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David C. Korten is president of the People-Centered Development Forum and author of When Corporations Rule the World published by Kumarian Press and Berrett-Koehler Publishers

People-Centered Development Forum columns and articles may be reproduced and distributed freely with appropriate credits without prior permission.

This article was written in memory of Willis W. Harman - philosopher, teacher, writer, futurist, and president of the Institute of Noetic Science, as well as my teacher, mentor, and friend for some 35 years - who died of brain cancer on January 30, 1997. Willis long held two central beliefs about business. First, he believed that the future of humanity requires a basic rethinking of the relationship of business to the whole. And second, he had a deep faith in the readiness and ability of business people to lead this rethinking through a process of critical self-reflection and action.


The Responsibility of Business to the Whole

by David C. Korten

Business has become, in this last half century, the most powerful institution on the planet. The dominant institution in any society needs to take responsibility for the whole...

- Willis W. Harman, August 1990

In this widely quoted statement on business responsibility, Willis Harman issued a wake up call. He pointed out that institutional changes have fundamentally realigned the power relationship between business and the rest of society and called on business leaders to examine the profound, but largely neglected, implications of this reality.

Such an inquiry must address a number of basic questions. How did business come to be the dominant institution of society? Is this dominance consistent with the healthy function of society? Given the distinctive nature and competence of business, what is its appropriate role and responsibility vis a vis other institutions? What is the responsibility of business to the whole and what are the most appropriate ways to assure its accountability to the whole for the discharge of this responsibility? These seldom asked questions take us to the heart of the dilemma's created by the rise of business to its current position of dominant power.

The Rise and Concentration of Corporate Power

It is not really business per se, but rather a complex interlocking web of global financial markets and corporations, a subset of the institutions of business, that have become the planet's most powerful institution. The power issue centers on the global corporation as a distinctive form of business organization.

It is instructive to recall that the institution of the corporation was first created by kings to serve as an agent of colonial expansion. Some claim the American revolution was as much a revolution against the crown corporations as against the crown itself. As a conse quence, corporations were treated with great caution in the early days of the new republic. The few corporate charters issued were generally for a limited duration to serve a carefully delineated public purpose. The crown has since been replaced by the modern shareholder and access to corporate charters has been democratized. Yet the original power and function of the corporation - concentrating wealth and power in the hands of an elite ruling class - have been largely restored.

Although a CEO may by choice organize the internal operations of a corporation around self-organiz ing networking structures that decentralize responsibility and make relationships more egalitarian, this does not change the corporation's formal structural overlay. Inherently one of the most authoritarian of human institutions, the structure of the corporation is designed to concentrate wealth and power at its apex. The CEO has the legal authority to at any time reclaim the power or authority previous delegated, hire, fire, and reassign staff, open and close plants, add and drop product lines, and change transfer pricing almost at will with virtually no recourse by the people or communities affected - either inside or outside the organization. Nor is the CEO at liberty to relinquish this power. By law it goes with the position.

Historically, exercise of the regulatory powers of the state was the primary restraint on the expansion of corporate power. Together the processes of deregulation and globalization have effectively relieved that con straint by placing the power of global corporations and finance beyond the reach of the state. The hopeful claims of some business observers notwithstanding, the mega- corporations are not shedding their power. To the contrary they continue to concentrate and consolidate it through mergers, acquisitions, and strategic alliances. The statistics are sobering.

The primary accountability of these corporations is to the global financial markets in which each day $1.4 trillion in foreign exchange changes hands in the search for speculative profits wholly unrelated to any exchange of real goods or services.

Whose interests are represented by these financial markets to which the world's most powerful corporations are beholden? In the United States 77 percent of share holder wealth is owned by a mere 5 percent of house holds. The broader population that holds a beneficial ownership through pension funds is represented in corporate governance by a few hundred fund managers who have no accountability to the beneficial owners beyond protecting the security of their benefits. Globally the share of the world's population that has a consequen tial participation in corporate ownership is far less than 1 percent. This concentration of corporate power ac countable only to a tiny global elite denies the most basic principles of democratic governance. It also results in an ever increasing concentration of the world's wealth. Forbes magazine now identifies 447 billionaires in the world, up from only 274 in 1991. Their combined assets are roughly equal to the total annual incomes of the poorest half of humanity.

It is axiomatic. In a healthy democratic society the dominant institution must be both responsible for the whole and accountable to the whole. Not long ago, nation states were our dominant institutions. The nation state had a clearly mandated responsibility for the whole and the institutions of democratic societies were struc tured to assure commensurate accountability to the whole.

By contrast, global corporations and financial markets serve financial bottom-line mandates that are as narrow as their constituencies. The deregulation and economic globalization that have increased their power, have done nothing to broaden their mandates and or accountability. To replace the power of the state with the power of the global corporation is tantamount to an act of collective suicide.

We are experiencing the consequences in the form of six current tendencies of the global system identified by Willis and colleague Thomas Hurley in a co-authored paper written only days before Willis' cancer was diagnosed.

  1. Destruction of the natural environment.
  2. Destruction of community.
  3. Transfer of wealth upward.
  4. Marginalization of persons, communities, and cultures.
  5. Erosion and denial of the sense of the spiritual or sacred.
  6. Creation of learned incapacity and helplessness.

Spiritually impoverished and on the brink of destroying the natural and social fabric on which human life and civilization depend, we are creating societies that diminish the human spirit and place our very survival at risk. Dominated by the power and values of global corporations and financial markets, the global economy bears a major responsibility

It is ironic that the policies that have concentrated power in our most authoritarian and least accountable institution have been promoted in the name of human freedom, democracy, and the market economy. In the true market economy envisioned by Adam Smith small producers compete for the favor of small consumers on the basis of price. We do not have an economy centrally planned by socialist governments to serve the party bosses. But what we do have is not so different as we might think - an economy centrally planned by the world's largest corporations to serve the interests of their wealthiest shareholders.

There is indeed a positive relationship between a market economy comprised of small independent producers and human freedom. However, corporate freedom is to human freedom and the market economy what monarchy is to democracy - they are fundamentally at odds. Confronting this conflict is key both to reversing the devastating trends that threaten our future and to defining the real challenge of socially responsible management. The perhaps startling implication is that the number one priority of socially responsible business leaders must be a commitment to create the conditions of a socially efficient market economy.

The Conditions for a Socially Efficient Market

The market is a powerful and indispensable mecha nism for facilitating efficient economic choices. However, even Adam Smith was quite clear that the invisible hand of the market works to the larger benefit of the society only to the extent a number of rather specific conditions are met. A number of such conditions have been identified and elaborated by subsequent generations of market economists.

For example, the socially efficient market will be comprised of small locally owned enterprises that are rooted in place and operate within a framework of community norms and relationships. There should be no producers sufficiently large that they can artificially manipulate prices or consumer preferences nor associa tions through which producers may act in combination to set prices outside the market. Proprietary information is also a no-no. All market participants must have full access to relevant knowledge and technology.

One of the most basic principles of social market efficiency is that producers must bear the full cost of the products they sell. There must be no subsidies that distort market prices and allocation. And since markets respond only to money and the socially efficient market must respond to the needs of everyone, there must be reasonable equality of income and financial assets to assure everyone an opportunity to participate. There must also be an effective and democratically accountable government to perform functions to which business is not suited and to provide for necessary regulation of the conduct of business. These are all conditions of the socially efficient market as envisioned by market theory. No serious student of this theory should be surprised by the social inefficiency of a global economy domi nated by free floating capital and footloose corporations that command internal economies larger than those of most states, externalize their costs by bidding down environmental, work and safety standards, taxes and wages under threat of moving jobs elsewhere, own and control the public media, command advertising budgets that rival public spending on education, and use intellec tual property rights to create government protected monopolies. The existing global economy systematically violates every one of the conditions required to align the workings of the market with the public interest. It delinks the global corporation from meaningful public accountability, facilitates the externalization of costs, and limits access by both consumers and investors to information essential to making informed decisions.

Market theory also embodies a number of basic assumptions regarding the fundamental responsibilities of the firm. Among others it should fully internalize its own costs, practice full disclosure with investors and consumers, avoid any form of anti-competitive practice or price fixing, and obey the law. While these are nothing more than fundamentals of ethical business practice, they represent serious commitments indeed for a business operating in an unregulated global market economy that encourages and rewards quite the opposite behaviors. A commitment to honoring these principles represents the essential core of the firm's responsibility to the whole and should be the foundation of any social responsibility program. To put it bluntly, a firm that is not seriously committed to meeting these standards has no legitimate claim to being socially responsible no matter how much it gives to charity or otherwise sup ports beneficial social causes.

Profits Earned vs. Profits Extracted

According to market theory a firm's profits measure its value added contribution to the society. To the extent this is true, it follows that a firm best maximizes its social contribution by maximizing the financial return to its shareholders. The catch here is that this same market theory also assumes that the firm fully internal izes the costs of its operation. To the extent that costs are externalized, however, the firm's profits represent not an addition by the firm to the wealth of society, but rather an expropriation by the firm of the community's existing wealth.

Sometimes the externalization takes the form of direct public subsidies - as for example the grant given by the State of Virginia to Motorola to locate a research and manufacturing facility in the state. It included a $55.9 million grant, a $1.6 billion tax credit, and a reimbursement package worth $5 million for employee training. Every dollar of this package represented a direct transfer of money from Virginia taxpayers to the profits of the Motorola corporation. Special property tax breaks given by New York City to private companies subsidized them to the tune of $301.8 million in 1994 alone. Direct U.S. government subsidies to tobacco growers will come to $41 million in 1997. The oil and gas industry gets $2.4 billion a year in federal subsidies in the form of oil depletion allowances. Over a ten year period the U.S. government subsidized Cargil's foreign grain sales by $1.3 billion. The U.S. government is currently in the process of giving away spectrum rights to the broadcast industry that former Senator Robert Dole estimates are worth from $12 to 70 billion. Mc Donald's receives $1.6 million from the government each year to advertise its fast food products overseas. The conservative Cato Institute estimates that such direct and tax break corporate subsidies total$135 billion a year.(1)

In the 1950's taxes on U.S. corporations provided 31 percent of the federal government's general revenues. Their share is now down to just 15 percent. In 1957, corporations provided 45 percent of local property tax revenues in the United states. By 1987, their share had dropped to about 16 percent. Since corporations rely on public services and infrastructure, expect the full protec tion of their assets by the U.S. military, and depend on workers educated at public expense they rightly bear a fair share of the tax burden required to pay for these and other public services. When they are excepted from paying their fair share of taxes, the cost of the services they enjoy is shifted to other taxpayers.

There are also the costs imposed on society by the products corporations sell. For example, the health consequences of the cigarettes from which corporations profit cost the public an estimated $53.9 billion a year. Similarly society bears a $135.8 billion burden for the consequences of unsafe vehicles. There are as well the costs born by workers who suffer injuries and accidents as a result of unsafe work places ($141.6 billion) or die from workplace cancer ($274.7 billion).(2)

These are all uncompensated costs imposed on society by the operations and activities of corporations. Every such externalized cost, whether in the form of a direct cash payment or in the form of diminished health and quality of life, involves privatizing a gain and socializing its associated costs onto the community. Each such externalized cost represents an unearned public subsidy to the firm's profits - a taking by the corporation from the society - and is properly deducted from reported financial profits when determining the value added contribution of the corporation to society.

Ralph Estes, author of Tyranny of the Bottom Line and Corporate Social Accounting, has compiled esti mates from a number of studies of the costs that corpora tions impose on U.S. society. He came up with a conser vative total annual figure of $2.6 trillion based on 1994 dollars - not even including the direct cash subsidies and special tax breaks estimated by the Cato Institute.(3) This figure compares to total 1994 before tax corporate profits in the United States of $515 billion.(4) In other words society subsidizes America's corporations by more than five times the amount of the profits they generate for their shareholders.

Some of the externalized costs might be considered a form of income transfer from society to the corporation and its owners. As disturbing as this may be, the truly tragic forms of cost externalization involve the absolute, and sometimes permanent, destruction or depletion of the real productive capital of the society. For example, when a corporation:

These are not hypothetical concerns. Take the case of the Benguet Mining Company in the Philippines docu mented by Robin Broad and John Cavanagh in their book Plundering Paradise. In the quest for gold, Ben guet Mining cut deep gashes into the mountains, stripped away trees and top soil, and dumped enormous piles of rock into local rivers. With their soils and water sources depleted, the indigenous Igorot people in the area can no longer grow rice and bananas and have to go to the other side of the mountain for drinking water and to bathe. The cyanide used by the Benguet corporation to separate the gold from the rock poisons the local streams, kills cattle that drink from the streams, and reduces rice yields of people in the lowlands who use the water for irriga tion. When the tailings and cyanide empty into the oceans they kill the coral reefs and destroy the fishing on which thousands of coastal people depend.

While no specific estimates are available, the cost of Benguet Mining operations born by the community almost certainly exceed the amount of the company's profits and local payroll by a wide margin, resulting in a substantial net loss to society. Tragically there is nothing at all special about the Benguet case. It is much the same with Shell Oil in Nigeria, Texaco in Ecuador, Freeport-McMoRan in Indonesia, or countless other less publicized cases of predatory corporations devastating the lives and habitats of people who have no democratic voice as they extract and destroy natural capital for a quick profit.

Or consider the report recently cited by Bob Herbert in the New York Times(5) on working conditions endured by young women ages 15 to 28 working at factories that make Nike shoes in Vietnam. Three meals of rice, a bit of vegetable and perhaps some tofu costs the equivalent of $2.10. Renting a room costs at least $6 a month. Workers must cover these and all other expenses out of a paycheck of $1.60 a day. Those interviewed com plained that since starting work at the factory they have suffered frequent headaches, general fatigue, and weight loss. Workers are allowed one bathroom break and two drinks of water per eight hour shift. Again, Nike is unfortunately not all that special. It just happens to have become the poster child symbol of corporations that profit from worker exploitation.

The profitability of a good many of our largest corporations has little to do with efficiency. Their profits depend to a disturbing extent on their ability to use their extraordinary economic power to extract huge subsidies from the larger society. That in turn allows them to outbid their competitors for capital and undercut their prices to consumers to further consolidate their power and demand still more subsidies. As ecological econo mist Neva Goodwin bluntly explains,"Power is largely what externalities are about. What's the point of having power, if you can't use it to externalize your costs - to make them fall on someone else?"(6)

Of course there will be those who argue that the public benefits from these "cost savings" in the form of lower prices. Here we must again come back to the concept of market efficiency. Where prices are lower due to a subsidy this distorts the market signals, giving the subsidized product an advantage over nonsubsidized alternatives and increasing the hidden burden on society. The various subsidies enjoyed by the automobile have no doubt contributed to making the automobile the dominant form of transportation in the United States, at enormous cost to our quality of life. The removal of these subsidies would likely shift the balance in favor of more environmentally and socially efficient public transportation and urban densities.

Corporations have long portrayed themselves as powerful engines of wealth creation for the benefit of the whole of society. This is a part of their reality. The corporation also presents a darker face to the world - a powerful engine of wealth extraction and concentration. Both faces re real, which defines a central dilemma of our time. How do we exorcize the dark side with out destroying the essential and beneficial wealth creation face of the business sector? Fortunately, there may be a truly market based solution to this dilemma based on linking together two fundamental market principles: internalized costs and fully informed buyers.

A Market Based Approach to Corporate Responsiblity

There has been a growing interest in various kinds of social accounting and auditing as a means of increasing the public accountability of corporations to their multiple stakeholders. A variety of initiatives seek to provide more information to the public on a host of concerns ranging from environmental performance, product safety, affirmative action, working conditions, and community charities. All make an incremental contribution toward increasing corporate accountability. Most, however, are at once fragmented, detailed, and partial. Beyond the quite valid idea that a corporation should serve more than the narrow financial interests of its shareholders they are not grounded in a coherent theory of either the market or the corporation. The corporation was never intended to function as a public charity or policy advocate and is not by design suited to such functions.

It is important to note that for all its power, the global corporation is a rather crude and simplistic organizational form. It is designed to be accountable to one constituency, its shareholders, for one thing, profit. Compare the corporation's accountability structures to the rich complexity and sophistication of the structures of modern democratic government designed to hold government accountable to the whole for the whole.

To ask the corporation to be responsible in some way to a broader set of stakeholders for meeting a variety of often vague and fragmented standards is to deny its nature as an institution designed to pursue a single clearly defined objective for a single interest constituency. It essentially means asking the corporate CEO to be responsible for making value choices on behalf of the corporation's shareholders, customers, and the society beyond profit maximization. Even if the law and the corporate board were to grant a CEO such discretion, what reason do we have to expect he or she will exercise it to the larger benefit of larger society? To whom and through what mechanisms is a corporate CEO accountable for the exercise of this discretion? Why should we assume that all persons who happen to head powerful corporations have the wisdom and the motiva tion to make decisions for the whole? And even for those who do have the wisdom and motivation, by what right do they hold such power over the rest of society?

Our efforts to correct the dysfunctions of unaccount able corporate power must be based on a more focused approach grounded in market theory and our understand ing of the nature of the corporation and its accountability structures. A straightforward focus on internalizing costs and assuring all stakeholders free access to relevant information relating to cost internalization meets both these conditions and would offer a market based ap proach to making the corporation a more socially responsible entity. Indeed, actualizing these two condi tions of a socially efficient market should be the central focus of any corporate responsibility program.

The centerpiece of such a social responsibility initiative would be a corporate cost internalization audit. We might call it the market efficiency audit (MEA) to highlight the fact it implements a basic market principle. Some critics of environmental, health, and safety regula tions argue that such matters should be left up to the market to be arbitrated by investor and consumer choice. Of course to exercise this choice intelligently requires access to the relevant information. Providing that information is the primary purpose of the MEA.

The MEA would not be a general social audit of all the things the firm might do to benefit society beyond its bottom line. Rather it would be a clear and specific measure of the corporation's externalized costs - the total public subsidy of its operations. As with financial accounting, market efficiency audit accounting should seek to arrive ultimately at a single bottom line number. This figure could be compared to the corporation's total sales, profits, and tax payments, and to averages for the industry and for all corporations to assess the extent of the corporation's welfare dependency.(7)

The full audit report should be in the public domain and readily available to any interested party. A summary of the results should be included in the firm's financial prospectus for review by all actual and prospective shareholders. The basic results should also be included in the labeling of any product of the corporation.

Just as a shirt label might report the cotton content, it might also indicate that the public subsidy content is say, $15. Thus the buyer will know the uncompensated cost to society of his purchase and can make an informed choice to chose an item from a more socially efficient producer. The lower the public subsidy content of a given product the more socially responsible the pur chase.

Similarly, the lower the percentage of a corpora tion's subsidy to total sales the more socially responsible it is to invest in that corporation. It would be a far more meaningful indicator for socially responsible investing than the crude yardsticks now applied. Corporations could be ranked by their percentage of cost internaliza tion just as they are now ranked by profit.

Firms seriously committed to being at the forefront of social responsibility may lead the way by undertaking MEAs on a voluntary basis as a demonstration of their commitment to serving the public good. However, an annual MEA should in due course be a legal requirement for any corporation with $500 million or more in either sales or assets. The preparation of a MEA by smaller corporations and unincorporated businesses should be encouraged, but not necessarily required.

Some will surely argue that such an audit would be an unnecessary and expensive diversion of economic resources because the amount of externalized cost for their corporations is negligible. Any executive who really believes this should be an active proponent of the MEA and be an early voluntary adopter. The audit should confirm the responsibility of their company and thereby strengthen its public legitimacy and good will. In any event the public that has granted the privilege of a corporate charter has both the need and the right to know.

The MEA cannot rightfully be considered an unjustified socialist intrusion of the state into private affairs. It in no way denies shareholders of their right to profits commensurate with the contribution of their investment to increasing the wealth of the society or the freedom of choice of consumers. It simply calls on the institutions of the market to play by the rules of the market so that consumers, investors, and communities negotiating for corporate investments can make more fully informed market decisions.

Furthermore, the burden of proof to establish that it is producing a net benefit to society should rest with the corporation that enjoys the special privileges con veyed by the corporate charter. The idea that the corpo ration enjoys such privileges as a natural right is a legal fiction without moral foundation. If there is a cost involved in producing such proof, it should be consid ered a price paid for those privileges - a part of the normal cost of doing business as a corporation. In any event, the costs involved will rarely be more than a small fraction of the public subsidy the corporation enjoys. Any corporation that finds it an excessive burden would be free to avoid the scrutiny by giving up their corporate charter and the special privileges it bestows.

Maintaining the independence and integrity of the MEA will pose an important challenge. There will be need for a well developed set of MEA accounting standards established by qualified and independent professional group under public oversight. A corpora tion's MEA accounting system should be maintained by a special unit accountable directly to a committee of outside board members and be subject to audit by an accredited independent external agency. Ralph Estes has suggested that the ultimate governmental oversight might be the responsibility of the Securities and Ex change Commission.

The idea of MEA accounting is not new. Corporate social accounting was a lively topic, especially within the accounting profession, in the 1970s. With the current upsurge in public awareness and concern about corpo rate responsibility it is now an idea whose time has come.

It could become an organizing issue for various groups concerned with increasing corporate responsibil ity and accountability. Groups developing social audit ing instruments might join with professional accounting groups to develop appropriate accounting and auditing standards. Advocacy groups campaigning on corporate issues can raise public consciousness of the extent and implications of cost externalization and build political support for legislation mandating the implementation of MEA accounting. Business groups that have a serious commitment to increasing business responsibility should call on corporations to make cost internalization a basic principle in corporate codes of conduct.

Such measures can never be an adequate substitute for a strong and vigorously enforced regulatory frame work designed to protect the public from the worst consequences of cost externalizing corporate practices. They can, however, be an important supplement to such measures consistent with sound market principles.

If MEA accounting were to become a standard feature of corporate management practice it would bring to light vast hidden inefficiencies of a system of business that in the name of the market violates nearly every principle of an efficient market economy. It will almost surely lead to radical and much needed restructuring of the institutions of the business sector as the market purges the truly inefficient and restores a needed institu tional balance in society by significantly reducing the dominance of the largest and most subsidy dependent global corporations and the disproportionate allocation of wealth to shareholders over workers.

It will also raise the prices, and thereby reduce the use, of many harmful market goods. Traumatic as this may be for the corporate world during the transition period, the end result will be a healthier business com munity, healthier societies, and an increase in both the legitimacy and efficiency of the world's market econo mies. In pressing forward this agenda, business leaders will be working to fulfill their social responsibility to the whole in ways that are both powerful in their positive implications for society and consistent with their roles and the nature of the institutions they head.


Endnotes

1. "The End of Corporate Welfare as We Know It?" Business Week, February 10, 1997, p. 36.
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2. Estimates are from Ralph Estes, Tyranny of the Bottom Line: Why Corporations Make Good People Do Bad Things (San Francisco: Berrett-Koehler, 1995), pp. 177-185.
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3. Ibid, p. 178.
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4. U.S. Bureau of Economic Analysis, Survey of Current Business, June 1996 as reported Otto Johnson, editor, 1997 Information Please Almanac (New York: Houghton Mifflin, 1996), p. 64.
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5. March 31, 1997, p. A-5.
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6. Neva Goodwin, "Externalities and Economic Power" (paper presented at the fall retreat of the Environmental Grantmakers Association, Bretton Woods, N.H., October 13-15, 1994), p. 2.
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7. A related approach, the corporate "Social Impact Statement," is presented in Ralph Estes' Corporate Social Accounting (John Wiley & Sons, 1976, Chapter 4). It matches corporate social benefits against social costs to arrive at a net social surplus or deficit. Estes is now organizing a national Stakeholder Alliance to press for full corporate accountability.
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Source: http://iisd1.iisd.ca/pcdf/1997/responsibility.htm


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