Why companies don’t make the environmental their top priority
By Peter Burnett
Corporate Social Responsibility has been in the news a lot lately. Corporates have been active in recent social debates, for example as advocates for same sex marriage and Indigenous recognition; and most recently when some companies backed September’s School Strike for Climate. This has prompted the Australian Government to push back, urging corporations to ‘stick to their knitting’.
In the USA, the high profile Business Roundtable, whose members are the CEOs of ‘leading American companies’ such as Tim Cook of Apple, recently dumped their long-held position that the purpose of a corporation is to serve shareholders, in favour of a commitment to ‘all of our stakeholders’ (their emphasis). This included a commitment to ‘protect the environment by embracing sustainable practices across our businesses.’
The ‘rules’ for corporations
Can a corporation really embrace sustainable practices if it is not in their immediate commercial interests to do so?
This is an issue with a long history (even longer than post-war discussions on this thing called sustainability). In the 1910s, on the back of the success of his Model T car, Henry Ford cut prices, gave his workers significant pay rises and started building a war chest to fund future expansion. But Ford hit the wall when he proposed putting an end to special dividends as a way of making his war chest even larger. Two of Ford’s shareholders, the Dodge brothers (themselves car makers), successfully sued Ford for such an audacious proposal. The Michigan Supreme Court forced Ford to continue paying the dividends on the basis that the company must operate in the interests of shareholders.
This case is often discussed as a key source of two key principles of corporate law, namely shareholder primacy and the ‘business judgement’ rule. And these are not just US principles, but are reflected in modern corporate law in Australia. Section 181 of Corporations Act 2001 requires directors to act in good faith in the best interests of the corporation, while section 180 enacts the business judgment rule, in essence that directors meet their duty to act in the best interest of the corporation if they believe, rationally and after exercising due diligence, that they are so doing.
The net result is that, while directors must act in the best interests of the corporation, directors have significant scope to apply their best judgment in determining what those interests are.
However, acting in the best interests of the corporation effectively means acting in the interests of the shareholders, since they are its owners. Furthermore, since (almost all) shareholders are investors, acting in the corporation’s best interests pretty much means making money, or at least increasing shareholder value, as much as possible.
So, broadly speaking, corporations are in it for the money. They have a one-track mind. And, allowing some leeway for management discretion, shareholders are entitled to make sure it stays that way.
Corporations and voluntary action for the environment
What does all this mean in terms of caring for the environment?
Well, corporations often claim they will care for the environment, as the US Business Roundtable has just done. Further, corporations often acknowledge the need for a social licence, which is not quite the same thing.
Finally, corporations sometimes take voluntary environmental action at the behest of government. A recent example came in a statement by Trevor Evans, Federal Assistant Minister for Waste Reduction and Environmental Management, who said that creating a more circular economy in Australia is a responsibility shared between individuals, governments and industry. (Of course, industry mostly consists of corporations).
Despite the impression created by such statements, the bottom line is set not by business roundtables and ministers, but by the rights that the law gives to shareholders.
If a company is led by a visionary and the shareholders share the vision, almost anything is possible. Elon Musk for example has managed to spend hugely on his vision to accelerate the world’s transition to sustainable energy, pushing Tesla Corporation to the limits of viability through borrowing and even giving valuable rights away by opening patents to all-comers, without attracting shareholder litigation of the Dodge Bros v Ford type*.
Keeping out of ‘Dodge’ City
On the more likely scenario that there will inevitably be some modern Dodge brothers among the shareholders in any large company, how might a corporation take voluntary action for the environment without risking shareholder litigation?
For example, how might companies respond to Minister Evans’ call to share in responsibility for the circular economy without getting in trouble? The answer depends on whether the corporation is a direct participant in the circular economy, such as a recycler, or simply affected by it, say a department store.
It is in the commercial interests of a recycler to see the circular economy grow as it will increase demand for recycled products. Therefore the directors might justify going well beyond general industry engagement with government policy development. They might decide for example that the company will sell recycled product at a loss, or adopt unprofitable circular economy practices within its own business, to establish itself as an exemplar. They might even justify paying their employees a ‘recycling allowance’ to promote recycling at home and to spread the word on social media.
A department store, on the other hand, may not be able to justify any voluntary investment in circular economy practices, beyond some basic ‘greenwashing’ at the margins to support a general ‘we are environmentally responsible’ stance. In fact, it might be in the interests of an upmarket store to maximise the use of virgin materials and extravagant packaging, to enhance the overall ‘customer experience’. These interests might even lead it to oppose some circular economy initiatives in the name of customer choice.
So it’s horses for courses. Yet in either these examples or others, companies can only justify voluntary environmental action if there is a business case for that action. If companies go significantly beyond what a business case would justify, they are inviting challenge by our modern Dodge brothers.
So what’s the right approach?
In a recent commentary on the US Business Roundtable decision to adopt the ‘stakeholder value’ approach, company director and philanthropist Alan Schwartz argued that it is the job of companies to maximise their profits within the rules, and the job of governments to get the rules, including environmental rules right, for example by setting a carbon price (‘Why Friedman was right’ and the Business Roundtable wrong).
In his view, efforts by companies to go beyond shareholder interests in pursuit of broader stakeholder interests are likely to be no more than a sideshow.
Looking through an environmental lens, as we do in this blog, I think Mr Schwartz has it right. It’s much better to have clear and comprehensive environmental rules set by government than to rely on the social ambition of directors and the tolerance of investors.
* There is shareholder litigation over Tesla’s acquisition of solar panel manufacturer SolarCity, but this is based on other grounds.