Putting the public interest first (Part 1)

Corporations can and should be made socially responsible
February 1, 2009

Corporations are different from other business entities because they attract capital investment by socializing a portion of shareholder risk. Investors are keenly aware that their investment returns are proportional to their investment risk, so their investment strategy aims at reducing risk while maintaining returns.

The corporate form reduces investors’ risk through “limited liability,” a legal feature of every jurisdiction’s corporate charter. This legal benefit enables shareholders to invest at less than real risk, delivering profit disproportionately higher than comparable investments outside the corporation. Each shareholder’s risk is limited to the loss of his invested dollars, whereas the investment’s potential liability can be much greater than that amount. Through the corporate charter’s limited liability provision, society bears the corporation’s un-met obligations, such as company debt or compensation due for damages, if those obligations exceed the shareholders’ original investment and company resources.

This advantage to corporate shareholders derives originally from the British Company Act of 1862 and subsequent legal refinements and legislative adjustments which protect shareholders from bearing the full risk of their investments. In Canada, and worldwide, corporate legislation designates the corporation as a “person” under the law. [See the Canada Revenue Agency website: www.cra-arc.gc.ca/E/pub/tp/it343r/it343r-e.html.] This designation fundamentally distinguishes the corporation from its shareholders, putting them at arm’s-length from corporate management decision-making. Shareholders are deemed innocent of management decisions and this innocence provides the rationale for limiting their liability.

According to the Canada Revenue Agency, “A corporation is an entity created by law having a legal personality and existence separate and distinct from the personality and existence of those who caused its creation or those who own it.”

An analysis of changes to the Ontario Business Corporation Act, effective Aug. 1, 2007, makes this point:

Limited liability effectively removes creditors and victims of corporate harm as stakeholders in the company’s transactions with its shareholders. The shareholder therefore need not be concerned about the legal consequences of his investment. His corporation’s directors are obligated to serve only the corporate interest, with no obligation to other stakeholders. [See http://www.mondaq.com/article.asp?articleid=49644.]

Five basic principles distinguished a corporation: 1) separate legal entity, also commonly “separate legal personality”; 2) perpetual existence; 3) limited liability; 4) transferable shares; and 5) centralized management.

These five elements work together to provide a rationale for the key element — the limited liability of the shareholders — and the consequential reduction of their investment risk.

An additional powerful factor is the primary corporate mandate to enrich its shareholders — a mandate well established in the courts and in legislation as in the “best interests” of the corporations’ principle. This principle was recently enunciated by the federal government in reference to its appointees to the boards of directors of shared-governance corporations: “Federal appointees do not represent the department or the government, and, like other board directors, they have a fiduciary responsibility to act in the best interests of the corporation.”

This principle has recently been clarified by the Supreme Court of Canada in a ruling on the often-quoted People vs Wise case in 2004:

“The fiduciary duty under s. 122(1)(a) of the C.B.C.A. requires directors and officers to act in good faith and honesty vis-a-vis the corporation... At all times, they owe their fiduciary obligations to the corporation, and the corporation’s interests are not to be confused with the interests of the creditors or those of any other stakeholder.”

Corporate legal precedents hold management personnel individually accountable for transgressions against this principle, so shareholder primacy drives every corporate decision, often in direct defiance of society’s concerns. Joel Bakan, in his book The Corporation: The Pathological Pursuit of Profit and Power, cites an impressive list of corporate crimes by one of America’s best known corporations, General Electric.

The effect of corporate law, therefore, is to socialize investment risks to the benefit of the shareholder, while eliminating other stakeholders from corporate management consideration. The investor is thereby far more willing to put his capital into corporate hands than he would be if he faced the real risk his investment could incur or feared a legal requirement to recognize other stakeholder interests. As a result, corporations reap the benefit of huge capital infusions that would never be available without such legally privileged shareholders.

It is ironic that, although capitalist ideology commonly shuns socialism, its modern elemental instrument, the corporation, in effect embraces socialism as a means to offload its shareholders’ risks and obligations to society.

Socialists might see this irony as a kind of grim deception, an inconsistency in capitalist ideology that permits socialism only in a skewed form where profits are privatized and risk (or loss) is socialized. The proponents of neoliberalism argue that the corporate form will perform better if left alone. When viewed from a strictly mechanistic point of view, or as a closed system, there is some merit to their argument. The problem, however, is that, as a closed system, corporations work too well. Their straightforward rules power industry, but do little in themselves to adapt practices to changing social and environmental conditions. They perform at a purely economic level with reference to society’s economic needs, but without reference to wider social issues or environmental effects. Within the corporate rules there is nothing to specifically address factors that cannot easily be quantified economically, or enable adaptation to factors outside an economic framework.

For example, the corporation provided the means when society needed a railroad to reach distant parts of a territory. The impact of building it, and the ensuing relatively small hydrocarbon emissions had little effect on the environment. But the same corporate model today overproduces transportation infrastructure and turns out vehicles to the extent that global climate is threatened. The corporate model does not “see” a world of finite scope and resources. It does not anticipate the cumulative impact of its own success.

Today’s corporate model was a product of the 19th century when society was enthralled with the cornucopia that was the Industrial Revolution. It is designed like a machine of that time, a masterpiece of simple precision, each part contributing efficiently to the functioning of the whole. Its interaction with society is similarly mechanistic, interleaving risk, profit and social need, calibrated to deliver equal advantages to all sides. It was a brilliant economic design for the time.

By the end of the 20th century, however, the original corporate model had already done its job of meeting society’s need for infrastructure, and yet it remains set up to do similar work over and over again, often far exceeding society’s real needs. The corporate cornucopia has delivered such a colossal overabundance of goods that society is being buried in them. This century needs to re-examine corporate operating principles to find if this creature of government, first created to serve society’s needs, has now started doing more harm than good.

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How is a corporation created and who ultimately controls it?

Corporations are creatures of government. Without the assent of government, a corporation cannot exist. It cannot have shareholders. It cannot do business.

Corporations are created by government through the terms of a corporate charter. The legislative body decides the terms of the corporate charter, and it can also amend the charter or even repeal it entirely. In British Columbia’s Business Corporations Act, typical of all other jurisdictions, we find this unconditional caveat:

“The Lieutenant Governor in Council may cancel the incorporation of a company and declare it to be dissolved.”

It is the responsibility of a government -- in Canada either the federal or a provincial government -- to decide if corporations can operate within its jurisdiction, and if so, what rights and privileges those corporations will enjoy, and what obligations they must meet. In Canada, corporations are generally given life through Business Corporations Acts.

The first legal obligation of the corporation is to enrich its shareholders. It has no implicit or explicit obligation to the public interest, but the federal government or any provincial government can legally and unilaterally amend a corporation’s charter to explicitly reference the public interest and treat it as an equal stakeholder with the corporate shareholder.

Corporation 20/20, an organization devoted in large part to empowering stakeholders affected by corporations, proposes these New Principles for Corporate Design:

1. The purpose of the corporation is to harness private interests to serve the public interest.
2. Corporations shall accrue fair returns for shareholders, but not at the expense of the legitimate interests of other stakeholders.
3. Corporations shall operate sustainably, meeting the needs of the present generation without compromising the ability of future generations to meet their needs.
4. Corporations shall distribute their wealth equitably among those who contribute to wealth creation.
5. Corporations shall be governed in a manner that is participatory, transparent, ethical, and accountable.
6. Corporations shall not infringe on the right of natural persons to govern themselves, nor infringe on other universal human rights.

These principles are an example of corporate goals that would be consistent with the public interest and could form the basis of a new corporate charter.

How could a government represent society’s interests within the corporate charter?

If society’s underwriting of corporate risk justifies including society as a stakeholder in corporate actions, then some might consider alternatives to this socialization of corporate risk as a means to maintain corporate autonomy.

Within the present worldwide business system, the de-socialization of shareholder risk in one jurisdiction would probably severely inhibit investment there because the risk would be perceived to be unknowable, and certainly beyond the tolerance of many investors. What investor, besides putting up his $10,000 to purchase shares, would be willing to provide his house as collateral against possible corporate liability?

This problem of de-socialization could be addressed through an insurance system whereby risk could be transferred to another part of the private sector, but here, too, de-socialization of risk would almost certainly alarm most investors, and drive capital away from the jurisdiction. Such a solution would isolate corporate interests even more from public interests, yet the need for regulation of corporate actions would remain. If completely at arm’s-length to each other, adversarial social-corporate relations would likely be further increased.

A more likely root cause of problems from the corporate form is the single-minded dedication to the enrichment of the shareholder to the exclusion of other stakeholders. It is the absence of society’s representation at the boardroom table that needs to be addressed.

The solution of amending the corporate charter to include society as a primary stakeholder could be the more attractive option to both society and corporate investors. A charter that includes society as a stakeholder could be referred to as the Social Corporate Charter, (SCC).

If both the public and corporate shareholders became educated to understand that society is already an important underwriter of corporate business risk, the logic would be acceptable to most people that society should also be a direct stakeholder in corporate goals and actions. In fact, there is already a growing investment sector where investors are acknowledging this reality.

The Socially Responsible Investment (SRI) has been increasing market share faster than other investment sectors. Also known as ethical investing, SRIs attract investors who choose to use their investment to benefit the public interest -- or at least to do it no harm.

Are there any cases where corporations already choose social goals?

Some government and non-government programs do in fact pursue this objective. British Columbia’s Partnerships B.C., for example, offers corporations public-private partnerships with a mission statement emphasizing the public interest:

“Partnerships B.C. evaluates, structures and implements partnership solutions which serve the public interest.”

This program, however, although it implements public oversight, does nothing to alter the corporation’s charter or essential character. It is merely a joint project between entities representing their respective interests, and in B.C., unfortunately, it has been used mainly to privatize work traditionally done in the public sector. For example, the Abbotsford Regional Hospital was a P3 project that privatized health care.

The Forum on Privatization of the Public Domain discusses how this and numerous other P3 projects actually act against the public interest by introducing into traditionally public sector projects corporate debt (more expensive than government debt), corporate marketing (not needed by government), and shareholder profit (adding 20% to the cost).

Some worthwhile non-government programs encourage and enable corporations to benefit from voluntarily choosing better social practices. For example, the Forest Stewardship Council (FSC) grants certifications to corporations that meet rigorous forest practices -- standards that exceed their legal obligations. In return for meeting FSC standards, these companies gain access to socially responsible investing (SRI) markets that would otherwise be denied to them.

The work of the FSC is particularly relevant to governments wishing to advance the public interest because they would share similar goals. In public policy polls, Canadians favour an economic/environmental link by at least two to one, and as great as four to one, depending on how the question is phrased:

When asked in a May 7, 2008 Harris/Decima poll if they supported “a carbon tax levied on people and businesses based on the carbon emissions they generate,” 61% said they supported this idea, with 32% opposed.

When asked in the same poll about “an environmental tax refund paid to those who succeed in reducing their use of fossil fuels, electricity, water, and the amount of garbage they produce,” support rose further, to 80%, with opposition falling to only 16%.

This reveals strong public support for a more cohesive policy integration of environmental, social and economic factors, an intention also reflected in the FSC mission statement:

“The Forest Stewardship Council (FSC) shall promote environmentally appropriate, socially beneficial, and economically viable management of the world's forests.”

The FSC forest practices requirements are severe by conventional forest management standards. Certified companies must adhere to FSC principles which emphasize sustainability, environmental protection, and social interests. It is especially significant that FSC certification is a choice corporations can make within a jurisdiction where less demanding alternative choices are available to them. This means that, under the right conditions, positive social goals can be the common choice of markets, investors, and corporate management.

In the FSC case, the choice is driven largely by consumer demand for ethically produced products and SRI investor demand for corporations using good practices. Corporate management presumably would choose ethical behaviour based on the ethical market premium — even though it would violate their primary mandate to enrich the shareholder -- if their choice were based on other criteria. It should be noted that “market premium” has not materialized as a significant economic incentive by way of direct increased financial returns, but rather can be understood as a premium of secure market access for certified products.

Generally, therefore, the aim of certification organizations can be summarized as an attempt to influence the behaviour of corporations through consumer education and the development of SRI markets. Intended or not, this influence has spilled over into government legislation mandating certification. Ontario and New Brunswick have also committed their forest industry to certifications by the FSC or other NGO certification agencies.

What happens when the public interest becomes a factor in the corporate agenda?

A critically important social benefit from programs like FSC certification is that, because the FSC has initiated better forest practices by some companies, governments come under pressure to require improved forest practices by all companies. Further analysis of NGO certification systems shows that, once started, a movement toward better social practices is profoundly self-reinforcing.

NGO certification began with enlightened companies that had already voluntarily chosen better forest practices and thus could receive certification with less effort, thereby receiving the ethical market premium as a bonus for their existing good practices. Awareness of this linkage may already be having a subtle effect throughout society, moving various kinds of government policy somewhat toward the public interest. In British Columbia, for example, the Procurement and Supplies Services (PSS), has applied for and received FSC certification for the Queen’s Printer in Victoria.

Examples of the influence on government by other independent certification organizations like the FSC are numerous, and the numbers are growing rapidly. Recently the Marine Stewardship Council was formed to promote responsible fishing practices. Others include the Sustainable Tourism Stewardship Council (STSC), Sustainable Travel International, (STI), IFOAM Organic Guarantee System, Fairtrade, and Social Accountability International, (SAI). These organizations, in turn, subscribe to the standards of overarching standard-setting organizations such as the International Social and Environmental Accreditation and Labelling (ISEAL).

Non-governmental certification organizations fall into two main categories: process-based and performance-based. The FSC is performance-based, while the International Standards Organization (ISO) puts its emphasis on quality control within industry, tracking and proving processes, and verifying identification of products through the “chain of custody” (CoC). While the ISO does not prescribe performance criteria like the FSC does, it does track performance, such as carbon footprint information. This information is therefore available for use to prescribe corporate practices, should government policy require it.

FSC certification has grown rapidly over the past decade in B.C., where almost every major forest company is in some stage of acquiring one of the available NGO certifications, expanding certified forests from zero to 50 million hectares in only eight years. It cannot be emphasized too strongly that this trend in B.C. and across Canada is driven by the consumer, not by the forest industry, nor by corporations themselves.

The first FSC-certified printer in B.C. was Hemlock Printers, the largest privately owned printer in the province. Marketing manager Heather Tyron told me that, since her company received certification in 2004, an average of 43% of their publications are printed on FSC-approved paper. The use of FSC paper increased 489% from 2006 to 2007 alone. Also since 2004, she estimated that 32 of Vancouver printers have become certified. She pointed out that this impressive growth was on account of two main factors: 1) the variety of FSC paper available, and 2) consumer demand. Paper availability, increasing from three to 80 types since 2004, had previously limited the second and more important factor: demand from consumers. Tyron said that consumer demand, not corporate demand, was easily discernible as the main stimulus, from the types of print jobs that required FSC paper.

In a democratic society, the questions must arise: where is government in this process? And why does its legislation continue to force directors to choose corporate interest over the public interest? Why is government, supposedly the custodian of the public interest, mostly absent in this positive influence on corporate behaviour, at least until after these certification programs are in place? This appears to be a neglected area of government policy, one which should have great potential for any political party genuinely concerned with the public interest. Notwithstanding the success of NGO certification, the obvious and most efficient place to address corporate social responsibility is in the corporate charter.

If any jurisdiction were to use its corporate charter as an instrument for promoting the public interest, the known influence of certification organizations on government policy could reasonably be expected to predict the effect of that jurisdiction’s influence on foreign governments as a similar process of public stimulus would unfold.

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