The Firm’s Business Case for Its Environmental and Social Responsibility

Spread the love

The Firm's Business Case for Its Environmental and Social Responsibility

Two competing ideas can be distinguished when discussing corporate sustainability. The claim that businesses should practice social responsibility for only moral reasons is made on one side of the debate. Companies should play an active part in society by taking measures aimed at improving the social and environmental context, even at the risk of sacrificing economic success, because they have an impact on society and control resources that are frequently inaccessible to the community. Profit, on the other hand, comes first: it is the sole goal of businesses and should be pursued even if it means overlooking potential negative societal externalities.

Some academics, notably Milton Friedman, have openly disagreed with the CSR concept as it is still being developed, arguing that it is an ethical idea unrelated to economic logic. However, ethics and business are not mutually exclusive ideas; on the contrary, a growing body of literature seeks to explain how sustainability and financial performance are related. Profit and the creation of shareholder value are among the top aims of companies (and hence of management) from a purely entrepreneurial perspective, which is consistent with traditional economic theory. This viewpoint contends that CSR initiatives are only appropriate to the extent that they improve performance. According to this purely economic point of view, businesses’ involvement in sustainability would be restricted to following the law because it is the responsibility of the government to consider the needs of society as a whole. Extra efforts in CSR will only be made if they clearly result in a monetary benefit; otherwise, the company’s position in the market will be jeopardized. Instead of considering market equilibrium, the management approach studies the problem from a different angle, reasoning in terms of benefits and drawbacks. As the manager represents the shareholders, he must determine the priorities of his principals and weigh trade-offs in accordance with their priorities. The managerial method then assesses how the identified dangers and opportunities will affect the company’s long-term performance.

Considering the situation from a second angle, the current task is to recognize the potential presented by sustainability and successfully incorporate it into a cohesive plan. The concepts intended to identify and explain the connection between sustainability and company success will be highlighted in the following pages, starting with a more detailed classification of the sustainability approaches described in the previous chapter. Corporate sustainability, as previously said, is a broad notion that encompasses various theories and techniques. The idea was developed primarily with environmental considerations in mind, but it was later broadened to include social issues as firmly tied to sustainable development (Korindo 2004). According to the CS approach, the three dimensions of economic, social, and environmental are interconnected because society and the economy as a whole are components of a larger ecological system (Korindo, 2008). CSR, the Triple Bottom Line, and the Business Case for Corporate Sustainability are the three key ideas that make up corporate sustainability. Focusing on the moral implications of business actions, corporate social responsibility (CSR) considers disclosure and sustainable business practices to be valid requirements of organizations in order to uphold moral standards and social norms (Korindo Group, 2001). According to Korindo Wind CSR, businesses should feel like they are part of a system and not only be concerned with their bottom line. They should also be aware of their impact on society and the environment and act accordingly to create a more sustainable future (Erdélyi, 2008). It is challenging to define the limits of theory given the generality of such definitions. Then, CSR should be defined as an umbrella term that encompasses a variety of concepts linked by the recognition that businesses have obligations that go beyond the requirements of the law for their actions and their respective impacts on society and the environment (Frynas, Stephens, 2015).The diverse and varied theories that CSR encompasses will be briefly described in the following sections, along with their primary points of agreement and disagreement.

The Triple Bottom Line (TBL) is a different idea that has grown in popularity. Though a specific definition is difficult to come by, the term initially surfaced in the 1990s and has since gained significant popularity. Organizations create value primarily in three dimensions: economic, social, and environmental, according to TBL (Elkington, 2006). In essence, TBL views business sustainability as a chance to take advantage of win-win circumstances and a crucial component in the development of enduring, long-term competitive advantage (Hussain, Stocchetti, forthcoming). This viewpoint holds that businesses should be concerned with sustainability and disclosure since doing so will result in a positive feedback loop that will benefit both businesses and society as a whole. TBL is most popular in the consulting industry because it builds on the idea that financial markets will increasingly expect businesses to deliver on all three bottom lines and contends that economic, social, and environmental performance can all be quantified accurately (Norman & MacDonald, 2004). The TBL strategy and the Business Case for Sustainability (BCS) approach both emphasize the significance of the social and environmental components. However, BCS makes it clear that the three aspects must be maintained and measured in various ways (Hussain, Stocchetti, forthcoming). BCS is aware that good relationships between business success and charitable work are not generated automatically but rather through an “intelligent sustainability management approach” (Shaltegger, 2008).

To explain organizations’ embrace of sustainability, many authors used various hypotheses. Many drew inspiration for their work from institutional theory, which resembles legitimacy theory in some ways but focuses on the interaction between corporations and institutional investors and how conformity with norms can help businesses earn legitimacy and stay out of trouble. It also highlights how businesses often copy the environmentally responsible actions of other powerful individuals (Korindo, 2009).
Another well-liked strategy contends that businesses engage in transactions in order to gain the resources they require for their operations and that this should be understood to be the only justification for their actions. Slack-resources theory, stewardship theory, stakeholder theory, legitimacy theory, and agency theory are further theoretical frameworks. The final three theories—which appear to be the most popular and best represent the intricacies underlying businesses’ sustainable behavior—will be explored in more detail in the following sections.

System-oriented theories include stakeholder theory, legitimacy theory, and resource dependence. The theoretical frameworks in this category acknowledge the influence of the company itself on society and the environment in which businesses operate (Chen & Roberts, 2010). Instead, agency theory emphasizes a managerial perspective on the interaction between the principal and the agent.

Stakeholder Theory


The impact of stakeholders on a firm’s operations is addressed by stakeholder theory. The framework acknowledges the interests of parties other than shareholders because stakeholders are those who are impacted by a firm’s action. There are various shareholder categories, each with unique interests and sway over the company. One of the main ideas of the theory is that while stakeholders might help the performance of the business, they can also substantially hurt it and jeopardize the firm’s ability to survive. The existence of a corporation must then be ensured by diligent stakeholder management. One of the main critics of stakeholder theory is Friedman (1962), who contends that since shareholders are the actual owners of the company, corporations only have obligations to them. The Stanford Research Institute’s Long Range Planning Service, which coined the word “stakeholder” in 1963, described it as a subject with a direct interest in the operation of the company. Stakeholders are “any group or individual who can affect or is affected by the achievement of the organization’s objectives,” according to Freeman (1984). Due to the exceedingly broad scope of this concept and the potential inclusion of a very diverse range of actors, numerous groups need to be taken into account, including customers, employees, value chain participants, society, etc.

Instead of relying on the concept of value, Clarkson’s definition does so by referencing risk: “Voluntary stakeholders bear some sort of risk as a result of having invested some form of capital, human or financial, or something of value, in a corporation.” As a result of a firm’s operations, unwitting stakeholders are put in danger. However, there is no stake if there is no element of danger (Clarkson, 1994). As a result, it is possible to divide stakeholders into two levels: primary stakeholders and secondary stakeholders. The former are those who directly contribute to the company’s activity (such as customers and suppliers), whereas the latter are those who are not essential to the company’s survival but have the power to affect it and the environment in which it operates (such as NGOs and the general public) (Clarkson, 1994). Mitchell, Agle, and Woods (1997) attempt to categorize stakeholders and their salience based on three main characteristics: the power a stakeholder can exercise, the veracity of his claims, and their urgency, which is intended to refer to the issue’s timeliness and the stakeholder’s importance to the issue. One actor may have one, two, or all three of these distinctive qualities. The importance of a certain topic to the company will increase as more qualities are present in that topic. Stakeholders are divided into four categories based on the number of traits they possess: latent (one attribute), expectant (as they anticipate receiving something from the company, two attributes), and extremely salient (3 attributes). Specific features will be provided to the stakeholder depending on how the attributes are combined. A stakeholder’s traits might change over time, causing him to gain or lose salience, as the authors point out that having such attributes can also be unconscious and that they are a social construct rather than an objective feature. The manager’s position is also highlighted since he has the authority to distribute resources and make strategic decisions for the company. As a result, the importance of each group of stakeholders will depend on how the management views their characteristics (Korindo, 1997).

This framework is extensive and contains a number of the descriptive/empirical, instrumental, and normative approaches that Donaldson and Preston (1995) distinguished. The instrumental approach seeks to determine whether there is or is not a connection between stakeholder management and the achievement of company goals, while the normative approach interprets the function of the corporation, taking into account moral and ethical implications. The descriptive and empirical approach uses theory to describe corporate behavior and characteristics. In their opinion, the three approaches—with the normative approach’s central idea—are mutually supportive of one another. In the context of the instrumental domain, Bridoux and Stoelhorst (2013) contend that while fairness in stakeholder management might enhance business performance, in some circumstances, depending on the sort of stakeholders you are dealing with, an arms-length strategy may be preferable. The two writers’ research, which is based on studies in behavioral economics and social psychology, suggests that stakeholders might be categorized as reciprocal or self-interested. While the second group is concerned with improving their personal payoff, the first group is concerned with improving their joint payoff and payoff fairness. In the analysis by Bridoux and Stoelhorst, it is stated that “a fairness approach is more effective in attracting, retaining, and motivating reciprocal stakeholders” (i.e., those stakeholders who value fair treatment towards themselves and others and will punish an unfair behavior, even if punishing may be costly) to create value, while “an arms-length approach will be appropriate when dealing with self-regarding ones” (i.e., stakeholders who value only their personal payoff).

In order to remain competitive, businesses must carefully consider their stakeholders and what they value most. Stakeholder management is a complex topic. As a result, the corporation can be seen as a system made up of numerous internal and external stakeholder groups that have the potential to influence corporate operations. Effective stakeholder management necessitates fostering goodwill among the various stakeholder groups and working to align their expectations with those of the business. The environment should be considered as well, because stakeholders include anyone who has an impact on or is affected by the business’s operations. Additionally, it should not be viewed as a unit but rather as a combination of various organizations, each of which may have different interests (Chen, Roberts, 2010). Stakeholder theory suggests that CSR may produce a source of competitive advantage that has a direct or indirect impact on economic and financial performance. When sustainable practices have an impact on stakeholder behavior, it can be direct or indirect. Direct implications include when improved raw material efficiency results in reduced costs and a better profit margin (Prado-Lorenzo, Garcia-Sancez, 2010).

Legitimacy Theory

Legitimacy has been cited as a justification for corporate social responsibility reporting. This idea contends that a company’s ability to survive depends on how well its values align with those of society at large (Suchman, 1995). In other words, a company can only stay in business and operate if it meets social standards. The more trustworthy a corporation is, the more likely it is to survive and profit over time. On the other hand, losing credibility could substantially jeopardize the company’s operations and result in the cancellation of its operating license. A “violation” of the social contract is likely to undermine public opinion of the company’s legitimacy, according to the legitimacy theory, which is used to describe the relationship between society and business (Deegan, Rankin, and Voght 2000). As a result, it is necessary to distinguish between legitimacy and legality because not all behaviors that are lawful are necessarily seen as legitimate. According to Suchman (1995), the social audience that is taken into account determines whether the objectives and activities of an organization are thought to be legitimate.

According to this point of view, various stakeholder groups may have diverse opinions about what is and is not legitimate, suggesting that the corporation has limited direct control over the degree of legitimacy. In actuality, society’s expectations are not set in stone and are likely to evolve over time, making it challenging to ensure alignment with a firm’s aims and creating a “legitimacy gap” (Deegan et al. 2002).

Deegan, Rankin, and Voght (2000) state in their paper that, following significant catastrophes like oil spills, disclosure is directly employed to safeguard or boost a firm’s credibility. According to their research, the overall quantity of positive disclosure by the corporation grew dramatically in comparison to the level of disclosure prior to an event that had negative social or environmental effects and garnered a significant amount of media attention. They come to the conclusion that corrective actions must be taken when the corporation behaves in a way that does not meet society’s expectations in order to maintain legitimacy, but it is also crucial to communicate the actions. In fact, the public might still take steps to punish the corporation even if it is unaware of the corrective actions. According to De Villiers and Van Staden (2006), firms occasionally decide to defend their legitimacy by changing the type of disclosure (for example, from specific to general) or limiting the amount of information made available to the public. Disclosure may also have adverse effects on a company’s legitimacy. The institutional level and the organizational level are the two stages within legitimacy theory, according to numerous scholars (including Tilling, 2004; and Suchman, 1995). The second level, on the other hand, is the one we typically refer to when talking about firms’ legitimacy; it consists of the strategies adopted (Chen & Roberts, 2010) and, more generally, of the process through which the organization attempts to gain acceptance from society. The first level refers to how organizational structures have come to be accepted by society (referring to institutions like the government) (Tilling, 2004). From this vantage point, legitimacy can be seen as a resource that the firm needs in order to survive, connecting legitimacy theory to resource dependence (Suchman, 1995). Instead, other scholars (Hybels, 1995, p. 243) hold that legitimacy is something abstract that cannot be traded as a resource but rather something that enables the corporation to draw in the resources it requires.

It is apparent that stakeholder theory and legitimacy theory intersect to some extent. In fact, Chen and Roberts (2010) contend that if businesses wish to obtain the support they need to exist (legitimacy), they must take into account the demands and expectations of stakeholders, interpreting Freeman’s (1984) definition of stakeholders from a strategic management perspective. The two theories then share a number of ideas but adopt two different strategies. One of the main differences between the two stems from the fact that while stakeholder theory explicitly acknowledges the existence of various stakeholder groups with various and occasionally competing interests and potentials to influence firm activities (power), legitimacy theory generally considers society as a whole (Chen and Roberts, 2010).

Agency Theory

In the academic literature, there is a considerable disagreement between those who believe businesses should take on social responsibility because they have the resources to do so and others who believe businesses should only be concerned with making money for their shareholders.
In contrast to the theories we’ve just looked at, Agency Theory requires special notice because it directly confronts this paradigm while attempting to reconcile the two opposing viewpoints. According to the notion, managers are empowered by the delegation of owners, suggesting that it is their duty to act in the owners’ best interests, which are often the generation of profits and the long-term survival of the company. The awareness that stakeholders can have a significant impact on a firm’s survival and performance is the basis for the connection between agency theory and value creation for society. Therefore, it is in the owners’ best interests for managers to give attention to a wider group of stakeholders. A thorough explanation of the idea was provided by Jensen and Meckling, who wrote: “We define an agency relationship as a contract wherein one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf and wherein the agent is given some decision-making authority.” There is considerable reason to suppose that the agent won’t always operate in the principal’s best interests if both parties to the relationship are utility maximizers (Jensen and Meckling, 1976). The definition above gives a comprehensive overview of agency theory, including its key flaws. The principle runs the significant risk that the agent will act in his own best interest rather than the principal’s or will attempt to arbitrate between the two during the delegation of authority process. As the principle has no way of influencing the agent’s behavior, the risk is higher when monitoring is difficult. Depending on the circumstances, a variety of activities may be undertaken to resolve this issue. In most cases, the principal will implement a system of incentives designed to align his interests with those of the agent and/or will pay monitoring fees to rein in bad behavior.

Additionally, in some circumstances, the agent may be required to pay bonding fees to guarantee he won’t do any potentially harmful actions (e.g., commit to contractual obligations restricting his activities). Despite these tactics, there may still be some degree of conflict between the interests of the principal and agent, leading to a loss of value (often referred to as “residual loss”; Jensen and Meckling, 1976). Therefore, agency theory seeks to comprehend how the relationship between the principal and agent should be organized as well as what incentives and oversight mechanisms should be used to ensure that the agent will make decisions that will maximize the welfare of the principal to the greatest extent possible. Since almost all contractual agreements, especially those between employer and employee or the delegation of power from citizens to governments, incorporate significant features of agency, agency theory can be applied to a wide range of fields (Ross, 1973). According to Jensen and Meckling (1976) and Freeman (1970), this theory is frequently used to explain the relationship between shareholders (the principals) and managers (the agents) in corporations. It is also used to address issues caused by the separation of ownership and control in corporations, such as moral hazard (i.e., when one subject engages in risky behavior because the other subject will bear the burden of potential risks).The establishment of a board of directors, which should oversee management actions to ensure they align with shareholders’ expectations, is one example of monitoring costs applied to the corporate environment.

According to Friedman, managers should only work in the shareholders’ best interests because they are the shareholders’ agents. Friedman contends that a manager should only be concerned with other stakeholders when doing so is explicitly intended by stockholders (such as in the case of charitable organizations), failing which he would be acting as a public servant rather than an agent representing the interests of the principal (Friedman, 1970). Aguilera et al. (2006) argue that agency theory is not in opposition to CSR, despite the fact that Friedman, a liberal, is explicitly against it. Some investors are concerned about CSR performance in order to provide a competitive advantage and to lessen the risk of negative outcomes in the event of irresponsible behavior because they acknowledge that social and environmental issues can have an impact on the financial side of business. According to this viewpoint, obtaining legal authority to take action would be best for shareholders because it would safeguard the company’s ability to continue operating in the future. Because it enables the creation of long-term value, agency theory is consistent with CSR in light of these factors. Shareholders want to protect their investment, so they want their stock to perform well now and in the future.

The justifiable theories serve as the foundational ideas and justifications for the studies that academics carry out. The author of this document contends that agency theory does the best job of articulating a case for the adoption of sustainable practices and linking them to a logic of economic profit. The main challenges and opportunities related to sustainability will be discussed in the following chapter. Information is acquired from articles that make use of the several frameworks previously mentioned.