The Virtue Matrix: Calculating the Return on Corporate Responsibility - Shareholder Value Versus Corporate Responsibility

by Roger L. Martin

The images from recent meetings concerning globalization in Seattle, Davos, and Genoa might seem to suggest that only the unwashed and the unruly are pressuring business to show a greater sense of social and environmental responsibility. But it's increasingly clear that the calls are coming from mainstream quarters of society as well. Many consumers and investors, as well as a growing number of business leaders, have added their voices to those urging corporations to remember their obligations to their employees, their communities, and the environment, even as they pursue profits for shareholders.

But executives who wish to make their organizations better corporate citizens face significant obstacles. If they undertake costly initiatives that their rivals don't embrace, they risk eroding their competitive position. If they invite government oversight, they may find themselves hampered by regulations that impose onerous costs without generating meaningful societal benefits in return. And if they insist on adopting the wage scales and working conditions that prevail in the world's wealthiest industrial democracies, they may succeed only in driving jobs to countries where less stringent standards are the norm.

These dilemmas, which have long bedeviled business thinkers, were the focus of discussion among a group of executives, academics, and public-sector policy makers, myself included, who gathered recently at the Aspen Institute in Colorado under the auspices of its Initiative for Social Innovation Through Business. It would be going much too far to say that our group arrived at any solutions to these urgent problems. But prodded by our discussion, I designed an analytical tool that helps executives think about the pressing issue of corporate responsibility. Having tested and refined it with my colleagues at the institute, I'm confident that this tool, which I call the virtue matrix, can help executives understand what generates socially responsible corporate conduct.

You'll notice that I refer to corporate responsibility in this article as if it were a product or service. That is no accident. It's my contention that, by treating corporate responsibility as an artifact subject to market pressures, the virtue matrix reveals the forces that limit its supply and defines measures likely to increase it. Before we turn to the matrix, let's explore the drivers of corporate virtue.

Generating corporate virtue
By now, the story of Malden Mills and its owner, Aaron Feuerstein, is so familiar that the company name has become a sort of shorthand for corporate benevolence. The tale briefly told: In 1995, a fire destroyed Malden Mills' textile plant in Lawrence, an economically depressed town in northeastern Massachusetts. With an insurance settlement of close to $300 million in hand, Feuerstein could have, for example, moved operations to a country with a lower wage base, or he could have retired. Instead, he rebuilt in Lawrence and continued to pay his employees while the new plant was under construction.

"Why don't more companies act that way?" is a common reaction when people first hear the story. It is much too simplistic to reply that Feuerstein is a better person than most. Whatever Feuerstein's relative level of virtue, he had far fewer shareholders to answer to than the average CEO. Feuerstein's only shareholders are himself and several members of his family, who presumably share his willingness to sacrifice profits for the sake of the employees' wellbeing. (Feuerstein was perhaps too willing—Malden Mills filed for bankruptcy protection last November.) The typical CEO of a publicly held corporation, by contrast, is accountable to thousands of shareholders.

My purpose here is not to denigrate the share-owned corporation, which is a fundamental building block of democratic capitalism, but to acknowledge that its legal structure imposes certain priorities on its senior leaders. If they fail to maximize earnings for shareholders, managers risk removal by the equity holders to whom they report. Worse, failure to serve shareholders' interests puts the corporation in jeopardy of being acquired by a stronger company or losing access to capital markets. In theory at least, self-interest and self-preservation ensure that no rational executive will engage in activities that clearly erode shareholder value.

But corporations don't operate in a universe composed solely of shareholders. They exist within larger political and social entities and are subject to pressures from other members of those networks, be they citizens concerned about environmental pollution, employees seeking to strike a balance between work and family, or political authorities protective of their tax bases. When the interests of shareholders and the larger community collide, management typically (and quite rationally) sides with shareholders. The almost inevitable next step is for management to come under fire for favoring the narrow interests of shareholders over the broader interests of the community—or to put it another way, for failing to meet the demand for social responsibility.

The interests of shareholders and those of the larger community are not always opposed, of course. Corporations often willingly engage in socially responsible behavior precisely because it enhances shareholder value. They choose to undertake philanthropic activities such as supporting local museums or soup kitchens because management believes such activities create goodwill among customers in excess of their price tag. Likewise, companies provide day care and exercise facilities because the improved productivity and retention rates generated by those perks outweigh their cost. And a growing number of companies such as the Body Shop, a global skin- and hair-care retailer, make corporate virtue part of their value proposition: Buy one of our products, the Body Shop tells its customers, and you improve the lives of women in developing countries, promote animal rights, protect the environment, and otherwise increase the supply of social responsibility.

There's a second class of socially responsible corporate conduct that generates shareholder value by keeping a business on the right side of the law. For example, company compliance with worker safety regulations and sexual harassment statutes serves shareholders' interests by keeping a company free from legal sanctions and by safeguarding its reputation.

Clearly, then, shareholder value and social responsibility are not necessarily incompatible. Whether their activities are dictated by choice—supporting charities and cultural institutions, for instance—or by compliance—adhering to laws and regulations—corporations can and do serve shareholders' interests while also serving those of the larger community. For the purposes of this article, such forms of corporate social responsibility are termed instrumental—that is, they explicitly serve the purpose of enhancing shareholder value. At any given moment, instrumental practices, backed by either laws and regulations or social norms and conventions, make up most of the supply of responsible corporate behavior.

Another set of activities, however, increases this behavior but is not guaranteed to do the same for shareholder value; in fact, these activities may diminish it. The motivation for such activities is not instrumental—that is, impelled by the clear purpose of enhancing shareholder value—but intrinsic: A company's leaders embark on a course of action simply because they think it's the right thing to do, whether or not it serves shareholder interests.

Some intrinsically motivated actions turn out to benefit shareholders as well as society. Henry Ford believed he ought to pay his workers enough to afford to buy the cars they produced. That policy appeared to place him at a disadvantage, since the wages and job security at his plants were well in excess of the norms in the auto industry at the time. But his decision ultimately benefited Ford Motor Company by making it an attractive employer and by stimulating demand for its products. At the same time, Ford's move benefited society by raising the bar for pay and labor practices across the auto industry. (Ford wasn't all corporate virtue, unfortunately. Among other things, he used lethal tactics in breaking the 1937 strike at the Rouge plant in Dearborn, Michigan, and he was anti-Semitic.)

Some intrinsic activities, like Feuerstein's, benefit society at the shareholders' expense. Others, however, unless widely adopted, are both detrimental to shareholders and ineffectual in establishing socially beneficial norms. For instance, the leaders of a chemical producer may believe that investing heavily in greenhouse-gas reduction is the right thing to do. But if the producer's rivals refuse to follow suit, the company may undermine its own cost-competitiveness without significantly lowering overall greenhouse-gas emissions. Similarly, a large exporter may balk at paying bribes to foreign officials to win sales. But if its offshore competitors persist in the practice, the company and its shareholders are put at a disadvantage while the norms that countenance bribery in the first place remain unchanged.

In retrospect, of course, it is fairly easy to determine whether a particular corporate action benefited shareholders, society, both, or neither. But corporate leaders don't have the aid of hindsight when making their decisions. They can, however, use the virtue matrix as a framework for assessing opportunities for socially responsible behavior.

· · · ·

Excerpted with permission from "The Virtue Matrix: Calculating the Return on Corporate Responsibility," Harvard Business Review, Vol. 80, No. 3, March 2002.

[ Order the full article ]

Roger L. Martin is the dean of the Rotman School of Management at the University of Toronto. He is the author of The Responsibility Virus, to be published in September 2002 by Basic Books.

Related stories in HBS Working Knowledge :
Does Misery Love Companies? How Social Performance Pays Off