Chapter 4

Virtue, Justice, and Social Responsibility

Like many rural towns, Coudersport, Pennsylvania, owed its prosperity to one family. Tucked among the rolling northern hills of Appalachia, Coudersport had cable company Adelphia Communications at its epicenter and town patriarch John Rigas as its protector. Rigas was an affable sort who, along with two of his sons, built Adelphia into the sixth-largest cable company in America. Starting from humble roots, Rigas seemingly was everyone's best friend in this tiny town of 2,600 residents. If you needed a loan, a job, or a donation to a local charity, Rigas and the company were always ready with a helping hand. Adelphia, which means brother in Greek, epitomized corporate social responsibility, figuratively serving as every resident's compassionate sibling in times of need. All of this changed, though, as this publicly traded company piled on unsustainable debt levels. Rigas and his sons started using a company jet as a family taxi for whirlwind shopping trips, and they raided the company bank account as if it was their private piggy bank.

As the Rigas family's acts of social responsibility transformed into reckless irresponsibility, the company's auditors and bankers tacitly acquiesced. Eventually, though, the family's misdeeds caused Adelphia to disintegrate into bankruptcy, and Coudersport crumbled alongside it. This town of brotherhood had lost its soul to the unscrupulous acts of a dysfunctional family and the financial professionals who idly failed to stop them.

This chapter will extend our previous discussion of ethical theories by focusing on philosophies of justice, virtue ethics, egoism, and social responsibility.

DISTRIBUTIVE JUSTICE

The Nature of Justice

Imagine that you are in charge of giving away a truckload of perishable food to residents of a small famine-struck village. Would you give every resident the same amount? Or, would you divide the food based on some other measure, such as a person's age, weight, health, gender, or social status? Distributive justice focuses on how individuals should share society's resources and burdens.1

Theories of Distributive Justice

The two most prominent philosophies of distributive justice were espoused by Aristotle and modern-day philosopher Thomas Rawls.

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Figure 4-1 How Wealthy Are the Richest 1% of People in the World?2

Aristotle's Theory of Distributive Justice

The core proposition of Aristotle's theory of distributive justice is straightforward: Equals should be treated equally.3 This ethical precept, first set forth over 20 centuries ago, has the advantages of simplicity and universal acceptance.

Despite the straightforward nature of Aristotle's view, it is often challenging to apply its core principle to real-world situations. Consider, for example, a company in which each of its two division managers earned exactly a 12.7% return on assets. One manager achieved this return by investing in risky projects, and the other only invested in low-risk projects. Are both managers equals who should receive the same year-end bonus? Or, was the second manager superior because she also benefited the company by minimizing its risks?

Aristotle's theory of distributive justice also established a corollary principle: Unequals shall be treated unequally, with the magnitude of their differential treatment proportionately reflecting the degree to which they are unequal. Simply stated, if one employee is 20% less productive than others, his employer should pay him 20% less.

Applying this principle, in practice, can be challenging. For example, under the tax law, a divorced parent who files a Head of Household tax return receives preferential treatment over a childless person who files as a Single taxpayer. However, quantifying the degree to which heads of household and single individuals merit disparate treatment is, at best, highly subjective.

Rawls's Theory of Social Justice

The Core Approach

Imagine that you and several strangers have decided to play a card game with a special twist. Rather than set the card game's rules ahead of time, all participants have agreed to set the rules of the game only after all players have reviewed the cards dealt to them. Naturally, subsequent to reviewing the dealt cards, one player might suggest a high point assignment for, say, aces and spades, but others might suggest a different scoring system. After failing to reach a consensus, the players naturally will conclude that the fair approach is to establish the rules of the game before any cards have been dealt.

Thomas Rawls was a 20th-century philosopher who essentially took the lesson learned from this imaginary card game and applied it to create Rawls's Theory of Social Justice. This philosophy of distributive justice rests on two core observations.

First, Rawls recognized that we all enter this world with various advantages and disadvantages. Some of us are born with extraordinary talents and abilities; others are not especially gifted. We also differ in myriad other ways, such as by gender, ethnicity, physical capabilities, and family social class. To continue the card game analogy, we all are dealt different sets of cards.

Second, Rawls recognized that the characteristics bestowed on us at birth invariably affect our attitudes and concepts of justice. For example, people who are born with physical limitations are more likely to favor societal policies that accommodate their disabilities. Similarly, people whose talents allow them to generate high incomes tend to favor lower taxes and smaller government, whereas those less fortunate tend to favor expansive government programs and greater wealth redistribution.

To achieve a just society, Rawls reasoned, we must establish societal principles that are not biased by the endowments with which, in hindsight, we fortuitously have been blessed or cursed. Rather, we should allocate society's resources as if we had made a binding pact prior to knowing our eventual status in life. Rawls calls this agreement a hypothetical social contract. Moreover, he coined the phrase veil of ignorance to describe his notion that decisions about what is fair should be made blindly, without an after-the-fact awareness of what our ultimate attributes and attainments are.

Consider two scenarios.

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Figure 4-2 The Wealth of the Richest 85 People Equals the Wealth of the Poorest Half of the World Population.6

As one choice, you can live in a society in which half of the population is very poor and half is very rich. The poor segment will struggle with satisfying its daily needs for food, shelter, and health care. The rich segment, in contrast, will live opulent lifestyles with yachts, vacation homes, and diamond jewelry.

Alternatively, you can choose to live in a society where all citizens enjoy a middle-class standard of living. No one is rich, and no one is poor.

Rawls contends that, if you had to make your choice under a veil of ignorance, without foresight about whether you ultimately will be in the rich group or the poor group, most people would opt for a society in which all members were equally well off.5

The Difference Principle

Rawls was a pragmatist who understood that if every citizen was assured an outcome of perfect equality, no one would have any incentive to work hard. Thus, Rawls set the equal sharing of wealth as an ideal goal, but then modified this view with what he called the difference principle. According to this principle, it is acceptable to provide greater rewards to some people as long as this difference also improves the welfare of those who are the least well-off.

THEORIES OF DISTRIBUTIVE JUSTICE CORE PHILOSOPHY
Aristotle
  • Equals should be treated equally
  • Unequals should be treated unequally in proportion to the degree of their differences
Rawls
  • The distribution of wealth should be agreed upon as if a veil of ignorance prevented us from knowing our eventual traits, skills, and status in life
  • The Difference Principle allows some people to receive greater rewards than others as this creates incentives that make the least fortunate better off as well

Figure 4-3 Distributive Justice Summary.

The Neurobiology of Distributive Justice

For some, a just distribution of society's resources is not just a political or economic goal; it is a biological imperative.

In a scientific experiment called the Ultimatum Game, participants hooked up to brain scanners were told that another person, called the Giver, was about to share a pool of money with them. If the Giver gave $5 of his $10 to the Receiver, this equitable offer activated the same brain regions that become excited when “we eat craved food, win money, or see a beautiful face,” said one researcher. Fairness “satisfies a basic need,” and “we apparently are wired to treat fairness as a reward.”8

In contrast, when the Giver gave the Receiver only $5 out of $23, the brain regions associated with disgust, rather than pleasure, were activated.9

Outside the laboratory setting, we can see this same phenomenon when, for example, people dance in the streets after learning of a just jury verdict or enthusiastically shout their approval when a football referee corrects an inaccurate touchdown call. Apparently, for many, justice tastes as sweet as candy.

VIRTUE ETHICS

As we previously have seen, many philosophies of ethics focus on the outcome of a specific act. Consequentialism focuses on whether an act generates a net societal benefit, deontology looks at whether a decision maker's act conformed to a duty, Aristotle's distributive justice view explores whether an act gives equal people equal treatment, and Rawls examines whether acts that benefit the most fortunate create outcomes that also benefit the least fortunate.

The virtue ethics philosophy, first propounded by Plato and Aristotle, is different. Rather than focusing on outcomes and concrete rules of action, virtue ethics focuses on improving inputs that develop a person's innate value system. These inputs may include education, parental teachings, peer discussions, attendance at professional association meetings, religious worship, and other forms of training that help prepare a person for the eventuality of making ethically correct decisions. To use a firefighting analogy, most philosophies focus on how a firefighter should behave when a forest is on fire. Virtue ethics instead focuses on making sure that rigorous training gives firefighters the strength and mental agility to face the daunting array of dangers they may one day encounter in dousing fires.

Adherents to virtue ethics promote a core set of traits that includes compassion, fairness, courage, honesty, integrity, wisdom, self-control, kindness, and loyalty.

The characters in the classic movie The Wizard of Oz provide a wonderful illustration of virtue ethics. The Tin Man seeks a heart so he can act with compassion and fairness. The Cowardly Lion pursues courage that will enable him to make brave, honest decisions that exemplify integrity. Their scatter-brained friend, Scarecrow, wonders out loud, “If I only had a brain,” as he pursues wisdom and self-control. Last, throughout this epic tale, Dorothy displays kindness to her newfound friends and loyalty to her family and dog Toto as she ultimately “clicks her heels three times” to return home to the loved ones who raised her.

EGOISM AND CONCERN FOR OTHERS

The Nature of Egoism

As we saw in the previous chapter, decision makers applying utilitarianism try to maximize the net benefits that inure to overall society.

Although utilitarianism is the most common form of consequentialism, consequentialism has other variations as well, including one called egoism. The philosophy of egoism, like all consequentialist approaches, looks at end results. However, egoism is solely concerned with maximizing the utility of a self-focused decision maker, not the utility of overall society.

Proponents of Egoism

The view that decision makers should only be concerned with themselves has been expressed in many different ways over the years. In ancient times, the philosopher Horace summarized the egoism viewpoint when he said, “Make money by honest means if you can; if not, by any means make money.”10 More recently, actor Matthew McConaughey expressed a modern-day version of egoism: “I'm a fan of the word selfish. Self. Ish. When I say I have gotten a lot more selfish, I mean I am less concerned with what people think of me. I'm not worried about how I'm perceived. Selfish has always gotten a bad rap. You should do for you.”11

The self-focused nature of egoism frequently is ridiculed for being uncaring and myopic. However, it has its defenders, such as Nobel Prize-winning economist Milton Friedman. Professor Friedman would never have encouraged businesses to make money “by any means.” He firmly believed that individuals and corporations alike are bound to abide by the law, as well as by ethical customs. Nonetheless, he expressed a view that was akin to egoism: “There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”12

Friedman's viewpoint encapsulates the neoclassic microeconomic models studied in introductory economics classes. One tenet of the perfect competition economic model is that resources are allocated most efficiently, and society most benefits, when individual market participants lawfully pursue their own well-being.

Friedman's views echo those of early philosophers, such as Adam Smith. In 1776, during the birth of America, Adam Smith famously wrote of the economy's invisible hand that guides us to prosperity: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.”13 Every man “intends only his own gain… led by an invisible hand to promote an end which was no part of his intention…. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it.”14

Author Ayn Rand was even more outspoken in expressing similar beliefs. She once wrote that “achievement of your happiness is the only moral purpose of your life,” and that she would “never live for the sake of another man, nor ask another man to live” for hers.15

Even ancient philosophers such as Aristotle wrote about the benefits that result from the pursuit of self-interest. According to Aristotle, a good in small quantities may have great value, but a saturation point eventually is reached at which having more of a good adds diminishing value to its owner. As a result, two property owners who have reached their respective saturation points can both be made better off by exchanging their goods with one another. In short, by acting purely out of self-interest, all participants in economic transactions are made better off.16

Critics of Egoism

Of course, not all philosophers, or entrepreneurs, agree with the self-interested nature of egoism. Henry Ford, one of America's greatest industrialists, once stated that “a business that makes nothing but money is a poor kind of business.”

Henry Ford's management style was an unusual mixture of generosity and paternalism. Ford paid workers far higher wages than other companies did. To qualify for this higher wage, though, workers had to allow the company's Socialization Committee to inspect their homes to verify that they were avoiding destructive activities, such as gambling and excessive alcohol consumption. Immigrant workers also were required to learn English and attend classes to become Americanized. Many believe that Ford was motivated by a sincere concern for his employees. Cynics, however, suggest that his principal goal was to create a reliable workforce that would resist the temptation to unionize.

Henry Ford's policies were heralded by many, but he also had many critics. When Ford Motor Company was sued for straying from its profit-seeking mission, a court had to remind Ford that “a business corporation is organized and carried on primarily for the profit of the stockholders.”17

CORPORATE SOCIAL RESPONSIBILITY

Here is a puzzle: A corporation has never paid a dividend in its nearly 100-year history, and its bylaws prohibit investors from reselling its stock for more than 25 cents per share. How much would you pay to buy this stock?

It may surprise you that over 250,000 people happily have purchased this stock at double-digit prices, fully aware that they overpaid millions of dollars. The stock is no ordinary stock; it is an ownership slice of the iconic Green Bay Packers football team. The buyers are not ordinary investors either. Rather, they are loyal Wisconsin Cheesehead fans who gladly overpaid because they know that the Green Bay Packers organization uses its profits to serve charities and other deserving stakeholders in its small community. These investors have soundly rejected egoism's parochial focus on profits and warmly embraced corporate social responsibility.

None of the Green Bay Packers benefactors will ever suit up for the game, catch the football, or stand anywhere near the huddle. Nonetheless, as believers in corporate social responsibility, they are team players in the truest sense.

The Nature of Corporate Rights and Duties

It is well established that corporations have numerous rights. Corporations have the right to enforce contracts, protect their inventions, and even exercise Constitutional rights under the First Amendment. For instance, corporations have certain free speech rights, such as the right to donate money to political candidates and the right to advertise the sale of liquor and other lawful products. Some corporations even have the right to freedom of religious expression. In a controversial 2014 decision, the U.S. Supreme Court exempted certain family-run corporations from having to provide contraceptives to female workers if doing so would violate the company's religious values.18

It is equally well established that corporations have responsibilities, but the scope and breadth of these obligations remain controversial. Does a corporation fulfill its responsibilities merely by adhering to laws and maximizing shareholder wealth? Or, does a corporation owe a broader set of ethical responsibilities to society? We will now examine two contrasting views, known as shareholder theory and stakeholder theory.

Shareholder Theory

According to shareholder theory, a corporation's sole duty is to maximize the welfare of its stockholders.

Imagine that you hired a smart friend to invest your money to earn the maximum profit attainable. If your friend instead spent your money in ways that did not further your goal, you surely would hold him accountable.

According to shareholder theory, corporate directors and officers, in economic terms, are like your smart friend. Investors entrust these individuals with capital and expect them to earn the maximum profit attainable. Unless they are given a different mandate, directors and officers have both the ethical and legal duty to manage a corporation in the best interests of the shareholders who effectively employ them.

Economist Milton Friedman summarizes this viewpoint as follows:

A corporate executive is an employee of the owners of the business. He has direct responsibility… to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.19

Billionaire Warren Buffett distinguishes between his personal responsibility to give to others and his duties as a corporate director to solely maximize shareholder profits. Although he has given billions of dollars to philanthropic causes in his individual capacity, Buffett nonetheless is skeptical about corporate philanthropy:

When A takes money from B to give to C and A is a legislator, the process is called taxation. But when A is an officer or director of a corporation, we call it philanthropy.20

Rather than eliminate all acts of corporate social responsibility, Buffett decided that the company he manages, publicly traded Berkshire Hathaway, would divide charitable giving into two categories: “(1) Donations considered to benefit the corporation directly in an amount roughly commensurate with the cost of the donation and (2) Donations considered to benefit the corporation indirectly through hard-to-measure, long-delayed feedback effects of various kinds.”21 Berkshire Hathaway directly oversees donations in the first category, but allows its shareholders to designate the charities benefited by the second expenditure category. As Buffett declared, the company's donations are “owner-directed” to “imitate more closely-held companies, not larger public companies.”

For many years, privately held Craigslist has been in a bitter ongoing battle with eBay, which is one of its three shareholders. Craigslist's other two shareholders are civic-minded individuals who believe that Craigslist's mission is to serve its community of users, not to maximize short-run profits. Craigslist provides most of its Internet-based services free of charge, which irks profit-minded eBay. In a landmark victory for eBay and the shareholder theory, a Delaware judge admonished Craigslist's directors that “the corporate form… is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment.”22

Stakeholder Theory

Stakeholder theory asserts that a corporation owes a broad set of duties to the various constituencies that it affects. Stakeholders include all groups that are “vital to the survival and success of the corporation,”23 including employees, customers, suppliers, community organizations, and governments.

Proponents of stakeholder theory contend that, just as individuals owe moral duties to their fellow citizens, corporations likewise have ethical obligations to the communities in which they conduct business. This viewpoint finds support in various philosophies. For example, utilitarians believe that ethical decisions must maximize the total welfare of all members of society, not just a subset of its members. Similarly, deontology speaks of a duty to respect the dignity of all people, and distributive justice requires successful corporations to share their largesse with less-fortunate stakeholders.

Contentions in Favor of Stakeholder Theory

Supporters of stakeholder theory point to numerous incidents, ranging from industrial explosions to oil spills, in which corporations have sacrificed safety and society in pursuit of higher profits. In particular, many point to Ford Motor Company's Pinto car model as a prototypical example of the catastrophic consequences that can result when cost accounting calculations have primacy over common sense.

While trying to compete in the 1970s against small imported cars, Ford Motor Company discovered that its much-awaited small car, the Pinto, had a serious design defect. In the event of a rear-end collision, the Pinto's gas tank could explode into flames, causing severe injuries to the car's passengers.

The Pinto was already in its preproduction phase, however, and Ford's management did not want to delay its introduction. As a result, well aware of the Pinto's fire hazards, Ford nonetheless decided to market the Pinto to an unsuspecting public.

After this defect was implicated in numerous tragic accidents, investigators discovered a document in which Ford's cost accountants had performed a disturbing breakeven analysis. If Ford were to fix the Pinto's defective design, this document showed that it would incur well over $100 million in costs. Alternatively, if Ford simply allowed the problem to persist, Ford's accounting analysis dispassionately estimated that the costs of compensating accident victims, at a “unit cost” of $200,000 per death and a lesser amount per injury, would be only about $50 million. Weighing these cost alternatives, Ford Motor Company decided to continue the Pinto rollout, knowing that an average of 180 additional drivers would die in fiery explosions and thousands more would suffer disfiguring burn injuries. As one commentator starkly stated, after crunching the numbers, Ford Motor Company decided, “Let 'em burn.”24

Figure 4-4

It is often said that those who forget the past are condemned to repeat it.26 Despite having the Ford Pinto debacle as a prologue, General Motors failed to heed its lesson about stopping a small design defect before it becomes a huge disaster. In 2014, investigators discovered that engineers at General Motors knew that the ignition switch on certain cars would shut off while driving, leaving drivers without the power to steer or brake. After many deaths, Congressional hearings, lawsuits, and widely publicized accusations about its lack of social responsibility, General Motors recalled millions of cars at a cost exceeding a billion dollars. And what was the cost of each replacement ignition switch? 57 cents.27

Contentions against Stakeholder Theory

In denigrating stakeholder theory, critics assert that corporations already promote the broader social welfare by creating jobs, advancing technology, delivering goods and services that satisfy consumers' desires, and paying taxes that support worthy social programs and public projects.

Critics further contend that corporations are ill-equipped to ascertain if their decisions, on balance, help or hurt various stakeholders. For example, proponents of the natural resource extraction process called fracking contend that it creates jobs, lowers gas prices, reinvigorates rural communities, and enhances America's energy independence. According to environmentalists, however, fracking may contaminate groundwater, release greenhouse gases that contribute to climate change, and pose unknown risks to our health and welfare. Does fracking, on balance, help or harm society?

Sustainability and Corporate Social Responsibility

Decades ago, Oskar Schindler was an opportunist who later epitomized the principles of corporate social responsibility, or CSR. As the Academy Award-winning movie Schindler's List chronicles, Schindler was a hard-nosed German businessman who hoped to capitalize on the Nazis' rise to power by setting up a factory run by cheap Jewish laborers herded into Polish detention camps. After observing the cruel treatment in the death camps, however, Schindler shifted his business focus from making money to serving humanity.

As the war continued, Schindler spent large sums bribing Nazi officials to give him more Jewish workers, ostensibly to expand his business. His true motive, though, was to spare the lives of these detainees. By the time that the Allied forces prevailed over Hitler, Schindler had sacrificed his personal fortune to spare over 1,000 lives from certain death. Schindler's devotion was a wonderful display of conscience, as well as one of the greatest examples of corporate social responsibility in modern history.

Corporate social responsibility is a natural extension of stakeholder theory. It is often said that to do well, businesses first must do good. Many professional services firms, such as accounting and law firms, encourage, or even require, their personnel to devote time to unpaid public-interest work. These activities commonly are referred to by the Latin phrase pro bono, which means “for the public's good.”

Defining Corporate Social Responsibility

The concept of doing good has defied precise delineation, with one scholar calling corporate social responsibility an “eclectic field with loose boundaries.”28 Three different meanings often are ascribed to the phrase “corporate social responsibility (CSR).”

According to the International Organization for Standardization, CSR is the “responsibility of an organization for the impacts of its decisions and activities on society and the environment through transparent and ethical behavior.”29 Most commentators, however, do not adopt this view that mere compliance with ethical and legal norms qualifies as social responsibility because all citizens are held to this minimal standard.

An alternate definition has been established by the Australian Securities and Investment Commission. According to this standard of CSR, entities must “voluntarily integrate social and environmental factors into their operations and their interaction with their stakeholders, which are over and above the entity's legal responsibilities.”30 Under this definition, a toy company that develops a line of educational toys that stimulates children's brain development would be engaged in CSR, even if the company's sole motive was to make more money, not to benefit society.

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Figure 4-5 What Is CSR?

Finally, among academicians, CSR commonly is defined even more narrowly as the set of “actions that appear to serve some social good, beyond the interests of the firm and that which is required by the law.”31 Under this definition, creating a safer workplace surely creates “social good.” However, if the company's purpose for creating a safer workplace was to boost profits by cutting workers' compensation costs, its expenditure would not qualify as a CSR act because the company lacked the intent to serve social good beyond pursuing its self-interest and obligations to comply with the law. To establish a consistent framework for analysis, this definition shall be used throughout this chapter.

Accounting for CSR

Nobel Prize-winner Joseph Stiglitz says that measuring national welfare by only computing Gross Domestic Product is like a car having “a dashboard [with] only one gauge… GDP tells you nothing about sustainability.” “There needs to be a focus on what we call Green GDP—taking account of environmental degradation and resource depletion.”32

The Global Reporting Initiative is a joint venture of various organizations, including accounting regulatory bodies, that has developed a comprehensive framework for assessing and reporting corporate social responsibility. Although the specific elements of doing good continue to evolve, the Global Reporting Initiative has identified the following benchmarks for evaluating corporate citizenship:

  • Environmental sustainability, including the use of renewable energy, abatement of water and air pollution, secure disposition of hazardous wastes, recycling, and resource conservation
  • Respect for human rights, humane working conditions, and diverse cultures
  • Employment practices that foster workplace safety, job security, and opportunities for advancement
  • Community involvement, such as through investment in the arts and education
  • Ethical business practices that enhance customer privacy and do not sanction corrupt or anticompetitive practices
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Figure 4-6 Corporate Social Responsibility.

The Sustainability Accounting Standards Board, or SASB, is a privately funded, nonprofit organization that is developing similar industry-specific standards for possible adoption by the SEC. Its approach is to encourage corporations to report a triple bottom line that reflects their financial, social, and environmental performance. John Elkington, the founder of British consulting firm Sustain-Ability calls this three-pronged approach the “three Ps” of reporting: Profit, People, and Planet.

The first official mandate of CSR accounting took effect in 2014, which supporters of CSR reporting heralded as a historical event. In accordance with the Dodd–Frank Act, American companies have to disclose in audited SEC filings whether inhumane central African militias supply them with so-called conflict minerals.33 To comply with this new rule, Intel issued the following disclosure:

Conflict minerals originating from the Democratic Republic of the Congo (DRC) and adjoining countries are sometimes mined and sold, under the control of armed groups, to finance conflict and violence.… We have worked diligently to put the systems and processes in place to enable us to reasonably conclude that the tantalum, tin, tungsten and gold in our products do not finance or benefit armed groups in the region.…34

In 2014, India as well imposed both CSR spending and accounting mandates on large firms doing business there. According to India's new Companies Act, covered companies must spend a minimum of 2% of their domestic profits on CSR activities, such as providing preventative health care, improving public sanitation, and sheltering the homeless. For this purpose, expenditures that improve the well-being of workers and their families do not qualify as CSR expenditures.35

The Importance of CSR Accounting

The importance of a company's image cannot be underestimated. According to the private consulting firm Reputation Institute, 60% of consumers' willingness to buy from a company depends how they perceive the company's reputation.36 Research in Europe suggests that a corporation's reputation for social responsibility is, on average, even more important to Western European consumers than to American consumers.

The Reputation Institute's study further states that a company's reputation in turn hinges on three key ingredients of CSR, which it labels Citizenship, Governance, and Workplace. Recently, Disney topped this study's list because of its efforts in promoting the well-being of families and minimizing its environmental impact.37

Emerging Challenges in CSR Accounting

Even supporters of CSR acknowledge that the emerging field of CSR reporting has its limitations.

Figure 4-7

First, it is not always clear if a well-meaning act actually promotes social good. To illustrate, does a company achieve social good when it closes a high-polluting coal-powered manufacturing plant, but its actions cause massive unemployment and bankruptcies in a nearby coal mining town? Or, consider the decision by top movie theater chains in 2014 to cancel showing the comedy The Interview when offended North Korean officials satirized in the film purportedly threatened to incite terrorist acts at theaters exhibiting it. Did these theaters achieve social good by protecting patrons against harm? Or would they have better promoted social good by exhibiting this movie, in defiance of these threats and in support of freedom of expression?

Consider, too, the plight of Duke Power Company. Duke thought that it was accomplishing social good when it built a renewable wind energy project in Wyoming. However, Duke's project angered conservationists because the massive spinning blades on its turbines killed endangered species, such as golden eagles.38 Although environmental regulators who initially favored Duke's project knew that harm to unsuspecting birds would be an unavoidable by-product, they nonetheless imposed a $1 million fine on Duke for violating the Migratory Bird Treaty Act.

In addition, as we have discussed, not all acts that benefit the public interest are considered to be CSR. For example, compliance with the law, such as implementing mandated safety and labor regulations, is not considered a CSR act. Moreover, actions implemented by a corporation in pursuit of its narrow self-interest are not considered CSR. For example, corporations that shift to recyclable packages solely to cut costs or embrace all-natural ingredients solely to attract health-conscious consumers are not engaged in CSR.

Unfortunately, it can be challenging to distinguish between true acts of CSR and mere publicity stunts. As a result, in evaluating CSR accounting, it is important to probe whether an act truly is motivated by the public interest or whether it merely is a cynical profit-seeking ploy designed to manipulate the public.

The Impact of CSR on Financial Results

Does being a good corporate citizen affect a company's stock performance?

Researchers valiantly have tried to answer this question, but they encounter great difficulties in distinguishing a true CSR act from a self-promoting public relations act.

Consider the following excerpt from candy maker Hershey's Corporate Social Responsibility Report:

West Africa is a region of continuing focus for our company. It is where we source the majority of Hershey cocoa—our most important commodity. We understand that improving sustainable cocoa farming practices leads to better lives for cocoa workers and their families.… We have expanded our commitment to cocoa communities in West Africa through a five-year, $10 million investment in innovative sustainability and sourcing initiatives.39

Is Hershey pursuing these sustainable farming practices out of compassion and concern for others? Or, is its true purpose to secure a stable source of cocoa that will be supplied by efficient, content workers? Or, possibly both reasons?

Furthermore, even if stock market researchers could identify pure CSR expenditures, it would still be difficult to gauge the impact of CSR acts on stock performance because CSR-focused companies tend to have characteristics that differ from other corporations. According to some studies, companies that spend significant funds on CSR are likely to be prosperous, image-conscious firms that have the resources to fund discretionary spending on CSR. Commonly, these companies are well-established marketers of consumer products, such as Nestle, Johnson and Johnson, Microsoft, Toyota, and major European automakers.

Nonetheless, recent research suggests that firms with high levels of CSR expenditures do tend to generate above-average profitability and stock performance.40 The key question, though, is: Do high CSR expenditures cause superior financial performance, or does superior financial performance generate excess cash flow that enables firms to make generous CSR expenditures? Or as another possibility, perhaps there is a positive feedback cycle in which one element reciprocally enhances the other element? More research is needed before definitive answers can be reached.

The Future of CSR

The intensity of the debate over CSR is not likely to diminish any time soon. Jack Welsh, the former CEO of General Electric, for example, remains a stalwart proponent of profit-maximization. In discussing whether alternative-energy projects need to generate money as well as power, Welsh contends that, “if it doesn't turn green to green,” a business project is not worth undertaking.41

Conversely, law professor Lynn Stout fiercely criticizes corporations that relentlessly focus only on profits and short-term stock price increases. She insists that because corporate shareholders have diverse goals, management's exclusive focus on profits often harms the very shareholders that the corporation professes to benefit. The age-old dogma of only maximizing shareholder value, she says, “privileges the interests of the most myopic, opportunistic, self-destructive, psychopathically asocial subset of shareholders,” to the detriment of others.42

Do Accounting Rules Discourage Corporate Social Responsibility?

When a company contributes to a worthy charitable cause, its expenditures often benefit the company's long-term reputation. However, from an accounting standpoint, charitable contributions are expensed rather than capitalized. As a result, companies that wish to support charitable causes may be dissuaded from doing so because charitable expenditures lower reported profits, at least in the short run, and do not appear as assets on their balance sheets.

Similarly, expenditures on employee training must be expensed under GAAP, even though these costs improve employees' contentment and future productivity. Likewise, technological advances that improve product safety or create sustainable production techniques usually must be expensed as Research and Development, hurting short-run reported profits.

Due to these perverse accounting effects, some commentators have suggested that the accounting profession should permit reputation-enhancing expenditures to be capitalized as a stand-alone intangible asset called CSR Investment Rights, much like Goodwill is capitalized as part of an acquisition.

EXERCISES

Issues of Distributive Justice

  1. A recent study shows that recent female medical school graduates earn 13% less, on average, than recent male medical school graduates.
    1. Is this consistent with Aristotle's philosophy of distributive justice?
    2. Why do you think that this pay differential exists?
    3. Do you believe that the reasons you identified are just or unjust?
  2. Two wealthy individuals each invested $1 million in productive assets. The first investor purchased real estate that generated net rental income of $80,000. The second investor bought stock in a start-up company that generated net long-term capital gains of $80,000. Under the Internal Revenue Code, rental income is taxed at ordinary tax rates, but long-term capital gains are taxed at a lower rate. Under Aristotle's philosophy of distributive justice, is this difference in taxation justified?
  3. Was philosopher Rawls more concerned with the relative well-being of the less fortunate compared to the more fortunate, or was he more concerned with the absolute well-being of the less fortunate?
  4. A coal producer in West Virginia pays its Chief Executive Officer more than 100 times the amount that it pays a typical coal miner. The CEO works in an air-conditioned office that overlooks a majestic river. The CEO also travels frequently on business to Europe in a private jet. The coal miners, in contrast, work arduous hours, expend substantial physical effort, and are subject to a meaningful risk of coal-related diseases and premature death.
    1. From the perspective of Rawls's theory of justice, is the compensation scheme fair? Why or why not?
    2. This same company pays its accounting staff members 30% less than the coal miners earn, on average. Most of the accounting staff members attended college, and most of the coal miners did not. From the perspective of Rawls's theory of justice, is the compensation scheme fair?
  5. A company has a diverse workforce that principally is comprised of African Americans and Asian Americans. According to actuarial statistics, its African-American employees will live 7 years postretirement, and its Asian-American employees will live 12 years postretirement. All employees receive $10,000 per year as pension benefits. At an applicable discount rate determined by company actuaries, the present value factor for a 7-year annuity is 5.60, and the present value factor for a 12-year annuity is 8.40.
    1. If the company wants to give the same pension benefits to its African-American employees that it gives to its Asian-American employees in economic value, what amount of annual pension benefit should the company pay to its African-American employees?
    2. Do you see any difficulties in administering such a plan?
    3. Does Aristotle's philosophy of distributive justice require the company to make this adjustment to annual pension benefits?
  6. Two unmarried individuals, Albert and Benita, each earn adjusted gross income of $100,000 for tax purposes. Their personal and professional activities are fundamentally identical. In each of the following independent cases, decide whether the pairs are “equals” who should pay the same amount of income tax, or “unequals” who should pay different amounts of income tax:
    1. Albert donates $6,000 to the church where he regularly worships, and Benita is an atheist who does not make similar expenditures
    2. Albert enjoys children and has three children that he supports, but Benita has no children
    3. Albert incurs medical costs of $600, and Benita does not incur any medical costs
  7. The Canadian province of Quebec has implemented a Pay Equity Act. It requires public employers and private-sector employers with more than 10 employees to provide equal pay for “work of equal value in terms of skill, effort, responsibility, and working conditions.”
    1. Do you believe that your community should enact such a law?
    2. McGill University in Quebec has had to develop a pay equity study to comply with this law. One of its challenges has been to determine whether its landscaping crew members deserve higher or lower pay than office administrative workers of comparable seniority. If you were asked to assist the university with this task as an outside consultant, what data would you gather?
    3. Would your efforts for McGill University be influenced by the fact that landscape workers disproportionately are male, and office administrative workers disproportionately are female?

    Virtue Ethics

  8. If you could develop personality traits comprised of four virtues, what virtues would you select?
  9. U.S. General George Patton led the Allies to victory during World War II. Known for uncompromising toughness, he once said, “Courage is fear holding on a minute longer.” Do you agree?

    Social Responsibility

  10. Many hotels post a sign in guestrooms that says, “As our contribution to the environment, we ordinarily do not wash bed sheets or towels daily. If you would like us to do so, please leave these washable items on the floor. Thank you for helping the environment.” Is this a commendable act of corporate social responsibility?
  11. During the summer, a large technology corporation located in a rural community provides funding for a free concert series. The concerts present varied genres of live music and are presented in a city park near the company's headquarters. Is this an act of corporate social responsibility?
  12. Before creating Berkshire Hathaway's “owner-directed” policy of social responsibility, Berkshire Hathaway requested an IRS ruling that its decision to empower shareholders would not result in them incurring a tax bill. Can you discern why Berkshire Hathaway had these concerns?
  13. In the aftermath of an earthquake in Chile, a large wireless phone company did not charge people for two weeks to make phone calls. This allowed customers in affected regions to inform their loved ones that they were safe.
    1. Was this an act of corporate social responsibility?
    2. A few days later, the other major phone company in Chile decided to match this same policy. Was this an act of corporate social responsibility?
  14. What pro bono activities commonly are engaged in by members of the medical and legal professions? Can you identify opportunities for accountants and businesspeople to perform pro bono activities in your community?
  15. When law-abiding citizens purchase a gun, they customarily are required to obtain a gun permit. Consequently, the names and addresses of people who possess guns are available in public records. A group opposed to gun ownership disseminated on its website the names and addresses of people in a particular New York county who own guns. Was this an act of social responsibility?
  16. The SEC historically has only required companies to disclose information that is “material to a reasonable investor.” Assume that Intel's disclosure of the sources of its conflict mineral supplies does not affect any of its financial results numerically. Do you consider its use or nonuse of conflict minerals to be information that Intel should be required to disclose?
  17. When a business engages in corporate social responsibility, it hopes to engender greater goodwill among its various stakeholders.
    1. How are these expenditures accounted for?
    2. If the resulting goodwill was capitalized under GAAP, do you believe that acts of corporate social responsibility would increase?
  18. Should the SEC require publicly traded corporations to disclose their annual expenditures on corporate social responsibility? How do think that requiring such disclosures would affect the companies' stock prices and, more broadly, the allocation of capital in financial markets?
  19. “The ‘social responsibility’ doctrine is brought into sharp relief when the doctrine is used to justify wage restraint by trade unions. The conflict of interest is naked and clear when union officials are asked to subordinate the interest of their members to some more general purpose.”43 If businesses are expected to engage in corporate social responsibility, should unions be expected to engage in socially responsible acts as well? If you are critical of corporations for failing to adequately pursue acts of corporate social responsibility, how do you feel about police, fire, or health care workers' unions that engage in concerted acts of refusing to show up for work to extract higher wages at the time of contract negotiations?
  20. While performing an inventory count at a medical supply company, an auditor observed that waste from radioactive isotopes produced at that facility appeared to be leaking into the surrounding soil. The auditor was concerned that these leaks might affect the underground water supplied in the community.
  21. The company states in its annual audited report that it is a “model citizen, concerned with maintaining a safe workplace for its employees and a pristine environment for all citizens.” What should the auditor do, if anything?
  22. As a student, you have the opportunity to work in the Volunteer Income Tax Assistance Program, commonly known as VITA. VITA volunteers principally prepare tax returns for indigent taxpayers, free of charge. Is working for VITA an act of social responsibility?

    Proctor and Gamble produces numerous consumer products, including detergents, cosmetics, and snack foods. Consider the following statement found in Proctor and Gamble's report on sustainability: “P and G strongly believes that ending animal testing is a benefit for all consumers.… Our goal is to stop animal testing completely.”

    1. If ending animal testing is a “benefit for all consumers,” why does Proctor and Gamble continue to do it?
    2. Is animal testing immoral if it helps prevent humans from suffering allergic reactions to cosmetics and detergents made by Proctor and Gamble?
    3. Proctor and Gamble also states that “we intend to only purchase and use palm oil that we can confirm to have originated from responsible and sustainable sources.” Some environmentalists contend that the production of palm oil from palm trees leads to deforestation and interferes with the natural habit of the Sumatran orangutans, an endangered species. Is it hypocritical for Proctor and Gamble to tout that it only purchases palm oil from “responsible” sources, while it continues to actively promote consumption of snack foods that contribute to childhood obesity and heart disease?
  23. “I focused on… green glass used for wine bottles. Glass is heavy and inert.… The commodity that glass can be ground into, called ‘cullet,’ just isn't very valuable. The alternative to recycling green glass is to use virgin materials—sand—and add the chemical compounds and color required. A cubic yard of mixed cullet can actually be much more expensive to convert into usable glass than a cubic yard of sand, depending on conditions. That means that ‘recycling,’ when you add on the fuel costs and pollution impact of collecting small quantities of the stuff from neighborhoods, actually uses more energy, and wastes more resources, than using virgin materials.”44

    Notwithstanding these facts about green glass, do we have a moral duty to recycle green glass?

  24. How important is the reputation of a company to you when you buy goods and services? Does a company's reputation matter to you more in certain situations than others? Does a seller's reputation depend primarily on it selling safe, durable, quality goods and services, or does its reputation primarily depend on it engaging in acts of corporate social responsibility?
  25. Which of the following acts of corporate social responsibility are most important to you? (Rank them from 1 to 5, with 5 being highest.)
    1. Recycling
    2. Eliminating genetically modified ingredients from their food products
    3. Ensuring that foreign subcontractors maintain safe working conditions for their employees
    4. Refusing to do business in countries that oppose gender equality
    5. Refusing to do business in countries that do not respect employees' seniority rights
    6. Donating significant sums to local theater groups
    7. Donating significant sums to local hospitals for patient care
    8. Donating significant sums to local hospitals for medical research
    9. Donating to political candidates that favor greater income redistribution
    10. Donating to political candidates that favor greater religious liberty
    11. Donating to political candidates that favor increases in unemployment benefits
  26. Which of the following would you consider to be acts of social responsibility?
    1. Flying on a private jet to give a speech about your tireless efforts to protect the environment
    2. Increasing the amount that your company contributes to workers' retirement plans
    3. Hiring a highly qualified CFO from an underrepresented minority group
    4. Selecting a supplier because its stock solely is owned by a woman
    5. Selecting a supplier because 51% of its stock is owned by a woman and the other 49% is owned by her husband
    6. Requiring employees to make mandatory contributions equal to 1% of their wages to the Red Cross and enforcing this contribution through payroll withholding
    7. Improving the safety of a product
    8. Increasing the warranty period on products sold to customers

    Social Responsibility and Religion

  27. Truett Cathy, founder of the Chick-fil-A restaurant chain, was a devout Christian who maintained a policy of keeping his restaurants closed on Sundays so his employees could spend more time with their families. Chick-fil-A generates revenues of about $6 billion per year. As a result, being closed on Sundays might cost the restaurant roughly one billion dollars in sales annually. Rent is an important fixed cost in the restaurant business. Is Chick-fil-A's policy an act of CSR?

    Comprehensive Problems

  28. According to popular folklore, Robin Hood and his band of merry men “robbed from the rich to give to the poor.”
    1. Would utilitarians approve of Robin Hood's actions?
    2. Would supporters of Rawls's theory of justice approve of Robin Hood's actions?
    3. Is Robin Hood a believer in egoism?
    4. Would believers in deontology approve of Robin Hood's actions?
  29. In your role as an internal auditor for a car manufacturer, you discovered that your employer can produce a car engine that will get 8 more miles per gallon than the existing engine. However, the cost of producing this car engine would be an additional $3,000 per car. Assume that a typical driver drives a car for 5 years and 200,000 miles. Also, assume that the cost of a gallon of gas is $5 per gallon and a typical car gets 24 miles per gallon. The company is wondering if it is ethical to not produce this more efficient engine.
    1. Is this an ethical question or just a simple cost accounting problem?
    2. How would you analyze this from the perspective of shareholder theory?
    3. How would you analyze this from the perspective of stakeholder theory?
    4. If this car manufacturer does decide to produce the more fuel-efficient car, would you consider it to be an act of corporate social responsibility?
    5. Would your answer to the preceding question be different if the car manufacturer's motivation was simply to increase its profits by selling more cars?

Notes

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