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Shareholder and Stakeholder Paradox
Since renowned economist Friedman (1970) expressed his strong convictions on the need for social responsibility in business, there has been much development in the theory and practical application of social responsible initiatives (McWilliams, Seigel & Wright, 2006). A whole movement has developed to cover a range of ethical practice which is now labelled under the umbrella of Corporate Social Responsibility (CSR). Many executives today face a dilemma between feeling compelled to invest in CSR initiatives whilst maintaining the cost controls so a necessary to maximise shareholder value. This essay first reviews the ideas of Freidman (1970), then the development of alternative theory is outlined, and the shareholder and stakeholder paradox is defined. The motives and actions of CSR policy at the international oil company British Petroleum (BP) are analysed and then related to the shareholder and stakeholder paradox.
The nature and context of Freidman’s views
Friedman (1970) wrote his infamous article in the New York Times Magazine as an explanation of what is known as the agency theory by scholars of CSR (McWilliams, Siegel & Wright, 2006). Agency Theory suggests that it’s not the role of executives in society to make decisions on social welfare of citizens. Since that time there has been a substantial growth in the definition and practical application of CSR policy and many have developed alternative views to Freidman (Crane and Matten, 2007). Freeman (1984) presented the concept of stakeholder theory that managers should consider the interests of all stakeholders other than the shareholders in a corporation. Importantly, Freeman’s ideas suggested that considering the needs of stakeholders is essential to a firm’s long-term success and not a benevolent additional ‘add-on. Stakeholder theory was developed further by Donaldson and Preston (1995) who stressed the ethical nature of CSR as well as the potential for increased financial performance that satisfies the interest of shareholders who invest in a business. Since then there has been a proliferation and transformation of CSR focus by scholars and businesspeople alike with an alignment between CSR practice and objectives in many corporations (Crane, 2013). In developed nations, large firms generally conduct CSR agendas or they feel they risk losing competitive advantage. Today in many markets, a strong CSR focus is a consumer expectation especially in cultures where the behaviour and role of corporations is closely monitored by media and pressure groups. Some businesses have even made the CSR theme central to their core mission, for example The Body Shop and Ben and Jerry’s. However many still have concerns about CSR initiatives in the corporate world and they would support Freidman’s view. Recently, Johnson (2015) suggested that CSR is an indulgence by executives in rich companies who complete to show who is most ethical and caring.
Friedman (1970) was dismissive of any attempts by executives to introduce initiatives that could be described as corporate social responsibility. He suggested that not only would CSR be harmful to shareholders who would suffer less returns on their investment, but there would be wider negative connotations for society has a whole as the executive would actually be administering a judgement that should be left to other agencies such as government. Friedman (1970) states “in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation or establish the eleemosynary institution, and his primary responsibility is to them” (Friedman, 1970, p.32). The only part of the article which we might interpret as a reflection of a stakeholder approach is when Friedman (1970) mentions it might be in the interest of a corporation that is a major employer in a local community to provide resources to that area or help improve local government. By doing so the business might attract more desirable workers, it may reduce the wage bill or have more loyal workers which ultimately would reduce costs and aid financial performance. However generally Friedman (1970) does not provide any notion that consumers may product differentiate on the grounds of the presence of CSR activity in a business which is an essential common tenant underpinning justification by managers today for promoting social responsibility. Friedman (1970) presented one end of the spectrum concerning the balance of focus between shareholder and stakeholder issues. The paradox managers face is the amount of focus they should give to the interests of various stakeholders through CSR initiatives whilst still securing shareholder interest and value.
The shareholder and stakeholder paradox
Those who promote stakeholder theory suggest that there are a range of benefits for a business adopting a strong CSR agenda that ultimately lead to an increased financial performance (Orlitzky, 2006). A business has the opportunity to increase organisational reputation by exercising CSR Policy which can develop consumer preference and loyalty. Businesses with CSR initiatives may be able to charge higher prices as consumers are prepared to pay extra where they believe they are helping others in need (Auger et al, 2003). For example, clearly labelled ethically sourced Fairtrade products found in British supermarkets such as coffee are available with a premium price. CSR policy can provide advantages when a business needs to raise capital as some investors and institutions are more willing to lend to firms with a strong ethical stance and at lower rates of interest (Spicer, 1978). Another prominent idea is that corporations with a high CSR agenda will benefit from better performing employees who increase their commitment and productivity as they respond to being part of an ethical mission (Greening & Turban, 2000). By consistent adherence to legislation such as contract, employment and environmental law, a business can avoid negative media coverage to catastrophic loss of reputation or even criminal misconduct charges (Wood & Jones, 1995). Corporations today see CSR expenditure as a way of generating revenues which improve financial performance (McWilliams, Siegel & Wright, 2006).
Direct costs can be attributed to CSR practice which have the potential to reduce profits and therefore the dividends to available to shareholders in the short-term (Frynas, 2009). Improving employee remuneration to provide a living wage has been adopted by many firms as late in the UK as socially responsible action but clearly incurs a direct expense (Living Wage Foundation, 2015). Ethically sourced suppliers tend to be more costly especially for example when eco-friendly production techniques are introduced. Introducing a more proactive recycling policy or pollution abatement policy above minimum legal requirements needs more resources and capital expenditure. Furthermore, there could be opportunity costs incurred where resources devoted to CSR practice are diverted away from other potentially beneficial projects in a business such as research and development activity, operational expansion or marketing campaigns. Business can only really take advantage of product differentiation if advertising reveals to potential consumers their CSR policy and practice so further expenditure is required for this purpose (McWilliams, Siegel & Wright, 2006).
Businesses that invest in CSR practices will have higher costs than those firms in the same industry that do not; executives have to make strategic decisions of the level of inputs they will commit to such activities. The vast majority of large corporations such as Multinational Corporations (MNCs) have considerable investments in CSR agendas and have whole departments dedicated to such activity (Crane, 2013). MNCs in the international oil industry are particularly renowned for having substantial CSR initiatives. Executives at multinationals(MNCs) such as British Petroleum(BP) constantly have to address the shareholder and stakeholder paradox in terms of balancing the needs of cost control so as to compensate shareholders fully whilst upholding the company’s organisational reputation through supporting a range of costly CSR initiatives.
Corporate Social Responsibility at BP as a reflection of the paradox in the oil industry.
BP is recognised as a corporate leader in its commitment and innovation to CSR initiatives (Frynas, 2009). In BP’s annual report, the opening statement stresses its CSR focus “We aim to create long-term value for shareholders by helping to meet growing demand for energy in a safe and responsible way. We strive to be a world-class operator, a responsible corporate citizen and a good employer” (BP, 2014).The highly visible effects of operations in the oil industry and a series of historical catastrophic events such as oil spills and local community devastation have made the ethical behaviour of companies like BP subject to close scrutiny. The very nature of the oil exploration, refinery and consumption raises ethical concerns due to the significant environmental and social impacts they create within the many countries they operate. Governments have introduced substantial legislation to protect their citizens and the environment; however international oil companies often choose to invest beyond legal minimum requirements which incur extra direct costs (Spence, 2010). Private organisations such as the media and pressure groups like Greenpeace constantly monitor oil companies and can considerably affect consumer purchase decisions.
BP has historically allocated substantial resources to CSR initiatives to limit negative impacts on the environment, to address the social impact on local communities they operate within and to manage the difficulties that can be created from a sudden inflow of oil revenues into economies in the developing world (Frynas, 2009). BP is a public listed company on the London and New York Stock Exchanges that attracts investors who expect regular dividends with satisfaction yields and capital gains in shares in the long-term. BP’s annual report outlines its current CSR focus into three areas: operational safety, environment and society, and employee welfare (BP 2014). It estimates that its annual environmental expenditure alone for 2014 was $2.216 billion for activity such as oil spill and clean-up costs, pollution abatement and environment restoration. BP’s annual dividend per share in 2014 was $0.39 and totalled $6.1 billion for all investors. Clearly CSR expenditure is significant in relation to investor returns. However, much CSR expenditure is necessary to meet minimum legal requirements and therefore cannot be considered totally as a strategic planning choice.
In April 2010 in the Gulf of Mexico a major oil spill incident took place around a BP ocean drilling operation subsequently called the “Deepwater Horizon accident” that significantly affected shareholder value and returns (BP, 2014). After an onsite explosion where 11 workers lost their lives, an estimated 200 million gallons of crude oil flowed into the ocean causing widespread onshore and offshore catastrophic environmental and social destruction. The U.S. Federal Government ruling in September 2014 finally held BP accountable for the incident imposing a fine of $18.5 billion which is still being appealed by BP. Also the incident caused many US consumers to boycott BP products and services which significantly decreased sales in the short-term. Other private litigations have been settled costing billions of dollars. As at 31 December 2015, BP has set aside $43.5 as a total pre-tax cost for the Deepwater Horizon accident (BP, 2014). The incident caused severe financial implications for BP shareholders; the share price dropped 55% immediately after the incident and still has not recovered to the pre-incidents levels. Dividends were suspended for the first 3 quarters of 2010. Incidents such as Deepwater Horizon damage organisation reputation and incur direct costs which deeply affect shareholder value. Part of the reasoning for substantial investment in CSR initiatives by multinationals is to mitigate such incidents and make sure they are minimalised by appropriate due care (Spence 2011). BP is dependent on the support of international financial markets and its international reputation for co-operation with its essential stakeholders and expansion of its operations (Frynas, 2009). Developing a strong corporate image is important for BP if it is to reach its long-term goals. BP executives have the paradoxical challenge of balancing the needs of shareholders with imperative CSR related expenditure.
Friedman (1970) expressed a view on Corporate Social Responsibility that still divides opinion and facilitates discussion today. However there have been considerable changes in the acceptance of CSR policy in recent years and many executives in corporations have embraced stakeholder theory with the need to understand and respond to the interests of various stakeholders such as consumers, employees and suppliers. The presence of CSR policy can provide benefits such as increasing an organisation’s reputation to encourage consumer loyalty, avoiding any unwarranted outside interference or improving employee commitment and productivity. Managers today explain their considerable CSR agendas leads to improving shareholder value through the variety of factors from which improve revenues which more than compensate for any costs incurred. Like many a major international oil companies, BP has embraced CSR culture at considerable expense as it understands it is vital to its long-term success. Like other public limited companies, BP is committed to shareholders through implementing a series of CSR practices to ensure the businesses reputation remains favourable with all its stakeholders and allows the company to generate sustainable returns.
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