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Corporate Social Responsibility Issues In Business And Law

| March 3, 2015

Introduction
Banks have been under intense scrutiny since the recession of 2008 which has been, as Wheelock observes, identified primarily as a banking crisis akin to that of the 1930s . The spectre of hundreds of customers queuing outside of Northern Rock to prevent the first run on a bank since 1878 focussed minds on the complex questions of corporate governance and regulation of the banking sector . The importance of banks to the financial and indeed social fabric of many countries in the world is irrefutable: their lending, particularly to Small and Medium Enterprises (SMEs), is vital in stimulating the economy as a whole and they owe fiduciary duties not only to shareholders but also to depositors . The repercussions of a banking failure are felt throughout society so dominant have banks become as financial institutions with senior management referred to, not unjustly, as “masters of the universe” . Even with the reformation of corporate governance since the 1990’s the shareholder primacy model prevails and it is difficult to argue against the idea that Britain’s banks, which have again started to pay out bonuses in the city and will not have to introduce any kind of ring-fencing into their operations until 2019 , are indeed reflecting on “business as usual” . HM Treasury, in a report recommending reform to the regulatory environment, observed of the banking crisis:
“The UK banking system is emerging from the most serious financial crisis in over a hundred years. In order to avert a total banking collapse, the last Government had to part-nationalise two of the largest banks in the world, and introduce financial sector interventions costing hundreds of billions of pounds. Much has been written – in academic journals, in the business press, and in books dedicated to the subject – about the recent financial crisis, and its impact on the global economy. There is now an emerging consensus on the fundamental causes of the crisis, citing factors such as:• global economic imbalances;• mispriced and misunderstood risk;• unsustainable funding and business models for banks;• excessive build up of debt across the financial system; and• the growth of an unregulated ‘shadow banking’ system”.

Will the 2008 recession prove to be as powerful a catalyst for corporate governance for banking institutions as the fall of Enron was for companies in the 1990s? The notion of corporate social responsibility, which is a buzz-word in the modern business world , has prompted many changes in corporate bodies which is, in the words of Sheikh, “inextricably linked” to the concept of enlightened shareholder value under the Companies Act 2006 and indirectly linked to the notion of corporate criminal responsibility . Voluntary and non-binding codes, principles and initiatives are proliferating at an astonishing speed and indeed a new industry has been born . A glance at many companies’ websites, across the world, in 2012 reveals that corporate social responsibility is becoming universal although there are those who would deride it as a mere illusion which preserves the status quo in much the same vein as those who attack s.172 of the Companies Act 2006 and the legal duty of ‘enlightened shareholder value’ as being nothing more than a vain gesture to make companies behave more responsible to stakeholders rather than putting profits above all . This essay will analyse the concept of CSR in the context of the banking industry since 2008 and ask whether CSR can prove to be an effective tool within the international and UK banking sector. In part 1 a brief history of the recession and the banking failure will be sketched out before examining the phenomenon of CSR in the UK and internationally. Part 2 will critically discuss the effectiveness of CSR in the context of banking and conclude that voluntary arrangements, such as s.172, are quite simply not enough to prevent another banking crisis. No less than statutory regulation and a change of the basis of capitalism from shareholder to stakeholder primacy are needed to rein in banks from taking risks and engaging in moral hazard . The HM Treasury reported published the apologies of the major banks with Andy Hornby’s (formerly of HBOS) apology best encapsulating the bank’s failure:

“I am very sorry about what has happened at HBOS; it has affected shareholders, many of whom are colleagues; it has affected the communities in which we live and serve; it has clearly affected taxpayers; and we are extremely sorry for the turn of events that has brought it about”.

Part 1: Corporate Social Responsibility: origins and evolution
1.1 Theories of Corporate Governance
That corporate bodies in the western world, covering companies and banks, have historically adopted a shareholder primacy approach aimed at maximising profts is well accepted and entrenched into financial and legal institutions . The intellectual revolt against scandals and recession in the 1990s most notably including Enron, led to an adoption of economic theory which simply and bluntly required more from such corporate bodies than, in the memorable words of Lord Avebury in the House of Commons, a company’s success being dependent on “its ability to continue damaging the environment, and within a fairly distant time horizon, making large parts of the globe uninhabitable” . The fall of Enron was, consequently, the catalyst for an international shake-up of corporate governance which had traditionally, at least for the Anglo-Saxon world, been founded upon the contractual theories of American thinkers for generations and filtered into s.172 of the 2006 Companies Act in the UK . The active debate between those who advocate shareholder primacy to maximise profits and those who insist that stakeholder primacy must be introduced into company law to reflect the 21st century and a more moralistic business environment polarises the issue. On the former, FE Mitchell has observed that requiring people to devote their working lives in companies to solely maximising profits is “unhealthy, demeaning and morally corrupting” while on the latter, Easterbrook and Fischel condemn the inclusion of social and moral factors in business as “unnatural and objectionable ‘social engineering’” . The House of Commons Treasury Select Committee’s report observed that the reformed legal director duties imposed by s.172 of the Companies Act 2006 had came into operation just a month before the spectacular crash : a flagship section which was designed to combat the epidemic of financial and corporate scandals stemming from the collapse of the American giant Enron in the mid 1990’s by introducing the concept of “enlightened shareholder value” (ESV) into British company law . The notion of Corporate Social Responsibility (CSR), linked heavily to theories of stakeholder primacy, also gained currency in the 1990s and gained currency within the context of the wider corporate governance debate.

1.2 The growth of CSR
Despite the predominance of American thinkers in the 20th century the intellectual tide in the UK was turned by the seminal work of Parkinson in the early 1990’s who first postulated a form of corporate social responsibility and rejected the American contractarian model in the United Kingdom . Parkinson himself distinguished the illustrious author E.Merrick Dodd who, in the shadows of the Great Depression in 1932, argued powerfully that the notion of a company is not a “legal fiction” but in fact reality and that with such power comes the responsibility to perform a social service . For Parkinson, however, social responsibility defined by democracy is a precondition to having power. Both Parkinson and Dodd were united, however, in seeing the corporation as a quasi-public company . The notion of corporate social responsibility, which, as noted in the introduction is a buzz-word in the modern business world has prompted many superficial changes in companies and banks which is, in the words of Sheikh, “inextricably linked” to ‘enlightened shareholder value’: the Labour government’s compromise between shareholder and stakeholder primacy under s.172 of the Companies Act 2006. Voluntary and non-binding codes, principles and initiatives are proliferating at an astonishing speed and indeed a new industry has been born . Other countries, most notably Germany and Japan, adopt a stakeholder primacy approach which sees employees sitting in German boardrooms and Japanese companies very much entrenched in local communities . Even Chinese companies are beginning to slowly wake up to the communities around them with events in 2011 leading the Communist mouthpiece to decry the pursuit of “blood-stained GDP” . Zhao, writing in the context of Chinese companies, provides a useful definition of CSR:

Corporate social responsibility (CSR) can be directly related to giving a name to the idea that corporations should engage in activities that are more than shareholder wealth maximisation or “strictly business”. Instead, companies, in addition to their economic responsibility at the bottom of the corporate responsibility pyramid, should have legal, ethical and philanthropic responsibilities. Within the common CSR literature, it is suggested that corporations provide various political and public goods commonly associated with governments and public welfare. The general thrust of CSR opponents is to refute Friedman’s pithy argument that the only social responsibility of business is to increase its profit.”

Part 2: An effective tool?

2.1 The Recession and the regulatory response

The Great Recession of 2008 has been the catalyst for a lot of soul searching within the banking world both internationally and in the UK. The sight of hundreds of customers queuing up outside of Northern Rock to withdraw money in 2007 was perhaps the most visible and visceral symbol of a gathering storm which was without precedent for 150 years in the UK . Senior bankers, such as the reviled Fred Goodwin of RBS, collected bonus payments which stoked popular hatred and resentment. Banks such as Lloyds and RBS were bailed out at an astronomical cost to the taxpayer. Repossessions of family homes rocketed as the host of “ninja loans”, as Vince Cable puts it, given to those without any home, car or credit began to unravel spectacularly and the housing bubble burst .

The concept of “enlightened shareholder value”, developed by the Companies Act 2006 to promote corporate social responsibility, has been met with both “apathy” and “disappointment” by lawyers and the fact that the banking crisis flourished even when it was in operation is worrying and suggests that without a change in the underlying model these disasters could happen again. Even with this slow reformation of corporate governance since the 1990’s the shareholder primacy model prevails and it is difficult to argue against the idea that Britain’s banks, which have again started to pay out bonuses in the city and will not have to introduce any kind of ring-fencing into their operations until 2019 , are indeed reflecting on “business as usual” .

What then of the response as we crawl slowly out of recession? The Coalition government, in its manifesto, sought to defuse the crisis by arguing for the following regulatory interventions to, in their own words, “avoid a repeat of Labour’s financial crisis” : the introduction of a bank levy, taking “robust” action to deal with bankers’ bonuses, the establishment of a commission to look into the separation of investment and retail banking and proposals to give the Bank of England more powers . The coalition argued that the present financial system is “fundamentally flawed and needs to be replaced with a framework that promotes responsible and sustainable banking, where regulators have greater power to curb unsustainable lending practices” . Now in 2011 two of these proposals remain unfulfilled with the Vicker’s banking committee stopping short of a full separation of retail and investment banking operations and bankers bonuses being untouched with the Government unwilling to interfere in legally binding contracts of remuneration . The inspiration to separate retail and investment banking stems from the regulatory aftermath of the Great Depression of the 1930s when President Roosevelt advocated a “New Deal” which witnessed the separation of investment and retail banking. The result of these groundbreaking reforms in America was that not a single bank failed between 1945 and 1971 . Vince Cable refers to this as a forgotten “golden age” which has been eroded by modern financial liberalization: a process which he points out needs to be reversed . Despite the scepticism of some it appears that the banks are, in some instances, paying heed to the public’s demands upon them to take into account more than just the “maximisation of profits” as Chatterjee wrote, back in 1996 . Although it is very early to analyse the full impact of the bank’s post-recession record it would appear that the government’s requirements that banks lend to SME’s as part of ‘project merlin’ has been fulfilled in the year 2011 with Patrick Collinson observing in the Guardian of November 2011:

“The five banks that make up ‘Project Merlin’ (Barclays, HSBC, Lloyds Banking Group, RBS and Santander) said they loaned £157.6bn to UK businesses during the first nine months of the year, pushing them slightly ahead of the target of £190bn for the full year. Lending to small and medium-sized firms lagged mildly behind, with the banks advancing £56bn in the first nine months compared to the £76bn full-year target agreed with the government.”

These strong lending statistics have not saved innumerable SMEs going out of business however, and the targets have been described by the Federation of Small Businesses as being “modest” while the Bank of England has disputed the figures released by Project Merlin as deriving from flawed statistics . The problems with asking banks to adhere to a voluntary code are obvious without a change in the underlying fundamental ethos which puts profits first . Chatterjee’s article from 1996 correctly points out the fundamental conflict which exists when trying to apply CSR to banks; a conflict which led many to defend the free market even in the immediate aftermath of the crisis:

“…the unresolvable issues remain that if banks do not maximise the profits of their shareholders, they will be in breach of their contractual obligations, and that in the absence of any zeal for profit maximisation, incomes from investment will decrease, with adverse socio-economic effects.”

2.2 The effectiveness of s.172 of the Companies Act 2006
Speculation that s.172 could be used to fight both the bonus culture endemic in UK banks and future oil disasters on a par with the BP deepwater horizon are noble visions but, with respect, betray the reality. Australia rejected such piecemeal reform and they were wise to avoid ‘enlightened shareholder value’ . While CSR is a difficult concept to analyse, s.172 has yielded some case law which allows some modest appraisal of whether it is advancing the interests of stakeholders or preserving the status quo. The most significant case so far on s.172 has been R (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 (Admin) (QBD). This case was an application for judicial review advanced by the organisation People & Planet regarding the policy adopted by HM Treasury for RBS, the bank which the Government has an 84% stake in after intervening during the banking crisis. Stephen Copp has voiced his surprise that this did not begin as a derivative claim although perhaps this is not so surprising given the exclusive nature of derivative claims: only if People & Planet were a shareholder in RBS could they have brought an action under s.260 as pointed out earlier . The activists objected to the government’s policy for RBS on two grounds relevant to s.172 as described by Copp:

“First, it had a legitimate expectation that when government exercised its powers, it would do so with a view to preventing public money being spent on projects with the most obviously detrimental impact on climate change. Secondly…HM Treasury had failed properly to evaluate the arguments for a more interventionist policy, that it had regard to an irrelevant consideration, specifically the desirability of industry-wide regulation as opposed to a policy focused on just two banks, and that there was a misdirection of law by HM Treasury as to the effect of Companies Act 2006 s.172.”

The government policy crystallised in the Green Book which assessed all of the options open to the government (including, inter alia, environmental concerns) and came to the conclusion, justifiably in the court’s view, that a commercial approach was the best way forward for UKFI and that should such matters as human rights and environmental concerns drive policy then that would, in the words of the Green Book, “cut across the fundamental legal duty of boards to manage their companies in the interests of all their shareholders” . This is an assertion of the primacy of shareholders debate which has clearly survived the financial crisis intact. The other cases which concern s.172 are s.260 derivative actions and s.994 unfair prejudice actions which have served only to highlight some problems in the weighting of the factors under s.172 and highlight the fact that the Government clearly wants s.172 to remain as guidance rather something upon which to found litigation .

Self-Regulation in the banking sector
How effective the new ethical code of conduct, which the question refers to, proves to be will be up to the banks themselves. At the time of writing it is difficult to believe that continuing to allow banks to regulate themselves will prevent future financial crises without any strong statutory framework in place. Dieux and Viencke augment this argument and point out that “The concept of social responsibility essentially means that companies decide on their own initiative to contribute to improving society and to making the environment cleaner. The concept is inspired by a long tradition of auto regulation and auto discipline, which goes way back in the life of the business community.”

The authors also identify three crucial international standards which also inform and comprise part of the CSR panorama: a. The Guidelines of the OECD for Multinational Enterprises, attached to the Declaration on International Investment and Multinational Enterprises,b. The Tripartite Declaration of the ILO on the Principles related to Multinational Enterprises and Social Policy (1997 – 2000),c. The “Global Compact for the 21st Century”, launched by the Secretary General of the United Nations in January 1999. These international guidelines complement the plethora of codes which affect the banking industry: let us not forget that there has been, for some time, a banking code which the banks are supposed to adhere to although in the days when Chancellor Gordon Brown could declare the “end of boom and bust” perhaps these guiding principles were conveniently forgotten. Of course banks are also subject to the legal constraints of contract and tort but these have proven to be patently insufficient despite Chatterjee’s curious insistence in 1996 that the law of negligence is sufficient to protect the public from derelictions in the duty of care and skill expected of the directors of a company . The premature conclusion, which admittedly occurs before the banking sector can be properly evaluated, is that CSR has some beneficial effects but the banks have so far paid a lot of lip-service without much action. Only when a boom occurs and risky lending would lead to incredible profits will we truly find out whether or not the banks are taking into account more than just their shareholders when making decisions. This is a time when reputations can be destroyed in seconds online however, and it is clearly in the interests of banks to comply with these voluntary codes:

“The social responsibility of companies is the object of a literature the abundance of which does not always seem to be in direct proportion with its impact on the reality which is present in companies. In part fashionable, in part the object of artificial speculation, social responsibility of companies, as we have tested in certain instances, nevertheless impacts in concrete terms in certain specific, sensitive and grave fields of economic life. The expectations created by these voluntary initiatives are not scanty. The stakeholders as well as companies have a specific interest in transforming them into a day to day reality.”

Conclusion
In conclusion the voluntary approach to CSR is patently insufficient to ensure another banking crisis does not occur. The fundamental ethos of the Anglo-Saxon model of capitalism which puts shareholders above stakeholders remains firmly in place as demonstrated by the Government’s approach to the judicial review case concerning s.172 . Although there has been a modest success in the shape of lending to SMEs even this is disputed and indeed the volume of such companies going out of business would seem to support the suggestion that the lending requirements were too modest in the first place. The central piece of legislation which has pushed forward the CSR agenda in banks has been s.172 which introduces the concept of enlightened shareholder value. This section has been exposed as being painfully inadequate in promoting a stakeholder agenda and is only a token gesture in holding companies to a wider scrutiny. S..172 and ‘enlightened shareholder value’ represent only a codification of the prior common law and do not significantly move UK company law towards stakeholder primacy but rather entrenches the notion of shareholder primacy. As noted above codes of conduct can only take us so far and it is up to the banks to push them forward. Self regulation has failed and it is time to push through regulation in order to compel banks to take into account more than just profits. The golden age of banking after the banking crisis of the 1930s was ushered in not by CSR but by enforcing a split between investment and retail banking. After this bold move no bank failed until the steady and inevitable deregulation commenced. The banks in the have until 2019 to prepare themselves for ringfencing and, when the time comes, the appetite for reform will have inevitably disappeared.

Bibliography

Journals
Adeyeye, Adefolake (2010) ‘The Limitations of Corporate Governance in the CSR Agenda’ in Company Lawyer vol 31(4) pp 114-118

Alexander (2010) ‘BP: protection of the environment is now to be taken seriously in company law’ Company Lawyer 2010 vol. 31(9) pp 271-273

Attenborough, Daniel (2007) ‘Recent Development in Australian Corporate Law and their Implications for Director’s Duties’ in I.C.C.L.R vol 18(9) pp 312-323

Chatterjee, Charles (1996) ‘The Corporate Social Responsibility of Banks’ International Company and Commercial Law Review 7(11) pp388-393 at p.388

Copp, Stephen F ‘s.172 of the Companies Act fails People and Planet?’ in Company Lawyer 2010 p.406 – 408 at p.406

Cova & Dance (2006) ‘Walking the Post-Enron line’ in European lawyer vol 57 pp 51 – 52;

Clarke (2005) ‘Accounting for Enron: shareholder value and stakeholder interests’ in Corporate Governance: An International Review vol 13 issue 5 p.1

Day (2009) ‘Challenging directors’ bonuses: the application of directors’ duties to service contracts’
Company Lawyer 2009, 30(12), 374-376

Dieux, Xavier & Vincke, Francois (Corporate Social Responsibility: Illusion or Promise?’ in International Business Law Journal 1, pp13-34

Fisher, Deryn (2009) ‘The enlightened shareholder – leaving stakeholders in the dark: will section 172(1) of the Companies Act 2006 make directors consider the impact of their decisions on third parties?’ International Company and Commercial Law Review 20-1 pp10-16

Kiarie, Sarah (2006) ‘At crossroads: shareholder value, stakeholder value and enlightened shareholder value: Which road should the United Kingdom take?’ International Company and Commercial Review 17(11), 329-343

Leisenger, Klaus M (2005) ‘The Corporate Social Responsibility of the Pharmaceutical Industry: Idealism Without Illusion and Realism without Resignation’ in Business Ethics Quarterly vol.15 pp577-594
Schwarz, Florian (2008) ‘The German co-determination system: a model for introducing corporate social responsibility requirements into Australian law?’ Parts 1 and 2 in the Journal of International Banking Law and Regulation vol 23(3) p 128
Wheelock, David C.(2010) ‘Lessons learned? Comparing the Federal Reserve’s responses to the crises of 1929-1933 and 2007-2009 in Federal Reserve Bank of St.Louis Review 92.2 p.89

Zhao, Jingcheng (2011) ‘The Regulation and Steering of Corporate Social Responsibility in China: Stories After the Enforcement of Chinese Company Law 2006’ International Company and Commercial Law Review 22(12) pp400- 407 at p.400
Books
Cable, Vince (2010) The Storm: The World Economic Crisis & What it means Atlantic Books: London
Dignam & Lowry (2010) Company Law Oxford Uni Press: Oxford

Ferguson, Niall (2008) The Ascent of Money Allen Lane: UK

Mayson, French & Ryan Company Law 26th ed Oxford Uni Press: Oxfordp.31

Miles & Friedman (2006) Stakeholders: Theory and Practice

Parkinson (1993) Corporate Power and Responsibility Issues in the Theory of Company Law Clarendon Press: Oxford
Sheikh, Saleem (2008) A guide to the companies act 2006 Routledge Cavendish 2008

Reports
Banking Crisis: Reforming Corporate Governance and Pay in the City: 9th report of session 2008-2009
The Guidelines of the OECD for Multinational Enterprises, attached to the Declaration on International Investment and Multinational Enterprises,
The Tripartite Declaration of the ILO on the Principles related to Multinational Enterprises and Social Policy (1997 – 2000),
The “Global Compact for the 21st Century”, launched by the Secretary General of the United Nations in January 1999.
Statute
Companies Act 2006
Cases
R (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 (Admin) (QBD).
Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch)
Phoenix Contracts Ltd Re [2010] EWHC 2375 (Ch) (Ch D)
Websites
Collinson, Patrick (November 2011) ‘Top Banks Say They Are on Track to Meet Lending Commitments’ from Guardian online accessed on 3/11/2012 and available from: http://www.guardian.co.uk/business/2011/nov/09/project-merlin-lending-targets-on-track
Guthrie, Jonathan (2011) ‘UK Bank Reforms Nudge Risk into the Shadows’ from Financial Times online retrieved on 17th September 2011 and available from: http://www.ft.com/cms/s/0/b39f3aca-dd1f-11e0-b4f2-00144feabdc0.html#axzz1YFCf1Usx

The Coalition: Our Programme for Government retrieved on 10th August 2011 and available from: http://www.cabinetoffice.gov.uk/sites/default/files/resources/coalition_programme_for_government.pdf at p.9

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