corporate citizen.”34 Th e every day.”30 “success” of the campaign can be seen in Wal-Mart’s battered reputation, coinciding with reduced sales and Th e changing landscape for information about busi- diffi culty in locating new stores. More recently, Wal- ness, and its meaning for corporate communications, Mart has shifted some policies to become a leading is well addressed by a report of the Arthur W. Page retailer of environmental products and a supporter of Society, an association of corporate communications healthcare reform and other societal initiatives.* offi cers and public relations agency CEOs.31 A particular concern highlighted by their report is the upending Wal-Mart Watch is but one organization focused on of the corporation’s ability to “segment audiences and one company. Th e number of NGOs and individu- messages and to mange how it wishes to be perceived.”32 als worldwide engaged in company-or issue-based Today’s corporation is more transparent to all its con- campaigns is too large to count—or to ignore. Such stituencies and less able to manage public perceptions. campaigns can impose real costs on companies. In this environment, authenticity—a grounded sense Societal demands are particularly acute in developing of what defi nes the company, why it exists, and what it countries, many of which hold a more expansive view stands for—is the clearest path to building a distinctive of both the social role of business and the validity of brand and achieving long-term success, according to civil society involvement in business decision making. these experts. Th e business environment in many developing countries challenges global companies in many dimensions. As discussed in Chapter 1, a company’s reputation can In some countries, the problem is not only that the be one of its most valuable assets. Th e Edelman Trust government or public opinion may demand greater Barometer is an annual survey of attitudes towards business involvement in society, but also that govern- business and other societal institutions. Th e 2008 ments and other social institutions may be unable edition of the Barometer showed the most powerful to supply basic public services such as education and

* CED, Wal-Mart, and SEIU are partners, along with other business, labor and public policy leaders, in the Better Health Care Together coalition, which seeks to reform the U.S. health care system.

19 health care or to establish and enforce appropriate plant trees, build homes, construct education centers, legal standards. In some locations, particularly in areas encourage employees to volunteer in their local com- where extractive industries have invested heavily in munities, provide free food to low-income countries, or long-term operations and where government authority engage in a vast number of other innovative activities.36 is weak, the global enterprise may be the dominant Of course, some do none of these things. Like all social institution. As such, it may be held accountable business challenges, some corporations are ahead of the both for results it cannot control as well as for those it curve and others are behind; each corporation will have can. In either case, the corporation may be vulnerable unique societal issues that may impact its performance. to negative publicity and obstruction of its goals unless Off -the-shelf solutions are unlikely to work well. it is prepared voluntarily to take on societal obligations. As a general observation, the manner in which corpora- Such challenges are not confi ned to low-income tions engage with society matters to results achieved. countries. Weak government authority, or the lack Surveys indicate that a majority of companies engage of government provision of services, also encourages defensively to minimize risk through public relations within the United States large corporations to provide campaigns (66 percent of those surveyed) or to mollify social services, especially in communities where they public concern by making charitable donations (65 have a dominant, long-term presence. In Chapter 5, we percent of those surveyed).37 Corporate executive of- take up the question of the division of responsibilities fi cers often employ such tactics despite admitting their between government and business. But in the present ineff ectiveness.38 More successful approaches emanate context, we observe that where government leadership from a core culture and strategy that guides behavior is particularly weak, organized civil society groups at all levels of decision making, throughout the value have ample room to become more active in promoting chain, across all areas of operation, at all times. Th ey business solutions to societal problems. tend to be proactive, interactive, transparent, and oriented toward integrating societal objectives into A signifi cant diffi culty for businesses, whether in long-term business strategy including product develop- developing countries or in the United States, is to ment—GE’s Ecomagination initiative is the model. understand both the host of demands on business and its capacity to meet those demands. Some groups Most corporate executives, especially those in large, admit to seeking a broad “new social contract” between global enterprises, profess a commitment to solving so- business and society, involving the shifting of some cietal problems. Th ey recognize that the value of their social responsibilities onto business—a goal beyond the company’s brand—its reputation—is based not only means of any one business to satisfy. A company may on the products and profi ts they make but also on how face so many individual demands that meeting them all they are made and, more broadly, how the company would be impossible. Further, it is often the case that is perceived to interact with society.39 Seventy-fi ve diff erent corporate constituents and NGOs have con- percent of executives of large fi rms say that reputation fl icting demands. How does a business decide which motivates their companies’ eff orts to engage in society.40 ones are legitimate, which ones ought to be addressed, Eighty-four percent of CEOs believe corporations and which ones can be addressed at reasonable cost? must contribute to the broader public good, for example by making philanthropic donations, providing Corporations Have Responded, but Most employee benefi ts, going beyond legal requirements to are Behind the Curve abate pollution, or meeting ethical standards, according to a McKinsey survey. 41 Surveys also indicate that Businesses diff er along many dimensions: size, location, companies pursue social objectives to retain and recruit industry, and other characteristics. Th ey also diff er employees, and because of the tangible contributions of on commitment to social engagement, engagement corporate citizenship activities to the business bottom with shareholders or other groups, and recognition of line. the importance of social factors to their own success. Some corporations (a majority according to one survey) Th e aspirations and attitudes of corporate executives, commit to meet specifi ed ethical guidelines.35 Others however, do not always translate into equivalent action. set goals to meet environmental and labor standards, A spearate McKinsey survey revealed that only half of

20 those surveyed actually integrate a stance on environ- In July 2008, the CFA Institute Centre for Financial mental, social and governance issues in strategies and Market Integrity, a professional association of fi nancial operations. Another survey showed 60 percent of U.S. market analysts, published an ESG Manual to help executives saying corporate citizenship is part of their investors and investment professionals better to “iden- business strategy, while only 39 percent reported that it tify and properly evaluate the risks and opportunities actually is part of their business planning process, and that ESG issues present.”46 Th e manual recognizes only 28 percent indicated they have formal corporate investors’ increased interest in social factors that citizenship policies and statements.42 Th e disparity increasingly are aff ecting the valuation of corporate between business claims and actions has led to the shares. It provides a primer on the vocabulary of ESG paradoxical result that corporate reputation is often analysis and a road map to help investors and analysts diminished rather than enhanced. Only forty percent fi nd applicable information in company reports. of the public trusts corporate businesses to act in the In 2007, Goldman Sachs launched its “GS Sustain” interest of society.43 focus list, which analyzes companies on the basis of Numerous factors constrain corporate behavior “sustainability of corporate performance.”47 While and make it diffi cult to engage in societal concerns. the GS Sustain analysis claims no hard evidence that Corporate executives, particularly those in smaller investing on the basis of environmental and social fi rms, typically cite “not enough money,” “not enough criteria adds value on its own, it does suggest that fi rms time,” and “not enough people” as the three principal that integrate and publish economic, social, and envi- factors limiting corporate engagement.44 Costs limit ronmental criteria with fi nancial analysis have outper- even the most productive activities of a corporation, formed the market by 25 percent.48 Other investment and diff erences in costs between a company and its groups, such as Citigroup, JP Morgan, and West LB, competitors can be a decisive factor. Unless a com- also have initiated dedicated ESG units.49 pany’s competitors bear similar costs, the individual Th e GS Sustain analysis starts from the premise that fi rm may conclude that it will be penalized if it diverts “Globalization and a changed political landscape are resources from immediately productive activities to combined with signifi cant changes in populations, pursue objectives that are longer term or appear ancil- urbanization, resource utilization, climatic patterns, lary to the company’s mission. Surveys suggest that and employee and consumer attitudes. Th e evolution of CEOs of large and small corporations alike seem to communications networks means that there is greater prefer structural-type governance reforms—instituting connectivity than ever before and, in conjunction with ethical guidelines and practices—over more substan- the rise of the NGO, companies operate in a more tive, and potentially costly, reforms. transparent environment than previously.”50 Its model evaluates how companies interact with four key factors: Financial Analysts and Investors Use the economy in general, their industry, society, and the Social Information to Evaluate Company environment. It specifi cally incorporates the principles Performance of the UN Global Compact and holds that “leadership 51 A frequently cited reason why corporations do not on these issues is crucial.” (See box 3 on the UN pay more attention to societal issues is that they do Global Compact, page 22.) not see such concerns to be relevant to the bottom Th e Goldman Sachs analysis grew out of an invita- line or of material interest to investors, aside from the tion from a group of investors that formed the Asset few socially responsible investment (SRI) funds that Management Working Group of the United Nations are managed specifi cally with regard to such concerns. Environment Program Finance Initiative (UNEP-FI). If investors and investment valuation models do not Th e UNEP-FI, launched in 2003, has been actively confi rm the worth of social engagement, the incen- examining “the materiality of environmental and social tive to undertake such activities will be low. Recent considerations and criteria as they relate to the port- research, however, indicates that social engagement is a folio management of mutual funds, pension funds and signifi cant factor in valuing a company’s performance, 52 45 other institutional funds.” In 2007, it issued fi ndings and stock analysts have begun to pay attention. based on reports provided by ten sell-side brokerages

21 Box 3. The Ten Principles of the UN Global Compact

Th e UN Global Compact has rapidly become the standard for companies and others seeking a forum for issues involving business/society interdependence. Launched in July 2000, the Compact had over 4000 business participants in April 2008. Th e Compact does not police or enforce adherence to these principles, although it has delisted companies that failed to report or demonstrate participation. It relies on voluntary compliance and the power of public information and non-