An Economist's Take on Corporate Responsibility

by Michael Brandl
As an economist let me state: Meus professio est crimen. My profession is to blame. My profession is to blame for the overemphasis on prices. Economists love movements in prices because we view them as wonderful signal senders.

Falling prices signal a surplus, ceteris paribus. Raising prices send a signal of shortages, again ceteris paribus. We teach our students the fundamental concepts of economics by introducing Alfred Marshall’s supply and demand curves with price on the vertical axis. We pound into our students’ heads the importance of prices and price movements.

And yet, as economists, we know there is so much more to optimal decision making than price. For example, consumer theory centers on the immeasurable concept of utility. We know utility maximization is critical to the efficient allocation of resources— and thus the well being of society—and yet we don’t have a cardinal measurement of utility.

Prices simply cannot express utility. Is there a “stated price” for the enjoyment we derive from watching our children at play or listening to a well-performed symphony? Clearly, there’s not. The price mechanism simply falls short.

Prices also miss externalities. These “unpriced” costs and benefits are all around us. The benefit to the neighborhood when we plant flowers in our yard is a positive externality. The harm to our neighbors when we play our music a bit too loudly is a negative externality. We fully realize these externalities need to be considered when making optimal decisions. If we don’t consider externalities, all of society suffers for it. We cannot perfectly measure these externalities, yet we know we must consider them when making decisions.

And so it is with corporate responsibility. Some argue that the only responsibility of a corporation is to maximize the returns they pay to stockholders. But this argument falls into the “prices are everything” fallacy. Just because we cannot perfectly measure the benefit to the corporation for being a socially responsible entity, that does not mean the corporate directors should ignore this responsibility.

Consider a corporation’s involvement in protecting the environment. Any corporate entity uses resources—land, labor and capital. In a market setting, the corporation needs to compensate the “owners” of these resources. This is exactly what the corporation is doing when it pays interest to bond holders and dividends to equity holders. The corporation is compensating the owners of financial capital for the use of their capital. But the corporation also uses land and labor.

If a corporation undertakes an action that protects the environment, let us assume the benefit is clearer air, cleaner water, and thus, a healthier population. This benefit goes to the “owners” of the air and water. That is, it “compensates” society. Thus, environmental protection is merely a way of compensating the owners of resources but in way that does not use prices.

An interesting twist on this “cost” of environmental protection is that it ultimately benefits the corporation.

Consider the clearer air, cleaner water and improved health of the society. All of these things make for an overall healthier workforce and client base for the corporation. These healthier workers are more productive than sick workers and healthier clients will tend to buy more (of most goods) than sick clients. Thus, the corporation benefits from this compensation of society.

Similar examples can be made of corporations’ involvement in fighting HIV/AIDS or hunger or promoting education. All of these actions, however, involve benefits that go well beyond price.

Focusing only on price or short-term earnings will lead to the ultimate decline of a corporation. Markets are extremely dynamic entities that punish those who do not think dynamically enough. Those who try to run their companies based on simplistic slogans like “maximize stockholder value” are sure to find themselves and their companies on the ash heap of history. This is what economics and history tell us.

Michael Brandl, senior finance lecturer at the McCombs School, writes a biweekly Macro Update of the current happenings in the macro and global economy, which may be of interest to McCombs alumni and current students. You can subscribe to or view the Macro Update at http://www.mccombs.utexas.edu/news/macro _updates. Brandl also blogs at http://brandl.easyjournal.com.