Globalization and Multinational Corporations - Creating

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Creating Social Accountability Through
Voluntary Codes of Conduct
S. Prakash Sethi, Ph.D.
University Distinguished Professor, Zicklin School of Business,
Baruch College, The City University of New York
And
Forrest Mars, Sr. Visiting Professor of Ethics, Politics and Economics
Yale University, New Haven CT
Prepared for presentation at a Workshop on the Role of Corporations in a ‘World at Risk’
Norwegian Institute of Science and Technology (NTNU)
Trondheim, Norway, November 19-20, 2012
Copyright © 2012, S. Prakash Sethi
10/5/2012
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Globalization, Multinational Corporations, and Voluntary Codes of Conduct
 Over the last 30+ years, there has been a dramatic increase in foreign direct investments,
which reached $1.5 trillion in 2011.
 FDI flows to developed countries increased by 21% between 2007 and 2011 reaching a
total of $748.0 billion.
 During the same period, FDI to developing countries increased by 11% reaching a record
total of $684.0 billion.
 A very large portion of these investments have been made by the institution of large
multinational corporations (MNCs).
 The twin factors of increased FDI and the enhanced role of MNCs have fundamentally
changed the process of global economic growth when contrasted with earlier periods of
international trade, which primarily focused on exchange of commodities and
manufactured goods.
 Currently, approximately one-third of the world trade consists of intra-firm transactions,
i.e., trade among various units (foreign affiliates, headquarters) that make up the
increasingly integrated production system of individual MNCs.
 The global reach of MNCs is further strengthened by their ability to integrate not only
global markets but also national production systems.
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Impact of Globalization and Growing Influence of MNCs
 Globalization of economic activities has led to an uncoupling of the corporate persona
from its local roots and weakened the traditional bonds of loyalty between the homegrown companies and their local communities and countries of origin.
 There is growing imbalance in the relative bargaining power of national and regional
governance authorities. This has led to a decline in social investments that enhance the
quality and supply of public goods.
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Impact of Globalization and Growing Influence of MNCs
continued…
 Globalization has facilitated a vast shift in economic activity among various regions and
countries. Production and consumption activities have become highly dispersed around
the world.
 Since labor and physical resources are relatively fixed while capital is largely mobile,
MNCs have used their increasing bargaining power to increase their share of the
economic output.
 MNCs have been able to extract a greater share of economic returns while imposing extra
costs on producing countries through negative externalities. All other factors of product,
e.g., labor in the emerging economies, and physical resources (environment) have shared
poorly in comparison.
 For the foreseeable future, it is unlikely that new regional or global protocols would
develop to restore balance between MNCs and national-local governments.
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A Paradigm shift in relations between MNCs and national-local governments
 The shifting landscape of national political regimes and MNC’s economic power has
brought about a new kind of instability in the political arena that has also created greater
uncertainty and enhanced risk in the economic arena.
 MNCs are facing increasing pressure to respond to societal needs and expectations that
were hitherto considered the responsibility of local political authorities and also homegrown economic organizations.
 One dimension of the resultant instability can be found in numerous and recurrent
campaigns – sometime violent and invariably destabilizing – against the operations of
MNCs whether they are dealing with resource extraction, e.g., mining for minerals and
oil; working conditions and wages for workers in low wage countries; and, pollution and
environmental degradation dealing with MNC operations.
 MNCs have also been blamed for supporting corrupt and repressive political regimes that
would help them with continuing their operations.
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Need for New Responses to Changes Socio-Political Environment
 MNCs have recognized that this situation is unsustainable. Consequently, they must
develop alternative approaches to creating an environment of greater acceptability of
their business model around the world.
 Further pressure for change has also come from two sources:
•
There has been a resurgence of regional and multilateral organizations, e.g., International
Monetary Fund, World Bank, and various regional development organizations, that have sought
to create regulatory regimes to hold MNCs accountable for some of the negative consequences of
their global business operations.
 Another important element in this context has been the rise of a new class of nongovernmental organizations (NGOs) that:
•
•
•
are often regional and international in scope;
enjoy a large measure of public trust; and,
command considerable financial and professional resources with the ability to challenge every
aspect of MNC conduct.
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MNCs Responses to Changing Socio-Political Landscape –
Voluntary Codes of Conduct
 MNCs have recognized the need for a more proactive response to deal with the new
socio-political order in a manner that would create a more hospitable environment for
their global business operations in a manner that would minimize the pressure for
increased regulation while also giving them considerable control over their business
activities.
 This has largely taken shape in the form of voluntary codes of conduct promulgated by
individual companies and industry groups, as well other organizations that espouse
proactive changes in MNCs’ corporate conduct.
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Characteristics of Voluntary Codes of Conduct (VCC)
 Over the last two decades, there has been a plethora of voluntary initiatives by
companies, industry groups, and national and regional bodies that call for creating
voluntary standards in those aspects of a corporate conduct that are inadequately
addressed in prevailing legal and regulatory mandates.
 A recent study of Sethi International Center for Corporate Accountability (SICCA), using
worldwide database of over 1300 corporations has identified literally hundreds of
individual company, industry, cross-industry (universal) codes promulgated by both
business-oriented organizations and NGOs.
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Characteristics of Voluntary Codes of Conduct (VCC) continued…
 These codes have addressed issues that are important to broad segments of society and
are aimed at changing corporate conduct to more adequately address issues that are
collectively stated as environment, social, and governance (ESG) issues.
 A voluntary code of conduct consists of a set of activities that the sponsoring
organization (SO) commits to undertake. The effectiveness of SO’s responses to society’s
concerns depends upon a number of factors:
•
The socio-political environment, public awareness, and the emotional intensity generated by the issue.
•
The dynamics of competition and industry structure in which the company operates.
•
The institutional character, corporate resources, and management style of a particular organization.
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Private Law Character of Voluntary Codes of Conduct
 A company or industry-based codes of conduct is in the nature of a “private law” or a
“promise voluntarily made” whereby an institution makes a public commitment to
certain standards of conduct.
 The voluntary approach provides the sponsoring organization (SO) with an opportunity
to “define” the conditions and “establish” standards by which the SO wishes its
performance to be measured. However, in order to be credible, the scope of the code and
the SO’s performance must meet an acceptable level of societal expectations.
 The “private law” character of voluntary codes gives the sponsoring organization a large
measure of discretion.
 The “private law” character, however, does not reduce the obligations of SOs, whether
companies or industries. Rather, it increases their burden to ensure that skeptical critics
and public-at-large have faith in the SO’s responses and performance claims.
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Private Law Character of Voluntary Codes of Conduct continued…
 The nature of voluntariness, and by implication, the flexibility afforded to companies
depends on the premise that SOs and their critics share a common interest in improving
the underlying conditions of impacted groups and regions.
 It is also assumed that all parties share a common interest to resolve the underlying
issues within realistic constraints of available financial resources and competitive
conditions.
 The success of the system depends on the ability of SOs to create and sustain a high level
of transparency and public credibility. It imposes a heavy burden on SOs to create
credible systems of governance, performance evaluation, monitoring, and public
disclosure.
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Voluntary Codes concerned with ESG issues
 Voluntary codes dealing with ESG issues present challenges for both the sponsors and
those who would be impacted by their actions.
 In direct contract to the more traditions codes of conduct by business organizations,
ESG-related codes call for the company and industry SOs to voluntarily undertake
additional costs to reduce negative externalities, which may adversely impact their overall
profitability and competitive stance (at least in early stages).
 However, the ability and willingness of individual companies to absorb the cost of groupbased codes may significantly differ and thus adversely impact their interest in
complying with code standards.
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Positive Aspects of Voluntary Codes
 From the business viewpoint, voluntary codes provide member companies with
mechanisms to develop solutions that are focused, take cognizance of the member
companies’ special needs and public concerns, and, are economically efficient.
 They engender public trust through “reputation effect” while avoiding being tainted for
the actions of other companies.
 This is a proactive stance and perhaps the best of all possible worlds. It provides scope
for experimentation and building consensus, and facilitate further expansion of “private
law”.
 However, to be effective, voluntary codes must have a large measure of acceptability from
most of the relevant stakeholder groups. They must also fit within the competitive
realities of the marketplace and local socio-cultured environment. The same activity
may be considered socially responsible at one time, under one set of circumstances, and
in one culture. It may be considered socially irresponsible when any of these factors
change.
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Current Status of Voluntary Codes
 Notwithstanding, the promising benefits from creating effective voluntary codes, their
current status is not encouraging in meeting corporate commitments and engendering
public trust.
 Codes are presented as public statements of lofty corporate intent and purpose, but are
short on specific content. The lack effective and meaningful monitoring procedures as to
verification and public disclosure of a company or industry’s compliance with code
provisions.
 Code compliance is not integrated into organization’s reward structure and operating
procedures. Codes are not taken seriously, event within the company or the industry
group, by either managers and employees, or member companies.
 This situation, if left uncorrected, would deprive the business community of an
important tool that would enhance corporate credibility and thereby reduce pressure for
greater regulatory oversight and mandatory compliance standards.
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Types of ESG-Related Voluntary Codes of Conduct
 ESG-related voluntary codes can be grouped into three broad categories
•
•
•
Company-based codes of conduct
Industry-wide codes of conduct
Multi-industry and multi-sector codes of conduct
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Group Based Codes – Positive Elements
 The case for an industry or region-wide approach is based on the premise that companies
in an industry or region face similar problems, competitive conditions, and external
pressures. A number of arguments are offered in support of group based codes.
•
•
•
•
A coordinated approach would be more cost effective.
A multiplicity of codes would make it hard for others to compare and evaluate performances
among different companies.
It would make it difficult for local manufactures to comply with codes from different companies.
It would give the participating companies a united position from which to respond to the
concerns of their critics and public-at-large.
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Group-Based Codes - Drawbacks
 An industry-wide approach is likely to deter a company that is willing to take initiative in
seeking more innovative approaches.
 An industry-wide approach may tempt companies to “collude” against more socially
responsive initiatives.
 Endless discussions, procrastination, and obfuscation may delay any real action
indefinitely, which inevitably leads to public ridicule and distrust.
 The need to keep the largest number of companies in the group pushes performance
standards to the lowest common denominator – the companies with the weakest records
can force standards down to what they are willing to live with.
 An industry-wide approach suffers from the free rider problem.
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Analytical Framework for Examining the Efficacy of Voluntary
Self-Regulation
 A schematic framework is provided in Figure 1. It explains the inter-related nature of
sponsoring organizations and their ability to create and implement different types of
voluntary codes of conduct.
 This framework has been developed through our analysis of a number of voluntary codes
of conduct promulgated by individual companies, industry groups, and multi-sector and
global organizations. This framework suggests that the effectiveness of a voluntary set of
principles or code of conduct depends on the confluence of two sets of factors.
a)
b)
The cohesiveness of the sponsoring group in shared interest in formulating and implementing
the voluntary standards.
The scope and specificity of enumerated standards and the governance and accountability
structures established by the sponsoring group to ensure effective implementation,
monitoring, and public disclosure.
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Figure 1 - Confluence of member characteristics and motivations, and the scope of
P1
High
principles and implementations structures in creating effective voluntary codes of conduct
Diversified group with unified focus. Standards are vague
and aspirational. Relative ineffective governance although
somewhat greater transparency and public disclosure.
Highly focused and committed group with shared values,
transparent reporting and strong accountability.
Examples: Mattel Inc., Freeport-McMoRan Cooper & Gold
Inc., Forest Stewardship Council, Chemical Industry’s
Responsible care program
P’
Example: Kimberley Process Certification System (KPCS)
deals with the issue of conflict and blood diamonds, The
Equator Principles, Extractive Industry Transparency
Initiative (EITI)
Sector A
voluntary code provisions and
implantation structures.
Sector D
Cohesiveness among sponsoring group members and commitment to the voluntary initiative.
S’
Sector C
Highly diversified group, Principles and standards are kept
deliberately vague. Governance system is insular and
resists
external
intervention.
Transparency
in
communication is largely rhetorical and insufficient in
terms of concrete information.
High
S1
Sector B
Highly Focused Group – But with heavy emphasis on selfpreservation. Government measures are lacking in
independence and transparent reporting.
Examples: International Council of Mining and
Minerals(ICMM), U.S. Defense Industry initiative (DII)
Po
Low
Example: UN Global Compact.
Specificity and materiality of the
strength of governance and
Low
So
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Cohesiveness of Sponsoring Groups
 The first dimension(S0-S1) is defined by the number of participating entities,
cohesiveness of their purpose, their view of the socio-political environment, and, their
willingness to share the costs and benefits of implementing a particular code of conduct.
 It suggests that the level of cohesiveness invariably suffers with increase in the number of
participants and the divergence in their views as to the scope of voluntary principles,
method of implementation and monitoring and discipline activities.
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Nature and Scope of Principles
 The second dimension(P0-P1) consists of the nature and scope of principles, or specific
undertakings that are incorporated in the voluntary principles or code of conduct. As
membership becomes more heterogeneous (either in business or region of operation),
application specificity decreases, and principles become more aspirational than
compliance-oriented.
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Problems of Adverse Selection and Free Rider Problems
 Underlying the difficulty in implementing industry-wide, and, multi-company, multipurpose voluntary codes are the challenges associated with the problem of adverse
selection and free rider.
 The primary driver of adverse selection is the number of participating entities. As the
number increases, the likelihood of adverse selection also increases.
 Cohesiveness and code specificity both decrease as well. Free riders (those unwilling to
share costs, but will gladly reap benefits) also increase as cohesiveness decreases, with
consequent governance loss.
 Decreases in code specificity also allow for free ridership.
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Sector A (P’-P1, S’-S1)
 In general, single companies or industries are more likely to possess robust, specific
voluntary principles/codes (Sector A).
 The single company, as a sponsoring organization (SO), is in the best position to create a
voluntary code that addresses the company’s conduct in response to external sociopolitical challenges.
 The company has a large measure of control as to how it meets its commitments under
the code and takes steps to ensure that performance measures are credible to its various
stakeholders.
 The most prevalent examples of these codes are individual company-based codes of
conduct, or industry-wide codes where a code of conduct is focused on a specific and
narrowly defined set of business practices, has identifiable external critics and the scope
of issues is largely under the control of member organizations.
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Sector B (P0-P’, S’-S1)
 This Group is comprised of companies that are cohesive but face strong external
pressures.
 They profess high commitment to their codes of conduct while keeping code provisions
or principles that are vague and loosely interpreted standards.
 It allows group members to appear to fulfill the standards, while at the same time not
costing the business much in the way of operational discomfort.
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Sector C (S0-S’, P0-P’)
 This group is comprised of companies that are quite diverse in character. They also face
multiple external challenges and regulatory environments.
 Voluntary codes in this category tend to be broad-based and that are more germane to
common issues faced by entire communities.
 There is considerable variance of opinion and outlook both within and between groups.
Therefore, common purpose is at best described in abstract terms leaving considerable
room for differing interpretations and thus skepticism as to the sincerity and
commitment of its sponsors.
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Sector D (S0-S’, P’-P1)
 This group includes organizations belonging to one or more industry groups and
geographical/political regions. As such, it faces a more challenging environment in the
creation and implementation of a voluntary code of conduct.
 Voluntary codes in this sector also vary considerably in their effectiveness because of the
divergent interests of their members. For example, members of a mature industry group
may have greater cohesiveness in their outlook to external challenges than an emerging
industry where participating companies might diverge considerably in terms of their
exposure to external challenges and their willingness/ability to respond to them in a
proactive manner.
 Free riders are a common problem for this sector.
 In general, universal codes or voluntary initiatives tend toward more abstraction and
generality with increase in group size and diversity.
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Sector D continued..
 The abstract nature of espoused principles becomes necessary because different
participants must interpret them differently in light of business conditions, competitive
pressures, lack of public trust and credibility in corporate conduct.
 Therefore, the success of universal codes would depend to a greater extent on its moral
and ethical connotations and societal expectations. It would also require that the SO
enjoys a high degree of public trust and respect (halo effect); has created a strong and
independent governance structure; and is willing to use its public reputation to bolster
performance accountability and transparency.
 It also follows that a failure to create meaningful governance structure and accurate
performance reporting would inevitably degenerate these universal codes or principles
into empty rhetoric and thus reinforce public distrust of signatory organizations and
also undermine the reputation and public credibility of the SO.
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Pre-Conditions for the Creation and Implementation
of Effective Credible Voluntary Codes of Conduct
 Based on our research and field work in monitoring code compliance, we have identified
eight conditions that must be met for an industry-based code to demonstrate measurable
and credible compliance with the industry’s voluntary initiative.
1. The code must be substantive in addressing broad areas of public concern pertaining to industry’s
conduct.
2. Code principles or standards must be specific in addressing issues embodied in those principles.
3. Code performance standards must be realistic in the context of industry’s financial strength and
competitive environment. The industry should not make exaggerated promises or claim
implausible achievements.
4. Member companies must create an effective internal implementation system to ensure effective
code compliance.
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Pre-Conditions for the Creation and Implementation
of Effective Credible Voluntary Codes of Conduct
continued…
5. Code compliance must be an integral part of a management performance evaluation and reward
system.
6. The industry must create an independent governance structure that is not controlled by the
executives of the member companies.
7. There must be an independent external monitoring and compliance verification system to
engender public trust and credibility in the industry’s claims of performance.
8. There should be maximum transparency and verifiable disclosure of industry’s performance to the
public. Standards of performance disclosure should be the sole province of the code’s governing
board.
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Further Explanation of Pre-Conditions

The Scope of coverage would include relevant issues pertaining to sponsoring organization’s
activities. However, these concerns would need to be amplified into objective, quantifiable, and
outcome-oriented standards. These would allow for uniformity in performance evaluation and
compliance assurance.

Code principles or standards must be specific in addressing issues embodied in those principles.

Code performance standards must be realistic in the context of industry’s financial strength and
competitive environment. The industry should not make exaggerated promises or claim implausible
achievements.

Member companies must create an effective internal implementation system to ensure effective code
compliance.

Code compliance must be an integral part of a management performance evaluation and reward
system. For example, at the individual company level, code compliance must be integrated into the
firm’s normal decision-making structure and systems. It should also have the oversight for
compliance assurance at the level of corporate general counsel, and preferably with a reporting
obligation to a committee of the board of directors, e.g., audit committee, or public policy
committee. In the final analysis, the top management of the company must be held accountable for
ensuring the company’s compliance with code standards.
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Governance Structure
 The industry or universal group must create an independent governance structure that is
not controlled by the executives of the member companies, or dominated by the private
sector organizations to the exclusion of other important stakeholders whose lives and
livelihoods are impacted by the conduct of the member companies and industry groups.
An effective governance structure should:
a)
b)
c)
Allow for a balanced representation of various industry segments and thus minimizes the
prospect of any industry segment to dominate decision-making in code implementation.
Must have independent, external input to ensure that the performance monitoring is not
controlled by the same group of people whose performance is being monitored at the
company level. The external input in the governance structure does not have to be from the
industry’s critics, but from independent experts who have the respect and confidence of all
parties involved.
the fee structure to defray the cost of code implementation must allow for funding that would
be sufficient to manage the operations, and will also take into account individual members’
ability to pay. the fee should not be used to allocate decision-making power in the governance
structure.
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Problems with Weak Governance Structure
 A weak or internally controlled governance structure often yields to members’ pressures
to do the minimum by way of code implementation and compliance verification.
 Lacking internal control and external trust, the system is reduced to an exercise in
superficial changes, which are unlikely to carry any weight with the stakeholders whose
trust in the code’s sponsors has to be one of its primary goals. It would also result in
the erosion in public credibility in the reported outcomes.
 This phenomenon is also apparent in many other group-based efforts sponsored by
multilateral and international organizations, e.g., UN Code of Global Compact,
Equator Principles jointly developed by banks and IFC, and the code of sponsored by
OECD, and Kimberley Process Certification System (KPCS) jointly sponsored by the
United Nations, members states, diamond mining and retailing industries, and nongovernmental organizations, to name a few.
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Independent External Monitoring and Verification
 The importance of an independent monitoring and verification system is the core
element in REGENERATING public trust in any type of voluntary code of conduct. And
yet, it is in this area that companies and industries offer the most resistance. It is argued
that external monitoring would create an environment of distrust and policing.
Companies also fear diluting their reputation with related negative consequences to their
business and financial operations. Unfortunately, mere assertions of compliance – in the
absence of credible evidence – are unlikely to carry much weight with external
constituencies.
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Transparency and Verifiable Disclosure
 An equally important element in enhancing public credibility and trust dependence on
the transparency and verifiable disclosure of industry performance to the public.
Standards of performance disclosure should be the sole province of the code’s governing
board.
 The code sponsors must be willing to make the findings of the independent external
audit available to the public without prior censorship.
 This condition too has faced considerable resistance on the part of companies and
industry groups. It is argued that release of such reports would expose those companies
to further assaults by their critics, who would not have access to similar information from
other companies whose performance may be far worse.
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