Wednesday, August 25, 2010

Corporate Social Responsibility summarizes a debate of sorts on corporate social responsibility between two professors at the Ross school. My sense is that two issues are being confused.

1. Sometimes when a firm hands out some of its profits to a non-profit, perhaps the local symphony or food bank, it is a direct result of the principal-agent problem between management and shareholders. The shareholders would prefer to have the profits returned as dividends or capital gains (depending on their tax bracket and other factors) while management prefers at the margin to get invited to nice parties and receive awards for philanthropy.

2. Sometimes, because firms operate in a complex legal and social environment, spending profits on things that are not directly profitable may indirectly increase profits. For example, if a firm can spend $10 million on "doing good" and thereby avoid regulation that would cost it $100 million, the shareholders are better off.

In my view, the first of these is to be avoided and the second not, though one might lament the presence of an environment that encourages misrepresentation of this sort along with encouraging conceptual confusion about the point of having public companies. Put differently, shareholder monitoring is easier when a firm tries to do one thing rather than two.

However, one could argue that firms have a comparative advantage at charity because of economies of scale in research. They can pick out the effective charities in a way that individual donors cannot. I don't think this is the argument being made by the second professor in the article but it does at least make sense, and as long as all the shareholders understand that they are buying a bundled product in which the firm pays out part of its profits in the form of well-targeted charity, then that is perfectly fine.

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