The dynamics of corporate social responsibilities

THE DYNAMICS OF CORPORATE SOCIAL RESPONSIBILITIES

THE RAOUL WALLENBERG INSTITUTE HUMAN RIGHTS LIBRARY VOLUME 33

THE DYNAMICS OF CORPORATE SOCIAL RESPONSIBILITIES

BY

RADU MARES

THE RAOUL WALLENBERG INSTITUTE HUMAN RIGHTS LIBRARY VOLUME 33

MARTINUS NIJHOFF PUBLISHERS LEIDEN/BOSTON 2008

A C.I.P. record for this book is available from the Library of Congress.

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ISBN 978 90 04 16392 8 Copyright 2008 by Koninklijke Brill NV, Leiden, The Netherlands Koninklijke Brill NV incorporates the imprints Brill, Hotei Publishing, IDC Publishers, Martinus Nijhoff Publishers and VSP. http://www.brill.nl All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, microfilming, recording or otherwise, without written permission from the Publisher. Authorization to photocopy items for internal or personal use is granted by Brill Academic Publishers provided that the appropriate fees are paid directly to The Copyright Clearance Center, 222 Rosewood Drive, Suite 910, Danvers MA 01923, USA. Fees are subject to change.

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CONTENTS ABBREVIATIONS.................................................................................................vii PREFACE ................................................................................................................ix CHAPTER 1 INTRODUCTION............................................................................. 1 1.1. Literature Overview......................................................................................... 4 1.1.1. Law-oriented approaches.......................................................................... 4 1.1.2. CSR approaches........................................................................................ 9 1.2. Critique of current research .......................................................................... 13 1.2.1. Law-oriented approaches........................................................................ 13 1.2.2. CSR approaches...................................................................................... 17 1.3. Matters of approach ...................................................................................... 19 1.4. Disposition of the book .................................................................................. 23 CHAPTER 2 ANCHORING CSR IN COMPANY LAW................................... 27 2.1. Managerial duties of care and loyalty under company laws ......................... 28 2.1.1. Clarification of duty of care through identification of whose interests can be considered ............................................................................................. 31 2.1.2. Clarification of duty of care through judicial review.............................. 40 2.1.3. Clarification of duty of care through other corporate governance mechanisms ...................................................................................................... 52 2.2. Company law: a partial clarification of the duty of care............................... 68 2.2.1. Triple spin-off that company law performs ............................................ 68 2.2.2. Divergent standards ................................................................................ 70 CHAPTER 3 NORMS ADVANCED IN THE CSR DEBATE ........................... 73 3.1. Milton Friedman and his critics .................................................................... 73 3.1.1. Friedman’s views.................................................................................... 76 3.1.2. Stakeholder theory’s response ................................................................ 80 3.1.3. Winning by default? ............................................................................... 86 3.2. The stakeholder norm .................................................................................... 90 CHAPTER 4 THE STAKEHOLDER NORM IN BUSINESS PRACTICE...... 97 4.1. Context of CSR: governance gaps and business responses ........................... 97 4.1.1. Labour .................................................................................................... 98 4.1.2. Natural resources .................................................................................. 100 4.1.3. New markets......................................................................................... 102 4.2. Business case of CSR................................................................................... 106 4.3. Stages of CSR implementation..................................................................... 110 4.3.1. Human rights impact assessments ........................................................ 112 4.3.2. Management systems............................................................................ 114 4.3.3. External audit of performance .............................................................. 139 4.3.4. Social reporting..................................................................................... 143 4.3.5. Assurance of reports ............................................................................. 146 4.4. Pull from market actors ............................................................................... 150 v

Contents 4.5. Scaling-up CSR............................................................................................ 155 4.5.1. Limits of CSR according to sceptics..................................................... 156 4.5.2. Limits of CSR according to proponents ............................................... 159 CHAPTER 5 POLICIES AND LAWS RELEVANT TO CSR......................... 167 5.1. State policies................................................................................................ 169 5.1.1. International level ................................................................................. 169 5.1.2. National level........................................................................................ 176 5.2. Disclosure regulations................................................................................. 177 5.2.1. Narrowly defined disclosures benefiting ‘reasonable investors’ .......... 177 5.2.2. Disclosures in the ‘grey zone’ benefiting multiple audiences .............. 186 5.2.3. ‘Right-to-know’ disclosures benefiting certain stakeholders................ 207 5.3. Laws referring to management systems....................................................... 220 5.3.1. US Sentencing Guidelines .................................................................... 220 5.3.2. US Environmental Protection Agency’s Audit Policy.......................... 226 5.3.3. Other regulations providing incentives for management systems ........ 228 5.3.4. Regulations mandating management systems ...................................... 228 5.4. Tort law ....................................................................................................... 230 5.4.1. Early days for transnational litigation................................................... 230 5.4.2. Legal definition of negligence .............................................................. 234 CHAPTER 6 INCREMENTAL INSTITUTIONALISATION OF CSR REGIME ............................................................................................................... 245 6.1. Making sense of procedural regulations...................................................... 245 6.1.1. Reporting regulations ........................................................................... 245 6.1.2. Regulations referring to management systems ..................................... 250 6.1.3. Negligence under tort law..................................................................... 256 6.1.4. Intermediary variables – understanding decentralised regulatory regimes ........................................................................................................... 261 6.2. Due process considerations in administrative law ...................................... 278 6.3. Observations from regulatory theory .......................................................... 289 6.4. Incremental institutionalisation of CSR regime........................................... 302 6.4.1. Functions and dynamics of regimes...................................................... 303 6.4.2. Specifying positive obligations (‘support’ human rights)..................... 311 CHAPTER 7 CONCLUSIONS ........................................................................... 321 REFERENCES ..................................................................................................... 333 INDEX ................................................................................................................... 367

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ABBREVIATIONS ABI ALI ASB ASIC ATCA BJR BP BPD BR BTC CEO CL CSR EITI EMAS EMS EPA ETI FDI FLA FLO FSC GATT GC GRI ‘Group’ IHRL ILO ISO KP LSE MNE MS NGO NRDC OECD OFR OHCHR RC SAI SEC SG SME SRI ST TNC TRI

Association of British Insurers American Law Institute Accounting Standards Board (UK) Australian Securities & Investments Commission Alien Tort Claims Act (US) business judgment rule British Petroleum Business Partners for Development Business Review (UK) Baku-Tbilisi-Ceyhan chief executive officer company law corporate social responsibilities Extractive Industry Transparency Initiative Eco-Management and Audit Scheme environmental management systems Environmental Protection Agency (US) Ethical Trading Initiative foreign direct investment Fair Labor Association Fairtrade Labelling Organization Forest Stewardship Council General Agreement on Tariffs and Trade Global Compact Global Reporting Initiative Company Law Review Steering Group (UK) international human rights law International Labour Organization International Organization for Standardization Kimberley Process London Stock Exchange multinational enterprise management system non-governmental organisation Natural Resources Defense Council Organisation for Economic Co-operation and Development Operational and Financial Report United Nations High Commissioner for Human Rights Responsible Care Social Accountability International Securities and Exchange Commission (US) Sentencing Guidelines (US) small and medium enterprises socially responsible investment stakeholder theory transnational corporation Toxics Release Inventory vii

Abbreviations UNDP UNEP UNIDO UNOCAL VP WHO WTO

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UN Development Programme UN Environmental Programme UN Industrial Development Organisation Union Oil Company of California Voluntary Principles on Security and Human Rights World Health Organization World Trade Organization

PREFACE The analysis herein proposes that the responsible business practices of leading companies are significant not only as isolated instances of self-regulation but they also contribute to a broader rule-making process which has been underway in the last decade and is aimed at making business more responsive to human rights and environmental concerns. The book highlights the flexibility of existing laws as well as the emergence of new regulations relevant to CSR. As CSR increasingly interacts with public policy, there appear some insufficiently understood effects of CSR that can help us advance toward more systemic solutions in the business and human rights area. By recognising their own roles and responsibilities in the emerging CSR regime, states can, and must, enhance the impact of corporate voluntarism so that responsible practices get diffused more widely and deeply in the business community. The study identifies variables that states can stimulate through a wide range of regulatory options starting with capacity-building measures to policy to hard law. Two audiences might find this analysis useful. Legal experts with an interest in enhancing the protection of human rights in developing countries form the primary audience. International human rights lawyers approaching the new and evolving area of ‘business and human rights’ deem voluntarism as an inherently inadequate response to corporate abuses, especially when compared with ‘hard law’ solutions. This book aims to sidestep a dichotomous understanding of law and CSR, and looks instead at the complex rule-making process in which the voluntary practices of leading companies can facilitate positive regulatory dynamics. The secondary audience is made up of CSR theorists and practitioners; not having a legal background or being necessarily interested in regulatory issues, they might find this study relevant if they ponder on enhancing the impacts of CSR, and on the broader social dynamics that surround the implementation of CSR commitments. For both audiences, a conceptual work of this kind can help one grasp when one defaults too fast toward one CSR extreme (pro or against corporate voluntarism). To the extent that CSR is implemented in a participatory manner and/or communication-based strategies for corporate accountability are adopted, an ability for finer conceptual reasoning will be critical. The book is an updated and revised version of my doctoral dissertation presented at the Faculty of Law, Lund University, Sweden in February 2006. It was titled ‘Institutionalisation of Corporate Social Responsibilities – Synergies between the Practices of Leading Multinational Enterprises and Human Rights Law/Policy’. I must acknowledge a number of colleagues and friends who guided my steps along the way or put a spring in my step. I am indebted to my principal supervisor, Professor Gudmundur Alfredsson. He oriented my efforts while patiently allowing me to find my own voice and shared his contagious optimism. Professor Lars Gorton, my second supervisor, ran through two voluminous drafts with infinite patience and humour; his critical and insightful comments as well as his gentle approach were much appreciated. Conversations with Professor Håkan Hydén were inspiring in finding a way to organize an otherwise heterogeneous material that could have been ‘sliced-up’ in different ways. The long discussions I had with Chris Mathieu have opened my mind to the variety of perspectives on complex organisations while remaining uplifting and thoroughly enjoyable. I would like to further acknowledge Arthur Diakité, Rachel Crossley, Marius Emberland, ix

Preface Neelambar Hatti, Jonas Grimheden, Ulf Linderfalk, Gregor Noll, Habteab Tesfay and the staff at the Prince of Wales International Business Leaders Forum in London where for four months in 2004 and 2005 I was privileged to work. My thanks also to Tim Maldoon and Carin Laurin for their time and effort to turn the manuscript into a book. Finally I am deeply grateful for the financial support provided by the Law Faculty in Lund, the Raoul Wallenberg Institute, the Swedish Institute and the Institutet för Rättsvetenskaplig Forskning (Institute for Legal Science Research). The conditions offered by the Faculty of Law and the Raoul Wallenberg Institute and their staffs were nothing short of outstanding and allowed full concentration on research.

Radu Mares 24 February 2007

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CHAPTER 1 INTRODUCTION Should companies voluntarily contribute to the social good beyond what is legally mandated to them? Some have argued that businesses should only follow the law and the signals of markets. Others have argued that large businesses, due to their significant impacts on society, have in addition a responsibility to protect stakeholders (people affected by corporate activities) and advance the public interest. Arguments for limited, respectively extended, corporate social responsibility (CSR) have been advanced for much of the 20th century ever since large corporations appeared in the US at the turn of this century. As the debate continues and intensifies with the accelerated internationalisation of trade and investment, new CSR issues emerge continuously. A part of the current debate is whether, and if so to what extent, multinational enterprises (MNEs)1 could and should do more to protect human rights in developing countries2 even in the absence of specific legal requirements. This is the subject of the present book. A multitude of CSR issues relevant to human rights have attracted attention in recent years. Thus in labour-intensive industries (e.g. the footwear, clothing and sporting goods industries) there are documented violations of labour rights (e.g. child labour, hindrance of freedom of association, harassment) and poor working conditions (e.g. health and safety violations, excessive overtime and low wages). In extractive industries (e.g. oil and gas, mining) environmental degradation affecting livelihoods is a significant issue, as are the repressive practices of security forces against local communities. Nike and respectively Shell are two well known examples of market leading MNEs that have come since the mid-1990s under constant scrutiny and criticism precisely for their connection to such human rights abuses. The credibility of the global diamond industry came under attack when in the late 1990s it become clear that warlords in some African countries were using revenues from diamonds for armed operations; the connection between diamonds and civil wars was unmistakable. The large pharmaceutical companies have received bad publicity for the manner in which they have protected their patents; the high prices of drugs effectively denying access to life-saving medicines for millions in poor countries. International banks have been confronted for their lending practices in cases involving large infrastructure projects in the Third World; nongovernmental organisations (NGOs) signalled that banks remain oblivious to issues such as forced relocation, indigenous rights and environmental destruction 1

The term ‘multinational enterprises’ (MNEs) will be used interchangeably with ‘transnational corporations’ (TNCs). 2 The focus of this study is on the protection of human rights in ‘developing countries’, ‘poor countries’, ‘Third World’ or ‘Global South’. 1

Chapter 1 associated with the construction of dams and extractive projects. Finally, the bribing of public officials to secure favourable contracts has been another issue high on the CSR agenda; bribery undermines good governance and shortcuts attempts to promote human rights and development. CSR issues have been instrumental in fuelling the heated broader debate on the fairness of globalisation. Confronted with threats to their reputation, and sometimes with social unrest surrounding their operation in the Global South, the most exposed businesses have responded with voluntary initiatives. Corporate codes of conduct stating the corporate policy on various CSR issues have proliferated in the hundreds; some tens of them explicitly refer to the Universal Declaration of Human Rights and various International Labour Organization (ILO) Conventions. Still some other businesses have entered, together with other public and private actors, into so-called ‘partnerships for development’; such partnerships often deal with single issues (e.g. water/sanitation, communications, HIV/AIDS, creation of economic opportunities) and have been legitimised at the World Social Summit at Johannesburg 2002 as a new implementation mechanism for tackling poverty in the South. Thus CSR covers both issues of corporate compliance with legal standards as well as business contributions to development and poverty-reduction. Early in their history corporate voluntary initiatives were mere policy statements with no serious implementation mechanisms and no outside monitoring. To preserve the credibility of such initiatives, some TNCs have accepted to varying degrees some external involvement of NGOs or professional auditors into the implementation of their codes, or have subscribed to collective codes of conduct which set up their own monitoring machinery. Leading businesses have thus responded to widespread expectations on them to effectively implement their own commitments and credibly demonstrate that through CSR reports. States and international governmental organisations (IGOs) have perceived a stake for themselves in this movement surrounding corporate voluntarism. Governments and IGOs have sought to enlist the participation of the business community, often through multistakeholder initiatives. The most prominent example regarding the cooperation with businesses is the UN Global Compact. In brief, states have used their convening power, provided financial support to multistakeholder initiatives dealing with various stages of CSR implementation and have lent crucial political backing and legitimacy to CSR. With localised exceptions, states have not employed the coercive force of law to regulate the human rights impacts of TNCs in the South. The preferred approach so far has been one of cooperation, capacitybuilding and non-binding policy pronouncements. Few jurisdictions have increased transparency around CSR through disclosure regulations. The recent and ongoing developments noted above make the area of ‘business and human rights’ relevant to human rights experts. Nevertheless, for human rights specialists, the twin developments – the global ascendance of influential for-profit actors and their voluntarism – raise a conceptual challenge. Human rights experts are accustomed to look at state actors and binding instruments as the means to protect human rights. However, the legal concepts that would allow human rights 2

Introduction lawyers to comprehend private actors and their voluntarism are still underdeveloped. Numerous questions await more rigorous analysis, especially from a regulatory and policy-making perspective: How to consolidate the gains brought by CSR and how to enhance its impacts? What regulatory avenues can be contemplated to help institutionalise CSR? What are the variables that lawmakers could target? How complex would then the causality between law and corporate behaviour become? How to account for the regulatory dynamics that leading businesses generate? This study takes steps towards answering these questions; at the end, it should have advanced the understanding of the interaction between CSR and law/public policy, and thus help forge a regulatory perspective on CSR. Discussions about the role of business in society use the term ‘CSR’ in two different ways. On the one hand, CSR refers to a managerial strategy through which managers voluntarily (i.e. in the absence of a clear legal command) respond to social expectations and pressures. CSR as ‘voluntarism’ is thus a shortcut for the strategies of proactive businesses following internal calculations about risks and opportunities, calculations that are facilitated by a sense of ethics, social awareness and fresh strategic thinking. On the other hand, CSR highlights fundamental concerns about accountability of corporations to society. In CSR as ‘accountability’, the focus is on corporate responsibilities that lawmakers should define and impose on all companies. The law or other forms of social control should be used to alter corporate behaviour; the respect of certain important standards should not be left to the voluntary decisions of corporate managers. Law does here a twofold job: one, it defines the appropriate level of responsibility (its scope or the limits of corporate responsibilities) to prevent businesses from ‘picking and choosing’ standards, and two, it creates legal incentives for businesses prepared to disregard their responsibilities. This study examines the potential and limitations of CSR as ‘voluntarism’ and draws on legal theory to explain the dynamics towards accountability that CSR may generate. There are various terms in circulation trying to account for the place of business in society: corporate social responsibility (CSR) is the most established, but also corporate citizenship, corporate responsibility, corporate accountability, corporate sustainability or responsible business practices. We use here the term ‘CSR’ for no other reason than because it is a widely recognised term. The priority herein is to understand the implementation of CSR and the dynamics it generates. CSR lacks a universally accepted definition, but a working definition for this study can be the one used by the Dow Jones Sustainability Index. The Index refers to ‘corporate sustainability’ rather than CSR and defines it as “a business approach that creates long-term shareholder value by embracing opportunities and managing risks deriving from economic, environmental and social developments”.3 This definition appropriately accounts for many parameters that will be used throughout this book. 3

Dow Jones Sustainability Indexes, Corporate Sustainability, <www.sustainabilityindexes.com/htmle/sustainability/corpsustainability.html>, visited on 14 February 2007. (emphasis added)

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Chapter 1 1.1. LITERATURE OVERVIEW This section aims to prevent confusion with other research agendas and to grasp some blind spots in current research. It splits literature relevant to ‘business and human rights’ into law-oriented (legalistic) approaches, and CSR (non-legalistic) approaches. The following overview is purely descriptive; the critique emphasising the strengths and drawbacks of each perspective follows in the next section. This disposition – first the description, then the critique – aims to prevent a plunge into polemics that can surround one’s preferred approach before the whole overview is completed. Afterwards and against this background the approach taken in this study will be clarified. 1.1.1. Law-oriented approaches The law-oriented literature has highlighted violations of human rights in developing countries and has proposed several regulatory paths – at national and international levels – to tackle them.4 Arguments have been made for state responsibility for corporate violations of human rights, corporate responsibility and individual responsibility of business executives.

4 See International Council on Human Rights Policy, Beyond Voluntarism – Human Rights and the Developing International Legal Obligations of Companies, Versoix, 2002; D. Kinley and J. Tadaki, ‘From Talk to Walk: The Emergence of Human Rights Responsibilities for Corporations at International Law’, 44:4 Virginia Journal of International Law (2003–2004) pp. 931–1024; International Peace Academy and Fafo, Business and International Crimes: Assessing the Liability of Business Entities for Grave Violations of International Law, 2004, <www.fafo.no/liabilities>; H. Ward, Swedish Partnership for Global Responsibility, Legal Issues in Corporate Citizenship, 2003; S. R. Ratner, ‘Corporations and Human Rights: A Theory of Legal Responsibility’, 111 The Yale Law Journal (December 2001) pp. 443–545; Council of Bars and Law Societies of the European Union, Corporate Social Responsibility and the Role of the Legal Profession – A Guide for European Lawyers Advising on Corporate Social Responsibility Issues, 2003, <www.ccbe.org/doc/En/csr_guidelines_0405_en.pdf>; M. Kamminga, ‘Holding Multinational Corporations Accountable for Human Rights Abuses: A Challenge for the EC’, in P. Alston (ed.), The EU and Human Rights (Oxford University Press, Oxford, 1999) pp. 553–569; MiningWatch Canada, A Policy Framework for the Regulation of Canadian Mining Companies Operating Internationally, 2005, <www.miningwatch.ca/updir/Policy_Framework.pdf>; Extraterritorial Legislation as a Tool to Improve the Accountability of TransnationalCorporations for Human Rights Violations, Seminar of Legal Experts, Catholic University of Louvain and the Free University of Brussels, Brussels, 2006, <www.business-humanrights.org/Documents/Extraterritorial-legislation-to-improveaccountability-legal-experts-seminar-Brussels-summary-report-3-4-Nov-2006.pdf>; International Committee of the Red Cross, Business and International Humanitarian Law: An Introduction to the Rights and Obligations of Business Enterprises under International Humanitarian Law, Geneva, 2006, <www.icrc.org/web/eng/siteeng0.nsf/html/p0882>, visited on 14 February 2007.

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Introduction State responsibility States can be assigned responsibility for their failure to prevent corporate abuses or for failure to offer redress following abuses. Thus liability of corporations could be pursued indirectly by first activating the positive obligations of states to regulate private actors within their jurisdictions. Indeed this is the obligation of states to ‘protect’ human rights, in addition to the obligations to ‘respect’ and ‘support’ human rights (i.e. states not to themselves infringe rights, respectively states to provide aid). Both host and home states can be expected to assume and act on these positive obligations. Host states (i.e. countries where subsidiaries and suppliers operate) already have obligations, under customary and treaty law, to protect human rights from business abuses within their jurisdictions. Home states (i.e. countries where the controlling entity – parent company or buyer company – is headquartered) are currently not under an international legal obligation to regulate controlling entities operating within their jurisdiction and hold them liable for human rights abuses overseas perpetuated by their business partners. Developing countries (host states) have the right and even duty to regulate private actors. Problems arise however as developing countries compete against each other to attract foreign direct investment (FDI). In the process many governments are inclined to relax enforcement of regulations (especially regarding labour rights) and may also use scarce resources to provide additional incentives for foreign investors. This nurtures a downward pressure which detrimentally impacts right-holders. To address the pressures of South-South competition developing countries could sign a treaty containing commitments to regulate certain corporate impacts. A multilateral treaty would tackle the collective action problem and reinforce the human rights protections eroded by economic competition. Developed states (home states) could accept an ‘oversight’ responsibility for the failings of parent companies incorporated in their jurisdictions, failings that contribute to human rights abuses overseas. The responsibility of the home state to regulate the controlling company is important as often strategic decisions are made by parent companies, which escape the jurisdiction of the host state. The responsibility of home states would ensure that host states do not shoulder alone the burden of regulating the impacts of transnational corporate groups. However, even more than in the case of host states, home states are reluctant to undermine their own competitiveness by imposing new obligations (‘red tape’) on their multinationals. To sum up, new treaty provisions would be required to hold states accountable before international monitoring bodies. Recourse to treaty would be able to solve collective action problems which otherwise would place the ratifying state at a competitive disadvantage against other non-ratifying states. The treaty would also clarify the extent of liability of both parent companies and their business partners. Corporate responsibility Various avenues can be conceived to pursue the direct responsibility of companies, rather than the states’ responsibility to ‘protect’ human rights.

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Chapter 1 Developed states could open up their judicial system and allow compensation claims be brought against the parent company for its own wrongdoings or those of their business partners (subsidiaries, contractors, joint venture partners). This would be done by applying the principles of tort law. The UK and the US have witnessed this kind of transnational litigation. UK courts have entertained claims grounded in the law of negligence when the parent company based in the UK culpably failed to prevent violations perpetuated through the activities of its subsidiaries.5 US courts have admitted civil suits brought by foreigners for serious violations of international law perpetuated overseas by a US-based company. The US Alien Tort Claims Act (ATCA) provides the main legal ground at federal level; it reads: “The district courts shall have original jurisdiction of any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States.”6 So far, these suits have not resulted in a judgment on the merits in favour of the plaintiffs; however, few settlements have been reached and also the courts have cleared some procedural hurdles.7 Developed states would pass binding ‘market access’ regulation targeted directly at suppliers from developing countries. For example, a document circulated within the EU notes: “Some argue for a binding regulatory system in which countries would commit themselves to withhold or withdraw registration in their country, and refuse to allow access to their markets, for any enterprise which breached certain social and environmental standards.”8 The strategy aims to prevent goods produced in violation of human rights standards from reaching the markets in the North. This would provide a disincentive for producers that use abusive methods of production. However the so-called ‘social clauses’ that make commercial exchanges conditional upon the fulfilment of some non-commercial considerations have in the past been vulnerable to abuse for political ends. Therefore developing states strongly oppose such conditionalities as disguised protectionism. Under the 5

Lubbe v. Cape Plc [2000] 1 WLR 1545, 2 Lloyd’s L. Rep 383; Connelly v. RTZ [1996] 3 WLR 373; Sithole & Ors v. Thor Chemicals Holdings Ltd & Anor TLR, 15 February 1999; see also R. Meeran, ‘The Unveiling of Transnational Corporations’, in M. K. Addo (ed.), Human Right Standards and the Responsibility of Transnational Corporations (Kluwer Law International, The Hague, 1999) pp. 161–169; R. Meeran, ‘Liability of Multinational Corporations: A Critical Stage in the UK’, in M. Kamminga and S. Zia-Zarifi (eds.), Liability of Multinational Corporations under International Law, (Kluwer Law International, The Hague, 2000) pp. 251–264. 6 Alien Tort Claims Act, 28 USC 1350, 1789. 7 Dozens of cases have been filed in the US courts using the ATCA. Among the companies sued have been Unocal, Royal Dutch Petroleum, Talisman Energy, Chevron, Exxon Mobil and Coca-Cola. For more cases and summaries see International Labor Rights Fund’s website, <www.laborrights.org/projects/corporate/ATCA%20summaries.htm>, visited on 14 February 2007. 8 European Parliament, Committee on Development and Cooperation, Report Accompanying the European Parliament’s Resolution on ‘EU Standards for European Enterprises: Towards a European Code of Conduct, A4-0508/98, 17 December 1998, <www.cleanclothes.org/ codes/howit.htm>, visited on 14 February 2007.

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Introduction current World Trade Organization (WTO) regime states do not have the discretion to adopt social clauses; in 1996 the WTO considered and declined to allow including protections of core labour rights to be included in trade agreements.9 Highly removed from the present realities is the possibility of devising an international regulatory regime where an international body – a court or a committee – is competent to determine culpability and impose liability directly on corporate groups. The United Nations (UN) Norms on the Responsibilities of Transnational Corporations proposed that UN agencies should periodically monitor and verify companies’ compliance with the standards therein.10 Nevertheless, as a result of the debate surrounding the Norms, in 2005 the UN Commission on Human Rights created the position of Special Representative on the issue of human rights and transnational corporations and other business enterprises with the mandate, among others, to clarify standards of corporate responsibility and to elaborate on the role of states in regulating the role of TNCs.11 Professor John Ruggie has been appointed as Special Representative. In the above cases it is state agencies and courts that would enforce the standards of business behaviour. However, public enforcement can be partly or wholly replaced with private enforcement. Enforcement could then be shared with other social actors, be they trade unions or other actors, as in the cases presented below. Another regulatory technique is to enhance corporate transparency through disclosure laws, and to rely on various constituencies to act upon the information. Both home and host states can pass binding regulations demanding disclosure of various kinds of information. For example, the French law mandates social and environmental reports from companies listed on the French stock exchange. Alternatively, lawmakers can target market intermediaries with ‘gatekeeper’ regulations; the most prominent example so far is the UK regulation targeting pension funds and imposing the obligation to disclose the extent to which their investments take into account CSR issues.12 The demands of NGOs for comprehensive regulation of TNCs have recently crystallised on several key points. Besides the already presented calls for disclosure regulations dealing with social and environmental impacts (‘mandatory sustainability reporting’) and access of victims to the courts of home states (‘access 9 World Trade Orgnization, Singapore Ministerial Declaration, adopted on 13 December 1996, WT/MIN(96)/DEC; See also <www.wto.org/english/thewto_e/whatis_e/tif_e/bey5 _e.htm>, visited on 14 February 2007. 10 Commission on Human Rights, Sub-Commission on the Promotion and Protection of Human Rights, Norms on the Responsibilities of Transnational Corporations and Other Business Enterprises with Regard to Human Rights, E/CN.4/Sub.2/2003/12/Rev.2, 26 August 2003, <www.unhchr.ch/huridocda/huridoca.nsf/(Symbol)/E.CN.4.Sub.2.2003.12.Rev.2.En? Opendocument>, visited on 14 February 2007. 11 Commission on Human Rights, Human Rights and Transnational Corporations and Other Business Enterprises, E/CN.4/2005/L.87, 15 April 2005. 12 See infra section 5.2.

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Chapter 1 to justice’), NGOs propose the modification of company laws to expand directors’ duties to include “a specific duty of care for both communities and the environment”.13 There are good reasons for taking an interest in drawing on the protective potential of company law, and CSR proponents have for long time sought to insert corporate responsibilities into company laws. That would arguably assure some default level of accountability when the protections offered by discrete regulations are found to be lacking. Suggestions were made to redefine managerial duties under company laws in a manner that expands the circle of beneficiaries. The means to enforce the broadened duties could be through new powers of a regulatory authority enforcing the duties on behalf of stakeholders through rights of beneficiaries themselves to sue management in courts, or through altering governing structures within the company itself. The latter structural avenue would see stakeholders’ (especially employees) representatives sitting on the board of directors, or, alternatively, independent directors or directors representing the public interest. There is a precedent in the case of ‘co-determination’ laws in Germany which place employee representatives on the governing board of the company. Another structural option is illustrated by an European Community (EC) directive14 which mandates a consultative structure (‘European Works Council’) or, alternatively, a procedure for informing and consulting employees. Employees of ‘Community-scale undertakings’ (i.e. operating in at least two member states) obtain a voice if not a veto in corporate management. The purpose is to allow employees access to the locus of real decision-making in a transnational company, that is, to the ‘controlling undertaking’. A part of those calling for legally binding solutions do not though place too much faith in the regulatory and policing abilities of states. Therefore they emphasise trade union activism and bargaining supported by internationally agreed and legally enforced labour rights as the best solution to work-related abuses. To sum up, the law-oriented proposals argue in principal either for assigning liability to the parent company (or the whole corporate group) for harms inflicted by subsidiaries/contractors, or to impose certain legally-binding procedural requirements (especially social reporting, but also impact assessments, consultation procedures and effective management systems) on the parent that would cover the activities of the whole group. Such provisions are to be included either in an international treaty, or in national laws.

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Corporate Responsibility Coalition (Action Aid, Amnesty International, CAFOD, Christian Aid, The Corner House, Friends of the Earth, Global Witness, New Economics Foundation, Tax Justice Network, WWF), A Big Deal? Corporate Social Responsibility and the Finance Sector in Europe , 2005, p. 2, <www.foe.co.uk/resource/reports/big_deal.pdf>, visited on 14 February 2007. 14 Council Directive 94/45/EC of 22 September 1994 on the Establishment of a European Works Council or a Procedure in Community-scale Undertakings and Community-scale Groups of Undertakings for the Purposes of Informing and Consulting Employees, Official Journal L 254, 30 September 1994, pp. 64–72.

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Introduction Individual responsibility Such an approach would pursue the personal accountability of corporate directors and managers. Criminal liability of business executives is already a possibility under the International Criminal Court regime, but only for the most serious crimes such as genocide, crimes against humanity and war crimes. The most relevant to CSR grounds for criminal liability are to be found in complicity, usually defined as the ‘association or participation in a criminal act’. It was noted that “[t]hree elements must be present in order to find a defendant guilty of complicity under international law: a crime against humanity or war crime must have been committed; the accomplice must contribute in a material (‘direct and substantial’) way to the crime; and there must be an element of intent and/or knowledge, such that the accomplice must have intended that the crime be committed or have been reckless as to its commission”.15 The international criminalisation of transnational bribery is also a precedent that CSR proposals can draw on.16 Following the appointment of Professor Ruggie as UN Special Representative the area of corporate complicity in violations perpetuated by business partners, has received increased attention.17 For harms not amounting to crimes, directors could be held accountable under the law of negligence for culpable acts or omissions in the exercise of their mandate. 1.1.2. CSR approaches CSR writings, often advanced under the umbrella term of ‘stakeholder theory’, can be roughly grouped into three streams: the descriptive, instrumental and normative.18 Descriptive accounts have an information-generating, awareness-raising function; instrumental works are applied capacity-building efforts to improve managerial responsiveness to the social environment; and normative contributions strive for 15

International Peace Academy and Fafo, supra note 4, p. 29. OECD, Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, 1997, Articles 1 and 3, 17 See Exploring Responsibility and Complicity, Business & Human Rights Seminar Report, London, 2005, <www.bhrseminar.org/BusinessHumanRightsSeminarReport2005.pdf>; International Peace Academy and Fafo, supra note 4; EarthRights International, The International Law Standard for Corporate Aiding and Abetting Liability, 2006, <www.earthrights.org/files/Legal%20Docs/UN%20Norms%20ILP/aiding_and_abetting_pape r.pdf>; The International Commission of Jurists launched in 2006 its Expert Legal Panel on Corporate Complicity in International Crimes to clarify when corporations should be held accountable for their involvement in international crimes, <www.icj.org>, visited on 14 February 2007. 18 For overviews of the CSR field and further references, see D. J. Wood, ‘Theory and Integrity in Business and Society’, 39:4 Business & Society (2000) pp. 359–378; A. B. Carroll, ‘Corporate Social Responsibility: Evolution of a Definitional Construct’, 38:3 Business & Society (1999) pp. 268–295; ‘The Toronto Conference: Reflections on Stakeholder Theory’, 33 Business & Society (April 1994) pp. 82–131; W. C. Frederick, ‘From CSR1 to CSR2: The Maturing of Business-and-Society Thought’, originally from 1978, reprinted in 33 Business & Society (August 1994) pp. 150–164. 16

9

Chapter 1 clarity of the responsibilities a company should have (i.e. the scope of CSR) and/or advance alternative models of the firm. The separation between the three streams of stakeholder theory is made here for clarification purposes only. Instrumental accounts can have a descriptive empirical segment (either case studies or mere illustrations). Descriptive accounts often conclude with prescriptions for businesses and regulators. Normative accounts often are backed with illustrations of responsible business practice. Despite this blend of the three streams, the centre of gravity in each case lies in one of the three areas. Models of responsible business behaviour can be proposed directly to corporate management for voluntary implementation. In addition, but not necessarily, they can be advanced to public policymakers as a conceptual base for new regulations. In the first case, the interest of CSR writers would lie with the development of management tools or with enhancing the capacity for moral reflection on the part of managers. In the second case, works particularly in the field of corporate governance target regulators with alternative models of the firm. The descriptive CSR Case studies highlighting the human rights impacts of business activity (mainly TNCs) have raised the awareness of corporations to emerging CSR risks, and also of society to the serious negative impacts of business activity and trade in developing countries.19 Some case studies record corporate abuses. Others illustrate ‘win-win’ situations in which a business successfully advances both profitability and social responsibility; such studies highlight new corporate strategies to manage the social environment. Large corporations operate in an increasingly complex social environment. As many large corporations became transnational, risks to corporate operations and reputations could not be discarded anymore, as Shell’s experiences (Nigeria and Brent Spar) illustrate. Descriptive accounts of the corporate social environment help identify and describe new actors, and new issues, that pose nontraditional risks to business. Other empirical studies not dealing specifically with human rights but more generally with CSR purport to reveal a correlation between CSR and financial 19

Human Rights Watch, The Price of Oil – Corporate Responsibility and Human Rights Violations in Nigeria’s Oil Producing Communities, New York, 1999, <www.hrw.org/reports/1999/nigeria>; I. Mamic, International Labour Organization, Business and Code of Conduct Implementation – How Firms Use Management Systems for Social Performance, 2003, <www.ilo.org/images/empent/static/mcc/download/supply_chain.pdf>, visited on 14 February 2007; Global Witness and Partnership Africa Canada, The Key to Kimberley – Internal Diamond Controls – Seven Case Studies, 2004; California Global Corporate Accountability Project (Natural Heritage Institute, Nautilus Institute for Security and Sustainable Development, and Human Rights Advocates), Beyond Good Deeds: Case Studies and a New Policy Agenda for Corporate Accountability, Berkley, 2002; R. Sullivan (ed.), Business and Human Rights – Dilemmas and Solutions (Greenleaf, Sheffield, 2003); E. Schrage, Promoting International Worker Rights Through Private Voluntary Initiatives: Public Relations or Public Policy, University of Iowa Center for Human Rights, 2004.

10

Introduction performance.20 Many such statistical studies are motivated to establish the existence of a ‘win-win’ in which both profitability and responsibility are advanced. A link to the financial bottom-line is crucial for starting discussions with business executives that see CSR as antithetical to business objectives. It fulfils the vital task of demonstrating the existence of practical possibilities that have escaped attention before. Once such possibilities are demonstrated: instrumental and normative streams of CSR analysis can take over. The instrumental CSR Instrumental accounts of CSR complement descriptive accounts to build a compelling business case of CSR. Instrumental approaches have an ‘engineering’ orientation; they propose deliberate direct changes in corporate structures and procedures able to deliver CSR. A sizable part of such research is professional research commissioned for multistakeholder CSR fora in which businesses, public policy-makers, NGOs and experts participate. Such fora exist to develop the management tools indispensable to identify, manage and communicate corporate social impacts. Sustained efforts along these lines have only been made in the last ten years. A human rights compliance assessment with 1000 indicators has recently been proposed by the Danish Institute for Human Rights; it aims to help businesses understand human rights risks and weak spots in their performance.21 A multitude of templates assist companies to integrate CSR considerations into their management processes: the Sigma guidelines for businesses22 and the FORGE guidelines on CSR for the financial services sector23 (both in the UK), and, still under development, the International Organization for Standardization (ISO) Guidance on CSR (ISO 26000). Further, the Global Reporting Initiative aims to standardise the way that businesses report their economic, social and environmental impacts.24 The auditing industry and NGOs develop auditing standards for CSR; corporate performance could then be audited and corporate claims (reports) ‘assured’, and gain thus in credibility. The Institute of Social and Ethical AccountAbility (UK) has developed

20 M. Tsoutsoura, Corporate Social Responsibility and Financial Performance, Berkeley, California, 2004, <www.haas.berkeley.edu/responsiblebusiness/documents/FinalPaperonCSR _PDFII.pdf>, visited on 14 February 2007; M. Orlitzky et al., ‘Corporate Social and Financial Performance: A Meta-analysis’, 24 Organization Studies (May-June 2003) pp. 403–441. 21 Danish Institute for Human Rights, Human Rights & Business Project, <www.humanrights business.org>, visited on 14 February 2007. 22 Sigma Project, The Sigma Guidelines, Putting Sustainable Development Into Practice – A Guide For Organisations, 2003. 23 FORGE, Guidance on Corporate Social Responsibility Management and Reporting for the Financial Services Sector, 2002, <www.bba.org.uk/bba/jsp/polopoly.jsp?d=123&a=728>, visited on 14 February 2007. 24 Global Reporting Initiative, Sustainability Reporting Guidelines v3 (“G3”), 2006, <www.globalreporting.org/Services/ResearchLibrary/GRIPublications>, visited on 14 February 2007.

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Chapter 1 the AA1000 series for this purpose.25 Toolkits dealing with multistakeholder collaborations have also been prepared to help business collaborate with other social actors.26 With few exceptions, most of these instruments have a wider reach than human rights and tend to cover both the social and environmental aspects of corporate performance. This new and worthwhile development in technical capacity building complements a much older effort in capacity-building. Back in the 1970s in the US, ethicists noted that the business school curricula ill-prepared managers with the conceptual tools necessary to enable moral reasoning in difficult business situations. Therefore business ethicists have worked on training managers on ethics-related issues arising in business operations; it was said that the fundamental difficulty raised by CSR “is simply that a mind attuned to the market place acquires an almost trained insensitivity to non-market considerations”.27 The normative CSR The descriptive and instrumental streams of CSR literature offer useful managerial tools for scanning and managing the business environment. Despite their merits from a stakeholder theory perspective, the two streams do not confront business structures and systemic market pressures that run counter to stakeholder concerns. This is the case with, for example, the profit-maximisation norm enforced by ‘impatient’ capital markets, or the organisation of some supply chains in labourintensive industries (resulting in pressures on suppliers to cut corners). The normative stream of CSR tackles such structural issues head on. Normative ethicists start by evaluating the classical model of corporation, which prioritises the interests of shareholders, as morally bankrupt. As Donaldson and Preston wrote, “[t]he plain truth is that the most prominent alternative to the stakeholder theory (i.e., the ‘management serving the shareowners’ theory) is morally untenable”.28 At the same time, as a matter of law and business reality, directors and management that run the company have a margin of discretion. If this discretion exists, and the people that run large corporations are obviously capable to use moral reasoning, then presumably a more morally tenable model of the corporation can be advanced. This is especially necessary for large businesses. The ‘stakeholder corporation’ should balance the interests of all its stakeholders; 25

The Institute of Social and Ethical AccountAbility, AA1000 Series, <www.accountability.org.uk/aa1000/default.asp>, visited on 14 February 2007. 26 Business Partners for Development, <www.bpdweb.com/index.htm>, visited on 14 February 2007; Copenhagen Centre, Partnership Matters – Current Issues in Cross-Sector Collaboration, Issue 1, 2003, ; International Business Leaders Forum, Partnership Matters – Current Issues in Cross-Sector Collaboration, Issue 2, 2004, , visited on 14 February 2007. 27 H. L. Johnson, Disclosure of Corporate Social Performance: Survey, Evaluation and Prospects (Praeger, New York, 1979) p. 116. 28 T. Donaldson and L. E. Preston, ‘The Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications’, 20:1 Academy of Management Review (1995) pp. 65–91.

12

Introduction environmental and social matters would not be trumped (severely discounted) by the blind (short-sighted) pursuit of the pecuniary interests of shareholders. The corporate institution must be subjected to moral evaluation, and businesses should behave like moral agents/actors. Normative CSR leaves it up to enlightened managers to voluntarily follow the tenets of the stakeholder corporation and/or to lawmakers uniquely positioned to change the ‘rules of the game’. The normative stakeholder theory has sometimes been advanced in the US and the UK in debates for the revision of company law and corporate governance regime. But another part of stakeholder theory is applications of theories of justice, exercises in moral imagination not related to company law. Chapter 3 will analyse in more depth such normative proposals. Normative works dealing specifically with human rights and business have not articulated a comprehensive model of the firm but seem sometimes content to draw for philosophical support on the existent works of normative ethicists as an alternative to shareholder-oriented theories of the firm. Otherwise, in order to identify and specify in more detail the human rights responsibilities for corporations, appeal has been made to the standards developed in international human rights treaties and other instruments. 1.2. CRITIQUE OF CURRENT RESEARCH This section assesses critically, but briefly, the strengths and weaknesses of the CSR approaches previously described. 1.2.1. Law-oriented approaches The priority of approaches focused on state responsibility is the drawing up of new international treaties or the reinterpretation of current treaties to enlarge state responsibility for corporate abuses. International law is clear on the legal obligations of host states to ‘protect’ human rights, that is, to offer protection against abuses perpetuated by private actors. However, a responsibility of home states to protect human rights overseas by regulating parent companies incorporated in their jurisdictions is not yet recognised under current international law. There have been arguments made otherwise. Thus Clapham would, for example, assign responsibility to the US for failure to legislate in a situation like the 1984 Bhopal accident in India which recorded thousands of dead following a poisonous leak from an industrial plant.29 The main interest of this study however is not on state responsibility under international law, for reasons, among others, that the negotiation of a comprehensive international treaty on corporate responsibilities is a cumbersome process likely to stretch over decades. In the meantime a lot can be learned about law and responsible business practices by focusing on regulation at national level, and on how law/policy interacts with CSR, at national and international levels, to shape corporate behaviour.

29

A. Clapham, Human Rights in the Private Sphere (Clarendon Press, Oxford, 1993) p. 348.

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Chapter 1 Personal responsibility of corporate executives can be sought through both criminal and civil law methods. The criminal liability of private actors under international law, including the individual responsibility of business executives, is a rapidly developing area in international law exemplified by the International Criminal Court regime and by the law of transnational bribery. In the corporate accountability area, human rights experts are concentrating now their efforts on identifying standards of corporate complicity by drawing on national laws and the jurisprudence of international criminal tribunals. However, criminalising directorial misbehaviour is likely to remain limited to most extreme cases and apply only to a narrow range of CSR issues. Seeking the deterrence of business executives through civil liability for their negligent acts and omissions has also obstacles to overcome: the constitutive articles of companies, insurance policies and also state regulations make possible for management to have the company itself pay compensation to third parties following acts of managerial negligence. Regulators approach cautiously this area of director liability for negligence, as exemplified by British policymakers: “The law on directors’ liability needs to strike a careful balance: on the one hand, the law must be firm and robust to deal fairly with cases where something has gone wrong, as a result of either negligence or of dishonesty; on the other, Britain needs a diverse pool of high-quality individuals willing to assume the role of company director, and a willingness by directors to take informed and rational risks.”30 This means that efforts to advance CSR at this juncture will run counter to strong dynamics present in most systems of corporate governance. Among the three levels of responsibility that a legalistic approach could elaborate, this book concentrates on the corporate responsibility level, not state or individual responsibility. It is at this level that numerous and interesting developments currently take place. Law-oriented literature reveals a clear focus on ensuring corporate liability through binding regulations. The proposals draw on rational choice analysis that is particularly able to highlight important dynamics surrounding corporate activity. Such analysis proposes that self-interest is a powerful motivator that should not be obscured, especially when dealing with profitmaking entities that are subject to the competitive pressures of markets. In support of tort law solutions, it was observed that “[c]alm, calculating manufacturers are particularly attractive targets for punitive damage awards, not because they are more evil than other injurers or because they are wealthier, but because they are more deterrable. Moreover, because manufacturers calculate, it is especially important to send them the correct signal.”31 This regulatory approach maintains that the judicial system is uniquely able to bring a perpetuator of serious violations of human rights to justice; also harsh financial sanctions have a deterrent effect on other corporations. Thus this approach offers reparations to victims and can also prevent 30

Department of Trade and Industry, Company Law Reform, White Paper 2005, p. 23, <www.dti.gov.uk/bbf/co-act-2006/white-paper/page22800.html>, visited on 14 February 2007. 31 N. K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics, and Public Policy (University of Chicago Press, Chicago, 1994) p. 189.

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Introduction further violations by other corporations: “Damages are a money payment to compensate the victim, that is to say, to restore him, so far as money can, to the position he would have been in if the wrong complained of had not been committed. Damages also serve the aim of preventing harm.”32 The logic employed, one of pure deterrence, offers conceptual clarity: the incentives are clearly specified and the mechanisms of accountability are formalised. For analytical purposes, a deterrent approach offers a direct causality between law and corporate behaviour. There are also downsides of this approach. By relying so heavily on international treaties and on national regulation, law-oriented approaches depend decisively on state action. Host states have often fallen short of properly regulating business impacts, and particularly enforcing these regulations. These states have, often for good reasons, seen proposals to integrate social and environmental issues with international trade as disguised protectionism, as politically motivated efforts made by rich countries and their trade unions to shelter own industries and work forces from foreign competition. Home states, where the parent company is based, may be disinclined to rigorously regulate it when the harms are not directly caused by the parent company and the place of abuses is in other jurisdictions and so geographically remote. These dynamics make the enactment of strong deterrent legal frameworks particularly difficult. More narrowly defined regulatory proposals have higher chances of success as, for example, the treaties on bribery or the regulation of diamond trade, at international level, and laws imposing obligations to report on social and environmental impacts, at national level. Less successful have been more comprehensive regulatory efforts such as the UN Norms on the Responsibilities of Transnational Corporations, at international level, and the reform of company laws, at national level. Lawmakers have difficulties in regulating TNCs which “constitute a new form of enterprise organisation where a plurality of separate legal entities are submitted to unitary economic direction. The central and enigmatic feature of such corporate phenomenon has thus been identified … with the tension or contradiction between diversity (multiplicity of legal entities) and unity (unity of economic entity)”.33 A legal obstacle to the liability of MNEs is the principle of legal separation of companies. To overcome it arguments have been made either for ‘group liability’ (the doctrine of ‘enterprise liability’) which makes the parent company automatically responsible for the subsidiary’s behaviour, or for ‘direct liability’ of the parent company for its own failings that resulted in harm overseas. In the latter case, liability is assigned to the parent either for acts of commission as in the export of dangerous technology to subsidiaries, or for acts of omission as in failure to keep informed about subsidiaries’ activities and exercise oversight. Group liability is a negation of the principle of legal separation, while direct liability is compatible with 32

European Group on Tort Law, Principles of European Tort Law, Article 10:101, 2005, <www.egtl.org/principles/index.htm>, visited on 14 February 2007. 33 J. E. Antunes, Liability of Corporate Groups – Autonomy and Control in Parent-Subsidiary Relationships in US, German and EU Law (Kluwer Law and Taxation Publishers, Deventer, 1994) p. 489.

15

Chapter 1 that principle as it sanctions only own wrongdoing. Muchlinski shows that the enterprise entity doctrine recognises the corporate group as a distinct form of business association. In keeping with this doctrine some a priori judgments should be made either toward the establishment of a supranational incorporation, or a presumption of control by the parent over the subsidiary.34 Muchlinski appreciates that the advantages of limited liability offered by the doctrine of corporate separation provides strong reasons for its retention, and an abandonment of this traditional approach to group liability is unlikely.35 The UK litigation mentioned previously applies the principles of direct liability. Deterrence itself can offer only a partial explanation to regulatory proposals focusing on structures and procedures. This avenue of legislative action departs from a ‘pure deterrence’ reasoning (i.e. deterrence achieved through state regulation and enforcement) as it does not prescribe (final) outcomes and does not assign liability for not meeting them. The law instead specifies only certain means (structures and procedures) to be employed. Procedural regulation crucially depends on the private use of these processes or structures in order to achieve law’s goals. One could refer, as examples, to: collective bargaining; legal requirements for consultation or for environmental impact assessments; a legal obligation to release a CSR report or to have its contents independently verified. It is apparent that such regulatory strategies are based on a different mechanism of influence which include deterrence (through public and private enforcement), but is not limited to it. Corporate voluntarism and various state policies (even if not binding in nature) suddenly appear relevant for understanding the operation of law because they can affect other processes of negotiation, clarification and innovation. All such mandatory procedures would empower stakeholders to negotiate with the business (subsidiary and/or parent company) the scope of its responsibilities. Understanding how law operates in these situations is particularly important when discussing the positive responsibility of the parent company to exercise oversight over its business partners. The final objective of law – obtaining the oversight of parent company – would be specified through negotiation and innovation in how to balance competing interests. Solving the complexity raised by how to specify positive obligations cannot be done solely through legislative fiat. In these circumstances it appears that an emphasis on ‘pure’ deterrence can easily overstate the distinction mandatory-voluntary. While it is true that there cannot be legal liability without binding regulation (or contracts), there are hybrid regulatory frameworks that combine state regulation with private regulation and private enforcement that can provide various degrees of accountability. A deterrent framework cannot account for the developments of the last ten years in the business and human rights area. This is problematic because much of what currently happens in the area of business and human rights does not involve state action; and much of what states do is not of a regulatory type. More broadly, lawmakers in developed countries increasingly rely on private enforcement due to 34

P. T. Muchlinski, Multinational Enterprises and the Law (Blackwell, Massachusetts, 1995) pp. 329–332. 35 Ibid., p. 329.

16

Introduction budgetary constraints and international competitiveness pressures; they design regulatory mixes to mobilise and oversee the regulatory potential of private actors. Therefore, a purely deterrent approach remains aloof of a multitude of policy and corporate developments. Thus the approach exclusively grounded in deterrence also precludes an evolutionary analysis of various CSR initiatives currently underway. Without this temporal dimension introduced by evolutionary reasoning, voluntary initiatives cannot overcome their condition,36 and therefore appear completely inappropriate to provide a systemic solution to CSR concerns. The possible interactions between voluntarism and public policy can however help lawmakers to advance toward systemic solutions in the area of business and human rights. Finally, the deterrence framework cannot properly accommodate leading businesses. Such companies do more than respect human rights in their operations; they develop standards, methods and tools to manage and communicate CSR. In the process they collaborate with stakeholders. The accumulation and availability of this CSR experience may make less defensible the position of less proactive companies which remain outside the CSR regime or free ride from within. By building capacity to handle CSR in various social actors, leading businesses may trigger important regulatory dynamics. Therefore, from a perspective that accounts for the influence exercised by proactive companies, the narrow angle of deterrence concentrating solely on laggards can be criticised. With regard to the entire range of corporate behaviours, deterrence limits itself to wrongdoers and does not account for major new developments triggered by leading TNCs. The impacts of the latter’s behaviour cannot be grasped. This critique of the predominant regulatory approach advanced by human rights proponents serves to highlight the gap in legal analysis; it also gives a rough direction of how this study will be developed. Now the discussion turns to some blind spots left by non-legalistic CSR approaches. This will also show the complementarity of this study with some CSR approaches. 1.2.2. CSR approaches Studies of the link between CSR and financial performance often aim to establish compatibility between responsible business behaviour and profitability. However, the more ambitious attempt to establish causality has not been successful: it is not clear whether CSR contributes to enhanced financial performance, or if it is profitability that generates the resources needed to implement CSR. It is said that such studies showing a positive relation between CSR and the financial bottom line may establish a correlation, but not causation. In addition, such studies in themselves are not meant to provide explanation or guidance on how to promote simultaneously both CSR and profitability. For that purpose, case studies are a useful complement as they may show how a certain experience unfolded.

36 Business self-regulation is notoriously affected by the ‘free-rider’ syndrome and assurance problems.

17

Chapter 1 The findings of case studies bring indispensable evidence on ‘what’ and ‘how’ questions. In the business and human rights area most case studies can be described as ‘thick descriptions’. This may be sufficient and serves important practical purposes, but findings often remained localised to particular contexts. However, better theory is needed to make sensible generalisations to other contexts. As Yin shows, one does not generalise to other case studies but one generalises to theory; theory becomes the vehicle for examining other cases.37 Case studies are thus not expected to inform directly other CSR contexts that are likely to differ significantly. Empirical research advances only when it is accompanied by theory and logical inquiry and not when treated as a mechanistic or data collection endeavour.38 Unfortunately, the theories that deal with possible ways of approaching the area of ‘business and human rights’ are still underdeveloped. Also better theory could shape the design of future case studies to obtain even more insightful evaluations of CSR. As a difference from descriptive approaches the instrumental stream of CSR research aims to build managerial capacity to implement CSR. We have distinguished between the capacity for moral reasoning and the more technical capacity to implement CSR. Business ethicists have emphasised the importance of moral reasoning especially as corporate decisions having a substantial social impact are ultimately taken by individuals capable of moral reasoning. Nevertheless, moral sensitivity needs to be doubled by managerial tools for identifying, measuring, managing, verifying and reporting their economic, social and environmental performance. The creation and on-going evolution of this significant infrastructure – composed of intermediary organisations and networks and managerial templates for CSR – is a development of the last five to ten years whose importance cannot be overemphasised. Chapter 4 looks more closely at this body of work. Both these efforts in capacity-building deliver indispensable managerial capacity, but positive outcomes may still be delayed or remain limited to a few ‘good corporate citizens’. It was left to normative stakeholder theories to embed CSR in a coherent understanding of the regulatory, market and social dynamics surrounding the corporation. As will be shown in chapter 3, normativists downplayed these dynamics and concentrated on developing a moral philosophy-inspired discourse. In fairness, normative stakeholder theories worked to define the foundations and scope of corporate responsibilities in a more hostile context: the ‘greed is good’ corporate climate of the late 1970s and 1980s in the US. Nowadays CSR is significantly more accepted in business circles, and their willingness to cooperate is clearly higher; these CSR practices and the variety of actors involved in CSR were simply not existent decades ago. In addition, CSR practitioners, after ten years of CSR at international level, have become more explicit about the need to make the impacts of CSR more sustainable and to scale them up. This puts a premium on normative works that strive to account for the aforementioned dynamics and articulate scalingup mechanisms. 37

R. K. Yin, Case Study Research: Design and Methods, third ed. (Sage Publications, Thousand Oaks, 2003) p. 38. 38 Ibid.

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Introduction There are direct implications for the business and human rights area, which does not have to import uncritically the normative constructs of stakeholder theory. Appreciation for previous modes of reasoning does not have to hold us blind to new realities and fresh opportunities to find answers to old problems. Despite the efforts of stakeholder theories there is still a way to go until the scope of CSR is satisfactorily defined, that is, the limits of corporate responsibilities. In the area of human rights this definition needs to be done without obscuring the social role of companies and the relationship between corporate responsibilities and state responsibilities.39 New models cannot discount the institutional pressures generated by markets and globalisation that reinforce the standing of shareholders in the economy of the firm.40 Chapters 2 and 3 will further analyse these aspects. A better capacity to assess the dynamics in the social environment is helpful for understanding the full range of effects of CSR and its future evolution. The hope is that this approach will provide a new impetus to bring sceptical companies on board and enhance the cooperative disposition of stakeholders. In this way normative stakeholder theory can truly complement and reinforce the instrumental stream of CSR work. 1.3. MATTERS OF APPROACH This study discusses the responsibilities of TNCs,41 more precisely, the responsibilities of the controlling entity, which will often be the parent company in

39

See J. Ruggie, Response to Fédération internationale des ligues des droits de l’Homme, 20 March 2006, <www.reports-and-materials.org/Ruggie-response-to-FIDH-20-Mar-2006.pdf>, visited on 14 February 2007. 40 M. T. Jones, ‘Missing the Forest for the Trees – A Critique of the Social Responsibility Concept and Discourse’, 35 Business & Society (March 1996) pp. 1–27; T. Mitchell et al., ‘Toward a Theory of Stakeholder Identification and Salience: Defining the Principle of Who and What Really Counts’, 22 Academy of Management Review (October 1997) pp. 853–886; A. Stark, ‘What’s the Matter With Business Ethics?’, Harvard Business Review (May/June 1993) pp. 38–48. 41 The definition of multinational enterprises used herein is broader than usual and includes not only ownership links (i.e. parent-subsidiary) but also other links that allow a degree of control or influence be exercised (i.e. buyer-contractor). As the OECD Guidelines read, MNEs “usually comprise companies or other entities established in more than one country and so linked that they may co-ordinate their operations in various ways. While one or more of these entities may be able to exercise a significant influence over the activities of others, their degree of autonomy within the enterprise may vary widely from one multinational enterprise to another... the different entities are expected to co-operate and to assist one another to facilitate observance of the Guidelines.” Organisation for Economic Co-Operation and Development, OECD Guidelines for Multinational Enterprises, adopted 21 June 1976, revised 27 June 2000, <www.oecd.org/document/28/0,2340,en_2649_34889_2397532 _1_1_1_1,00.html>. See also International Labour Organization, Tripartite Declaration of Principles Concerning Multinational Enterprises and Social Policy, adopted by the Governing Body of the International Labour Office in 1977, amended 2006, para. 6,

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Chapter 1 the North or a large subsidiary in the South. In the following chapters the emphasis is on how the responsible business practices of leading companies within the CSR regime clarify and operationalise CSR, and how states, through law and policy, can reinforce the emerging CSR regime and contribute to the institutionalisation of CSR. Historically CSR has developed in a mode characterised by voluntarism, decentralised non-hierarchical enforcement, pressure of the public opinion mobilised by advocacy groups and facilitative state action. Concepts of rights, duties, the binding nature of instruments and centralised settings to regulate and enforce are not automatically applicable to CSR. This mismatch between legal concepts and social reality is manifest in the difficulty of the legal theory to account for CSR practices. Conversely, the difficulty is also present for business executives and CSR theorists to relate corporate voluntarism to law and state actors. The legal and business systems have thus difficulties of communication when it comes to CSR. As shown above an important implication of this study should lie with challenging widely held perceptions that CSR and regulation are mutually exclusive. This study does not search for static maps based on highly rigorous classifications, but examines the subtle variations in concepts that open an evolutionary path toward accountability on which businesses may move or not depending on the specifics of each context. This research will increase analytical sensitivity by defining the main concepts, where possible, as continuums instead of striving for categorical delimitations. For example, leading TNCs can be positioned on a continuum ranging from ambivalent/aspiring TNCs to decidedly committed TNCs: the gap between altruistic and self-interested behaviour can be narrowed by referring to enlightened self-interest (a longer term and more inclusive type of self-interest). Different regulatory strategies – enabling or mandatory – can be examined in terms of opt-out procedures: the more elaborate and costly the opt-out procedures, the closer the rules are to being, in effect, mandatory. Finally CSR standardisation or benchmarking can be examined along a continuum ranging from guiding problem solving to accountability for reaching targets. This research takes a step back to grasp the paths and trends in the larger picture. Instead of striving for clear-cut ideal categorisations, the argument herein deliberately leaves place for social choice, struggle and contrary arguments. Such a theoretical stance is humble, but makes it more likely for this study to be a useful complement to more applied approaches to CSR and human rights protection. Conceptual treatments as herein cannot obscure the initial understanding that practical solutions need compromises and innovation. As Amartya Sen observed, insistence on completeness of judgements of justice over every possible choice is an enemy of practical social action, while the overuse of the concept of justice reduces the force of the idea.42 Instead the aim here is to identify concepts compatible with both the regulatory and business systems. For purposes of my study, the threshold in developing these border constructs is not perfect alignment, but mere compatibility. <www.ilo.org/public/english/employment/multi/download/declaration2006.pdf>, visited on 14 February 2007. 42 A. Sen, Development as Freedom (Oxford University Press, Oxford, 1999) pp. 253–254.

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Introduction The final goal is, on one hand, to highlight ideas that affect CSR but have outlived their usefulness, and on the other hand, to enrich and clarify the CSR ideas by importing ‘wisdom’ from jurisprudence and regulatory theory. Sensitivity to context is essential. Some regulatory theorists refer to the need to design policies fit to the ‘regulatory space’. This requires proponents to understand business and societal dynamics that can impact on law’s effectiveness. Such attention to context gives to the present study a functionalist orientation. It has been shown in the international law context that functionalism emphasises the need for problem-solving, confronts problems of great complexity with minimal dependency on legal abstractions and doctrines that lack operational utility in the context of those problems; it replaces analogies with functionally specific concepts, techniques and institutions.43 Formalism appears less attractive for the area of business and human rights at this early stage of its evolution; instead of limiting the field of inquiry solely to legally binding instruments, an orientation grounded in functionalism could account for both state and corporate policies, even if they have not the binding nature of law or contract. Their utility in enhancing the protection of human rights would be judged in context. The normative orientation of this study lies with the human rights standards developed in international law instruments. Human rights are legitimised interests that the international community has recognised in the last half century for every human being and are accompanied by legally binding obligations on states. Following Drahos, one can “assume that the current set of human rights recognised in international law serve as an adequate description of those interests that individuals all over the world wish to have protected from interference or promoted”.44 This study also looks at CSR from a human rights angle. It is important when dealing with CSR and human rights to account for established actors (states, trade unions and other non-governmental bodies) and to reinforce their capacity to discharge own responsibilities towards good governance. This study breaks with the tendency to view CSR and regulation as two independent parallel channels to advance human rights; instead it deliberately connects CSR with public policy and state actors, which are the obligation-holders under international human rights law. The practices of leading businesses create opportunities for policy makers to regulate or devise innovative governance arrangements that can, in turn, pressure other companies to emulate good business practices. As Ruggie noted, “[o]ne line of constructivist research seeks to identify, inventory and specify the consequences of innovative micro-practices. This approach is most productive when linked up with

43

D. Johnston, ‘Functionalism in the Theory of International Law’, 26 Canadian Yearbook of International law (July 1988) pp. 55–56. 44 P. Drahos, ‘The Right to Food, Health and Intellectual Property in the Era of “Biogopolies”’, in S. Bottomley and D. Kinley (eds.), Commercial Law and Human Rights (Ashgate, Aldershot, 2002) p. 215.

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Chapter 1 macro-structures, to determine which microagents are potentially transformative agents”.45 Articulating standards for CSR management and creating supporting infrastructure (organisations and networks) makes it possible for businesses to implement and demonstrate CSR. The next step for CSR is to scale-up this infrastructure, to enhance its impacts. By adopting a legal angle the present study begins to analyse the interaction between CSR and law/public policy as a scale-up mechanism. Critics of CSR, both from business and from the civil society, have discussed the relationship between CSR and regulation. Both consider that CSR triggers unwelcome regulatory dynamics. The long-standing business objection to CSR sees it as a step on a slippery slope towards intrusive regulation that impedes the creation of wealth through market mechanisms. Sceptics from civil society assert that CSR displaces regulation (de-regulation) and is too weak to change profitdriven corporate behaviour. By comparison with these two viewpoints, theories that look at constructive interactions between CSR and public policy, at the dynamics for transparency and participation CSR may generate, are less developed. There is an uncharted area where CSR may facilitate sensible regulation, as opposed to deregulation or intrusive regulation. The interaction between law and corporate voluntarism is a complex one. Better understanding it is an effort in capacitybuilding that complements the two aforementioned instrumental efforts aimed at building technical capacity to implement CSR and capacity for moral reasoning. The business case of CSR usually links TNCs with human rights through ‘winwin’ reasoning, but at a certain point there is a conflict. This point is bound to be reached and cannot be disguised through ‘win-win’ rhetoric, especially when one expects a significant and sustainable contribution from business to tackle the numerous human rights problems of the Third World. Where exactly this point is placed is a matter of persuasion and bargaining in each specific context with a look at available alternatives, not a matter of normative or technocratic pre-determination. Still, the point can be sensibly pushed further with an empirically-informed redefinition of self-interest, of poverty, of implementation mechanisms, of the roles of various actors, etc. The interest of this study is to frame CSR in a manner compatible with current business institutions and dynamics, and to be alert to the possibilities for incremental change and evolution toward economic and political arrangements favourable to human rights goals. Karl Popper has ably articulated this orientation. He agreed that many social problems are pressing; one should not rest content with interpreting the world but should strive to contribute to its transformation. It is easier to reach agreement on how to identify and eliminate poverty than to agree on an ideal form of social life. The strategy is to work toward the objective through direct means and not indirectly by conceiving and following a remote ideal.46 45

J. G. Ruggie, Constructing the World Polity: Essays on International Institutionalism (Routledge, London, 1998) p. 27. 46 K. Popper, Conjectures and Refutations: the Growth of Scientific Knowledge (Routledge, London, 2002) pp. 337, 361.

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Introduction 1.4. DISPOSITION OF THE BOOK An analysis of the relationship ‘multinational business – human rights’ can start from either the business end or the human rights law end. This study begins with a discussion of company law and corporate governance. This choice is made in order to anchor the subsequent CSR argument more solidly in business and legal realities and acquire maximum compatibility with them. Chapter 2 presents the legal duties corporate directors have under company laws and also their enforcement through courts of law and corporate governance mechanisms. The discussion will highlight the way that this body of regulations has dealt with stakeholders’ interests. The analysis covers legal formulations employed in the US, British, French and German systems, but concentrates on the US and British ones: On one hand they emphasise the role of shareholders in the economy of the firm, a role that is growing increasingly important in other developed corporate governance systems. This is a timely emphasis as both pro- and con-CSR writings have often obscured or misrepresented the standing of shareholders. On the other hand, the case law and theory regarding managerial duties is best developed in these two jurisdictions. Further insights are derived from the British reform of company law under way since late 1990s; it serves as an excellent example of lawmakers clarifying the established duties of directors and in the same time creating an opening for stakeholders’ interests to be taken into account. Company laws lay down a duty of care on corporate managers in their pursuit of business success. In discharging their duties directors may come to adopt a longerterm perspective and a more stakeholder-inclusive manner; the result is obviously an increase in complexity for managers. Chapter 3 picks up where the company law discussion ended: how did CSR writings – both arguments in favour of or against CSR – assist managers in tackling the complexity of their profit-making mandate? We look at the norms or belief systems that pro- and con- CSR arguments have promoted. While company laws lay down a managerial duty of care, it can be rendered meaningless if the norms that guide managerial decision-making are incompatible with policy aims such as long-term profitability of business and reduced frictions between shareholders’ and stakeholders’ interests (British law being most explicit in this regard). Without looking at managerial norms the effectiveness of the duty of care provided in company laws cannot be understood. In the corner that dismisses CSR we use Milton Friedman’s writings; he is the most resilient critic of CSR. In the other corner are contributors to stakeholder theory who for long and with uncertain success have answered Friedman’s critique. We disaggregate the arguments along three levels in search of valid points and blind spots generated by this lasting debate. The results are compared with the approach that seems to guide leading businesses active in the CSR area. This chapter draws on business ethics and stakeholder theory, which have been mostly developed in the US. As the analysis so far will have found that neither of the two traditional ways of supporting or dismissing CSR properly account for legal realities and recent CSR 23

Chapter 1 developments, chapter 4 provides a descriptive account of what leading businesses do regarding CSR and how the experience of some businesses redefine what reasonable care entails. The last ten years have witnessed an important process of standard-setting and creation of supporting CSR infrastructure. This massive and ongoing effort in capacity building creates new means for businesses to pursue commercial success while taking stakeholders’ interests into account; evolving business practice challenges the simplifications managers used in the past for dealing with their stakeholders. The emphasis in chapter 4 is not on individual business practices but on multistakeholder fora where business actors, civil society groups and governments cooperate to develop shared understandings and tools to manage CSR. The materials used in this chapter are instruments of relevant organisations active in the field and writings of CSR specialists with first hand experience in the implementation of CSR. There is a ‘grey zone’ where corporate and stakeholders’ interests overlap, instances where responsible business practices can contribute to a corporation’s success. Previous chapters highlighted some forces that operate in this grey zone: the legal duty of care that company law imposes on directors (chapter 2), the norms proposed by pro- and con- CSR theories (chapter 3) and the emerging good practices of leading businesses and their stakeholders (chapter 4). Nevertheless, policymaking in the ‘grey zone’ is a relatively new area for regulators. In addition to soft law and policy measures, the law can play here a stronger role, and to that end chapter 5 presents a selection of regulations that do not make CSR redundant, but complement it. In other words there is hard law that does not eliminate managerial discretion, but instead guides it. The aim here is to document this complementarity between law and the managerial discretion on which CSR is built. We screen out pure deterrence approaches where states both lay down the end result and provide the enforcement. Instead we look for combinations of private and public codification and enforcement. We examine instruments that either directly deal with ‘business and human rights’, or could serve as models for future regulations in this area. Examples of such strategies come from corporate governance, environmental protection, criminal law and most recently from regulations dealing with corporate social impacts (especially on employees). The overview covers most jurisdictions that have been active in this new area: the UK, France, Germany, Belgium, Sweden, South Africa and Australia. Otherwise, regulations dealing with corporate governance are selected from the UK and the US. Chapter 6 follows that descriptive account with an explanation of the aforementioned regulations. The complex causality between state action (law and policy) and corporate behaviour is highlighted. As a difference from pure deterrence models where the causality is straightforward, in our case there are some important variables that intermediate between law and business behaviour. Through their CSR practices, leading businesses have already impacted on these variables. States can capitalise on this development and further stimulate the variables through both law and soft law, and capacity-building strategies. Working within the emerging regulatory regime of CSR puts a premium on understanding the context where CSR 24

Introduction and law co-evolve (regulatory space), on the regulatory potential of public and private actors and the norms/rules they apply. Explanations are then placed in a broader context provided by regulatory theory and administrative law. The argument now reaches the human rights end of the ‘business – human rights’ relationship. We highlight the guiding and constraining functions of a regime, and the interaction between corporate voluntarism and law/policy that can happen around those two functions. The state-centred understanding of international law and international relations needs a slight adjustment to account for non-state actors and the regulatory dynamics their practices generate.

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CHAPTER 2 ANCHORING CSR IN COMPANY LAW Why is an analysis of company law (CL) and corporate governance systems necessary? Many CSR arguments have fallen on deaf ears due to a perception that the pursuit of stakeholders’ interests clashes with managerial duties under CL and with the prominent role of shareholders under CL. In this chapter we look to what extent this perception is justified. The following main questions are raised here: What are the managerial duties under company law? Whose interests do these duties protect? How are these managerial duties enforced? To what extent does CSR require a fundamental overhaul of CL? If lawmakers are to regulate companies is CL the proper place for regulatory intervention or should corporate accountability be obtained by strengthening other discrete regulatory areas (e.g. regulations of health and safety, labour rights, environmental protection, etc.) closer to the problem-issue motivating CSR? Corporate managers47 are subject to a broad array of regulations. In running the company they have to obey company law and specific regulations (e.g. tax, anticompetition, tort laws, the above-mentioned regulations, and many others), and also observe the company’s constitution and internal company legislation. Company laws in various jurisdictions require directors to operate companies for the benefit of shareholders: “this obligation is reflected in the powers of shareholders to hold directors to account, which include powers of appointment, dismissal and indeed control of the company constitution”.48 It is up to the company, or to shareholders suing on behalf of the company, to enforce these duties. It should not be deduced from this simplified legal picture that CL imposes legal duties enforceable in courts of law that bind management to follow the whims of most mercantilist shareholders with complete disregard of stakeholders’ interests. This chapter highlights the complexities encountered by CL in steering directors to pursue corporate success. Corporate management is expected under CL to discharge its mandate with care and with loyalty (without self-dealing or conflicts of interest). These two aspects are present in most CL systems. Legal provisions of some important Western systems (mainly the US and the UK, but also France and Germany) will be compared to understand better some recurrent concerns of lawmakers. At the same time managerial accountability is obtained not only through judicial enforcement of these duties, but also to a significant extent by shareholders helping themselves in other 47

The terms ‘directors’, ‘managers’ and ‘business executives’ are used interchangeably unless distinctions are required by the context. 48 Company Law Review Steering Group, Modern Company Law for a Competitive Economy – Developing the Framework, para. 2.7, <www.dti.gov.uk/bbf/co-act-2006/clr-review/page 22794.html>, visited on 14 February 2007. 27

Chapter 2 arenas. Such self-help can use several channels such as the power to elect the board of directors, the influence that comes with large size (institutional shareholders) and market valuations (market indicators such as share price). Therefore the enforcement of managerial duties cannot be understood without comprehending the larger corporate governance context. Both legal issues of CL and wider non-legal aspects of corporate governance will be discussed in this chapter. The following sections present two main issues: how do CL systems clarify managerial duties, with a special emphasis on the duty of care, and what implications does a CL analysis carry for CSR argumentation? 2.1. MANAGERIAL DUTIES OF CARE AND LOYALTY UNDER COMPANY LAWS A concise statement of managerial duties is found in the Organisation for Economic Co-operation and Development (OECD) Principles of Corporate Governance under the heading ‘The Responsibilities of the Board’: “Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders.”49 The analysis of managerial duties follows US jurisprudence, as this is best developed and can highlight more general concerns of company laws elsewhere, and British regulations, as the UK has just finished a major reform of its company law and in the process has dealt explicitly with many issues of relevance here. Eisenberg observes that “[t]he duty of care of corporate directors and officers is a special case of the duty of care imposed throughout the law under the general heading of negligence … if a person assumes a role whose performance involves the risk of injury to others, he is under a duty to perform that role carefully and is subject to blame if he fails to do so”.50 Brudney concisely presents the main elements of the duty of care which requires “some level of attentiveness, some process for (and actual) acquisition or possession of relevant information, some reasoned deliberation in performing services, and exercise of some conscious (but virtually unrestricted) judgment about acceptable levels of return per unit of risk or other measure of enhancing stockholder well-being”.51 The judiciary will not review managerial care unless plaintiffs (shareholders) substantiate that managers were grossly negligent, not merely ordinarily negligent. This higher threshold of negligence exists either explicitly in laws (the ‘business judgment rule’ (BJR) doctrine in some common law systems) or as a matter of judicial self-restraint. The OECD notes: “In nearly all jurisdictions, the duty of care does not extend to errors of business judgement so long as board members are not 49

OECD, OECD Principles of Corporate Governance, 2004, Section VI.A, <www.oecd.org/ dataoecd/32/18/31557724.pdf>, visited on 14 February 2007. (emphasis added) 50 M. A. Eisenberg, ‘The Divergence of Standards of Conduct and Standards of Review in Corporate Law’, 62 Fordham Law Review (1993) p. 439. 51 V. Brudney, ‘Contract and Fiduciary Duty in Corporate Law’, 38 Boston College Law Review (July 1997) p. 599.

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Anchoring CSR in company law grossly negligent…”.52 In the UK it was noted that “our courts have shown a proper reluctance to enter into the merits of commercial decisions”.53 In all developed economies, courts are unwilling to second-guess management, especially in substantive business decisions. Main reasons are that regulators do not want to inhibit necessary risk-taking in business by strengthening managerial liability for cases where risky decisions failed to pay off, and courts regard themselves as not competent to review business decisions. For the judiciary to routinely specify the concrete level of care for each case would put courts in a situation close to making commercial decisions themselves. Courts consider that they do not have the special expertise or the mandate (legitimacy) to assess the wisdom of risky commercial decisions: “One of the important reasons for the existence of the business judgment rule is the institutional incompetence of courts to pass upon the wisdom of business decisions.”54 The business judgment rule “generally protects from substantive review for wisdom”.55 The rule operates in two basic contexts: to protect a business decision from attack (transactional justification cases), and to protect individual directors from monetary liability (personal liability cases). A more detailed discussion of the precise standards of negligence follows later. Directors and officers are under a duty of loyalty that forbids self-dealing. They cannot divert to themselves a business opportunity that belongs to the corporation with which they are associated. In other words a director of the corporation has an obligation to not compete against the corporation. Exceptions are defined in each jurisdiction, but they do not have relevance for the present CSR discussion. Courts scrutinise aspects of loyalty (managerial self-dealing) more severely than matters of due care. However, conflicts of interest can come in many forms. Directors can pursue not only their own pecuniary interest, but also seek nonpecuniary gains or even aim to improperly benefit third parties. One US case has explicitly dealt with the diversity of managerial motivations. The Court in RJR Nabisco, Inc. Shareholders Litigation56 stated: “Greed is not the only human emotion that can pull one from the path of propriety; so might hatred, lust, envy, revenge, or, as is here alleged, shame or pride. Indeed any human emotion may cause a director to place his own interests, preferences or appetites before the welfare of the corporation.”57 Shareholders had attacked a decision of directors to accept a tender offer on grounds that a committee of directors was “not motivated to try to achieve the best available transaction for the benefit of the shareholders, but was inappropriately motivated to repudiate, and more importantly, 52

OECD, supra note 49, p. 59. Company Law Review Steering Group, supra note 48, para. 3.70. 54 Freedman v. Restaurant Associates Industries, Inc., quoted in D. G. Smith, ‘Chancellor Allen and the Fundamental Question’, 21 Seattle University Law Review (Winter 1998) p. 594. 55 Re J.P. Stevens & Co., Inc. Shareholders Litigation, quoted in Smith, ibid. 56 In re RJR Nabisco, Inc. Shareholders Litigation, 1989 WL 7036 (Del.Ch.), (14 Del. J. Corp. L. 1132). 57 Ibid., p. 1159. (emphasis added) 53

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Chapter 2 to be seen publicly as repudiating the Company’s management”.58 There was public dismay caused by the self-enrichment actions of the chief executive officer (CEO) trying to buy the corporation for himself on the cheap. The committee of directors deciding on tender offers did not aim for the highest priced offer, but were said to parade as righteous, independent directors, free of influence from a grasping CEO. US courts have considered only pecuniary self-dealing transactions as duty of loyalty issues: “Aside from the takeover cases, which consider the general motive of entrenchment in office, the issue has always been the potential divergence between the pecuniary interests of the insider and that of the corporation and the shareholders.”59 If courts reviewed the entire spectrum of non-pecuniary interests that managers can pursue, the resulting extensive interpretation of managerial selfinterest would colonise vast territory of managerial discretion in making business judgements (risky commercial decisions). It would overlook all considerations that have lead to judicial restraint in the case of the duty of care. Eisenberg explains: “For corporate-law purposes … it is desirable to define interestedness in a bounded manner, to include only financial and close familial relationships, because a corporate-law definition that turned on objectivity or impartiality would seriously diminish the protection afforded by the business judgment rule. The business-judgment rule protects only directors who are defined as disinterested… In practice, therefore, for corporate-law purposes interestedness is defined in a bounded way, to include only certain kinds of interestedness.”60

A narrow definition of managerial self-interest limited to pecuniary gains is thus warranted because self-dealing removes the protection of the business judgment rule. This has to do not with the concept of self-interest itself (in which CSR could certainly be included as a possible non-pecuniary preference of conscientious directors); it has to do with the (un)willingness of courts to scrutinise business decisions on the merits. Sometimes satisfying the interests of stakeholders (employees or consumers) is the best way towards business success; other times it is not. But courts refrain from analysing what is the best way to success as long as managers remain within the limits of the law. These considerations of judicial policy are relevant to CSR discussions. It is important to understand that CSR enters CL not through the door of the duty of loyalty. Critics of CSR charge that directors use company money, not their own, to support pet causes and obtain public recognition by parading as responsible leaders. This would indeed appear to be self-interested, ‘disloyal’ behaviour, but for courts applying CL there is no pecuniary interest involved and therefore such cases would receive the deferential treatment applied to ordinary business decisions. In the architecture of CL, CSR is an issue pertaining to the duty of care, to be enforced 58

Ibid., p. 1138, 1139. F. S. Kahn, ‘Legislatures, Courts and the SEC: Reflections on Silence and Power in Corporate and Securities Law’, 41 New York Law School Law Review (1997) p. 1125. 60 Eisenberg, supra note 50, p. 452. (emphasis added) 59

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Anchoring CSR in company law accordingly. Therefore from now on the analysis concentrates only on the duty of care: both judicial and non-judicial mechanisms to obtain higher levels of managerial care will be considered. 2.1.1. Clarification of duty of care through identification of whose interests can be considered There has for long been a perception that CL orients managerial decision-making towards the interests of shareholders alone. As a remedy, some CSR writers have proposed indeed that CL should protect stakeholders’ interests in addition to those of shareholders. The confusion surrounding this area is in urgent need of clarification. Indeed, in the UK, the Company Law Review Steering Group noted: “we do not accept that there is anything in the present law of directors’ duties which requires them to take an unduly narrow or short-term view of their functions… There is nevertheless considerable evidence that the effect of the law is not well recognised and understood.”61 The following overview of various company law systems presents references made to shareholders, as beneficiaries of managerial duties, but also draws attention to the qualified formulations of shareholders’ interests as well as to express mentions being made to stakeholders. The OECD Principles of Corporate Governance deal with the responsibilities of the board as following: “Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders.”62 What are then the ‘interests of the corporation’ itself? They need definition. The Millstein Report, on which the Principles are based, wrote about the objective of companies: “Generating economic profit so as to enhance shareholder value in the long term, by competing effectively, is the primary objective of corporations in market economies. Corporate governance must acknowledge this objective while simultaneously fulfilling broader economic, social and other national objectives. This multiplicity of functions is complex but necessary to the perpetuation of the corporation and the market system.”63

The UK system has little tolerance for the concept of ‘company’s interest’, deemed unnecessary and troublesome. The duties of directors under UK case law require directors to manage the undertaking for the benefit of the company. 61 Company Law Review Steering Group, Modern Company Law for a Competitive Economy – The Strategic Framework, 1999, paras. 5.1.19–5.1.20, <www.dti.gov.uk/bbf/co-act-2006/ clr-review/page22794.html>, visited on 14 February 2007. 62 OECD, supra note 49. (emphasis added) 63 Business Sector Advisory Group on Corporate Governance, Corporate Governance: Improving Competitiveness and Access to Capital in Global Markets: A Report to the OECD (OECD, 1998) pp. 30,31. (emphasis added)

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Chapter 2 “That benefit is defined by case law as the interest of members present and future… The reference to future members causes some difficulty; there is little sense in imposing a duty in favour of a class which is unidentifiable and unable to enforce it. But, once it is recognised that the interest of members at any time consists of an interest in the value of the enterprise as a revenue generating entity in the future, including the medium and longer term, this problem largely disappears…”64

The UK Company Law Review Steering Group considered an “obligation of each director to act to serve the purposes of the company as laid down in the constitution and as set for it by its members collectively: that is, it sets as the basic goal for directors the success of the company in the collective best interests of shareholders”.65 Similarly when it comes to pursuing a derivative action,66 the collective interests of shareholders are to guide directors: this “is an issue which should be determined by reference to the collective interests of members within the structure of the company designed to identify and secure them, rather than their individual interests”.67 The recently adopted Companies Act 2006 lays down the ‘duty to promote the success of the company’: “(1) A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to— (a) the likely consequences of any decision in the long term, (b) the interests of the company’s employees, (c) the need to foster the company’s business relationships with suppliers, customers and others, (d) the impact of the company’s operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company.”68

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Company Law Review Steering Group, supra note 61, para. 5.1.18. (emphasis added) Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Final Report, 2001, para. 3.8, <www.dti.gov.uk/bbf/co-act-2006/clr-review/page 22794.html>, visited on 14 February 2007. (emphasis added) 66 “Derivative actions are the route by which shareholders, usually minority shareholders, are able to enforce the company’s rights where directors have breached their duties, (since in these circumstances it is unlikely that the directors, who usually act on behalf of the company, will want to take action).” Department of Trade and Industry, supra note 30, para. 3.4. 67 Company Law Review Steering Group, supra note 48, para. 3.79. 68 Companies Act 2006, UK, 2006, Article 172, <www.opsi.gov.uk/ACTS/acts2006/ukpga _20060046_en.pdf>. 65

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Anchoring CSR in company law The US system displays less concern with employing the term ‘company’s interest’ although it is obviously a misnomer, as everybody understands the interests of shareholders by that. This can be attributed to the dominance of an economic paradigm over company law. The Model Business Corporation Act require a director to act “in a manner [the director] reasonably believes to be in the best interests of the corporation”.69 Furthermore, Smith notes, most states with statutory statements of the managerial duties require that a director perform his or her duties in a manner that he or she reasonably believes to be in the best interests of the corporation. “‘The best interests of the corporation’ are generally understood to coincide with the best long-term interests of the shareholders.”70 The American Law Institute (ALI) Principles of Corporate Governance state: “A director or officer has a duty to the corporation to perform the director’s or officer’s functions … in a manner that he or she reasonably believes to be in the best interests of the corporation…”71 What are the ‘interests of the corporation’ itself? The American Law Institute specifies the company’s objective in an unusually explicit way. It combines strong references to profitability with ethical considerations. Thus the “corporation should have as its objective the conduct of business activities with a view to enhancing corporate profit and shareholder gain … [C]orporations are generally entitled, and indeed obligated, to seek to maximize their wealth for the benefit of their shareholders.”72 Expanding beyond the interests of shareholders, the ALI provides that “(e)ven if corporate profit and shareholder gain are not thereby enhanced, the corporation, in the conduct of its business: (1) Is obliged, to the same extent as a natural person, to act within the boundaries set by law; (2) May take into account ethical considerations that are reasonably regarded as appropriate to the responsible conduct of business; and (3) May devote a reasonable amount of resources to public welfare, humanitarian, educational, and philanthropic purposes.”73

Under Delaware law, directors have a general duty to act with care and in the best interests of the corporation and its stockholders.74 69

Model Business Corporation Act ann., 1996, para. 8.30(a). D. G. Smith, ‘The Shareholder Primacy Norm’, 23 Journal of Corporation Law (Winter 1998) p. 285, <papers.ssrn.com/sol3/papers.cfm?abstract_id=10571>, visited on 14 February 2007. (emphasis added) 71 American Law Institute, Principles of Corporate Governance: Analysis and Recommendations, (American Law Institute Publishers, St. Paul, Minn., 1994), section 4.01(a). (emphasis added) 72 Ibid., section 2.01(a). (emphasis added) 73 Ibid., section 2.01(b). 74 “[D]irectors are charged with an unyielding fiduciary duty to protect the interests of the corporation and to act in the best interests of its shareholders.” Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 360 (Del. 1993); “In discharging [duties to manage business and affairs of 70

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Chapter 2 Pennsylvania’s Act 36/1990 contains an exceptional formulation: managers are not required “to regard any corporate interest or the interests of any particular group … as a dominant or controlling interest or factor” as long as the action serves the best interest of the corporation.75 French law is the most doctrinally committed to enforcing the concept of ‘company’s interest’. The law defines managerial duties as following: “In his business relations with other partners, and in the absence of any statutory definition of his powers, the manager may undertake all managerial decisions in the interest of the company.” 76 Also “[i]n dealings between partners, the manager may undertake all acts of management which the interest of the company requires”.77 In France the interest of the company takes precedence over group interests. The Vienot Report I also comments on the representation of interest-groups and expertise on corporate boards. It affirms “its attachment to the traditional principles or French law and practice. However it is made up, and whoever its members may be, the board of directors collectively represents all company shareholders, and is not the sum of conflicting interests. It must carry out its duties in the interests of the company and if it fails to do so, its members are jointly and severally liable. Similarly, whatever the status or expertise of individual board members, they must consider themselves representatives of all shareholders and behave as such, and are personally liable if they fail to do so. The board of directors of a listed company must be particularly vigilant in applying these principles, bearing in mind the need for its membership to win the confidence of markets, as well as the specific features of its shareholder base… Some have suggested that board members should include representatives of certain interest groups but the Committee believes that a move in this direction would not be desirable. The result could well be to make the board a focus for conflicts between such groups instead of collectively representing the interests of all shareholders as it is supposed to. Moreover, the presence of independent directors should suffice to ensure that all legitimate interests are taken into account… once directors are appointed, it is their duty to represent all the shareholders and to act in the sole interest of the company.”78

a corporation,] directors owe fiduciary duties of care and loyalty to the corporation and its shareholders.” Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 179 (Del. 1986). 75 R. Monks and N. Minow, Corporate governance, second ed. (Blackwell Publishers, Oxford, 2001) p. 78. 76 Article 13 of the 1966 Company Law as translated in C. Alcouffe, ‘Judges and CEOs: French Aspects of Corporate Governance’, 9:2 European Journal of Law and Economics (2000) p. 133. (emphasis added) 77 Article 1848 of the Civil Code, ibid., p. 133. 78 Viénot I Report, The Boards of Directors of Listed Companies in France, 1995, p. 12–14. <www.ecgi.org/codes/documents/vienot1_en.pdf>, visited on 14 February 2007. (emphasis added)

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Anchoring CSR in company law As in the OECD and US cases, French law needs to go on and define the ‘interest of the company’ itself. The Civil Code defines the objective of the company in relation to the common interest of shareholders: the ‘company contract’ should have as its main objective the common interest of the company members.79 The Vienot Report I observes: “The interest of the company may be understood as the over-riding claim of the company considered as a separate economic agent, pursuing its own objectives which are distinct from those of shareholders, employees, creditors including the internal revenue authorities, suppliers and customers. It nonetheless represents the common interest of all of these persons, which is for the company to remain in business and prosper. The Committee thus believes that directors should at all times be concerned solely to promote the interests of the company.”80

In Germany, corporations have a ‘management board’ running the day-to-day operations, and a ‘supervisory board’ where employees can appoint up to a half of the board members. Under the German Stock Corporation Act, the management board is bound by corporate interest, company policy and the group’s guidelines as well as the basic principles of proper management.81 The German Corporate Governance Code, which has been referred to in the Stock Corporation Act,82 deals with managerial tasks and responsibilities: “The Management Board is responsible for independently managing the enterprise. In doing so, it is obliged to act in the enterprise’s best interests and undertakes to increase the sustainable value of the enterprise.” 83 Regarding the Supervisory Board the Code writes: “The representatives elected by the shareholders and the representatives of the employees are equally obliged to act in the enterprise’s best interests.”84 Birk observed that although German law institutionalises employee participation on the board it “cannot be directly deduced from this concept to what extent the employee’s interests are to be taken into account”.85 The Dutch system also seems tilted toward the ‘interests of the company’:

79

Alcouffe, supra note 76, Article 1833 of the The Civil Code, p. 130. Viénot I Report, supra note 78, p. 7. (emphasis added) 81 Article 77 of the German Stock Corporation Act (AktG), referred to in German Panel on Corporate Governance, Corporate Governance Rules for Quoted German Companies, 2000, p. 3, <www.ecgi.org/codes/documents/code0700e.pdf>, visited on 14 February 2007. 82 Article 161 of the Stock Corporation Act, amended by the Transparency and Disclosure Law, in force July 2002. 83 Government Commission, German Corporate Governance Code, 2003, para. 4.1.1, <www.corporate-governance-code.de/index-e.html>, visited on 14 February 2007. (emphasis added) 84 Ibid., p. 1. (emphasis added) 85 R. Birk, ‘Germany’, in A. R. Pinto and G. Visentini (eds.), The Legal Basis of Corporate Governance in Publicly Held Corporations: A Comparative Approach (Kluwer, The Hague/London, 1998) pp. 68, 69. 80

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Chapter 2 “For many years the prime idea behind the Dutch corporation was not so much the maximization of shareholder value, but basically to continue its own existence. … Dutch corporations are not based on maximization of short-term profits for the benefit of shareholders, but rather the main concern is a sustainable, stable, and continuous growth … A stable corporation promotes a stable tax base, in turn, making the social security and welfare programs more stable.”86

This overview shows how company laws and corporate governance instruments refer to the beneficiary of managerial duties. The interests of shareholders are either qualified with varying terms or replaced by the ‘interest of the company’. Laws thus either qualify the interests of shareholders with differing adjectives (‘collective’, ‘long-term’ or ‘common’ interests of shareholders) or introduce the concept of the ‘company’s interest’. In the same time, CL often makes explicit reference to the interests of stakeholders: employees, creditors including the internal revenue authorities, suppliers and customers, the community and the environment, even the market system. From this presentation it appears that both proponents of changes in CL and sceptics of CSR that emphasise the standing of shareholders in the CL architecture do not however account for the true extent to which CL favours the continued existence of the company when this clashes with shareholder wishes. The ‘success of the business’ appears as the organising concept with which CL approaches the variety of competing interests converging on the corporation. A look at two areas of US case law illustrates to what extent CL has overridden some of its own important concerns in order to protect the ‘success of the business’. These concerns of CL refer to the necessity for undivided loyalties (the ‘duty of loyalty’ context) and respectively to the property rights that shareholders have over their stock (the ‘take-over’ context). Traditionally CL in common law countries has seen the relationship management-shareholders as a fiduciary one.87 Brudney shows that from its origins in the law of trusts, the fiduciary obligation of loyalty has entailed the exclusive benefit principle: “To assure such exclusive service, the fiduciary is to refrain from engaging in any transaction with the trust’s or principal’s assets … from which he might either gain for himself or harm the beneficiary … The exclusive benefit principle and its prophylactic implementation impose the costs of over-prohibition on the beneficiary, the fiduciary and society. 86 W. van den Muijsenbergh, ‘Corporate Governance: The Dutch Experience’, 16 Transnational Lawyer (Fall 2002) p. 65. (emphasis added) 87 Civil law jurisdictions do not recognise fiduciary duties as such, those duties being a product of the common law, but refer to obligations that in many circumstances give rise to equivalent duties. Freshfields Bruckhaus Deringer, UNEP and Finance Initiative, A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment, 2005, p. 10, <www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf>, visited on 14 February 2007.

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Anchoring CSR in company law Transactions that might be beneficial to all may be required to be foregone in order to ensure that the beneficiary receives the full benefits of the fiduciary’s services.”88

To take out these costs of over-prohibition, economists have advanced a contractarian perspective that aims to provide additional incentives for managers to pursue wealth-maximisation. The premise is that “the law, which cannot force managers or controllers to engage in wealth-maximizing behavior for the enterprise, should at least not get in the way by restricting their self-appropriative behavior”.89 The fiduciary duty of loyalty is “a significant obstacle to that maximizing goal, particularly as it prophylactically precludes transactions that might maximize – or at least make – gains for the enterprise. The classic fiduciary duty is also said to dampen the incentives of decision-makers by denying them the rewards from selfaggrandizing behavior that they think necessary, in addition to the rewards for which they expressly contract.”90 A reform along contractarian lines authorises the power to self-deal which may derive from the beneficiary freely giving its informed express consent, or from the easy imputation of consent by stockholders. The fiduciary relationship appears as simply a species of contract. Fiduciary duties are merely default rules to reduce the costs associated with providing the fiduciary with incomplete instructions. Parties are free to depart from them by contracting instead.91 Courts in the US have shifted their position regarding the duty of loyalty and eroded the protection shareholders used to get from the exclusive benefit principle. “Over the course of the last century, although the conditions underlying the historic application of the exclusive benefit principle and its prophylactic implementation in the corporate context have not changed materially, the principle has been abandoned, notwithstanding the continued characterization of management’s relationship and obligations to the enterprise and its stockholders as fiduciary. As the legal doctrine has evolved, the restrictions on managerial conduct no longer prophylactically forbid self-aggrandizing behavior … Legislation that authorizes management to take into account the interests of other stakeholders qualifies the scope of the exclusive benefit principle … Notwithstanding occasional pious allusions to the exclusive benefit principle in opinions, the surviving body of corporate fiduciary doctrine has lost that principle’s normative underpinning … Whatever the reasons for relaxing the restrictions on management’s appropriative behavior, a curtain of fiduciary discourse still screens the loosened strictures. The

88

Brudney, supra note 51, p. 603. Ibid., p. 623. 90 Ibid. 91 Ibid., p. 605. 89

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Chapter 2 fiduciary rhetoric of courts may have an impact on investors’ expectations; but these expectations are hardly fulfilled.”92

Thus the goal of wealth-creation has split shareholder-oriented theories in two camps: one has prophylactically prioritised undivided loyalty despite immediate losses in efficiency; the other has accepted self-dealing (divided loyalties) for the sake of wealth-maximisation. The latter trades off shareholders’ rights in the pursuit of efficient wealth creation; the former sees shareholders’ rights as sacrosanct. US courts have moved toward the latter view. There has appeared a gap in CL, at least in the US, between the rhetoric surrounding shareholders’ rights and the reality of their judicial protection. In this context, the ‘success of the business’ (efficient wealth creation) has asserted itself over the rights of shareholders under CL, and reaffirmed its prominence in the CL architecture. In the takeover context, the shareholder is not waiting for a dividend to be distributed by management, but prefers to sell his/her stock for a price higher than the market price. Here s/he exercises not a qualified right to participate in the profits of the company, but a property right over shares. In a hostile cash tender offer it is possible that the vast majority of a target company’s shareholders want to accept the tender offer. US laws have tended to side with directors to the detriment of shareholders either through case law as in Delaware or through passing new laws. It is necessary to briefly recount the historical context. In the 1980s, the ‘market for corporate control’ has become the principal mechanism for reigning in managerial power. If a company appeared to be poorly managed, corporate ‘raiders’ could be willing to buy enough shares to acquire control over the target company, reorganise it more efficiently and eventually sell it profitably. Raiders are defined as an individual or organisation that tries to take over a company by initiating a hostile takeover bid. Hostile takeovers go against the wishes of the target company’s management. Markets thus curtail managerial discretion from outside of the corporation, not from within as the board of directors does. However, the benefits of this form of control came at the price of social disruption and of endangering the longer-term economic value of some businesses. Consequently, many US states passed so called ‘constituency statutes’. They allow managers, “in considering the best interests of the corporation, to consider the effects of any action upon employees, suppliers, and customers of the corporation, communities in which offices or other establishments of the corporation are located, and all other pertinent factors”.93 The purpose is to provide managers with a stronger legal basis to pursue the long-term interests of the company through anti-takeover defences. Such laws explicitly trumped the short-term interests of shareholders, which would be tapped by raiders offering premium prices for shares. Incumbent management could invoke the interests of stakeholders (e.g. workers, communities, various market actors), the long-term interest of the corporation itself and the public interest in wealthgenerating corporate activities. 92 93

Ibid., p. 617. (emphasis added) Smith, supra note 70, p. 289.

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Anchoring CSR in company law Delaware has ruled on the disruptive effects of takeover not through new laws but through judge-made law. Commenting on the 1986 Revlon case94 and subsequent jurisprudence, Smith identifies three important alterations of directors’ duties in a takeover situation. First, following the Revlon case, the board of directors has to obtain “the highest price for the benefit of the stockholders”; the board must focus on maximising the current value of shares held by common stockholders. Normally, a board of directors is allowed to sacrifice current value in pursuit of future value. Second, the other duty imposed by Revlon is the duty to “fully consider alternative transactions offered by any responsible buyer”. In other contexts, a board is empowered to ‘just say no’ to proffered transactions. Third, the standard of review of Revlon claims is more searching than for other applications of the business judgment rule.95 In Paramount Communications, Inc. v. Time, Inc.96 the Delaware Supreme Court expressed the view that corporate directors, if they act in pursuit of some vision of the corporation’s long-term welfare, may take action that precludes shareholders from accepting an immediate high-premium offer for their shares. Delaware does not have a ‘constituency statute’; so its courts settled for a case-bycase approach. However, the Delaware Supreme Court reinterpreted case law along lines similar to the reasoning of constituency statutes. Smith refers to the Macmillan case97 which subtly reinterpreted the Revlon case: “In Macmillan the court’s emphasis on the ‘best interests of the stockholders’ and on the ‘highest value reasonably attainable’ suggests a subtle shift away from the ‘best price’ or sale ‘to the highest bidder’ that was required by Revlon. Indeed, the court in Macmillan defined the board’s Revlon duties as follows: ‘The proper objective of Macmillan’s fiduciaries was to obtain the highest price reasonably available for the company, provided it was offered by a reputable and responsible bidder’.”98

Factors that a board might consider, according to the Court, in determining whether the bidder is reputable and responsible, include not only the adequacy and terms of the offer, but also “the impact of both the bid and the potential acquisition on other constituencies, provided that it bears some reasonable relationship to general shareholder interests”, and “the bidders identity, prior background, and other business venture experiences”.99 Thus, in the take over context, the US law prioritises the welfare of the company as a going concern over the wishes of shareholders to obtain the highest 94

Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). Smith, supra note 54, p. 602. 96 Paramount Communications, Inc. v. Time, Inc., [1989 Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 94, 514 (Del.Ch. July 14, 1989), aff’d, 571 A.2d 1140 (Del.1990). 97 Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261 (Del. 1989). 98 Smith, supra note 54, p. 586. 99 Ibid., p. 587. 95

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Chapter 2 price for their shares. CL in this case elevated the long-term interest of the business above the very property rights that shareholders have. The analysis in this section brings clarity on the issue of how CL defines the duty of care in regard to the interests corporate management should take into account. Although CL is commonly associated with the rights and interests of shareholders the picture is more complex. It is certain that CL does not instruct directors to disregard the interests of stakeholders but the contrary. Policymakers in the UK felt necessary to set the record straight when they wrote: “The concern is that current arrangements lead to directors neglecting the long term, often under (actual or perceived) misguided pressure from shareholders.”100 Through the statutory clarification of the managerial duty of care, lawmakers aim at “clarifying the law, to ensure recognition of a proper long term perspective and inclusive approach to business relationships”.101 In a restatement of directors’ duties, the UK Company Law Review Steering Group, following a broad consultation process, laid out its vision: “[T]he obligation of each director [is] to act to serve the purposes of the company as laid down in the constitution and as set for it by its members collectively: that is, it sets as the basic goal for directors the success of the company in the collective best interests of shareholders. But it also requires them to recognise, as the circumstances require, the company’s need to foster relationships with its employees, customers and suppliers, its need to maintain its business reputation, and its need to consider the company’s impact on the community and the working environment.”102

The American Bar Association’s Committee on Corporate Laws noted on similar lines: “Directors have fiduciary responsibilities to shareholders which, while allowing directors to give consideration to the interests of others, compel them to find some reasonable relationship to the long-term interests of shareholders when so doing.”103 2.1.2. Clarification of duty of care through judicial review We can ease in by noting first two US cases involving managerial decisions justified in CSR terms. Minority shareholders contested the good faith of management in allocating corporate resources for seemingly CSR-type purposes. After that the analysis will cover the evolution of judicial review towards more stringent specifications of the duty of care.

100

Company Law Review Steering Group, supra note 48, para. 3.54. Ibid., para. 2.14. (emphasis added) 102 Company Law Review Steering Group, supra note 65, para. 3.8. (emphasis added) 103 Committee on Corporate Laws, ABA, ‘Other Constituencies Statutes: Potential for Confusion’, 45 Business Lawyer (1990) p. 2261. (emphasis added) 101

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Anchoring CSR in company law In Dodge v. Ford Motor Co (1919),104 the Dodge brothers, minority shareholders owning ten per cent of the stock, challenged Henry Ford (owning 58 per cent of the stock) in courts because he proclaimed that future dividends would be limited to five per cent monthly while the remaining profits would be used for business expansion, and also “to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes”.105 The Court was asked to rule on two distinct decisions justified by Ford in CSR terms: first, the decision to use corporate funds for CSR purposes; second, the decision to expand the business by building a new plant. Regarding the first issue – the motives alluding to CSR – the Court indicated that the motives of Ford in keeping so much money in the corporation for expansion and security were to benefit the public generally and spread the profits out by means of more jobs, etc. The Court found that management has breached their good faith duty by not pursuing shareholders’ interests, that is, by not distributing significant dividends in a time of extreme prosperity for the Ford company. The Court stated: “There should be no confusion … of the duties which Mr. Ford conceives that he and the stockholders owe to the general public and the duties which in law he and his codirectors owe to protesting, minority stockholders. A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end and does not extend to a change in the end itself, to the reduction of profits or to the nondistribution of profits among stockholders in order to devote them to other purposes.”106

Regarding the second decision – to expand the business – the Court refused to interfere, in stark contrast with its ruling on the motivational aspects: “We are not, however, persuaded that we should interfere with the proposed expansion of the business of the Ford Motor Company. In view of the fact that the selling price of products may be increased at any time, the ultimate results of the larger business cannot be certainly estimated. The judges are not business experts. It is recognized that plans must often be made for a long future, for expected competition, for a continuing as well as an immediately profitable venture. We are not satisfied that the alleged motives of the directors, in so far as they are reflected in the conduct of business, menace the interests of the shareholders.”107

In this case the Court delineated the powers of management. On one hand it reaffirmed the discretion management has to pursue a business strategy by choosing 104

Dodge v. Ford Motor Co., 204 Mich. 459, 170 N.W. 668 (1919). Ibid., p. 468. 106 Ibid., p. 507. 107 Ibid., pp. 507–508. 105

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Chapter 2 whatever legal means necessary, including by embracing CSR considerations. This discretion is substantial, as courts will not assume the role of business experts in assessing means. On the other hand, this discretion is not unlimited and cannot amount to a change in the revenue-generating orientation of a company. It is an enduring judicial statement to acceptability and limits of CSR-behaviour under CL. The Court summarises the complaint in Shlensky v. Wrigley (1968)108 as follows: “The action was a stockholders’ derivative suit against the directors for negligence and mismanagement. Plaintiff alleges that defendant Wrigley has refused to install lights, not because of interest in the welfare of the corporation but because of his personal opinions ‘that baseball is a ‘daytime sport’ and that the installation of lights and night baseball games will have a deteriorating effect upon the surrounding neighborhood.’ It is alleged that he has admitted that he is not interested in whether the Cubs would benefit financially from such action because of his concern for the neighborhood. Plaintiff also alleges that the other defendant directors knew Wrigley was not motivated by a good faith concern as to the best interests of defendant corporation, but solely by his personal views set forth above. It is charged that the directors are acting for a reason or reasons contrary and wholly unrelated to the business interests of the corporation; that such arbitrary and capricious acts constitute mismanagement and waste of corporate assets, and that the directors have been negligent in failing to exercise reasonable care and prudence in the management of the corporate affairs.”109

The motivation attached to Wrigley’s decisions follows the tenets of CSR and the Court treats the case as a matter of due care and good faith. So the Court has to assess the (ir)rationality of management’s decision, that of not scheduling nighttime games because of its adverse effects on the neighbourhood. The Court tried to assess the rationality through a loss-benefit analysis counting elements such as the following: ƒ

ƒ

108

Adverse effects on the neighbourhood may in turn result in the absence of the club’s patrons at the games (“it appears to us that the effect on the surrounding neighborhood might well be considered by a director who was considering the patrons who would or would not attend the games if the park were in a poor neighborhood”).110 Adverse effects on the neighbourhood may in turn result in lower value of property owned by the company in that neighbourhood (“the long run interest of the corporation in its property value at Wrigley Field might demand all efforts to keep the neighborhood from deteriorating”).111

Shlensky v. Wrigley, 237 N.E.2d 776, Ill.App. 1968, 25 April 1968. Ibid., p. 177. 110 Ibid., pp. 180, 181. 111 Ibid., p. 181. 109

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Anchoring CSR in company law ƒ

ƒ

ƒ ƒ

ƒ

Plaintiff’s allegation that the installation of lights would have resulted in additional revenues for the company (however, “[t]here is no allegation that the night games played by the other nineteen teams enhanced their financial position or that the profits, if any, of those teams were directly related to the number of night games scheduled” ).112 Plaintiff’s allegation that the cost of installation of lights would be recaptured by increased revenues (“[h]owever, no allegation is made that there will be a net benefit to the corporation from such action, considering all increased costs” ).113 Plaintiff’s claim that the losses are due to poor attendance at home games (“[h]owever, it appears … that factors other than attendance affect the net earnings or losses” ).114 Plaintiff’s allegation that every member of the major leagues, other than the Cubs, scheduled substantially all of their home games in 1966 at night. (However “it cannot be said that directors, even those of corporations that are losing money, must follow the lead of the other corporations in the field. Directors are elected for their business capabilities and judgment and the courts cannot require them to forego their judgment because of the decisions of directors of other companies … [M]ere failure to ‘follow the crowd’ is not such a dereliction.”)115 Plaintiff did not adequately address the multitude of factors relevant to the contested business decision (“[t]he record shows that plaintiff did not feel he could allege that the increased revenues would be sufficient to cure the corporate deficit. The only cost plaintiff was at all concerned with was that of installation of lights. No mention was made of operation and maintenance of the lights or other possible increases in operating costs of night games and we cannot speculate as to what other factors might influence the increase or decrease of profits if the Cubs were to play night home games.”)116

The case illuminated how a court will deal with the question: can a CSR-like decision of management (not to play games during night hours because of adverse effects on neighbourhood) be reasonably capable of benefiting the company? There are a multitude of factors that can be relevant in answering this. The assessment of the exercise of managerial powers performed by the Court was thorough and nuanced. The Court was unwilling to censor managerial discretion and sustained that particular business decision. American courts have shown great tolerance for directors to consider the interests of stakeholders in their pursuit of the corporate interest. In the Wrigley case 112

Ibid. Ibid., p. 182. 114 Ibid. 115 Ibid., p. 183. (emphasis added) 116 Ibid., p. 182. 113

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Chapter 2 the Court was satisfied that the CSR-like decisions of the management could be rationalised in terms of business success. It wrote: “By these thoughts we do not mean to say that we have decided that the decision of the directors was a correct one. That is beyond our jurisdiction and ability. We are merely saying that the decision is one properly before directors and the motives alleged in the amended complaint showed no fraud, illegality or conflict of interest in their making of that decision.”117 This reasoning is indicative of the self-restraint courts show when asked to review duty of care aspects. In the US this attitude is encapsulated in the business judgement rule. The discussion of BJR below helps us to understand the more precise standard of care that courts enforce. Courts in the US have defined differently the BJR. Some courts have adopted lax standards that would limit the area of judicial review and thus allow a broader margin of managerial discretion. Others have shown judicial activism and defined more stringent conditions for the BJR to apply, for managerial decisions to be protected from the judicial claims of shareholders. As courts have clarified when they will review managerial decisions, they also increasingly clarified what the duty of care entails. While doctrine and practice agree that BJR is a special standard of culpability in matters involving the duty of care, opinions however diverge to the exact standards contained in the BJR. Nevertheless they all hold that director liability under BJR requires greater fault than ordinary negligence. Gewurtz identifies three main standards developed in the US case law: 1.

2.

3.

The good faith standard. The heart of the matter is whether or not the directors believed that what they were doing was in the best interest of the corporation. Excluded from the courts’ inquiry for the most part is any review of the objective reasonableness of such a belief. This is a largely subjective approach that confers virtually unlimited discretion to management. The gross negligence standard strikes a middle ground between ordinary negligence and the ‘good faith only’ and is applied in Delaware. It offers still very substantial but more limited discretion than above. The process-versus-substance distinction. The American Law Institute’s Principles of Corporate Governance draw a distinction between the level of judicial scrutiny of the directors’ decision itself, and the review of the process that directors used to arrive at the decision. The review of the process of decision-making is tighter than the review of the decision arrived at through that process.118

Gevurtz further notes that 117

Shlensky v. Wrigley, supra note 108, p. 181. F. A. Gevurtz, ‘The Business Judgment Rule: Meaningless Verbiage or Misguided Notion?’, 67 Southern California Law Review (January 1994) pp. 297–303. 118

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Anchoring CSR in company law “views of the business judgment rule … form a continuum rather than precisely defined positions … The cases following a good faith approach illustrate this point. Few unequivocally rule out any review of objective reasonableness. Instead, after proclaiming that directors’ decisions are unassailable in the absence of bad faith, dishonesty, or fraud, such opinions often soften such statements by backpaddling in varying degrees.” 119

An analysis of BJR presents the question to what extent can we expect to see courts actively enforcing the managerial duty of care? So far, it is recalled, courts have rebuffed overreaching shareholders that claimed that CSR-minded managers were in breach of the duty to carefully pursue shareholders’ interests. The inclination of courts to move from subjective (good faith) to objective reasonableness, as Gewutz explains, and the distinction decisionmaking process – decision itself, articulated by the American Law Institute – create an important opening for courts to actively enforce higher care rather than defensively shielding management from shareholder litigation.120 The result is having the court look more closely at the factual issues of the case to see whether management acted with reasonable care. Immediately relevant for CSR purposes, courts could arguably censor directors that stick to outdated business models and remain ignorant of CSR risks and opportunities that actually can affect business success. Company law relies on directors being informed, knowledgeable and diligent. Directors are expected to operationalise that approach through management systems. The OECD notes: “The principle [duty of care] calls for board members to act on a fully informed basis. Good practice takes this to mean that they should be satisfied that key corporate information and compliance systems are fundamentally sound and underpin the key monitoring role of the board advocated by the Principles. In many jurisdictions this meaning is already considered an element of the duty of care, while in others it is required by securities regulation, accounting standards etc.”121

119

Ibid., p. 297. This analysis does not insist on subjective or objective standards of care, but on the distinction process-decision as it is easier for courts to operationalise it. As an example, the UK Companies Act 2006 writes that “[a] director of a company must exercise reasonable care, skill and diligence… that would be exercised by a reasonably diligent person with – (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and (b) the general knowledge, skill and experience that the director has.” Companies Act 2006, supra note 68, Article 174. 121 OECD, supra note 62, p. 59. 120

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Chapter 2 In the US state of Delaware, the Caremark case122 dealt with a facet of the duty of care: the duty to monitor corporate activities. The duty of care contains a duty to “follow up reasonably on information that has been acquired and should raise cause for concern”.123 The stockholders claimed that “Caremark’s directors breached their duty of care by failing adequately to supervise the conduct of Caremark employees, or institute corrective measures, thereby exposing Caremark to fines and liability”.124 The court held that corporate directors have a duty to implement and maintain “reporting systems … that are reasonably designed to provide to senior management and the board itself timely, accurate information sufficient to allow management and the board … to reach informed judgments concerning both the corporation’s compliance with law and its business performance.”125

The Court handled the case as a duty of care issue; the standard of review applied is the ‘business judgement rule’. As the BJR applies only when directors make a decision (passivity is outside the BJR), the Court devised a similarly protective standard based on good faith for situations in which directors have failed to decide. It was acknowledged that “such a test of liability – lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight – is quite high”.126 Furthermore, “where a claim of directorial liability for corporate loss is predicated upon ignorance of liability-creating activities within the corporation … only … an utter failure to attempt to assure a reasonable information and reporting system … will establish the lack of good faith that is a necessary condition to liability”. 127 This language indicates a very high burden that will not be met simply by showing that the reporting system is ineffective.128 The Court arrived at this standard of care by reinterpreting previous case law, which did not take this trenchant position. In 1963, the Delaware Supreme Court held in Graham v. Allis-Chalmers Manufacturing Company: “[A]bsent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists.”129 Graham may be construed to stand for the proposition that directors have no obligation or affirmative duty to implement reporting systems designed to monitor corporate activities.130

122

Caremark International, Inc. Derivative Litigation, 698 A.2d 959, 970 (Del. Ch. 1996). S. F. Funk, ‘In Re Caremark International Inc. Derivative Litigation: Director Behavior, Shareholder Protection, and Corporate Legal Compliance’, 22 Delaware Journal of Corporate Law (1997) p. 311. 124 Caremark International, Inc. Derivative Litigation, supra note 122, p. 964. 125 Ibid., p. 970. 126 Ibid., p 971. (emphasis added) 127 Ibid., (emphasis added) 128 Funk, supra note 123, p. 322. 129 Caremark International, Inc. Derivative Litigation, supra note 122, p. 969. 130 Funk, supra note 123, p. 314. 123

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Anchoring CSR in company law Chancellor Allen’s reinterpretation was done in light of legal developments in company law and in other branches of law. An example of the latter is the US Sentencing Guidelines which offer benefits to corporations that implement an ‘effective’ system of legal compliance,131 the type of monitoring system envisioned in Caremark. Thus Chancellor Allen set forth three important factors to support why he believed the Delaware Supreme Court, in 1996, would agree with his interpretation of Graham. First, he noted the “seriousness with which the corporation law views the role of the corporate board. [Second, he noted] the elementary fact that relevant and timely information is an essential predicate for satisfaction of the board’s supervisory and monitoring role… [Finally,] the United States Sentencing Guidelines, which mandate specific sentence calculations and offer reduced penalties for organizations that have implemented adequate compliance systems, necessitate that reporting systems become standard practice.”132 Another case refers to Graham and qualifies it as following: “[W]hile it is true that a director is not under a duty to ‘install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists,’ … a director does have a duty to be reasonably informed about the company and must make sure that appropriate information and reporting systems are in place so that the Board receives relevant and timely information necessary to satisfy its supervisory and monitoring role. Thus, a claim of directorial liability ‘predicated upon ignorance of liability creating activities within the corporation’ will lie where the plaintiff shows a ‘sustained or systematic failure of a director to exercise reasonable oversight.’”133

An article reviewing the US Sentencing Guidelines refers to developments in company law to conclude that “[i]t has thus become critical for corporate directors to make sure that their organization has implemented effective programs for ‘legal and regulatory compliance’.”134 The author notes: “Citing Caremark, the Fourth Circuit recently ruled in Dellastatious v. Williams that directors can avoid liability in shareholder derivative suits by showing a good faith attempt to create ‘an adequate corporate information-gathering and reporting system.’ The Sixth Circuit held in McCall v. Scott, another derivative suit in the Caremark line, that directors can breach their fiduciary duty if they intentionally or recklessly 131

See infra section 5.3.1. Funk, supra note 123, p. 320. 133 Benjamin v. Kim, 1999 WL 249706 (S.D.N.Y. 1999), quoted in Report of the Ad Hoc Advisory Group on the Organizational Sentencing Guidelines, 2003, p. 32, <www.ussc.gov/ corp/advgrprpt/AG_FINAL.pdf>, visited on 14 February 2007. (emphasis added) 134 D. E. Murphy, ‘The Federal Sentencing Guidelines for Organizations: A Decade of Promoting Compliance and Ethics’, 87 Iowa Law Review (March 2002) p. 714, <www.ussc.gov/corp/Murphy1.pdf>, visited on 14 February 2007. 132

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Chapter 2 disregard ‘red flags’ that should alert them to fraudulent practices within the organization. According to the court in McCall, even ‘[u]nconsidered inaction can be the basis for director liability because … ordinary business decisions … can significantly injure the corporation and make it subject to criminal sanctions.’”135

Also in Delaware, in RJR Nabisco, Inc. Shareholders Litigation, the Court wrote: “[T]o invoke the [business judgment] rule’s protections directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them. Having become so informed they must then act with requisite care in the discharge of their duties.”136 The Court further accounted for the fact that information has costs and concluded that “the amount of information that it is prudent to have before a decision is made is itself a business judgment of the very type that courts are institutionally poorly equipped to make… The risks (costs) associated with getting more information had to be weighed by the Committee against the likely benefits.”137 So the design of the information gathering system is an issue involving business judgment. Managerial discretion is protected here by the BJR. As William T. Allen explained, the duty of care states a “command to be efficient with respect to the acquisition and use of information”.138 The ex ante formulation of the duty of care cannot be otherwise than vague and general. Determining when an optimum amount of information is available for a decision with a time-fuse on it involves estimating the unknown costs associated with getting more info, the possible value that unknown info may bring and the attitude toward risk.139 Investors and directors know that an important part of the utility of the corporate form derives from information efficiencies that centralised decision-making offers. Therefore they have wide discretion to react in a timely way to changing circumstances. This case law shows company law stressing the role of internal management systems. This is facilitated by a distinction made in cases of duty of care between the decision itself and the decision-making process; the latter can be made subject to closer judicial review. The American Law Institute’s Principles of Corporate Governance draw an explicit distinction between the level of judicial scrutiny of the directors’ decision itself, and the review of the process that directors used to arrive at the decision. The review of the process of decision-making is tighter. Veasey comments on the business judgment rule as applied in Delaware:

135

Ibid. (emphasis added) In re RJR Nabisco, Inc. Shareholders Litigation, supra note 56, p. 1164. 137 Ibid., p. 1165. 138 W. T. Allen, ‘The Corporate Director’s Fiduciary Duty of Care and the Business Judgement Rule Under US Corporate Law’, in K. J. Hopt et al. (eds.), Comparative Corporate Governance: The State of the Art and Emerging Research (Oxford University Press, Oxford, 1998), p. 317. 139 Ibid. 136

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Anchoring CSR in company law “Courts do not measure, weigh or quantify directors’ judgments… Due care in the decision making context is process due care only … [T]here is no liability for the substance of a bad business judgment reached in good faith, even if the decision was stupid by hindsight, unless, of course, the decision fails the waste test [‘cannot be attributed to a rational business purpose’] or the decision-making process was materially flawed [‘grossly negligent process that includes the failure to consider all material facts reasonably available’].” 140

This evolution of CL can be observed in other jurisdictions as well.141 British case law also refers to a high threshold in assessment of duty of care. It did so in the context of the delegation of board’s functions which left directors completely unaware of risks. The case Re Barings plc142 showed a company collapsing because of the wrongdoings of a single individual: “the unauthorised and ultimately catastrophic activities of, it appears, one individual (Leeson) that went undetected as a consequence of a failure of management and other internal controls of the most basic kind”.143 The Court took this opportunity to clarify the contents of the duty of care of directors. Thus directors have a duty to be informed and knowledgeable of the company’s business which is compatible with directors delegating their functions down the management chain, but directors retain a residual duty of monitoring and supervision.144 The Court stated in this case: “(1) Directors have, both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company’s business to enable them properly to discharge their duties as directors. (2) While directors are entitled (subject to the company’s articles of association) to delegate particular functions to those below them in the management chain and to trust their competence and integrity to a reasonable extent, the exercise of a power of delegation does not absolve a director from the duty to supervise the discharge of the delegated functions. (3) No rule of universal application can be formulated as to the residual duty of monitoring and supervision referred to in (2) above. The extent of the duty, and the question whether it has been discharged, must depend on 140

E. N. Veasey, OECD, The Role of the Judiciary in Corporate Law, Corporate Governance and Economic Goals, 2000, p. 9, <www.oecd.org/dataoecd/40/5/1857539.pdf>, visited on 14 February 2007. 141 In Italy, the courts do not second-guess the business judgment of directors which owe the company a duty of care (Article 2392, Civil Code). The judge’s review is limited to the decision process and cannot extend to the merits of the actual decision. E. Ruggiero, ‘Italy’, in Pinto and Visentini, supra note 85, pp. 103–105. 142 Re Barings plc (No. 5) [1999] 1 BCLC 433. 143 The report of the Board of Banking Supervision in Singapore, quoted in A. Walters, ‘Directors’ Duties of Care, Skill and Diligence – Case Comment’, Company Lawyer (1999) p. 142. 144 Ibid.

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Chapter 2 the facts of each particular case, including the director’s role in the management of the company.”145

By employing the process-versus-substance distinction, CL lowers the protection offered by BJR and correspondingly increases scrutiny of managerial decisionmaking. As courts have become more assertive in duty of care aspects this could raise the hopes of CSR proponents that see CSR as a duty of care issue. First, there is compatibility between the emphasis placed by CSR proposals on sound management systems able to account for CSR risks and opportunities and the emphasis of CL on informed, diligent decision-making. Second, with the multitude of references to stakeholders there have been proposals to expand the duty of care to stakeholders as well. Then directors could be made answerable on the charge that they do not ‘promote the success of the company’ with sufficient ‘care, skill and diligence’ (to borrow British terminology) as they have disregarded important relations with stakeholders.146 CSR proposals to reinterpret managerial duties aim, of course, to obtain the enforcement potential of CL. They seem to build on the assumption that judicial enforcement has a strong role in ensuring that managers comply with high standards of care. This role of CL can be doubted in light of how courts currently enforce the duty of care; courts exercise self-restraint or apply the explicit business judgement rule. Gewurtz writes: “[T]he bottom line is that remarkably few courts have found directors liable for breaching their duty of care in making a business decision. As a result, the duty of care has provided the shareholders and the corporate entity little protection from the directors making decisions that are harmful to the interests of the shareholders or the corporate entity. Accordingly, it is difficult to see how making employees also the recipients of a duty of care, when enforcement of the duty is limited by the business judgment rule, is significantly going to improve decisions from the standpoint of the employees… My concern is that much of the literature on these issues … fails to consider the limited practical impact of these various corporate law rules, particularly in light of the actual manner in which courts enforce such rules.”147

There can be more ambitious proposals that go beyond giving a right to stakeholders to check on management about how to best to pursue business success. Arguments can be made for complementing business success with another objective making reference to stakeholders. A multiplicity of objectives towards which management 145

Ibid. (emphasis added) The consultation process carried out by the UK Company Law Review Steering Group revealed that supporters of the ‘pluralist approach’ wanted either a power for the Secretary of State to intervene, or a consultative system, with very few favouring giving rights to stakeholders. Company Law Review Steering Group, supra note 48, para. 2.12. 147 F. A. Gevurtz, ‘Getting Real About Corporate Social Responsibility: A Reply to Professor Greenfield’, 35 U.C. Davis Law Review (February 2002) pp. 664–665. 146

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Anchoring CSR in company law care should be oriented would likely enhance further the self-restraint that courts have traditionally shown in duty of care cases. Crespy concurs that a re-specified duty of care would be implemented by the courts under a standard of review likely to be even more deferential and procedural in character than at present.148 In addition, the fundamental orientation toward the company’s success, as shown in the previous section, makes it highly difficult to modify the objective of the corporation. Some laws that attracted attention in corporate governance literature because of mentioning stakeholders have not granted stakeholders any active standing in enforcing managerial duties. The examples come from the US and UK. The Companies Act 2006 clarifies the ‘nature of general duties’ by expressly saying they “are owed by a director of a company to the company”.149 A section of the Companies Act 1985, now overridden, stated explicitly: “(1) The matters to which the directors of a company are to have regard in the performance of their functions include the interests of the company’s employees in general, as well as the interests of its members. (2) Accordingly, the duty imposed by this section on the directors is owed by them to the company (and the company alone) and is enforceable in the same way as any other fiduciary duty owed to a company by its directors.”150

The UK Review Group commented upon this legislation: “Section 309 is arguably a statutory declaration of an enlightened shareholder value duty, requiring that directors consider the interests of employees in reaching a view of what is in the best interests of the company. That this is the effect intended is confirmed by its declaratory character, by ministerial statements in Hansard and by the unusual statutory language emphasising that the duty ‘is owed to the company (and the company alone) and is enforceable in the same way as any other fiduciary duty owed to a company by its directors’ … It is clear that employees have no remedy under the section.”151

The already mentioned ‘constituency statutes’ in many US states authorise directors to weight the interests of nonshareholder constituencies in their decision-making. Stakeholders did not obtain under the new laws corresponding rights or fora to back their claims. Some CSR advocates found in these statutes the legal support for extending directors’ duties toward employees and other stakeholders. However it is apparent that these statutes safeguard discretion for managers – a discretion that they have originally and legally had, but that capital markets have eroded – but have been 148

G. S. Crespi, ‘Redefining the Fiduciary Duties of Corporate Directors in Accordance with the Team Production Model of Corporate Governance’, 36 Creighton Law Review (2003), p. 641. 149 Companies Act 2006, supra note 68, Article 170. 150 Section 309 of the Companies Acts of 1963 to 1990. (emphasis added) 151 Company Law Review Steering Group, supra note 61, para. 5.1.21.

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Chapter 2 ineffective in providing stakeholders with a remedy. The more relevant concept in this equation proves to be not that of (a particular category of) stakeholders’ interest, but the concept of company’s interest or even public interest. The latter includes an interest in safeguarding the productivity of the target company against financial speculation destructive of actual wealth, another interest in protecting those businesses and authorities relying on the target company for contracts and tax revenues, and still another interest in avoiding the social welfare burden entailed by employees loosing their jobs. It appears that the judicial enforcement performed by CL is a sword with one sharp edge only. It enforces its ‘due care’ norm defensively, against overreaching shareholders. The discretion granted deliberately to directors results from the reluctance of courts to interfere with business decisions except for gross negligence and bad faith cases. However, the managerial discretion backed by judicial selfrestraint that protects against shareholder suits also prevents courts actively from compelling directors to act at higher levels of care. Therefore judicial enforcement of the duty of care, including through internal systems that can account for CSR risks and opportunities, is likely to remain marginal. Courts have explained that the design of such systems is a mater of business judgment taken in the light of risks (costs) and likely benefits. CL may have other roles to play regarding the duty of care, as will be discussed shortly, but for CSR proposals the search for other enforcement mechanisms is still needed. This also requires a closer look at broader corporate governance dynamics that surround CL. 2.1.3. Clarification of duty of care through other corporate governance mechanisms Company laws lay down a legal duty of care but how management actually comes to abide by higher standards of care cannot be understood only by examining CL. This section will highlight the manner in which CL relies on non-judicial mechanisms to enforce the precepts of the duty of care. Our incursion in the broader corporate governance system begins by taking a look at the standing of shareholders in this system, that is both the legal rights of shareholders under CL and the mechanisms available to them to protect their interests. A. Standing of shareholders in the corporate governance system The discussion on managerial accountability draws on the previous sections that dealt exclusively with legal duties of loyalty (no self-dealing) and care that usually directors owe to the company. One of the points highlighted there was the selfrestraint that courts manifested in holding directors accountable for negligence. Courts are ill positioned to actively enforce the duty of care. Therefore the enforcement of higher levels of managerial care remains more an issue of shareholder self-help than of litigation. The analysis of shareholders’ standing in corporate governance continues here by referring to the legal rights shareholders have under CL and then to the extra-legal channels shareholders have for advancing their interests.

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Anchoring CSR in company law Shareholders have a bundle of rights, which following the OECD can be split into property rights over the shares and the right to influence the corporation: “Equity investors have certain property rights. For example, an equity share can be bought, sold, or transferred. An equity share also entitles the investor to participate in the profits of the corporation, with liability limited to the amount of the investment. In addition, ownership of an equity share provides a right to information about the corporation and a right to influence the corporation, primarily by participation in general shareholder meetings and by voting.”152

Shareholders’ rights to influence the corporation are specified in company law and internal company statutes. Varying with each jurisdiction, shareholders have rights in relation to the most important decisions in the life of the corporation. Shareholders elect the board of directors (subject to employee rights in certain EU states), have authority to amend the constitutive documents of the company, approve the distribution of dividends, approve the selection of the external auditors, approve the annual accounts, approve new share issues and approve extraordinary transactions such as mergers, acquisitions and takeovers.153 Shareholders adopt the constitutive acts of the company and elect the directors. According to law, directors are to exercise this delegated power carefully and loyally. The discretion that directors have in running the company appears unavoidably as a mere fact of delegation, but is also allocated purposively to them in order to take risks that could increase corporate wealth. It is important to emphasise that discretion is allocated by purpose, and it is not merely an accidental, undesirable fact of life. Brudney refers to the virtues of centralised management which “preclude both officers and directors from being subject to the daily control of stockholders, as a commercial agent in such matters might be. Moreover, the wealth-enhancing function of management implicates taking risks with the assets that are not permitted to a trustee”.154 The OECD notes the same functional necessity: “As a practical matter, however, the corporation cannot be managed by shareholder referendum. The shareholding body is made up of individuals and institutions whose interests, goals, investment horizons and capabilities vary. Moreover, the corporation’s management must be able to take business decisions rapidly. In light of these realities and the

152

OECD, supra note 62, p. 32. Weil, Gotshal & Manges LLP, Comparative Study of Corporate Governance Codes Relevant to the European Union and its Member States, Annex IV ‘Discussion of Individual Corporate Governance Codes Relevant to the European Union and its Member States’, 2002, p. 224, <europa.eu.int/comm/internal_market/company/docs/corpgov/corp-gov-codes-rptpart2_en.pdf>, visited on 14 February 2007. 154 Brudney, supra note 51, p. 612. 153

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Chapter 2 complexity of managing the corporation’s affairs in fast moving and ever changing markets…”155

CL has accounted for the above considerations. In the US, once elected, directors have the legal power to run the company even if the majority of shareholders disapprove. Shareholders can elect different directors at the next annual meeting, or call a special meeting to remove the directors. But once elected directors are ‘fiduciaries’ of the corporation and must look out for all shareholders and the corporation.156 Already in 1908 a UK court wrote: “The directors are not servants to obey directions given by the shareholders as individuals … .”157 Sir Adrian Cadbury wrote that shareholders elect directors and entrust them with control of corporate affairs. From there on directors owe their duty to the company and the recourse of shareholders is to vote a new board in the general meeting. Shareholders are not part owners of the undertaking; they own shares.158 As a difference from ordinary agents, directors have a duty to act consistently with the legal document that created their authority (constitutional documents) and a legal obligation to exercise their honest judgement.159 CL does not impose the regular obligation of an agent to conform to any wish of some shareholder; British law expressly provides that “a director of a company must exercise independent judgment” which is limited only in some circumstances: “This duty is not infringed by his acting (a) in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or (b) in a way authorised by the company’s constitution.”160 Section 2.1.1. dealing with managerial duties has already introduced, through a comparative survey, various CL formulations of shareholders’ interests. Laws thus either qualify the interests of shareholders with differing adjectives (‘collective’, ‘long-term’ or ‘common’ interests of shareholders), or introduce the concept of the ‘company’s interest’. Shareholders’ interests thus suffer a transformation which has an impact on metaphors of agency. From a legal perspective the UK Company Law Review Steering Group explains the transformation of shareholders’ interests once they are pursued in a corporate form: “[A] company is an association of shareholders who have agreed to subordinate their individual interests in the undertaking and to organise their protection in accordance with a set of jointly accepted rules and institutions – the company’s constitution. Shareholders therefore normally assert their rights collectively in accordance with those rules (to the extent 155

OECD, supra note 62, p. 32. A. Pinto, ‘United States’, in Pinto and Visentini (eds.), supra note 85, p. 261. 157 Gramophone and Typewriter Ltd v. Stanley (1908), quoted in Sir Adrian Cadbury, Corporate Governance and Chairmanship: A Personal View (Oxford University Press, Oxford, 2002) p. 41. 158 Ibid., p. 42. 159 Allen, supra note 138, pp. 315, 316. 160 Companies Act 2006, supra note 68, Article 173. 156

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Anchoring CSR in company law that they have not been delegated to directors) and are bound to accept the decisions which emerge.”161

To safeguard the powers of managers against overreaching shareholders CL has stricken a balance and at times has limited the rights of shareholders to influence the corporation. For fears of excessive litigation, CL discourages shareholders from pursuing their wishes through litigation. The Annotations to the OECD Principles of Corporate Governance state: “There is some risk that a legal system, which enables any investor to challenge corporate activity in the courts, can become prone to excessive litigation. Thus, many legal systems have introduced provisions to protect management and board members against litigation abuse in the form of tests for the sufficiency of shareholder complaints, so-called safe harbours for management and board member actions (such as the business judgement rule) as well as safe harbours for the disclosure of information. In the end, a balance must be struck between allowing investors to seek remedies for infringement of ownership rights and avoiding excessive litigation.”162

CL has thus erected procedural hurdles for shareholders initiating derivative actions in courts, similar high hurdles for shareholder resolutions filed with the annual general meeting of shareholders, the boards of directors have been restructured to include independent directors or employee representatives and in takeover situations some US jurisdictions even empowered directors to block shareholders from selling their shares (and exercising their property rights over their shares). Writers have found substantial evidence that company laws are tilted in management’s favour.163 The existence of managerial powers and the limits CL imposes on shareholders’ rights cannot mislead one into obscuring either the prominent standing of shareholders in corporate governance systems or the main non-legal avenues available to them to protect their interests. The globalisation of capital markets has made share capital an increasingly attractive form of financing even for companies that until recently had relied mainly on debt financing (loans from banks). Thus the EC regulation on the European public limited-liability company emphasises the importance of share capital, “that being the form most suited, in terms of both financing and management, to the needs of a company carrying on business on a European scale”.164 In addition, the liberalisation of product and services markets under the WTO regime compels developed states to strengthen the competitiveness and efficiency of their economies and businesses. Furthermore, as Allen observed: 161

Company Law Review Steering Group, supra note 48, para. 4.19. (emphasis added) OECD, supra note 62, p. 41. 163 G. F. Davis and T. A. Thompson, ‘A Social Movement Perspective on Corporate Control’, 39 Administrative Science Quarterly (1994) pp. 141–173. 164 Council Regulation (EC) No. 2157/2001 of 8 October 2001 on the Statute for a European Company (SE), preamble (13). 162

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Chapter 2 “Each of the two dominant social trends that will exert potentially transformative power on corporate governance in the years immediately ahead – the evolution of a truly global economy and the continuing growth, and coming dominance, of institutional shareholders – is more consistent with the property conception of the corporation than with the entity conception … These developments tend to push shareholders, as residual risk bearers, back towards the center of thinking about the enterprise.”165

In this environment the standing of shareholders’ concerns is correspondingly strengthened.166 Shareholders have extra-legal channels for advancing their interests: capital markets, through the impersonal valuations they made, and institutional shareholders, through their large size. In addition, mandatory disclosure of corporate information is a particularly important regulatory strategy in corporate governance;167 policy-makers view favourably disclosure strategies that facilitate shareholder self-help in issues of managerial care. First, in the US and the UK shareholdings have been rather dispersed. Stock markets are said to be ‘liquid’ as it becomes easier for shareholders to buy and sell shares, to enter and exit the market. Historically, shareholdings in other developed economies have not dispersed to the same extent as in the US and UK, with large shareholdings being held by banks, families or the state; correspondingly, stock markets have developed less in Germany, France, Italy or Japan.168 Well functioning stock markets are a powerful mechanism for obtaining managerial accountability and enforcing shareholder wishes. Shareholders can simply sell their stock in protest if dissatisfied with management. The expectations of financial analysts are influential in measuring managerial performance; the failing to meet analysts’ forecasts drives the stock price down and signals to shareholders that management is underperforming. This self-help mechanism finds support from financial transparency laws that facilitate market valuations and enforcement. Second, institutional investors holding large stocks cannot easily sell in bulk; also their leverage with management increases together with the larger size. This combination makes ‘voice’ a more attractive option for institutional shareholders than ‘exit’ from the market. Institutional investors therefore have attempted to engage corporate management and raise their concerns in private meetings or at the 165 W. T. Allen, ‘Our Schizophrenic Conception of the Business Corporation’, 14 Cardozo Law Review (1992) p. 279. 166 For an explanation about how the shareholders-rights movement reasserted a prominent role for shareholders in corporate governance since the 1980s, see Davis and Thompson, supra note 163. 167 See infra sections 5.2.2. and 6.1.1. 168 R. La Porta et al., NBER, Corporate Ownership Around the World, Working Paper No. 6625, 1998, <www.nber.org/papers/w6625>; M. Berndt, Global Differences in Corporate Governance Systems – Theory and Implications for Reforms, Harvard Law and Economics Discussion Paper No. 303 (2000), <papers.ssrn.com/sol3/papers.cfm?abstract_id=255886>, visited on 14 February 2007.

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Anchoring CSR in company law general shareholder meetings. Institutional investors have acted as forces for both quick high returns as well as for longer-term sustainable polices that can accommodate CSR concerns.169 Shareholders also have the power and right under CL to replace directors through ordinary or extraordinary shareholder meetings. Well functioning stock markets, when they are liquid, and institutional investors, because of their size, provide the main opportunities to obtain managerial accountability. Overall, corporate management is subject to the internal control performed by the board of directors and also to the external control exercised by the markets (mainly the capital markets) properly informed on managerial performance as a result of disclosure regulations. Thus the locus of managerial accountability varies with jurisdictions toward the external pole – as in the US and UK with their developed capital markets – or toward the internal pole – as in Germany, France and Japan with their concentrated ownership. A comparison of corporate governance systems explains why CSR debates have developed mainly in the US and the UK. There, shareholders’ influence and oversight over managerial decisions have been weakened by the separation of ownership and control. More precisely, by the fragmentation of ownership into many dispersed shareholdings. Dispersed shareholders have few incentives and possibilities to effectively monitor management, rendering it virtually unaccountable. This shaped both the priorities for company law, as well as CSR arguments about the role of management in society. On one hand, the central concern of company laws in the US and the UK has been the “omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders”.170 Managerial accountability is a top priority here, and not in Germany, France or Italy, where banks, the state or families own the bulk of the stock. These large shareholders control the managers without having to rely on courts or markets. Therefore the jurisprudence on managerial duties is scarce in these jurisdictions and the accountability of directors has not been a priority for CL there. Also CSR arguments find here less fertile ground in discussing the responsibilities of managers and corporations in society as a difference from the US and UK where the existence of a broad managerial discretion stimulated debate about how to exercise it (to benefit shareholders or broader social interests). Indeed most CSR literature is British and especially American. Actually the discussion about the interests of shareholders and their role in corporate governance can be well facilitated by taking a look at the main theories of the firm that have been influential in CL and corporate governance. They can highlight some crucial features and mechanisms of corporate governance. They are all shareholder-friendly theories that see the company as oriented towards economic wealth-generation. In the next chapter a radically different theory of the firm 169

J. P. Hawley and A. T. Williams, The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic (University of Pennsylvania Press, Philadelphia, 2000). 170 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d at 954. (Del. 1985).

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Chapter 2 (‘stakeholder corporation’) will be highlighted because it is sometimes at odds with CL, the primary subject of interest in this chapter. B. Theories of the firm The three theories are: First, the ‘property rights’ view of the firm gives shareholders (‘owners’) a sacrosanct place, and consequently managers should pursue exclusively shareholders’ interests with undivided loyalty. Second, the ‘nexus of contracts’ view of the firm is preoccupied with efficient wealth creation guided by market signals. Third, the ‘productivity’ view is similarly oriented towards wealth creation but argues for management to have the power to sometimes override the signals of markets. We will highlight how each theory conceives the issues of how to deliver accountability of management and what should guide managerial decision-making. This will help placing CL in the broader context of corporate governance systems and highlight the regulatory role of financial markets. The mainstream theories of the firm affirm the primacy of shareholders. Such views come in at least two broad forms: in one shareholder primacy stems from a moral imperative and in the other from the pursuit of efficiency. The ‘property rights’ view of the firm sees shareholders as the owners of the firm. The concern here is with ensuring fairness for shareholders who risk their money by investing in companies. Their rights should not be diluted by claims of other stakeholders who can protect themselves through contracts or laws. Milton Friedman based his famous attack on CSR171 on this ethical conception of shareholders’ rights. The ‘nexus of contracts’ view of the firm does not see shareholders as owners of the firm because the firm is not something that can be owned. Although the nexus of contracts theory rejects the notion of shareholders as owners, characterising them as merely one provider of inputs among many others, it strongly defends their interests through the market mechanism. The firm is a legal fiction constituting a nexus of contractual relations between various resource providers (investors, workers, contractors, consumers, etc). The primary concern lies with efficiency in wealth creation. Shareholders are viewed as residual-risk bearers. This ‘finance model’ of corporate governance dominates the Anglo-American legal, economic and management scholarship.172 Hill notes that “[w]hile the contractual theory deprecates shareholder participatory rights in corporate governance, it resurrects shareholder interests to preeminence, through the guiding principle of ‘profit maximization’”.173 Shareholders are deemed to have “exchanged corporate control for marketability of their shares”. Thus “the hub of shareholder protection should be 171

M. Friedman, ‘A Friedman Doctrine – The Social Responsibility of Business Is to Increase Its Profits’, New York Times Magazine, 13 September 1970, pp. 32, 33 and 122–124. 172 J. Cioffi and S. Cohen, ‘The State, Law and Corporate Governance: The Advantage of Forwardness’, in S. S. Cohen and G. Boyd (eds.), Corporate Governance and Globalization (Edward Elgar, Cheltenham, 2000) p. 315. 173 J. Hill, ‘Visions and Revisions of the Shareholder’, 48 American Journal of Comparative Law (Winter 2000) pp. 61.

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Anchoring CSR in company law located outside the corporation, in ensuring a fair and open market, offering shareholders ease of entry and, crucially, exit”.174 This functional justification of the shareholder primacy norm asserts that allowing other constituents to participate in the control of the firm presents an externality problem because stakeholders would not internalise the risks to the shareholders’ investment. Stakeholders would take risks otherwise regarded as imprudent and use corporate capital as a source of rents. This set of incentives would increase risks, lower expected returns and reduce the amount of equity investment in the aggregate.175 “The utilitarian justification is that this preference is the price paid for strong capital markets, and allocative efficiency and that these benefits are so powerful that they overwhelm the normative benefit of any distributional favoring of current employees over current shareholders. In the long run, the argument goes, employees and other stakeholders are overall better off with fluid and efficient capital markets, managers need a simple metric to follow, and both wealth and, in the end, fairness are maximized by shareholders being the corporation’s residual beneficiary, with the other claimants getting what they want via contract with the corporation. Current employees might be made worse off in some industries, but employees overall will have more opportunities, higher salaries, and better working conditions. Furthermore, a stakeholder measure of managerial accountability could leave managers so much discretion that managers could easily pursue their own agenda, one that might maximize neither shareholder, employee, consumer, nor national wealth, but only their own.”176

The ‘productivity’ view of the firm also aim to ensure the productivity of the business system but reacts to the short-termism of business decisions guided by the shareholder primacy norm, which is enforced by impatient capital markets. Such a perspective purposively parts with a narrow focus on the interests of shareholders. The productivity view has gained currency in the US and the UK since 1970s where the perception was that impatient capital markets shun longer-term investments (e.g. investment in research and development) which made the American economy less competitive than the Japanese and German ones.177 “Our need for productive business enterprise commits us to the entity view … because it is corporate management, with its special organizational skills, that knows how to balance the claims made on the corporation in order to make large scale enterprise productive over the long term. For the common good, those managements cannot be hobbled by 174

Ibid., p. 62. Cioffi and Cohen, supra note 172. 176 M. J. Roe, ‘The Shareholder Wealth Maximization Norm and Industrial Organization’, 149 University of Pennsylvania Law Review (2001) p. 2063, <papers.ssrn.com/sol3/papers.cfm? abstract_id=282703>, visited on 14 February 2007. 177 A. Gamble and G. Kelly, ‘Shareholder Value and the Stakeholder Debate in the UK’, 9 Corporate Governance (April 2001) pp. 110–117. 175

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Chapter 2 a short-sighted orientation geared exclusively to stockholders.”178 More recently, theories of the firm argue that not only shareholders are residual risk-takers, but also that other stakeholders who make firm-specific investments are bearers of risks that are impossible to diversify; the success of business would be inhibited unless these stakeholders gain more say in the control of the company.179 These arguments are consistent with the traditional wealth creation role of the business and focus on a narrow range of stakeholders such as the employees and creditors seen as residual risk takers. Other theories, usually the stakeholder approaches of an instrumental type, further expand the circle of stakeholders on which the success of the company depends. The UK Company Law Review Steering Group referred to this reasoning as the ‘Enlightened Shareholder Value’ approach: “Those who adopt an approach of this kind [Enlightened Shareholder Value] argue that the ultimate objective of companies as currently enshrined in law – ie to generate maximum value for shareholders – is in principle the best means also of securing overall prosperity and welfare. Many who take this view point out as well, however, that … exclusive focus on the short-term financial bottom line, in the erroneous belief that this equates to shareholder value, will often be incompatible with the cultivation of co-operative relationships, which are likely to involve shortterm costs but to bring greater benefits in the longer term. Thus the law as currently expressed and understood fails to deliver the necessary inclusive approach.” 180

For the ‘property rights’ and the ‘nexus of contracts’ views of the firm, shareholders, because of their investments made, appear as best at controlling that the company operates efficiently and delivers competitive returns. Shareholders as owners, respectively as residual-risk bearers, are ideally positioned to control management. The review of UK company law reaffirms this role of shareholders: “Shareholders focus on wealth creation and are … very suited to act as ‘watchdog’ not only on their own behalf, but also, in normal circumstances, on behalf of other stakeholders.”181 The corresponding managerial duties laid down by CL are either oriented exclusively towards the interests of shareholders, as ‘owners’, or are a rather unimportant, almost irrelevant concept – according to the nexus of contracts view. In the latter case market discipline will much better fulfil the function assumed by managerial duties; markets are more effective enforcers of shareholders’ interests than boards of directors or courts of law could ever be.

178

Allen, supra note 165, p. 272. Crespi, supra note 148, pp. 623–642. 180 Company Law Review Steering Group, supra note 61, para. 5.1.12. 181 High Level Group of Company Law Experts, Report of the High Level Group of Company Law Experts on a Modern Regulatory Framework for Company Law in Europe, Brussels, 2002, p. 47, <www.ec.europa.eu/internal_market/company/docs/modern/report_en.pdf>, visited on 14 February 2007. 179

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Anchoring CSR in company law The overriding concern of the ‘property rights’ and the ‘nexus of contracts’ views of the firm lies with the opportunities for self-dealing that managers encounter while running companies, and with how to limit such opportunities. Managerial selfdealing negatively affects both shareholders’ interests and the efficient creation of wealth in society. Managers can extract too many private benefits, for example, business opportunities belonging to the company, leisure, entrenchment, empire building and pet projects. Allowing for multiple loyalties, as proposed by some stakeholder theories, creates broad opportunities for managers to abuse their discretion. The UK Company Law Review Steering Group has considered and resisted orienting managerial duties toward a balance of stakeholders’ interests, and the public interest. Their objection rests on the effect these formulations (dropping the reference to shareholders or referring to stakeholders) would have. They would “create an undisciplined and unlimited power” for directors with no practicable means to enforce such a reformulated duty.182 Increasing managerial discretion would be undesirable. Thus a managerial power to consider stakeholders widens discretion for managers; a managerial duty to consider stakeholders creates discretion for courts leading to a judiciary management of companies.183 A reformulation of CL bringing non-pecuniary interests of shareholders besides the wealth-making interests of shareholders confuses the benchmark on which managerial performance is measured. An ambiguous benchmark makes it difficult for stock markets to value businesses and thus to hold managers accountable. A pluralistic norm serving multiple constituencies throws away the criterion of valueseeking and its enforcement by markets.184 In the same vein, “the fiduciary norm which instructs the agent to act solely for the principal, is one of the coping mechanisms for the principal to economise on specification and policing costs.”185 Veasey explained the position of the Delaware judiciary: “Although the interests of stakeholders other than stockholders may be considered by the board according to some Delaware caselaw dicta, it is clear under the holdings of Delaware judicial decisions that the interest of the stockholders is paramount… [T]he singular focus on stockholder interests avoids diffusing the accountability of the board. Thus, Delaware does not give the board unfettered discretion that could be rationalized under the ‘other constituency’ regime because almost any action could be

182

Company Law Review Steering Group, Modern Company Law for a Competitive Economy – Completing the Structure, 2000, p. 34, <www.dti.gov.uk/bbf/co-act-2006/clrreview/page22794.html>, visited on 14 February 2007. 183 Ibid. 184 M. C. Jensen, ‘Value Maximization, Stakeholder Theory, and the Corporate Objective Function’, 14 Journal of Applied Corporate Finance (Fall 2001) pp. 8–21, <papers.ssrn.com/ sol3/papers.cfm?abstract_id=220671>, visited on 14 February 2007. 185 B. M. Mitnick, ‘The Theory of Agency and Organizational Analysis’, in N. E. Bowie and R. E. Freeman (eds.), Ethics and Agency Theory: An Introduction (Oxford University Press, New York, 1992) p. 91. (emphasis added)

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Chapter 2 justified or rationalized as being in the interest of one or more of these outside groups.”186

A clear benchmark makes it possible for market mechanisms to exert control and enforce shareholders’ expectations. Markets occupy a prominent role in both shareholder-oriented models as an essential controlling mechanism limiting the discretion of management. The market for corporate control was intensively active in the US in the 1980s, with hostile takeovers seen as the ultimate disciplinary mechanism against underperforming managements. Aside from the drastic measure of hostile takeovers, the mere existence of liquid capital markets where shareholders can easily sell and acquire stock can bring management to account. It was noted that “[d]ispersed shareholder ownership elevates exit over voice as the mechanism by which shareholders can call management to account. Given the deep liquidity of the London stock exchange, the threat of shareholder exit is a meaningful one.”187 In addition to market control considerations, the property rights view of the firm, which sees shareholders as owners of the firm, resist conceptions that managerial duties could be owed to other constituencies than shareholders; the duties are ‘fiduciary’, based on trust and can be owed solely to the shareholders. The ‘productivity’ view of the firm rely on managerial discretion to better account for, and manage, the multitude of factors that affect corporate success and/or social welfare. Contrary to strictly shareholder-oriented views, the discretion of management is not necessarily a great problem (of accountability), but a potential solution (to productivity and fairness problems). This implicitly discounts the enforcement role of markets. In fact, the focus is not on market discipline but on market impatience; markets are part of the problem rather than the solution. Markets, especially financial markets that facilitate ever increasing and quicker returns on investment, came to be perceived as inimical to both business productivity (competitiveness) and to fairness considerations in society. There is a different emphasis on the various forces active in the corporate governance system – directors, markets and the state. On one side, mainstream economic theories give primacy to markets (decentralised and impersonal mechanisms) while regarding with suspicion state intervention and rejecting the capacity of directors for selfdiscipline. On the other side, ‘productivity’ views regard financial markets as potentially destructive to real wealth creation, while relying on wisely exercised managerial discretion (bureaucracies) and state regulation. Williamson noted that economists have a “long tradition of working out of spontaneous rather than intentional mechanisms” of which the ‘invisible hand’ of Adam Smith is a prime example.188 They regard with suspicion state policies that overrule market signals and, more generally, the wishes expressed by individuals through spontaneous social 186

Veasey, supra note 140, p. 6. S. Deakin, ‘Squaring the Circle? Shareholder Value and Corporate Social Responsibility in the U.K.’, 70 George Washington Law Review (October/December 2002) p. 978. 188 O. E. Williamson, Human Actors and Economic Organization, 1998, p. 11, <www.isnie.org/ISNIE98/OEWilliamson.doc>, visited on 14 February 2007. 187

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Anchoring CSR in company law exchanges. CSR appears as a form of social engineering that deeply clashes with market valuations, which in addition does not have the political legitimacy that the state and the law might have. The ‘property rights’ and especially the ‘nexus of contracts’ view of the firm see in markets not only the main controlling mechanisms of managerial discretion but would also rely on market signals to facilitate managerial decision-making. For economists, markets are the principal protective mechanism of shareholders (accountability), as well as the main source of information and guidance for managers (decision-making). Markets appear as large machines for gathering, processing and translating information into a price that reflects underlying economic values. It was noted that shareholder-oriented models offer shareholder value maximisation as a guidance for decision-making provided by markets. The assumption is for strong market efficiency whereby optimality in the long run is simply the result of a series of optimal short-run decisions.189 The ‘efficient market’ hypothesis comes in three forms: weak (prices reflect past movements of equity), semi-strong (prices reflect public information) and strong (prices reflect all public and private information). 190 For ‘nexus of contracts’ theories companies are seen as resembling markets allocating resources at arms-length rather than institutions, hierarchical organisations. Managing, usually described as a hierarchical exercise, is really a continuous process of negotiation of successive contracts. This has created a way around management hierarchies and succeeded in opening the interior of the firm to neoclassical microeconomics analysis. Thus economists could “discuss organizations while remaining within the traditions of their discipline and without sullying their hands with ‘engineering’”.191 In effect, “the neoclassical picture denies altogether the existence of the management power on which lawyers and legal academics have long focused their analysis of corporate law”.192 Managers are instead expected to follow markets’ signals. However, there is information that markets have not acquired or processed. As Stone wrote, “[t]he opponent of voluntarism [of discretion exercised by management] … is likely to begin by extolling the presumptive capacity of ‘market signals’ to correctly indicate social preferences. All but the most dogmatic anti[-CSR] concedes that the signals may be misleading and may require overriding in certain circumstances.”193

189

A. Sundaran et al., ‘The Corporate Objective Revisited’, 15:3 Organizations Science (2004) p. 358. 190 Hawley and Williams, supra note 169, p. 191. 191 W. W. Bratton, Jr., ‘The “Nexus of Contracts” Corporation: A Critical Appraisal’, 74 Cornell Law Review (March 1989) p. 417. 192 Ibid., p. 420. 193 On aspects that will be discussed in later chapters, the author continues: “But the anti maintains that it is for public representatives, accountable to the general electorate, to decide when and how to override the market signals, and not for the managers of private firms, whose training, expertise, and accountability is nonpolitical.” C. D. Stone, ‘Corporate Social

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Chapter 2 An important clash occurs here between shareholder and stakeholder views on the firm. Allen observed: “In claiming that management’s unique expertise enables it to maximize corporate performance, and that its expert judgments about long-term value creation are more dependable than market valuations reflecting investor decisions, this … view directly challenges the premise of many economist critics that markets in widely traded securities value future prospects more dependably than does internal management.”194 One could now ask: so, in the end, for whose benefit …? The overwhelmingly dominant theoretical perspective applied in corporate governance is agency theory.195 CSR discussions in the CL context commonly asked: ‘for whose benefit are those in control of a corporation supposed to act?’ The question goes back as far as the 1930s when Professors Dodd of Harvard Law School and Berle of Columbia Law School started to debate the question ‘for whom are corporate managers trustees?’196 Then, Professor Berle argued that managerial powers are held in trust for stockholders as sole beneficiaries of the corporate enterprise, while Professor Dodd argued that these powers were held in trust for the entire community. For shareholder-oriented theories inspired by economics the firm is a legal fiction and is conceived in contractarian terms in line with the methodological individualism traditionally favoured in economics. The “corporation tends to disappear, transformed from a substantial institution into just a relatively stable corner of the market in which autonomous property owners freely contract”.197 Speaking of the ‘interest of the company’ is nonsense and could never be different from shareholder value maximisation. For the ‘property rights’ view of the firm there is an additional ethical command to pursue solely the interests of shareholders. For authors animated by concerns to reduce managerial discretion (improve managerial accountability), references to company’s interests are ‘schizophrenic’. Fanto clearly summarises the argument in the French context: “From an agency perspective of countering management power, this justification for decision-making simply invites managers to ‘divide and conquer’: rather than serving company interests (whatever they are), executives can play various company constituents (e.g. creditors, employees, shareholders) off against one another to maintain their own primacy.”198 Management “no longer checked by State controls and increasingly Responsibility: What It Might Mean, if It Were Really to Matter’, 71 Iowa Law Review (January 1986) p. 566. 194 Allen, supra note 178. 195 C. M. Daily et al., ‘Corporate Governance: Decades of Dialogue and Data’, 28:3 Academy of Management Review (2003) pp. 371–382 196 A. A. Berle, ‘Corporate Powers as Powers in Trust’, 44 Harvard Law Review (1931) p. 1049; E. M. Dodd, ‘For Whom Are Corporate Managers Trustees?’, 45 Harvard Law Review (1932) p. 1145; A. A. Berle, ‘For Whom Corporate Managers Are Trustees: A Note’, 45 Harvard Law Review (1932) p. 1365. 197 Allen, supra note 178, p. 265. 198 J. Fanto, ‘France’, in Pinto and Visentini (eds.), supra note 85, pp. 48, 49.

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Anchoring CSR in company law operating in market capitalism, can now use the ‘interet social’ strategically to pursue their own interests, generally at the shareholders’ expense”.199 The debate in France about corporate governance has involved the ‘company’s interest’ concept. There it was observed that “surrounding the prime interest of the company is the fine web of the interest of society as a whole”.200 Thus an emphasis on company’s interest brings a wealth creating entity a step closer to public interest which is susceptible to manipulation and abuse. Alcouffe shows that the notion of the interest of the company itself has been used with different meanings and intentions. Thus judges refer to it mainly to guarantee the continuity of the firm, especially when the latter faces economic difficulties. CEOs refer to it to keep a free hand in managing the company. Shareholders see the notion as ambiguous and mostly used against their own interest.201 There has been preoccupation with the value of having a single-minded focus on shareholders and blindly relying on the capacity of markets to provide guidance. Some writers (the ‘productivity’ view of the firm) are troubled by the framing effects that such a focus generate, with negative effects on sustainable wealth creation; others (instrumental stakeholder theory) concerned more with social justice than with economic wealth think that business success and stakeholders’ interests could be (partly) reconciled by improving managerial practices. Both these approaches concerned with improving managerial decision-making find the question ‘for whose benefit are those in control of a corporation supposed to act?’ ill-posed altogether. Those concerned with the practicalities of decision-making tend to find most relevant other concepts. These are exactly those that the analysis of CL in this chapter has highlighted: the qualified interests of shareholders and/or the company’s success/interest. These are intermediary concepts that have been rejected by economic models of agency because of ‘distorting’ the direct link investormanagement; similarly stakeholder theories have neglected or misrepresented them. However various writers have struggled to account for and specify these intermediary concepts. Leader and Dine use established company law concepts to account for the transformation of shareholders’ interests. They distinguish between derivative and personal interests. The authors argue that the question ‘whose interests should be served’ raises a false dilemma if it asks for choice between classes of individuals. The relationship between the interests of shareholders and corporate performance are linked in two ways: derivatively (damage to the company) and personally (damage done by the company to shareholders). The company should satisfy shareholder’s derivative, not personal interests. As a side constraint, it must not abuse those personal interests, but that is not its very reason for existence. “Indeed, the success of the company depends on satisfying a varying mix of wants among

199

Ibid., p. 50. Alcouffe, supra note 76, pp. 134, 135. 201 Ibid., p. 127. 200

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Chapter 2 these groups at any given moment…”202 The authors further note: “[T]he conception of the company as a set of constituencies is partly right: no single group can be allowed to dominate the allocation of the company’s resources if it is to function successfully. On the other hand, it is wrong to see the company as a ‘community’ … That view fails to appreciate how there will inevitably be tensions … between personal and derivative interests within the enterprise.”203 Rolf Birk, commenting on the German system of corporate governance, understands the interest of the corporation in a procedural rather than a substantive sense. He notes that the material content of the ‘interest of the corporation’ is vague: it aims at “securing the existence, the inner stability and success of the corporation in the market”.204 The concept is however a variable and dynamic notion: “[T]he interest of the corporation does not set forth an order of priority of the interests to be taken into account, but rather fixes rules of conduct related to the corporation such as rational discussion of conflicts and a cooperative managerial behaviour. Hence the interest of the corporation can be understood in a ‘procedural’ rather than in a substantive sense.”205 German law institutionalises employee participation on the board; however it “cannot be directly deduced from this concept to what extent the employee’s interests are to be taken into account”.206 Teubner considers that Berle and Dodd207 posed the wrong question by searching for social groups. Instead of an ‘interest group approach’ he proposes a ‘functional approach’ as more able for selecting and weighting social interests.208 Teubner emphasises the orientation of the firm towards efficient wealth creation. By careful wording Teubner hints that his approach is superior for ‘selecting’ and ‘weighting’ interests, while tacitly leaving the ‘identifying’ of interests to other approaches, such as stakeholder approaches working as an environment-scanning technique. How effective a system CL is in pressing for higher managerial care and especially for maintaining managerial accountability remains to be seen. CL itself relies on markets and shareholder self-help to reign in abuses of managerial discretion. Something clear can still be said about those arguments that draw on CL to either disregard CSR out of hand or to promote CSR. Both these arguments have searched for intuitive, easy-to-define concepts, towards which to orient managerial duties and in the process they obscured intermediary concepts at the foundation of CL. The analysis in this chapter makes it clear that CL introduces some intermediary 202

S. Leader and J. Dine, ‘The United Kingdom’, in Pinto and Visentini (eds.), supra note 85, pp. 248, 249. 203 Ibid., p. 250. 204 Birk, supra note 85, p. 68. 205 Ibid., p. 69. 206 Ibid. 207 See supra note 196. 208 G. Teubner, ‘Corporate Fiduciary Duties and Their Beneficiaries’, in K. J. Hopt and G. Teubner (eds.), Corporate Governance and Directors’ Liabilities (W. de Gruyter, Berlin/New York, 1985) pp. 150, 151.

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Anchoring CSR in company law concepts between shareholders (principal) and directors (agent) – the qualified interests of shareholders and/or the company’s interest – and that the agency metaphor deliberately disregards these intermediary concepts. Both critics and supporters of CSR have framed it as a matter of divided loyalties (to shareholders, respectively to stakeholders). However company laws in the area of the duty of care can hardly be understood in term of loyalties. Difficulties are unavoidable even if shareholders are the principals and managers their agents; business executives pointed to the heterogeneous nature of shareholders’ interests. For example, Sir Adrian Cadbury noted that “interests differ among shareholders. Some are more concerned with trading in a company’s shares than in holding them; others will differ over the relative importance which they attach to dividends and to capital appreciation. Shareholders are not a homogenous group with a common set of interests, as chairmen soon discover.” 209 It is apparent that management already has some kind of split loyalty: it has to pursue the interest of the business as a going concern (as a wealth-generating entity) while in the same time satisfying the expectations of shareholders for competitive returns (as an entity able to attract market investments). CL has conceptually sided with the management and favours the interests of business as a going concern, but corporate governance systems to which CL belong have increasingly emphasised the importance of shareholders and stock markets. Labelling directors as agents of shareholders cannot be allowed to obscure the complexity of the decision-making process that directors face in business life. Other ways to obtain simplification of that complexity may need to be found; the more compatible they are with agency model’s concerns for accountability and with the working of markets, the better. Policymakers in the UK have recognised the necessity to clarify managerial duties under CL and help markets develop wider criteria (including CSR) linked to business success in a complex economy. The British strategy requires companies to disclose information on a wider range of material risks to business, not only financial data.210 The Company Law Review Steering Group writes about the “pivotal role [of increased transparency] in improving understanding of business performance and prospects, as well as promoting accountability and encouraging responsiveness and high standards of business practice”.211 This is a modality to sustainably create shareholder value and also to promote stakeholders’ interests though “freedom of contract and exchange in the broadest sense”.212 The concerns advanced by agency perspectives cannot be dismissed; they highlight the essential issue of the accountability of management. This is at the heart of CL; it was noted that “[in] nearly all modern governance research governance mechanisms are conceptualized as deterrents to managerial self-interest”.213 But there is another side of the CL coin. To what extent does the agency model assist 209

Cadbury, supra note 157, pp. 42, 43. Companies Act 2006, supra note 68, Article 417. 211 Company Law Review Steering Group, supra note 65, para. 3.32. (emphasis added) 212 Company Law Review Steering Group, supra note 61, para. 2.22. 213 Daily, supra note 195. 210

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Chapter 2 managers struggling to discharge their duty of care under CL and enhance the success of their business, as a difference from that of the economy as a whole, in unsettled issues, such as when dealing with CSR risks and opportunities? To what extent can agency reasoning aid managers obeying the duty to exercise judgement under CL when managers grow aware of the negative externalities their business may produce and backfire on their own company? 2.2. COMPANY LAW: A PARTIAL CLARIFICATION OF THE DUTY OF CARE The tension that permeates CL in the area of the duty of care has become clear by now. The analysis below highlights the way in which CL spins off certain of its prerogatives into the wider corporate governance system. Then we boil down the norm that CL seems to advance as a reference for CSR-supportive arguments. 2.2.1. Triple spin-off that company law performs There are some important dynamics that a CSR argument needs to take into account. First, CL tends to concentrate on wealth creation and to spin-off distributional issues. While economists support this tendency, CSR proponents try to reverse it and build CSR protections within CL. Second, in CL the judiciary tends to enforce the prohibition of self-dealing (duty of loyalty) and to spin-off enforcement of aspects of due care. While economists emphasise the controlling function of the market and downplay judicial enforcement, some CSR advocates have long sought a change in the managerial duties in CL and to enrol judicial enforcement. However, the current managerial duty of care is weakly enforced by CL; not only is the present duty of care not a legal obstacle to CSR, but mentioning stakeholders’ interests in legal definitions of managerial duties may not be effective because CL cannot anyhow deliver the judicial enforcement sought after. Third, CL also spins-off the specification of what due care entails in concrete contexts. Economists have relied on the signals sent by markets as the best assessment of managerial due care being exercised or not, while most CSR proponents have fought to include a mention of stakeholders’ interests in legal definitions of managerial duties assuming that this will somehow automatically lead to higher managerial care. Below I expand on this triple spin-off that CL performs. First, regarding distributional issues, the overwhelming concern of company law is for wealth creation. The EU positions CL within an increasingly explicit and assertive paradigm of wealth creation and competitiveness: “Company law should primarily concentrate on the efficiency and competitiveness of business … Company law should provide a flexible framework for competitive business. Using company law for other regulatory purposes may lead to an undesirable tightening of rules … there is a tendency to use the traditional field of company law to achieve all sorts of other regulatory purposes, for example to combat tax fraud. … This development leads to quite the opposite of company law as a

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Anchoring CSR in company law framework for competitive business: more compulsory rules, heavier monitoring and enforcement regimes and slower, more cumbersome and burdensome procedures for all … [Other regulatory purposes] should be achieved through specific law enforcement instruments outside company law, and should not be allowed to hinder the development and use of efficient company law structures and systems.”214

The reform of British company law currently under way operates in a likeminded wealth creation paradigm: “We would stress in this context that we interpret our terms of reference as requiring us to propose reforms which promote a competitive economy by facilitating the operations of companies so as to maximise wealth and welfare as a whole. We have not regarded it as our function to make proposals as to how such benefits should be shared or allocated between different participants in the economy, on grounds of fairness, social justice or any similar criteria.”215

The US commentators note that the US public corporation law manifests a similar indifference to distributional issues.216 Thus company law shuns distributional issues from its purview in most jurisdictions with the exception of a handful of countries – Germany, Netherlands – that use ‘co-determination’ to build employees’ representation in the corporate governing structure; Germany however is currently scaling down its long established co-determination system.217 Most systems tend to relegate solutions to distributional issues to other branches of law such as labour law, tort law, environmental law, tax law and so on. Because CL has a tendency to spin off distributional issues, including CSR, one of the challenges encountered by CSR arguments directed at CL is to show why CL is the right arena for legal alterations, and not the specialised legal fields closer to the problem-issue motivating CSR. Arguably this would be less of a problem if CSR proposals strove more insistently for compatibility with CL’s basics, which has seldom been the case. A way to address this fundamental objection is to relate CSR to CL’s guiding concept, the intermediary concept of ‘business success’ (the interest of the company as a going concern), and to refocus from debating ‘loyalty’ to various beneficiaries towards positioning the implementation of CSR as an issue of reasonable care owed to the company. In its defence, CSR is a relevant issue for CL to a larger extent than it is for other legal fields because it guides the broad discretion that managers have whenever they are not guided by specific laws or shareholders’ instructions. It is true that less ambitious proposals to alter corporate behaviour could pursue discrete reforms in other legal fields closer to the problem. 214

High Level Group of Company Law Experts, supra note 182, p. 36. Company Law Review Steering Group, supra note 61, para. 2.5. 216 T. A. Smith, ‘The Efficient Norm for Corporate Law: A Neotraditional Interpretation of Fiduciary Duty’, 98 Michigan Law Review (October 1999) p. 248. 217 H. Williamson, ‘Shake-Up Looms for German Workers’ Board Role’, Financial Times, 5 April 2005. 215

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Chapter 2 But, in an important sense, CSR does not necessarily seek to overhaul CL. CSR can merely aim to correct some misguided belief systems grounded in the agency metaphor that misrepresents the managerial decision-making process and that could impede the very wealth creation objective of CL. Thus CSR helps contesting simplistic views of loyalty to shareholders’ interests that disregarded the cornerstone of CL: the interest/success of the business entity. Second, the enforcement aspects related to the duty of care leads one to move beyond analysing judicial enforcement and legalistic strategies only. The discussion herein about company law, and its enforcement potential, did not obscure the manner in which CL deliberately relies on other legal and non-legal forces that impact on how corporations are governed. In advancing the duty of care, CL relies on wider corporate governance mechanisms (especially markets), on shareholder self-help, on soft law approaches, backed by disclosure regulations,218 as a first line of enforcement. An understanding of the enforcement of the duty of care in corporate governance regimes informs about where feasible regulatory solutions to CSR lie in the current economic-political climate. The spin-off of enforcement performed by CL requires an analysis of the causality between the objectives of law (expressed herein in the managerial duty of care articulated in CL) and corporate behaviour.219 This focuses analysis on the regulatory potential of public and private actors, and the norms/rules they apply. As the OECD noted, the “corporate governance framework typically comprises elements of legislation, regulation, selfregulatory arrangements, voluntary commitments and business practices that are the result of a country’s specific circumstances, history and tradition”.220 In light of this, attention should be given to both the context where CSR and law co-evolve (‘regulatory space‘) and the regulatory strategies that states can employ (‘regulatory mixes’). Regulatory interventions in support of CSR are bound to use all these forms and can be included in an array of legal domains that regulate corporate governance, such as company law, securities regulation, accounting and auditing standards. Third, the specification efforts of CL related to the duty of care tell mangers what to strive for, but not how to do that except to do it with ‘care’. Courts could clarify no more than that managers are expected to perform in an informed manner, attentively, skilfully and by employing rigorous processes. It appears then that legal duties (of care) are accompanied by a norm that provides guidance to managers with how to approach complexity and how to reduce it to manageable dimensions. This norm occupies an essential intermediary position between law’s objectives and corporate behaviour. 2.2.2. Divergent standards Courts in various jurisdictions have consistently held that managers are free to pursue corporate success by taking a long-term perspective that can include 218

See infra sections 5.2.1. and 5.2.2. See infra section 6.1.4. 220 OECD, supra note 62, p. 29. 219

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Anchoring CSR in company law stakeholders’ interests. Courts have exercised self-restraint in assessing the wisdom of managerial decisions or the care with which they were made. This judicial restraint generates confusion regarding what signal CL really sends regarding the duty of care: on one hand, CL says that directors should act with care and skill; on another hand, courts will hear shareholders only if they hint that directors were grossly negligent, not ordinarily negligent. When directors are merely negligent shareholders have no judicial remedy; in these cases the legal duty has no sanction. This is an embarrassment for CL and seeds confusion on what standard of care CL really advances. Some authors referred to this puzzling situation as the divergence between ‘standards of conduct’ and ‘standards of review’ (liability): company law presents a distinct case where law mandates standards for the directors’ conduct that are higher than the standards that courts use for adjudicating related disputes. This happens precisely in the duty of care area which is central to CSR discussions. As Eisenberg explains, standards of conduct and review diverge most dramatically in respect of due care, less so in respect of self-dealing (duty of loyalty).221 What accounts for this divergence of standards that breeds confusion? William T. Allen tries to answer this question by zooming out of corporate law and analysing the broader context where CL has to play its role. The duty of care as formulated and enforced is subject to two cross-cutting efficiency effects. On one hand, law tries to accomplish a positive effect – the standard states a “command to be efficient with respect to the acquisition and use of information”.222 On the other hand, law tries to prevent a negative effect; indeed the pursuit of directors’ liability generates personal risks which would impede rational risk assumption and therefore impede wealth creation. This results in a divergence of the standard of care and that of liability. Some lawyers seem sceptical of the practical value that the duty of care under CL has. Brudney for example writes: “[I]n the case of investor-owned publicly held corporations, the principal normative concern for the law and lawyers over the years has been with the loyalty aspect of management’s (including directors’) and controlling stockholders’ fiduciary obligations. That emphasis on loyalty reflects substantial doubt that the ‘care’ obligation entails a useful norm of behavior.”223 Other lawyers take a second look at the duty of care. Eisenberg, who first conceptualised the divergence of standards in CL, refers to the expressive and clarifying functions of law. These functions impact social norms and roles. He writes: “Although legal standards of conduct are characteristically accompanied by liability rules or other enforcement regimes, even a legal standard of conduct that is unaccompanied by such a regime may be effective because of its impact on social norms.”224 Thus law indirectly affects corporate behaviour by first making an impact 221

Eisenberg, supra note 50, p. 465. Allen, supra note 138, pp. 317, 318. 223 Brudney, supra note 51, p. 599. 224 M. A. Eisenberg, ‘Corporate Law and Social Norms’, 99 Columbia Law Review (June 1999) p. 1269. 222

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Chapter 2 on norms. This explanation referring to ‘norms’ points to the necessity to understand broader legal and non-legal dynamics mediating between law and corporate behaviour. Such divergence of standards complicates the causality between formal state regulation and corporate behaviour; the neat simplicity of deterrence theory is not available in the area of due care. CL advances important pointers regarding the duty of care. The main elements of the norm is to orient managerial loyalty solely toward the interest/success of the company itself as a wealth-creating entity, to refer to the necessity to take a longerterm perspective of business success, to take an inclusive view of the relationships (with stakeholders) that can affect business success and install sound processes for decision-making to enable directors to discharge their duties in an informed and attentive manner. It is then a matter of independent business judgement on how to approach complexity in each specific context. By clarifying the contents of the duty of care, CL could only go that far in specifying how managers should approach and simplify complexity. The next chapter continues with an analysis of the norms and belief systems that pro- and con- CSR theories have proposed to managers as a way to approach complexity in their environment.

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CHAPTER 3 NORMS ADVANCED IN THE CSR DEBATE The previous chapter has analysed the relationship between management and shareholders from a company law perspective. CSR debates have elaborated on this relationship but also asked broader questions: What is the role of large businesses in society? What should managers concretely do when confronted with instances of injustice linked to their company’s activities? Thus this chapter continues the comparison of theories of the firm done in chapter 2 in the context of company law; now we rely on other types of considerations that CSR debates have brought up. The purpose here will be to deconstruct pro- and con-CSR CSR arguments because they seem to be in fact ‘packages’ whose elements are held together in a questionable manner. For this purpose I identify three levels on which CSR arguments develop. The analysis is driven by a concern that ‘contaminations’ among these levels seem to have taken place in both camps of the CSR debate. Highlighting this issue will hopefully make it easier to cut through the dense rhetoric and normative positions, and step closer to genuine dilemmas and practicable solutions. In the end the reader who feels attached to one element in the package may find that s/he may not necessarily have to ‘buy’ the whole package. 3.1. MILTON FRIEDMAN AND HIS CRITICS Probably the most articulate voice against CSR remains that of the economist Milton Friedman; his 1970 article225 contains the key objections to CSR which will be presented below. Critics of CSR still rehearse the same basic insights 35 years later and have hardly added anything new.226 I rely on this article also because it attracted countless responses from business ethicists. Even very recent works on business and human rights in developing countries (international CSR) often start by disagreeing with Friedman. Friedman though raised important issues that were left without an appropriate answer. As the responses to Friedman’s article are heterogonous I will present what I perceive are the crucial points where pro-CSR literature has concentrated, as well as the points on which it did not mount a sustained response. The following critique is done from a specific perspective taken by this study, which focuses on the situation of human rights in developing countries and the role of the parent company (or MNE group) regarding the operations of its subsidiaries/contractors. What is primarily targeted here is the temptation of current writers in the business and human rights area, both pro- and con-CSR, to rely 225

Friedman, supra note 172. See for example ‘The Good Company – A Sceptical Look at Corporate Social Responsibility’, The Economist, 22 January 2005. 226

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Chapter 3 uncritically on arguments that could carry important lessons, but were advanced in a different context (in the US) in different times (over the last 30 to 40 years). Proand con-CSR models have often accounted insufficiently for important dynamics and considerations. Using them as a base to perpetuate advices to managerial decision-making that have outlived their usefulness makes it more difficult to account for important recent developments (in management and public governance) and to come closer to viable solutions to pressing human rights problems. We begin by briefly introducing each level of analysis. The three levels are the following: (1) the role of the large business in society; (2) the duties of management; and (3) the norm managers should use to approach complexity. Later sections will present how proponents and sceptics of CSR have conducted their analysis at each level. Level 2 in this analysis has been dealt with in chapter 2 from a corporate governance perspective. Friedman’s argument belongs to the ‘property rights’ view of the firm that sees shareholders as the ‘owners’ of the company and draws on markets, which guide managerial decisions, limits managerial discretion and hold them accountable to shareholders. To avoid unnecessary duplication only some of Friedman’s own words will be added here with a more detailed presentation of the response from stakeholder theory. The next two levels of analysis bracket level 2 ‘upwards’ and ‘downwards’. Thus level 1 zooms out to discuss views about the role of business in society. Level 3 in turn zooms in to hint to the intricacies of managerial decision-making. An analysis at level 1 – role of large businesses in society – refers to the necessity for role separation. This necessity arises from concerns with efficient wealth creation and with the legitimacy of corporate power. I will take them in turn. A division of labour needs to exist in society; specialised subsystems are then able to fulfil their respective functions more efficiently. Such specialisation would entail, by definition, that one could pursue its respective mandate without having to concern himself with the fulfilment of other functional roles. Thus efficiency gains from the division of labour result precisely from the deliberate disregard of other works pursued simultaneously. Then organisations should not expand beyond primary tasks: “[I]f each individual and organization seeks to accomplish in the most efficient manner the highest-valued specific tasks of which he (it) is capable, the value of the total product of society will be as great as possible.”227 CSR arguments have mainly been advanced with large businesses in mind because with large size comes commensurate economic, social and environmental impacts. CSR basically proposes that these large business groups should have responsibilities that go beyond wealth generation towards a fairer distribution of risks, losses and gains of corporate activity among stakeholders. There is a potential contradiction of CSR with this important principle of role separation and efficient social organisation. Indeed CSR advances proposals that go against this trend: 227

L. E. Preston and J. E. Post, Private Management and Public Policy: The Principle of Public Responsibility (Englewood Cliffs, N.J., 1975) p. 31.

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Norms advanced in the CSR debate monofunctional systems become multifunctional. Structural-functionalism suggests that as societies modernise and complexity increases, their subsystems differentiate and multifunctional system structures are replaced by single function systems. CSR blurs this division of labour by resurrecting the question: what is the role, or the roles, of the business system in society? March and Olsen have insightfully remarked a characteristic of institutions in general that is pertinent to our discussion about role separation. They noted that a central anomaly of institutions is that they increase capability by reducing comprehensiveness; politics is uncoupled from administration; various parts of administration are uncoupled from each other. “As a result of these various forms of simplifications, political institutions are simultaneously an affront to our sense of comprehensive rationality and a primary instrument for approximating it. The uncouplings are justified not by a judgment that the aspects are independent but by the assumption that the errors introduced by treating them independently are less than the errors introduced by trying (and failing) to treat them as interdependent.”228

The role of businesses (of corporate managers) in society has been discussed since Berle and Means wrote in the 1930s about the separation of ownership and control in large corporations. The perception was that the management of large corporations in the US has escaped any significant oversight by shareholders and acquired significant discretion. This ascendance of managers as a professional group was recorded as the ‘managerial revolution’, and the question was whether to orient this managerial discretion toward broader social goals or toward narrow profit-making. Thus CSR writings have built on the existence, in fact and in law, of managerial discretion in how to allocate corporate resources and attempted to steer the managerial power to mediate among conflicting social interests. An analysis at level 3 – the norm managers should use to approach complexity – should provide guidance to managers with how to fulfil their role, how to approach complexity and how to reduce it to manageable dimensions. Managerial duties under company laws tell mangers what to strive for – the interest/success of the company – but not how to do that except to do it with no self-dealing and with ‘care’. It is not possible for lawmakers to define ex ante what reasonable care entails in each context; courts are also limited in their ex post review assessing whether due care was exercised or not. It fell then on others – both pro- and con-CSR theories – to propose a guiding norm. For present purposes, a norm can be defined as a set of attitudes, beliefs and guidance for how to approach complexity. Following Talley, a norm can be seen as a “tendency for individuals to adopt a particular strategy or pattern of behavior within a broader social context”.229 This study takes a 228 J. G. March and J. P. Olsen, Rediscovering Institutions: The Organizational Basis of Politics (Free Press, New York, 1989) p. 17. (emphasis added) 229 E. Talley, ‘Disclosure Norms’, 149 University of Pennsylvania Law Review (June 2001) p. 2011.

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Chapter 3 behavioural view of norms as “commonly shared practices that people tend to pursue even though legal rules alone do not compel them to do so”230 rather than the moral view of norms, which conceives a norm as a moral imperative that is independent of individual preferences. The exposition of various theories of the firm in chapter 2 revealed the clash between the mainstream theories of the firm and the ‘productivity’ view. The former instructed managers to follow the law and (financial) market signals; the latter cautioned that market signals could not replace completely the role of managerial judgment in longer-term planning, drawing thus attention to market failures. CSR goes further to propose that a sense of responsibility is indispensable for making economically- and morally-sound business decisions in complex situations. CSR would raise the question: what will provide guidance to managers when following certain social and environmental negative impacts of business market signals aren’t there, laws are also inadequate, but damage to reputation and other liabilities may be forthcoming? How does the manager simplify complexity in such a business environment? Limiting your attention only to the law and market signals will surely not provide the answer. 3.1.1. Friedman’s views Friedman offered the following definition of CSR: “[T]here is only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud.”231 I will follow the three levels of analysis identified in the beginning to present Friedman’s argument. Friedman starts his analysis with the relationship between management and shareholders (level 2). Shareholders are the ‘owners’ of the business and managers are their agents. Friedman examines an agency relationship and identifies the mandate that binds business executives: in opposition with the non-profit social corporation, their mandate is “to make as much money as possible while conforming to the basic rules of society, both those embodied in law and those embodied in ethical custom”.232 Thus the interests and wishes of owners are deduced from the legal process of incorporating a for-profit entity. Friedman appears to conceive the agency relationship from three perspectives: moral, legal and functional. From a legal viewpoint the agency relationship he sees between shareholders and managers does not hold. His argument has however never been meant as a legalistic one: he mainly emphasises the moral right of shareholders who invest their money, and the function that markets have in protecting shareholders’ interests and sanctioning managers abusing their discretion.

230

Ibid., p. 1962. Friedman, supra note 172, p. 126. 232 Ibid., p. 33. 231

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Norms advanced in the CSR debate Friedman applies his reasoning to both managers and union leaders, which at that time in the US were expected to show restraint in their labour grievances that could increase inflation. He considered that the CSR doctrine by definition asked corporate executives, as well as labour leaders, to accept social responsibilities that go beyond the interest of their members. As to level 1, the key characterisation of CSR is that managers that allocate scarce corporate resources in order to satisfy stakeholders’ claims would in fact impose a tax on shareholders, employees and customers. But it is the province of democratic representative governments to impose taxes and allocate their proceeds. If CSR were given course, democratic procedures would be bypassed in determining a fundamental political issue such as redistribution. That deprives CSR of legitimacy. The way to go instead of imposing social responsibilities on business executives, Friedman proposed, is to accept that “it is the responsibility of the rest of us to establish a framework of law…”233 so that the invisible hand can operate. Friedman thus insists on the functional separation of roles in a democratic society, but this is insufficient to understand his views on the roles of law and government. The emphasis on role separation could in itself reinforce the role of political institutions in distributive matters. However Friedman subscribes to a libertarian philosophy on which Robert Ayres commented: “It is argued that businesses exist only to make profits for their owners (stockholders) and that any diversion of managerial effort in other directions is actually a breach of fiduciary responsibility. It is also argued that, if there are environmental problems resulting from the profit-making activities of business, the resulting problems should be dealt with by tort law, meaning that parties suffering damages should sue the parties causing those damages ... Ultimately, it is the government that sets the rules under which companies operate and compete. Unfortunately, many of those who argue vociferously that the business of business is only to make profits – and there are a lot in the financial world – also argue, in the same breath, that there is too much government and too much regulation and that the ‘free market’, left to its own devices, would take care of any environmental problems. I think they are wrong.”234

Indeed, Friedman’s overriding concern is to safeguard the free-market system, threatened by private and public concentrations of power (monopolies and governments). Friedman says: “The existence of a free market does not of course eliminate the need for government. On the contrary, government is essential both as a forum for determining the ‘rules of the game’ and as an umpire to interpret and enforce the rules decided on. What the market does is to reduce the range 233 M. Friedman, Capitalism and Freedom (University of Chicago Press, Chicago, 1962) pp. 133, 34. 234 R. Ayres, ‘What is the business of business?’, International Herald Tribune, 4 June 2002, p. 9.

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Chapter 3 of issues that must be decided through political means, and thereby to minimize the extent to which government need participate directly in the game.”235

In that regard it was observed: “What galls Friedman the most is the idea that some people should employ the apparatus of state power to remake the world to their own liking, usually by regulating profit endeavors and taxing some to spend on others. While he differs from pure libertarian economists by accepting the state as a protector of private property, persons and contracts and as a preserver of free competition, Friedman delights in discovering ways in which the free market can solve problems which many feel are within the province of government.” 236

Friedman is concerned that acceptance of CSR, and the managerial discretion it entails, is the first step on a slippery slope. If the private tax raising that CSR is deemed to be is allowed then for the sake of ensuring accountability and the supremacy of democratic state institutions the political machinery should check such tax raising. This would however mean to adopt the socialist view that political mechanisms, not market ones, are the appropriate way to allocate scarce resources in a society. Because CSR is likely to shift the balance between state and markets, Friedman concluded that CSR is a ‘fundamentally subversive doctrine’. Hayek refers approvingly to Friedman and similarly argues that pursuing idealistic aims present the danger of corporations acquiring real and uncontrollable power. Such power cannot be left to private managers but would be made subject to increasing public control: “The argument against specific interference of government in the conduct of business corporations rests on the assumption that they are constrained to use their resources for a specific purpose.” 237 Monks and Minow also note that legitimacy of corporate power requires that it be “limited to business and not extend to the trade-offs necessary to balance competing social goals”.238 Friedman’s argumentation reaches the norm level (level 3) where he has a prescription for business executives. They should be guided by the signals sent by markets and law, and should stay aloof of CSR concerns and distributional issues. This norm is derived from a range of ‘positives’: managers to act toward the interests of the ‘owners’, to pursue their profit-maximising mandate within the rules of the game, companies to stick to their legitimate role in a functionally differentiated democratic society and markets know best how to allocate scarce resources. Thus Friedman’s norm is derived directly from the insights articulated on 235

Friedman, supra note 233, p. 15. M. Friedman, ‘Milton Friedman Responds: A Business and Society Review Interview’, 1:1 Business and Society (1972), p. 6. 237 F.A. Hayek, ‘The Corporation in a Democratic Society: In Whose Interest Ought It and Will It Be Run?’, in H. I. Ansoff (ed.), Business Strategy: Selected Readings (Penguin books, Harmondsworth, 1969) p. 231. 238 Monks and Minow, supra note 75, p. 72. 236

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Norms advanced in the CSR debate the previous two levels. But there is more. Friedman also backed his norm with a series of ‘negatives’. These have to do with the managers’ lack of expertise for dealing with complex macroeconomic and social issues, the immorality of fraudulent CSR rhetoric and the possible perverse effects that result from businesses adopting CSR strategies. First, business managers lack the expertise to deal with complex macroeconomic issues, not to mention dealing with social issues. Second, Friedman does note the arguments of advocates who showed the benefits to the company resulting from CSR strategies (e.g. desirable employees, less sabotages, other worthwhile effects). Friedman agrees that “in the present climate of opinion with its widespread aversion to ‘capitalism’, ‘profits’, ‘the soulless corporation’, [CSR] is one way for a corporation to generate goodwill as a by-product of expenditures that are entirely justified in its own self-interest”.239 Later he would comment more explicitly that if an energy company can demonstrate that the controversy surrounding the release of industrial effluents makes it difficult to recruit and retain employees, or offers the prospect of adverse publicity or litigation, then voluntary reduction or clean-up of the effluent makes business sense.240 Although Friedman agrees that such strategies can benefit the firm, he deems them hypocritical windowdressing activities approaching fraud. If CSR paid back then only hypocrites would call it ‘CSR’ as it would in fact be pure business self-interest. However CSR’s benefits to the company must pay back ‘dollar for dollar’, which imposes a quantitative threshold on CSR expenditures that can hardly be passed by CSR proponents: “It may very well be in the self-interest of that corporation to spend money on improving conditions in that community. That may be the cheapest way it can improve the quality of the labor it attracts. The crucial question for a corporation is not whether some action is in the interest of the corporation, but whether it is enough in its interest to justify the money spent … But the corporation isn’t exercising a social responsibility. The executive is performing the job he was hired for.”241

On a later occasion Friedman described oil companies’ television ads as ‘turning his stomach’ for making it seem that their purpose was to preserve the environment. However, he noted that he would probably sue if they did not engage in such ‘nonsense’ because otherwise they would endanger their competitiveness: Friedman makes the point that companies must profess social responsibility to appeal to the public at large, keep regulators at bay, and thus ensure profits.”242

239

Friedman, supra note 172, p. 124 Friedman referred to in J. Entine, The Odwalla Affair – Reassessing Corporate Social Responsibility, January/February 1999, <www.jonentine.com/articles/odwalla.htm>, visited on 14 February 2007. 241 Friedman, supra note 236, p. 7. 242 Entine, supra note 240. 240

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Chapter 3 Third, Friedman considers that adopting CSR strategies to please vocal constituencies can have unintended effects. CSR rhetoric may gain business benefits in the short run, but may also strengthen the prevalent view that profit-making is wicked/immoral and needs be controlled by external forces, that is, the iron fist of government bureaucrats. The norm boils down to Friedman advising business executives to solely obey the law and listen to the signals of the market. Managers should respond to CSR expectations only if the business case is obvious. This is what Friedman arguably hinted at when he referred to the ‘ethical custom’ that managers should respect in addition to the law; though he never elaborated on what ethical custom is. Otherwise the norm hardly leaves space for managers even to inform themselves of, and understand, CSR risks. CSR expenses must pay back ‘dollar for dollar’, according to Friedman. In this view, as Ayres wrote, “any diversion of managerial effort in other directions is actually a breach of fiduciary responsibility”.243 3.1.2. Stakeholder theory’s response The literature on business ethics/stakeholder theory is immense and heterogeneous. The purpose here is not to present a comprehensive catalogue of the responses triggered by Friedman’s challenging article; I will simply limit myself to showing some broad tendencies manifested by stakeholder theory on each of the three levels of analysis. Stakeholder theorists observe the discretion that management of large companies has when ownership is dispersed; also they account for the complexity of modern business environment where business success depends on motivated employees, satisfied consumers, institutional investors with a long-term investment horison, trusting regulators, etc. Thus the prominent role granted to stockholders by shareholder-oriented theories inadequately mirrors business reality in present days;244 it also cannot satisfactorily be justified in moral terms. Regarding the issue of managerial duties, which in mainstream theories covers the relationship between managers and shareholders (level 2), stakeholder theory is concerned primarily with finding a way to elevate the interests of other stakeholders. Large businesses should heed not only signals sent by markets and law, but also their moral responsibilities and expectations of society. While for Friedman managers are, legally and morally, the agents of shareholders and should therefore act solely on their behalf, ethicists would correctly show that, under CL, managers are not the agents of shareholders and have a legally sanctioned discretion to exercise their ‘business judgment’. Therefore seeing shareholders as the owners of the company provides a false justification for orienting managerial duties solely toward the shareholders’ interests. Such arguments have often accounted for the central role that CL allocates to the corporation towards which managerial duties are 243

Ayres, supra note 234. R.E. Freeman, Strategic Management – A Stakeholder Approach (Pitman, Boston/London, 1984). 244

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Norms advanced in the CSR debate oriented. However, to the extent that stakeholder theories have referred to the ‘company’s interest’ or its success, the tendency has been to see the company as a social entity rather than simply a commercial entity. Then the concept of ‘company’s interest’ in a commercial sense is either stretched to overlap with the public good, or subordinated to other concepts (public good or stakeholders’ interests). The company is portrayed as a social entity distinct from the interests of shareholders and in which the public (or stakeholders) impacted by corporate activities has a stake. This entity view of the firm has surfaced in the US at the turn of the 20th century against a certain economic and social background. Allen notes: “The evolution of these large entities and the impact of German philosophy on American scholarship triggered an outburst of scholarly writing on the nature of the corporation… National securities markets emerged and stockholders gradually came to look less like flesh and blood owners and more like investors who could slip in or out of a particular stock almost costlessly. These new giant business corporations came to seem to some people like independent entities, with purposes, duties, and loyalties of their own; purposes that might diverge in some respect from shareholder wealth maximization … [T]he corporation is not strictly private; it is tinged with a public purpose… [The] corporate purpose can be seen as including the advancement of the general welfare.”245

Friedman identified the mandate of management as one of profitability which soon becomes profit-maximisation because of the constraints imposed by efficient financial markets. Normative stakeholder theory, to which the UK Company Law Review Steering Group referred to as the ‘pluralist’ approach, “argue[s] that the ultimate objective of maximising shareholder value will not achieve maximum prosperity and welfare. … [A] company [should be] required to serve a wider range of interests, not subordinate to, or as a means of achieving, shareholder value (as envisaged in the enlightened shareholder value view), but as valid in their own right.”246 Stakeholder-oriented perspectives reject any primacy accorded to shareholders. “Surely contributors of capital (stockholders and bondholders) must be assured a rate of return sufficient to induce them to contribute their capital to the enterprise. But the corporation has other purposes of perhaps equal dignity: the satisfaction of consumer wants, the provision of meaningful employment opportunities, and the making of a contribution to the public life of its communities.”247 In the end, normative ethicists object either to profitability or to profit-maximisation as the ultimate goal of business; they

245

Allen, supra note 179, p. 265. Ibid., 5.1.13. 247 Allen, supra note 179, p. 271. 246

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Chapter 3 ƒ ƒ ƒ

offered taxonomies that include profitability but offered no criteria of how to make trade-offs among various categories,248 trumped profitability with the weight of pressing moral concerns, avoided profitability with the understanding that making CSR arguments in a vocabulary using profitability-related concepts would automatically deemphasise moral considerations.

In stakeholder theories, shareholders lose their central position in the economy of the firm. They are just one among many stakeholders whose interests management must consider and balance. Normativists challenge Friedman who saw management as owing a moral duty to shareholders who entrusted management to act on their behalf. Ethicists argued that, on the contrary, managers should be seen as ‘agents’ not of shareholders, but as agents in a different meaning: ƒ Agents of all stakeholders, not merely shareholders, because they are all 249 affected by or can affect the corporation, ƒ Agents of the corporation, but the corporation should maximise social welfare instead of its own wealth (profitability), ƒ Moral agents instead of agents obeying the will of their principal(s). In other words – agents of change. Agents in this sense have free will and managers are bound by moral duties as much as any other moral agents. Normative stakeholder models suggest a managerial role informed by ‘multiple loyalties’ over the strong objections of shareholder-oriented models based on the agency (fiduciary) principle of ‘undivided loyalty’. The board of directors’ duties should “extend beyond assuring investors a fair return, to include a duty of loyalty, in some sense, to all those interested in or affected by the corporation … [C]orporations as independent social actors … do not simply owe contract or other legal duties to those affected by its operation, but owe loyalty in some measure to all such persons as well.”250 In such situations the agency metaphor soon loses its analytical usefulness: it does not take one very far towards accountability once multiple principals are present (managers acquire split loyalties to conflicting interests), or when the preoccupation to keep agency costs (i.e. specification and monitoring costs incurred by the principal) down is not a major concern. Other fundaments such as ‘social contracts’, deontology, rights-based theories, etc. are more useful than principal-agent reasoning to advance broader managerial and corporate accountability to stakeholders and society. Stakeholder theories aim to enshrine stakeholders as beneficiaries of managerial duties. If corporate management were loyal to stakeholders, the resulting duty of care would require management to handle with due care stakeholders’ interests. That would require 248

A. B. Caroll, ‘The Pyramid of Corporate Social Responsibility: Towards the Moral Management of Organizational Stakeholders’, 34:4 Business Horizons (1991) pp. 39–48. 249 Freeman, supra note 245. 250 Ibid., p. 271.

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Norms advanced in the CSR debate directors to both identify better stakeholders’ interests as well as to weigh them heavier while pursuing the wealth-creation goal. Loyalty to stakeholders’ interests would allow directors to distribute risks differently in their business decisions (e.g. turning down business opportunities harmful to some stakeholders, set up protective managerial systems, invest in safer or less polluting technologies, etc.). Multiple loyalties would also require management to provide shareholders with reasonable returns only, not necessarily competitive returns; a part of profits could be used to satisfy the other loyalty recipients. Friedman was preoccupied by the potential to abuse the managerial discretion that CSR creates, and with ways to ensure managerial accountability. By employing agency reasoning, he sought to diminish managerial discretion by orienting it toward a clearly measurable, unique goal (profitability) that markets can enforce. In response, CSR supporters concerned with capital markets that generate short-term pressures and inhibit responsible managerial behaviour have severely downplayed the role of the markets in their models of the firm. In their pursuit for corporate accountability, normative stakeholder theories have posited the enforcement of (wider) managerial responsibilities either with the state (courts and regulatory agencies) or with the self-discipline of managers themselves (or board of directors) guided by moral imperatives. If managerial accountability toward shareholders is secondary, then what counts for stakeholder analysis is either accountability toward all stakeholders (normative stakeholder theory) or guidance for managerial decision-making (instrumental stakeholder theory). Here stakeholder theory has split into two branches, as explained in chapter 1. The normative branch aims to design a new model of the firm with revised managerial duties oriented towards stakeholders, and is concerned with matters of corporate accountability (to whom, how broad, according to what principles, etc.). The instrumental branch does not challenge the basics of the shareholder-oriented model of the firm, and sets up to help management in their decision-making with better tools and systems in order to be more responsive to pressing social issues. The discussion at the norm level (level 3) kicks in as one asks: how to manage with a longer-term perspective (instrumental stakeholder theory – ‘instrumental ST’) or with a moral attitude that treats all stakeholders fairly (applied business ethics)? The stakeholder norm roughly proposes that managers need to identify stakeholders and then to somehow balance their interests. Instrumental ST has developed an environmental scanning technique to identify threats and opportunities in an increasingly complex environment. Actually the strategic planning literature has first used the term ‘stakeholder’ in relation to information systems: as planning moves from reactive to proactive strategy formulation, the need for ‘environmental scanning’ increases.251 Freeman originally used the stakeholder concept as “an intelligence gathering mechanism to more accurately predict environmental

251

Ibid., p. 34.

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Chapter 3 opportunities and threats”.252 Alert managers confronted with pressing risks in their environment found it non-contentious to adopt the stakeholder norm; they followed Freeman who proposed that managers should identify the concerns of their stakeholders defined as groups affected by or that affect the business. Business ethics and instrumental ST have contributed substantially at the norm level by building capacity for moral reasoning, respectively building technical capacity. Friedman opposed CSR as a hypocritical exercise bordering on fraud that would backfire in the long term. Thus Friedman saw CSR as only superficially rational from a business standpoint; therefore he stopped short of rationalising CSR in terms of organisational utility. His norm also suggested to managers to stay aloof of CSR issues, not to make efforts to rationalise them. Normative stakeholder theory has followed Friedman in his disregard for rationalisation attempts because the structural obstacles to CSR seem insurmountable and need to be dealt with first. It offers a vision of a moral company, but barely helps managers operating in competitive markets with a norm to simplify complexity. In contrast instrumental ST considers that the rationalisation of CSR – aligning CSR means with profitability/organisational goals – is key to reconciling business and societal needs. It has concentrated precisely on offering guidance to managers in how to deal with their social environment. Friedman disputed that the proper locus of responsibility could be an artificial person, but only the people operating it; even so, such individuals are ill-suited for the task at hand because they lack expertise. Business ethicists working in a more applied stream concurred with Friedman in locating moral responsibility at individual (manager) level and offered their advice on this basis. They have stimulated exercises of moral reasoning applied to concrete business contexts (e.g. conflicts of interest, bribery, whistle-blowing, etc.) and generated numerous training materials. As a result, the work of ethicists in this area has played a crucial role in raising the awareness of managers to social concerns and their ability to reason ‘out of the box’. Correct identification of issues is a necessary first step in managing them properly. Thus business ethicists deliberately worked solely at the norm level; there they made a contribution to building managerial expertise, but not necessarily to rationalising CSR. For the latter, they offered intuitive arguments under the umbrella term of ‘enlightened self-interest’; however, to go beyond rhetoric and illustration more technical capacity was needed. Stakeholder theorists of an instrumental mind followed business ethicists in meeting managers where they were. They all agree with Friedman in his assessment that managers lack the necessary expertise to manage CSR. Instrumental ST realises that not only moral expertise is what managers lack, but also, once awareness is built, proper managerial tolls to implement and communicate CSR. Researchers belonging to the ‘corporate responsiveness’ stream – a response to the overly moralistic treatment provided by the ‘corporate responsibility’ stream’253 – started in 252 253

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Ibid., p. 35. Frederick, supra note 18.

Norms advanced in the CSR debate the 1970s in the US to develop the tools that the rationalisation of CSR requires; therefore they replaced the moral lenses used by Friedman and normative ST with the technocrat’s lenses. Then crucial questions related to the CSR process could be raised: what stakeholder issues could affect firms, how could they be managed, with whom could business collaborate to solve the issues and safeguard its own interests, how much and what kind of resources business could contribute, for how long business needs to stay involved with an issue before other actors can take over? Multistakeholder fora have started in the last ten years to address these issues, which will be reviewed in the next chapter. Similarly to business ethicists, this work concentrates solely on the norm level and aims to create expertise to handle CSR; as a difference, these managerial tools are essentially a rationalisation attempt to align CSR means with organisational goals. Customarily it has been understood that management has to decide by remaining in compliance with the law and by competing successfully in the marketplace. Friedman made this clear. CSR has emphasised that business executives should not limit their attention solely to legal and market signals, but also develop their sense of social responsibility in order to distribute more fairly among stakeholders the risks, losses and benefits of corporate activity. Indeed, a focus on the protection of human rights in developing countries cannot abstract away the severe regulatory gaps as well as the difficulties that markets in the North have in accounting for, and putting an accurate value on, overseas corporate impacts. In other words CSR can provide useful guidance in a context where pressing social or environmental issues are not addressed because of both political and market failures. As business ethicists and instrumental ST have concentrated at the norm level, it was left to normative ST to reflect on how CSR fares at level 1 – role of large businesses in society. The difference of opinions on the issue of what gives legitimacy to business seems irreconcilable. Friedman questioned the legitimacy of CSR (of managerial discretion) because allocating resources through CSR bypasses both market and political processes that are meant to allocate efficiently, respectively fairly, the scarce resources available to society. He proposed that it is preferable for elected and accountable political representatives to handle the pressing social issues that CSR highlights rather than give to management the power and discretion of deciding issues of fair distribution. For con-CSR writers, legitimacy of business rests precisely with separating the pursuit of corporate interests from other public interests in order to avoid corporations abusing their economic power in legitimate areas of politics and societal debate. CSR opponents assert that “it is repugnant to our democratic ideals to have corporate oligarchies determining which of many competing claimants for financial support should be awarded that support”.254 However legitimacy of managerial power can be discussed not solely from a political angle but also from its conformance with ethical principals. Business activity does have negative externalities and sometimes the political process systematically fails to correct them. In stakeholder-oriented 254

Allen, supra note 179, p. 269.

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Chapter 3 writings the legitimacy of corporate power depends on respecting the interests of stakeholders and further contributing to the public good, if possible. For pro-CSR authors, a single-minded pursuit of profits while remaining aloof of wider corporate impacts of society is evidence of corporate irresponsibility and illegitimacy. Businesses are expected to strive and reconcile commercial and non-commercial interests; an arbitrary dichotomous understanding of these interests should be rejected. Probably more difficult to analyse is the loss in efficiency that results from blurring the division of labour between business and politics. Proposals to expand business responsibilities beyond the core competencies of businesses, even if legislated, do not explain why the separation of roles should be disregarded. That would probably be justified if shown through a comparative institutional analysis255 that in a specific area extending the responsibilities of business is a better option than all other available alternatives. It is conceivable that in some situations governance mechanisms are inexistent or too weak, markets do not account for the respective issues and capacities for self-help through social networks are insufficient. That often seems to be the case with protecting human rights in poor countries. 3.1.3. Winning by default? If the previous section showed the reply that stakeholder theory offered to Friedman, now we turn attention to what stakeholder theory failed to address in its replies. Discussing some blind spots in stakeholder analysis reveals the (in)adequacy of the ‘package’ put together by stakeholder theories on the three levels compared to Friedman’s own package. The implications for the norm (how to approach the complexities of decision-making) will then be spelled out. In relation to level 2, managerial self-dealing has not preoccupied stakeholdersensitive writers to the same extent as it has concerned shareholder-oriented theories; consequently a thorough analysis of practicable modalities to ensure managerial accountability is hard to find in stakeholder theories. Friedman emphasised the interests of shareholders enforced by financial markets. In response, stakeholder theory has stressed stakeholders’ interests or relied on ‘company’s interest’ to dismiss Friedman’s claims that directors are simply the agents of shareholders. This strategy can easily run into problems; as it was noted in France, with its references to ‘company’s interest’, “in Anglo-American countries, the emphasis in this area is on enhancing share value, whereas in continental Europe, and particularly in France, it tends to be on the company’s interest. This difference in approach does not amount to a radical contradiction… Demonstrating concern for the company clearly does not mean ignoring the market, which regulates all aspects of economic life.”256 Stakeholder-oriented views have both decentred the 255

See Komesar, supra note 31; N. K. Komesar, Law’s Limits: The Rule of Law and the Supply and Demand of Rights (Cambridge University Press, New York, 2001). 256 Viénot I Report, supra note 78.

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Norms advanced in the CSR debate shareholder and downplayed the disciplinary force markets exert on management. As such, the appeal of normative stakeholder theorists to company laws has been simplistic, while models downplaying the power and role that shareholders have in corporate governance can easily become misleading. In addition normative proponents of CSR have tended to relax excessively the profitability benchmark that markets use to assess and sanction managerial performance; exclusive reliance on judicial or regulatory agency enforcement appears not to be a practical controlling mechanism. Company law itself relies on self-help and market enforcement instead of judicial enforcement of its provisions regarding the duty of care. As stakeholder theories have failed to come with a controlling mechanism, corporate governance experts are not persuaded: stakeholder theorists have not produced a credible solution concerning how to handle the managerial discretion that CSR presupposes. This approach is appropriate for putting the spotlight on abuses, for debating issues of accountability to stakeholders, but has proved unable to account for the essential dynamics in the corporate governance system and for the challenges that the institutionalisation of CSR processes (within the company and in its operating environment) raises. The analysis that normative stakeholder theory performed on the efficiency and legitimacy of role separation in society (level 1) has been limited and lacking depth. If normative ST mounted a sustained response to Friedman’s challenge at this level, then the relationship of CSR with other controlling mechanisms – markets, regulation – could have been analysed. Ethicists followed another path and manifested an isolationist focus where the corporation alone is the object of moral analysis and the bearer of moral duties. Indeed some writers explicitly assume that for purposes of locating moral agency, it is irrelevant that corporations are market actors. Influential writers sometimes talked of ‘Kantian capitalism’257 and drew on deontology, which has the shortcoming that it poorly accounts for deterministic pressures as it assumes the free will of the moral agent. Freeman later admitted that deontology is an inadequate foundation for CSR.258 Thus the critical link of business with its market environment is severed or downplayed; there is further neglect of other institutions with a role in public governance (governments, civil society groups, etc.). Sometimes CSR theories propose enhanced social disclosure which presuppose decentralised mechanisms of control, but CSR theories have tended to shy away from an in-depth analysis of the numerous facets of such complex coordinating mechanisms. Overall, because the pro-CSR literature has not articulated a compelling reply at this level of analysis, the CSR idea appears less persuasive even to sympathetic or ambivalent readers. On the level of norms (level 3) stakeholder theory has not clarified that Friedman’s prescription to managers is derived exclusively from the upper levels of analysis and not from the practical problems managers encounter in their activities. 257

R. E. Freeman, D. R. Gilbert, Jr., Corporate Strategy and the Search for Ethics (PrenticeHall, Englewood Cliffs, N.J, 1988). 258 R. E. Freeman, ‘The Politics of Stakeholder Theory: Some Future Directions’, 4 Business ethics quarterly (October 1994) pp. 409–421.

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Chapter 3 Friedman was primarily interested in the wealth that markets efficiently create rather than in what specific factors ensure the success of a particular company in its specific circumstances. In other words his interest is in economics rather than business administration. The agency model on which Friedman drew from focuses attention, on one hand, on how to curtail managerial discretion rather than how to use it and, on the other hand, on efficient wealth creation in the aggregate rather than on individual businesses success. This distinction is clearly formulated by a likeminded sceptic of CSR: “It may be true, or become true, that businesses will increasingly have little choice but to take the path of CSR, in the interests of profitability or even survival. This does not alter the fact that its general adoption, whether from social pressures or legal requirements, would do more harm than good. The case against CSR is not that it would necessarily be bad for profits, but that, whatever its effects on enterprise profitability in particular cases, it would make people in general poorer by weakening the performance of business enterprises in their primary role.”259

Instrumental ST has concentrated its efforts on level 3, that is, on building capacity to back the stakeholder norm. Business ethicists have improved the abilities of managers for moral reasoning while instrumental ST has delivered managerial tools to measure and communicate CSR performance. Unfortunately, normative ST has traditionally framed CSR unproductively at those upper levels; then a comprehensive alternative pro-CSR package spanning all three levels has not appeared to stand on par against the package that Friedman presented. Normative stakeholder theorists have promoted the stakeholder norm – a managerial disposition to identify social issues that pose risks and opportunities and then manage them with reasonable care – as part of a package that contains new models of the firm. The stakeholder norm appears needlessly as part of an indigestible package at the levels of managerial duties and role separation. The incompatibility of the package with legal and market realities compromises, by association, the valuable norm. The stakeholder norm is cut short even further if one accounts that some managers may hold their own ideological persuasion (e.g. a libertarian outlook like Friedman’s) and have acquired certain habits of doing business. In these circumstances it does not seem to matter anymore whether Friedman’s norm for approaching complexity – managers should follow exclusively the signals of the market and the law and forget about their sense of social responsibility – is able or not to deliver business success in a complex competitive and social environment. Friedman’s norm is simply part of a more persuasive package than the stakeholder norm. The concerns that he advanced have not been answered properly. Some writers drew attention that Friedman’s recommendation (norm) may be reinforced artificially to the dislike of ethicists and to the detriment of businesses caught in risky situations. Argyris explains the troublesome possibility of research 259

D. Henderson, ‘The Role of Business in the World of Today’, 17 Journal of Corporate Citizenship (2005) pp. 30–32.

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Norms advanced in the CSR debate “helping unintentionally to rigidify the society precisely in the state that it rejects”.260 Wicks noted: “[M]uch of the ‘business and society’ literature has worked within the confines of the separation thesis rather than getting beyond it. The flaw in their approach has been accepting these dichotomies as given and then trying to overcome them, an unsuccessful strategy. The efforts of other researchers, management consultants, and companies offer a more promising route. They offer ways of understanding the corporation, and business activity, such that the value dichotomies do not arise.”261

The dichotomies referred to were self-interest – altruism; profits – self-sacrifice; competition – cooperation; and responsibility to shareholders – responsibility to society. To the extent that these dichotomies are accepted, the author argued, this will help to create an intellectual climate that makes the separation thesis a compelling, and perhaps inevitable, way to think about business activity; researchers thus perpetuate this underlying division despite their efforts to overcome it. Wicks was commenting on the remarks of Freeman, the initiator of stakeholder theory, who decried the ‘separation thesis’ which sees ethics and business as categorically distinct and independent realms, each with its own particular concepts, language and logic. As long as the separation thesis goes unchallenged, Wicks thought that the efforts to reshape or soften the logic of business best captured by Friedman will be ineffective at both the academic and practitioner levels.262 Friedman and his critics hold vastly different worldviews. CSR debates will not change them; so the solution is to move CSR debates to lower levels (levels 2 and 3) where the pragmatic search of solutions to practical problems has already incrementally redefined understandings about better ways to approach complexity (chapter 4) and about what the managerial duty of care entails (chapter 2). Pro-CSR arguments (normative stakeholder theory) advance a valuable norm that can account for the increasing complexity of the social environment in which businesses operate, but unnecessarily present it as an element of an unworkable package. In contrast con-CSR arguments promote a norm that is not adequate anymore to guide managers of large businesses in a complex economy; however, being part of a unified package that highlights real concerns strengthens this norm. It is probably a fair assessment to say that Friedman has won the argument with (normative) stakeholder theory. He did so largely by default. Till now.

260

C. Argyris, Inner Contradictions of Rigorous Research (Academic P., New York, 1980), p.

77. 261

A. C. Wicks, ‘Overcoming the Separation Thesis: The Need for Reconsideration of Business and Society Research’, 35:1 Business & Society (1996), p. 111. 262 Ibid., pp. 90, 91.

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Chapter 3 3.2. THE STAKEHOLDER NORM As a difference from normative models, instrumental ST does not reject the current legal duties imposed on management; they are seen as conceptually flexible and with boundaries that can be tested in practice to cover the interests of stakeholders. The intent is to safeguard the long-term profitability of the company. This approach explicitly positions CSR management as a modality to effectively discharge the legal duties of management; the duty of care is effectively fulfilled when a more relationship-inclusive and longer-term frame is adopted. The gains that instrumental ST has been achieving are decisive and need to be accounted for in order to articulate a comprehensive response to Friedman on all three levels of analysis. These capacities are related to clarified (not modified) statements of managerial duties in company law (level 2), and also to innovative governance arrangements that rely on the regulatory potential of private actors (level 1). The implicit understanding is that if managers take such a longer-term perspective, the area of overlap between corporate and stakeholders’ interests, between private and public interests will grow. The comparison side by side of Friedman’s views and the responses they attracted reveals not only the chasm between them but also some peculiar similarities. First, on level 2, both camps ignored the tensions with which company law has struggled for decades. Thus while Friedman ignores legal managerial duties altogether and prefers markets as the controlling mechanism for managerial discretion, normative ST selectively refers to ‘company’s interest’ while disregarding the rest of the legal architecture of CL. While Friedman ignores CL altogether his opponents conveniently ignore the tensions inherent in CL. Second, on level 1, Friedman works in a nearly perfect market paradigm and hardly refers to regulatory and market failures. In turn, his normative critics extract the company from its environment to subject it to an ethical analysis and show a similar disregard for regulatory and market dynamics. Third, on level 3, Friedman emphasises legal constraints, market pressures and moral duties to shareholders while his critics rely on moral imperatives derived from theories of justice. Deterministic approaches cut through tensions and simplify complexity for decision-makers, but dot not necessarily offer the better way of handling the tensions surrounding business operations. Both Friedman and his critics have misled managers and evaluators in regard of the task at hand. Their prescriptions perpetuate the illusion that factual complexity can be tackled mechanistically by obeying the dictates of both law and markets, or of some moral imperatives. Entangled in principled reasoning, this literature has oriented investigation toward deterministic solutions instead of affirming the nature of the problem as one of informed reflection. Legal analysis has occupied a marginal role in CSR debates. On one hand, CSR proponents have ignored the essentially reflective nature of legal managerial duties (particularly the duty of care). On the other hand, corporate lawyers dealing with CSR raised expectations that managerial duties, if expanded and severely enforced, could ensure corporate compliance, once 90

Norms advanced in the CSR debate again dissimulating the reflexivity of managerial duties. However, at a closer reading CL itself has sent a signal about the nature of the managerial task that was not properly recorded in CSR debates: an informed, reflexive, deliberative, rational process of decision-making oriented toward the function of business to create wealth. CL relies on managerial independent judgment and implies that a conceptual balancing of the interests of stakeholders is essentially reflective and deliberative, not determinate. Friedman sought to reduce complexity for managers by simply discarding the social environment of business. But complexity can be simplified in another way: instead of offering prescriptions for universal applicability, one can clarify the tensions that managers confront. Peter Drucker noted: “To manage a business is to balance a variety of needs and goals. This requires judgment. The search for the one objective is essentially a search for a magic formula that will make judgment unnecessary. But the attempt to replace judgment by formula is always irrational; all that can be done is to make judgment possible by narrowing its range and the available alternatives, giving it clear focus, a sound foundation in fact and reliable measurements of the effects and validity of actions and decisions.”263

Approaching issues in the deterministic, moralistic, mechanic, blueprint-oriented manner employed by both Friedman and his critics is not confirmed by the current efforts of decision-makers on the ground. The focus is not on off-the-shelf solutions to complex problems, but on off-the-shelf tools. A context-sensitive approach gives up the hope of finding silver bullets; instead it focuses on accounting better for the peculiarities of each context and on providing managerial tools to conduct attuned balancing acts. This approach emphasises the necessity and inevitability of social innovation by all actors instead of mechanistic applications of preconceived notions. The previous discussion regarding Friedman and his critics shows that the incumbent norm still wins by default because of the comprehensive package put together by Friedman and the inadequate package advanced by normative ST. Despite its better fit with the business environment, the stakeholder norm gains ground more slowly because Friedman’s norm is internalised by managers. It is important to understand why and how deep the norm is internalised, which the previsions analysis addressed. One is then better positioned to negotiate and speed up the replacement process. Internalisation of a norm reduces receptivity to new information that shows the norm is obsolete; then it takes longer to appreciate the merits of a new and better norm, and the old norm makes it costly for the new norm to establish itself.264 Bad or inefficient social norms which do affect human conduct may result from a variety of causes, including self-interest, inertia and improper belief-systems. Such belief-systems, in turn, may “result from bad information or 263

P. F. Drucker, The Practice of Management, (Butterworth-Heinemann, Oxford, 1999 (1955), p. 59. 264 R. Ellickson, ‘The Market for Social Norms’, 3 American Law and Economics Review (Spring 2001) p. 33.

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Chapter 3 from persuasion that is founded on false premises or developed by fallacious or incomplete reasoning.”265 Friedman proposed a well-articulated argument culminating with his prescription (norm) that is able to simplify complexity for managers, but as the norm has become internalised it also hinders fresh evaluations of how fit this package is to changing circumstances and inhibits possible corrections. Douglas North explained that neoclassical theory assumes that players know the correct way to achieve their objectives; if not, even though their models may be erroneous, the theory counts that the informational feedback process (and arbitraging actors) will correct initially incorrect models, punish deviants and lead survivors to correct models. Institutions (for North, these are the rules of the game: norms and ideology) make sense when you take distance from this assumption; informational feed-back may be so poor that the actor cannot identify better alternatives.266 But as experience filters through existing mental constructs, it gradually alters norms and ideologies. The lower the cost of information, the more rapid is the alteration of norms and ideologies through informational feedback.267 Friedman advised managers that stakeholders’ interests are not within their sphere of responsibility (mandate) and expertise; not only this but considering stakeholders’ interests generates dynamics detrimental to profit-making endeavours and to the market system itself. Corporate resources should not be spent on trying to rationalise stakeholders’ interests in terms of organisational utility. Thus Friedman drew the boundaries of legitimate business inquiry very tightly to exclude stakeholders. This in effect makes it very difficult for those who internalised Friedman’s norm to account for what necessity, examples and tools for the rationalisation of CSR are out there. As DiMaggio observed, “[f]ield boundaries, as they are perceived by participants, affect how organizations select models for emulation, where they focus information-gathering energy, which organizations they compare themselves with, and where they recruit personnel”.268 This analysis suggests that one does not have to buy either Friedman’s or normative ST’s ‘package’. The stakeholder norm can be accompanied by different modes of reasoning that simplify complexity for decision-makers in different ways. On one hand, one can follow Friedman and normative ethicists that both developed deterministic accounts of CSR. Proponents of the stakeholder norm would then develop along the lines of normative ST, with all its drawbacks. On the other hand, one can be more sensitive in analysis and proposals to the context where CSR is discharged, to tensions and social dynamics surrounding CSR. These proponents of

265

Eisenberg, supra note 224, p. 1271. D. North, Institutions, Institutional Change and Economic Performance (Cambridge University Press, Cambridge, 1990) pp. 16, 24 and 104. 267 Ibid., p. 138. 268 P. DiMaggio, ‘Constructing an Organizational Field as a Professional Project: U.S. Art Museums, 1920–1940’, in W. W. Powell and P. J. DiMaggio (eds.), The New Institutionalism in Organizational Analysis (University of Chicago Press, Chicago, 1991) p. 267. 266

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Norms advanced in the CSR debate the stakeholder norm would draw on the gains made by instrumental ST. The aim of CSR modelling would be to clarify the tensions rather than assume them away. The neat separation of the economic and social that Friedman pursues through his deterministic reasoning is more likely to be overcome not by striving to show its fallacy, but rather by revealing its partial loss of relevance and employing a contextsensitive approach geared toward effectiveness of (corporate and public) policies. It is probable that a viable modelling of CSR has no radical changes to make at the functional differentiation in society and managerial duties levels (levels 1 and 2). The approach taken by instrumental ST has no attraction to develop revolutionary models of the corporation. Instead of feeding on polarisation, it draws on pragmatic efforts to identify areas of agreement: pressing social needs, resource constraints, valuable inputs and necessity of viable tools for measuring and reporting impacts. Perceptive observers pointed at how much the different discourses – the value-based and the pragmatic one – converge in terms of practical recommendations if proper weight is given to the contextual complexity where business decisions are made. Practicing strategies designed to fulfil certain values are very much the same as the strategies devised in the pursuit for effectiveness.269 Following the analysis in chapter 2, the new norm would state that managers are responsible to take a more impact-inclusive and longer-term view of their business in order to manage effectively new business risks and opportunities. After the presentation in this chapter, the emerging norm would imply: in view of numerous complicating factors that have changed the environment in which MNEs operate, it is the independent judgment of managers that is properly informed by an environment scanning technique and by their capacity for moral reasoning, in addition to market and law’s signals, that can more reliably address the complexity of the profit-making mandate. The basic thrust of the stakeholder norm rests with overcoming the artificial separation between the economic and social that Friedman’s norm has encouraged. The stakeholder norm roughly proposes that managers need to identify the stakeholders and then balance their interests. CSR criteria of balancing could be found in ‘normative’ writings oriented toward fairness and just society, or in ‘instrumental’ writings oriented toward long-term wealth of the company. One is free to use the stakeholder norm in association with either criterion. The norm implies that managers need to be aware, open for partnering and socially innovative to maximise the beneficial impact of corporations; to look afresh at the means they can use in order to achieve their respective goals more effectively. This is the general standard, which is better specified by the emerging good practices of leading TNCs; the new means toward traditional business goals are identified and tested for viability by leading TNCs. What has been customarily seen as not being the concern of business may become the business of business after some proactive TNCs recognise the need to deal with some pressing problems 269

M. Hemmati et al., Multi-Stakeholder Processes for Governance and Sustainability (Earthscan, London, 2002) p. 8.

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Chapter 3 perpetuated by governance gaps. To anticipate the next chapter, which contains more detailed illustrations of how the contents of the emerging norm are shaped by leading TNCs, the stakeholder norm posits that (in as much as it is feasible in the circumstances of the respective case) ƒ it might be the business of business to see that the governmental forces provide security to corporate operations without abusing human rights; ƒ it might be the business of business to see that taxes paid by corporations are not diverted, but are used for development and poverty reduction (as shown by revenue sharing regimes and by corporate initiatives to disclose the taxes paid to host governments); ƒ it is not enough to create jobs, but it might be the business of business to protect minimum labour standards in the workplace; ƒ it might be the business of business to offer self-help opportunities for local small and mediums sized enterprises (SMEs) through business contacts, training and credits. The next chapter will use illustrations how the stakeholder norm is currently specified in different human rights contexts, how technical capacity is built in multistakeholder fora to assist businesses to use the norm, and the mode of reasoning used by leading TNCs as exemplified with their own statements. As one considers mechanisms to enforce a new norm, one also needs to deinternalise the incumbent norm. One has to provide a new understanding on all CSR levels before the current norm is de-internalised. As argued above, Friedman has won by default because normative stakeholder theory did not offer a compelling response on levels 1 and 2. This study can be seen as an effort to de-internalise Friedman’s norm. Thus chapter 2 examined the relationship between management and shareholders (level 2) by drawing on company law and corporate governance to highlight shortcomings in both pro- and con-CSR arguments. Further, chapter 4 will highlight recent CSR progresses that leading businesses and their stakeholders have made in specifying the norm of reasonable care and rationalising CSR expenses in terms of organisational utility (level 3). Finally, chapters 5 and 6 discuss innovative regulatory strategies and governance mechanisms that can encourage the diffusion of the stakeholder norm (level 1). The biggest hole in the ‘package’ that stakeholder theory developed as a response to Friedman is at the role separation level. This can also be explained by the fact that only very recently have leading businesses engaged their stakeholders in a concerted effort to implement the tenets of CSR. Stakeholder modelling needs to grasp these new realities and account for the transformative potential of the corporate voluntarism of leading TNCs, possibly as proposed herein in terms of an emerging norm – the stakeholder norm – that seeks to replace the established business norm articulated by Friedman. Nobody, neither business people nor policymakers and civil society groups seem eager to have TNCs assume roles that belong properly to lawmakers; this however does not exclude innovative forms of governance and regulation. From this governance perspective one can ask how does 94

Norms advanced in the CSR debate the capacities built at norm level (level 3) which are compatible with the managerial duties laid down in CL (level 2) influence arrangements for the protection of human rights? What opportunities and threats does this bottom-up process of social ordering offer to policymakers and to businesses? How could various mechanisms of social control (i.e. regulation, markets, social networks) relate to the existence of this norm and its accompanying expertise (moral and technical)? These are issues of governance that can be analysed at level 1.

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CHAPTER 4 THE STAKEHOLDER NORM IN BUSINESS PRACTICE This chapter illustrates how private actors active in the CSR regime (e.g. businesses, market intermediaries, civil society groups) specify the stakeholder norm discussed before. The first part presents a variety of CSR contexts and adds the necessary factual background for later analysis. Reference will then be made to the ‘business case’ of CSR, that is, the idea that the company will benefit from its responsible practices; CSR turns out to be a matter of enlightened ‘self-interest’. The main section of the chapter looks at the management of CSR. Here are identified the stages of implementing CSR commitments, and we especially insist on multistakeholder fora that build the necessary tools and understandings. The review of recent CSR developments concludes with a discussion about the limits and potential of CSR as perceived by both its sceptics and proponents. 4.1. CONTEXT OF CSR: GOVERNANCE GAPS AND BUSINESS RESPONSES Businesses contribute to society’s well-being through products/services supplied at competitive prices, taxes, job creation, skills dissemination, technology transfer, returns to suppliers of capital, philanthropic contributions, etc. However when good governance is missing, tax revenues are often diverted by corrupt officials and do not benefit the people. Host governments may tolerate jobs that sometime do not provide even a livelihood for the worker and his family or may be so hazardous to result in ill-health, accidents or death. Such instances have been referred to as ‘governance gaps’. Sometimes governance gaps exist due to insufficient resources in circumstances beyond the control of host states. Examples could be external shocks produced by global markets (product and financial markets), insufficient external aid and foreign direct investment, lack of access to the markets of developed countries, armed conflicts, external debt, etc. Other times governments pursue questionable development strategies based on low-cost production that deliberately weaken the protection of human rights in order to attract foreign investment. Still in other cases governance gaps and low accountability levels are maintained to promote the interests of corrupt elites. Thus states might be unable or unwilling to develop proper regulatory and institutional frameworks. Governance gaps allow unscrupulous corporate groups to get away with violating human rights. The relationship between business and human rights then turns to an examination of how a TNC relates to these governance gaps: does it take advantage of the gaps or not?; does it attempt to narrow the gaps or not? Treating both self97

Chapter 4 regulation (aimed at compliance with human rights standards) and partnerships for development (aimed not at compliance but at improving the environment where human rights are protected) together is justified. Framing them together is not done here for the sake of descriptive accuracy and comprehensiveness, although this would be necessary for making an accurate assessment of the impacts of corporate voluntarism. The main reason is that both these types of business initiatives appear as different illustrations of the same stakeholder norm; both self-regulation and contributions to poverty-reduction help to establish the stakeholder norm to the detriment of the incumbent norm articulated by Friedman. They both reveal the ability of some businesses to have a positive impact on the host countries and being able to demonstrate it. Self-regulation and developmental partnerships both impact governance gaps in a positive way by either not taking advantage of gaps or by deliberately working with others to narrow such gaps. They respond to the expectations articulated by policymakers; for example the UN’s Global Compact guides businesses to respect human rights and avoid complicity in abuses, and also to support human rights within their spheres of influence.270 Thinking of CSR as a response to governance gaps allows not only to see the variety of contexts in which CSR issues appear, but also to account for the policies of other actors (i.e. other businesses, civil society groups and governmental agencies) that aim to narrow those gaps. This encourages one to avoid an isolationist focus, as often done in normative CSR writings, and to search for comprehensive solutions and possible synergies between various actors. Thus awareness to governance gaps helps CSR analysis with both diagnosis of the deeper roots of problems and solutions likely to be effective (for rightholders, businesses and public-interest bodies). The next section reviews some areas where most high profile CSR cases have arisen. CSR controversies have appeared in situations where the host country has abundant cheap labour, natural resources or new markets attractive to MNEs. A quick look at these cases highlights the diversity of CSR issues, organisational challenges and CSR solutions. 4.1.1. Labour The case of labour intensive industries (e.g. clothing, footwear, sport equipment and toy industries) is epitomised by Nike, which in the mid-1990s was confronted with evidence of sweatshop conditions throughout its supply chains in East Asia. Typical issues for these industries include unsafe and unhealthy work environments, overtime, inadequate wages, physical abuses, child labour, restrictions on unionisation and collective bargaining, etc. Especially in the late 1980s and 1990s, MNEs operating in these labour intensive industries have moved production to countries whose competitive advantage is cheap and abundant labour, especially in Southeast Asia and Central America, in order to cut labour costs. The company headquartered in the North 270

UN Global Compact, Principles 1 and 2, <www.unglobalcompact.org>, visited on 14 February 2007.

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The stakeholder norm in business practice typically does not own the production facilities in the South. Supply chains sometimes involve hundreds or thousand of contractors and many layers of subcontractors or even self-employed in tens of countries. The supply chain has been defined as “a network of facilities and distribution channels that encompasses the procurement of materials, production and assembly, and delivery of product or service to the customer … The complexity of the supply chain and the business relationship between the various components varies greatly from industry to industry and company to company.”271 Businesses dealing in final consumer goods are particularly exposed to CSR risks. Nike, Adidas (including Reebok now), Levi’s and major retailers in the US and Europe have been targeted by consumer boycotts and protests, and even lawsuits (in the US).272 These companies have come to fiercely compete not only on quality and price, but try to differentiate themselves from competitors through their brand. A poor CSR reputation can severely short-change efforts to build a brand appealing to consumers. Indeed the embarrassment of sweatshops run by contractors and subcontractors taking advantage of weak regulatory frameworks in less developed countries has prompted brand-sensitive companies to monitor more tightly their supply chains despite the considerable managerial challenge such an undertaking involves. Many of the larger brands in these sectors have adopted individual codes of conduct. Some business groups (e.g. the toy,273 cocoa,274 coffee,275 electronics,276 automotive277 industries) have moved forward with collective self-regulation and 271

OECD Roundtable on Corporate Responsibility, Supply Chains and the OECD Guidelines for Multinational Enterprises, Business and Industry Advisory Committee Discussion Paper on Supply Chain Management, 2002, p. 2, <www.oecd.org/dataoecd/50/2/2089098.pdf>, visited on 14 February 2007. 272 A federal class-action suit was filed in 1999 against a group of 26 US retailers on behalf of some 30,000 workers in Saipan (U.S. Commonwealth of the Northern Mariana Islands) alleging that they worked in sweatshop conditions. The legal basis of the lawsuit lied with misleading advertising, unlawful conspiracies under the racketeering law and a system of garment production which violates the Anti-Peonage Act (use of forced labour). The case was settled in 2002. N. Bas, presentation in Internationally Binding Legislation and Litigation for the Enforcement of Labour Rights, Report of the Seminar Organised by the Clean Clothes Campaign, 2002, pp. 9, 10, <www.cleanclothes.org/ftp/legal_sept02.PDF>, visited on 14 February 2007. 273 International Council of Toy Industries, Code of Business Practices, 2001, <www.toyicti.org/resources/code.htm>, visited on 14 February 2007. 274 International Cocoa Initiative, <www.worldcocoafoundation.org//Labour/Child/ Initiative/default.asp>, visited on 14 February 2007. 275 Common Code for the Coffee Community, <www.sustainable-coffee.net>, visited on 14 February 2007. 276 Electronic Industry Code of Conduct, <www.eicc.info/index.html>, visited on 14 February 2007. 277 Automotive Industry Action Group, Leading Automakers and Suppliers Promote Global Working Conditions – Collaborative Project to Advance Workplace Standards throughout

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Chapter 4 drew up their own codes of conduct and monitoring mechanisms. Some leading companies have joined coalitions that involve NGOs and carry out independent monitoring of suppliers’ facilities (e.g. the Fair Labour Association, Social Accountability International, Ethical Trading Initiative); this can be seen as a form of voluntary co-regulation. 4.1.2. Natural resources In 1995 the Royal Dutch/Shell Group, despite its significant leverage with the Nigerian government, stood on the sidelines during the unfair trial that resulted in the execution of several community leaders which were critical of the social and environmental impacts of oil exploitations. At the time the corporation considered that it was not its role to interfere with seemingly internal affairs of a sovereign state. The position of Shell appeared to the public as complicity in the abuse and resulted in a reputational disaster that awakened Shell and some other MNEs to the need to identify and manage human rights risks. Human rights experts have extensively researched the extractive industry (oil, gas, minerals) because: ƒ the location of natural resources is often in undemocratic or weak states where human rights abuses are routine and can be exacerbated by business operations, ƒ the investment is significant and long-term, ƒ MNEs are a major source of governmental revenues in an often impoverished country, ƒ the operations of this industry have a major environmental impact followed by the disruption of traditional ways of living for local communities, ƒ MNEs have often protected their personnel and facilities by weaponed means, which makes inevitable clashes with protestors, clashes that can easily get out of hand, ƒ the popular dissatisfaction with the government often gets channelled toward the MNE seen as the agent of government, ƒ the industry delivers its products to increasingly concerned customers in the affluent North, and ƒ numerous businesses (e.g. Shell, British Petroleum (BP), Union Oil Company of California (UNOCAL), Talisman, Freeport-McMoran, Rio Tinto) have been sued in relation to environmental and human rights issues, mainly in the US, but also in the UK. The extractive industries encounter different challenges compared with the labour intensive industries discussed in the previous section. The difficulties arise here from having to operate in turbulent, risky environments, and not from choosing to rely on long supply chains. Subsidiaries of transnational groups have been criticised Supply Chains, Press Release, 4 December 2006, <www.aiag.org/press/releases/ GENERAL/ AIAG_WorkingConditions_PR_120406_FINAL.pdf>, visited on 14 February 2007.

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The stakeholder norm in business practice especially for their heavy environmental footprint. This could amount to violations of human rights if livelihoods were threatened through pollution or displacement. Also the cultural rights of indigenous people have been an issue. The major issue from a human rights viewpoint seems however to be one of ‘complicity’ when abuses are perpetuated by governments. The mere corporate presence in a country ruled by an oppressive government supports the latter by generating large revenues. Similarly, in cases of a civil war or of boiling tensions over controlling resource-rich areas, the revenues generated can raise the stakes and perpetuate the state of conflict. In other cases the surrounding communities have come to associate extractive companies with endemic poverty and governmental corruption as they do not share in the benefits generated by the project. In such cases, the central governments have neglected the rights and interests of affected communities, and they have failed to provide effective remedies and adequate development strategies. Most often it is not the mere presence of a MNE that leads to charges of complicity, but its collaboration with the government in jointly running the project. The government is in charge of providing security to the project, and its military may use heavy-handed interventions to deal with restive local populations. For example, evidence of beatings, torture, rape, forced labour, and forced relocations perpetrated by governmental armed forces have been documented in connection with UNOCAL’s activities in Burma. To sum up, MNEs get associated with abuses that military forces commit against local communities (e.g. Burma, Nigeria), with poverty as authorities do not invest in those communities where oil is extracted (e.g. Nigeria), with corruption as public servants divert oil revenues for personal use, with perpetuation of dictatorial regimes (e.g. Burma) and even with civil wars that are fueled by the desire to control natural resources (e.g. Sudan). Against the background of a deficit of democratic accountability compounded by the pecuniary interest of state officials in uninterrupted business operations, the exploitation of oil and gas, diamonds and other minerals has proven a curse rather than a blessing for impoverished local communities.278 Recently the extractive industry has become involved in multistakeholder initiatives at a global level. There are three main examples. The Extractive Industry Transparency Initiative (EITI) aims to increase disclosures of payments made by oil, gas and mining companies to governments and enhance the transparency over revenues host country governments receive from extractive projects. The Kimberley Process (KP) is a joint initiative of governments, the international diamond industry and civil society groups to stem the flow of conflict diamonds, that is, rough diamonds used by rebel movements to finance wars against legitimate governments. Both KP and EITI are driven by states; they represent inter-state political agreements, not legally binding treaties, in which businesses and civil society groups have a special, facilitative role to play. The Voluntary Principles on Security and 278 On resource curse, see with references mentioned there, International Council of Mining and Metals, Resource Endowment initiative, The Challenge of Mineral Wealth: Using Resource Endowments to Foster Sustainable Development, Analytical Framework, 2006, <www.icmm.com/project.php?rcd=16>, visited on 14 February 2007.

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Chapter 4 Human Rights (VP) aim to prevent human rights abuses committed by those public or private forces that provide security to extractive projects.279 Extractive industry companies often undertake social obligations in the concession agreements concluded with governments. The industry is also highly profitable, and companies often contribute in excess to such contractual requirements in order to obtain the so-called ‘social license to operate’. As a result of regulations or philanthropy, the industry is often engaged in infrastructure development and community services. Health centres, education facilities, roads, training and credit for start-up and small enterprises are often provided to the surrounding communities. Leading businesses have increasingly entered into partnership for development at local and regional level to more effectively implement these goals. 4.1.3. New markets The more liberalised trade and investment regime of the last two decades has created new business opportunities in developing countries for the MNEs based in the North. This opportunity to service the markets in the South has created fresh challenges for MNEs. We briefly refer below to areas that have raised questions about the social responsibilities of MNEs: large infrastructure projects (construction of dams and privatisation of water services), and access to health and lifesaving medicines. a) The World Commission on Dams published in 2000 a groundbreaking report which has comprehensively analysed the multifaceted impacts that the construction of dams generates. The problems relate to “what the dam will do to river flow and to rights of access to water and river resources; to whether the dam will uproot existing settlements, disrupt the culture and sources of livelihood of local communities or deplete or degrade environmental resources; and to whether the dam is the best economic investment of public funds and resources”.280 Also dams as large-scale infrastructure projects provide opportunities for corruption. The construction of dams raises questions of responsibility especially for lenders, be they developmental banks (World Bank) or private banks. Important progress in identifying the problems and solutions has been made by the World Commission on Dams. Over a period of two years the Commission drew on the participation and expertise of various private and public, business and civil society organisations in what was hailed as a model multistakeholder process. The Commission identified solutions based on best practice such as “innovative examples of processes for making reparations and sharing project benefits … that provide hope that past injustices can

279

See infra section 4.3.2.C, which presents the role of business in these regimes. World Commission on Dams, Dams and Development: A New Framework for DecisionMaking, An Overview, 2000, <www.dams.org/report/wcd_overview.htm>, visited on 14 February 2007. 280

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The stakeholder norm in business practice be remedied and future ones avoided”.281 The report also noted that substantial improvements in policies, legal requirements and assessment guidelines have occurred, particularly in the 1990s. b) The privatisation of water services in developing countries was also discussed in the context of CSR. The World Bank has been actively promoting the privatisation of water services as a condition for its funding; MNEs have obviously benefited from these new market opportunities. The situation of people that could not afford to pay market prices has been of particular concern. Business Partners for Development explains that “[b]y and large, opposition is around the privatisation (or wholesale selloff) of the assets, ownership of water as a natural resource, and the commoditization of water. Other arguments are around the trustworthiness of multinational companies to safeguard such a critical and life-giving resource, the inherent monopolistic tendencies of water supply (and that companies bidding together shrinks the pool of competitive bidders even further), and the untested track record with regard to service provision in poor communities. For many the issue is less around the decisions taken but the process used to reach those decisions – processes that seemed to occur behind closed doors.” 282

International human rights law itself is neutral on the issue of ownership as long as the state oversees private companies to ensure that human rights are respected in the private delivery of essential services. International financial institutions (e.g. World Bank) have sometimes made privatisation a condition for poor governments to access funds. Following grave instances of poor performance and in recognition of the impacts that privatisations have on access of the poor to water a new understanding has emerged. The Bonn Freshwater Conference (2001) reached an agreement that “private sector participation should not be imposed on developing countries as a conditionality for funding”.283 In other words, there must be no preconceived formula or underlying assumptions and that options analysis must be pursued on a case-by-case basis. 284 Privatisations are often referred to as (public-private) partnerships; this alludes to CSR where partnerships are an important, collaborative implementation strategy for CSR commitments. Probably CSR does not offer the right lenses to look at the issue of privatisation of basic services as this is a contract-based relationship. 281

Ibid. Business Partners for Development in Water and Sanitation, The Changing Context of Partnerships, <www.bpd-waterandsanitation.org/english/changingcontext.asp>, visited on 14 February 2007. 283 International Conference on Freshwater, Bonn Recommendations for Action ,2001, para. 17, <www.water-2001.de/outcome/BonnRecommendations/Bonn_Recommendations.pdf>, visited on 14 February 2007. 284 Business Partners for Development in Water and Sanitation, supra note 282. 282

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Chapter 4 Judicial enforcement or arbitration are available mechanisms that can be used if the company fails to rise to expected standards of service contained in contracts. The focus should be on properly drafting and enforcing the concession contracts rather than appealing to the sense of responsibility of companies. This contractual option is simply not available in other areas that CSR deals with. CSR arguments build on much weaker grounds than those provided by privatisations with their contractual devolution of authority and the corresponding mechanisms for redress. c) The issue of access to health and lifesaving medicines (e.g. HIV/AIDS treatments) has generated much interest in clarifying the responsibilities of pharmaceutical MNEs. As in the case of privatisations above, the concern is for those lacking purchasing power. Such MNEs have high profit margins and, by the nature of their line of business, an image linked to the alleviation of suffering, which leaves them exposed to CSR-type criticism. Some pharmaceutical MNEs have adopted various policies ranging from donations to differential pricing to voluntary licensing of their patented drugs. A proactive corporate response to the public health crisis in impoverished countries is justified for several commercial reasons. Thus the Pharmaceutical Shareowners Group (PSG), a group of institutional investors, has stressed as reasons to develop a CSR response the issues of patents and pricing dynamics within rich markets in addition to the usual benefits associated with CSR. A proactive stand would limit the potential for emerging market countries to opt out of or otherwise weaken international patent treaties; decrease controversy that fuels the public trust deficit that already exists in mature markets; and prevent possible spillover effects on pricing power and regulatory regimes in the USA and other lucrative markets. The PSG believe that “the sector’s response to the crisis could impact shareholder value in the long term and therefore want to enhance their understanding of how companies are addressing this issue”.285 Therefore the PSG has issued a reporting framework that pharmaceutical companies could use to improve disclosure in their annual/social reports. Governments in poor countries with high rates of HIV infections may not afford the high prices of drugs; so the question is whether MNEs have a responsibility to make medicines available at a fraction of the market price. However balancing the intellectual property rights (patents) of businesses and the right to life and access to health can hardly be understood simply by using CSR reasoning. If effective medication has already been developed and is used in rich countries, the issue of patents is crucial. This could probably be best addressed at the interstate level; states have to interpret WTO rules, which already permit exceptions for public health reasons, so as to allow manufacturers of generic medicines to service the poor markets, but not the markets of rich countries where MNEs make the bulk of their 285

Quoted in Global Compact, Who Cares Wins – Connecting Financial Markets to a Changing World, Recommendations to Better Integrate Environmental, Social and Governance Issues in Analysis, Asset Management and Securities Brokerage, 2004, p. 34, <www.unglobalcompact.org/docs/news_events/8.1/WhoCaresWins.pdf>, visited on 14 February 2007.

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The stakeholder norm in business practice profits. This is the case of HIV/AIDS where impoverished countries do not have a market for MNEs to profitably service, in the first place. Searching for a solution within the WTO regime and focusing on generic medicine manufacturers is likely more feasible and sustainable than to campaign for MNEs to voluntarily waive their patents on lifesaving drugs. In fact, Pascal Lamy, head of the WTO, recently urged poor countries to use the WTO ‘compulsory licences’ rules to override protection on patented drugs.286 Also, in late 2006, the World Health Organization started its first intergovernmental review of the pharmaceutical sector to find ways of making medicine more easily available to the world’s poorest people. There is also no market for MNEs in other situations: in the case of diseases that claim victims solely in poor countries (e.g. African sleeping sickness, river blindness). In this case there is no incentive for MNEs to produce medicines in the first place. Here the issue is not of patents but of incentives to make the necessary investment to develop a new medicine. There is place for CSR arguments in this respect but probably more sustainable solutions are desirable. The WHO referred to the research and development of medicines where there is little profit motive. Various incentives could be given such as a preferential status (e.g. the drug’s manufacturer may enjoy tax breaks, or an extended patent period), or setting up public purchase funds that would guarantee that governments buy vaccines for developing country markets at a fixed price from any firm that could develop an effective new product.287 Such incentives could combine with a CSR commitment from companies. Then business would not be expected to deliver a pure public good but due to incentives combined with its CSR stance, it would deliver an intermediate, ‘impure’ public good. Indeed high prices on patented medicines or the lack of incentives for research and development reduce the availability of lifesaving medicines for poor populations. However, another important aspect refers to the distribution of medicines. States remain primarily responsible for this, but there might be a role for businesses to use their specific assets. The Pharmaceutical Shareowners Group noted that corporate strategies limited to making medicines available “is a very challenging area and the success of company activities is highly dependent on external factors, not least the development of adequate health care infrastructures in the poorest countries”.288 Regarding the distribution infrastructure, the PSG learned of examples when “action by pharmaceutical companies can stimulate action by other important parties”.289

286

A. Jack, ‘The Drug Companies: A New Mood of Co-Operation’, Financial Times, 1 December 2006. 287 World Health Organization, Globalization, Trade and Health, <www.who.int/trade/ glossary/story079/en>, visited on 14 February 2007. 288 Pharmaceutical Shareowners Group, The Public Health Crisis in Emerging Markets – An Institutional Investor Perspective on the Implications for the Pharmaceutical Industry, 2004, p. 4. 289 Ibid.

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Chapter 4 4.2. BUSINESS CASE OF CSR The potential benefits for those TNCs that do not remain aloof of the human rights risks and opportunities surrounding them have been well-identified. Since the 1960s Milton Friedman and his critics referred to an entire list of potential business benefits resulting from CSR. Benefits can be split into two categories. Some gains stem from increased operational efficiency, such as cost savings by avoiding disruptions of operations caused by unrest in surrounding communities, or from adopting more efficient and environment-friendly technologies that save raw materials or minimise waste. Some other gains will be reputational gains associated with being perceived as a good corporate citizen; they will result in attracting talented employees, better employee morale, better relations with institutional investors concerned with the ability of management to spot and handle ‘corporate governance’ risks and opportunities, better terms with business partners, consumers, regulators, etc.290 Responsible companies will be granted the benefit of doubt when things go wrong.291 Such reputational considerations can eventually be reflected in the financial bottom-line, although CSR risks and opportunities are not easily quantifiable. The business case of CSR presents CSR as being in the self-interest of business. Once a longer-term perspective is taken, CSR appears as an investment rather than a cost. The International Organisation of Employers wrote that “[e]nterprises play an indispensable role in providing employment, generating wealth and raising the overall standard of living. They operate in, and need acceptance by, society. They are, therefore, well advised to register carefully any changes in the general perception of society. It is obvious that today the role of private enterprise in a market economy, the importance of entrepreneurial initiative and the value of risk-taking as motors for economic well-being and prosperity and thus as basis for social progress are being increasingly recognized worldwide. However, enterprises also have to realize that the sensitivity of society regarding the fundamental principles of social justice has grown.”292

The assessment on which the UK Review of company law, discussed in chapter 2, is based refers to the necessity for companies to manage a ‘Modern Asset Mix’: 290

World Economic Forum, Global Corporate Citizenship Initiative, Global Corporate Citizenship: The Leadership Challenge for CEOs and Boards, 2002, <www.rekombinant.org/ old/images/articles/wef_2002.pdf>, visited on 14 February 2007. 291 For example, in 2002 Chiquita was defended by the trade union Colsiba, with which the company concluded a framework agreement, following a Human Rights Watch report that found child labour in Ecuador. J. G. Taylor and P. J. Scharlin, Smart Alliance: How a Global Corporation and Environmental Activists Transformed a Tarnished Brand (Yale University Press, New Haven, 2004) pp. 154,165. 292 International Organisation of Employers, Position Paper – Codes of Conduct, 1999, p. 15, <www.ioe-emp.org/ioe_emp/pdf/codes_conduct.pdf>, visited on 14 February 2007.

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The stakeholder norm in business practice “Effective management and control of resources requires a decisionmaking process which takes proper account of all the factors relevant to the outcome. In the modern economy these factors have become very wide in scope… Relevant factors include the need to manage relationships with employees, with suppliers of all kinds of resources – physical, intangible and intellectual – and with customers, both direct and indirect. They include the need to manage wider impacts on consumers, the community and the environment. Reputational assets are also of critical importance in a world where external perceptions can transform business prospects, for better or worse.”293

The Association of British Insurers has noted the complexity of the business environment with its threats and opportunities linked to CSR. Sound business management should recognise both. CSR risks are: ƒ diverse (might come from many different directions, from any stakeholder group), ƒ accumulative (may build slowly from a number of small events, but one of those events can be the catalyst which sets off an uncontrollable reaction), ƒ escalating (the relatively minor cost of an incident in one country or subsidiary may have a much bigger indirect impact elsewhere, such as the loss of a contract worth many times the immediate cost of the original incident), ƒ issues-driven (constantly shifting in importance, with new issues emerging suddenly), ƒ short on data (hard predictive data is usually sparse or non-existent), and ƒ based on relative rather than absolute performance (may stem from one company’s position relative to its peers, rather than absolute performance).294 IKEA provides an example, from the many available, of how some companies conceive CSR as being in their self-interest: “Problems that we face in China and Asia are often related to fulfillment of local legislation, minimum wages, working hours, overtime compensation, falsified records, and lack of production planning. These problems result in tired workers, low production efficiency, high rates of accidents and illness, high worker turnover, large influx of unskilled workers and factories not meeting local legislation. This is not cost efficient and it poses many corporate risks. Through our special projects, we can show suppliers that by meeting standards, the end result will be increased productivity, improved human resources management,

293

Company Law Review Steering Group, supra note 65, para. 1.23. Association of British Insurers, Investing in Social Responsibility – Risks and Opportunities, 2001, p. 36, <www.abi.org.uk/Display/File/85/CSR_FullReport.pdf>, visited on 14 February 2007. 294

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Chapter 4 improved labor-management communication and reduction of working hours.”295

CSR proponents point to the benefits that CSR delivers; this emphasis is welcome as some CSR benefits can be intangible and need more time to materialise, with the result that they can be and have been easily ignored. However, merely identifying possible benefits is hardly enough. There are also associated costs. For example, any business committed to CSR may need to ƒ pay higher prices for inputs (higher wages and better labour protection, less hazardous or polluting technology but more expensive, etc.) ƒ spend executive time on CSR issues, ƒ invest in CSR training for their personnel, ƒ multiply the assessment criteria of (middle level) management; this results in a corresponding increase in complexity regarding the assessment of managerial performance and consequently the control of managers, ƒ pay for certification in case the company decides to credibly publicise its performance (e.g. ISO certification for quality and environmental systems, or specialised CSR certifications such as SA8000 on labour standards), ƒ pay for compiling CSR reports, ƒ incur opportunity costs296 generated by not adopting a cost-cutting strategy, ƒ pay for internal or external monitors to track respect of labour standards in the suppliers’ workplace, and ƒ restructure their supply chains (i.e. fixed delivery times, longer-term contracts) resulting in reduced flexibility. The balance between the costs and benefits of CSR depends on the context where a business operates. To be persuasive, the business case of CSR needs more careful elaboration in each situation to determine what issues, how broad involvement and how to implement. For example, referring to developmental partnerships, the Global Health Initiative sees as key success factors “[d]esigning programmes that reflect the implementing company’s size, geographic presence, type of labour force, markets, financial strength and core capabilities. Programme design should reflect the local levels of infrastructure, the activities of other health providers (such as government programmes) and the availability of alternative information or services.”297 295

A. Dahlvig, ‘IKEA Group President and CEO, on Balancing Opportunities and Risks in Asia’, 1 Compact Quarterly, Issue 2006, <www.enewsbuilder.net/globalcompact/e_article 000513975.cfm?x=b7M9Tc5,b4Q3wtmp,w>, visited on 14 February 2007. 296 Opportunity costs are ‘The difference in return between a chosen investment and one that is necessarily passed up.’ For example the opportunity cost of going to college is the money you would have earned if you worked instead. Or, if a gardener decides to grow carrots, his or her opportunity cost is the alternative crop that might have been grown instead (potatoes, tomatoes, coffee beans, etc.). <www.answers.com/topic/opportunity-cost>, visited on 14 February 2007. 297 Global Health Initiative, Resource Paper, 2002, p. 18 <www.weforum.org/pdf/Initiatives/ GHI_Resource_Paper.pdf>, visited on 14 February 2007.

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The stakeholder norm in business practice The business case for suppliers (as opposed to the buyer company) is not necessarily clear despite the emphasis some buyers place on their codes of conduct. Code of conduct requirements have been developed at the same time that suppliers have faced substantially increased pressures to lower their prices and speed their delivery of goods. A World Bank report noted the “unresolved tensions among price, quality, and delivery time on the one hand, and CSR requirements on the other risked undermining the credibility of the business case… [M]any buyers acknowledged that their organizations send mixed messages about the balance between commercial and CSR requirements.”298 The market does not yet send a consistent message about the importance of CSR299 Only recently have some buyers300 and investors301 acknowledged this state of facts. Investors have their own business considerations to pay attention to CSR in the companies they are invested in. For investors, CSR issues become relevant as a risk assessment and risk management issue. A financial analyst succinctly articulated the reasoning: “The rationale for our research is that good environmental performance is a proxy for, and indicator of good management in general, and good management has always been seen by the investment community as an excellent indicator of good financial performance.”302 The grievance of CSR critics has long been that voluntary approaches (CSR) cannot force companies to behave responsibly. Simply relying on the ethical convictions of few managers or on self-interest calculations that make the business case may generate improvements limited only to very few companies. States and the law have to make the business case for all companies; therefore voluntarism and arguments about the benefits CSR brings should be replaced by applying the coercive force of law. This study is in a way fundamentally concerned with answering the grievance of CSR critics about how to make the business case for corporate laggards. For that purpose the question asked is: how does the ‘business case’ of leading businesses help to make the ‘business case’ for the rest of them? This requires a study of the ‘social change case’ triggered by the responsible practices of leading businesses and highlights the role of states. From this perspective should be read the following descriptive inquiry into new CSR developments. 298

H. B. Jørgensen et al., World Bank Group, Strengthening Implementation of Corporate Social Responsibility in Global Supply Chains ,October 2003, p. 25, <www.bsr.org/ BSRResources/ResourcesDocs/Strengthening.pdf>, visited on 14 February 2007. 299 Note that the World Bank study is confined to the apparel and agriculture sectors; they also reflect more accurately the reality in some industries than in others within the same sector. 300 Pentland, ‘How WE can cause excessive overtime in factories!’, 12 Business Standards News (2005). 301 Insight Investment, Buying Your Way into Trouble? The Challenge of Responsible Supply Chain Management ,2004, <www.insightinvestment.com/Documents/responsibility/ responsible_supply_chain_management.pdf>, visited on 14 February 2007. 302 D. Sutherland, ‘Europe Tightens Corporate Environmental Accounting Rules’, Environmental News Service, 5 October 2001.

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Chapter 4 States do have a role in making the business case of CSR. As proponents of binding regulations indicate, imposing liability for violations would make all the business case that is needed, and CSR reasoning would be redundant, as corporations have to count financial losses on their bottom line. Deterrence occurs when the size of penalty and the likelihood of its imposition combine to impose costs which outweigh the benefits from disregarding human rights. While the spectre of legal liability easily permeates the risks assessments made by managers, incentives provided by tax laws or any other preferential treatments similarly impact the calculations managers make. In other words, both sanction and support can make the business case. States have so far been reluctant to act in the decisive manner implied by deterrent approaches. Public policymakers have leaned toward incentives which however are not as clear-cut as tax incentives would be. Thus states have opted for a strategy of reducing costs for businesses willing to engage with CSR; the main avenue is through capacity-building in multistakeholder fora. As shown later in this chapter, numerous initiatives aim to develop management tools that are needed at each implementation stage of CSR. States have provided legitimacy, brokerage and even financial support for stakeholders to convene and jointly work on CSR issues. The strategy of reducing costs is increasingly doubled by a transparency strategy (i.e. disclosure regulations) which is able to mobilise private enforcement and create thus new incentives. We now turn to the managerial tools that are currently being developed to implement CSR. 4.3. STAGES OF CSR IMPLEMENTATION The material in this section is organised in two parts: the implementation stage in which CSR commitments are operationalised through impact assessments, internal management systems and joint partnerships (for compliance or for development), and the demonstration stage where CSR processes and performance are publicly communicated through a CSR report. As the ISO Advisory Group on Social Responsibility has noted, voluntary initiatives such as codes of conduct “raise questions concerning how companies that are adopting them could implement them and demonstrate to the public that the terms of the codes are actually respected. The search for answers to these sorts of questions has led to a number of private standard-setting initiatives in the social area, as well as an industry of private labour inspectors, or social auditors, and related multi-stakeholder initiatives which have had a profound impact on the CSR phenomenon.”303

Below I will refer to the best known multistakeholder initiatives and approaches in as much as they are relevant to human rights, in an attempt to establish a more solid 303

ISO Advisory Group on Social Responsibility, Working Report on Social Responsibility, 2004, para. 53, <www.jisc.go.jp/policy/pdf/Working%20Report%20on%20SR(Apr30).pdf>, visited on 14 February 2007.

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The stakeholder norm in business practice factual basis for later analysis and account for new CSR developments which do not surface usually on the radar of human rights experts. Later chapters will show how states have supported advances at each stage of CSR implementation. Then an analysis of the regulatory regime surrounding CSR can be performed. We need to draw some serious limitations on what CSR initiatives will be presented here for reasons of space and not to lose focus of the points this study makes. We cannot refer to all these important developments as a mere overview would run into hundreds of pages.304 There are also numerous descriptive studies that introduce CSR initiatives. Also we do not intend to comprehensively exemplify good CSR managerial practice. CSR practice and understandings evolve rapidly with guidelines and standards being updated often. There are numerous companies and actors involved, and it would not be possible or particularly useful to meticulously explain here their fast-evolving practices. Furthermore this chapter is not concerned with an analysis of the pluses and minuses of CSR either. Thus we do not take a strict regulatory perspective and discuss whether self-regulation is effective or not, or what bodies apply what rules in each case. Writings in corporate accountability have done a thorough job at highlighting the various shortcomings of CSR schemes. Neither do we take an organisational theory or a business administration angle to discuss how to design and embed a CSR system within the organisation. First, we segment corporate voluntarism into stages of implementation: social impact assessment, implementation of CSR policies through internal management systems and partnerships for compliance or development, auditing of performance, reporting and assurance of reports. This segmentation brings more clarity about the management of CSR and orients one in the jungle of recent CSR initiatives. We stress the infrastructure that is currently being developed with the participation of leading businesses, other business actors and stakeholders at each stage of CSR management. Here we stress the main cross-sector, multi-issue initiatives that other companies can join rather than individual, commendable examples of CSR. Second, this overview gives priority to examples of good practice that emphasise the relationship of business with stakeholders, that is, how companies engage stakeholders in the implementation of CSR and report to stakeholders on CSR issues. Broader involvement of affected parties can make the management of CSR more cumbersome, but also more effective and credible. Third, by way of illustration only, when discussing implementation of CSR, we still exemplify with two areas: the management of supply chains and partnerships in the extractive industry. These areas have raised particularly pressing human rights issues for MNEs; most experience has accumulated in these areas and naturally they deserve a closer look. However this study deliberately avoids bringing concreteness to analysis by singling out violations of human rights in the extractive industry, as much analysis on human rights has done. It is easy to lose sight of the broader CSR picture and dynamics by becoming immersed in this specific context, with its 304

R. Mares (ed.), Business and Human Rights – A Compilation of Documents (Martinus Nijhoff Publishers, Leiden, 2004).

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Chapter 4 specific challenges and solutions. Therefore we prefer to highlight not only issues of compliance in the extractive industry, but also its contribution to good governance and development, and not only this industry, but also labour-intensive industries with long supply chains in developing countries. 4.3.1. Human rights impact assessments The decision of a business to deal with the CSR risks and opportunities in its environment is often, but not necessarily, formalised into codes of conduct. The implementation of such commitments is a multi-layered process, beginning with businesses assessing social impacts of their activities and understanding the human rights risks in their environment.305 Other stages in the management process are discussed in the following sections. Environmental and social impact assessments of large business projects have become common practice for leading corporations. Massive infrastructure projects, such as construction of dams or oil and gas projects, have increasingly undertaken environmental and social impact assessments. From the extractive industries, the Chad-Cameroon pipeline and the Baku-Tbilisi-Ceyhan (BTC) oil and gas pipeline project are good examples. The BTC project involves an international consortium of 11 partners lead by British Petroleum. BP publicly stated that it was critical to the project’s success that affected communities were actively involved in project planning. BP undertook steps to ensure that the more than 450 communities and 30,000 landowners and land users affected by the pipeline were consulted over a 20month period. No other extractive sector project has undertaken a broader or more extensive multidimensional assessment of its impact on surrounding communities.306 In a unique case, the UN Development Programme has undertaken a social impact assessment in China at the request of Shell, the representative of the international group of companies that have signed a joint venture framework agreement with PetroChina to develop the $8.5 billion West-East Pipeline Project, which is the backbone of China’s energy policy. According to a UNDP report completing a social impact assessment of the Project was a crucial internal factor in Shell’s decision to participate. Shell insisted on an assessment although it was not required under Chinese law. Despite enormous coordination and operational

305

For an overview of recent and ongoing developments, see United Nations High Commissioner for Human Rights Office, Human Rights Impact Assessments, Discussion Paper, 2006, <www.reports-and-materials.org/Discussion-paper-human-rights-impact-assess ments-Jul-2006.pdf>, visited on 14 February 2007. 306 United Nations Global Compact Office and the Office of the United Nations High Commissioner for Human Rights, Embedding Human Rights in Business Practice, 2004, pp. 69–70, <www.unglobalcompact.org/docs/issues_doc/human_rights/embedding.pdf>, visited on 14 February 2007.

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The stakeholder norm in business practice challenges, more than 10,750 people living along the 3,583-kilometre pipeline route were interviewed in less than four months.307 According to the International Petroleum Industry Environmental Conservation Association, a social impact assessment in the oil industry typically addresses issues such as: ƒ Demographics: Changes in size and make-up of population due to migration of people in search of work, emigration from an area as the result of safety or security issues or any other reasons. ƒ Socio-economic: Taxes and royalties, local sourcing opportunities, potential inflationary impacts on local markets for goods and services, impact on non oil and gas sectors; labour practices; changes in existing industries as workers shift from traditional industries to oil and gas activities, movement of other necessary workers (e.g. teachers and police) into the oil and gas industry (as translators or security personnel), potential oil and gas dependency. ƒ Health: Spread of diseases to or from indigenous communities, impacts on health of operations personnel. ƒ Social infrastructure: Adequacy of health care and education facilities, transport and roads, power supply, fresh water supply to support project activities and personnel as well as the community. ƒ Resources: The taking of land for facilities and resettlement, new or increased access to rural or remote areas. ƒ Psychological and community aspects: Changes from traditional lifestyles, community cohesion, perception of risk, sites with historical, religious, cultural or aesthetic values. ƒ Social equity: Identifying who gains and who loses as a result of the project or operation.308 There is a case not only for having an impact assessment, but a participatory impact assessment. The point is made by the case of the footballs industry in Sialkot, Pakistan. The multistakeholder partnership aimed at eliminating child labour is one of the more widely known examples of CSR. A child-labour-free production arrangement was the effect of this CSR initiative; over 1,000 stitching centres have been organised by local football manufacturers in both urban and rural Sialkot, with 20,000 stitchers. The centres are monitored. The initiative generated both positive and negative outcomes. On the positive side, child labour was eliminated, better working conditions were created, children and families benefited from the improved education system and income-generation programmes. On the negative side, the project resulted in lower aggregate family income as adults (largely male) replaced 307

J. Barsky, ‘Social Impact Survey of Gas Pipeline in China’, in UNDP and the Private Sector – Building Partnerships for Development (UNDP, 2004) pp. 30–34. 308 The International Petroleum Industry Environmental Conservation Association, A Guide to Social Impact Assessment in the Oil and Gas Industry, 2004, p. 5, <www.ipieca.org/down loads/social/SIA_Document_Final.pdf>, visited on 14 February 2007.

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Chapter 4 the family as the producing unit, a widened gap between already better-off football stitchers and the marginalised football stitchers (semiskilled, part-time, seasonal and those who live in remote areas lost their income-generating opportunities). The lesson learned from this case study, according to its authors, is the need for a participatory social impact assessment to ensure that positive socio-economic impacts outweigh the negative impacts.309 IPIECA also considers that “[s]takeholder engagement underpins the [social impact assessment] process. It is critical that stakeholder engagement takes place early and often. This allows stakeholder input to be considered in the project design, planning and implementation … Consultation is one of the most commonly used elements of stakeholder engagement. Consultation makes local communities aware that information is sought to mitigate future impacts and identify opportunities for improvements in social and economic conditions. Legislation can often dictate consultation requirements in project planning processes and [environmental impact assessment] studies … Initial public consultation is often used to assist in stakeholder analysis to ensure that no relevant groups are excluded and to develop culturally appropriate and effective engagement with relevant groups.”310

The Danish Institute for Human Rights took up in 1999 the task of developing a comprehensive ‘human rights compliance assessment’ tool and released it in 2005.311 It contains approximately 350 questions and 1,000 indicators that are drawn from all major human rights instruments, including the Universal Declaration of Human Rights, the two International Covenants on civil and political rights and economic, social and cultural rights and the most important conventions of the International Labour Organization. It was developed with the participation of some large businesses (e.g. Shell) and helps companies identify the human rights risks to which they are exposed due to a turbulent social environment and/or because of lacking internal management systems. 4.3.2. Management systems In this section we first refer to general CSR guidelines on internal management systems; then we concentrate on the implementation process in two settings: supply chain management in labour intensive industries, and partnerships for compliance and development undertaken by the extractive industries.

309

B. A. Kazmi and M. Macfarlane, ‘Elimination of Child Labour – Business and Local Communities’, in Sullivan, supra note 19, pp. 192–196. 310 International Petroleum Industry Environmental Conservation Association, supra note 308, p. 8. 311 Danish Institute for Human Rights, supra note 21.

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The stakeholder norm in business practice A. General CSR guidelines Public interest organisations assess corporate commitment to CSR not by taking statement of intentions at face value, but by looking at their implementation through management systems. Thus Amnesty International stated: “The key indicators of the extent to which human rights policies are embedded in corporate structures and strategies will be found in the attitude of the company’s leadership, in its core business principles, in internal communication, in training programmes, in management information systems and in the internal audit function.”312 States also have sent strong signals regarding the desirability of various management systems by linking policies, regulation and judicial settlements to the effectiveness of these systems.313 The OECD noted that “[i]mplementing a corporate compliance programme can be a formidable task requiring considerable managerial know-how. Normally all aspects of the firm’s operations will be affected – structure of responsibilities, hiring, record keeping, incentive systems, external communications, training, production, legal services, emergency preparedness, etc.”314 An effective management system is built incrementally by taking into account numerous factors: “It is common for companies to build and implement a CSR management and reporting system over a number of years. This incremental approach is particularly common in larger companies or in those with diverse business units in terms of activities and/or geographic locations … The timeframe for implementation of a CSR management and reporting framework or system will vary from company to company, and across individual business units, depending on the: ƒ ƒ ƒ ƒ

Size and diversity of activities; Management structure; Other ongoing management activities and priorities; Stability of the organisation (i.e. occurrence of mergers, divestments, acquisitions); ƒ Extent of existing CSR management and reporting processes; ƒ Effectiveness of these existing processes; and ƒ Level of the company’s ambitions for CSR.”315

The detailed elements of an effective CSR management system can be ascertained from law but especially from CSR guidelines and best corporate practice. A multitude of instruments have been developed recently to assist with the setting up of managerial systems that are able to account for environmental and social impacts.

312

Amnesty International, Human Rights Guidelines for Companies, <www.amnesty.org.uk/ business/pubs/hrgc.shtml>, visited on 14 February 2007. 313 See infra section 5.3., on how regulators have defined an effective management system. 314 OECD, Corporate Responsibility: Results of a Fact-Finding Mission on Private Initiatives, 2001, p. 12, <www.oecd.org/dataoecd/45/28/1922698.pdf>, visited on 14 February 2007. 315 FORGE Guidance, supra note 23

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Chapter 4 The SIGMA guidelines were developed since 1999 by the British Standards Institution, Forum for the Future and AccountAbility, with the support of the British Department of Trade and Industry. The SIGMA Management Framework, launched in 2003, is modelled on approaches widespread in formal and informal management systems based on the ‘plan, do, check, act’ model. The SIGMA Management Framework is a step-by-step guide with four implementation phases: a leadership and vision phase, a planning phase, a delivery phase and ultimately a review, feedback and reporting phase. The guidelines consist of a set of principles that help organisations to understand sustainability and their contribution to it; a management framework that integrates sustainability issues into core processes and mainstream decision-making; and a series of targeted tools and approaches to help with specific management challenges. The SIGMA Guiding Principles consist of two core elements: the holistic management of five different types of capital [natural capital, human capital, social capital, manufactured capital and financial capital] that reflect an organisation’s overall impact and wealth (in the broadest sense); and the exercise of accountability, by being transparent and responsive to stakeholders and complying with relevant rules and standards.316 SIGMA believes that these two core elements combined best reflect an organisation working towards sustainable development. The FORGE Guidance on Corporate Social Responsibility Management and Reporting for the Financial Services Sector, launched in 2002, has been developed by eight financial services companies (CGNU, Abbey National, Barclays, Legal & General, Lloyds TSB, Royal Bank of Scotland, Royal & SunAlliance and Zurich Financial Services) supported by three British government departments (DEFRA – Department for Environment, Food and Rural Affairs, DTI – Department of Trade and Industry and DFID – Department for International Development) and in consultation with seven stakeholder organisations. The FORGE Guidance is supported by the British Bankers’ Association and the Association of British Insurers. The Guidance provides thoroughly detailed advice for financial service companies on how to develop a CSR management and reporting framework (their own systems rather than those of the companies they invest in). It identifies the key steps and provides ‘tips’ to assist in understanding each stage and achieving implementation: Stage 1: Complete a strategic review of the business case Stage 2: Prepare business case and obtain Board approval Stage 3: Design governance arrangements Stage 4: Complete a detailed CSR review to identify priority CSR impacts, risks and opportunities Stage 5: Prepare and begin implementation of stakeholder engagement plan Stage 6: Draft a CSR policy and/or specific CSR issue policies Stage 7: Design and develop the CSR management and reporting system 316

Sigma project, supra note 22, p. 3,13.

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The stakeholder norm in business practice Stage 8: Implement and operate the CSR management system Stage 9: Audit the management system Stage 10: Complete Board level review Stage 11: Prepare CSR reporting (internal/external).317 The FORGE Guidance further notes that “most organisations already have elements of a CSR management and reporting programme in place. For example, human resource management programmes, customer survey programmes, business risk assessment processes, procedures for identifying corrupt practices and eco-efficiency programmes. However, these elements are rarely well connected across the organisation and not recognised for their CSR contribution.”318

The Principles for Responsible Investment, issued in 2006, are the result of a process convened by the United Nations Secretary-General. Signatories undertake to promote, where consistent with their fiduciary responsibilities, environmental, social and corporate governance (ESG) issues that can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). Signatories undertake, among others, to incorporate ESG issues into investment decision-making, seek disclosure on ESG issues from companies, promote the Principles within the investment industry, work together with other signatories to enhance effectiveness and report on the implementation of Principles.319 The International Standards Organization is the main international body in the area of standardisation of management systems. The vast majority of ISO standards are highly specific to a particular product, material or process. However, both ISO 9000 (quality management systems) and ISO 14000 (environmental management systems) are known as generic management system standards, which means that the same standards can be applied to any organisation, large or small, whatever its product – including whether its ‘product’ is actually a service – in any sector of activity, and whether it is a business enterprise, a public administration or a government department.320 This work of ISO is especially relevant for our purposes as it has decided to develop a new series dealing with CSR (ISO 26000) and build on the 9000 and 14000 series. Wood commented on the relatively recent emergence of environmental management systems (EMSs) and related standardisation efforts:

317

FORGE Guidance, supra note 23, p. 26. Ibid., p. 27. 319 Principles for Responsible Investment, 2006, <www.unpri.org/principles>, visited on 14 February 2007. 320 International Organization for Standardization, Generic Management System Standards, <www.iso.org/iso/en/iso9000-14000/understand/basics/general/basics_3.html>, visited on 14 February 2007. 318

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Chapter 4 “Environmental management systems emerged as a distinct management tool in the late 1980s in the wake of several prominent environmental disasters including the chemical disaster at Bhopal, India and the Exxon Valdez spill in Alaska … By the early 1990s many firms based in the advanced industrialized countries supported the development of uniform standards for EMSs to enable comparability and create a level playing field for trade. Standardization bodies in several jurisdictions took up this challenge and began to develop voluntary EMS standards. The first national EMS standard to be published was the British Standards Institution’s BS 7750 standard, in 1992. The European Community followed shortly with its own voluntary Eco-Management and Audit Scheme (EMAS) in 1993. EMAS took effect in 1995, whereupon existing national standards, including BS 7750, were withdrawn by member countries … [T]he ISO 14000 series, quickly emerged as the most prominent EMS standardization initiatives.”321

The ISO 14000 series was published starting in 1996 and since then it has been updated, last time in 2004. The ISO 14001 standards for environmental management systems offer guidance on EMS based on thousands of firm-level case histories. According to this benchmark, a business (a plant) must take the following EMS steps to achieve ISO certification: ƒ Perform an initial managerial review to identify environmental issues of concern, such as excessive use of polluting inputs and the potential for a serious environmental accident; ƒ Establish priorities for action, taking into account factors such as local environmental regulations and potential costs; ƒ Establish an environmental policy statement, signed by the CEO, that includes commitments to compliance with environmental regulations, pollution prevention, and continuous improvement; ƒ Develop performance targets based on the policy statement (such as reduction of emissions by a set amount over a defined period); ƒ Implement the environmental management system (EMS) with defined procedures and responsibilities; and ƒ Measure performance and conduct management audits. In June 2004, at its conference in Stockholm, the ISO decided, after two years of research and consultations, to develop an international standard on social responsibility. 322 The process for developing a CSR instrument will take ISO three years, with publication expected in early 2008. ISO plans to launch “a guidance document, written in plain language which is understandable and usable by nonspecialists, and not for a specification document intended for conformity 321

S. Wood, ‘Environmental Management Systems and Public Authority in Canada: Rethinking Environmental Governance’, 10 Buffalo Environmental Law Journal (Fall 2002– Spring 2003) p. 136. 322 ISO Technical Management Board, Social Responsibility, resolution 35/2004, 2004.

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The stakeholder norm in business practice assessment.”323 As the ISO states on its website, its standards are market-driven: “In order to use resources most efficiently, ISO only launches the development of new standards for which there is clearly a market requirement.”324 ISO Secretary-General Alan Bryden commented: “ISO’s decision is based on a thorough analysis of trends and initiatives relating to social responsibility and the active involvement of all interested groups of stakeholders.”325 Kofi Annan wrote on the occasion: “Let me also commend ISO for broadening the scope of its work in the area of social and environmental performance. In this way, too, you are making an important contribution towards a more sustainable world. I welcome, in particular, ISO’s recent decision to develop a standard on social responsibility – an initiative which dovetails well with the universal principles of the UN Global Compact on human rights, labour conditions, the environment and anti-corruption.”326

Webb observes that ISO 9000 quality and ISO 14000 environmental management systems standards lay out the intellectual groundwork for ISO 26000 corporate responsibility management system standards (CR MSSs). However, the new ISO standards will have unique features compared with ISO 9000 and 14000: “[A]t the firm level, the meaningful involvement of a firm’s full range of stakeholders in both articulation of a firm’s substantive CR commitments, and in implementation (including monitoring and verification) is essential to the success of a firm’s CR approach … [T]his need for involvement of a diverse range of external stakeholders who do not necessarily have a commercial relation to the firm is quite different from conventional quality and environmental MSSs.” 327

The involvement of stakeholders is expected to add credibility to self-declarations of compliance with the forthcoming ISO standard. Where a firm “fully involves its affected stakeholders in articulation and implementation of its CR approach, and communicates both this involvement and the firm’s performance in meeting its CR objectives to 323

Ibid. International Organization for Standardization, Overview of the ISO System, <www.iso.org/iso/en/aboutiso/introduction/index.html>, visited on 14 February 2007. 325 ISO to go ahead with guidelines for social responsibility, ISO Press Release 924, 29 June 2004, <www.iso.org/iso/en/commcentre/pressreleases/archives/2004/Ref924.html>, visited on 14 February 2007. 326 International Organization for Standardization Makes Unique Contribution in Vital Areas of Health, Safety, Environment, Secretary-General Says, SG/SM/9492, 22 September 2004, <www.unis.unvienna.org/unis/pressrels/2004/sgsm9492.html>, visited on 14 February 2007. 327 K. Webb, Standards as a Mechanism for Corporate Social Responsibility, ISO COPOLCO Workshop on CR, Trinidad and Tobago, 2002, p. 6, <www.iso.org/iso/en/commcentre/ presentations/wkshps-seminars/copolco/copolco2002/cop2002proceedings/cop2002_7Kerna ghanWebb.pdf>, visited on 14 February 2007. 324

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Chapter 4 its stakeholders and the broader community, its communications on CR matters should carry considerable weight. If these conditions are met, self-declarations by firms about compliance with ISO CR MSSs are likely to be credible.”328

The standard (guidance document) can be implemented at different levels ranging from facility-level to corporate level: “[S]ome say that if the ISO 9000 or 14000 experiences are any indication, there would appear to be value in adopting the facility by-facility application model also for SR, but this does not rule out other approaches, including on particular product lines or at the corporate level (i.e. all-ornone of the facilities). Some [Advisory Group on Social Responsibility] members believe that, independent of the existence of a standard, SR is most relevant and should be applied at the facility level. This is also consistent with the need to fine-tune SR programs to suit local conditions. Nevertheless, a multi-level implementation approach can probably not be avoided. If the facility level corresponds to certain needs, a national level is often required to implement social policies, and the international level is required by SR investors who are interested in global/international results.”329

A stricter counterpart to the ISO 14000 is the EU Eco-Management and Audit Scheme. EMAS is a EU scheme that has been available to companies for voluntary participation since 1995.330 Under EMAS a company is expected to: 1. conduct an environmental review considering environmental impacts, regulatory framework, and existing industry practices. 2. “in the light of the results of the review, establish an effective environmental management system aimed at achieving the organisation’s environmental policy defined by the top management. The management system needs to set responsibilities, objectives, means, operational procedures, training needs, monitoring and communication systems.”331 3. carry out an environmental audit (assessing the management system and legal compliance). 4. provide a statement of its environmental performance (results achieved and future steps to improve performance).332 328

Ibid., p 7. ISO Advisory Group on Social Responsibility, supra note 303, para. 317. 330 Council Regulation (EEC) No. 1836/93 of 29 June 1993. It was revised in 2001 through Regulation (EC) No. 761/2001 of the European Parliament and of the Council of 19 March 2001 Allowing Voluntary Participation by Organisations in a Community Eco-Management and Audit Scheme (EMAS), Official Journal L 114 , 24/04/2001, pp. 1–29, <europa.eu.int/eurlex/pri/en/oj/dat/2001/l_114/l_11420010424en00010029.pdf>, visited on 14 February 2007. 331 <europa.eu.int/comm/environment/emas/about/summary_en.htm>, visited on 14 February 2007. 332 Ibid. 329

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The stakeholder norm in business practice Companies could make an exclusively in-house effort by setting up internal systems to avoid CSR risks. There would be no participation in collective self-regulatory efforts (at industry level), no public reporting (CSR reports), no involvement of external monitors, donations rather than joint efforts using partnerships for development (focused on poverty alleviation) and no participation in multistakeholder fora that shape the CSR agenda (such as the UN Global Compact). This go-alone, low profile strategy for managing CSR risks may be defendable, at least for a while. This reasoning notwithstanding, companies soon go public and cooperate with various stakeholders for two main reasons: to access expertise, and to obtain credibility from external participation or review. The idea is well captured by the International Cocoa Initiative: “In fashioning a long-term solution, the problemsolving process should involve the major stakeholders in order to maximize both the credibility and effectiveness of the problem-solving action plan that is mutuallyagreed upon.”333 The GAP has also recently reached out to its stakeholders by publishing its first CSR report (2004) and joining schemes such as the UN Global Compact, the US-based Social Accountability International and the UK-based Ethical Trading Initiative. Previously GAP concentrated on internal monitoring of its suppliers for adherence to its code of conduct. GAP has been very much doing things on their own and have attracted quite a lot of criticism for not engaging.334 In its report the GAP explains its changed strategy: “Retailers, manufacturers, governments, unions and NGOs must work together more effectively to create a stronger framework … In the past few years, we have begun to broaden our focus beyond monitoring, recognizing the need for broader stakeholder engagement and capacity building to more fully address issues in the garment industry longer term … We are convinced that collaborative, multi-stakeholder engagement is the only way to create sustainable change industry-wide. That’s why we’ve been expanding our global partnerships and significantly broadening our work with outside groups.”335

The next sections look more closely at the implementation process in two contexts: labour intensive industries336 and extractive industries.337 Thus we discuss issues of 333

The International Cocoa Initiative, Protocol for the Growing and Processing of Cocoa Beans and their Derivative products In a Manner that Complies with ILO Convention 182 Concerning the Prohibition and Immediate Action for the Elimination of the Worst Forms of Child Labor, 19 September 2001, p. 1, , visited on 14 February 2007. 334 Dan Rees, Ethical Trading Initiative’s director quoted in A. Maitland and S. Murray, ‘The trouble with transparent clothing’, Financial Times, 12 May 2004. 335 GAP Inc., Social Responsibility Report 2003, 2004, pp. 2–4, 7, , visited on 14 February 2007. 336 For good overviews of human rights issues in labour intensive industries, see R. Casey, Corporate Social Responsibility Initiative, Meaningful Change - Raising the Bar in Supply Chain Workplace Standards, Working Paper No. 29, 2006, <www.ksg.harvard.edu/m-

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Chapter 4 supply chain management, and partnerships for compliance and development. Special emphasis will be placed on multistakeholder initiatives. B. Specialised guidelines on supply chain management The buyer companies in the North may come to accept a twofold moral responsibility: first a ‘negative obligation’ to abstain from causing labour abuses down the supply chain, and second a ‘positive obligation’ to monitor suppliers for compliance with labour rights. Regarding the negative obligation, a recent report highlights some pressures that buyers exert on suppliers in order to shorten delivery times and better adapt product characteristics to changing consumer demands: “Almost all supply chains seem to be under continual pressure to produce goods faster. In some cases, this is to enable design decisions to be taken as near to product launch dates as possible and so that product volumes can be altered at short notice in accordance with up-to date stock and sales data. This tendency is particularly pronounced in manufacturing and retailing apparel, footwear, home-ware and gifts, and in other sectors that produce for markets driven by rapidly changing consumer trends. In other sectors – for example automotive and electronics – this pressure is a consequence of ever-shorter product development cycles. Similar effects are also observed in fresh produce, but in this case, shortening the time between farm and plate is related principally to retailers’ attempts to deliver higher standards of quality and freshness … Also buyers often deliberately defer a decision until the last possible minute in order to understand better what their competitors might do and to reflect exactly current consumer demands … This manifests as a constant drive for ‘perfection’. Participants quoted many examples of final samples of products being subject to revisions, even after production is underway or (in one case) entirely complete.”338

As a result the supplier’s production time is being dramatically squeezed, and this situation can lead to suppliers hiring short-term labour, working excessive hours, enforcing mandatory overtime and/or outsourcing.339 In a similar vein Pentland observes that “any delayed decisions or inefficiencies at our end can have huge negative effects in the factory”, especially overtime. The rcbg/CSRI/publications/workingpaper_29_casey.pdf>; R. Locke et al., Does Monitoring Improve Labor Standards?: Lessons from Nike, MIT Sloan Working Paper No. 4612-06, Massachusetts Institute of Technology, Sloan School of Management, 2006, <www.reportsand-materials.org/Does-Monitoring-Improve-Labor-Standards-July-2006.pdf>, visited on 14 February 2007. 337 For a good overview of the context of oil exploitation in the leading oil-producer in Africa, Nigeria, see U. Idemudia and U. E. Ite, ‘Demystifying the Niger Delta Conflict: Towards an Integrated Explanation’, 33:109 Review of African Political Economy (2006) pp. 391–406; See also relevant literature at supra note 19. 338 Insight Investment, supra note 301, p. 24. 339 Ibid.

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The stakeholder norm in business practice solutions include giving more control to factories on buying raw materials, and encouraging suppliers to query requests and say ‘no’ clearly (account for cultural differences).340 In a review of its own performance, Nike concluded that half the instances of serious non-compliance on the part of suppliers can be traced back to its own decisions. Ruggie noted that “[c]apacity building in the supply chain is desirable and necessary, but it won’t take care of brand-induced problems”, such as flexible production, fast turnaround, surge orders, changed orders, etc.341 The positive responsibility of the buyer company to monitor its suppliers, on which this study concentrates, raises a different managerial challenge than the case above. The buyer is expected to exercise its influence, if any, to redress abuses in geographically remote workplaces in the South. It is challenging to design effective and cost-efficient management systems in these conditions. The supplier (often a sub-contractor or even a home worker) has to respond through its management processes to a more limited challenge of managing solely its own workers within its own workplace. This is not to underrate the difficulties suppliers face, some of them already mentioned and others to be discussed in this section. However monitoring the own workplace is less open-ended than monitoring a vast network of suppliers. Here we discuss only the systems that the buyer company implements to monitor and support suppliers for compliance with labour rights. The OECD’s Business and Industry Advisory Committee has identified some structural challenges to the management of supply chains and the implementation of codes; they have to do with some peculiarities of business relationships. ƒ Companies that purchase commodities as raw material for their products buy such goods in middle markets, and not from the farms or factories that produce the goods. Commodity markets have hundreds or thousands of small producers feeding into it, making it virtually impossible to identify the supply chain. ƒ Companies in some sectors have thousands of suppliers and supply chains that are both complex and deep. These enterprises may be able to communicate corporate responsibility principles to a limited number of suppliers with which they have direct relations, but cannot feasibly communicate them to all indirect suppliers deeper in the supply chain. ƒ Many businesses rely on short-term contracts with suppliers and change suppliers frequently. ƒ Some companies’ purchases represent a small portion of a particular supplier’s output, leaving the customer with very limited influence over the supplier’s operations. In such cases, the customers may be able to communicate its policy, but will find it difficult to demand observance.

340

Pentland, supra note 300. J. G. Ruggie, Remarks Delivered at Forum on Corporate Social Responsibility, Bamberg, Germany, 14 June 2006, <www.reports-and-materials.org/Ruggie-remarks-to-Fair-LaborAssociation-and-German-Network-of-Business-Ethics-14-June-2006.pdf>, visited on 14 February 2007; see also Locke, supra note 336. 341

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Chapter 4 ƒ

Suppliers owned by government (e.g. public utilities) can be extremely difficult to influence by private companies.342

There are two ways a buyer can stimulate improvements in suppliers’ compliance. The easier way, from a managerial viewpoint, is to buy certified goods. It is the task of the suppliers themselves to raise their own standards and apply for certification from independent specialised organisations, such as those accredited by the ISO. The responsibility of the buyer then is simply to give preference to certified goods and to likely pay a higher price for them. The buyer thus creates a powerful incentive. More often though there is no certification infrastructure available. Then the buyer has to implement a monitoring system, which is a far more demanding undertaking compared with buying certified goods. Here the buyers’ employees or independent monitors conduct inspections and make assessments on workplace conditions in hundreds and thousands of suppliers and subcontractors. This often entails that buyers work together with suppliers to raise standards (offer training, make longer-term commitments that reduce flexibility, terminate contracts if CSR expectations are not fulfilled, etc). Below I refer to the main elements of management systems adopted by buyers as they are specified in a supply chain context. A report by Insight Investment notes that despite variations across companies and across sectors, the general approach to the management of labour standards is common: 1. 2.

3. 4.

5.

6.

Devise a code of conduct. Carry out a risk assessment: This is generally a desk-based assessment to determine which suppliers are most likely to contravene any of these standards. Train staff. Carry out ethical audits: This involves visiting suppliers’ production facilities, interviewing management and workers and assessing their compliance with the code of conduct. Audits can either be done by internal staff (typically product technologists or quality representatives) or by external specialists. Draw up improvement plans: On the basis of the audit results, a list of suggested improvements is drawn up for the supplier to implement in order to meet the required ethical standard. Ideally the buying company works with the suppliers to help them achieve the required standards. Report publicly.343

Here we refer less to internal monitoring/audit, but to multistakeholder schemes in which buyer companies participate and acquiesce to external monitoring/audit of 342 343

Business and Industry Advisory Committee, supra note 271, p. 4,5. Insight Investment, supra note 301, p. 19.

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The stakeholder norm in business practice their suppliers. This could be discussed in the later section that deals specifically with external audits. However, there is merit in presenting these multistakeholder schemes in a single place as they not only certify auditors that would inspect suppliers’ factories but also advise buyers on how to refine their policies and systems. We also highlight the reasoning of leading buyers that open up their monitoring process even further and involve workers’ representatives and local NGOs. The Fair Labor Association (FLA) is a US-based multistakeholder coalition of companies (currently 12 brand-name companies), 185 colleges and universities and NGOs. The FLA builds on the Apparel Industry Partnership (AIP). Back in 1996, President Clinton summoned a task force to examine labour issues in the overseas operations of American apparel companies. The AIP included US-based multinationals, like Nike and Levi Strauss, and NGOs, like the Robert F. Kennedy Foundation and the Lawyers Committee for Human Rights. In April 1997, the AIP established its Workplace Code of Conduct and its Principles of Monitoring. In November 1998, after the defection of many of its labour and NGO members, the AIP agreed to create the Fair Labor Association.344 It has issued a ‘workplace code of conduct’ that covers forced labour, child labour, harassment or abuse, nondiscrimination, health and safety, freedom of association and collective bargaining, wages and benefits, hours of work and overtime compensation.345 Any company that adopts the Workplace Code of Conduct shall require its licensees, suppliers and contractors to comply with applicable local laws and with the Code, and to apply the higher standard in cases of differences or conflicts. The FLA accredits monitors to conduct independent external monitoring of facilities used by member companies. Since 2003 the FLA has issued annual public reports on companies’ efforts to fulfil FLA requirements, including non-compliance findings of each independent external monitoring. The FLA has instituted a ‘thirdparty complaint’ system through which any individual or group – such as a community organisation, NGO, union or relative of a worker – may report a FLA Code violation at a factory that manufactures products for an FLA-affiliated company. This procedure is designed to offer a confidential channel to report serious violations of the FLA Code. FLA staff will investigate complaints, and a mediation procedure can be initiated by the FLA executive director to resolve the problem.346 Through its ‘Principles of Monitoring’, the FLA lays down obligations for the buyer company which is expected to:

344

M. Gillen, ‘The Apparel Industry Partnership’s Free Labor Association: A Solution to the Overseas Sweatshop Problem or the Emperor’s New Clothes?’, 32 NYU School of Law Journal of International Law and Politics (2000) p. 1062. 345 Fair Labor Association, Workplace Code of Conduct, <www.fairlabor.org/all/code/ index.html>, visited on 14 February 2007. 346 Fair Labor Association, First Public Report: Towards Improving Workers’ Lives, 2003, p. 137, <www.fairlabor.org/all/transparency/charts_2002/Public%20Report%20Y1.pdf>, visited on 14 February 2007.

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Chapter 4 A. Establish clear standards. This step requires the buyer to adopt written workplace standards; to formally convey its standards to suppliers; to receive written certifications from suppliers that standards are being met, and that employees have been informed about the standards; to obtain written agreement of suppliers to submit to periodic inspections and audits, including by accredited external monitors; B. Create an informed workplace by informing and educating employees about the standards; C. Develop an information database by having suppliers complete questionnaires; D. Establish programs to train company monitors; E. Conduct periodic visits and audits. Company monitors are to conduct periodic announced visits to an appropriate sampling of factories, and perform periodic audits of records and practices; F. Provide employees with opportunity to report non-compliance; G. Establish relationships with labor, human rights, religious or other local institutions; H. Establish means of remediation. This entails work with suppliers to correct instances of noncompliance and to take steps to ensure that such instances do not recur. 347 Social Accountability International (SAI) is a US-based, non-profit organisation dedicated to the development, implementation and oversight of voluntary, verifiable, social accountability standards. Its standard, the SA8000, was launched in 1998 and is based on international workplace norms in the ILO conventions and the UN’s Universal Declaration of Human Rights and the Convention on Rights of the Child.348 The SAI offers two options: certification of suppliers according to the SA8000 standard, and involvement of buyers through the ‘Corporate Involvement Program’ (CIP). Regarding certification, the SAI does not itself audit factories or farms but it accredits/licenses qualified auditors to certify workplace compliance. SAI accreditation ensures that auditors have the procedures and resources needed to conduct thorough and objective audits. There are currently nine organisations accredited to provide SA8000 certification. Since the SA8000 system became fully operational in 1998, facilities in 30 countries on five continents and across 22 industries have been certified. The Corporate Involvement Program provides buyers (e.g. retailers, brand companies, wholesalers, sourcing agents) with the tools they need to go from evaluation to implementation to external communication. There are two levels of involvement. The first – ‘SA8000 Explorer’ – assists buyers to evaluate SA8000 as an ethical sourcing tool via training, pilot audits, technical assistance and sharing 347

Fair Labor Association, Monitoring Guidance, Version 1.1, p. 45, <www.fairlabor.org/ docs/monitoring.pdf>, visited on 14 February 2007. 348 <www.sa-intl.org>, visited on 14 February 2007.

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The stakeholder norm in business practice best practices. The second – ‘SA8000 Signatory’ – helps buyers to develop and execute a plan to work towards certification of designated supplier facilities. Buyers are also expected to communicate progress to stakeholders via SAI-verified annual reports. Then signatories may use the SA8000 logo to have credible communications with stakeholders. The German retailers association, AVE, and the German government have initiated a project in textile industry that aims to install a system to audit the social performance of suppliers producing for German retailers. The system covers 12 countries and is based on the SA8000 with all auditing companies being accredited by Social Accountability International to guarantee independent, transparent and credible audits of the working conditions.349 The UK-based Ethical Trading Initiative (ETI), founded in 1998, is an alliance of companies, NGOs and trade union organisations working to promote and improve the implementation of corporate codes of practice which cover supply chain working conditions. ETI has adopted its Base Code that is accompanied by Principles of Implementation.350 ETI had 37 member companies at the end of 2004. The UK Department for International Development provides 40 per cent of ETI’s funding. NGOs, trade unions and corporate members work together to identify what constitutes ‘good practice’ in code implementation, and then promote and share this good practice. For companies, ETI offers practical guidance on how to manage and implement an ethical sourcing strategy. In addition ETI offers a safe forum for debate, the opportunity to learn from the leaders, the chance to develop new contacts with NGOs and trade unions in the UK and overseas, and the opportunity to join forces with other companies to strengthen impact. “Member companies accept the principle that the implementation of codes will be assessed through monitoring and independent verification; and that performance with regard to monitoring practice and implementation of codes will be reported annually.”351 As a difference from SAI and FLA, the ETI does not issue ‘ethical trade’ certificates or labels to any company. Approaches to monitoring vary, as the Fair Labor Association notes in its 2003 report. Some companies monitor 100 per cent of their manufacturing facilities, some others target monitoring at the highest volume producers, and still others target internal monitoring based on a risk assessment. For example, Adidas-Salomon has targeted those facilities that had a higher risk of being noncompliant based on

349

BMZ, ‘Lessons Learned from Multi-Stakeholder CSR-Initiatives Supported by German Development Cooperation’, in Development Cooperation and Corporate Social Resposibiblity –Exploring the Role of Development Cooperation Agencies, Appendix 2: How Donor Agencies Are Aupporting and Enabling Corporate Social Responsibility, 2004, p. 6, <www.regeringen.se/content/1/c6/02/18/54/37a8a0e1.pdf>, visited on 14 February 2007. 350 Ethical Trading Initiative, The Base Code, <www.ethicaltrade.org/Z/lib/base/code_ en.shtml>, visited on 14 February 2007. 351 Ethical Trading Initiative, The Base Code, Principles of Implementation, para. 2.1. <www.ethicaltrade.org/Z/lib/base/poi_en.shtml>, visited on 14 February 2007.

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Chapter 4 assessments of country risk factors or factory-specific characteristics reported by Adidas staff.352 The Gap explained its approach to assessing when suppliers are deemed to be in compliance: “For long-term improvement of working conditions, we believe our monitoring will be more effective when we can assess how factories perform over time. Compliance isn’t just about the issues we identify during a visit, but the types of violations, how quickly they are resolved and how often they are repeated. In 2002, we developed a tool to help us assess a factory’s overall level of compliance through quantifiable metrics. The current rating tool rates factories according to the number, type and pattern of compliance violations during a 12-month period. Rating factories is harder than it sounds. It requires us to make subjective decisions about the relative importance of different social issues.”353

Termination of the contract for non-compliant suppliers is often seen as an effective sanction for non-compliant suppliers and referred to in some codes of conduct and contracts. It is an extreme measure that needs to be preceded by remediation schedules and support for suppliers to move them toward compliance. For example, under the Ethical Trading Initiative, “[m]ember companies commit themselves, on the basis of knowledge gained from monitoring to (a) negotiate and implement agreed schedules for corrective actions with suppliers failing to observe the terms of the code, i.e. a continuous improvement approach; (b) require the immediate cessation of serious breaches of the code; and (c) where serious breaches of the code persist, to terminate any business relationship with the supplier concerned.”354

This top-down system of monitoring with the buyer conducting comprehensive and costly inspections can soon reach its limits. Leading buyers have recently attempted to make their systems more effective and cost-efficient by reaching out to other companies or to NGOs and trade unions. One avenue is to cooperate with other buyers that source from the same supplier. The Gap explained in its first CSR report: “Most garment manufacturers work with many customers. Our influence on a given manufacturer’s practices is limited when we represent only a fraction of its production. So, in 2002, we initiated a strategy to collaborate with partners worldwide in an effort to foster longer-term solutions.” 355 A 2003 ILO study has observed nascent acts of industry cooperation despite the hesitance instilled by anti-trust concerns. Thus compliance teams from different buyers have met to discuss differing standards in an effort to reduce 352

Fair Labor Association, supra note 346, p. 16. GAP Inc., supra note 335, p. 16. 354 Ethical Trading Initiative, supra note 352, para 4.1. 355 GAP Inc., supra note 335, p. 8. 353

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The stakeholder norm in business practice confusion. In a similar case an NGO has organised a buyers compliance group which met in Hong Kong about four to six times per year to discuss issues relating to compliance in China primarily. A buyer’s representative commented: “We talk about issues we have in common, how we can leverage and how we can think creatively to create training programmes. This is very useful. We also pick up the phones and talk to each other. For example, if a factory has been failed by one brand and [our company] comes in and assesses it and it passes, we call to find out why. In this example the previous failure was due to a sub-contractor.”356 Since then more joint business action have been forthcoming. The Fair Factories Clearinghouse was set up to share information about factory audit and remediation to prevent wasteful duplication. This is a collaborative efforts of retailers, consumer brands and trade associations to which Reebok donated its human rights tracking system.357 Another avenue is to enhance the role that trade unions (worker representatives) could play in monitoring factories. A growing number of buyers such as Reebok, Gap, Levi’s, Nike and Adidas are preoccupied to develop ‘autonomous monitoring systems’ for their suppliers. These can be seen as partnerships for compliance, and usually have occurred in the apparel/footwear industries. The reasoning behind this approach was aptly captured: “A legitimate, independent union is a compliance officer’s best friend. It’s like having a dozen of your best auditors in the factory. It removes the risk that the factory will embarrass the brand.”358 Along the same lines Reebok has defined their current priorities in light of their experience with top-down monitoring: “While monitoring has done much good, we cannot be in all factories at all times. The most sustainable method of ensuring decent workplace conditions is to facilitate the participation of workers in protecting their own rights. Therefore, our current priority is to augment our monitoring with worker participation projects. These projects seek to create the capacity for making ongoing improvements in workplace conditions in the factories themselves. They also seek to ensure workers are part of finding problems and solutions in dialogue with management. For example, we are launching innovative projects that promote workers’ rights to freedom of association, particularly in China … We actively seek collaborations with non-governmental organizations to help us better address the complexity of regional or local labor conditions.”359

356

Mamic, supra note 19, p. 157. <www.fairfactories.org>. See also Reebok, Disclosure of Factories, 2006, <www.reebok.com/Static/global/initiatives/rights/pdf/ReebokHR_FactoryLists.pdf>, visited on 14 February 2007. 358 Cornell’s ILR School, Rocks and Hard Places, Seminar on Monitoring and Freedom of Association under Corporate Codes of Conduct, 2005, <www.ilr.cornell.edu/international/ news/080905_SummaryFreedomOfAssociation.html>, visited on 14 February 2007. 359 Reebok, Evolution of Our Standards And Priorities, <www.reebok.com/Static/global/ initiatives/rights/business/popup/evolution.html>, visited on 14 February 2007. (emphasis added) 357

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Chapter 4 In the same vein buyers have started to acknowledge the role that specialised organisations (e.g. professional auditors, civil society groups, experts) can play in monitoring. The GAP stated: “We have found that independent monitoring can complement our program. Independent monitors are respected members of the local community and enjoy credibility among factory workers. Because they visit fewer factories than our team does, they can focus more deeply on specific facilities, build a greater rapport with workers and discover problems that our team might miss on a given visit.”360 The presence of external, independent monitors is crucial to assuring that CSR policies are not window-dressing exercises. The aforementioned ILO research considers that a significant feature of emerging compliance management programs is the use of third party auditors. Their presence is justified not only by the added credibility they bring to monitoring. There are also considerations of feasibility: the choice between using third parties or using in-house staff appears to be based on the particular requirements of the factory location as well as the internal capabilities of the MNE. There is also a question of cost since third party auditors are usually more expensive than in-house auditors.361 In as much as labour issues are concerned, there can be tensions between NGOs and trade unions. The latter voice their concern that third-party monitoring displaces the monitoring function trade unions customarily assume in the workplace; that it is a paternalistic approach to workplace issues that disempowers workers. Still another strategy is to strive for self-regulation at industry level. The GAP for example supports “multistakeholder efforts currently under way to develop a universal code adopted and enforced by all apparel brands and retailers” because a “strong universal code, with consistent enforcement by all apparel brands and retailers, will promote more collaboration and result in more effective use of industry monitoring and compliance resources”.362 C. Specialised guidelines for the extractive industry Most human rights issues in the extractive industries arise either from the company being in a joint venture with the government that provides security to the project or from authorities misusing the large revenues generated by the industry. New partnership initiatives have sprung at both international and local levels to address these issues. The Kimberley Process The Kimberley Process (KP) Certification Scheme came into effect on 1 January 2003. African diamond-producing countries initiated the Process. Its main objective is to ensure that the proceeds from the sale in rough diamonds never again fuel armed conflicts; it also aims to protect the interests of the legitimate diamond

360

GAP Inc., supra note 335, p. 22. Mamic, supra note 19, p. 152. 362 GAP Inc., supra note 335, p. 2. 361

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The stakeholder norm in business practice industry and those who depend on it for their livelihoods.363 Back in 1998, two NGOs, Global Witness and Partnership Africa Canada, brought to the attention of the diamond industry and the world media that the illegal trade of rough diamonds was funding the activities of rebel organisations in Angola and Sierra Leone. The UN imposed comprehensive economic and political sanctions on Angolan rebels mining diamonds in Angola in June 1998. In May 2000 the South African government convened a meeting in Kimberley for all interested parties to meet and discuss a way forward. These meetings were primarily inter-governmental, but they invited the industry and NGOs to participate. What followed was a series of meetings, hosted by governments around the world, which came to be known as the Kimberley Process. In December 2000, all 191 members of the United Nations General Assembly voted unanimously to support the process.364 The Kimberley Process works to certify rough diamonds and eliminate them from international trade by prohibiting the exportation and importation of uncertified gems. To achieve this goal both governments and the industry are called upon to implement specific measures. Business has a facilitative role in the implementation of the scheme. Exporting states are to ensure that “each shipment of rough diamonds being exported and crossing an international border be transported in a tamper-resistant container and accompanied by a government-validated Kimberley Process Certificate”.365 As laid down in a KP’s document, “[t]he Exporting Authority should then transmit a detailed e-mail message to the relevant Importing Authority containing information on the carat weight, value, country of origin or provenance, importer and the serial number of the Certificate”.366 The situation in importing states presents a mixture of business self-regulation at industry association (or diamond bourse) level and supporting binding regulation. At one end of the spectrum, the American system is based largely on industry selfregulation; at the other end is the Belgian system where the bourses submit annual reports to the Belgian Ministry of Economic Affairs, which in turn submits an annual report to the European Commission. The details of the regulatory frameworks cannot be covered in the limited space available here;367 here we have to 363

Kimberley Process Chair’s Report to Plenary, Kimberley Process Plenary Meeting, Gatineau, Canada, 2004, p. 7, <www.kimberleyprocess.com:8080/site/www_docs/plenary_ meetings20/chair_report_to_plenary.pdf>, visited on 14 February 2007. 364 World Diamond Council, The Essential Guide to Implementating the Kimberley Process, 2003, p. 10, 11, <www.jvclegal.org/kimberely.pdf>, visited on 14 February 2007. 365 Ibid., p. 1. 366 Kimberley Process Certification Scheme, Essential Elements of an International Scheme of Certification for Rough Diamonds, with a View to Breaking the Link between Armed Conflict and the Trade in Rough Diamonds, Working Document No. 1/2002, Annex II, para. 19. 367 For an in-depth analysis, see Global Witness and Partnership Africa Canada, supra note 19; SOMO, The Kimberley Process Certification Scheme One Year Ahead: State of Affairs in the European Union, 2004, <www.somo.nl/html/paginas/pdf/Kimberley_Process_Full_ Report_2004_EN.pdf>, visited on 14 February 2007.

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Chapter 4 discuss the role that business has played in the development and the implementation of the Kimberley process. The KP outlined the ‘Principles of Industry Self-Regulation’ and provided that “a voluntary system of industry self-regulation … will provide for a system of warranties underpinned through verification by independent auditors of individual companies and supported by internal penalties set by industry, which will help to facilitate the full traceability of rough diamond transactions by government authorities”.368 The World Diamond Council noted that the System of Warranties is an industry-driven initiative that has been designed to complement and support the International Certification Scheme being developed by governments.369 From a business viewpoint this is done in order to “strengthen the credibility of the Kimberley Process agreement, as well as to provide the means by which consumers might more effectively be assured of the origin of their diamonds”. 370 Companies are expected not to buy any diamonds lacking warranty. In addition, “each company trading in rough and polished diamonds is obliged to keep records of the warranty invoices received and the warranty invoices issued when buying or selling diamonds. This flow of warranties in and warranties out must be audited and reconciled on an annual basis by the company’s own auditors … [It] will be considered a violation to issue a warranty declaration on a sales invoice unless it can be corroborated by warranty invoices received for purchases … As a minimum requirement, if asked by a duly authorized government agency, you must be able to demonstrate in an auditable manner that the diamonds contained in the shipment are covered by the necessary warranties. Every year, your auditor must be able to verify that you have maintained accurate and reconcilable records of warranties received and warranties given.”371

The industry bodies or bourses adopt their own codes of conduct which are compulsory for their members and carry with them the possibility of expulsion for non-compliant members: “Each member organization shall expel and publicize the expulsion of any members that after a due process investigation by the member’s trade organization have been found to be in violation of the above resolutions.”372 The Kimberley Process is backed by an international implementation mechanism. In the Process 43 states participate, including the European Community, which account for approximately 99.8 per cent of the global production of rough diamonds. There are three main ‘observers’: the World Diamond Council, representing industry, and Global Witness and Partnership Africa Canada, representing civil society. In 2003 the scheme strengthened its monitoring 368

The Kimberley Process Certification Scheme, supra note 366, section IV. The World Diamond Council, supra note 364, p. 12. 370 Ibid., p. 2. 371 Ibid., p. 7. 372 International Diamond Manufacturers Association and the World Federation of Diamond Bourses, Industry System of Self Regulation, 2002, pp. 1, 2, <www.kimberleyprocess.com: 8080/site/www_docs/related_docs1/wdc_resolution_0210.pdf>, visited on 14 February 2007. 369

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The stakeholder norm in business practice mechanisms: now states are to report on an annual basis on their implementation of the Scheme, on the basis of a uniform questionnaire agreed by Plenary, and encouraged to use the peer review system. While these visits will take place on a voluntary basis, the Plenary agreed that it would be “desirable for the largest number of Participants [States] possible to volunteer to receive a review visit” by 2006.373 The UN General Assembly welcomed the establishment of a peer review system and encouraged participating states to allow voluntary review visits.374 At the international level, the Kimberley Process is a political, not a legal, agreement. It is however enforced through legally binding national law.375 The Process raises issues of conformity with the WTO regime as its key provision is: “Each Participant should … ensure that no shipment of rough diamonds is imported from or exported to a non-Participant.”376 However the General Council of the WTO has granted a waiver in 2003 with respect to the measures taken to implement the Kimberley Process Certification Scheme.377 Extractive Industry Transparency Initiative The UK proposed the Extractive Industry Transparency Initiative at the 2002 World Summit for Sustainable Development in Johannesburg as a public-private initiative. The EITI is based on a simple idea: the host government reports its revenues from natural resources, the companies report the payments they made to the government, and an independent third party aggregates and analyses the data disclosed by the host government and the companies. As the EITI explains, “[a]longside other efforts to improve transparency in government budget practice, the EITI begins a process whereby citizens can hold their governments to account for the use of those revenues”.378 The initiative aims to develop reporting guidelines which are then adapted at country level by tripartite fora that reflect country-specific situations and requirements. The natural resources covered by EITI processes are limited to: metal ores (such as copper, gold, iron, nickel, lead, zinc, silver, tin and platinum); gemstones; crude oil and natural gas; and coal and industrial minerals. The EITI states:

373

Kimberley Process Plenary Meeting, Final Communique, 29–31 October 2003, p. 2, <www.kimberleyprocess.com:8080/site/www_docs/plenary_meetings13/1sun_city_final_co mmunique.pdf?PHPSESSID=17bc0e5689992802c924ee76436fbae1>, visited on 14 February 2007. 374 United Nations General Assembly, The Role of Diamonds in Fuelling Conflict: Breaking the Link between the Illicit Transaction of Rough Diamonds and Armed Conflict as a Contribution to Prevention and Settlement of Conflict, A/58/L.59, 5 April 2004. 375 Kimberley Process Chair’s Report to Plenary, supra note 363, p. 6. 376 Kimberley Process Certification Scheme, supra note 366, section III (c). 377 United Nations General Assembly, supra note 374, p. 3. 378 Extractive Industries Transparency Initiative, Source Book, 2005, p. 2, <www.eitransparency.org/docs/sourcebookmarch05.pdf>, visited on 14 February 2007.

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Chapter 4 “Implementation of the EITI is the responsibility of the resource-rich country concerned. However, the EITI recognises that companies also have a critical role to play in ensuring that the objectives of the EITI are achieved … At the national level, the EITI is a government-led initiative. However, the EITI Principles and Criteria call for the active involvement of other partners from wider society. Broad local leadership and participation are essential, and active public engagement from a range of stakeholders will be required … A stakeholder is defined as an individual, community, group or organisation with an interest in the outcome of the EITI, including both those who are affected by it (positively or negatively) and those who are able to influence it (in a positive or negative way). Stakeholders will be drawn from within state institutions, the private sector and civil society.” 379

A country will be implementing the EITI when it “can demonstrate that – with the full engagement of key stakeholders – there is a regular cycle of disclosure, dissemination and discussion on extractive industry revenues … A review of EITI implementation may, for example, lead to redesigning the EITI decision-making process, changing stakeholder representatives and adjusting capacity building programmes.”380 The implementation of EITI in a particular country has to be adapted to reflect the cultural and legal frameworks of that country. The EITI did not emerge from a vacuum, but has built on the search for solutions within the CSR area. Some companies have disclosed the revenues provided to the host state’s budget in order to improve transparency, while others have entered into partnerships creating revenue sharing regimes. Transparency, as a method to implement CSR, has not been without its risks. In some instances risks can come unexpectedly from stakeholders. For example, a OECD-based mining company with operations in Indonesia decided in order to improve governmental transparency to disclose the amount of money that it had paid to Jakarta; this initiative however resulted in unintended adverse consequences for the company, as local actors realised how rich the company was and targeted it for extortion attempts.381 In most cases, however, risks come from the host government. For example, BP announced in 2001 its intention to disclose the payments made to the Angolan government. This brought threats from Sonangol, the Angolan state oil company, that their contract would be terminated. BP did disclose its signature bonus but not information about tax payments and royalties. The threats were deemed serious enough and none of BP’s competitors followed suit. Talisman, the Canadian company that operated in Sudan, has received strong criticism for its presence there and withdrew in 2003 from Sudan. The company notes that its 379

Ibid., p. 5. Ibid., p. 11. 381 K. Gordon, OECD, Multinational Enterprises in Situations of Violent Conflict and Widespread Human Rights Abuses, Working Papers on International Investment Number 2002/1, 2002, para. 51, <www.oecd.org/dataoecd/46/31/2757771.pdf>, visited on 14 February 2007. 380

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The stakeholder norm in business practice reporting on fiscal transparency has steadily evolved since 2001. Currently Talisman provides a breakdown of all fiscal contributions made to host governments wherever it operates.382 According to the Publish What You Pay (PWYP) campaign, a collation of over 250 NGOs worldwide that calls for the mandatory disclosure of the payments made by oil, gas and mining companies to governments, “[r]elying on voluntary transparency is problematic as companies face having their operating licenses revoked and awarded to less scrupulous competitors. Companies are also often prevented from disclosing information because of confidentiality clauses in contracts.”383 PWYP says that regulation, probably through stock market disclosure rules, would supersede confidentiality clauses in contracts which currently hamper companies that would otherwise be able to disclose their payments. Many MNEs however prefer the voluntary approach of the EITI as a collective action mechanism that addresses the issue of unaccountability in a more holistic fashion, and also levels the playing fields among competitors. MNEs see the EITI as an important implementation mechanism for their CSR policies. Revenue sharing regimes Another CSR implementation mechanism consists of company support for ‘revenue sharing’ regimes. This links companies even more to the revenues generated by their operations. One company with operations in Nigeria noted that conflict in that country’s oil producing region might be reduced if that region received more of the oil revenues, and successfully lobbied (along with host country partners) for a redistribution of the revenues between central and regional governments.384 In another case, in Papua New Guinea, after local communities complained that the benefits promised by the government to be paid from taxes received were not materialising, the company Placer Dome agreed with the government that a percentage from taxes could be retained and invested directly by the mines in local infrastructure improvements under the direction of local communities and authorities. The resulting Tax Credit Schemes and Infrastructure Development programme contributed millions of dollars to fund initiatives on education, health and administrative infrastructure.385 BP in Casanare, Columbia used “its convening power to set up regional, multisector forums that would begin to address long-term regional development planning and institutional reform to ensure that royalty revenues from resources extracted flowed to where the need was greatest”.386

382

Extractive Industries Transparency Initiative, Newsletter, December 2004, p. 3. Publish What You Pay, Background, para. 7(a), <www.publishwhatyoupay.org/english/ background.shtml>, visited on 14 February 2007. 384 Gordon, supra note 381. 385 J. Bennett, UN Global Compact, Conflict Prevention and Revenue Sharing Regimes, 2002, p. 22. 386 T. Kent and D. Jones, Managing Corporate Responsibility, Ethical Corporation Europe 2003 Conference, Conference report, 2003, p. 20, <www.ethicalcorp.com/resources/ 383

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Chapter 4 Corporations have often considered that paying taxes exhausts their responsibility toward the host state and its population. However leading companies have tried to contribute to the search for solutions to the serious public governance problems that exist in some host countries. Thus practical considerations and the need to make their strategies effective determine leading businesses to interpret the principle of role separation (see chapter 3) not as an escape from CSR, but as a justification to cooperate with governments and civil society groups, and jointly address a social issue. The responsibility of businesses in these instances seems to be to work jointly with other actors toward the long-term solution. The OECD noted that the long-term solution to these problems lies in the establishment of a broad framework for public governance – including fiscal, political and civic institutions. This will require sustained efforts by host societies, working in cooperation with enterprises, other governments and international organisations.387 Voluntary Principles on Security and Human Rights Security forces – whether under the control of the government or just private contractors – are entrusted with protecting company personnel and property. Such forces have sometimes committed serious human rights violations that led to accusation of corporate complicity. The highest profile multistakeholder initiative in this area is the Voluntary Principles on Security and Human Rights.388 The Principles have been developed with the active support of the US and UK governments and published as a non-binding instrument in 2001. Currently, four governments (US, UK, Netherlands and Norway), 15 MNEs and seven NGOs are involved in the refinement and implementation of the Principles. The Principles fall into three categories: factors to be considered to conduct an accurate, effective risk assessment, interactions between companies and public security forces and interactions between companies and private security forces. The Principles have been cross-referenced as standards of good practice in contracts, for example in the Baku-Tbilisi-Ceyhan oil and gas pipeline project.389 Partnerships for development at local level The surrounding communities have come to associate extractive companies with endemic poverty and governmental corruption as they do not share in the benefits generated by the project. Businesses have traditionally responded with charitable contributions. They have built schools, clinics, wells, roads, etc. Here we briefly refer to business initiatives that move toward joint implementation with stakeholders in order to obtain more sustainable and effective impacts. We highlight here

downloads/20039974352_Ethical_Corporation_Europe_2003_Conference_Report.pdf>, visited on 14 February 2007. 387 Gordon, supra note 381, para. 47. 388 <www.voluntaryprinciples.org>, visited on 14 February 2007. 389 Azerbaijan, Georgia, Turkey and BTC Co., Joint Statement on the Baku-Tbilisi-Ceyhan Pipeline Project, 16 May 2003, para. 6.

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The stakeholder norm in business practice partnerships for development at local level; the cases mentioned in the previous sections were broad based partnerships at international and national levels. Partnerships for development have been defined as “[p]eople and organisations from some combination of public, business and civil constituencies who engage in voluntary, mutually beneficial, innovative relationships to address common societal aims through combining their resources and competencies”.390 Business Partners for Development (BPD) was a multistakeholder project initiated by the World Bank in 1998.391 BPD concentrated on 30 ‘focus projects’ in 20 countries and grouped into four ‘clusters’: Natural Resources, Water & Sanitation, Global Partnership for Youth Development and Global Road Safety Partnership. In 2002 BPD delivered a set of guidance notes about partnerships. The main document was Tri-Sector Partnership Results and Recommendations 19982001, and four separate ‘Results and Recommendations’ for Business, NonGovernmental Organisations, Developing Country Governments and Multilateral and Bilateral Organisations.392 BPD shows that partnerships do sometimes deliver better results for business and communities than business managing CSR issues in-house or outsourcing them through charitable grants. Nevertheless, BPD has identified the conditions where partnering should not even be attempted: ƒ An assessment shows that the costs and the risks are too high compared with the anticipated benefits. Organisations need to take into consideration the additional transaction costs related to partnerships and various risks (reputation risk, cost escalation risk, undelivered commitments), ƒ There are no significant complementarities to be gained from pooling competencies, skills, and resources from other sectors, that is, where the objectives or activities do not require skills from another sector, ƒ The partnership does not have institutional relevance to the organisation’s core activities, ƒ Significant pre-existing grievances exist between potential partners that have not been resolved. Some degree of suspicion can be accommodated, but significant conflict must be resolved before partnership exploration, ƒ The partners do not have the knowledge or the capacity to react flexibly to changing political realities and socio-economic contexts, ƒ One of the partners is likely to require results too fast, because of their organisational time frames, ƒ Alternative approaches have not been considered, or

390

J. Nelson and S. Zadek, The Copenhagen Centre, Partnership Alchemy – New Social Partnerships in Europe, 2000, p. 14, <www.accountability.org.uk/uploadstore/cms/docs/ Partnership_Alchemy.pdf>, visited on 14 February 2007. 391 <www.bpdweb.com/index.htm>, visited on 14 February 2007. 392 <www.bpdweb.com/products.htm>, visited on 14 February 2007.

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Lack of commitment. 393

From the point of view of practitioners, any attempt to extract a single partnership model from this multi-layered environment would be questionable, but important recommendations can be made about the partnership-building process.394 The effective functioning of a partnership needs agreement on rules governing the decision-making process and governance of the joint undertaking. While the appropriate balance between flexibility and formalisation needs to be found on a case-by-case basis, BPD advices that decision-making processes in partnerships need to be agreed in advance. Therefore a partnership agreement should deal with some key elements: ƒ The objectives of the partnership, ƒ Joint work plan encompassing activities, schedules and performance indicators, resource commitments, roles, and responsibilities, ƒ Funding arrangements (if applicable), ƒ Decision-making principles, ƒ A grievance mechanism to resolve differences, ƒ Procedures for communication amongst partners, ƒ Measures to strengthen the capacity of partners to implement their commitments, ƒ Measures to mitigate external risks and threats to the partnership, ƒ Strategies for dealing with staff turnover, ƒ A strategy for communicating to constituents and other interested parties, ƒ Procedures for monitoring and measuring the impact of the partnership, and ƒ Exit strategies. 395 Far from being members of permanent institutions partners need to be able to enter and leave as their capacities, needs and strategies dictate. To prevent disruption, early discussion and agreement between partners on when and how involvement begins and ends are essential. Structures and processes must therefore be established to accommodate and respond to change. BPD has seen partnerships as dynamic entities; its experience has shown that even over a short timeframe, roles, responsibilities and even partnering organisations can all change in a partnership. These changes may reflect those in the external environment, community, funding streams, performance levels and individual relationships. 396 The contributions that business can make to partnerships are not immediately obvious. They certainly extend beyond financial contributions. In the case of partnerships for development, businesses can contribute nonfinancial resources, such 393

Business Partners for Development, Putting Partnering to Work, Tri-sector Partnership Results and Recommendations 1998–2001, 2002, p. 16, <www.bpdweb.com/docs/main1 or5.pdf>, visited on 14 February 2007. 394 Ibid., p. 9. 395 Ibid., p. 24. 396 Ibid., p. 26.

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The stakeholder norm in business practice as managerial expertise, information and contacts, credibility with other business actors, distribution networks, a customer-oriented way of approaching problemsolving, willingness to adopt a leadership role, mediation skills, etc; these are all valuable inputs into a partnership and may prove indispensable to its effectiveness. The idea behind trisector partnerships involving TNCs, civil society and government is that each party should bring its core complementary competencies; the competency of business is certainly not limited to the disbursement of financial resources through philanthropic handouts. Understanding what these core complementary competencies are, how they fit together and what motivates their fellow partners is hardly simple, and very contextual. BPD observed that companies have often “not really identified their core competencies and understood how these could be applied or enhanced in a partnership context”. 397 4.3.3. External audit of performance The next two sections cover neither internal reporting (those information systems through which managers report upwards in the managerial hierarchy) nor internal audits (controls performed by the company’s own employees or by third parties for the exclusive use of management). These are internal procedures that can be properly discussed at the previously discussed stage of implementing CSR. The following sections highlight how leading businesses have opened up to external audits of performance, social reporting and assurance of reports. All three will be discussed below. External verification can be useful to top managers to obtain an accurate image of their business (internal use of a third-party audit), or to demonstrate to stakeholders that the business is accountable (external use of a third-party audit).398 Here we refer to the latter use. External auditors verify a business for its compliance with certain standards. External audit schemes, which result in certification, follow two basic approaches: substantive and procedural. The scheme could set substantive performance standards to be met by all certified firms, as with the timber certification offered by the Forest Stewardship Council. Another approach is essentially procedural, requiring firms to implement environmental management systems with defined responsibility structures for planning, operations, monitoring, corrective action, and so on, as with the ISO 14001 programme. There are also cases where systems combine substantive and procedural approaches. The Forest Stewardship Council, for example, has a modest EMS requirement while the Canadian Standards

397

Business Partners for Development, supra note 394, p. 9. PT Freeport Indonesia and Freeport- McMoRan Copper & Gold Inc., Response to the Audit of Indonesian Operations by the International Center for Corporate Accountability, 2005, <www.icca-corporateaccountability.org/PDFs/PTFIResponse05.pdf>, visited on 14 February 2007. 398

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Chapter 4 Association places heavy stress on the EMS while incorporating modest substantive standards.399 We have referred above to ISO 14000 and EMAS as important environmental audit and certification schemes. Parent companies have sometimes required their subsidiaries and suppliers to obtain ISO 14000 certification, as it happens in the auto industry. Buyer companies can also require their suppliers to open up to external monitors/auditors in their efforts to implement labour protections throughout their supply chains. Such auditors can be financial auditing organisations (PWC, Ernst & Young, etc.), auditors accredited by specialised schemes (like ISO, SAI, FLA, etc.), local NGOs or respected experts. External audit is a multi-layered process. Not only companies are to be certified by auditors, but also auditors themselves will have to be certified. There were proposals for the ILO to assume a certification function, particularly of training and certifying social auditors sent to inspect the workplace. Fair Labor Association and Social Accountability International do not themselves conduct audits, but both schemes certify auditors. The FLA contains detailed provisions regarding the monitoring process. Its ‘Principles of Monitoring’ refer to the obligations assumed by external monitors that verify the suppliers’ performance. The obligations of accredited external monitors are as following: a) Establish clear evaluation guidelines and criteria; b) Review company information database; c) Verify creation of informed workplace; d) Verify establishment of communications channel; e) Conduct independent audit of employee records; f) Conduct periodic visits and audits; g) Establish relationships with labor, human rights, religious or other local institutions; h) Conduct confidential employee interviews; i) Implement remediation by working, where appropriate, with suppliers to correct instances of non-compliance; j) Complete evaluation report.400 External audits can result in a label for conformance to certain standards (such as ISO 9000 or ISO 14000 or EMAS or Rugmark) or in a report that can be incorporated in the company’s CSR report for added credibility. Both labels and CSR reports have been used to communicate CSR information to external audiences. In this section we refer only to labels because the bulk of the discussion is about the external audit itself, rather than about the label to be affixed on products. The next section deals with CSR reports, a much more complex method of communicating 399 E. E. Meidinger, ‘Environmental Certification Programs and U.S. Environmental Law: Closer than You May Think’, 31 Environmental Law Reporter (2001) p. 10163, <www.law.buffalo.edu/homepage/eemeid/scholarship/certlaw.pdf>. 400 Fair Labor Association, supra note 347, pp. 45, 46.

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The stakeholder norm in business practice CSR information to stakeholders, which however does not necessarily require an external audit of corporate performance. The Fairtrade Labelling Organizations International (FLO), a consortium of Fair Trade groups in Japan, Canada, the US and 17 European countries, is an international NGO headquartered in Germany and founded in 1997. Fairtrade labelling started in the Netherlands in 1989, where coffee was the first labelled product in response to fast falling world coffee prices.401 Nowadays there are Fairtrade Labels on dozens of different products such as coffee, tea, rice, bananas, mangoes, cocoa, sugar, honey, fruit juices and footballs. FLO is constantly expanding and should soon include other goods such as fresh fruit, wines, nuts, oils and in the years to come more non-food products as well.402 To maximise its impact, FLO’s main aim is for products to be sold in supermarkets. According to the FLO, Fairtrade is an “initiative for small farmers and wage workers in the South, who have been restrained in their economical and/or social development by the conditions of trade”.403 It aims to increase the income of (mainly agricultural) producers. The FLO has two sets of generic International Fairtrade Standards: one for small farmers and one for workers on plantations and in factories. Small farmers can join Fairtrade if “they have formed organisations (in cooperatives, associations or other organisational forms) which are able to contribute to the social and economic development of their members and their communities and are democratically controlled by their members”.404 Workers can participate in Fairtrade if they “are organised, normally in unions, and if the company they work for [farms, plantations, etc.] is prepared to promote workers’ development and to pass on to the workers the additional revenues generated by Fairtrade”.405 On plantations and in factories, minimum health and safety as well as environmental standards must be complied with, and no child or forced labour may occur. In setting its standards FLO follows certain internationally recognised standards and conventions, especially those of the International Labour Organization. Finally, in addition to these generic standards, there are product-specific FLO standards that determine for each product such things as minimum quality, price and processing requirements. FLO explains how its minimum prices are established. FLO’s pricing methodology first defines the cost of sustainable production and the cost of sustainable living; Fairtrade minimum price at least covers these two costs. On top of that price, FLO establishes a premium, which has to be invested in social,

401

For an overview of the industry, see A. Kolk, ‘Corporate Social Responsibility in the Coffee Sector: The Dynamics of MNC Responses and Code Development’, 23:2 European Management Journal (April 2005) pp. 228–236. 402 <www.fairtrade.net/sites/aboutflo/faq.html>, visited on 14 February 2007. 403 Fairtrade Labelling Organizations International, Generic Fairtrade Standards for Small Farmers, version 01/03, 2003, p. 2. 404 Ibid. 405 Ibid.

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Chapter 4 economic or environmental projects of improvement, decided upon democratically within the organisation. 406 The certification is based on the complementary roles of the FLO-International and of each National Initiative so that the entire chain of custody is tracked. FLO International manages the Fair Trade Register, a list of certified producer cooperatives and associations. FLO reviews each cooperative that applies for certification. The applicant answers an extensive questionnaire detailing membership information and organisational structure. Once a producer group’s written application is approved, a regionally based FLO inspector visits the group to determine whether it meets Fair Trade criteria. In addition to ground-level inspections, FLO inspectors review financial documents and Fair Trade transactions of each producer group. FLO compares producers’ Fair Trade sales data with purchase data from importers – provided by each National Initiative. In this way, all Fair Trade transactions are cross-checked for discrepancies. FLO reviews financial records to ensure that the Fair Trade premiums are being paid directly to the farmer. Finally, FLO interviews members of each producer group to ensure that members are fairly represented – and their voices clearly heard – within the producer groups.407 National Initiatives, for example TransFair in the US, monitor and audit the activities of importers. For every unit purchased from a Fair Trade producer group, TransFair receives supporting documentation – contracts, bills of lading and invoices – from licensed importers. Every purchase is tracked with a unique identification number to ensure accuracy.408 Many other organisations promote socially and ecologically sustainable production. The International Social and Environmental Accreditation and Labelling Alliance (ISEAL), set up in 2000, is a collaboration of all of the leading international standard-setting, accreditation and labelling organisations that are concerned with social and environmental management certification. These organisations have recognised for some time that there are areas of overlap in their focus issues and similarities in the way they operate. Among the organisations that participate in ISEAL are Social Accountability International, Fairtrade Labelling Organizations, the Forest Stewardship Council, Conservation Agriculture Network and the Marine Stewardship Council.409 The UK-based Ethical Trading Initiative points to the risks of labelling. It does not award labels. ETI considers that it is easy to understand why consumers would prefer products carrying a label basically saying: “Workers who produced this product have not been exploited in any way – 100% guaranteed”. However “there are some real risks involved in pursuing ethical labelling of products. In seeking to ‘get labelled’, companies would be discouraged 406

Supra note 402. <www.transfairusa.org/content/about/certification.php>, visited on 14 February 2007. 408 Ibid. 409 <www.isealalliance.org>, visited on 14 February 2007. 407

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The stakeholder norm in business practice from buying from countries with structural problems such as restrictions on freedom of association or very low wage levels, thus risking putting suppliers out of business and workers out of a job. These are arguably the workers who are most vulnerable and need most protection. There is also the risk that smaller companies with narrow profit margins would be penalised because they cannot make the grade as quickly as larger, more capital-intensive companies with higher profit margins. Labelling would reward companies and suppliers who go for the ‘quick fixes’ to labour problems and penalise those who aim for longer-term but more sustainable solutions.”410

Having discussed labels we refer below to CSR reports as another modality for businesses to communicate their performance. 4.3.4. Social reporting For a company reporting on its CSR performance the difficulty is to determine what information is relevant (material) to (each) stakeholders. There seem to be at least two ways to deal with materiality. One way is to strive for an authoritative standardisation of reporting indicators. Another way is to engage stakeholders on the ground and undertake consultations with the most affected stakeholders to ascertain their views on what information is material. The Global Reporting Initiative (GRI) is a multistakeholder undertaking started in 1997 by the UN Environmental Programme and Coalition for Environmentally Responsible Economies (CERES). It became an independent organisation in 2002. The GRI is a global, multistakeholder effort that draws on representatives from business, accountancy, investment, environmental, human rights, research and labour organisations.411 The GRI is the most significant effort under way aimed at increasing the quality of CSR reporting. The motivation underlying GRI is based on a perceived demand from business managers, investors, consumers, governments and others in asking for a clear picture of the human and ecological impact of business in order to make informed decisions about investment, purchases and partnerships. “Achieving such clarity in measurement and reporting holds the promise of delivering value both to business – by providing a critical management tool – and to external stakeholders – by providing timely, relevant, and credible information on the reporting organisation.”412 GRI issued its Sustainability Reporting Guidelines in 1999, revised them in 2002, and the third edition came in 2006. They contain a multitude of economic, environmental and social indicators on which companies can report; human rights 410

Ethical Trading Initiative, Raising the Stakes, Annual Report 2001/2002, 2002, p. 5, <www.ethicaltrade.org/Z/lib/annrep/2002/en/eti-annrep01-02.pdf>, visited on 14 February 2007. 411 <www.globalreporting.org>, visited on 14 February 2007. 412 Global Reporting Initiative, Sustainability Reporting Guidelines on Economic, Environmental and Social Performance, 2000, p. 2.

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Chapter 4 and labour standards are explicitly mentioned among social indicators. “The purpose of these Guidelines, and the GRI framework as a whole, is to capture an emerging consensus on reporting practices. This provides a point of reference against which reporting organisations and report users can approach the challenge of developing effective and useful reporting practices.”413 The latest guidelines from GRI clarify the issue of materiality and provide that “[a] combination of internal and external factors should be used to determine whether information is material, including factors such as the organization’s overall mission and competitive strategy, concerns expressed directly by stakeholders, broader social expectations, and the organization’s influence on upstream (e.g., supply chain) and downstream (e.g., customers) entities. Assessments of materiality should also take into account the basic expectations expressed in the international standards and agreements with which the organization is expected to comply.”414

GRI aims to increase the quality of CSR reporting by developing indicators and also referring to the need for stakeholder consultation. Its centre of gravity is however tilted toward standardisation of reporting indicators to enable comparability by a multitude of social actors, rather than contextual definitions agreed by the company with its local stakeholders. Thus one of the principles on which the Guidelines are based is that of ‘completeness’: “Defining whether such information meets the test of significance to stakeholders should be based on both stakeholder consultation as well as broad-based societal concerns that may not have surfaced through the stakeholder consultation process. Such broad-based concerns may derive, for example, from national policy and international conventions.”415 Further, CSR reports should help place the organisation’s performance in the broader context of sustainability challenges, risks and opportunities. “The GRI framework aims to identify organisational level indicators to enable reporting that offers a view of the organisation as a whole, whether it has a few or many sites … the GRI Guidelines were not designed with the intention of specifying all of the project/site level information that may be of interest to stakeholder groups.”416 Under the principle of ‘inclusiveness’ the reporting organisation should systematically engage its stakeholders to help focus and continually enhance the quality of its reports. “Aspects of reporting enriched by stakeholder consultation include (but are not limited to) the choice of indicators, the definition of the organisation’s reporting boundaries, the format of the report, and the approaches 413

Global Reporting Initiative, supra note 24, p. 9. Ibid., p. 8.. 415 Global Reporting Initiative, Sustainability Reporting Guidelines, v2, 2002, p. 26 <www.globalreporting.org/Services/ResearchLibrary/GRIPublications>, visited on 14 February 2007. 416 Global Reporting Initiative, GRI Mining and Metals Sector Supplement, Pilot Version 1.0, 2005, p. 8, <www.globalreporting.org/NR/rdonlyres/25EEF0C7-F050-48CA-9FF5-C79F359 D9976/0/SS_MiningMetals_ENG.pdf>, visited on 14 February 2007. 414

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The stakeholder norm in business practice taken to reinforce the credibility of the reported information.”417 Because many reporting organisations have a wide range of potential stakeholders, it is necessary to prioritise stakeholders for purposes of engagement. “In the spirit of the inclusiveness and transparency principles, it is important for reporting organisations to clearly and openly explain their approach to defining whom to engage with and how best to engage.”418 In 2005 the GRI released a Boundary Protocol that defines with more accuracy how reports should cover various entities in the business group. For purposes of the Protocol, ‘boundary’ refers to the range of entities for which the reporting organisation gathers information. The organisation is advised how to report impacts, though only ‘significant impacts’. There is a decreasing scale. Thus when the company has control over the other entities it should use indicators that capture outcomes (operational data). When there is not control but still significant influence, the company should use indicators on existent procedures (management performance). Finally when influence exists even if it’s not ‘significant influence’, reports should highlight dilemmas encountered and provide a narrative disclosure on the strategy in place.419 The reporting framework also arrives at a broader than usually definition of the business group (or MNE); instead of concentrating solely on ownership relationships the scheme covers control, significant influence and influence. While control requires a minimum of 50 per cent ownership in the subsidiary or joint venture, significant influence can arise as early as 20 per cent ownership, but also in some contractual relationships (as often happens in labour-intensive industries).420 This understanding of the MNE for purposes of reporting is broader than the usual definition of a MNE421 or its definition under International Financial Reporting Standards (IFRS), but is particularly suited for the CSR context. It appears as a useful elaboration of the concept of ‘sphere of influence’ used by the UN Global Compact. GRI recognises that sector-specific guidance must be developed to supplement the general Sustainability Reporting Guidelines. GRI works to develop industryspecific guidance in the form of Sector Supplements. So far the GRI has developed Supplements for the following industries: Financial Services, Automotive, Mining 417

Global Reporting Initiative, supra note 24, p. 24, 25. Global Reporting Initiative, supra note 415, p. 25. 419 Global Reporting Initiative, GRI Boundary Protocol, 2005 pp. 7,8, <www.globalreporting. org/NR/rdonlyres/CE510A00-5F3D-41EA-BE3F-BD89C8425EFF/0/BoundaryProtocol.pdf>, visited on 14 February 2007. 420 Ibid, pp. 9–11. 421 ‘Transnational corporations (TNCs) are incorporated or unincorporated enterprises comprising parent enterprises and their foreign affiliates. A parent enterprise is defined as an enterprise that controls assets of other entities in countries other than its home country, usually by owning a certain equity capital stake [at least 10%].’ United Nations Conference on Trade and Development, World Investment Report 2005: Transnational Corporations and the Internationalization of R&D, 2005, p. 1, <www.unctad.org/en/docs/wir2005_d&s_en.pdf>, visited on 14 February 2007. 418

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Chapter 4 and Metals, Public Agency, Tour Operators, Telecommunications and Logistics and Transportation. The industry-by-industry approach to reporting is “widely viewed as being the most effective means of setting a benchmark against which individual companies can gauge their progress and set targets to strive toward, and for a greater degree of transparency to be attained in the interests of stakeholders”.422 CSR reporting can de-emphasise the role of indicators and instead identify on a case-by-case basis what stakeholders deem as material information, and then report on that in an accessible form. For example, the 2003 report of United Utilities deals almost exclusively with issues that have been raised and prioritised via stakeholder engagement and dialogue. “The results were surprising. The issues we instinctively would have placed at the top, such as water quality, actually ended up at the bottom of the pile. Instead, stakeholders were more interested in investment programmes and pricing structures.”423 The pioneering report (1996) of Body Shop ran four volumes long. Zadek explains that its underlying approach was to focus on the interests and perspectives of stakeholders and measure company performance from this vantage point. Stakeholder dialogue was a core element. “The stakeholder dialogue underlying that 1996 report remains one of the technically most sophisticated in recent times in terms of structure and handling of data, and of the most sensitive in feeding stakeholder concerns into the design of the survey and other dialogue tools.”424 The Fédération des Experts Comptables Européens states that “[a] company may use stakeholder dialogue relating to a sustainability report to ascertain: what matters stakeholders want in a sustainability report (and whether past reports have met their needs), the levels at which matters become significant enough to be included, what imprecision in measurement or degree of approximation is acceptable, and what assurance, if any, stakeholders value”.425 Finally, there is another way to cut through complexity. Thus Zadek observed that “more recently there has been a shift in assessing completeness toward providing strategic clarity rather than operational detail”.426 4.3.5. Assurance of reports This stage in the management of CSR refers to the manner in which businesses communicate their CSR performance. Not only is external reporting expected, but

422

R. Stanc, ‘Corporate characters growing up within the Guidelines’, Ethical Corporation, 20 June 2003. 423 Quoted in ibid. 424 S. Zadek, The Civil Corporation – The New Economy of Corporate Citizenship (Earthscan, London, 2001) pp. 191,192. 425 Fédération des Experts Comptables Européens (FEE), Providing Assurance on Sustainability Reports, FEE Discussion Paper, 2002, p. 39, <www.fsr.dk/41256B 0500435720/no/01000961/$File/DP%20Providing%20Assurance%20on%20Sustainability%2 0Reports.pdf>, visited on 14 February 2007. 426 Zadek, supra note 424, p. 167.

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The stakeholder norm in business practice this should also be credible which entails some form of independent verification of the claims made (assurance). The International Federation of Accountants issued in 2004 the ISAE 3000,427 a standard for assurance of non-financial information. As KPMG observed, compared with the AA1000 standard discussed below, the ISAE 3000 is “largely focused on the information in the report, [it] places greater emphasis on the company reporting its limitations and weaknesses”. 428 The UK-based Institute of Social and Ethical AccountAbility (ISEA), established in 1995 as an international non-profit institute that brings together partners from business, civil society and the public sector from across the world, developed the AccountAbility 1000 (AA1000) standards.429 ISEA noted that numerous approaches to assurance offer different ways of evaluating the credibility of published reports, but they tend to be commercially proprietary and so are not easily open to scrutiny, comparison or replication. In general, these approaches focus on the accuracy of quantitative data and the robustness of accounting systems. The AA1000 Assurance Standard is an initiative offering a non-proprietary, opensource Assurance standard.430 The AA1000 Framework helps users to establish a systematic stakeholder engagement process that generates the indicators, targets and reporting systems. The AA1000 Series consists of the AA1000 Framework plus some specialised modules.431 The first specialised module (AA1000 Assurance Standard), launched in 2003, deals with providing assurance to company reports. This module complements the reporting guidelines developed by the Global Reporting Initiative, and is particularly relevant for this section. Under the AA1000 Framework, the reporting organisation selects the audit method, the audit scope and the auditor(s) to provide an overall high level of assurance to all of its stakeholders.432 Under the specialised module, “[t]he Assurance Provider must gather and consider the evidence supporting the

427

International Federation of Accountants, International Standard on Assurance Engagements 3000, 2004, <www.ifac.org/Store/Details.tmpl?SID=1141163071358587&Cart =11697482091311571>, visited on 14 February 2007. 428 KPMG Global Sustainability Services, KPMG International Survey of Corporate Responsibility Reporting, 2005, p. 34, <www.eldis.org/static/DOC18813.htm>, visited on 14 February 2007. 429 <www.accountability.org.uk>, visited on 14 February 2007. 430 Institute of Social and Ethical AccountAbility, AA1000 Assurance Standard, 2003, p. 4, <www.accountability.org.uk/uploadstore/cms/docs/Assurance%20Standard%20for%20Web.p df>, visited on 14 February 2007. 431 <www.accountability.org.uk/aa1000/default.asp>, visited on 14 February 2007. 432 The Institute of Social and Ethical AccountAbility, AccountAbility 1000 (AA1000) Framework – Standards, Guidelines and Professional Qualification, 1999, p. 38, <www.accountability.org.uk/uploadstore/cms/docs/AA1000%20Framework%201999.pdf>, visited on 14 February 2007.

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Chapter 4 information in the Report, as well as the robustness of the systems and procedures underpinning its production and application”.433 Evidence includes: ƒ Quantitative information about historical performance and the systems underlying its production. This information should in general be investigated using existing approaches to assurance procedures common in analysing financial and environmental data. ƒ Qualitative information about historical performance, such as Stakeholder views. The assurance provider may deem it necessary to engage directly with stakeholders to assess the quality of evidence provided by the reporting organisation. This may include the assurance provider deciding on whether a need exists to witness engagement between the stakeholder and the reporting organisation. ƒ Qualitative and quantitative information relevant to assessing the feasibility of targets and other commitments set by the reporting organisation in response to stakeholders’ views or existing commitments related to policies and relevant standards. This will include evidence that the organisation has the requisite systems, competencies and resources in place to be able to implement activities designed to meet public policy statements and commitments.434 An important principle that assurance providers should follow is that of materiality of reported information. The assurance provider should form an opinion as to the materiality – to the reporting organisation itself and also to its stakeholders – of possible omissions and misrepresentations in the report. The assurance provider should discuss material omissions and misrepresentations with the reporting organisation and encourage it to amend the report. If these material omissions and misrepresentations are not included in the report the assurance provider should include them in its assurance statement.435 AA1000 defines information as material “if its omission or misrepresentation in the Report could influence the decisions and actions of the Reporting Organisation’s Stakeholders”. 436 The following parameters might be taken into account to determine materiality: “(a) Compliance performance. The materiality test must consider those aspects of non-financial performance where a significant legal, regulatory or direct financial impact exists. (b) Policy-related performance. The materiality test should identify those aspects of performance linked to agreed policy positions, irrespective of financial consequences. (c) Peer-based norms. Aspects of performance could be material where a company’s peers and competitors take it as being so in their own case, 433

The Institute of Social and Ethical AccountAbility, supra note 430, p. 21. Ibid., pp. 21, 22. 435 Ibid., p. 17. 436 Ibid., p. 15. 434

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The stakeholder norm in business practice irrespective of whether the company itself has a related policy or whether financial consequences can be demonstrated. (d) Stakeholder-based materiality, which can include: i. Stakeholder behaviour impact. Materiality should take into account concerns of Stakeholders where disclosure of related information could impact on their decisions and behaviour, both towards the company and in other situations. ii. Stakeholder views and perceptions. Materiality should include aspects of performance demonstrably relevant to the views and perceptions of Stakeholders where these are considered relevant to their future decisions and behaviour.” 437

The AA1000 Framework refers to various methods of stakeholder engagement: oneto-one interviews, group interviews, workshops and seminars, public meetings and questionnaires. “The appropriate method for each process of stakeholder engagement will depend on the nature and size of the organisation and the scope of the engagement – the stakeholders included, the complexity and nature of the issues covered and the geographic location. The choice of method will also be affected by the capacity of the organisation – in terms of financial resources, staff resources and management systems – and by the capacity of its stakeholders.”438

Zadek noted that “[t]here are numerous challenges to overcome in developing useful approaches to measuring the quality of stakeholder engagement. But the best way forward is not to create another measurement jungle. Far better is that companies more fully describe, and assurance providers more systematically assess, what happened. - Explain what you (the company) are trying to achieve through engagement, particularly the balance between learning and influencing. - Describe how you decided with whom to engage (and who not to engage with) and why. This piece is usually the key to understanding how a company sets its own accountability boundaries. - Explain who showed up and who didn’t (and if possible why), and more generally the stakeholders’ and your experience of the engagement process. - Clarify assumptions made about stakeholder representivity (e.g. in which ways do the International Chamber of Commerce or the International Confederation of Free Trade Unions really represent their members). - Give a sense of the history of engagement, since the longevity of engagement often says a great deal about a company’s underlying approach. 437 438

Ibid., pp. 15, 16. The Institute of Social and Ethical AccountAbility, supra note 432, p. 109.

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Chapter 4 - Describe what you and those consulted discovered, if anything (be honest!). - Identify which new company policies, decisions and activities (really) emerged from the engagement process (and those just being validated through it), and what the degree of support is from stakeholders consulted.”439

The next chapters will discuss the implications that the benchmarks and process of capacity building described herein have for public policy and the accountability of the corporate sector. 4.4. PULL FROM MARKET ACTORS A variety of market actors have an interest in ensuring that corporations remain accountable to shareholders and that the corporate problem-solving in the ‘grey zone’, where corporate and stakeholders’ interests overlap, is sound. For these actors CSR is a matter of risk management and good corporate governance able to deliver sustainable shareholder value. The aim here is to show a trend that various actors are actively tracking CSR and increasingly carry out due diligence assessments against emerging CSR benchmarks. Mainstream investment funds, such as pension funds in the US and UK, have increasingly approached corporations with suggestions and demands to improve their governance systems, sometimes referring to human rights in the Global South. The long-term interest that pension funds may exhibit makes them a potential partner to the CSR movement. Some examples in the UK include Hermes, Universities Superannuation Scheme and Insight Investment (asset manager). In the US the California Public Employees’ Retirement System (Calpers) has for a long time taken interest in corporate governance issues. As a difference, ethical investment funds have screened corporations on grounds of their social performance and often refused to invest in companies with questionable activities. These funds, in contrast with pension funds, do not target the ‘grey zone’, but may be ready to sacrifice profitability to maintain an ethical stance. Insurance and banking companies have required information and impact assessments from their (potential) clients in regard of their environmental performance in order to assess the potential liability risks faced by their clients. More recently social issues within CSR have been addressed. For example, the Association of British Insurers (ABI) issued guidelines that take the form of disclosures expected to be included in the annual report of listed companies.440 For ABI the object of interest is whether the company has in place effective systems for managing significant risks (social, environmental and ethical matters). Therefore the Association has issued its own guidelines and expects disclosures from companies. This transparency is related to board responsibilities, to the company’s policies and 439 440

S. Zadek, ‘The Era of Stakeholder Engagement’, Ethical Corporation, 17 February 2003. Association of British Insurers, supra note 294.

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The stakeholder norm in business practice procedures for managing risks and to the credible verification of disclosures made on those aspects. This information would be included in the annual report of listed companies. The ABI expects that the verification procedure used by reporting companies should be such as to achieve a reasonable level of credibility. “Independent external verification of SEE [social, environmental and ethical] disclosures would be regarded by shareholders as a highly significant advantage. Credible verification may also be achieved by other means, including internal audit. It would assist shareholders in their assessment of SEE policies if the reason for choosing a particular method of verification were explained in the annual report.”441 Shareholders have filed so-called ‘shareholder resolutions’. Shareholder activism is present especially in the US where company laws impose lower hurdles than in other countries for the initiation of proxy resolutions. Shareholder activism acts less as a deterrent than to draw public attention and to challenge corporate management to rethink their policies to improve corporate impacts. Stock exchanges, as private regulators, may impose disclosure requirements on listed companies to allow investors better information on social risks to their investment. The London Stock Exchange and the Johannesburg Stock Exchange have required broader disclosures on corporate governance issues that cover also the grey zone. Social index providers which rank corporations according to various indicators, including human rights impacts, among other grounds, have proliferated and show the extent of market demand in this area. Some examples are the FTSE4Good, Dow Jones Sustainability Index, Domini 400 Social Index and Jantzi Social Index. Trade associations have drawn guidelines and disseminated knowledge for their members. Examples of active trade associations are in the toy industry, chemical industry and cocoa industry, to mention just a few. Accounting firms, including the biggest ones like KPMG and PricewaterhouseCoopers, offer audit services of corporate social performance and/or assurance of CSR reports. Finally, business consultancies develop toolkits for human rights impact assessment and management systems that enable users to better manage their social environment. Institutional investors, due to their large size and wealth-related stake in business, can be singled out as one market actor that can be more assertive in advancing their views to corporate directors. Due to their longer-term perspective on business success, some institutional investors have an interest in clarifying the ‘grey zone’ where their interests and those of stakeholders overlap. These funds have also increasingly formalised their expectations from businesses and have referred to CSR issues. Institutional investors expect company managers to be diligent about understanding risks in the grey zone, as shown by the policy of a British fund: “Hermes’ overriding requirement is that companies be run in the long term interest of shareholders … We believe a company run in the long 441

Ibid., p. 45.

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Chapter 4 term interest of shareholders will need to manage effectively relationships with its employees, suppliers and customers, to behave ethically and have regard for the environment and society as a whole … [W]e believe that ethical behaviour by companies is likely to involve some notion of fairness and reciprocity; that managers seek to understand the position of those whom their action affects, and that they deal fairly with them … Once a company has understood the argument it may, of course, be appropriate for it to resist such pressures.”442

There are various modalities that institutional investors (and the assets managers that handle their investments) use to influence the way that companies manage their CSR risks. For example, Insight Investment “pursues its objective of encouraging high standards of governance and corporate responsibility in the following ways. ƒ Company monitoring. Insight Investment conducts its own research on the performance of individual companies on a wide range of issues. We also commission external agencies to provide additional research. ƒ Dialogue. Insight Investment holds regular discussions with board directors and other executives of the company, both of a general nature and with regard to specific issues of concern. ƒ Voting. Insight Investment seeks to vote shareholdings on behalf of clients in line with the provisions of its policies. In exceptional circumstances it will take further steps such as requisitioning meetings and proposing resolutions. ƒ Policy research. Insight Investment commissions bespoke research on a range of governance and corporate responsibility policy issues in order to achieve greater understanding of the current shape and future direction of practice. ƒ Public statements. Insight Investment publishes its views on important issues of corporate governance and responsibility, both with regard to specific companies and in general. ƒ Sponsoring debate. On many policy issues, particularly with regard to corporate responsibility, there is a lack of clarity about appropriate principles of good practice. From time to time, Insight Investment will sponsor discussion between interested parties in order to seek clarity.

442 Hermes Pensions Management Ltd., The Hermes Principles. What Shareholders Expect of Public Companies – and what Companies Should Expect of Their Investors, 2002, p. 17, <www.hermes.co.uk/pdf/corporate_governance/Hermes_Principles.pdf>, visited on 14 February 2007.

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The stakeholder norm in business practice ƒ Working with others. Where we believe it will be advantageous to do so, we will work with other institutional investors and interested parties in pursuing our goals.”443

A survey done by Deloitte & Touche indicated that “most fund managers use a combination of approaches to SRI involving negative screening (screening certain stocks out from portfolios based on CSR criteria); positive selection (selecting specific stocks based on strong or sector-leading performance against CSR criteria); engagement (contacting company boards to influence behaviour in relation to CSR criteria); and shareholder activism (actively using voting power as a shareholder to change behaviour).”444

It was ethical investment funds that have long catered to the ethical stance of their clients by selecting only CSR-worthy companies to invest in. One means employed was ‘negative screening’, that is, screening out companies that are known violators of human rights and environmental standards, or that are in contestable lines of businesses (e.g. tobacco, arms, nuclear power). Although this sends a clear signal to companies and can create an incentive, ‘engagement’ can induce companies to alter their behaviour and importantly can be used by mainstream funds as it does not polarise profitability and ethics. A survey of UK funds found that “a clear preference for the various forms of engagement over screening as a way to implement SRI”.445 It further found that “[c]learly the biggest change among UK pension funds over the next three years will be the substantial increases in both engagement with investee companies and in exercising voting rights”.446 Institutional investors have however to stop short of raising issues with corporate management to an extent that it amounts to micro-managing the company. As shown in chapter 2, company law not only discourages shareholder litigation but also affirms the role of managerial judgement. According to Ira Millstein, “where there is a ‘problem’ company, an institution [institutional investor] can ask for meetings with the board, pose the problem, and determine whether the board is dealing with it or ignoring it … [I]n our system, if the shareholder satisfies itself that the board is knowledgeable, diligent, aware of the problems and attempting to deal with them, generally this should suffice.”447 The talk of private enforcement by actors with leverage on business can mislead into believing that a purely coercive 443

Insight Investment, Corporate Governance & Corporate Responsibility - Statement of Policy, <www.insightinvestment.com/documents/responsibility/00292_SRI_Policy.pdf>, visited on 14 February 2007. 444 Deloitte & Touche, News Release: Survey released today by Deloitte & Touche, 22 April 2002, <www.deloitte.co.uk>, visited on 14 February 2007. 445 C. Gribben and A. Faruk, Ashridge Centre for Business and Society, Will UK Pension Funds Become More Responsible? A Survey of Trustees, 2004, p 11. <www.uksif.org/J/Z/Z/ lib/2004/files/01/jp-ukpf-will/ukpf2004-justpens.pdf>, visited on 14 February 2007. 446 Ibid. 447 Monks and Minow, supra note 238, p. 152.

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Chapter 4 mechanism is at work. Their role in controlling management promoting CSR need not be overblown, as was done in the early 1990s; they can be better seen as influencing rather than controlling management and contributing standards, expertise and incentives to the debates in the grey zone. Institutional investors have an important role not only in clarifying the management of the ‘grey zone’, but also in the diffusion of such clarifications to a wider pool of companies. The pension system TIAA-CREF, a long-term shareholder with $240 billion of assets, says: “[S]hareholders and the organized institutional investors have been very effective in raising the standards of corporate disclosure and corporate commitments from one company to the next. In other words, investors will work out a deal with one company and then go to competitors and say, ‘this is a minimum now.’ In this manner, the shareholder action on that issue with one company serves to raise the whole standard in the industry on disclosure and dealing with that particular issue – having the company enter the public debate and having an issue discussed in the annual report, quarterly reports, and responses to shareholders. So we find that is a very effective means with the large group of shareholders we work with. One small action between one set of shareholders in one company can have a large ripple effect when it comes to raising environmental issues or sweat shop issues and others.”448

Market actors do judge the economic performance of corporations against their peers. Some rating agencies make CSR evaluations in which they compare companies to their peers. Vigeo for example performs “a sector-based rating on each [corporate sustainability] criteria designed to illustrate how successfully a company is managing stakeholder issues relative to other companies of the same sector”.449 Companies are then positioned as ‘Pioneer’ company, ‘Advanced’ company, ‘Average’ company, ‘Below average’ company and ‘Unconcerned’ company. Also investors have clarified, through their statements on corporate governance, that assessments of operational and financial performance are performed relatively to the practices of similarly situated corporations. This cuts both ways: the CSR innovations of leading TNCs are relevant to assessments investors make in regard to laggards; conversely, comparative assessments perform a reality check on the viability of CSR suggestions. The ICGN Statement on Global Corporate Governance Principles defines the expectations of investors: “7. Operating Performance – Corporate governance practices should focus board attention on optimizing over time the company’s operating performance. In particular, the company should strive to excel in specific sector peer group comparisons.

448

Corporate Social Responsibility: Paradigm or Paradox?, Symposium Transcript, 84 Cornell Law Review (July 1999) p. 1309. 449 <www.vigeo.com>, visited on 14 February 2007.

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The stakeholder norm in business practice 8. Shareholder Returns – Corporate governance practices should also focus board attention on optimizing over time the returns to shareholders. In particular, the company should strive to excel in comparison with the specific equity sector peer group benchmark.” 450

Intermediary market actors, in the pursuit of their purely economic mandate, follow the efforts of leading companies to attune their self-interest to evolving realities in order to avoid risks and grasp opportunities. As the FORGE guidelines write, “[i]ncreasingly, those organisations actively responding to CSR recognise that their activities help inform the definition of CSR and shape stakeholders expectations of an appropriate response. This helps these organisations manage the CSR agenda and positions them to be able to realise the benefits from managing and reporting on CSR.”451 Informed by new developments, market actors can find modalities to voice their expectations in their dealings with indifferent businesses. 4.5. SCALING-UP CSR Proponents of CSR have so far focused more, and rightly so, on developing the effective tools to implement and demonstrate CSR, but they have seldom concentrated on the governance implications of CSR. To prevent CSR from becoming isolated islands of good practice fading into irrelevance as a protective mechanism unable to make a significant impact and cope with corporate laggards, CSR practitioners have been looking for ways to scale-up CSR. Collective action by like-minded businesses can enhance the effects of CSR. If trade associations are brought in, not only is joint action among leading businesses facilitated but the trade association can exert influence on laggards to improve their act. Yet another scaleup mechanism highlights the role of states that could collaborate more with businesses and stakeholders and facilitate implementation of CSR. Highlighting the role of states as a scaling-up mechanism is particularly relevant to a human rights perspective on CSR because states have the primary obligation under international law to protect human rights. There is a recent frankness among some CSR practitioners that CSR needs to evolve fast due to its inherent limitations, and that states might have an important role to play precisely because of the inherent limits of voluntarism. Strangely enough, some supporters and critics have come to agree that CSR has limitations. They disagree however on whether it is worthy to insist on CSR’s ability to enhance the protection of human rights. Critics from NGOs summarily dismiss the concept and concentrate on proposals for public regulation. Supporters of CSR continue their efforts to rationalise and institutionalise bits of CSR within the business system, but mindful of CSR’s limitations see a role for states. This section presents the views of 450

International Corporate Governance Network, Statement on Global Corporate Governance Principles, 1999, p. 4, <www.ecgi.org/codes/documents/icgn_principles.pdf>, visited on 14 February 2007. (emphasis added) 451 FORGE Guidance, supra note 23, p. 1.

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Chapter 4 both camps in the CSR debate and suggests that paying close attention to in-built CSR dynamics could narrow the disagreements between CSR critics and supporters. 4.5.1. Limits of CSR according to sceptics One critical account of CSR concisely states: on the social front, “the existing marketsystem simply will not permit corporate management to act within the principles of social justice as the centrepiece of strategy. Such an organization would probably be acting illegally, outside its zone of competence, and would in all likelihood be ‘disciplined’ most severely by the marketplace.”452 The very ‘rules of the game’ need to change and such a task is incumbent upon government and international regulation. Utting illuminates one of the main NGO grievances against corporate voluntarism: it pre-empts legally binding approaches. On the plus side, “civil regulation in general, and multistakeholder standard-setting and certification initiatives in particular, can be seen as a constructive attempt to fill the large gap in regulatory or governance arrangements”.453 However, on the minus side, “[h]istorically, such regulation has often emerged either in contexts of crisis or in response to significant social pressures. At present, much of the social force that is promoting corporate responsibility is channelling its energies and resources towards corporate self-regulation and civil regulation. Until greater public concern and civil society activism puts pressure on political parties, governments and multilateral organizations to support other regulatory approaches, it is unlikely that significant developments in this area will be made.”454

And “[t]he Global Compact has always stated that it is not meant to be a substitute for other ‘regulatory’ approaches at the international level that rely on monitoring and enforcement. In practice, however, it is just about the only game in town that extends to a significant number of corporations. A basic concern with UN-TNC partnerships in general is that they reflect a shift in approach whereby lukewarm voluntary initiatives have crowded out important mechanisms and institutional arrangements involving new forms of international law…”455

Utting further writes: 452

R. Gray quoted in P. Utting, Regulating Business via Multistakeholder Initiatives: A Preliminary Assessment, 2001, p. 108. 453 Ibid., p. 100. 454 Ibid. 455 P. Utting, The Global Compact and Civil Society: Averting a Collision Course, 2002, p. 3, <www.unrisd.org/unrisd/website/document.nsf/0/66CB08F0D5BF9B8DC1256BDD002D8A E6?OpenDocument>, visited on 14 February 2007.

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The stakeholder norm in business practice “The problem with much of today’s CSR agenda is that it ignores or forgets history. It hails the virtues of voluntary initiatives and the wellintentioned motives of ‘corporate citizens’ and tends to shun, rather than acknowledge, the role of regulation and struggle. Corporate selfregulation and voluntary approaches are generally portrayed as a welcome alternative to government or international regulation, which are dismissed as unworkable, passé or an attempt to ‘command and control’. From this perspective, multistakeholder dialogue becomes as much a means of diluting activism as a tool for organizational learning… CSR needs to shed its image as part of a process associated with deregulation, to one associated with ‘reregulation’.”456

Jim Baker of the International Confederation of Free Trade Unions looks specifically at the narrower area of labour standards from a trade unionist perspective. He realistically notes the limits of corporate voluntarism and emphasises union representation as a preferable remedy against abuses of labour rights. He writes: “[E]nthusiasm for CSR is often generated to such an extent that it implies that private solutions to improving labour standards are sufficient, instead of relatively marginal… Perhaps the most problematic area of CSR is the relationship with workers and the world of work. [In] many of the unilateral codes of conduct … certain critical standards are missing, usually freedom of association and collective bargaining. And often, interlocutors are not sought; they are created … Sustainable CSR is of value to a company in terms of its production as well as its reputation. It can also ensure that company CSR policy is being carried out on the ground. Free trade unions can guarantee that workers’ rights are being respected, something that unilateral human resource management methods or third party approaches, no matter how sophisticated, cannot provide.”457

Amnesty International worries that voluntarism has negative effects on governmental performance of their human rights obligations. At the 2003 World Economic Forum, Amnesty explained its decision to focus its campaign on legal accountability of corporations for human rights under international law: “[L]eaving the debate in the realm of voluntary commitments has, in practice, too often let governments off the hook. Governments have clear obligations to ensure companies respect human rights. Dialogues on human rights and the private sector that leave

456

P. Utting, ‘Corporate Responsibility and Labour Issues in China: Reflections on a Beijing Conference’, 10 Journal of Corporate Citizenship (Summer 2003) pp. 21–27, <www.unrisd.org/80256B3C005BE6B5/search/09094F7FC5D60BCBC1256CC2004CE52B? OpenDocument&cntxt=8898B&cookielang=en#top>, visited on 14 February 2007. 457 J. Baker, Global Industrial Relations, Labour and Sustainable CSR (on file with the author).

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Chapter 4 out the role of law altogether play into the hands of governments who are failing to live up to these obligations.”458 NGOs have been suspicious of the emerging relationship between CSR and public policy. Regarding the inclusion of (environmental) partnerships in the final documents of the Johannesburg Summit, a report wrote: “The move toward partnerships … has met fierce opposition from large parts of the NGO community. Many NGOs express concern that the partnership theme was a fad exploited by governments to abdicate their responsibility to agree on further binding commitments during the Johannesburg Summit, and is a cheap plot by companies to ‘greenwash’ their operations.” 459 NGOs argue that “partnerships can complement – not substitute for – governmental action, but only if there is a strong rules-based framework in place to ensure that critical issues such as power asymmetries, transparency, and accountability can be addressed. Similar objections had previously been raised by NGOs at the end of 2000 about the U.N.’s Global Compact and the U.N. General Assembly’s Partnership Resolution.”460 A rather analogous objection came from a coalition of developing countries which “lobbied until the very end against the adoption of partnerships as an official outcome of the Summit. Their mistrust was based on the fear that the introduction of partnerships would take pressure off industrialized countries to provide additional resources for sustainable development.”461 A report of the UN Secretary-General sought to answer these concerns: “Partnerships today are an integral part of the work of many United Nations organizations and of particular relevance to those who have the on-the-ground capacities to deliver … Some stakeholders have expressed concerns that in focusing on the development of voluntary partnerships, the United Nations could divert attention away from and reduce the pressure on Governments to implement goals. While such fears must be taken seriously, experience has shown that in many cases partnerships can play a key role in facilitating intergovernmental decision-making and in supporting the development and implementation of effective policy at the national level.”462

458

Amnesty International, Irene Khan’s Speech at the World Economic Forum, Davos, 23 January 2003, AI Index: IOR:50/002/2003, <web.amnesty.org/library/index/ngIOR 500022003?open&of=eng-398>, visited on 14 February 2007. 459 J. M. Witte and C. Streck, ‘Introduction’, in B. Thorsten et al. (eds.), Progress or Peril – Partnerships and Networks in Global Environmental Governance – The Post-Johannesburg Agenda (Global Public Policy Institute, Berlin/Washington D.C., 2003) p. 3. 460 Ibid., p. 4. 461 J. M. Witte et al., ‘The Road from Johannesburg: What future for Partnerships in Global Environmental Governance?’, in Thorsten, supra note 459, p. 60. 462 United Nations Secretary-General, Enhanced Cooperation between the United Nations and All Relevant Partners, in Particular the Private Sector, A/58/227, 18 August 2003, p. 18.

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The stakeholder norm in business practice 4.5.2. Limits of CSR according to proponents Supporters of CSR have been aware of the possibility that CSR may remain an isolated island of good practice without having an impact commensurable with the scale of the problems. Zadek observed that external verification schemes have been “positive and productive … during this period of experimentation…[,] but these approaches … are seeking—and largely failing—to deal with issues that should properly be dealt with elsewhere in the overall process of corporate and societal governance … [E]xternal verification will [not be able to] provide an adequate substitute for establishing a framework of accountability that extends across and beyond the corporate body.”463

The International Organisation of Employers “strongly believes that the best way of assuring sound, basic minimum employment practices is through governments implementing and enforcing employment practices … It is the view of the IOE that private codes can complement, but can never replace, adequate national provisions.”464 Gordon observed that during the lengthy process of building a system of global rules, voluntary codes assume an important role as the only de facto system; but binding approaches still have much to offer. As the business community itself often points out, these voluntary efforts can only be, at best, a highly imperfect substitute for a uniform, appropriate policy framework supporting them.465 Business for Social Responsibility (BSR), a leading business consultancy in the CSR field, has planed to devote increasing attention to the nexus of CSR and public policy. BSR observes a “growing consensus that the widespread development of codes of conduct need to be coupled with national government action to make these codes more effective”.466 John Ruggie, one of the architects of UN’s Global Compact, noted: “How do we reach the tipping point, beyond which change becomes irreversible? At the risk of sounding like a heretic, I would contend that private governance arrangements, no matter how successful, can take us only so far. They will remain relatively small

463

S. Zadek quoted in Utting, supra note 453, p. 109. (emphasis added) International Organisation of Employers, supra note 292, p. 2. (emphasis added) 465 K. Gordon, Rules for the Global Economy: Synergies between Voluntary and Binding Approaches, OECD, Working Papers on International Investment Number 1999/3, 2000, p. 14, <www.oecd.org/dataoecd/57/25/1922674.pdf>, visited on 14 February 2007. (emphasis added) 466 Business for Social Responsibility, ‘CSR and Public Policy’, in Leading Perspectives: Trends and Solutions, Fall 2004, p. 16, <www.bsr.org/CSRResources/ LeadingPerspectives/2004/Fall.pdf>, visited on 14 February 2007. (emphasis added) 464

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Chapter 4 islands of progress unless their achievements are rooted in, and generalized through, the sphere of public authority.”467 George Kell, executive head of the UN Global Compact Office, wrote: “Without a doubt, the primary responsibility for human rights promotion and protection rests with governments. Most of the dilemmas we face at the intersection of business and human rights arise from governments’ inability or unwillingness to meet their human rights obligations … Voluntary initiatives are not a panacea to this problem. They are primarily an effort to fill the gap and therefore must be formed and fashioned in such a way as to simulate improvement in public policy so that the root causes of the problem are tackled.”468

Haufler performed a comprehensive survey of voluntary initiatives, noting their potential and limits. She concludes that self-regulation has the potential to improve situation, but only in concert with traditional political processes. Ultimate responsibility rests with host governments. Improvements cannot be imposed from outside (i.e. corporations, foreign activists and governments).469 A report from a business network noted: “More political support is also needed. This does not necessarily mean more regulation (even though this may occasionally be required). A global framework is particularly important for orienting and supporting company efforts in this direction.”470 Zadek looked at the possible effects of corporate citizenship practices. He identifies three: one, create micro-climates where a small number of businesses can survive and prosper; two, good companies can be squeezed out of the market through the ability of other businesses to take advantage of any cost disadvantages created for good companies; and three lead to shifts in the underlying conditions of the market that extend the take-up of the particular good practices.471 Thus CSR that is not linked to public policy is either insignificant, or unsustainable. If leading companies in CSR “are not emulated by their competitors, it means either that the corporation has failed to achieve any competitive advantage through its good practices, or that its competitive advantage exists only within a restricted market niche that has high barriers to entry and does not threaten the broader market (and so will not have extended impact). From this perspective, corporate citizenship based on leadership practices that 467

J. G. Ruggie, The Global Compact and the Challenges of Global Governance, Annual Meeting, Global Compact Learning Forum, 11–13 December 2002, p. 3. (emphasis added) 468 G. Kell, ‘Foreword’, in United Nations Global Compact Office, supra note 306, p. 9. (emphasis added) 469 V. Haufler, Public Role for the Private Sector: Industry Self-Regulation in a Global Economy (Carnegie Endowment for International Peace, Washington, DC, 2001) p. 122. 470 European Business Campaign on Corporate Social Responsibility, It Simply Works Better! Campaign Report on European CSR Excellence 2002 – 2003, 2003, p. 98. (emphasis added) 471 Zadek, supra note 424, p. 34.

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The stakeholder norm in business practice are not institutionalized beyond the individual corporation is unlikely to make a major contribution to achieving a sustainable development path. But corporate citizenship can become a significant route for overcoming global poverty, inequality and environmental insecurity. This requires that it evolves to a point where business becomes active in promoting and institutionalizing new governance frameworks that effectively secure civil market behaviour, globally. Leading civil corporations will therefore be those that go beyond getting their own house in order, and actively engage in promoting governance frameworks that enable the wider business community to address, effectively and without contradiction, the aspirations underpinning sustainable development.”472

Zadek analysed CSR in evolutionary terms; the very limits of voluntarism coupled with the need to show effective results demand that states play a reinforcing role in the CSR regime. Failure to achieve significant improvements can backfire; the wellintended efforts of leading businesses risk becoming a self-defeating experiment in the absence of state support. Zadek split corporate citizenship in three generations: 1. The first generation is largely a defensive exercise in reputational spin, often involving ‘bolt-on’ philanthropy unrelated to a company’s overall operations and impact. 2. The second generation of corporate citizenship links explicitly social and environmental aims to their core business strategies, to their brand-building and relationships with consumers, to the productivity of their employees and their relationship with the government. The second generation of corporate citizenship – however enlightened and evolved individual companies may become – will not deliver the gains needed to put a meaningful dent in the facts (poverty, underdevelopment). 3. A third generation of corporate citizenship is needed where the corporate world supports national governments and the international community in re-writing the global rules of the game. Without this third generation, those businesses honestly seeking to contribute in addressing serious social and environmental challenges will find themselves short-changed in the markets as consumers become cynical in the face of a manifestly worsening situation. This in turn will encourage the financial markets to retain their short-termist attitudes, thus further pressing companies to abandon potential long-term win-win corporate citizenship strategies. 473 A report from the UN Industrial Development Organization picked up on this reasoning: “[T]he key question is how to move into a third generation, even if the second generation is still in its infancy. The reason why jumping to this 472

Ibid., p. 13. (emphasis added) S. Zadek, ‘What Should We Really Expect from Big Business?’, Global Thinking, Winter 2001, , visited on 14 February 2007. 473

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Chapter 4 question is so important is that CSR will flounder when the expectations put upon companies, be they TNCs or SMEs, to solve such problems as poverty are not met. A parallel process needs to take place whereby CSR melds into core business strategy, while the external market and public policy environment is adapted in order to make real change.”474

In order to make real progress, and reverse the unfolding backlash against globalisation, a report from AccountAbility called on leading companies to help drive system-level change. “Business is generally encouraged to stay out of politics, but the challenge business leaders face is increasingly political. ‘Corporate responsibility has the potential to bring about positive change on a much larger scale’, agrees Georg Kell, Executive Head of the Global Compact. ‘But to get there, the CR movement will need to focus on two things simultaneously: achieving critical mass across all industry sectors, and connecting private actions with public policy efforts so that root causes of problems are tackled. CR cannot operate in isolation any longer.’ To make these connections in a legitimate way, companies must be more transparent and consistent in their public policy positions – and they will need to involve other interested parties.”475

Simon Zadek expressly dealt with a widespread perception that the enhanced role of corporations is necessarily accompanied by a shrinking role for the state. “Actually, the reverse is the case. The role of strong government is all the greater where business forms an important mechanism for delivering public goods. Indeed, the more we rely on diverse institutions to deliver public goods, the more (not less) do we need over-arching stewardship that democratic and accountable government provides to ensure that it all adds up to the right level delivered in the best way to the right people.”476

Along the same lines, interviews conducted with public officials, corporate and NGO representatives in the EU have raised the same concerns. Some contested that it is simply about shifting power or the burden of responsibility from the public to the private sector: “Partnerships are a new channel for participation and influence, but they complement the larger picture rather than replace it.”477 474

P. Raynard and M. Forstater, United Nations Industrial Development Organization, Corporate Social Responsibility – Implications for Small and Medium Enterprises in Developing Countries, Vienna, 2002, p. 68, <www.unido.org/userfiles/BethkeK/csr.pdf>, visited on 14 February 2007. 475 SustainAbility, Corporate Responsibility Initiatives Hit Limits, Press release, 29 June 2004, <www.csrwire.com/article.cgi/2844.html>, visited on 14 February 2007. 476 Zadek, supra note 473. 477 C. Gribben et al., Copenhagen Centre, Government as Partners – The Role of Central Government in Developing New Social Partnerships, 2001, p. 37, <www.copenhagencentre .org/graphics/CopenhagenCentre/Publications/Governments_as_Partners.pdf>, visited on 14 February 2007.

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The stakeholder norm in business practice Even critics of CSR observe the incremental transformation of voluntarism: “CSR is, nevertheless, gradually evolving and maturing. The most obvious change is the shift from so-called ‘corporate self-regulation’ – where, for example, companies unilaterally design and implement codes of conduct – to ‘co-regulation ‘ or ‘multistakeholder’ initiatives, which involve two or more actors (e.g. government, inter-governmental organizations, business and NGOs) coming together to design and implement norms and instruments that attempt to improve the social and environmental performance of firms. These typically involve codes of conduct, monitoring, verification, reporting and certification. This shift has partially addressed five of the major limitations of corporate selfregulation, namely, the tendency of companies to: ƒ pick and choose among the CSR initiatives with which they engage; ƒ ignore key aspects of CSR such as labour rights; ƒ limit CSR obligations to affiliates, as opposed to suppliers; ƒ pay insufficient attention to the need for independent monitoring or verification of corporate compliance with new policies and standards; ƒ each do their own thing, resulting in a confusing proliferation of standards and procedures.”478

Commenting on a conference hosted by the World Bank on ‘Public Policy for Corporate Responsibility’ in 2003 Zadek wrote: “There was an extraordinary level of consensus that sustainable, impactful corporate responsibility depends on business initiative and innovation working hand in hand with public policy, including new regulations where necessary.”479 Further, “[t]he risks of encouraging greater public sector involvement are considerable: the dangers are of increasing bureaucracy, driving forward unproductive compliance approaches, reducing market flexibility and increasing business costs unnecessarily and damagingly. But the alternative … is even more problematic.”480 For CSR sceptics the obstacles to CSR are structural and insurmountable; only regulation can tear them down. CSR is insignificant and one should not get distracted by the rhetoric of voluntarism. Worse still, CSR is a deregulatory plot or at least pre-empts indispensable regulation. While CSR sceptics concentrate on the (lack of) political will to regulate as the key issue and practically discourage further evaluations of CSR, proponents of CSR have grappled with the complexities of CSR and begun to reassess the roles states could play in CSR. For proponents, it is the limitations of CSR that reaffirm a role for states; these very limitations point to an evolution of the CSR movement from in-house company efforts towards more participative ways of implementing CSR and more interaction with public policy. 478

Utting, supra note 456. S. Zadek, ‘Voluntarism Versus Regulation for Corporate Responsibility’, Ethical Corporation, 27 November 2003. 480 Ibid. 479

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Chapter 4 Although critics of CSR have always called for regulation, dismissing CSR altogether is a shortcut not conducive for understanding the characteristics of future regulations. A closer look at CSR reveals that the role of state is as relevant as before in shaping corporate behaviour, but in a different mode which would account for the regulatory potential of private actors. Because of its concerns with scaling-up the effects of CSR, the movement has begun to look at innovative governance arrangements. The next chapters advance in this area with an analysis of regulatory techniques that do not rely exclusively on governmental coercion. This section was meant to highlight that, for reasons of practical necessity rather than philosophical conviction, CSR proponents see a role for state action to accompany corporate voluntarism; such action could be in the form of policy, or even regulation. An evolutionary perspective seems to make more space for obtaining a necessary zone of agreement between supporters of CSR mindful of its limitations and NGOs wary of deregulation. However, assessments of CSR, informed by aging CSR reasoning and not necessarily updated by recent developments in CSR, are bound to contain and perpetuate a range of misconceptions and unnecessary dichotomies. This fixes the terms of debate on moot points and thus inhibits faster convergence toward the zone of agreement. As Sinclair noted, false dichotomies do not describe the range of policies and constrain refinements of regulation.481 Simplistic understandings of CSR tend to be accompanied by simplistic understandings of law; they could misrepresent the role and capacities of states and undercut regulatory innovations by solidifying understanding in unproductive, needlessly polarised terms. *** The merits and shortcomings of each CSR initiative presented in this chapter will not be analysed here. For CSR sceptics, the importance and necessity of binding regulation cannot be overemphasised. The overriding concern continues to be the voluntary nature of CSR instruments: by definition they cannot be forced upon reluctant businesses. Indeed, taken in isolation, none of the CSR initiatives discussed here can force a MNE into compliance, as each remains voluntary. Taken together, these initiatives appear to create a ladder on which businesses willing to deepen their CSR commitment voluntarily climb higher. This ladder of voluntarism is on the way of being institutionalised with the indispensable participation of leading businesses. On each level  engagement fora, impact assessments, implementation, measurement and reporting, verification and certification  countless organisations are active (be they business actors, public-interest NGOs or governmental agencies). They disseminate to larger audiences the challenges, processes and outcomes of each step of the ladder. To what extent does walking this ladder remain ‘voluntary’ if one takes into accounts the dynamics of increased stakeholder participation and 481

D. Sinclair, ‘Self-Regulation Versus Command and Control – Beyond False Dichotomies’, 19 Law & Policy (October 1997) p. 552.

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The stakeholder norm in business practice CSR reporting nurtured by the emerging CSR regime? What roles can states play to strengthen this emerging regime in which private standard setting and leverage have been the main driving force? The multitude of actors involved in developing benchmarks and guidelines can be seen as an essential capacity-building process. It took leading businesses five to ten years to implement changes to a level where they could confidently and credibly report on CSR; businesses often start small, conducting impact assessments and focusing on immediate priorities, then implement effective internal systems, and eventually report in a credible fashion on their processes and results. It is important to account for this process of CSR institutionalisation even in the absence of legally binding rules. The mere existence of credible benchmarks can create important regulatory dynamics. While this chapter presented the main CSR initiatives that specify the stakeholder norm and touched upon the private pressures for compliance that the CSR regime generates, the next chapter shows how state policy encouraged such CSR developments. It will concentrate on examples of how states, through binding regulation and policy, relate to the stages of CSR management identified in this chapter.

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CHAPTER 5 POLICIES AND LAWS RELEVANT TO CSR This chapter highlights examples of hard law in order to tackle in the next chapter the widespread perception that law and CSR are mutually exclusive. Quite often CSR proponents have to answer the NGO criticism that CSR is a deregulatory strategy which relaxes or prevents necessary regulation, that CSR is an inapt substitute for law. The reply from CSR circles is to reaffirm the role of law and to position CSR as being complementary to law in achieving public policy goals; in other words to say that CSR starts where law ends. This explanation of CSR portrays it as a desirable but strictly voluntary type of corporate behaviour built on the bedrock of hard law, which enforces minimum standards. This study presents the complementarity of CSR and law in a different way. CSR as a responsible way to exercise corporate discretion actively interacts with ‘weaker’ and flexible law, more precisely with laws that aim to guide that managerial discretion, rather than overrule this discretion through ‘pure’ deterrence strategies. The mainstream way of explaining the relationship of CSR with law explains more ably the case of national CSR in developed countries. It does not however account for two other cases which make the object of analysis here: the case of transnational (international) CSR where parent companies assume some responsibility for human rights overseas (i.e. other jurisdictions than their own), and the case of national CSR in poor countries. In both these cases the bedrock of law defining legal obligations is actually very weak: in the first case the responsibilities of the parent company are not yet legally defined (except maybe for the really worst crimes and torts), and in the second case poor countries have sometimes inadequate laws to protect human rights, and very often these laws are not enforced. In both these contexts, CSR is not a desirable add-on complementing the law, but acts as a temporary substitute for law and more importantly interacts with law to shape the contents of flexible legal provisions (e.g. positive obligations of companies); CSR has a role in the rulemaking process and in the evolution of law regarding responsibilities of TNCs. Thus, a legal perspective on CSR can clearly conceive a role for hard law. If concerns about imposing ‘red tape’ on businesses do not unduly prevail, the spreading of the type of regulations discussed in this chapter appears as imminent and has actually already begun. This chapter continues the discussion in company law (chapter 2) about the duty of reasonable care that directors owe to the company. There we concluded that the duty of care laid down in company law has its more precise contents defined elsewhere (good business practice and soft law instruments of corporate governance), and has its enforcement provided especially by markets and shareholders’ self-help, informed by disclosure regulations. Chapter 3 then 167

Chapter 5 accounted for CSR writings which aim to guide managerial decision-making; we saw how pro- and con-CSR arguments have proposed competing norms of how a loyal and careful manager should approach complexity. In chapter 4 we described recent developments in CSR practice that offer standards of good managerial practice for the implementation and demonstration of CSR. We tracked some multistakeholder initiatives that create benchmarks and guidelines able to specify better what reasonable care entails in different contexts. These developments build on, and elaborate, the business case of CSR which maintains that CSR is in the selfinterest of business. In this chapter, we will see how states increasingly encourage through binding regulations higher levels of managerial care when CSR may make business sense. Especially disclosure regulations are relevant here. Such transparency requirements elaborate the ‘grey area’ between economic and social considerations, an area of overlap where the company’s interests are better served in the long-run by taking into consideration stakeholders’ interests. These regulations are directly relevant to understanding the duty of care that mangers owe to the company. For clarity, these regulations need to be distinguished from disclosure regulations of a ‘right-to-know’ type which promote primarily the interest of stakeholders, do not operate in the ‘grey zone’, and thus relate to an implicit duty of care that directors and the company owe to stakeholders. Regulations of a right-toknow type are much more an accountability mechanism than a CSR-stimulating technique, as disclosure regulations in the ‘grey zone’ are. The focus of this study is on the latter type of regulations. Regulations on corporate transparency are the central, though not the exclusive, organising theme in this chapter. Laws referring to management systems form the other object of analysis. The previous chapter looked at evolving good business practice in the management of CSR; now we compare it with the procedural benchmarks that lawmakers have recently laid down regarding compliance systems, information systems, risks assessment systems, environmental management systems and social and environmental impact assessments. We examine these laws because they show the importance lawmakers attach to rigorous procedures, as distinct from results/outcomes; in complex situations attention to procedures and their structuring through regulations can generate improvements in performance. This chapter surveys public policies and hard laws that are relevant to the emerging CSR regime. The first part highlights various policies that states have employed, at national and international levels, to encourage the development of CSR initiatives. The second and third parts are the main ones and contain a collection of laws and regulations from a variety of fields such as corporate governance, securities regulations, environmental protection and criminal law. These laws have been enacted in the US, UK, France, Belgium, Australia, South Africa, Indonesia and also the EU. Some of these instruments explicitly cover the social segment of CSR wherein human rights aspects naturally fall; some others refer to purely financial or environmental aspects. The aim behind this heterogeneous selection is twofold. On one hand, we account for recently enacted laws directly relevant to the area of business and human rights, mainly disclosure regulations. On the other hand, 168

Policies and laws relevant to CSR we review corporate governance and environmental regulations that inform by way of analogy the path along which human rights regulations may develop in the future. 5.1. STATE POLICIES States, at both national and international levels, have the capacity to create an enabling environment for CSR. A review of the roles states have played found examples of governments mandating, facilitating, endorsing and partnering with businesses.482 The reason why governments have related in various ways to CSR initiatives was stated by the European Commission in its 2002 White Paper on CSR: “In principle, adopting CSR is clearly a matter for enterprises themselves, which is dynamically shaped in interaction between them and their stakeholders. Nevertheless, as there is evidence suggesting that CSR creates value for society by contributing to a more sustainable development, there is a role for public authorities in promoting socially and environmentally responsible practices by enterprises.”483 5.1.1. International level This section takes note of international instruments supportive of CSR that states have recently adopted. Some government-driven instruments, often referred as ‘soft law’, lay down in some detail principles and specific human rights that businesses are expected to observe throughout their operations. Most prominent examples are the OECD Guidelines,484 ILO Declaration485 and UN Norms.486 From the numerous CSR schemes that have emerged in the last ten years, the more credible of them expressly refers to international instruments such as the ILO conventions and the Universal Declaration of Human Rights. We do not expand on presenting the substantive expectations of the international community as this would result in a long descriptive account that would add little value. Instead the focus here is on governmental actions that help CSR implementation and also legitimise new collaborations with businesses. The United Nation’s Global Compact (GC) is the most high-profile initiative at international level dedicated to advancing CSR.487 The initiative has begun as a personal initiative of former Secretary-General Kofi Annan in 1999 as an attempt to 482

T. Fox et al., World Bank, International Institute for Environment and Development, Public Sector Roles in Strengthening Corporate Social Responsibility: A Baseline Study, 2002, pp. 3–5, <www.ecodes.org/documentos/archivo/Public%20policies%20CSR-World% 20bank.pdf>, visited on 14 February 2007. 483 Commission of the European Communities, Communication From The Commission Concerning Corporate Social Responsibility: A Business Contribution To Sustainable Development, COM(2002)347 final, July 2002, p. 7, <europa.eu.int/comm/employment_ social/soc-dial/csr/csr2002_en.pdf>, visited on 14 February 2007. 484 See supra note 41. 485 Ibid. 486 Commission on Human Rights, supra note 10. 487 <www.unglobalcompact.org>, visited on 14 February 2007.

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Chapter 5 address some imbalances of economic globalisation; his aim was to enrol companies in a renewed push by the United Nations to achieve its goals of peace, development and poverty reduction. 488 The Compact asks companies to “embrace, support and enact, within their sphere of influence”, a set of ten core principles in the areas of human rights, labour standards, the environment and anti-corruption. Regarding human rights, businesses should respect and support the protection of internationally proclaimed human rights; and make sure that they are not complicit in human rights abuses. In respect of labour standards businesses should uphold the freedom of association and the right to collective bargaining, the elimination of forced labour, the abolition of child labour and the elimination of discrimination in employment. Concerning the environment businesses should support a precautionary approach, promote greater environmental responsibility and encourage the development and diffusion of environmentally friendly technologies. The anti-corruption principle was added in 2004. To achieve its objectives, the GC uses several mechanisms: Policy Dialogues,489 Learning, Country/Regional Networks,490 and Projects (local partnerships).491 The Compact is open to the participation of all main stakeholders. Currently there are around 3,000 companies signed up, from both developed and developing countries. Civil society organisations and trade unions are also involved. For promoting its principles the GC relies on the specific expertise of six UN agencies.492 The trademark of the Compact is its learning approach: “Global Compact initiative is inspired by a belief in the capacity, indeed the necessity, for collective learning among business, labour, civil society … The Global Compact is neither an instrument for monitoring companies nor a regulatory regime to legislate corporate behaviour.”493 The Compact reaches out to companies, helps them to incrementally build internal capacity and offers opportunities to connect with other businesses and stakeholders to move towards consensus and practical action. The Compact aims to 488

Secretary-General Proposes Global Compact on Human Rights, Labour, Environment, in Address to World Economic Forum in Davos, Press Release, SG/SM/6881, 1 February 1999, <www.un.org/News/Press/docs/1999/19990201.sgsm6881.html>, visited on 14 February 2007. 489 Policy dialogues on topics such as the role of the private sector in zones of conflict (2001 and 2004), business and sustainable development (2002), HIV/AIDS (2003), supply chain management and partnerships (2003), transparency and the fight against corruption (2004). 490 Around 60 such networks exist currently. 491 United Nations, Global Compact Office, Corporate Citizenship in the World Economy – The Global Compact, 2004, <www.unglobalcompact.org/docs/about_the_gc/2.0.1.pdf>, visited on 14 February 2007. 492 The Office of the UN High Commissioner for Human Rights (OHCHR), the International Labour Organisation (ILO), the UN Environmental Programme (UNEP), the UN Industrial Development Organisation (UNIDO), the UN Development Programme (UNDP) and United Nations Office on Drugs and Crime. 493 United Nations, Global Compact Office, The Global Compact: Report on Progress and Activities, 2002, p. 17, <www.iccwbo.org/home/global_compact/ProgressReport%20July% 203.pdf>, visited on 14 February 2007.

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Policies and laws relevant to CSR disseminate the good practices and experience that leading businesses have accumulated.494 The vision behind the Compact has generated intense exchanges between the GC Office and NGOs (participating in the Compact or not) about the very nature of the GC. One of the concerns of NGOs has been that of ‘bluewash’: if the Compact is voluntary and dedicated to learning, the UN should at least refrain from granting legitimacy by association to companies that promise to but fail to abide by its principles. Therefore GC should monitor its members and exclude the unworthy. Georg Kell, executive head of the GC, explained that the Compact was not meant as “a membership program that conveys recognition”495 and therefore does not require monitoring and measurement; it is not a club of the worthy with high exclusionary thresholds for tainted businesses. The initiative is rather an open house that does not aim to ostracise immediately the unworthy but attempts to meet them where they are and help them improve their act. The GC has shown remarkable conceptual clarity about what it is and what it is not, and consistently kept with its initial vision: it stimulates change not through coercion, but through learning and creating opportunities. This distinction is necessary for clarifying the non-regulatory emphasis of the GC, but in practice the Compact’s approach does not exclude degrees of coercion against poorly performing members. Thus the GC has adopted so-called ‘integrity measures’ such as corporate reporting requirements (‘Communications on Progress’) and a complaint procedure for “systematic or egregious abuse[s]”.496 Governments have lent legitimacy to the Global Compact through a series of resolutions passed in the UN General Assembly authorising the continued engagement of the UN with the private sector, including through the Global Compact initiative.497 In 2000 the General Assembly of the UN passed resolution GA/55/215 ‘Towards Global Partnership’ authorising the continued engagement of

494

UN General Assembly, Towards Global Partnership, A/C.2/60/L.38/Rev.1, 14 December 2005, “[e]ncourages the Global Compact Office to promote the sharing of best practices and positive action through learning, dialogue and partnerships”. <www.unglobalcompact.org/ docs/news_events/9.1_news_archives/2005_12_16/ResolutionDec_14_05.pdf>, visited on 14 February 2007. 495 G. Kell, ‘The Global Compact: Selected Experiences and Reflections’, 59:1–2 Journal of Business Ethics (June 2005) pp. 69–79. 496 The GC will use good offices and/or refer the complaint to other UN bodies; sanctions for non-cooperation with the GC can result in sanction such as being labeled inactive or completely removed from the list of participants. UN Global Compact, Note on Integrity Measures, 2006, <www.unglobalcompact.org/About TheGC/integrity.html>, visited on 14 February 2007. 497 The UN General Assembly adopted a series of resolutions entitled Towards Global Partnership, resolutions A/55/215, 2 August 2000; A/56/76, 24 January 2002; A/58/129, 19 February 2003; A60/38 (2005).

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Chapter 5 the United Nations with the private sector, including through the Global Compact initiative.498 Key persons involved in the GC recalled the controversy surrounding it in its early phases, and the role states have played in strengthening this CSR scheme. Kofi Annan wrote that when he initially had proposed the Compact at the 1999 World Economic Forum in Davos, “many of my colleagues in the Secretariat – and many representatives of Member States – would hardly have been more shocked if I had proposed a compact with the Devil”.499 Governmental support for the GC was not assured from the beginning; Kell remembers: “Developing countries were initially suspicious that the Compact was a disguised form of protectionism, introducing social conditions through the back door of the realm of economic transactions… In response, the Group of 77, the political platform of developing countries at the UN, called for an intergovernmental oversight of the Compact in their Ministerial Declaration of 2000. It took major efforts by European governments to avoid institutionalization of the Compact, and to negotiate a General Assembly resolution entitled ‘Towards Global Partnership,’ which secures a mandate for the Secretariat to continue working on the Compact.”500

Kell further explains that although the GC is a strictly voluntary initiative, “governments are intimately involved, by providing policy space for the initiative within the intergovernmental framework of the UN and by offering funding and other means of direct support… Governments hold the key – they enable the initiative – but they can also withdraw support and instantly bring the experiment to an end, or at least alter its orientation.”501 The GC has placed the cooperation of the UN with businesses and civil society groups on the international agenda. A string of international pronouncements made references to ‘partnerships’, defined by the UN as “voluntary and collaborative relationships between various parties, both public and non-public, in which all participants agree to work together to achieve a common purpose or undertake a

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The resolution was followed by a Report of the Secretary-General which provided a comprehensive survey of the UN’s partnership activities. See Report of the Secretary General, Cooperation between the United Nations and All Relevant Partners, in Particular the Private Sector, A/56/323, 29 August 2001, <www.un.org/documents/ga/docs/56/a56323.pdf>, visited on 14 February 2007. Drawing on this report, the Global Compact Office issued subsequently J. Nelson, Building Partnerships: Cooperation between the United Nations System and the Private Sector (United Nations Department of Public Information, New York, 2002). 499 United Nations Secretary General, ‘The United Nations Cannot Stand Still, Because the Threats to Humanity Do Not Stand Still’, Secretary General Tells Davos World Economic Forum, Press release 26 January 2006, SG/SM/10325 ECO/103, <www.un.org/News/Press/ docs/2006/sgsm10325.doc.htm>, visited on 14 February 2007. 500 Kell, supra note 495. 501 Ibid. (emphasis added)

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Policies and laws relevant to CSR specific task and, as mutually agreed, to share risks and responsibilities, resources and benefits”.502 The 2002 World Summit on Sustainable Development (WSSD) in Johannesburg affirmed the importance of CSR and the legitimacy of public-private partnerships. The Plan of Implementation of the Summit referred to the stages of CSR management analysed in the previous sections. Thus the Plan: “a) Encourage[s] voluntary initiatives, including environmental management systems, codes of conduct, certification and public reporting on environmental and social issues, taking into account such initiatives as the International Organization for Standardization (ISO) standards and Global Reporting Initiative guidelines on sustainability reporting …; b) Encourage[s] dialogue between enterprises and the communities”503

The Summit identified partnerships between corporations and public interest bodies as an important implementation mechanism. The Summit split partnerships into the so-called Type I, intergovernmental partnerships that establish public priorities, and Type II, public-private partnerships implementing the priorities identified by states: “We recognise that the implementation of the outcomes of the Summit … should involve all relevant actors through partnerships, especially between Governments of the North and South, on the one hand, and between Governments and major groups, on the other, to achieve the widely shared goals of sustainable development. As reflected in the Monterrey Consensus, such partnerships are key to pursuing sustainable development in a globalizing world.”504

With this occasion more than 200 Type II partnerships have been launched. In the preparatory meetings to WSSD, government representatives indicated areas in which they have started to elaborate Type II partnerships: sustainable agriculture, food security and rural development, clean energy, chemicals, education and training, freshwater and sanitation, forests, information and communication technologies, initiatives for Africa, health, sustainable urbanisation, sustainable mountain development, oceans and fisheries, sustainable consumption and production patterns and technology transfer.505 A 2005 resolution of the UN General Assembly reaffirms the role of partnerships: “172. We welcome the positive contributions of the private sector and civil society, including non-governmental organizations, in the promotion and implementation of development and human rights programmes and 502

UN General Assembly, supra note 494. World Summit on Sustainable Development, Report – Plan of Implementation (United Nations, New York, 2002) para. 18, p. 15. 504 Ibid., para. 3, p. 8. 505 Vice-Chairs’ Summary of the Informal Meetings on Partnerships/Initiatives, New York, 5 April 2002, para. 8. 503

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Chapter 5 stress the importance of their continued engagement with Governments, the United Nations and other international organizations in these key areas. … 175. We encourage responsible business practices, such as those promoted by the Global Compact.”506

One examination of the UN practice with partnership approaches has identified six functions of global public-private networks as follows: help establish a global policy agenda; ƒ facilitate standard-setting processes; ƒ develop and disseminate knowledge; ƒ create or deepen markets; ƒ provide innovative mechanisms for implementing global agreements; and ƒ address the participatory gap by creating inclusive processes.507 The UN Industrial Development Organisation (UNIDO) explains its interest in forging partnerships with international businesses: “With SMEs [small and medium enterprises] thus providing the backbone of the private sector not only in developed countries but also in developing countries and countries with economies in transition, UNIDO has adopted SME development as one of its principal objectives. In pursuing this goal, the Organization has increasingly sought to engage in partnerships with the business community, and especially with transnational corporations (TNCs), who are themselves often actively engaged in promoting SMEs in developing countries and transition economies as part of their global vendor and supplier development programmes.”508

UNIDO aims to capitalise on transnational business chains to help SMEs in developing countries access the markets in the North. “The main idea of the UNIDO Partnership Programme has been to develop an alternative model for delivering technical cooperation because the classical relationship between donors, national governments and multilateral implementing agencies does not meet the needs of SMEs entering into global value chains.”509 Along these lines, UNIDO’s Triple 506

UN General Assembly, 2005 World Summit Outcome, resolution 60/1, 16 September 2005, <domino.un.org/UNISPAL.NSF/0/af55614504378054852570980054e21a?OpenDocument>, visited on 14 February 2007. 507 W. H. Reinicke and F. Deng, Critical Choices – The United Nations, Networks, and the Future of Global Governance (International Development Research Centre, Ottawa, 2000). 508 United Nations Industrial Development Organization, Integrating SMEs in Global Value Chains – Towards Partnership for Development, Vienna, 2001, p. 2, <www.unido.org/ userfiles/PuffK/partnerships02.pdf>, visited on 14 February 2007. 509 K. Bethke, United Nations Industrial Development Organization, Partnerships with Private Business, Rationale, Benefits, Risks and Approaches, Proceedings of an Expert Group

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Policies and laws relevant to CSR Bottom Line project aims to enhance the ability of medium-sized enterprises in developing countries to comply with requests from their foreign buyers to make technical and managerial changes that would enable them to meet environmental and social standards. For these purposes, the Triple Bottom Line (TBL) Project in Asian Countries was initiated in 2001 in India, Pakistan, Sri Lanka and Thailand.510 More broadly, it was noted that some development assistance has always been used to finance private sector activities, but the range of partnerships is now broader. The changing global and policy environments have altered the nature and importance of partnerships with private business.511 The OECD has also encouraged the involvement of corporations in partnerships. Its Guidelines on Poverty Reduction aim to “[m]arshall all potential development partners to ensure ownership, sustainability and effectiveness”: “Civil society, the private sector, Parliaments, local government, trade unions, poor people, external agencies – all should participate in designing and implementing strategies for reducing poverty. This diversity of actors demands better communication, reinforced by strong co-operation, and a good understanding of the relative strengths and comparative advantages of each of them. Due consideration should be given to the scope for non-governmental organisations, Chambers of Commerce and the enterprise sector to spearhead effective and innovative initiatives for reducing poverty.”512

Besides the abovementioned policy statements on the role of partnerships, states have built international frameworks that deliberately give businesses a facilitative role. This has happened in the extractive industries.513 Thus the Kimberley Process, in which 45 states meet minimum requirements to participate, creates legally binding obligations on states to implement the necessary regulatory frameworks within their jurisdictions while businesses are invited to build a reinforcing system of warranties to help tracking diamonds. The Extractive Industry Transparency Initiative, initiated by the UK, is entirely voluntary as both states and companies are invited to disclose revenues received and taxes paid. Finally, four governments (US, UK, Netherlands and Norway) have facilitated the drafting of the Voluntary Principles on Security and Human Rights in which 16 companies currently participate. Actually the role of these governments in this initiative is highlighted also by their inability to offer more support to companies; TNCs are expected to Meeting, Vienna, 2001, p. 12, <www.unido.org/userfiles/PuffK/partnerships01.pdf>, visited on 14 February 2007. 510 International Institute for Environment and Development, Development Agency Round Table on Corporate Social Responsibility, Round Table Report, 2002, p. 35. 511 Department for International Development, Poverty: Bridging the Gap – An Introduction, 2001, p. 154. 512 OECD, Development Assistance Committee of OECD, Guidelines on Poverty Reduction, 2001, p. 21, <www.oecd.org/dataoecd/47/14/2672735.pdf>, visited on 14 February 2007. 513 See supra section 4.3.2.C.

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Chapter 5 safeguard human rights in a heavily politicised context where the assistance of their home states is crucial to deal with the sensitivities of host governments. A close observer of the process notes that limited progress has been made in reaching out to the governments and security forces in Indonesia and especially Nigeria, while more progress has been made with the government of Colombia. In his view, “this essential interaction among the convening and host country governments remains the weakest link in the entire Voluntary Principles process”.514 International governmental agencies have also initiated important initiatives dedicated to certain aspects of CSR. The best example is probably the UN Environmental Programme which was one of the actors that initiated the Global Reporting Initiative, the multistakeholder undertaking aiming to provide standards and guidelines on CSR reporting. The World Bank initiated the multistakeholder project named ‘Business Partners for Development’ to lay down guidance about multistakeholder partnerships. 5.1.2. National level Chapter 4 presented current multistakeholder CSR initiatives. Without recalling their characteristics it can be noted here the role governments have played in their development. 515 The list is without a doubt much longer and only a few instances will be noted below. In the UK, the Department of Trade and Industry has supported both the SIGMA Guidelines and the FORGE Guidance on Corporate Social Responsibility Management and Reporting for the Financial Services Sector. The Department for International Development provides 40 per cent of Ethical Trading Initiative’s funding. The CSR scheme in the coffee industry – Common Code for the Coffee Community – is a multi-stakeholder initiative started by the German international development agency (GTZ) on behalf of the German Ministry for Economic Cooperation and Development (BMZ) in cooperation with the German trade association (German Coffee Association – DKV).516 The Swiss State Secretariat for Economic Affairs, World Bank and Inter-American Development Bank also participated in the process. In the US, the Clinton administration summoned the Apparel Industry Partnership to work out a solution to labour issues in the overseas operations of American apparel companies, which ended becoming the Fair Labor Association. 514

B. Freeman, To What Extent Can Voluntarism Provide Answers?, Wilton Park Conference on Business and Human Rights, 11 October 2005, <www.reports-and-materials.org/BennettFreeman-Wilton-Park-11-Oct-2005.doc>, visited on 14 February 2007. 515 H. Ward, World Bank and International Finance Corporation, Public Sector Roles in Strengthening Corporate Social Responsibility: Taking Stock, 2004, <www.ifc.org/ifcext/ economics.nsf/AttachmentsByTitle/CSR-Taking_Stock.pdf/$FILE/CSR-Taking_Stock.pdf>, visited on 14 February 2007. 516 <www.sustainable-coffee.net>, visited on 14 February 2007.

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Policies and laws relevant to CSR States have also supported the capacity of business and their stakeholders to use emerging CSR guidelines and standards. The UK government was the first to appoint a Minister with responsibility for CSR in March 2000.517 The Swedish government has an Ambassador for CSR within the Foreign Affairs Ministry since 2002. Besides building such formal structures to support CSR, there are numerous gatherings organised by governments, or by trade associations and universities with governmental participation, where good CSR practices are communicated to wider audiences. 5.2. DISCLOSURE REGULATIONS The starting point in discussing corporate transparency can only be financial disclosures. Section 5.2.1. introduces some considerations of securities regulations taking the US as a case in point where experience has accumulated since the 1930s. These regulations are geared towards the information needs of the ‘reasonable investor’. We refer to the information needs of ‘reasonable investors’ and to those of ‘ethical investors’, as they have been discussed in US case law. The analysis of the US legal framework introduces some basics of disclosure regulations that are directly relevant to CSR discussions about how to enhance corporate transparency. Because what is ‘material’ and what a ‘reasonable’ investor is may not always be clear cut, there is a ‘grey zone’ where shareholders’ and stakeholders’ information needs overlap. Numerous arguments elaborate the ‘business case’ of CSR, which is based on the understanding that a good CSR performance benefits the corporation in some way. That would automatically make relevant to investors information about how corporate management handles its social and environmental impacts. 5.2.1. Narrowly defined disclosures benefiting ‘reasonable investors’ Disclosure regulations are an essential element of corporate governance regimes because they empower investors to act on publicly available information and help themselves rather than seek judicial enforcement. This raises the question of what type of information should such disclosure regulations require? Beginning to answer this question depends on assessments of how the managerial duty of care owed to the company is defined. The definition of the duty of care can be stretched to make management take a more relationship-inclusive and long-term approach, as is the case in the UK; then the area of overlap between stakeholders’ and shareholders’ interests expands and new information needs arise for shareholders. The question then is what information is ‘material’ (relevant) to investors to assess whether managerial duties have been fulfilled? ‘Investors’ do not make a homogenous category. There are shareholders concerned solely with short-term financial gains (speculators), prudent investors having a longer-term stake in the success of the business or ethical investors that place CSR before maximum profits. Here we discuss the situation of prudent investors and ethical investors, and how disclosure 517

<www.csr.gov.uk>, visited on 14 February 2007.

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Chapter 5 regulations cater, or could cater, to their information needs to assess the longer-term sustainability of a business. In the US, disclosure under the securities regulations follows two general principles. First, there are specific disclosure requirements set forth in the Securities Act of 1933 and the Securities Exchange Act of 1934, and detailed in the rules and forms promulgated by the Securities and Exchange Commission (SEC). These specific disclosures are complemented by the antifraud provisions which cover statements misleading by omission of material information.518 Particularly relevant for CSR discussions are the antifraud rules because the specific disclosure regulations have traditionally focused on financial and other core business indicators, and have not mandated disclosures of wider social and environmental impacts. The relevant antifraud regulation provides: “It shall be unlawful for any person … [t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading … in connection with the purchase or sale of any security.”519 Kitch explains the reasoning behind antifraud rules: “[I]n addition to the information expressly required to be included in a registration statement (under the applicable regulations), there shall be added such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading. The point here is that the responses provided in disclosure forms should disclose the full truth. The telling of half-truths by failing to mention additional information, which affects the meaning of the information that is disclosed is prohibited. This standard can be generalized to apply to any statement.”520

We then need to discuss materiality and to whom should information be material. The US regulatory system is extremely detailed about what needs to be disclosed. Regulation S-K first identifies the specific issues to be disclosed, and second limits disclosures on each issue through a specific materiality benchmark. For example, in describing the legal proceedings facing a company, the disclosure must “[d]escribe briefly any material pending legal proceedings, other than ordinary routine litigation incidental to the business … ”.521 Williams notes that regulators further set out a materiality benchmark of 10 per cent of the current assets of the 518

Kahn, supra note 59, p. 1135. Rule 10b-5(b), promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, <www.law.uc.edu/CCL/34ActRls/rule10b-5.html>, visited on 14 February 2007. 520 E. W. Kitch, ‘The Theory And Practice Of Securities Disclosure’, 61 Brooklyn Law Review (Fall 1995) p. 820. 521 Regulation S–K, Item 103, Standard Instructions for Filing Forms under the Securities Act of 1933, Securities Exchange Act of 1934, and Energy Policy and Conservation Act of 1975, <www.law.uc.edu/CCL/regS-K/SK103.html>, visited on 14 February 2007. 519

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Policies and laws relevant to CSR issuer, except in an environmental proceeding against a government entity, in which case proceedings with the possibility of a $100,000 fine must be disclosed. When regulations do not specifically provide a materiality benchmark, the general materiality standard prevails.522 The US Supreme Court has formulated the general materiality benchmark. For an item to be material “there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available”.523 Information is considered material if a reasonable investor would consider it important in deciding to purchase the security registered or how to vote.524 Thus the general benchmark of materiality helps with both identifying the issues/information that need to be disclosed when no specific regulations exist, and also sets a level of relevance where regulations do identify an issue for disclosure but do not mention a specific threshold above which disclosure is mandatory. Commentators though have explained that ‘materiality’ could not provide clear delimitations of what should be disclosed or not. Thus Williams shows that “materiality is a filter for determining which information must be disclosed that is affected by normative evaluations of the perceived costs and benefits of disclosure … While the SEC’s definitions of materiality refer only to the significance of information to a reasonable investor, in fact the SEC considers a broader range of issues in determining what is ‘material’, including the costs to issuers and society in making more information available, and the net benefits to society from expanded disclosure.”525

Brudney argues that materiality entails indeterminacy: “If ‘materiality’ is a filter for determining which information (whether soft or hard) must be disclosed, the fineness or porosity of the filter is determined in part by analytic considerations, such as how adequately the filter measures degrees of relevance and reliability or certainty, and in part by normative considerations. The normative considerations that must necessarily affect the meaning of materiality go beyond a concern for the welfare of the intended recipient of information (the transacting purchaser or seller or voter of a security) and, through him or her, of society. They also relate to the interests of those required to disclose the information and of others. The costs to the disclosing corporation, corporate insiders, market insiders, other players in the market for corporate control, and, in the long run, to society, may in some circumstances be less and in others more than the benefits to transacting public investors and society from compelled disclosure. The concept of materiality entails indeterminacy 522

C. A. Williams, ‘The Securities and Exchange Commission and Corporate Social Transparency’, 112 Harvard Law Review (April 1999) p. 1208. 523 Basic Inc. v. Levinson, 108 S. Ct., p. 983. 524 Kahn, supra note 59, p. 1137. 525 Williams, supra note 522, p. 1264.

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Chapter 5 that is a function not only of the need for a descriptive or analytic inquiry in selecting from degrees of relevance and reliability of information in any given case. It is also a function of the need for normative judgments about the purposes to be served and the net benefits to be derived from the particular disclosure requirement in a particular context. Those variations in purpose and context affect the point in the acceptable range of relevance and reliability (in analytic terms) at which the law should declare information to be material. In short, the question of materiality cannot be answered, as the SEC suggests in its rules and the Court indicated in Basic, by inquiring only into whether an abstract reasonable investor would in all contexts want the information in order to make a rational estimate of the future.”526

The concept of ‘reasonable investor’ is included in the definition of materiality articulated by the US Supreme Court. This raises the question of how securities laws conceive the shareholder for purposes of corporate reporting. Kahn elaborates on the concept of ‘reasonable investor’: “Although the SEC and the courts describe the body of material information in terms of the information desired by reasonable investors, the system is not designed to monitor and reflect the actual interests of real investors. Rather, the SEC’s disclosure system operates on the basis of a reified ‘reasonable investor’.”527 This issue – whether the disclosure system should be ‘responsive’ to actual shareholders’ disclosure preferences – was addressed by the SEC, which concluded that reference to the actual interests of investors “would not have been workable and would have been totally unstable”. The SEC stated that “[w]e have serious reservations as to whether Commission rulemaking can be premised upon an attempt to quantify investor interest”528 and defended the propriety of operating independent of ‘the actual interests of investors’, on the rationale that a statistical survey “would at best produce results that might rapidly become outdated in light of the shifting and fluctuating nature of public opinion and the focus of popular attention from time to time”.529 The SEC “has thus manufactured a scheme of disclosure which reflects its own view of what investors should be interested in”.530 Kahn based her conclusion also on a litigation involving the SEC in the 1970s. The question here is to what extent do ethical shareholders, as distinguished from prudent investors, have special information needs that securities laws should address through enhanced transparency requirements? This issue was an object of litigation in the 1970s in the US. Plaintiffs were three public interest groups that had filed a rulemaking petition with the SEC in 1971; they asked the SEC to require broader corporate disclosures 526

V. Brudney, ‘A Note on Materiality and Soft Information under the Federal Securities Laws’, 75 Virginia Law Review (May 1989) pp. 734–735 (footnotes omitted). 527 Kahn, supra note 59, p. 1136. 528 Quoted in ibid. 529 Ibid. 530 Kahn, supra note 59, p. 1136.

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Policies and laws relevant to CSR in the area of environmental protection and equal opportunity practices. The SEC had already modified its corporate disclosure regulations to require each reporting corporation to state: (1) the material effect which compliance with environmental laws and regulations may have upon the corporation’s financial condition, and (2) material litigation which involves the corporation and relates to environmental protection. The plaintiffs wanted broader disclosure rules. They required the SEC to modify its corporate disclosure regulations so that each reporting corporation must provide to the SEC for public disclosure information concerning: (1) the effect of its corporate activities on the environment, and correcting plans and their feasibility, and (2) statistics about its equal employment practices.531 The plaintiffs referred to the information needs of ethical investors, not necessarily prudent investors. As the court noted, “Plaintiffs were public interest groups which wanted information about corporations in order to make socially responsible investment decisions, to further public education, and other purposes … The importance of Plaintiffs’ claims is underscored by a large number of ‘ethical investors’ in this country – individuals and institutions such as our great universities and foundations which have large funds to invest and need the information that Plaintiffs seek in order to make investment and voting decisions in accordance with their high principles and societal interests.”532

In the later stages of litigation, the plaintiffs asked for regulatory support in their efforts to reach a larger base of investors. The court noted the plaintiffs’ argument: corporate responsibility campaigns have achieved positive results in some cases, but their “usefulness is currently limited by a shortage of information available to stockholders and an imbalance in the information that is distributed. Stockholders receive considerable lobbying by management through annual reports, selective disclosure, image advertising, and other mechanisms involving large corporate expenditures. In contrast, [campaigning] groups … find it expensive to compile and disseminate information even when managements are cooperative, and often difficult or impossible when managements are not. Institutional investors in particular, so it is claimed, are naturally reluctant to vote against management in the absence of full and balanced information, whatever their position would be if they were fully informed. [Plaintiffs] believe that this impediment to corporate responsibility campaigns could be considerably reduced if corporations were forced to disclose comprehensive information about their environmental and equal employment policies.”533

531

Natural Resources Defense Council, Inc. v. SEC, 389 F. Supp. 689 (D.D.C. 1974) p. 692. Ibid. 533 Natural Resources Defense Council, Inc. v. SEC, 606 F.2d 1031 (D.C. Cir. 1979) p. 1036. 532

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Chapter 5 The court further noted that “the proposed disclosures would be extremely voluminous, subjective and costly to all concerned … There appears to be virtually no direct investor interest in voluminous information of this type. Proponents, apparently conceding this, suggest that the disclosures be contained in documents which are filed with the Commission but which are not furnished directly to investors. They claim that analysts will study the materials and report their conclusions to investors in some meaningful, understandable form.”534

The SEC declined to adopt the proposed disclosure rules, which raises the question on what factors would expanded disclosures depend? We have seen that materiality entails indeterminacy. This aspect is essential for CSR proponents that seek to expand corporate transparency by using security regulations. It is important to grasp on one hand the lax contours of materiality that could accommodate CSR information, but on the other hand the institutional framework where this concept is used imposes limitations on an expanded understanding of materiality. We refer here to some factors mentioned by the SEC and then to the institutional mandate of the SEC. The SEC explained why it would not adopt the proposed disclosure rules, and thus hinted at what considerations are pertinent in CSR discussions about the materiality of information. In summarising SEC’s position, the court referred to the costs to registrants, the administrative burdens, the extent to which the added mass of information would confuse or mislead the average investor and the likelihood that disclosure of the type requested would cause corporations to adopt sounder environmental policies. Also there appears to be no established, uniform method by which the environmental effects of corporate practices may be comprehensively described; this would result in information that is “extremely voluminous, subjective and costly to all concerned. They also would not lend themselves to comparisons of different companies, which is of great importance to investors since investment decisions essentially involve a choice between competing investment alternatives.”535 Such disclosures “would in the aggregate make disclosure documents wholly unmanageable and would significantly increase the costs to all involved without, in our view, corresponding benefits to investors generally”.536 The litigation – a review of how SEC exercised its administrative discretion – was not successful as the court deferred to SEC’s expertise and mandate and concluded that SEC did not act arbitrarily and capriciously in denying the plaintiffs’ petition. Williams notes that most of the arguments presented by the SEC in support of its decision to decline to expand corporate disclosure were practical, rather than conceptual or philosophical in nature; and 20 years later, in light of changed

534

Ibid., p. 1040. Ibid. (emphasis added) 536 Ibid., p. 1041. 535

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Policies and laws relevant to CSR circumstances, these practical arguments should be re-evaluated.537 The SEC had basically argued that the transaction costs of social disclosure were prohibitive in relation to the amount of investor interest. 538 Williams considers that while the SEC was probably correct in its conclusion based on the typical 1970s investor, today there is reason to believe a substantial and growing subset of investors consider this information material. Expanded social disclosure could be required today, even applying the standards used by the SEC to reject it in 1975 and 1980.539 In Basic v. Levinson, the US Supreme Court explicitly considered the drawbacks of a too low standard of materiality. This is important for CSR proposals seeking to expand CSR disclosures by emphasising materiality. The Supreme Court referred to TSC Industries, Inc. v. Northway, Inc.540 and wrote: “The Court also explicitly has defined a standard of materiality under the securities laws… Acknowledging that certain information concerning corporate developments could well be of ‘dubious significance,’ the Court was careful not to set too low a standard of materiality; it was concerned that a minimal standard might bring an overabundance of information within its reach, and lead management ‘simply to bury the shareholders in an avalanche of trivial information – a result that is hardly conducive to informed decision-making.’ It further explained that to fulfill the materiality requirement ‘there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.’”541

Materiality in itself seems to provide insufficient grounds to force a company through litigation to disclose CSR information that could arguably be ‘material’ to prudent shareholders. New specific regulations are then necessary. Mansley noted that “[m]uch of the debate in the US is over the issue of materiality. Companies only have to report if a particular impact is ‘material’, which is typically taken to mean as greater that 5% of net assets. Despite SEC guidance that the qualitative information can be material, companies find it easy to use ‘materiality’ to limit disclosure of information on environmental and social factors. This is compounded by the fact that the US case law has made it clear that in the absence of a specific regulation

537

Williams, supra note 522, p. 1206. Kahn, supra note 59, p. 1142. 539 Williams, supra note 522, p. 1206. 540 TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976), pp. 448, 449. 541 Basic Inc. v. Levinson, 485 U.S. 224 (1988) pp. 231, 232. 538

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Chapter 5 to disclose defined information, it is difficult to press companies to disclose using general principles.”542

Proposals to incorporate broader CSR reporting in securities regulations need to account for the institutional mandate of that regulatory body. The US Securities and Exchange Commission has the power to issue disclosure regulations as “necessary or appropriate in the public interest or for the protection of investors”.543 We discussed above how the SEC deals with the information needs of both prudent and ethical investors. Now we turn to the ‘public interest’ ground that could arguably be used for enhanced disclosures. There is a public interest in the efficiency of capital markets and there is another public interest concerned with correcting externalities (fairness). There is a public interest in having efficient capital markets. Coffee refers to “securities market as the principal allocative mechanism for investment capital[;] the behavior of securities prices is important not so much because of their distributive consequences on investors but more because of their effect on allocative efficiency. In this light, it is important not only that the game be fair, but that it be accurate – that is, that capital be correctly priced.”544 Along similar lines, Brudney wrote that transparency has to do with increasing the quantity and improving the quality of corporate information available to investors “so as to facilitate intelligent investment decisions and the efficiency of securities markets in pricing securities and in allocating financial capital to real capital”.545 There is however a natural limit to enhancing transparency. Kitch observes that mandatory disclosure requirements are not correctly understood as simply a matter of disclosure, more disclosure and still more disclosure in pursuit of accurate market valuations. The goal of ‘accuracy enhancement’, that is, making prices in securities markets more accurate to reflect available information, is constrained by other and competing considerations such as the welfare of the issuer, restraints on fiduciary abuse, control of promotional practices, reasonable compliance costs and enforcement feasibility.546 As the text of the SEC’s mandate implies, CSR disclosures could be introduced not as an instrumental concept to achieve accurate market valuations, but aligned with the public interest in a fairer society. Besides the public interest in allocative efficiency, there is a public interest in treating fairly stakeholders that can suffer the externalities produced by the search for efficiency in markets. The mention of ‘public interest’ creates an opening for CSR disclosures. However in one of the NRDC cases, the court noted: 542

M. Mansley, Claros Consulting, Open Disclosure – Sustainability and the Listing Regime, 2003. p. 34, <www.foe.co.uk/resource/reports/open_disclosure.pdf>, visited on 14 February 2007. 543 Section 14(a) of the Securities Exchange Act of 1934. 544 J. C. Coffee, ‘Market Failure and the Economic Case for a Mandatory Disclosure System’, 70 Virginia Law Review (May 1984) p. 734. (emphasis added) 545 Brudney, supra note 526. pp. 735, 736. 546 Kitch, supra note 520, p. 875.

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Policies and laws relevant to CSR “[The SEC] argued, first, that [its] discretion to adopt particular disclosure requirements was very broad, depending in every case on balancing, in its expert judgment, the incremental value of the proposed disclosure against the potentially confusing effect on investors and the increased costs to registrants. Despite this broad discretion, however, the [SEC] contended that its authority was limited to contexts related to the objectives of the federal securities laws. And these laws, in the [SEC’s] view, were designed generally to require disclosure of financial information in the narrow sense only.”547

The SEC wrote at the time: “The staff continues to believe that the use of disclosure to affect conduct is consistent with the philosophy of the securities laws so long as the principal objective of a given requirement is the provision of information to shareholders and investors ...”548 Commentators such as Williams showed that the NRDC proceedings clarified that the SEC is prohibited from “adopting disclosure ‘for the sole purpose of promoting social goals unrelated to those underlying’ the securities acts… [T]he SEC interpreted its public interest authorization to require that disclosure be limited by the social goals underlying the acts.”549 Further, SEC’s allegiance to the primary purpose behind securities regulations “is unexceptionable, but it does not constrain the SEC from requiring expanded social disclosure”.550 There is indeed a grey area of overlap between financial and social disclosures, which is best visible through good governance lenses. In the NRDC proceedings the Court cautioned against too sharp a separation between ‘social disclosure’ and ‘economic disclosure’ because of the potential for adverse economic effects from ‘socially adverse’ actions.551 Judge Richey wrote: “There are many so-called ‘ethical investors’ in this country who want to invest their assets in firms which are concerned about and acting on environmental problems of the nation. This attitude may be based purely upon a concern for the environment; but it may also proceed from the recognition that awareness of and sensitivity to environmental problems is the mark of intelligent management. Whatever their motive, this Court is not prepared to say that they are not rational investors and that the information they seek is not material information within the meaning of the securities laws.”552

An illustration of this grey area is the situation of bribery. In the late 1970s American MNEs came under fire for the bribery of foreign officials. The SEC decided that the use of corporate funds to bribe foreign officials was evidence of the lack of integrity of the corporate officers and therefore material. In that case, a 547

606 F.2d 1031 (D.C. Cir. 1979). Quoted in Williams, supra note 522, p. 1270. 549 Williams, supra note 522, p. 1272. 550 Ibid. 551 Ibid., p. 1262. 552 Natural Resources Defense Council, Inc. v. SEC, supra note 531, p. 700. 548

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Chapter 5 handful of regulatory agencies, including the Security Exchange Commission, the Internal Revenue Service and the Overseas Private Investment Corporation insuring investments abroad against political risks, exercised their powers to mandate corporate disclosure of relevant information. The exceptional treatment that bribery received needs however to be understood against the special circumstances of the US of the mid-1970s, following the Watergate scandal and international bribery scandals involving American MNEs.553 To conclude on the US system, there are arguments against integrating CSR disclosures in securities regulations and enforcing them by the respective supervisory bodies (the SEC in the US). The public goal aimed at fairness (correcting externalities) can be pursued through alternative bodies of regulation, and not necessarily through securities law. We showed in this section that the US system has so far been reluctant to issue new disclosure regulations covering CSR, and the Supreme Court deliberately set a higher standard of materiality. We identified a ‘grey area’ where the information needs of shareholders and stakeholders overlap in which US regulators have not ventured. The next section begins with the British system where expanded disclosure requirements are coming now into force to address the information needs of prudent investors concerned with the long-term success of a company. The efforts of the Company Law Review Steering Group can be seen as basically trying to achieve clarification of the grey areas that both company law and securities law exhibit. 5.2.2. Disclosures in the ‘grey zone’ benefiting multiple audiences Some instruments in corporate governance emphasise the need to systematically identify and manage risks, emphasise qualitative reporting and non-financial data as necessary for shareholders to understand the business. The UK Company Law Review Steering Group noted: “We already have a well-developed system of financial reporting, which is essentially quantitative and historic. But companies are increasingly reliant on qualitative and intangible assets such as the skills and knowledge of their employees, their business relationships and their reputation. Information about future plans, opportunities, risks and strategies is just as important as the historical review of performance which forms the basis for reporting at present.”554

CSR disclosures can be advanced as part of this trend to expand data to investors beyond the quantitative, financial information customarily provided by businesses. A EC Directive from 2003 has given new impetus to European laws and expanded the range of data companies are to report; it provides that “[t]o the extent necessary 553

B. Seymour, ‘Illicit Payments in International Business: National Legislation, International Codes of Conduct, and the Proposed United Nations Convention’, in N. Horn (ed.), Legal Problems of Codes of Conduct for Multinational Enterprises (Kluwer, Deventer, 1980). 554 Company Law Review Steering Group, Final Report, supra note 65, para. 3.33.

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Policies and laws relevant to CSR for an understanding of the company’s development, performance or position, the analysis shall include both financial and, where appropriate, non-financial key performance indicators relevant to the particular business, including information relating to environmental and employee matters”.555 A. UK’s Business Review The British approach to improving corporate governance is based, as shown in chapter 2, on clarifying the duty of care of directors, and on enhancing corporate disclosures through the Business Review (BR) (known until 2005 as the Operational and Financial Review (OFR)).556 As policymakers noted, the British requirements aim, similarly to the Directive, to provide “a balanced and comprehensive analysis of the development and performance of the company’s business … [which] shall include both financial and, where appropriate, non-financial key performance indicators” but are more detailed and precise than the Directive;557 in addition, the consultation process that lead to the BR has been extensive and is particularly informative for grasping regulatory alternatives and choices in the area of corporate transparency. The government (Chancellor Brown) abruptly renounced the OFR in late 2005 when he said that the OFR was unnecessary ‘goldplating’ of current EU regulations.558 This sudden u-turn was motivated by the commitment of British regulators to elimination of ‘red tape’ under the ‘better regulation’ agenda. The resulting outcry from many quarters, including from business actors, resulted in the OFR making its way in the recently passed Companies Act under a different name and with some changes to be highlighted below. The law provides that the “purpose of the business review is to inform members of the company and help them assess how the directors have performed their duty under section 172 (duty to promote the success of the company)”.559 As it was noted 555 Directive 2003/51/EC of the European Parliament and the Council (18 June 2003), amending the 4th Directive (1978) on annual accounts and the 7th Directive (1983) on consolidated accounts. 556 “The Government, in its ‘Modernising Company Law’ White Paper in 2002, decided to take forward the three broad proposals of the CLR to improve corporate governance: a. a statement of directors’ duties; b. improved transparency and accountability, with improvements on the quality, timeliness and accessibility of information available for shareholders and others; and c. more effective machinery for enabling and encouraging shareholders to exercise effective and responsible control.” Accounting Standards Board, Reporting Standard 1: Operating and Financial Review, 2005, p. 35, <www.frc.org.uk/images/uploaded/documents/Web%20optimized%20OFR%20RE PORTING%20STANDARD.pdf>, visited on 14 February 2007. 557 Department of Trade and Industry, Company Law – Draft Regulations on the Operating and Financial Review and Directors’ Report, A consultative document, 2004, paras. 2.11 and 2.13. 558 P. M. Saha, ‘The Operating and Financial Review – Testing Transparency’, Ethical Corporation, 4 January 2006. 559 Companies Act 2006, supra note 68, Article 417(2),

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Chapter 5 in mid-2006 the “Government’s objective has always been to encourage meaningful strategic, forward-looking information to assist shareholder engagement while avoiding disproportionate burdens on business, in line with our better regulation agenda”.560 The regulatory purpose of the OFR was defined early when the Company Law Review Steering Group proposed the OFR as a measure of strategic importance and wrote about the “pivotal role [of the proposed OFR] in improving understanding of business performance and prospects, as well as promoting accountability and encouraging responsiveness and high standards of business practice”.561 The government noted: “[T]he introduction of the OFR for all quoted companies [is] a key plank in promoting more effective dialogue between companies and investors and helping to maintain trust and confidence in capital markets.”562 The guidance issued by the government explained who the likely beneficiaries of the BR would be: “Directors are addressing the OFR to shareholders. The purpose of the OFR is to assist shareholders assess a company’s strategies and the potential for them to succeed… Information in the OFR will also be of interest to other stakeholders, including: employees, suppliers, customers, regulators and other users of reports and accounts such as those particularly interested in the environment and broader community.”563 The Accounting Standards Board (ASB) clarified that one of the Principles of the OFR is that “[t]he OFR shall focus on matters that are relevant to the interests of members … Members’ needs are paramount when directors consider what information shall be contained in the OFR.” 564 The BR can cover an entire corporate group, both the parent company and its subsidiaries. That would result in the parent company issuing a consolidated report.565 The BR, and CSR reporting in general, requires attention at two stages: (1) the production of the report itself, and (2) the assurance that auditors provide on the report. The way that British lawmakers reasoned in both these respects is informative for CSR discussions about corporate transparency. The BR raises dilemmas regarding both the scope of reporting (materiality) and its quality (assurance). Policy-makers have attempted to strike a middle balance: remain faithful to an orientation toward the interest of the company and its members while encouraging a more inclusive decision-making process that can account for the interest of stakeholders. In addition, the different regulatory techniques – binding regulation, standardisation and guidance – have been weighted.

560

Department of Trade and Industry, Regulatory Impact Assessment, Companies Act 2006, 2007, p. 16, <www.dti.gov.uk/files/file29937.pdf>, visited on 14 February 2007. 561 Company Law Review Steering Group, Final Report, supra note 65, para. 3.32. 562 Department of Trade and Industry, White Paper, supra note 30, para. 4.10. 563 Department of Trade and Industry, Guidance on the OFR and Changes to the Directors’ Report, 2005, para. 3(b). 564 Accounting Standards Board, supra note 556, p. 7. 565 Companies Act 2006, supra note 68, Article 415,

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Policies and laws relevant to CSR Production of the report The guidance issued by the government clarifies the expected contents of the business review: it “will include a company’s (or group’s) objectives, strategies and the key drivers of the business, focusing on more qualitative and forward-looking information than has traditionally been included in annual reports in the past”.566 The BR must contain a fair review of the company’s business, and a description of the principal risks and uncertainties facing the company. For quoted companies, the business review must include, ‘to the extent necessary’567 to comply with the previously defined objective of BR, “(a) the main trends and factors likely to affect the future development, performance and position of the company’s business; and (b) information about (i) environmental matters (including the impact of the company’s business on the environment), (ii) the company’s employees, and (iii) social and community issues, including information about any policies of the company in relation to those matters and the effectiveness of those policies; and (c) subject to subsection (11), information about persons with whom the company has contractual or other arrangements which are essential to the business of the company.”568

Furthermore, to help measure effectively the company’s performance, the BR must, ‘to the extent necessary’, include, in addition to financial indicators, “where appropriate, analysis using other key performance indicators, including information relating to environmental matters and employee matters”.569 The handling of social and community matters can affect the company’s reputation and ‘licence to operate’ in a way similar to the management of environmental matters. The ASB mentions, among others, employee health and safety; social risks existing in the supply chain, for example the use of child labour and payments of ‘fair wages’; and indigenous and human rights issues relating to communities local to overseas operations. 570 The Company Law Review Steering Group stated its vision regarding the purpose and audience of the BR, which affects the information to be included therein:

566

Department of Trade and Industry, supra note 563, p. 6. The wording ‘to the extent necessary’ derives from the EU Accounts Modernisation Directive, but is the equivalent of the concept of ‘materiality’ that the UK Group has previously employed. Accounting Standards Board, supra note 556, p. 27. 568 Companies Act 2006, supra note 68, Article 417(5). 569 Ibid. 570 Accounting Standards Board, supra note 556, p. 72. 567

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Chapter 5 “[I]t is on the basis of the purpose that the issue of materiality will fall to be addressed. A number of responses suggested that the approach should be narrowly financial and the target audience limited to shareholders. But a wide range of responses advocated a broader approach, including some business players and accountants as well as those representing the wider range of users of company accounts. Our approach is that the document is not financial in the narrow sense; as the title indicates, it is a qualitative, as well as a financial, evaluation of performance and trends and intentions. On the other hand it is an analysis and description of the business as an operational and commercial entity prepared by the directors from their perspective as managers of the business.”571

Should the BR (then OFR) be subject to a binding legal obligation, or should it remain a voluntary exercise recommended by governmental policy? The Group noted the “concern that replacing the present voluntary OFR with a mandatory requirement will stifle innovation in a fast-developing field and lead to defensive, less informative, ‘boilerplate’ reporting”.572 The result has been a mandatory, but flexible, approach: “We recognise these concerns, but believe that they are misplaced. Many of the largest companies are already producing high quality OFRs in line with best practice. … If the practice of the best is to be extended more widely, some form of mandatory requirement is needed. But it must be done in a way which gives companies wide scope to report in the way which enables them best to describe their business – in terms of both the format and the content of the report. And it must allow for development over time, rather than seeking to ‘freeze’ existing best practice.”573

Further the government wrote: “The risk is that experience over 10 years of the voluntary standard has shown best practice remains restricted to the very largest companies, even within the category of quoted companies, and fails to deliver improving standards across a wider cross-section of companies. There is also a danger that directors have too much discretion and can thus pick and choose the matters to report, producing reports that are uneven in content and designed to present the best possible gloss, rather than a balanced and comprehensive view that will allow for a full understanding of the directors’ view of the business. Comparison between companies would be restricted to partial rather than complete information. An expanded directors’ report, reviewed by auditors, will provide for a fair review of a company’s performance, including an assessment of the principal risks and uncertainties. However, experience to date suggests that, without a

571

Company Law Review Steering Group, Completing the Structure, supra note 183, paras. 3.32–3.33. 572 Company Law Review Steering Group, Final Report, supra note 65, para. 3.35. 573 Ibid., paras. 3.36, 3.37. (emphasis added)

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Policies and laws relevant to CSR statutory OFR, the more substantive information we are seeking from quoted companies will not be forthcoming.”574

After deciding the mandatory versus voluntary matter, the question facing lawmakers is still how to ensure that directors will report appropriately? Should there be standards deciding what information is material for reporting purposes? Should there be standards on the decision-making process that directors should follow when producing the report? The answer has been negative. On one hand, standardisation (of materiality and decision-making processes) has a role in rendering the law more specific and enforceable but, on the other hand, standards diminish discretion, and therefore the scope for directors to exercise their judgement. Company law places heavy emphasis on directors’ judgment, and standardisation works at cross purposes with this. The presentation below shows how British policymakers dealt with these tensions. As seen in chapter 2, lawmakers remained committed to the role of directors’ judgment. This approach follows an important company law principle that emphasises ‘independence of judgement’ as one of directors’ powers and indeed legal duties under British law: “The main concern here was that it should be absolutely clear that these [adopting a longer term timeframe and a more inclusive list of stakeholders] are matters which, so long as they are identified and assessed in accordance with the duty of care and skill, are subject to the good faith business judgement of directors both as to whether they are relevant and as to the weight to be attached to them, in considering the promotion of the success of the company.”575

Thus it is up to directors to assess which information is relevant (material) for making better business decisions; one such decision is about what info should be included in the BR. The government explained that while the law specifies what information directors need to consider for inclusion, “[d]irectors will need to make judgements about what data and analysis to include, and the level of detail to which it is appropriate to go”.576 The standard of care to be applied in preparing a BR is the same as that for preparing other company reports and accounts. 577 Regarding the level of detail expected in the BR, the government explains: “for disclosure to be effective it must be relevant; it must provide investors with a realistic understanding of a company’s business model and the economic risks and potential rewards that it faces. In addition, it must not reach the pivotal point where further information actually reduces transparency by obscuring important

574

Department of Trade and Industry, supra note 557. Company Law Review Steering Group, Completing the Structure, supra note 183, paras. 3.18, 3.19. 576 Department of Trade and Industry, supra note 563, p. 7. 577 Ibid., p. 8. 575

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Chapter 5 information amidst a wealth of detail.”578 The British government clarifies the relation of the BR (then OFR) with specialised CSR reports: “Many companies already provide information on such issues in separate reports such as reports on corporate social responsibility and sustainability. The directors of these companies will be well placed to make informed judgements as to the relevance of these issues for the OFR. The OFR will thus be complementary to, and not a substitute for, such reports, which the government continues to encourage on a voluntary basis.”579 This will influence the level of detail that CSR issues might receive in a BR. As the ASB wrote, “while directors will need to consider the extent that information on environmental risks should be included within the OFR, this should be set in the context that there is a wide range of risks to which business are subject”.580 How will an adequate level of reporting be obtained? The Group rejects standardisation of both what information is material for reporting purposes and the process managers used to arrive at these materiality decisions. Instead of standardisation on these two issues, the Group proposes guidance as the way forward. In addition, standardisation of the reporting format is delegated to the Accounting Standards Board. The Company Law Review Steering Group wrote: “The OFR is to be a description prepared by the directors as managers of the business described. The preparation processes will be more judgmental than those for financial accounts and there will be more scope, indeed necessity, for discretion. This must of course be exercised in good faith. But standards in this area would go too far in interfering in directors’ judgements, stifling the good faith exercise of discretion and perhaps also leading to ‘boilerplate’ reporting. On the other hand, we consider that guidance can play a role without being unduly restrictive; for example, the ‘Turnbull’ guidance fulfils a similar function for the directors’ review of the effectiveness of internal controls, which is subject to auditors’ review.”581

To facilitate transparency, the law provides that “[i]f the review does not contain information of each kind mentioned in paragraphs (b)(i), (ii) and (iii) and (c), it must state which of those kinds of information it does not contain”.582 Directors are not required to explain how they have arrived at their decision.583 During the drafting stage of OFR there has been a ‘comply or explain’ provision, which is now abandoned: “The review must (a) state whether it has been prepared in accordance with relevant reporting standards, and (b) contain particulars of, and reasons for, any

578

Department of Trade and Industry, Final Regulatory Impact Assessment on the Operating and Financial Review and Directors’ Report Regulations, 2005, para. 84. 579 Department of Trade and Industry, supra note 557. 580 Accounting Standards Board, supra note 556, p. 44. 581 Company Law Review Steering Group, Final Report, supra note 65, para. 8.51. 582 Companies Act 2006, supra note 68, Article 417(5). 583 Department of Trade and Industry, supra note 563, p. 7.

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Policies and laws relevant to CSR departure from such standards.” 584 A related provision, also abandoned, further provided: “A company that prepares its OFR in accordance with the relevant standards will enjoy a presumption that it has complied with the law on the contents of the OFR. This will provide a strong incentive to follow standards while providing flexibility, should a company decide it is necessary or desirable, to depart from the standards provided that it gives particulars of, and reasons for, any such departure.”585 After rejecting standardisation as a policy option, a special working group was set up to issue a guidance document to assist directors determine the materiality of information to be included in the BR (then OFR). In its final guidance, the working group wrote: “In arriving at their judgements as to what should be included, directors will want to consider both principles and process.”586 The six principles are contained in Part I of the document. Among them are the following aspects: ƒ deal with the objective of the OFR (the OFR must enable the members of the company to assess the company’s strategies and the potential for those strategies to succeed); ƒ directors will want to take a broad view (will want to ensure that they have explored and understood the agendas not only of members but also of other stakeholders that are likely, directly or indirectly, to influence the performance of the business and its value); ƒ it is key to the OFR that directors include in the OFR information that strike a balance between historic review and a focus on the future; ƒ quantitative and qualitative information, financial and non-financial information (both are likely to feature in the OFR); ƒ once the directors have decided to include an item, precisely how it is reported upon may be subject to whatever standards are laid down in due course by the Accounting Standards Board.587 Part II of the guidance provides a set of six criteria for assessing the process, which are based on best practice, that directors could use to make judgments about what to include in an OFR. Among them are the following aspects: the process should provide for appropriate consultation within the business (management and employees), with members, and with other key groups whose decisions can affect performance; ƒ ensure that all relevant existing information and comparators are taken into account (looking also externally at models of best practice, industry guidance, reports produced by other companies in the same sector etc.); 584

Companies Act 1985 (Operating and Financial Review and Directors’ Report etc.) Regulations 2005, Schedule 7 ZA(8), <www.legislation.hmso.gov.uk/si/si2005/200510 11.htm>, visited on 14 February 2007. 585 Department of Trade and Industry, supra note 578, para. 177. 586 Department of Trade and Industry, The Operating and Financial Review – Practical Guidance for Directors, 2004, p. 8. 587 Ibid., pp. 9–15.

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Chapter 5 ƒ

the process should be subject to review, both internally and by the external auditors.588

Assurance of report The enforcement regime for the BR mirrors the existing framework in respect of financial statements. The latter contains criminal sanctions for directors who knowingly or recklessly approve defective accounts, and an administrative procedure whereby the Secretary of State or the Financial Reporting Review Panel apply to the court for an order obliging a company to prepare revised accounts. Regarding the administrative procedure, “[t]here is plenty of room for genuine debate and difference of view on what is required in particular circumstances, for example whether a particular issue needs to be included for ‘a balanced and comprehensive analysis’, or whether a forecast of company performance is sufficiently supported by evidence. Nevertheless, there needs to be a means of obliging companies to correct mistakes in the OFR, in order to ensure that shareholders and other users are not given false or misleading information. That is why there is a fundamental difference between deliberately or recklessly preparing a defective OFR (subject to criminal sanction on individual directors) and making an ‘honest mistake’ (which could ultimately result in a civil order to the company to revise its OFR).”589

Another piece in the enforcement mechanism is related to the assurance that auditors provide on the BR. British lawmakers have opted for guidance on the contents of the report, instead of standardisation of materiality or of the reporting process employed by directors. Guidance will assist directors in producing reports and may help investors and markets assess whether management has carefully and in good faith exercised its discretion and judgement. However, besides managers, shareholders, market analysts and stakeholders, auditors are a distinct group having a stake in the standardisation of BR. During the consultation process, auditors have demanded such standardisation because they will assume responsibility for the assurance they provide. “The accountancy profession … argued that standards should cover all items, including materiality and the process … In particular it was argued that if the process is to be subject to auditor review there should be standards against which to review it.”590 What would auditors verify: the managerial judgments on materiality or the process used by managers in reaching those judgments? The Company Law Review Steering Group opposes the audit of materiality judgments, but recognised that managers may abuse their discretion. It is the “proper preparation (that is to say the process by which the document has been prepared) [that] should be subject to audit. This would not require or enable the auditors to 588

Ibid., pp. 19, 20. Department of Trade and Industry, supra note 578, para. 175. 590 Company Law Review Steering Group, Final Report, supra note 65, para. 8.50. 589

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Policies and laws relevant to CSR substitute their own judgements for that of directors, but it would require them to examine whether a proper process had been gone through in reaching those judgements.”591 So the judgement on the materiality of information to be reported is not subjected to audit at all, while the decision-making process is to be reviewed by auditors. What would be the benchmark used by auditors? As the Company Law Review Steering Group rejected standardisation of both what information is material and the process managers used to arrive at materiality decisions, the Group does meet the concerns of auditors that they are asked to perform the impossible, to assume responsibility for a report even when a benchmark is lacking. Thus, the solution is to standardise not the process used by directors, but the measuring process performed by auditors themselves; to standardise not what auditors will measure, but how they will measure. This would preserve discretion for managers to exercise their judgement, and render the responsibility of auditors less open-ended by providing them with a template for doing their job: “We accept the need for limitation here, leaving proper scope for auditors’ judgements as to the necessary extent of their work and to enable APB standards and guidance to provide a framework for this.”592 Thus, auditors’ concerns are met in a twofold manner: first the law would accept some discretion for auditors themselves, and second the profession could develop standards for the assurance process. The auditor is under a legal duty to “report on the consistency of the Directors’ Report [but] there will be no additional requirement to check for other inconsistencies”.593 This stance regarding assurance providers has weakened the original design of the OFR. The government had initially stated that by the nature of the information contained in the OFR, the latter warrants “a higher level of assurance than consistency with accounts only. This is because certain information – about future objectives, strategies by which these might be achieved, and milestones, for example – will not be verifiable against accounts and so other sources need to be considered. For this reason, the Government proposes that the auditors’ review be extended beyond checking for consistency with accounts to include consideration of any other matters that have come to their attention in the conduct of the (annual) audit… It is satisfied that these two requirements will provide the level of assurance required to satisfy investors (and other users) that the information is complete and trustworthy.”594

To sum up, the BR aims to present a more accurate picture of the business as an operational and commercial entity. The BR tracks the wealth-creation function of business; its purpose is not to highlight the wealth-distribution or social fairness 591

Company Law Review Steering Group, Completing the Structure, supra note 183, para. 3.39. 592 Company Law Review Steering Group, Final Report, supra note 65, para. 8.59. 593 Department of Trade and Industry, supra note 560, p. 17. 594 Department of Trade and Industry, supra note 578, para. 73. (emphasis added)

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Chapter 5 aspects related to business activity. What the BR, and the whole approach to corporate governance taken in the UK, does is to highlight the complexities of business that require managers to consider stakeholders’ interests. Therefore the BR focuses attention on the area of overlap between prudent shareholders’ and stakeholders’ information needs and to encourage reflexive managerial judgement on issues within this area. While the approach taken by the British policymakers remains consistent with the established tenets of company law, it makes inroads in the ‘grey area’ where the US regulators have refused to venture. B. Germany’s Commercial Code The EU Accounts Modernisation Directive (2003) has lead to amendments to the German domestic legislation (paragraphs 289 and 315 of the Commercial Code). The Accounting Law Reform Act (Bilanzrechtsreformgesetz) provides for the integration of non-financial performance indicators into the management reports of large corporations and groups in Germany from 1 January 2005. The German Accounting Standards Committee (Deutsches Rechnungslegungs Standards Committee) subsequently adopted DRS 15 (December 2004). The only examples of non-financial performance indicators are the “development of the customer base and information about environmental and employees’ concerns”.595 C. France’s New Economic Regulations The New Economic Regulations (NER) (2001) amend Article 116 of the Company Law and provide: “The report [of the board or executive board] contains information, the list of which is determined by a decree of the Council of State, about the way the company takes into account the social and environmental consequences of its activity.” 596 The subsequent Decree (2002) makes specific references to subcontractors and foreign subsidiaries of French businesses, to the worker’s rights contained in ILO conventions and to the impacts of subsidiaries’ activities on regional development and neighbourhood populations. The relevant part of the Decree reads: “[T]he following social information must appear in the report of the board or of the executive board: 1. a) Total workforce, recruitment’s with a distinction between fixed term contracts and permanent contracts and with an analysis of the possible difficulties in recruiting, of the redundancies and their motives, of overtime, of sub-contracted labour. b) If need be, information relating to staff reduction and employment safeguard plans, to the efforts made for staff redeployment, reemployment and subsequent accompanying measures; 595

OEKOM research newsletter, December 2004, p. 2, <www.oekom-research.de/ag/ english/Newsletter/Newsletter1204.pdf>, visited on 14 February 2007. 596 Article 116 of Company Law, New Economic Regulations, <www.legifrance.gouv.fr/ WAspad/UnTexteDeJorf?numjo=ECOX0000021L>, visited on 14 February 2007.

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Policies and laws relevant to CSR 2. Organisation of working hours, their duration for full time and part time wage earning employees, absenteeism and its motives; 3. Wages and their evolution, welfare costs, the application of the Title IV, Book IV of the code of Labour, professional equality between women and men; 4. Industrial relations and the assessment of collective bargaining agreements; 5. Health and safety conditions; 6. Training; 7. Employment and integration of disabled workers; 8. Company benefits and social schemes; 9. Importance of sub-contracting. The report should detail how the company takes into account the territorial impact of its activities as far as employment and regional development are concerned. It should describe, if need be, the relations the company develops with associations for social integration, educational institutions, associations for the protection of the environment, consumers’ associations and neighbourhood populations. It should indicate the importance of sub-contracting, how the company promotes to its subcontractors the provisions stipulated by the fundamental conventions of the International Labour Organisation and how the company makes sure its subsidiaries abide by them. It should indicate furthermore the way the foreign subsidiaries of the company take into account the impact of their activities on the regional development and neighbourhood populations.”597

The law does not provide any geographical boundaries to environmental and social reporting; however, so far, subcontracting is one of the topics least reported on.598 At the time NER were adopted, the Parliament decided against external certification of reports. 599 A report notes that the Parliament envisaged investors as the main recipients of social and environmental reports, rather than the other stakeholders.600 Because of the main focus on shareholders we classify this regulation within the ‘grey zone’; it 597

Decree No. 2002–221 of 20 February 2002, Article 1, relative to the implementation of the Article L. 225–102–1 of the Code of commerce and modifying the decree No. 67–236 of 23 March1967 on company law. (emphasis added) 598 Entreprises pour l’Environnement (EpE), OREE, and Observatoire sur la Responsabilité Sociétale des Enterprises (ORSE), Critical Review of How Companies Are Applying French Legislation on Special and Environmental Reporting, 2004, p. 13, <www.orse.org/gb/home/download/uk0406critical%20review.pdf>, visited on 14 February 2007. 599 Ibid., p. 35. 600 Ibid., p. 46.

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Chapter 5 is nevertheless a case bordering on right-to-know type of regulation. The same report further notes that the motivations behind the amendment of NER were: ƒ to provide stakeholders with transparent and comprehensive information, ƒ to permit comparison of companies by establishing a joint framework of indicators, ƒ encourage French companies to join an international movement promoting sustainability as a factor in medium and long-term competitivity.601 D. South Africa’s King Report on Corporate Governance The Code of Corporate Practices and Conduct (2002), also known as the King Report II, applies to all companies with securities listed on the Johannesburg Stock Exchange, banks, financial and insurance entities and to certain public sector enterprises and agencies.602 Further the Code draws attention to subsidiaries and contractors: “Companies should strongly consider their dealings with individuals or entities not demonstrating its same level of commitment to organisational integrity.”603 The Code requires broad reporting on sustainability issues under Chapter 5: Integrated Sustainability Reporting. The disclosures refer to the management systems developed by the company (from the code of conduct to its implementation to the demonstration of outcomes). Thus, “Every company should report at least annually on the nature and extent of its social, transformation, ethical, safety, health and environmental management policies and practices… Stakeholder reporting requires an integrated approach … Companies should categorise issues into the following levels of reporting: ƒ First level would be disclosures relating to acceptance and adoption of business principles and/or codes of practice that can be verified by reference to documents, board minutes or established policies and standards. ƒ Second level should address the implementation of practices in keeping with accepted principles involving a review of steps taken to encourage adherence to these principles evidenced by board directors, designated policies and communiqués, supported by appropriate non-financial accounting mechanisms. ƒ Third level should involve investigation and demonstration of changes and benefits that have resulted from the adoption and

601

Ibid., pp. 10–11. Institute of Directors in Southern Africa, Code of Corporate Practices and Conduct, King Report on Corporate Governance, 2002, <www.ecgi.org/codes/documents/executive_ summary.pdf>, visited on 14 February 2007. 603 Ibid., para. 5.2.4. 602

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Policies and laws relevant to CSR implementation of stated business principles and/or codes of practice.”604

The Code offers guidance on materiality considerations: “The board must determine what is relevant for disclosure, having regard to the company’s particular circumstances … Criteria and guidelines for materiality should be developed by each company for consistency, having regard to international models and guidelines, as well as national statutory definitions.”605 Four matters are singled out for specific consideration: occupational health and safety (including HIV/AIDS), environmental issues, social investment (including black economic empowerment), and human capital development.606 In addition to the abovementioned criteria for materiality, the Code requires disclosures regarding the effectiveness of the management systems that implement the company’s code. Disclosure regarding the adherence to the company’s code of ethics “should include a statement as to the extent the directors believe the ethical standards and the above criteria are being met. If this is considered inadequate there should be further disclosure of how the desired end-state will be achieved.”607 The Code further specifies the criteria that the management system should meet in order to be considered effective. Disclosures should relate to the following criteria. “Each company should demonstrate its commitment to its code of ethics by: ƒ creating systems and procedures to introduce, monitor and enforce its ethical code; ƒ assigning high level individuals to oversee compliance to the ethical code; ƒ assessing the integrity of new appointees in the selection and promotion procedures; ƒ exercising due care in delegating discretionary authority; ƒ communicating with, and training, all employees regarding enterprise values, standards and compliance procedures; ƒ providing, monitoring and auditing safe systems for reporting of unethical or risky behaviour; ƒ enforcing appropriate discipline with consistency; and ƒ responding to offences and preventing re-occurrence.”608

The Code explicitly recommends for non-financial information the reporting format developed by the Global Reporting Initiative’s Sustainability Reporting Guidelines on economic, environmental and social performance.609 604

Ibid., paras. 5.1.1., 5.1.2. (emphasis added) Ibid., paras., 5.1.1., 5.1.3. 606 Ibid., para. 5.1.4. 607 Ibid., para. 5.2.3. 608 Ibid., para. 5.2.2. 609 Ibid., para. 5.1.3. 605

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Chapter 5 The Code is somehow ambivalent in clarifying whose interests the Code will advance. On one hand the Code notes: “Unlike its counterparts in other countries at the time, the King Report 1994 went beyond the financial and regulatory aspects of corporate governance in advocating an integrated approach to good governance in the interests of a wide range of stakeholders having regard to the fundamental principles of good financial, social, ethical and environmental practice. In adopting a participative corporate governance system of enterprise with integrity, the King Committee in 1994 successfully formalised the need for companies to recognise that they no longer act independently from the societies and the environment in which they operate.”610

Further, the Code notes: “It is the board’s duty to present a balanced and understandable assessment of the company’s position in reporting to stakeholders. The quality of the information must be based on the principles of openness and substance over form. Reporting should address material matters of significant interest and concern to all stakeholders. Reports and communications must be made in the context that society now demands greater transparency and accountability from companies regarding their non-financial matters.” 611

On the other hand, the Code clarifies the term ‘stakeholder’ as used therein: “The stakeholder concept of being accountable to all legitimate stakeholders must be rejected for the simple reason that to ask boards to be accountable to everyone would result in their being accountable to no one. The modern approach is for a board to identify the company’s stakeholders, including its shareowners, and to agree policies as to how the relationship with those stakeholders should be advanced and managed in the interests of the company.”612

Chief among the interests of the company is access to capital on advantageous terms, and the Code reflects concerns with the ability of South Africa’s capital markets to attract foreign capital. South Africa ranks high among the emerging markets in terms of corporate governance, but it rates poorly in terms of disclosure and transparency. “While South Africa may arguably offer investment returns comparable with some of the best in the world, even after accounting for political, currency and other risks, it must visibly demonstrate impeccable governance standards in all sectors of commercial activity not only in 610

Ibid., p. 4. Ibid., paras. 8.1, 8.2. 612 Ibid., p. 6. 611

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Policies and laws relevant to CSR principle, but also in practice, if it is to remain a destination of choice for emerging market global investors … If there is a lack of good corporate governance in a market, capital will leave that market with the click of a mouse.”613

E. Listing Rules of New York Stock Exchange The Listing Rules of the New York Stock Exchange provide: “Listed companies must adopt and disclose a code of business conduct and ethics for directors, officers and employees, and promptly disclose any waivers of the code for directors or executive officers.”614 The commentary accompanying this text explains the role of codes: “No code of business conduct and ethics can replace the thoughtful behavior of an ethical director, officer or employee. However, such a code can focus the board and management on areas of ethical risk, provide guidance to personnel to help them recognize and deal with ethical issues, provide mechanisms to report unethical conduct, and help to foster a culture of honesty and accountability.”615 Regarding the transparency provision attached to codes, the commentary notes: “This disclosure requirement should inhibit casual and perhaps questionable waivers, and should help assure that, when warranted, a waiver is accompanied by appropriate controls designed to protect the listed company.”616 The regulatory approach of the New York Stock Exchange (NYSE) is similar to the principle-based strategy taken by the UK regulators. “Each code of business conduct and ethics must also contain compliance standards and procedures that will facilitate the effective operation of the code … Each listed company may determine its own policies, but all listed companies should address the most important topics …”617 (enumerated in the text). A report written by an advisory group on the US Sentencing Guidelines refers to the regulatory philosophy of the NYSE: “The NYSE described the codes required under its new standards in somewhat general terms, but it indicated that listed companies are expected to fill in the details themselves in light of the specific characteristics of each firm’s business and operating environment. The NYSE emphasized that listed companies should be proactive and open in implementing codes of business conduct. It described the overall approach that companies should adopt as follows: ‘While many of the requirements set forth in this new rule are relatively specific, the Exchange is articulating a philosophy and approach to corporate governance that companies are expected to carry out as they apply the requirements to the specific facts and circumstances that they confront 613

Ibid., p. 9. NYSE Group, Listed Company Manual, Article 303A.10 ‘Code of Business Conduct and Ethics’, <www.nyse.com/Frameset.html?displayPage=/listed/1022221393251.html>, visited on 14 February 2007. 615 Ibid. 616 Ibid. 617 Ibid. 614

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Chapter 5 from time to time. Companies and their boards are expected to apply the requirements carefully and in good faith, making reasonable interpretations as necessary, and disclosing the interpretations that they make.’”618

F. Codes of corporate governance Codes of corporate governance, as attempts at standardisation pursued by recognised experts with governmental support, have recently proliferated. A report from 2003 shows that since 1998 all but two EU countries have had produced non-binding governance codes. Code activity in Europe has accelerated with the preparations and the issuance of the OECD Principles of Corporate Governance in 1999. 619 The codes express a relatively small range of objectives: improving the quality of the (supervisory) board (most common objective), improving accountability of companies to shareholders and/or maximising shareholder value, and improving companies’ performance, competitiveness and/or access to capital. Apparently, codes of corporate governance are not meant primarily to promote the human rights aspects of CSR that are of interest in this study; however risks related to human rights issues can fall under the incidence of these instruments. This presentation offers to CSR proponents a glimpse into how the corporate governance framework, where the implementation of CSR takes place, accounts for emerging risks. Interestingly, such codes are not mandatory under law, but this has not prevented lawmakers to impose reporting requirements on companies. These regulations aim to have companies clarify their positions against the codes’ authoritative benchmarks. In the EU, the High Level Group of Company Law Experts wrote: “Disclosure can be a powerful regulatory tool: it creates an incentive to comply with best practice, and allows members and third parties to take necessary actions. Disclosure requirements can be more efficient, more flexible and easier to enforce. Information and disclosure requirements are at the intersection of company law and securities regulation, and responses to the consultation confirmed that disclosure was particularly suited in the area of corporate governance.”620

Transparency as a regulatory strategy identifies some key items to be disclosed among which is “a reference to a national code of corporate governance with which the company complies or in relation to which it explains deviations”.621 This is the ‘comply or explain’ regulation pioneered in the UK since the early 1990s. The

618

Ad Hoc Advisory Group on the Organizational Sentencing Guidelines, Report of Advisory Group on the Organizational Sentencing Guidelines, 2003, pp. 41, 42, <www.ussc.gov/corp/ advgrprpt/AG_FINAL.pdf>, visited on 14 February 2007. 619 Weil, Gotshal & Manges LLP, supra note 153, p. 285. 620 High Level Group of Company Law Experts, supra note 182, p. 4. 621 Ibid., p. 47.

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Policies and laws relevant to CSR approach can properly be explained as allowing opting-out, but also creating some special opting-out procedures. The Combined Code622 was adopted in the UK in 1998, revised in 2003 and builds on earlier reports on corporate governance (the Cadbury and Greenbury Reports). The Code provides the following principle on internal controls: “The board should maintain a sound system of internal control to safeguard shareholders’ investment and the company’s assets.”623 The Code also contains more detailed recommendations in this area: “The board should, at least annually, conduct a review of the effectiveness of the group’s system of internal controls and should report to shareholders that they have done so. The review should cover all material controls, including financial, operational and compliance controls and risk management systems.”624 The Turnbull Guidance on Internal Control (‘Turnbull Report’)625 was published in 1999 to assist companies to comply with the internal control requirements of the Combined Code: “It is intended primarily to be an aid to better performance as well as being used to demonstrate compliance with the requirements of the Combined Code on Corporate Governance.”626 Regarding its scope of application, the Report “applies to all aspects of internal control, including financial, operational and compliance matters. This approach contrasts, for example, with the US Sarbanes-Oxley Act which is concerned with internal control over financial reporting.”627 The Report draws attention to “significant business, operational, financial, compliance and other risks”628 which are illustrated in Appendix 1: “Significant risks may, for example, include those related to market, credit, liquidity, technological, legal, health, safety and environmental, reputation, and business probity issues.” 629 The Report further writes that “[a] company’s objectives, its internal organisation and the environment in which it operates are continually evolving and, as a result, the risks it faces are continually changing. A sound system of internal control therefore depends on a thorough and regular evaluation of the nature and extent of the risks to which the company is exposed. Since profits are, in part, the reward for successful risktaking in business, the purpose of

622

Committee on Corporate Governance, The Combined Code on Corporate Governance, 2003, <www.fsa.gov.uk/pubs/ukla/lr_comcode2003.pdf>, visited on 14 February 2007. 623 Ibid., Principle C.2. [Principle D.2 in the Code (1998)] 624 Ibid., para C.2.1. (emphasis added) 625 Institute of Chartered Accountants, Internal Control: Guidance for Directors on the Combined Code – Turnbull Report, 1999, <www.icaew.co.uk/viewer/index.cfm?AUB=TB2I _6342&tb5=1&CFID=4559372&CFTOKEN=40828431>, visited on 14 February 2007. 626 Turnbull Review Group, Review of the Turnbull Guidance on Internal Control – Evidence Gathering Phase, Consultation Paper, 2004. 627 Ibid., p. 12. 628 Institute of Chartered Accountants, Turnbull Report, supra note 625, para. 20. 629 Ibid., p. 13. (emphasis added)

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Chapter 5 internal control is to help manage and control risk appropriately rather than to eliminate it.” 630

Regarding some elements that make “a sound system of internal control in the particular circumstances of the company, the board’s deliberations should include consideration of the following factors: ƒ the nature and extent of the risks facing the company; ƒ the extent and categories of risk which it regards as acceptable for the company to bear; ƒ the likelihood of the risks concerned materialising; ƒ the company’s ability to reduce the incidence and impact on the business of risks that do materialise; and ƒ the costs of operating particular controls relative to the benefit thereby obtained in managing the related risks.” 631

Since 1993 a company listed on the London Stock Exchange (and incorporated in the U.K.) is required to include in its annual report a narrative statement of how it applies the principles of the Combined Code. The ‘comply or explain’ provision pioneered here has spread in numerous other corporate governance regimes. The Listing Rules read as follows: “[I]n the case of a company incorporated in the United Kingdom, the following additional items must be included in its annual report and accounts: (a) a narrative statement of how it has applied the principles set out in Section 1 of the Combined Code, providing explanation which enables its shareholders to evaluate how the principles have been applied; (b) a statement as to whether or not it has complied throughout the accounting period with the Code provisions set out in Section 1 of the Combined Code. A company that has not complied with the Code provisions, or complied with only some of the Code provisions or (in the case of provisions whose requirements are of a continuing nature) complied for only part of an accounting period, must specify the Code provisions with which it has not complied, and (where relevant) for what part of the period such noncompliance continued, and give reasons for any non-compliance.”632

The Financial Services Authority (FSA) is charged with overseeing company compliance with London Stock Exchange listing requirements. It regularly reviews companies on a sample basis. As to sanctions for non-compliance, companies are subject to public censure or a fine. It appears, however, that the FSA addresses the 630

Ibid., para. 13. Ibid., para. 17. 632 Para. 12.43A of the London Stock Exchange Listing Rules. (emphasis added) 631

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Policies and laws relevant to CSR few instances of substandard disclosure through private exhortation to remit the required information. FSA views the quality of disclosure as generally high.633 Other organisations also compile unofficial surveys to track compliance in reference to a code. Disclosures regarding compliance with the Combined Code are part of the annual report, and thus subject to independent audit. The level of assurance auditors have to provide in the UK under LSE Listing Rules is less stringent than under the US Sarbanes-Oxley Act, though the Combined Code is concerned with more extensive risk systems than the US law which is concerned with internal control over financial reporting. “The auditors … consider the company’s claim to have complied or not with the relevant provision of the Combined Code, and where the auditors considered there was not proper disclosure the auditors report this. The auditors are not asked or expected to consider whether the board’s statements on internal control covered all risks and controls, or to form an opinion on the effectiveness of the company’s corporate governance procedures or its risk and control procedures. This contrasts with the approach mandated under section 404 (a) of the US Sarbanes-Oxley Act of 2002, and the Securities and Exchange Commission’s related rules. Under US law, the auditors are required to attest to, and report upon, management’s assessment of the effectiveness of internal control. In other words, the auditors have to form an opinion, not as to the board’s process for assessing effectiveness, but as to whether or not the auditor concurs with the board’s view as to the effectiveness of their internal controls.”634

As a small parenthesis to the US law, the Securities and Exchange Commission noted in 2005 that accountants were being too inflexible, ‘overly cautious’ and ‘mechanical’ in interpreting the statute. The SEC called for the exercise of greater discretion – something which, three years ago, the architects of the statute had seemed to frown on.635 The Combined Code and the Turnbull Report apply to groups of companies; thus the parent company is expected to report on its management systems that cover its subsidiaries as well: “Throughout this guidance, where reference is made to ‘company’ it should be taken, where applicable, as referring to the group of which the reporting company is the parent company. For groups of companies, the review of effectiveness of internal control and the report to the shareholders should be from the perspective of the group as a whole.” 636 Other EU states have followed this approach of linking a legally non-binding instrument (a code based on good business practice) to disclosure regulations of a ‘comply or explain’ type. The Preda Report in Italy and the Kørby Commission 633

Weil, Gotshal & Manges LLP, supra note 153, p. 228. Department of Trade and Industry, supra note 578, paras. 141–143. 635 The Economist, ‘A price worth paying? Auditing Sarbanes-Oxley’, The Economist 19 May 2005. 636 Institute of Chartered Accountants, Turnbull Report, supra note 625, para. 14. 634

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Chapter 5 Report (Denmark) are associated with a ‘comply or explain’ disclosure framework.637 The attempts for harmonisation of company laws at EU level also envisage the ‘comply or explain’ option; thus the High Level Group of Company Law Experts notes that “monitoring and reliance on market response and general governance powers on the basis of a ‘comply or explain’ rule can often replace formal legal enforcement in company or securities law”.638 Disclosure requirements may not be of a ‘comply or explain’ type. Germany for example requires only a statement whether the code was complied with or not, without further explanations. The German Stock Corporation Act deals with the ‘Declaration on the Corporate Governance Code’: “The executive board and supervisory board of exchange-listed companies shall declare once a year that the recommendations of the ‘Government Commission on the German Corporate Governance Code’ … have been and are being complied with or which of the Code’s recommendations are not being applied. The declaration shall be made permanently accessible to stockholders.”639 In the US, the Sarbanes-Oxley Act of 2002 promotes enhanced financial disclosures through a toned-down ‘comply or explain’ approach. In this case it is each company that sets the ethical standards it intends to pursue; there is no externally drafted code of good practice as in the previous cases. The Act requires, among others, that every publicly traded company either adopt and disclose a ‘code of ethics’ addressing law compliance and ethical conduct by key corporate officers, or explain publicly why the company has not adopted such a code.640 “These standards are significant both because they recognize the importance of conduct codes for the organizational leadership and because the types of codes envisioned go substantially beyond mere law compliance to address diverse types of ethical conduct as well.”641 This section highlighted an interesting regulatory strategy at work in the British corporate governance system, replicated elsewhere as well. The government has initially stimulated good practice by defining an authoritative benchmark of good business practice (a string of reports that culminated with the Combined Code). It also offered further guidance (the Turnbull Report). Then the London Stock Exchange referenced this benchmark and applied a flexible transparency regulation asking companies to report against the Code with a ‘comply or explain’ option. Overall, policymakers insist on the importance for companies to design rigorous internal procedures able to account for diverse risks. This emphasis on sound 637

Weil, Gotshal & Manges LLP, supra note 153. High Level Group of Company Law Experts, supra note 182, p. 4. 639 Article 161 of the Stock Corporation Act (AktG), as amended by the Transparency and Disclosure Law, in force on 26 July 2002, <www.corporate-governance-code.de/eng/news/ transparenzgesetz20020801.html>, visited on 14 February 2007. 640 Sarbanes–Oxley Act, Section 406 (a)(b) ‘Code of Ethics for Senior Financial Officers’ in Title IV ‘Enhanced Financial Disclosures’. 641 Ad Hoc Advisory Group on the Organizational Sentencing Guidelines, supra note 618, pp. 38, 39. 638

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Policies and laws relevant to CSR managerial decision-making is consistent with the increased interest of company law in enforcing the managerial duty of care. Chapter 2 presented examples from important jurisdictions where courts do not question business decision, but defer to managerial expertise and judgement; still courts increasingly scrutinise the decisionmaking process itself that lead to that decision. What we have seen here is an incremental process of specification of what the duty of care means. This government-driven process dovetails with the voluntary CSR regime where leading businesses and their stakeholders similarly develop systematic business approaches to implement CSR while remaining commercially successful. Chapters 4 and 5 allow a comparative perspective of what rigorous managerial systems entail from a CSR and a regulatory perspective. 5.2.3. ‘Right-to-know’ disclosures benefiting certain stakeholders The previous section (5.2.2.) covered transparency regulations that help investors assess whether directors have sound systems in place to create long-term sustainable value. This is done through securities regulations, which have customarily dealt with narrow financial and quantitative information or have more recently included more extensive non-financial and qualitative data. The latter situation accounts for the ‘grey zone’ where the information needs of shareholders and stakeholders overlap. While US lawmakers refrained from regulating in the grey zone, other jurisdictions have seen some regulatory activity. As the British case shows, from a public policy angle, a law that makes clear the “inclusive character of the existing duties … maximise[s] the opportunity for synergy between the securing of shareholders’ and of wider interests”.642 This section now turns to disclosures that aim to make the company more accountable for its social and environmental impacts. ‘Right-toknow’ regulations place first the interests of various stakeholders rather than the interests of the company itself. Such disclosure regulations do not promote an understanding of the company as a commercial, revenue-generating entity, but as an entity that (dis)regards its social and environmental impacts, that complies or not with certain standards that stakeholders deem important. ‘Right-to-know’ regulations have been successfully employed in the environmental protection area. The main stakeholders to benefit in these cases are public authorities and especially the community living in the vicinity of polluting manufacturing plants; empowered with new data on pollutants local communities can make their case more effectively. Recently this type of regulations has promoted not only environmental, but also social aspects of CSR. A wave of regulations of investment funds, triggered by the British example, requires pension funds to disclose their investment policy, if any, regarding CSR concerns. The stakeholders that benefit from such regulations are ethical investors (end-beneficiaries) which have previously found it difficult to

642

Company Law Review Steering Group, Developing the Framework, supra note 48, para. 3.24.

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Chapter 5 access information on how responsibly collective investment institutions invest their savings. Still another case of regulations envisages the creation of labels to be affixed on products. Containing information on compliance with labour standards throughout the production process, these regulatory schemes, so far tried only in Belgium, aim to benefit the customers, often the final consumers. In the environmental area, the EU had already created a labelling system (EMAS) in which companies can voluntarily participate if they adopt sounds environmental management systems. The EC announced several years ago that it was looking into the possibility to expand this approach to address social impacts as well. Both the Belgian law and the EMAS fall short of mandating requirements all businesses must fulfil, as participation remains voluntary, but they regulate the infrastructure that support a credible label. A. Disclosures on policies regarding ethical investment United Kingdom The amendment to the UK Occupational Pension Schemes Regulations that came into force in July 2000 requires new disclosures from pension funds. The content of the statement of investment principles must now also state: (a) “the extent (if at all) to which social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investments; and (b) their policy (if any) in relation to the exercise of the rights (including voting rights) attaching to investments.”643 A report observes that “[b]efore this amendment, pension fund trustees, who manage funds that own a third of the UK stock market, were under no obligation whatsoever to inform their members of their ethical stance”.644Another source comments on the background of this law: “SRI has been growing for 20 years, but has hitherto been largely associated with specialist retail funds. In mid-1999 the UK Government transformed the SRI landscape … Although the new legislation … does not oblige trustees to adopt SRI policies, it increases their transparency on the issue. Provided they are prudent, seek advice and follow due process, trustees can adopt SRI policies without contravening their fiduciary duty to maximise benefits for members … The early signs are that the transparency requirement, allied with other forms of pressure, has ushered in a new era – the adoption of SRI policies by mainstream occupational 643

Occupational Pension Schemes (Investment, and Assignment, Forfeiture, Bankruptcy etc.) Amendment Regulations 1999, Article 11A, <www.legislation.hmso.gov.uk/si/si1999/1999 1849.htm#n1>, visited on 14 February 2007. 644 E. Mathieu, UK Social Investment Forum, Response of UK Pension Funds to the SRI Disclosure Regulation, 2000, p. 4, <www.uksif.org/Z/Z/Z/lib/2000/files/10/reprt-pf-discl/ dloads/ukpfsurv.pdf>, visited on 14 February 2007.

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Policies and laws relevant to CSR Pension Funds. The impact is potentially vast. While specialist SRI retail funds accounted for £3.3bn in 2000, they were dwarfed by the total Pension Fund market of £800bn.”645

A survey of pension fund trustees carried out by Just Pensions found some support for the government to further encourage the incorporation of social, ethical and environmental issues into investment practice. Such measures could be: ƒ additional regulation or legislation to require pension funds to report on the implementation of their Statement of Investment Principles in their report and accounts, ƒ a legal requirement for defined contribution schemes in the UK to offer an ‘ethical’ option, ƒ additional regulation or legislation to require all pension fund trustees to receive investment training incorporating social, ethical and environmental issues, ƒ the Government to promote a formal code of best practice for pension funds in dealing with social, ethical and environmental issues, ƒ legislation or regulation by the Government to encourage a longer term perspective in equity investment.646 The role of government may be called into action because an ‘implementation gap’ has opened between statements and implementation: “Although a minority of schemes simply state that they will not take SEE considerations into account, previous Just Pensions research found that commitments to SRI in SIPs [Statement of Investment Principles] often do not translate into changes in practice.”647 A recent report confirms this state of affairs. This report covers the top 20 pension schemes based on capital value and notes that only 12 out of 20 schemes publicly disclosed the information required by law. Furthermore, “[n]one of the schemes surveyed disclosed material which mentioned human rights as having any impact on whether or not a scheme was willing to be an investor in a company. This was of concern given that many UK pension schemes disclosed investments in companies that have been widely criticised for their human rights behaviour.”648 The pension funds regulation has been expected to have positive effects in developing countries, not solely within the UK. The Department for International Development funds ‘Just Pensions’, which is a programme of the UK Social Investment Forum. The overall purpose of Just Pensions is to contribute to the Millennium Development Goals, by improving the social and environmental impact 645

UK Social Investment Forum, Just Pensions, <www.uksif.org/J/Z/Z/lib/2001/05/jp-hbook/ jph-1.shtml>, visited on 14 February 2007. 646 Gribben and Faruk, supra note 445, p. 3. 647 Ibid., p. 4. 648 FairPensions, UK Pension Scheme Transparency on Social, Environmental and Ethical Issues, 2006, <www.fairpensions.org.uk/pdf/Pension%20Scheme%20Transparency%20Re port%20Nov2006.pdf>, visited on 14 February 2007.

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Chapter 5 of foreign trade and investment in developing countries. Just Pensions has among its aims: ƒ To raise awareness and educate the UK pensions and the wider investment industry about the importance of international development issues in their practice of SRI. ƒ To influence the behaviour of companies investing in or trading with less developed countries by persuading institutional investors that responsible corporate behaviour preserves long-term shareholder value, mitigates reputational risk and contributes to a just and sustainable society.649 Australia The Corporations Act of 2001 dealing with disclosure related to financial products contains a provision similar to the British law, but more detailed. The Product Disclosure Statement (PDS) should mention whether the product issuer does, or does not, take into account labour standards or environmental, social or ethical considerations in the selection, retention or realisation of an investment. If yes, the statement has to outline the standards/considerations that the product issuer considers to be labour standards, respectively environmental, social or ethical considerations. It also has to outline the extent to which the product issuer takes those standards/considerations into account.650 According to the Guidelines issued by the Australian Securities & Investments Commission (ASIC), “[T]he purpose of this improved disclosure is to: (a) enhance consumers’ ability to compare products and to select the product that best matches any goals they may have regarding these standards or considerations; (b) provide industry with greater certainty about how it can meet the new disclosure requirements without inhibiting developments in this area or product design, and without being commercially unrealistic or exposing product issuers to unreasonable levels of risk; and (c) ensure that products are ‘true to label’ and do what they say they do.”651

The ASIC explained its approach: “Because this is a new area of disclosure we have deliberately adopted a non-prescriptive, principles-based approach.”652 The ASIC

649

<www.uksif.org/J/Z/Z/jp/about/aims/index.shtml>, visited on 14 February 2007. Corporations Regulations 2001, REG. 7.9.14C ‘Labour Standards and Environmental, Social and Ethical Considerations’, <scaleplus.law.gov.au/html/pastereg/3/1682/1/PR 005130.htm>, visited on 14 February 2007. 651 Australian Securities & Investments Commission, Section 1013DA Disclosure Guidelines – ASIC Guidelines to Product Issuers for Disclosure About Labour Standards or Environmental, Social And Ethical Considerations in Product Disclosure Statements, December 2003, p. 2, <www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/s1013DA_final guidelines.pdf/$file/s1013DA_finalguidelines.pdf>, visited on 14 February 2007. 650

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Policies and laws relevant to CSR does not intend to “specify the labour standards or environmental, social or ethical considerations that may be taken account of, or the methodologies that should be used”.653 In its final guidelines the ASIC notes: “These guidelines do not set out what constitutes a labour standard or an environmental, social or ethical consideration, or what methodology product issuers should use for taking these issues into account. The guidelines do, however, make it clear that you must disclose which of these standards and considerations you take into account and how… The more a product is marketed on the basis that such standards and considerations are taken into account, the more detail is required.” 654

Disclosure about the extent to which the standards and considerations are taken into account involves “providing retail clients with sufficient detail to understand the activities undertaken by or on behalf of a product issuer, by disclosing: (a) the methodology for taking the standards or considerations into account where one exists (including the absence of a methodology, if there is none); and (b) the weight given to the standards or considerations, where a weighting system is used.” 655

The guidelines explain that disclosures should make the lack of a formalised approach clear when SRI issues are considered merely on an ad hoc basis: “If you have no predetermined view about how far labour standards or environmental, social or ethical considerations will be taken into account (i.e. you have no specific methodology), this must be clearly stated. For example, a PDS may say that you have no predetermined view other than you take into account labour standards or environmental, social or ethical considerations you may become aware of, but only to the extent that they financially affect the investment.” 656

652

Australian Securities & Investments Commission, Disclosure about Labour Standards and Environmental, Social and Ethical Considerations in Product Disclosure Statements – Draft ASIC s1013DA Guidelines for Product Issuers, September 2003, p. 3, <www.asic.gov.au/asic/ pdflib.nsf/LookupByFileName/s1013DA_draft_guidelines.pdf/$file/s1013DA_draft_guidelin es.pdf>, visited on 14 February 2007. 653 Australian Securities & Investments Commission, Socially Responsible Investing Disclosure Guidelines?, ASIC Discussion Paper, December 2002, para. 1.3, <www.asic.gov .au/asic/pdflib.nsf/LookupByFileName/social_resp_discussion.pdf/$file/social_resp_discussio n.pdf>, visited on 14 February 2007. 654 Australian Securities & Investments Commission, supra note 651, p. 3. (emphasis added) 655 Ibid., para. 1.21. 656 Ibid., para. 1.24. (emphasis added)

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Chapter 5 Finally the Guidelines clarify that “[w]here labour standards or environmental, social or ethical considerations are not taken into account when selecting, retaining or realising an investment, the Corporations Regulations state that the PDS must explicitly state this. These guidelines do not apply to products where these standards or considerations are not taken into account.” 657 France France has two laws relevant to this section: one refers to mutual funds, the other to the Pension Reserve Fund. The reform of Employee Savings Plans in 2001 also resulted in the introduction of CSR considerations into investment decisions. This law applies to mutual funds, which collect money from the Employee Saving Plans, the Inter-Companies Saving Plans and the Voluntary Partnership Employee Saving Plans.658 The Monetary and Financial Code, Article L. 214-39, now reads: “The [fund’s] internal rules specify, if need be, the social, environmental or ethical considerations the fund management company must take into account when buying or selling securities, as well as when exercising the voting rights attached to the ownership of these securities. The fund’s annual report reports on how these considerations have been taken into account, in terms defined by the Commission des Opérations de Bourse.”659

The Pension Reserve Fund supports the state pensions system through financial investments in stocks and shares. The management board “regularly reports to the supervisory board and particularly relates on how [fund’s investment policy guidelines] have taken into account social, environmental and ethical considerations”.660 The Fund has a supervisory board and a management board. The supervisory board is formed by members of Parliament, representatives of social contributors appointed by nationally recognised interprofessional trade-unions, representatives of employers and self-employed employers appointed by the corresponding nationally recognised trade-unions, state representatives and qualified personalities. “On the proposal of the management board, the supervisory board determines the fund’s investment policy guidelines which must respect, on the one hand, the objective and the detention horizon of the fund and, on the other hand, the

657

Ibid., para. 1.6. European Commission, Promoting a European Framework for Corporate Social Responsibility, Green Paper, 2001, p. 22, <europa.eu.int/comm/employment_social/soc-dial/ csr/greenpaper_en.pdf>, visited on 14 February 2007. 659 Law No. 2001–152 of 19 February 2001, Article 21, on the Generalisation of Employee Savings Plans. 660 Law No. 2001–624 of 17 July 2001, Titre II, Article L. 135–8. Relative to Various Social, Educational and Cultural Provisions. 658

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Policies and laws relevant to CSR prudent man and risk diversification principles.”661 The management board implements the investment policy guidelines. A driving force behind these two laws has been the French Social Investment Forum – Forum pour l’Investissement Responsible (FIR). Created in 1999, the FIR has actively participated in the SRI parliamentary and public debate. The FIR successfully ensured the inclusion of a ‘disclosure’ amendment in the law on the generalisation of Employee Savings Plans and the Financial Management of the French Pension Reserve Fund. FIR promotes the interests of the ethical investment community.662 Comité intersyndical de l’épargne salariale (France) is an initiative created in 2002 by four French trade unions (CFDT, CGC, CFTC, CGT) with the aim to control the way the épargne salariale (employees savings) are invested and to guide fund managers towards secure and socially responsible funds. The Committee has launched a quality label for financial products in France which certifies their financial, social and environmental quality. In 2002, seven financial products have been labelled.663 Germany In August 2002 a pension reform come into effect in Germany. Part of the reform is the introduction of disclosure regulations following the British example. The disclosure regulations apply to both occupational pension funds (branch and corporate pensions funds) and private pension schemes. EUROSIF reports that starting in January 2002 certified private pension schemes and some occupational pension schemes “must inform the members in writing, whether and in what form ethical, social, or ecological aspects are taken into consideration when investing the paid-in contributions”.664 This disclosure regulation applies only to a small segment of the pension fund market where it has had a distinctive impact. The rest of the pension funds market has seen some new SRI initiatives inspired by the new regulation, but no major shift, according to EUROSIF.665 OEKOM notes that since 1 January 2005, “all providers of promotable pension products in Germany must report before concluding a contract, and thereafter annually, on whether and how sustainability criteria will be taken into account in the use of funds paid in by customers. This duty to report already existed in principle before the reform of the Pension Earnings Act which has now taken effect, but it was 661

Ibid. European Social Investment Forum, SRI History: France, <www.eurosif.org/pub2/lib/ ref/ctry/fr/hist.shtml>, visited on 14 February 2007. 663 Socially Responsible Consumption Socially Responsible Investment (SRI), <europa.eu.int/ comm/employment_social/soc-dial/csr/abc3.htm#_Toc85625669>, visited on 14 February 2007. 664 AltZertG, Article 1(9), Para. 1, 665 Eurosif, SRI among European Institutional Investors (2003) p. 39. 662

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Chapter 5 in part undermined by a particular interpretation of the law by the Federal Agency for the Supervision of Financial Services. Expert bodies like the German Sustainable Investments Forum do not, however, anticipate any material changes to investment practice from the new arrangement.”666

Sweden In 2000, the Swedish government decided that the state-owned National Pension Funds must take ethical and environmental concerns into consideration when making investment decisions. Not, however, at the cost of sacrificing high returns. The law on National Pension Funds, which came into effect in January 2002, states that account shall be taken of environmental and ethical considerations in investment activities without compromising on the overall target of earning a high return.667 Pernilla Klein of AP3, the Third Swedish National Pension Fund, explained that as a state-owned investment fund, “[AP3] would not carry out negative screens of companies involved with for example, tobacco, weapons production or nuclear energy since all of these are legal activities according to Swedish law. On the other hand, seeing as Sweden has bound itself to a number of international labour and human rights conventions, we have begun to develop an active engagement policy to first of all review and consequently improve the social performance of the companies we invest in.”668

Austria Since 23 September 2005, the Pension Fund Act provides that pension funds must include within their written declaration on investment policy “the selection of assets, where applicable, according to ethical, environmental and/or social criteria”.669 European Union At EU level, the High Level Group of Company Law Experts issued in their report a recommendation that would have institutional investors state their investment policies. This provision, apparently inspired by the British law, would support the information needs of final beneficiaries. However it is not explicit on ethical and environmental considerations as the above-mentioned laws have been. “Regulation of the relevant types of institutional investors by Member States should include an obligation on those institutional investors to disclose their investment policy and their policy with respect to the exercise of voting rights in companies in which they

666

OEKOM research newsletter, January 2005, p. 3, <www.oekom-research.de/ag/english/ Newsletter/Newsletter0105.pdf>, visited on 14 February 2007. 667 Regeringens proposition 1999/2000:46. 668 European Business Campaign on Corporate Social Responsibility, supra note 470, p. 83. 669 Para. 25 of Pension Fund Act (PKG), OEKOM Research Newsletter, October 2005.

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Policies and laws relevant to CSR invest, and to disclose to their beneficial holders at their request how these rights have been used in a particular case.” 670 B. Labelling schemes Belgium’s ‘social label law’ Belgium has since January 2002 a law aiming to promote socially responsible production, known as the ‘social label law’.671 The social label672 will guarantee consumers that a product has been produced with respect to four fundamental social rights,673 as identified by the eight basic conventions of the International Labour Organization. The label is awarded to products and not to a company. Any enterprise, Belgian or foreign, that sells a product on the Belgian market may obtain the label if it shows compliance with labour standards throughout its entire production line, both in Europe and in developing countries. Having the social label is not a condition for selling products on the Belgian market. The applicant company must agree to inspections by social auditing firms accredited by the Belgian Ministry of Economic Affairs. The Ministry will give the label after obtaining the opinion of a stakeholder committee. The law calls for the setting up of a 16-seat multistakeholder committee consisting of employers’ federation representatives, NGOs, trade unions, consumer organisations and public officials to oversee the awarding of a social label to eligible products. The committee is responsible for reviewing the social audits of a company that has applied for the social label. The label is valid for a maximum of three years. An enterprise that applies for and receives the social label and is then found to have cheated is liable to penalties that range up to 2.5 million Euro. Commentators refer to a twofold reasoning behind this legislative initiative: ƒ “By having one publicly sanctioned social label, confused consumers who are faced with an overload of labels, packaging, and other information can be given the option of choosing ethically.”674 ƒ “The process of applying for the label can actually elevate the social responsibility of a company as it is provided with an opportunity to

670

High Level Group of Company Law Experts, supra note 182, Recommendation III.7. and p. 56. (emphasis added) 671 Loi du 27 février 2002 visant à promouvoir la production socialement responsable (Moniteur belge du 26/03/2002); Arrêté royal du 4 avril 2003 portant exécution de certaines dispositions de la loi du 27 février 2002 visant à promouvoir la production socialement responsable (Moniteur belge du 28/08/2003); Arrêté ministériel du 7 avril 2003 approuvant le règlement d’ordre intérieur du Comité pour une production socialement responsable (Moniteur belge du 28/08/2003); Arrêté ministériel du 7 avril 2003 approuvant le cahier des charges pour une production socialement responsable (Moniteur belge du 28/08/2003). 672 <www.social-label.be>, visited on 14 February 2007. 673 Freedom of association and collective bargaining, non-discrimination in employment, prohibition of forced labour, and prohibition of child labour. 674 European Business Campaign on Corporate Social Responsibility, supra note 668.

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Chapter 5 evaluate its own performance, and this is perhaps one of the most important benefits of the label.”675 EU’s Eco-Management and Audit Scheme (EMAS) In the environmental protection area, the EC passed regulations that provide guidance on environmental management systems, and also facilitate environmental communications through a dedicated label. For convenience these instruments are discussed in this section dealing with transparency, instead of the next section dealing with legal instruments focused on management systems. The EMAS deals with both CSR disclosures and implementation processes (that can substantiate environmental due diligence). EMAS is a scheme that has been available since 1995, and was updated in 2001.676 It is now open to voluntary participation by organisations not only in the manufacturing sectors, but also in all economic sectors including public and private services. The entity to be registered as an organisation under EMAS can be a site or an entire business as long as it does not exceed the boundaries of one member state.677 The regulation asks member states to encourage organisations to participate in EMAS on a voluntary basis as they may benefit in terms of regulatory control, cost savings and public image;678 Member states shall create incentives to encourage organisations to participate in EMAS.679 In accordance with the principle of subsidiarity, “[t]his Regulation limits itself to ensuring an equal implementation of EMAS throughout the Community by providing for common rules, procedures and essential requirements regarding EMAS whilst the measures that can be adequately performed at national level are left to the Member States”.680 The EMAS aims “to promote continual improvements in the environmental performance of organisations by: (a) the establishment and implementation of environmental management systems by organisations as described in Annex I; (b) the systematic, objective and periodic evaluation of the performance of such systems as described in Annex I; (c) the provision of information on environmental performance and an open dialogue with the public and other interested parties; (d) the active involvement of employees in the organisation and appropriate initial and advanced training that makes active participation in the tasks referred to under (a) possible. Where they so request, any employee representatives shall also be involved.”681

675

Ibid. Council Regulation (EC) No. 761/2001, supra note 330. 677 Ibid., Article 2(s). 678 Ibid., Preamble (9). 679 Ibid., Preamble (15). 680 Ibid., Preamble (8). 681 Ibid., Article 1 676

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Policies and laws relevant to CSR In a nutshell, an organisation must comply with the following steps to receive EMAS registration: 1)

2)

3)

4)

“conduct an environmental review considering all environmental aspects of the organisation’s activities, products and services, methods to assess these, its legal and regulatory framework and existing environmental management practices and procedures. in the light of the results of the review, establish an effective environmental management system aimed at achieving the organisation’s environmental policy defined by the top management. The management system needs to set responsibilities, objectives, means, operational procedures, training needs, monitoring and communication systems. carry out an environmental audit assessing in particular the management system in place and conformity with the organisation’s policy and programme as well as compliance with relevant environmental regulatory requirements. provide a statement of its environmental performance which lays down the results achieved against the environmental objectives and the future steps to be undertaken in order to continuously improve the organisation’s environmental performance.”682

There are similarities with the requirements of the ISO 14000 series dedicated to environmental management systems, though EMAS is more stringent. An accredited verifier must approve the environmental review, EMS, internal environmental audit and the environmental statement.683 Since 2001 a business implementing ISO 14001 is deemed in compliance with the environmental management system required by EMAS. The regulation binds member states to establish a system for the accreditation of independent environmental verifiers and for the supervision of their activities.684 “It is … necessary to ensure and steadily improve the competence of the environmental verifiers by providing for an independent and neutral accreditation system, retraining and an appropriate supervision of their activities in order to ensure the overall credibility of EMAS. Close cooperation between the national accreditation bodies should accordingly be set up.”685 C. Disclosures of environmental pollutants Mandatory disclosures have been tried in the environmental field with positive results; they have also provided a cost-effective and less interventionist regulatory avenue. Reporting directly to the public is different from reporting to public authorities, which in turn make some information publicly available. In the latter case, reporting is often a condition of licensing, which allows a business activity to 682

Summary, <europa.eu.int/comm/environment/emas/about/summary_en.htm>, visited on 14 February 2007. 683 Council Regulation (EC) No. 761/2001, supra note 330, Annex V–5.4.1. 684 Ibid., Article 4. 685 Ibid., Preamble (13).

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Chapter 5 take place. A report observed: “Most mandatory reporting schemes however were designed with the obligations on companies to report to public authorities under various licensing regimes. Mandatory public reporting of environmental information is currently limited to a few countries, while mandatory reporting to the authorities is more widespread.”686 The US Toxics Release Inventory (TRI) is a pioneering disclosure programme introduced in 1986.687 The TRI is a publicly available database of the Environmental Protection Agency that contains information on toxic chemical releases reported annually by certain covered industry groups as well as federal facilities. The law’s “primary purpose is to inform communities and citizens of chemical hazards in their areas. The goal of TRI is to empower citizens, through information, to hold companies and local governments accountable in terms of how toxic chemicals are managed.”688 The United Nations Economic Commission for Europe (UNECE) Convention on Access to Information, Public Participation in Decision-making and Access to Justice in Environmental Matters (known as the ‘Aarhus Convention’), adopted in 1998, emphasises the role of transparency in promoting environmental protection. As Kofi Annan wrote, “Although regional in scope, the significance of the Aarhus Convention is global. It is by far the most impressive elaboration of principle 10 of the Rio Declaration, which stresses the need for citizen’s participation in environmental issues and for access to information on the environment held by public authorities. As such it is the most ambitious venture in the area of environmental democracy so far undertaken under the auspices of the United Nations.”689

Article 5 of the Convention deals with the collection and dissemination of environmental information and require states to encourage businesses to inform the public regularly of the environmental impact of their activities, using where appropriate voluntary eco-labelling or eco-auditing schemes.690 States are also obliged to “develop mechanisms with a view to ensuring that sufficient product information is made available to the public in a manner which enables consumers to make informed environmental choices.”691 686

T. Emtairah, Corporate Environmental Reporting: Review of Policy Action in Europe (International Institute for Industrial Environmental Economics, Lund, 2002) p. 18, <www.en viroreporting.com/others/cer_europe.pdf>, visited on 14 February 2007. 687 TRI was established under the Emergency Planning and Community Right-to-Know Act of 1986 (EPCRA) and expanded by the Pollution Prevention Act of 1990. 688 <www.epa.gov/tri>, visited on 14 February 2007. 689 <www.unece.org/env/pp/welcome.html>, visited on 14 February 2007. 690 Convention on Access to Information, Public Participation in Decision-Making and Access to Justice in Environmental Matters, Article 5.6, Aarhus, 1998, <www.unece.org/env/pp/ documents/cep43e.pdf>, visited on 14 February 2007. 691 Ibid., Article 5.8.

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Policies and laws relevant to CSR In 2003, 34 countries and the European Community signed the new Protocol on Pollutant Release and Transfer Registers to the Aarhus Convention. Under the new Protocol, companies will be required to report annually on their releases (into the environment) and transfers (to other companies) of certain pollutants (86 pollutants). The information will then be placed in a public register. “Some of the reported information may be kept confidential, for example where disclosure could affect commercial confidentiality, national defence or public security, but such exemptions should be interpreted in a restrictive way, taking into account the public interest served by disclosure.”692 Further “[a]lthough regulating information on pollution, rather than pollution directly, the protocol is expected to exert a significant downward pressure on levels of pollution, as no company will want to be identified as among the biggest polluters”.693 Pollutant Release and Transfer Registers (PRTRs) are modelled after the successful TRI. A report noted: “The OECD published a guidance manual for governments regarding [PRTRs] in 1996. A PRTR system usually calls for firms to report periodically on their releases and transfers of a variety of substances of interest. The information is made publicly accessible bearing in mind legitimate needs for business confidentiality. The results provide comparative quantitative information among reporters and have stimulated investors and other stakeholders to ask questions of firms whose performance are significantly below normal for their sector and demand improvement. A PRTR thus provides a powerful incentive for reporters to cut releases and transfers. Corporate and environmental groups alike have said that PRTRs have had a stronger impact than many regulatory programmes even though a PRTR sets no mandatory improvement goals. Simply by making pollutant release and transfer information accessible encourages firms to take pollution prevention actions.”694

An innovative disclosure scheme was tested in Indonesia and few other countries695 in the mid- and late-1990s. As a difference from TRI, which disseminates ‘raw’ information on toxic emissions with no interpretation or risk assessment the Program for Pollution Control, Evaluation, and Rating (PROPER) in Indonesia is a 692

United Nations Economic Commission for Europe, Governments Reach Agreement on New United Nations Treaty on Pollution Information Disclosure, Press Release ECE/ENV/03/P01, 31 January 2003, <www.unece.org/env/pp/press.releases/prtr.31.01.03. pdf>, visited on 14 February 2007. 693 Ibid. 694 Emtairah, supra note 686, p. 19. 695 S. Afsa, International Resources Group Ltd., PROPER – Program for Pollution Control Evaluation and Rating, A Model for Promoting Environmental Compliance and Strengthening Transparency and Community Participation in Developing Countries, undated document, <www.worldbank.org/nipr/work_paper/PROPER2.pdf>, visited on 14 February 2007.

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Chapter 5 performance evaluation system that ranks companies. The rankings of PROPER are based on Indonesia’s legal emissions standards, and are graphically communicated though five colours: gold, green, blue, red and black.696 5.3. LAWS REFERRING TO MANAGEMENT SYSTEMS This section concentrates on the innovative approach adopted by the US Sentencing Guidelines (SG), as well as the incentive policy followed by the US Environmental Protection Agency and modelled after the SG. A reading of the following regulations helps clarify what due diligence entails from a regulatory perspective. Policymakers deliberately open the corporate ‘black box’ and encourage the adoption of sound internal procedures. The EMAS scheme discussed above also contains extensive descriptions of what an effective environmental management system entails; in contrast, the Guidelines are addressed to courts dealing with criminal law cases, while other instruments create incentives for, or even mandate, the implementation of rigorous management systems. 5.3.1. US Sentencing Guidelines The US Sentencing Guidelines, adopted in 1991, belong to the area of criminal law. Chapter 8 (‘Sentencing of Organizations’)697 applies to all organisations whether publicly or privately held, and of whatever nature, such as corporations, partnerships, labour unions, pension funds, trusts, non-profit entities and governmental units.698 The Guidelines also have a bearing on outsourcing.699 The sanctions imposed upon organisations in Chapter 8 both deter and provide incentives for organisations to maintain internal mechanisms for preventing, detecting and reporting criminal conduct. These guidelines provide “a structural foundation from which an organization may self-police its own conduct through an

696

GOLD (Clean technology, waste minimization, pollution prevention, conservation), GREEN (Above standards & good maintenance, housekeeping, sludge management, etc.), BLUE (Efforts meet minimum standards), RED (Efforts don’t meet standards), and BLACK (No pollution control effort; Serious environmental damages). 697 United States Sentencing Commission, Sentencing Guidelines, 1991, <www.ussc.gov/2004guid/tabconchapt8.htm>, visited on 14 February 2007. 698 United States Sentencing Commission, An Overview of the United States Sentencing Commission and the Federal Sentencing Guidelines, 2004, p. 2, <www.ussc.gov/TRAINING/ corpover04.pdf>, visited on 14 February 2007. 699 The Guidelines require the organization to communicate its compliance and ethics program not only to the organization’s board of directors, its high-level personnel and employees, but also to ‘agents’ of the organization. Supra note 697, para 8B2.1.(b)(4). See also Baker & McKenzie, ‘Revised US Sentencing Guidelines Could Affect Outsourcing Arrangements’, in Digest of Key Monthly Developments, November 2004, <www.bakernet.com/NR/rdonlyres/76AA87EB-BF18-4949-920F-3E4E105DDEFA/0/NAOut Legalbytes1104.pdf>, visited on 14 February 2007.

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Policies and laws relevant to CSR effective compliance and ethics program”.700 While organisations cannot be imprisoned, they can be fined, sentenced to probation for up to five years, ordered to make restitution and issue public notices of conviction and apology to their victim and exposed to applicable forfeiture statutes.701 Here we concentrate on fines as the Guidelines use them to provide a scheme of incentives including reduction of up to 95 per cent “if an organization can demonstrate that it had put in place an effective compliance and ethics program and that the criminal violation represented an aberration within an otherwise law-abiding community”. 702 The Guidelines are detailed and technical in calculating fine levels. The Sentencing Commission summarises the fines range for any other organisation as being based on the seriousness of the offence and the culpability of the organisation. “Fines are based on two distinct analyses. The first analysis yields a ‘base fine’ that is a measure of the seriousness of the offense involved. The second analysis yields a ‘culpability score’ that is a measure of how culpable the organization was in committing and responding to the occurrence of the offense. Together, these two determinations yield a ‘guideline fine range’ from which the court has discretion to select the precise fine amount to be imposed.”703

The Guidelines state that “Culpability generally will be determined by six factors that the sentencing court must consider. The four factors that increase the ultimate punishment of an organization are: (i) the involvement in or tolerance of criminal activity; (ii) the prior history of the organization; (iii) the violation of an order; and (iv) the obstruction of justice. The two factors that mitigate the ultimate punishment of an organization are: (i) the existence of an effective compliance and ethics program; and (ii) selfreporting, cooperation, or acceptance of responsibility.”704

The Sentencing Guidelines extensively define an effective compliance and ethics programme: it entails showing due diligence and promoting a supportive organisational culture: “(a) To have an effective compliance and ethics program … an organization shall (1) exercise due diligence to prevent and detect criminal

700

United States Sentencing Commission, Amendments to the Sentencing Guidelines – Policy Statements and Official Commentary, 2004 p. 75, <www.ussc.gov/2004guid/2004cong.pdf>, visited on 14 February 2007. 701 United States Sentencing Commission, supra note 698. 702 Ibid. 703 United States Sentencing Commission, The Federal Sentencing Guidelines for Organizational Crimes: Questions and Answers, 1991. <www.ussc.gov/training/corpq&a .pdf>, visited on 14 February 2007. 704 United States Sentencing Commission, supra note 700.

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Chapter 5 conduct; and (2) otherwise promote an organizational culture that encourages ethical conduct and a commitment to compliance with the law.”705 The Guidelines explicitly link management systems to due diligence. Due diligence is understood to require: ƒ Standards and procedures to prevent and detect criminal conduct, ƒ Responsibility at all levels and adequate resources, and authority for the program, ƒ Personnel screening related to program goals, ƒ Training at all levels, ƒ Auditing, monitoring, and evaluating program effectiveness, ƒ Non-retaliatory internal reporting systems, ƒ Incentives and discipline to promote compliance, and ƒ Reasonable steps to respond to and prevent further similar offences upon detection of a violation.706 The Guidelines further identify relevant variables that impact on organisational compliance. In determining what specific actions are necessary to meet the SG requirements, three factors shall be considered: (i) applicable industry practice or the standards called for by any applicable governmental regulation; (ii) the size of the organisation; and (iii) similar misconduct. Particularly relevant to CSR discussions is the reference to applicable industry practice: “An organization’s failure to incorporate and follow applicable industry practice or the standards called for by any applicable governmental regulation weighs against a finding of an effective compliance and ethics program.”707 Also the provisions on the size of the organisation are instructive given the focus of CSR arguments on large businesses: “A large organization generally shall devote more formal operations and greater resources in meeting the requirements of this guideline than shall a small organization. As appropriate, a large organization should encourage small organizations (especially those that have, or seek to have, a business relationship with the large organization) to implement effective compliance and ethics programs.”708 The incentive contained in the Guidelines results in penalty discounts when a management system exists; it has been discussed to modify the SG to aggravate the penalty when a MS does not exist. “The Advisory Group evaluated whether a culpability enhancement for the absence of an effective program is necessary to create additional incentives for the institution of effective compliance programs, and concluded that it is not. In considering this issue, the Advisory Group 705

United States Sentencing Commission, supra note 697, para. 8B2.1.(a). Ibid, para. 8B2.1.(b) as summarised in United States Sentencing Commission, supra note 698, p. 3. 707 United States Sentencing Commission, supra note 700, p. 79. 708 Ibid. 706

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Policies and laws relevant to CSR came to understand that the consequence of an amendment of this nature will most likely have a disproportionate impact upon small companies … The U.S. Department of Justice representatives, while opposing changes to the culpability score, suggested that the Sentencing Commission consider adding commentary to §8C2.5(f) stating that the ‘failure to have an effective program to prevent and detect violations of law could be weighed against larger organizations as evidence that ‘an individual within high-level personnel of the organization … condoned, or was willfully ignorant’ of the criminal conduct …’”709

The Sentencing Guidelines do neither mandate management systems nor increase penalties for the absence of a compliance programme; they simply provide incentives through reduced fines. Probation is another sanction. Under the SG, “organizational offenders who did not have an effective compliance program would be sentenced additionally to a term of probation and ordered to develop such a program during their period of court-supervised probation”.710 The Guidelines define probation as “an appropriate sentence for an organizational defendant when needed to ensure that another sanction will be fully implemented, or to ensure that steps [a compliance programme] will be taken within the organization to reduce the likelihood of future criminal conduct”.711 Under the Guidelines, probation may entail the following elements. The organisation shall develop and submit to the court an effective compliance and ethics programme and shall include a schedule for implementation of the programme. The organisation shall make periodic reports to the court regarding its progress in implementing the programme. In order to monitor implementation of the programme, the organisation shall allow a reasonable number of unannounced examinations of its books and records and interrogation of knowledgeable individuals within the organisation.712 Large businesses often settle the case in court and the setting up of compliance systems results from the terms of the settlement. “The overwhelming majority of organizations ultimately criminally convicted and sentenced in federal court are small, closely-held companies… In contrast to the manner in which cases involving small business typically are resolved, large, publicly-held corporations typically employ their considerable legal resources to negotiate civil settlements; or if there is a criminal indictment, they successfully bargain with the government to obtain a plea agreement that is presented to the court (and generally accepted) as a mutually satisfactory settlement of the criminal 709

Ad Hoc Advisory Group on the Organizational Sentencing Guidelines, supra note 618, pp. 132–133. (emphasis added) 710 J. R. Steer, Changing Organizational Behavior – The Federal Sentencing Guidelines Experiment Begins to Bear Fruit, 2001, p. 6, <www.ussc.gov/corp/corpbehavior2.PDF>, visited on 14 February 2007. 711 United States Sentencing Commission, Federal Sentencing Guideline Manual ,2004, p. 468. <www.ussc.gov/2004guid/CHAP8.pdf>, visited on 14 February 2007. 712 Ibid., §8D1.4. ‘Recommended Conditions of Probation’. (c)(1),(3) and (4).

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Chapter 5 case. An examination of these plea agreements often will reveal that the organization’s compliance efforts (or lack thereof) and the degree of its self-disclosure and post-offense cooperation, have figured prominently in the manner in which the case was resolved. In fact, there are a growing number of negotiated settlements in high visibility cases that together illustrate important facets of the organizational guidelines.”713

This approach of setting up compliance systems is evident in other cases as well. In the US two corporate employers (Texaco in 1996 and Coca-Cola in 2000) paid large settlements ($176 million and respectively $192.5 million) to minority employees on grounds of race discrimination. “The terms of both settlements required the insertion of outside auditors into typically internal and private corporate governance decisions, and the creation of governance processes designed to investigate and monitor compliance with laws prohibiting race discrimination.”714 As an accolade, there have been cases reported in which Canadian courts have ordered the environmental offender to implement an ISO 14001-based environmental management system or obtain ISO 14001 certification.715Wood notes that “[p]rosecutors and judges support such orders because they believe ISO [14001] certification will enhance future compliance; moreover it is easy to verify and is obtained at the defendant’s expense”.716 Wood refers to Canadian case law where ‘due diligence’ requires the establishment of a proper system to prevent commission of the offense.717 Litigation regarding the environmental protection laid down several elements of such proper systems: “(1) [T]he firm’s directors should establish a ‘pollution prevention system’, including supervision and inspection, improvement of business methods and exhortation of employees; (2) the directors should ensure that corporate officers have been instructed to set up a system “sufficient within the terms and practices of its industry of ensuring compliance with environmental laws” and to report to the board periodically on the operation of the system and promptly on any substantial non-compliance; (3) the directors should ensure that the officers address promptly any environmental concerns brought to their attention by regulators or other interested parties; (4) the directors should immediately and personally react when they notice the system has failed.” 718

713

Steer, supra note 710, p. 18. C. L. Wade, ‘Racial Discrimination and the Relationship between the Directorial Duty of Care and Corporate Disclosure’, 63 University of Pittsburgh Law Review (Winter 2002) p. 389, , visited on 14 February 2007. 715 Regina v. Prospec Chemicals Ltd., 19 Can. Envtl. L. Rep. (New Series) 178 (Alta. Prov. Ct. 1996); Regina v. Van Waters & Rogers Ltd., 220 A.R. 315 (Alta. Prov. Ct. 1998); Regina v. Calgary (City), 272 A.R. 161 (Alta. Prov. Ct. 2000). 716 Wood, supra note 321, p. 181. 717 Regina v. Bata Industries Ltd., 9 O.R. (3d) 329 at 339 (Ont. Prov. Ct. 1992). 718 Wood, supra note 321, p. 185. 714

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Policies and laws relevant to CSR The model advanced by the Sentencing Guidelines has been noted in the regulatory community. In 1991 the Commission has learned that “while courts have in the past viewed strong compliance programs as a mitigating factor, compliance programs on the whole have not played a prominent role in federal sentencing”.719 After years of experience with the SG, a report reached the “conclusion that the organizational sentencing guidelines have been successful in inducing many organizations, both directly and indirectly, to focus on compliance and to create programs to prevent and detect violations of law”.720 The report also noted that “[M]uch has changed in the field of organizational compliance since the advent of the organizational sentencing guidelines in November 1991. Over the last twelve years legal standards in a remarkably diverse range of fields have recognized organizational law compliance programs as important features of responsible organizational conduct. The legal standards which have emerged are often built upon the original organizational sentencing guidelines model. However, these standards have increasingly articulated more detailed and sophisticated criteria for identifying organizational law compliance programs that warrant favorable organizational treatment. Efforts and experience by industry and private organizations have also contributed to an evolution of ‘best practices’ during the last decade.”721

Further “[t]he organizational sentencing guidelines have had an important indirect effect on compliance incentives through their influence on the policies of various federal regulators. These regulators now consider whether an organization has an effective compliance program in deciding whether to pursue enforcement actions or impose significant penalties…” 722 The Guidelines have influenced several federal agencies that, unlike the Sentencing Commission, interact directly with and regulate segments of the business community. Such examples are the Environmental Protection Agency’s Enforcement Division, the Office of Inspector General in the Department of Health and Human Services, the US Department of Justice and the Securities and Exchange Commission.723 Finally, “[t]he organizational sentencing guidelines have had an influence far beyond criminal sentencing, and have even begun to influence the shape of corporate governance law. The seminal decision of In re Caremark International Inc. Derivative Litigation by the Delaware Chancery Court marks this trend.” 724 Further details on the policies of the US Environmental Protection Agency follow below. 719 720

United States Sentencing Commission, supra note 703, p. 4. Ad Hoc Advisory Group on the Organizational Sentencing Guidelines, supra note 619, p.

3. 721

Ibid. Ibid., p. 33. 723 Steer, supra note 710, pp. 13, 14. 724 Ad Hoc Advisory Group on the Organizational Sentencing Guidelines, supra note 619, p. 31. 722

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Chapter 5 5.3.2. US Environmental Protection Agency’s Audit Policy The Environmental Protection Agency (EPA) adopted in 1995 an Audit Policy that uses incentives to enhance environmental protection.725 “To take advantage of these incentives, regulated entities must voluntarily discover, promptly disclose to EPA, expeditiously correct, and prevent recurrence of future environmental violations. Disclosures are often preceded by consultation between EPA and the regulated entity, so that they can discuss mutually acceptable disclosure details, compliance, and audit schedules…”.726 The Policy, updated in 2000, contains nine conditions laid down in Section E: 1. systematic discovery of the violation through an environmental audit or a compliance management system; 2. voluntary discovery; 3. prompt disclosure (21 days); 4. discovery and disclosure independent of government or third-party plaintiff; 5. correction and remediation; 6. prevent recurrence; 7. no repeat violations; 8. other violations excluded; 9. cooperation.727 Entities that meet all of these conditions are eligible for 100 per cent mitigation of any gravity-based penalties, though EPA retains its discretion to collect any economic benefit that may have been realised as a result of non-compliance. Entities that do not meet the first condition – systematic discovery of violations – but meet the other eight conditions are eligible for 75 per cent mitigation of any gravity-based civil penalties.728 The reasoning stated by EPA reveals its willingness “to encourage disclosure and correction of violations even in the absence of systematic discovery… EPA expects that a disclosure under this provision will encourage the entity to work with the Agency to resolve environmental problems and begin to develop an effective auditing program or compliance management system.” 729 Incentives include, besides the elimination or reduction of civil penalties, abstaining from recommending criminal prosecution of the disclosing entity and not requesting copies of entities’ voluntary audit reports to trigger federal enforcement investigations.730 Thus EPA encourages the ‘systematic discovery’ of environmental violations; the sanctions will be milder if the company performs an environmental audit or adopts a compliance management system. The environmental audit is defined as “a systematic, documented, periodic and objective review by regulated entities of 725

S. A. Herman, ‘Voluntary Environmental Self-Policing and Self-Disclosure Interim Policy Statement’, 60:63 Federal Register, 3 April 1995, pp. 16875–16879, , visited on 14 February 2007. 726 EPA, EPA's Auditing Policy, <www.epa.gov/compliance/incentives/auditing/audit policy.html>, visited on 14 February 2007. 727 S. A. Heman, ‘Incentives for Self-Policing: Discovery, Disclosure, Correction and Prevention of Violations’, 65:70 Federal Register, 11 April 2000, pp. 19618–19627, <www.epa.gov/compliance/resources/policies/incentives/auditing/auditpolicy51100.pdf>, visited on 14 February 2007. 728 Ibid., Section I.B. 729 Ibid., Section I.D.2. 730 Ibid., Section I.A.

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Policies and laws relevant to CSR facility operations and practices related to meeting environmental requirements”.731 According to EPA, the compliance management system “encompasses the regulated entity’s documented systematic efforts, appropriate to the size and nature of its business, to prevent, detect and correct violations”. 732 EPA’s policy further notes the essential characteristics of effective management systems: “(a) Compliance policies, standards and procedures that identify how employees and agents are to meet the requirements of laws, regulations, permits, enforceable agreements and other sources of authority for environmental requirements; (b) Assignment of overall responsibility for overseeing compliance with policies, standards, and procedures, and assignment of specific responsibility for assuring compliance at each facility or operation; (c) Mechanisms for systematically assuring that compliance policies, standards and procedures are being carried out, including monitoring and auditing systems reasonably designed to detect and correct violations, periodic evaluation of the overall performance of the compliance management system, and a means for employees or agents to report violations of environmental requirements without fear of retaliation; (d) Efforts to communicate effectively the regulated entity’s standards and procedures to all employees and other agents; (e) Appropriate incentives to managers and employees to perform in accordance with the compliance policies, standards and procedures, including consistent enforcement through appropriate disciplinary mechanisms; and (f) Procedures for the prompt and appropriate correction of any violations, and any necessary modifications to the regulated entity’s compliance management system to prevent future violations.”733

EPA’ policy mentions that these criteria are adapted from existing codes of practice, such as the US Sentencing Guidelines. They are deemed “flexible enough to accommodate different types and sizes of businesses and other regulated entities”. 734 The policy considers these elements as due diligence criteria and points out that the disclosing entity should be prepared to document how its programme reflects the due diligence criteria (where the violation is discovered through a compliance management system and not through an audit). “The revised Policy uses the term ‘compliance management system’ instead of ‘due diligence,’ which was used in the 1995 Policy. This change in nomenclature is intended solely to conform the Policy language to terminology more commonly in use by industry and by regulators to refer to a systematic management plan or systematic efforts to achieve 731

Ibid., Section II.B. Ibid. 733 Ibid. 734 Ibid., Section I.E.1. 732

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Chapter 5 and maintain compliance. No substantive difference is intended by substituting the term ‘compliance management system’ for ‘due diligence,’ as the Policy clearly indicates that the compliance management system must reflect the regulated entity’s due diligence in preventing, detecting and correcting violations.” 735

5.3.3. Other regulations providing incentives for management systems In other cases regulators employ a different set of incentives for businesses to set up proper management systems. The Connecticut ‘Act Concerning Exemplary Environmental Management Systems’ provides companies: (1) with registered ISO 14001 environmental management systems, (2) that have adopted approved principles of sustainability, and (3) that have good compliance records with: expedited permit review, reduced fees, less frequent reporting, a facility wide permit for all approvals and public recognition of having attained this achievement. 736 In Australia (Victoria state), environmental regulations relieve businesses from some regulatory burdens (approvals and licenses) if they have a commendable environmental record, prepare an environmental plan, conduct periodic audits and implement management systems.737 Aalders reports on the link made between environmental management systems and regulation (permits) in Netherlands. Thus if a business has an EMS (usually ISO-certified) it can apply, instead of an ordinary permit, for a ‘framework permit’ (FP). The intention is to ease the burden for those businesses with an EMS. There was initial enthusiasm for this scheme, but in 2001 hints of stalling appeared. Getting this FP is more cumbersome than getting a regular permit. There are longer negotiations and more paperwork. Once the FP is obtained, there is more reporting to do than ordinarily. Government officials suffer from much greater workload; there is a need for enhancement of knowledge and experience in controlling sophisticated paperwork, more personnel with higher education and more professional attitudes.738 5.3.4. Regulations mandating management systems More rarely there are laws that do not merely offer incentives but impose an obligation to adopt management systems. Examples come from antibribery, health and safety and environmental protection.

735

Ibid. Connecticut Public Act Number 99–226, 29 June 1999. 737 Sinclair, supra note 481, p. 548. 738 M. Aalders, Drivers and Drawbacks – Regulation and Environmental Risk Management Systems, London School of Economics and Policitcal Science, 2002, p. 10 <www.lse.ac.uk/ collections/CARR/pdf/Disspaper10.pdf>, visited on 14 February 2007. 736

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Policies and laws relevant to CSR In 1977, the US enacted the Foreign Corrupt Practices Act (FCPA) as part of the 1934 Securities Exchange Act. The FCPA criminalises the bribery of foreign officials by US corporations and individuals pursuing business in other countries, and requires that companies with publicly-traded stock implement some internal controls, including record-keeping elements. There must be a system of internal accounting controls that provide reasonable assurances that transactions are properly authorised. In implementing FCPA’s provisions, the Securities and Exchange Commission considers several factors to determine the adequacy of a system of internal controls: (i) the role of the board of directors; (ii) communication of corporate procedures and policies; (iii) assignment of authority and responsibility; (iv) competence and integrity of personnel; (v) accountability for performance and compliance with policies and procedures; and (vi) objectivity and effectiveness of the internal audit function. 739 The US Sarbanes-Oxley Act contains a provision that makes managers responsible for maintaining an “adequate internal control structure and procedures for financial reporting”.740 The provision is backed by criminal penalties, and auditors are expected to ‘attest’ to the management’s assessment of these controls and disclose any ‘material weaknesses’. The Economist refers to this Section 404 as the law’s most complained-of provision in the Act.741 The EC Directive on health and safety establishes an obligation for employers to perform risk assessments.742 This is part of the preventative approach taken by the Directive, which has since 1989 generated improvements in the workplace. However there are areas to be improved concerning the practical implementation of the provisions related to the risk assessment. The experience so far identifies a tendency towards superficial, schematic procedures which tend to focus on obvious risks, while long-term effects (e.g. psychological and psycho-social factors) as well as the more insidious risks (e.g. those caused by chemical substances) are neglected. There is no overall or integrated approach to risks, and measures are taken in isolation. Risk assessment is often considered as a one-off obligation and lacks continuity. Finally the effectiveness of steps taken is not sufficiently monitored by employers. 743

Wood refers to the Canadian state of Alberta that has the LEAD programme which makes “implementation and maintenance of an environmental management system a licence term and specif[ies] the minimum elements of the EMS in the licence itself. This appears to be the first instance in Canada in which regulators will 739

W. Perkel, ‘Foreign Corrupt Practices Act’, 40 American Criminal Law Review (March 2003) p. 690. 740 Sarbanes-Oxley Act, Section 404, 2002. 741 The Economist, supra note 635. 742 Council Directive 89/391/EEC of 12 June 1989 on the Introduction of Measures to Encourage Improvements in the Safety and Health of Workers at Work. 743 European Commission, Communication on the Practical Implementation of Directives on Health and Safety at Work, undated document, <europa.eu.int/scadplus/leg/en/cha/c111 49.htm>, visited on 14 February 2007.

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Chapter 5 require EMS implementation or certification as a term of an operating permit or administrative order.”744 In the US, federal agencies are required to implement environmental management systems by the end of 2005 at all federal facilities.745 In the corporate governance area, mandating the setting up of risk management systems was discussed. The High Level Group of Company Law Experts recommends that details on the system of risk management applied by the company shall be disclosed; where such a system does not exist, this must also be disclosed. The Group did not go so far as to recommend the mandatory introduction of such systems: “Introducing a requirement in EU law for listed companies to have a developed system of risk management needs further study.”746 5.4. TORT LAW Even in the absence of new legislation assigning responsibilities to parent companies for the deeds of their business partners in the South, national courts in developed countries may reinterpret principles of tort law to cover transnational torts. National tort laws, in which a corporation can be held responsible for an act which causes harm to another person, whether intentionally or not, are particularly relevant as a means by which corporations may be held accountable in the absence of express human rights law obligations.747 5.4.1. Early days for transnational litigation Transnational litigation in the UK – the Thor, Rio Tinto and Cape cases748 – has been based on conventional tort/negligence principles. Commenced in the mid1990s, the UK courts have relied expressly on the law of negligence. Meeran, who represented the plaintiffs in these cases, writes: “The likelihood is that provided there is sufficient involvement in, control over and knowledge of the subsidiary operations by the parent there seems to be no reason in principle why the general principles of negligence should not apply so that in certain circumstances such a duty should exist … [I]ndeed here, it is arguable that the proximity of a TNC to overseas employees of its subsidiaries is closer than that of a manufacturer to

744

Wood, supra note 321, p. 182. Greening the Government Through Leadership in Environmental Management, Executive Order 13148 of 21 April 2000, Section 401.(b), , visited on 14 February 2007. 746 High Level Group of Company Law Experts, supra note 182, p. 47. 747 Allens Arthur Robinson (AAR), Brief on Corporations and Human Rights in the AsiaPacific Region, 2006), <www.reports-and-materials.org/Legal-brief-on-Asia-Pacific-forRuggie-Aug-2006.pdf>, visited on 14 February 2007. 748 The three cases refer to mercury poisoning of workers in South Africa (Thor), asbestos related disease of miners in South Africa (Cape PLC), and throat cancer of worker in Namibian uranium mine (RTZ); See also supra note 5. 745

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Policies and laws relevant to CSR consumers of its products.”749 The author makes reference to a case from 1932 (Donoghue v. Stevenson) that established the tort of negligence in common law, and a duty of care owed by the manufacturer to consumers. The UK cases have been fought over procedural issues of allowing, or not, the plaintiffs to sue the parent company before British courts instead of the courts in the South where the injuries occurred. Meeran notes that while “jurisdictional barriers having been largely overcome in the UK cases, the issue of whether or not MNC parent companies will be assigned with a legal duty of care towards those affected by their overseas operations remains the only real barrier between the claimants and justice”. 750 Meeran considers that “[t]he key issue raised is whether an MNC parent company owes a legal duty of care to those injured by its overseas operations. The first Court of Appeal in the Cape case described the duty of care issue as a ‘substantial question of law’. There is presently no precedent on this apparently controversial issue of the existence of a ‘duty of care’ owed by an MNC parent to those affected by overseas operations.”751 So far, all the cases of corporate liability for transnational torts have been dismissed on procedural grounds or have concluded with settlements. One of the cases involved Thor Chemicals and claims of mercury poisoning. Twenty South African workers argued that the English central company was liable because of its negligent design, transfer, set-up, operation, supervision and monitoring of intrinsically hazardous process. Thus the claim was based on negligent acts and omissions (i.e. failure to take steps to protect the South African workers against the foreseeable risk of mercury poisoning). As the company shifted in 1986 mercury operations to South Africa, precisely the same deficiencies were replicated. In addition, it relied extensively on untrained labour. Workers with high levels of mercury were laid off and replaced by new casual labourers who queued at the factory gates for work every day. This recycling of workers rather than a proper health and safety system appear to have been how Thor attempted to control mercury exposures of its workforce.752 Parent companies have been brought before the US courts for the human rights impacts of their subsidiaries and joint venture partners in countries such as Burma and Nigeria. These cases have in common the fact that the defendants were businesses in the extractive industries and the accusations were linked to international crimes such as forced labour (the modern equivalent of slavery), or executions/murders. Plaintiffs have brought these cases under the Alien Tort Claims Act (ATCA), a law that refers to violations of the law of nations, which the US 749

R. Meeran, ‘The Unveiling of Transnational Corporations: A Direct Approach’, in Addo, supra note 5, p. 170. (emphasis added) 750 R. Meeran, Castan Centre For Human Rights Law, Corporations, Human Rights and Transnational Litigation, 2003, <www.law.monash.edu.au/castancentre/events/2003/meeran paper.html>, visited on 14 February 2007. 751 Ibid. 752 R. Meeran, Liability of Multinational Corporations: A Critical Stage, 1999, <www.labournet.net/images/cape/campanal.htm>, visited on 14 February 2007.

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Chapter 5 courts have interpreted as violations that are ‘specific, universal and obligatory’ under international law.753 It is a short list that includes genocide, extra-judicial killing, torture, war crimes, slavery and extreme arbitrary detention.754 The crimes in these cases were committed by the government in connection with its providing security to the projects, and companies were sued as accomplices in these crimes. The fundamental question raised in the ATCA cases is: “Under what circumstances may a private entity doing business abroad be held accountable in federal court for international law violations committed by the host government in connection with the business activities of the private entity; and to what body of law do we look in order to determine the answer?”755 Judge Reinhardt considers that the ATCA makes international law applicable to determine whether a violation has occurred. “The statute is silent, however, as to what body of law applies to ancillary issues that may arise, such as whether a third party may be held liable in tort for a governmental entity’s violation of the law of nations.”756 The ATCA courts have applied standards developed in international criminal law rather than draw on the principles of tort law. There is also an ongoing uncertainty surrounding the precise standard ATCA courts should apply as the groundbreaking UNOCAL case was settled on the eve of the day when the Ninth Circuit was scheduled to hear an appeal that could have reversed the gains made by the human rights movement. American lawyers are just at the beginning of a longterm effort to shape the meaning of ATCA and of the applicable standard of liability.757 Because of these reasons, this section does not aim for an analysis of ATCA jurisprudence, but limits itself to Judge Reinhard’s opinions on how tort law could be applied in transnational tort cases. In 2002 he issued a concurring opinion to Judge Pregerson’s decision in the UNOCAL case, which “sent shockwaves through corporate America”.758 In Reinhardt’s view, the courts should have looked “to traditional civil tort principles embodied in federal common law, rather than to evolving standards of [criminal] international law …”.759 The charge in the UNOCAL case was one of ‘aiding and abetting’ the perpetuators, that is, “knowing practical assistance or encouragement that has a 753

Sosa v. Alvarez-Machain, 124 SCt 2739, 159 LEd 2d 718 (2004) p. 38 , visited on 14 February 2007. 754 J. Birchall, ‘The Limits of Human Rights Legislation’, Financial Times, 20 January 2005. 755 Concurring opinion of Judge Reinhardt, in Decision on John Doe et al. v. Unocal corporation et al., United States Court of Appeals for the Ninth Circuit, 18 September 2002, p. 14247, <www.ca9.uscourts.gov/ca9/newopinions.nsf/3D534390583B882F88256C380004 FE18/$file/0056603.pdf?openelement>, visited on 14 February 2007. 756 Ibid. 757 A. J. Sebok, ‘Unocal Announces It Will Settle a Human Rights Suit: What Is the Real Story Behind Its Decision?’, FindLaw, 10 January 2005, <writ.lp.findlaw.com/sebok/ 20050110.html>, visited on 14 February 2007. 758 Ibid. 759 Reinhardt, supra note 755.

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Policies and laws relevant to CSR substantial effect on the perpetration of the crime”.760 Judge Reinhardt urged courts to apply the theories of third-party liability ordinarily applied in tort cases – of joint liability, agency and reckless disregard – rather than the international criminal law doctrine of aiding and abetting.761 The theory of joint liability holds that a member of a joint venture is liable for the torts of its co-venturer; it is well-established in international law and in other national legal systems. The theory of agency liability would have held Unocal liable for the acts of the Myanmar military because the military acted as the company’s agent. The record before the court indicated that Total and Unocal executives and Myanmar military commanders held daily meetings in which the corporations could instruct the military leaders regarding security, and Unocal stated publicly that it controlled the Myanmar military’s actions in connection with the pipeline project. An agency relationship may be express or implied, and courts may infer from the factual circumstances that agency authority exists.762 The theory of reckless disregard of risks of injury is applicable when “a party is aware of (or should be aware of) an unreasonable risk, yet disregards it, thereby leading to harm to another.”763 In the UNOCAL case, “plaintiffs allege that Unocal had actual knowledge that the Myanmar military would likely engage in human rights abuses, including forced labor, [if it provided security to the pipeline project]. Nevertheless, according to plaintiffs, Unocal recklessly disregarded that known risk … and thereby set in motion international law abuses that were foreseeable to Unocal.”764 Judge Reinhardt explains that on a continuum that runs from simple negligence to intentional misconduct, recklessness lies between gross negligence and intentional harm. He concludes that “[t]he common law principle of recklessness has typically been applied to acts by a defendant that directly cause harm to a plaintiff. Nevertheless, I see no reason why the general principle that liability arises for one party’s conscious disregard of unreasonable risks to another should not apply when a defendant consciously disregards the risks that arise from its decision to use the services of an entity that it knows or ought to know is likely to cause harm to another party.”765

In both the case of complicity under criminal law and that of tort under civil law companies have to reach a certain level of participation and knowledge about the harming activity perpetuated by a third party in order to be held accountable. However, in civil cases “the tests are lower. You don’t need the same level of contribution to the act, and the degree of knowledge can be lower.”766 This study 760

Decision on John Doe et al. v. Unocal corporation et al., supra note 755, p. 14212. Reinhardt, supra note 755, p. 14269. 762 Ibid., p. 14261. 763 Ibid., p. 14264. 764 Ibid., p. 14263. 765 Ibid., p. 14265. 766 Nicholas Howen, in Business & Human Rights Seminar Report, supra note 17. 761

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Chapter 5 revolves basically around the element of indifference, which is common to both complicity and negligence. By using the concept of negligence we simply try to assess whether the parent companies can be culpable of failing to take reasonable due diligence steps, increasingly articulated and clarified by the CSR movement, to identify and mitigate human rights abuses in their overseas activities. The primary interest of this study is to draw on jurisprudence to understand factors relevant to how responsibility for harms is established; whether criminal or civil sanctions follow once responsibility is established is secondary for the purposes of this study. We now turn to the question of how the duty of care is defined and what factors courts will consider in order to find liability for negligence. Here we refer to charges of negligence that stakeholders make against the corporation and its directors, not to shareholders claiming the negligence of directors for failing to pursue diligently the success of the company. We have discussed the latter in chapter 2, which showed how directors are protected by the ‘business judgement rule’ against judicial review. A comparative report of five jurisdictions recognised the potential of the concept of negligence in promoting corporate accountability. It notes: “One of the most flexible –and therefore most important – features of tort law is the concept of negligence … Negligence is a relative term. Whether a certain act or failure to act constitutes negligence depends upon the facts and circumstances of each particular case.”767 The report further reads: “Negligence involves a lack of such concern for the probable consequences of an act or failure to act as a person of ordinary prudence would have had in conducting its affairs. … [I]f a company hires members of another state’s military forces for security purposes but fails to take sufficient measures to prevent them from torturing civilians in the course of providing ‘security,’ it is conceivable that the company’s failure to implement protective measures could result in a determination of negligence, and that it would be required by a court to compensate the harmed individuals.”768

5.4.2. Legal definition of negligence Negligence laws in different jurisdictions contain a basic and general principle. The French civil code states that “every act whatever … which causes damage to another obliges him by whose fault the damage occurred to repair it”.769 Since 1932, the UK law also has established the tort of negligence containing an ethical injunction of extremely wide potential scope: “[T]ake care not to injure your neighbours.” 770 The case affirms that not all moral wrongs can be remedied, but only those fulfilling the ‘neighbour principle’: “[Y]ou must take reasonable care to avoid acts or omissions 767

International Peace Academy and Fafo, supra note 4, pp. 26, 27. Ibid., p. 27. 769 Civil Code, Article 1382. 770 Donoghue (or McAlister) v. Stevenson, [1932] All ER Rep 1; [1932] AC 562; House of Lords. 768

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Policies and laws relevant to CSR which you can reasonably foresee would be likely to injure your neighbour … persons so closely and directly affected by my act that I ought reasonably to have them in contemplation as being so affected when directing my mind to the acts or omissions which are called into question.”771 The European Group on Tort Law explains the liability based on fault: “The required standard of conduct is that of the reasonable person in the circumstances, and depends, in particular, on the nature and value of the protected interest involved, the dangerousness of the activity, the expertise to be expected of a person carrying it on, the foreseeability of the damage, the relationship of proximity or special reliance between those involved, as well as the availability and the costs of precautionary or alternative methods.” 772

The following analysis draws upon case law in the common law systems and on the Principles of European Tort Law.773 In discussing the duty of care, relevant to the present study is to highlight non-legal considerations that courts have been taking into account and what are some of the defences allowed in courts. References will also be made to the case of liability for omissions, that is, liability where a defendant has unreasonably failed to prevent harm to a claimant; such liability is exceptional in tort law. This legal analysis can inform the CSR discourse and research which articulate expectations from the parent company; paying attention to the nuanced reasoning that courts adopt can introduce a degree of authoritativeness in CSR proposals. In discussing the elements of the ‘neighbour test’ this section does not aim to replicate a cursory introduction to the law of negligence and immerse in doctrinal legalistic analysis. It was noted that “[a]part from discussion of the issue of what types of loss are recoverable, conventional analysis of the duty of care takes only a few pages, and consists mainly of a legal history of concepts such as ‘foreseeability’, ‘proximity’ and ‘fair, just and reasonable’, together with often purely semantic discussion of their deeply puzzling meanings, or about the contested and near incomprehensible boundaries between them, or about the occasions (‘novel cases’) on which they should be deployed”.774

Three elements must be proved in order to obtain liability. First, the existence of a duty of care; is there a duty, and if yes, what is its scope? Second, the breach of that duty. Third, causation of damage.775 Below I deal solely with the first element:

771

V. Harpwood, Principles of Tort Law, 3rd ed. (Cavendish, London, 1997) pp. 18, 19. European Group on Tort Law, supra note 32, Article 4:102(1). 773 Ibid. 774 D. Howarth, ‘Many Duties of Care – Or A Duty of Care? Notes from the Underground’, 26 Oxford Journal of Legal Studies (Autumn 2006), pp. 449–472. 775 Harpwood, supra note 771; R. M. Jackson, Jackson & Powell on Professional Negligence, 5th ed. (Sweet & Maxwell, London, 2002); R. F. Balotti and J. Hinsey IV, ‘Director Care, 772

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Chapter 5 establishing a new legal duty of care where none previously existed – this seems to be the case at the moment when it is unclear whether the duty of care of the parent company in the North extends toward the rightholders in the South. The neighbour test, which determines the existence and scope of the duty of care, contains three elements: proximity between plaintiff and defendant (proximity), foreseen injury (foreseeability) and whether it is just and reasonable to impose the duty of care (fairness).776 Foresight of consequences is defined as reasonable contemplation of harm. The European Group on Tort Law refers to “the foreseeability of the damage to a reasonable person at the time of the activity, taking into account in particular the closeness in time or space between the damaging activity and its consequence, or the magnitude of the damage in relation to the normal consequences of such an activity”.777 In cases of omission, the forseeability test is not applied simpliciter: a mere forseeability is not enough; something very likely to happen is needed.778 The risk must be foreseeable; it is not negligent to fail to take precautions against an unforeseeable risk. Foresight is a function of knowledge, which raises two questions: Did anyone (not anyone in the world, but anyone situated similar to the defendant) have the knowledge necessary to foresee it? Ought the defendant to have that knowledge? Cane notes that the second question is not empirical as is the first, but can be answered only by making a value judgement.779 This judgement is reflected in the concept of reasonableness (reasonable person). Then did the defendant take reasonable care/precautions to reduce risk, to arrive at an ‘acceptable risk’? Buckley observes that risk is a function of various elements: probability of occurrence, seriousness of effect, utility/value of the activity in which the defendant is engaged and extent and cost of effective precautions.780 Courts often determine the acceptability of risk in an impressionistic and imprecise way, ultimately based on the decision-maker view of what constitutes good society. The idea of reasonableness implies a value judgement about which honest and fair people may legitimately disagree.781 From a policy perspective, negligence is not about eliminating risk, but about reducing risk to an acceptable level by taking reasonable precautions. Harpwood writes that proximity between parties is an important consideration, particularly in cases of omissions.782 The general principle is that failure to prevent

Conduct, and Liability: The Model Business Corporation Act Solution’, 56:1 Business Lawyer (2000) pp. 35–61. 776 P. Cane, The Anatomy of Tort Law (Hart, Oxford, 1997) p. 125. 777 European Group on Tort Law, supra note 32, Article 3:201(a). 778 R. A. Buckley, The Modern Law of Negligence, third ed. (Butterworth, London, 1999) pp. 7, 8. 779 Cane, supra note 776, pp. 38–40. 780 Buckley, supra note 778, p. 40. 781 Cane, supra note 776, p. 40. 782 Harpwood, supra note 771, pp. 20, 21.

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Policies and laws relevant to CSR third parties from causing harm does not give rise to liability:783 “[I]t is well-known hornbook tort law that, absent a duty based on a special relationship, there is no duty to rescue an innocent party in peril.”784 An exception arises when the defendant is in position to actually control activities; the degree of control is also relevant.785 The Principles of European Tort Law refer to those circumstances when someone has a positive duty to prevent harm committed by a third party: “A duty to act positively to protect others from damage may exist if law so provides, or if the actor creates or controls a dangerous situation, or when there is a special relationship between parties or when the seriousness of the harm on the one side and the ease of avoiding the damage on the other side point towards such a duty.”786 Omissions are especially relevant to CSR where the parent company has a degree of influence or control over its partners but fails to act where it could (should) to prevent harms committed by business partners overseas. In such cases, proximity may be insufficient to entail liability because of the remoteness of business partners in the South from the controlling entity in the North. Omissions to acquire information, to design appropriate policies, or to systematically implement them are all relevant. If foreseeability and proximity exists courts have to decide whether it is ‘fair, just and reasonable’ for the law to impose a duty of care. Judicial policy is the third element that affects the existence and scope of the duty of care. Such policy is a matter of social and economic pragmatism rather than logical application of preexistent legal rules. Among the factors influencing judicial policy are the floodgates argument (a ‘flood’ of suits following a particular decision); loss allocation (the ‘deepest pockets’ principle pointing to those best able to compensate for harm); whether imposition of duty would create inconsistencies with other areas of law; forward-planning by manufacturers; the notion that professionals (doctors, barristers) need protection from the threat of negligence actions which could inhibit their professional skills/judgement; constitutional roles (most appropriate institution, e.g. parliament and courts to decide the issue) and moral considerations.787 From the arguments against extension of negligence liability, the most familiar is the floodgate argument: so many other people have suffered or could suffer damage in similar situations.788 Harpwood observes that if judges want to restrict development of law, they will find insufficient proximity and not openly discuss policy.789 This will be an obstacle when at issue are human rights abuses perpetuated overseas, in remote locations.

783

Buckley, supra note 778, pp. 7, 8. A. J. Sebok, ‘Should American Courts Punish Multinational Companies for Their Actions Overseas? More on Indirect Injuries and the Alien Tort Claims Act’, FindLaw, 29 July 2002, <writ.news.findlaw.com/sebok/20020729.html>, visited on 14 February 2007. 785 Buckley, supra note 778, pp. 7, 8. 786 European Group on Tort Law, supra note 32, Article 4:103. 787 Harpwood, supra note 771, pp. 29, 30. 788 Buckley, supra note 778, p. 16. 789 Harpwood, supra note 771, p. 36. 784

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Chapter 5 Meeran discusses one element of the ‘neighbourhood test’ – forseeability – to prevent defences of corporations arguing that they have complied with local laws. He writes: “[P]ractising ‘double standards’ in relation to health and safety is morally indefensible and should be legally indefensible too. It is frequently suggested, on behalf of MNCs, that MNCs need only comply with the laws of the countries in which they operate. However, whether or not a risk of injury ought to have been foreseen by a defendant does not depend on local laws or regulations. The liability of a parent company based in England ought to be judged against its knowledge and experience of what was required to be done to protect against risks in England. If standards are less stringent overseas, it would be entirely artificial to base liability on such lesser standard if in fact the MNC had a greater awareness of the risks, based on the practices and knowledge acquired at home. Consequently whilst compliance with local standards may ensure no prosecutions for contravention of local laws, they cannot and should not be a defence to a claim brought in negligence.”790

While the law lays down the duty of care, the standard of due diligence needs to be specified more precisely. At this level an interesting interaction of law with private actors takes place at two levels: law accepts standards laid down by private organisations as benchmarks for due diligence (e.g. the ISO in the environmental area, or standardised industry practices in conformity with the custom of the industry), and courts accept defences based on sound management systems as evidence of due diligence. The Commission for Environmental Cooperation regards the ISO 14001 as a major benchmark of environmental due diligence. An environmental management system is defined as an organised system for carrying out due diligence.791 The ISO 14001 is “more detailed and more demanding than any environmental management measure yet proposed by the Canadian courts and gives businesses clearer guidance as to what is expected of them … A business which has a registered or self-declared ISO 14001 EMS will have gone a long way towards preparing the groundwork to establish that it has exercised the required standard of care. Because ISO 14001 is a management system, it is not the complete answer to determining what the standard of care is for all industries or all circumstances. Reference will still be required to industry custom and practice.”792

790

Meeran, supra note 750. Commission for Environmental Cooperation, ‘Canada’ in Voluntary Measures to Ensure Environmental Compliance, A Review and Analysis of North American Initiatives, 1998, p. 67, <www.cec.org/files/PDF/LAWPOLICY/volune_EN.pdf>, visited on 14 February 2007. 792 Ibid., p. 73. 791

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Policies and laws relevant to CSR Courts in several jurisdictions recognise standards – substantive or procedural – as providing evidence that a company has or has not exercised ‘reasonable care’. Webb has located many examples of Canadian, Australian and New Zealand courts drawing on ISO or domestic standards as evidence of whether a particular company had exercised due diligence.793 In the Canadian decision in R. v. Bata Industries,794 which first made corporate boards across the country take notice of environmental requirements, Judge Ormston proposed a list of due diligence indicators for directors. Among them was the following: “The Directors should be aware of the standards of their industry and other industries which deal with similar environmental pollutants or risks.” 795 Where minimum standards for proper conduct in a trade have been established, they are an essential part of due diligence. The reports and standards of industry task forces and research institutes are a traditional source of such standards. As an example, the authors provide the Imperial Oil case.796 There the court used Report 80-3 of the Petroleum Association for Conservation of the Canadian Environment on oil spill prevention as a benchmark of the company’s failure to use due diligence. The Report described the need for and method of constructing proper impoundments at railcar unloading facilities. Imperial Oil’s unloading facility had no such impoundment.797 Wood, commenting on Canadian jurisdiction, showed that widely accepted voluntary standards and other evidence of industry custom are relevant for determining whether a defendant exercised ‘reasonable care’. “In both civil and regulatory cases, conformance to industry custom is usually strong evidence of reasonableness unless the custom itself is unreasonable or the defendant’s particular circumstances require more.”798 Webb and Morrison comment on the role of private standards in a tort case, whether they have become industry custom or not: “[I]t is clear that voluntary codes are useful to the court both as examples of safe practices and as typical industry practices … The increasing prevalence of voluntary codes might have the effect of ratcheting up the standard of care for a particular industry. This can occur in two ways. First, if the voluntary standard is adopted by a significant portion of the industry it will be taken to be the industry standard by the courts. Those who ignore the standard will have difficulty in defending a negligence suit … Second, a voluntary standard which is not adopted by the industry will still provide a comparison for the court. Courts will often presume, for example, that a voluntary standard is an example of a safe practice in a particular situation. Even where the industry practice is different, the 793

Webb, supra note 866, p. 14. R. v. Bata, 1992, 7 C.E.L.R. (N.S.) 245 at 287. 795 Commission for Environmental Cooperation, supra note 791, p. 66. 796 R. v. Imperial Oil Ltd., 16 September 1990, Ont. C. A. 797 Commission for Environmental Cooperation, supra note 791, p. 68. 798 Wood, supra note 321, p. 184. 794

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Chapter 5 court may hold out the voluntary standard in order to demonstrate that the company did not use all due diligence in ensuring that the public was safe.”799

Gunningham and Grabovsky show that in many jurisdictions companies have a general legal obligation of due diligence, or reasonable care, in the conduct of their operations. However, the definition of due diligence is often imprecise. In part, courts go about deciding what it means by asking if a defendant has met the accepted standards of the relevant industry. For the chemical industry, it is highly probable that the courts will look to Responsible Care as a standard not only for Responsible Care members, but also for other chemical companies. Thus, Responsible Care and due diligence are mutually reinforcing: due diligence becomes more precisely defined as a result of the Responsible Care codes, and the Responsible Care codes become enforceable through due diligence. The authors thus try to address simplistic evaluations of voluntary initiatives, such as the codes of practice under Responsible Care, seen as only voluntary measures which are of guidance to Responsible Care members and of no consequence whatsoever to nonmembers. The authors argue that they are important in indirectly shaping the regulatory environment, and in influencing the firm’s perceptions of it.800 Along the same lines, Meidinger wrote regarding the Forest Stewardship Council’s timber certification scheme (FSC) that the environmental effects of the FSC as a free standing voluntary system is likely to be positive but modest. However there are dynamics with the capacity to amplify the effects of the FSC programme, such as incorporation into traditional legal systems. “Although this could occur through the formal adoption of FSC standards or requirements by either legislatures or administrative agencies, not many legal systems seem likely to take this route in the near term. However, incorporation can also occur through the informal, often almost invisible adoption of FSC requirements into existing legal regimes. These include the definition of best management practices in administrative regulation, tort law, financial reporting, and so on.”801

Suchman and Edelman noted: “Courts frequently measure compliance against ‘industry standards‘ or ‘business necessity’ or ‘the limits of current technology,’ and all these yardsticks, in one way or another, embody the institutionalized 799

K. Webb and A. Morrison, ‘Voluntary Approaches, the Environment and the Law: A Canadian Perspective’, in C. Carraro and F. Leveque (eds.), Voluntary Approaches in Environmental Policy (Kluwer Academic, Dordrecht/London, 1999) p. 247. (emphasis added) 800 N. Gunningham and P. Grabovsky, Smart Regulation – Designing Environmental Policy, (Clarendon Press, Oxford, 1998) pp. 258, 259. 801 E. E. Meidinger, ‘“Private” Environmental Regulation, Human Rights, and Community’, 7 Buffalo Environmental Law Journal (Spring 2000) p. 166, <www.law.buffalo.edu/homepage/ eemeid/scholarship/hrec.pdf>, visited on 14 February 2007. (emphasis added)

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Policies and laws relevant to CSR expectations of the organizations supposedly being regulated. Further, courts almost never formulate potential solutions sua sponte; judicial opinions may identify which existing responses are acceptable and which are not, but judges rarely demand new options that did not appear previously somewhere within the target population. Thus, the demands of the law can never be entirely separated from the processes by which particular organizations define for themselves what is possible, normal, and desirable.”802

Muchlinski has evaluated the practices of transnational business groups and suggested that “[the] significant issue may not be so much how a business association organizes its internal operations, but how it endeavours to influence the external legal environment that affects the markets in which it operates … The more powerful the market actor the more likely it is to generate the generally accepted commercial customs of that market, perhaps to go further and to enshrine those customs into standard form contracts, and, at the highest level of influence, to persuade courts and legislatures to give official legal sanction to those customs through recognition in case law and/or codification through statute.” 803

A report discussing environmental ‘due diligence’ – the defendant had taken reasonable precautions to prevent the offense – notes that due diligence is surprisingly difficult to define, especially for larger, more complex businesses. “The most definite thing that can be said is that the individual circumstances play a large role. The care warranted in each case is principally governed by the likelihood of harm, the gravity of it, the available alternatives, the skill required, and the extent [to which] the accused could control the causal elements of the offense.”804 In these conditions, the authors highlight two modalities to enhance clarity in the ‘due diligence’ area. One is to lay down a substantive benchmark that would specify the concrete solution to each problem; the other is to define a process benchmark specifying requirements for an effective management system. “In practice, it has proved as difficult for the regulated community as for regulators and courts to determine exactly how much diligence is enough. Due to the huge variability of pollution control problems and the need to encourage innovation and pollution prevention, it is not possible to set a benchmark for due diligence which consists of an exhaustive set of concrete solutions to problems. An alternative approach to due diligence 802

M. C. Suchman and L. B. Edelman, ‘Legal Rational Myths: The New Institutionalism and the Law and Society Tradition’, 21 Law and Social Inquiry (Autumn 1996) p. 939. (reference omitted) 803 P. M. Muchlinski, ‘“Global Bukowina” Examined: Viewing the Multinational Enterprise as a Transnational Law-Making Community’, in G. Teubner (ed.), Global Law without a State (Dartmouth, Aldershot, 1997) p. 80. (emphasis added) 804 Commission for Environmental Cooperation, supra note 791, p. 13.

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Chapter 5 with a global application in a wide variety of situations is an attentive and responsive system of management. This is borne out by the fact that many incidents involving health and safety issues have been attributed to poor or inadequate management strategies or systems … [In the area of coal mine safety] a small number of organizational defects were characteristic of most of the disasters in which five or more miners died: poor or no planning to deal with hazards, a general pattern of sloppiness in safety matters, poor internal communication, inadequate staff training and inadequate definition of responsibilities. Similar defects in management systems are also characteristic of many environmental cases.”805

*** This chapter took notice of various regulatory regimes which employ both soft and hard law. However, the mere existence of hard law does not mean that a purely deterrent mechanism to influence corporate behaviour is at work. The picture is more complex. Thus the law may deter misbehaviour through sanctions, as in the case of tort laws, but the precise standard of culpability is not clearly specified: nonlegal considerations, factual circumstances of the case and practices of the industry weigh heavily. Thus legal deterence is mediated by various factors. In other instances, the law seeks through deterrence or incentives to enforce sound procedures within a corporate group. However, sound procedures do not guarantee improved performance and compliance with law’s objectives. A sense of responsibility is needed to prevent unproductive ‘paper compliance’ and to make hard law effective. Still in another case, that of transparency regulations, there is no legal deterrence at all. The fact that law requires some information to be made public does not in itself require a change in corporate performance. Only if actors with leverage on the company act on the information will deterrence, private deterrence, be a factor. Furthermore, private actors may be unable to exert deterrence and a more subtle influencing mechanism will be at work. Here, as in the previous cases, the effects of law are mediated by non-legal factors. Finally, hard law may establish a needed infrastructure for compliance, as with labelling schemes, but participation is wholly voluntary. Thus private actors and the markets provide the incentives to join, not the lawmakers. What the next chapter aims to do is to draw on the regulatory examples contained in this chapter to explain the actual mechanism of change. Is deterrence public or private? Is it deterrence or other less constraining forces at work? How do flexible legal standards get better specified? How do hard law and soft law combine to obtain precise codification and reliable enforcement in complex situations? How does law and policy interact with new CSR benchmarks and expertise? These questions are topical for CSR proposals that aim to institutionalise the emerging CSR regime and to scale-up the impacts of CSR. An 805

Ibid., p. 65. (emphasis added)

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Policies and laws relevant to CSR analysis of the mediating elements between law and compliance can help understand the value and effects of CSR, and articulate a legal perspective on CSR.

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CHAPTER 6 INCREMENTAL INSTITUTIONALISATION OF CSR REGIME The ‘business and human rights’ literature usually proposes the adoption of laws that assign liability to businesses for harms produced. We refer to such regulatory strategies as ‘pure deterrence’ laws; they exhibit a simple causality between law and corporate compliance. The analysis in this chapter builds an understanding on promoting compliance that is alternative to models of deterrence based solely on public regulation and public enforcement; the causality is complex and a range of intermediary variables are at work. To facilitate the presentation of an alternative regulatory strategy we analyse the laws presented in chapter 5. The material presented therein shows that states seek corporate compliance by employing various instruments besides pure deterrence laws: some can use deterrence while others have no relation to deterrence whatsoever. Thus law can operate in a deterrent mode, but instead of simply holding the company liable for harms produced, the law either targets private actors with the expectation that they will deter or influence the company, or opens the corporate ‘black box’ and regulates internal structures and processes within the target company. In neither of these cases does law deter the company by imposing liability for outcomes. Law can also act in a non-deterrent mode as when it provides incentives for compliance, when it facilitates compliance by structuring the exchanges the company has with its stakeholders, or when it clarifies previously ill-defined or misunderstood legal expectations. Also in a nondeterrent mode states adopt policies that can activate various variables (within the company or in its environment) that are linked to compliance. This analysis allows for a discussion of the interaction between CSR and state action within the emerging CSR regime. 6.1. MAKING SENSE OF PROCEDURAL REGULATIONS The aim here is to discuss a range of instruments which, although they are legally binding, cannot function independently of various private actors. The role of these private actors in the regulatory regime will be discussed as well as the discretion that law deliberately leaves to private actors. Various bodies of law have accumulated experience in how to handle this discretion, what are the potential solutions and their limitations. 6.1.1. Reporting regulations First, the regulatory approach based on disclosure automatically involves both private and public enforcement. Lawmakers create the necessary incentive for all 245

Chapter 6 companies to issue reports. Reporting in itself does not require any change in managerial policy or goals. States do not require certain substantive outcomes but lay down procedural requirements for companies to issue reports. It will be private enforcement acting on the information disclosed that will alter corporate policy. Thus disclosure regulations summon the private enforcement potential of various actors. Bernard Black has pointed out that formal disclosure rules, by themselves, do not make for a strong securities market. The harder task, he notes, is enforcing the rules, and that includes “both direct public enforcement and indirect enforcement through reputational intermediaries, securities analysts, the financial press, and other market institutions”.806 A report noted the wider implications of codes of corporate governance, backed by disclosure regulations: “Even though compliance with substantive code provisions is wholly voluntary, reputational and market forces, together with heightened disclosure, can result in significant compliance pressures, depending on the status of the issuing body, and the degree of information on compliance available to the market. Moreover, the exercise of establishing a code helps focus the attention of companies and investors on governance issues. Codes have proven highly effective in stimulating discussion of corporate governance issues. They help educate the general public and investors about governance-related legal requirements and common corporate governance practices. They may also assist to prepare the ground for changes in securities regulation and company law, where such changes are deemed necessary. Moreover, codes are increasingly being used by investors and market analysts and commentators to benchmark supervisory and management bodies.” 807

Second, in addition to jump-starting corporate transparency, lawmakers can also need to identify issues to be disclosed. As the regulations examined in this chapter reveal, states can be more or less specific on what should be reported. A cursory reading of these regulations highlights a continuum from the high specificity of environmental disclosures (e.g. TRI) to a detailed list of items to be addressed in reports (e.g. New Economic Regulations in France) to very general requirements about how a business takes into account its social and environmental impacts (e.g. SRI regulations). This point about the specificity of law is crucial for understanding the interaction between public and private codification, between legal command and corporate discretion.

806

Quoted in J. W. Hicks, ‘Harmonization of Disclosure Standards for Cross-Border Share offerings: Approaching an “International Passport” to Capital Markets?’ 9 Indiana Journal of Global Legal Studies (Summer 2002) pp. 378, 379. 807 Weil, Gotshal & Manges LLP, Comparative Study of Corporate Governance Codes Relevant to the European Union and Its Member States, Final Report & Annexes I–III, 2002, p. 68 <europa.eu.int/comm/internal_market/company/docs/corpgov/corp-gov-codes-rpt-part1 _en.pdf>, visited on 14 February 2007.

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Incremental institutionalisation of CSR regime In the environmental area, disclosure regulations have contained precise, quantifiable requirements and relied on private enforcement. There seems to be agreement among parties on all sides of the toxics debate – from chemical manufacturers to regulators to environmentalists – that this regulatory strategy has been successful.808 The government has simply provided a list with the environmental pollutants that companies must report on. Such is the case of the US Toxic Release Inventory (TRI) which provides raw data to the public. The TRI is explicit in its aim to empower citizens while the Aarhus Convention similarly aims to enable consumers. PROPER in Indonesia provides refined data to the public with the government ranking companies and communicating visually in five colours corporate environmental performance. Regarding their effects it was noted: “Both EcoWatch in Philippines and PROPER in Indonesia have shown that public disclosure can have a strong impact even where formal regulation is weak, because it enlists social norms and market forces in pressuring polluters to clean up. Public information programs carry the extra benefit of generating political support for pollution control, by educating communities and raising the credibility of environmental agencies.”809 In the US, the Lawyers Committee for Human Rights has found inspiration in the TRI and has drafted the ‘International Right to Know Act’. This would require broader social disclosures from TNCs: “The International Right to Know would require U.S. corporations and foreign multinationals that sell securities in the U.S. to disclose crucial information about their labor, environmental and human rights practices abroad to several U.S. agencies, which would publish this information on the Internet.”810 The authors expressly build on the success of domestic right to know environmental legislation – the Emergency Planning and Community Right to Know Act of 1986 – to which TRI belongs. The UK SRI regulation mandates disclosure of a very vague kind. It asks no more than that pension funds disclose the extent (if at all) to which they take into account social, environmental or ethical considerations in the pursuit of their investment policies. As a report has noted, the law “does not require any SRI action, give any definition or clarification of these terms, and critically, does not require any proof that the stated policy is in fact being carried out, or that the stated policy is not misleading pension members”.811 Another report wrote:

808

D. O’Rourke, World Bank, Opportunities and Obstacles for Corporate Social Responsibility Reporting in Developing Countries, 2004, , visited on 14 February 2007. 809 World Bank, Greening Industry: New Roles for Communities, Markets and Governments, 2000 Chapter 3, <www.worldbank.org/research/greening/TableofContentsnew.html>, visited on 14 February 2007. 810 Human Rights First (formerly Lawyers Committee for Human Rights), International Right to Know Act, undated document, <www.lchr.org/workers_rights/wr_intl_rkc/wr_intl_rkc _01.htm>, visited on 14 February 2007. 811 Mathieu, supra note 644, p. 5.

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Chapter 6 “A majority of the jurisdictions have legislated (or are expected to do so shortly) to require investment decision-makers, particularly in the pensions context, to disclose the extent to which they take ESG considerations into account (see table below). Such legislative endorsement of the relevance of ESG considerations to investment decision-making constitutes an important additional factor in favour of the view that decision-makers must have regard to ESG considerations at some level, even if they are ultimately given little or no weight.”812

Third, although states have required increased corporate transparency they also allowed companies to opt-out altogether under certain conditions. These ‘opt-out’ clauses themselves can be stricter as with the ‘comply or explain’ approach or more permissive as when directors have to expressly clarify without explanation that certain information has not been included in the report. In this way regulators help the reader of corporate reports and draw his/her attention to what is missing from reports. Codes of corporate governance (soft law) coupled with various types of disclosure regulations have been widely employed in the British corporate governance system, and increasingly throughout the EU. This strategy can properly be explained as allowing opting-out, but also creating some special opting-out procedures. The Company Law Review Steering Group comments on the philosophy behind the ‘comply or explain’ approach: “We regard the present structure of the Combined Code, relying on disclosure of a ‘comply or explain’ type, as powerful and entirely consonant with our overall philosophy of relying, so far as possible, on effective transparency and market responses.” 813 Further the UK Group emphasises the role of institutions which are close to market conditions: “The structure we propose is thus designed to provide a regime which ensures that constraints and expectations laid upon companies with regard to their governance, operation and control are tested and validated through institutions which are consultative and close to market conditions, responsive to changing needs, as light in terms of intervention as possible and based on generally accepted perceptions of best practice.”814

Australia has adopted regulations of pension funds modelled after the British law. The Australian Securities & Investments Commission (ASIC) has issued guidelines and has deliberately adopted a principle-based approach, which does specify neither the labour or environmental standards nor the methodologies that should be used. However the ASIC guidelines require investment funds to disclose which of these standards and how they are taken into account. If no attention is paid to CSR considerations this must be disclosed. If no predetermined approach is used in handling CSR issues this must also be clearly stated. Thus, similar to the British 812

Freshfields Bruckhaus Deringer, supra note 87, p. 11. Company Law Review Steering Group, supra note 65, para. 3.63. 814 Ibid., para. 3.65. 813

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Incremental institutionalisation of CSR regime company law regarding the Business Review, disparate transparency requirements are set up to facilitate communication with stakeholders. In the UK, company laws now require directors to report on several issues relevant to CSR. The Business Review is not however a mandatory CSR report as information should be released only ‘to the extent necessary’ to allow shareholders understand how directors fulfil their legal duty to promote the success of the company. This threshold of materiality offers indeed an ‘opt-out’ clause. The only condition imposed under the law is that directors must explicitly state which of those kinds of information enumerated in the law their report does not contain. Directors are not required to explain how they have arrived at their decision, although under initial plans there was a ‘comply or explain’ provision, which was later abandoned. It appears that states create a multi-layered procedural regime around corporate reports. There are cases when policymakers create certification schemes that allow companies to credibly communicate their social or environmental credentials. This is the case of the EMAS or the Belgium social labelling scheme. It is up to each company whether to join or not, but for those that join there are legal requirements (substantive and/or procedural) and legal sanctions for non-compliance. These schemes are voluntary; so instead of having ‘opt-out’ clauses there are ‘opt-in’ conditions. The EU’s Eco-Management and Audit (EMAS) scheme makes participation in the scheme voluntary. EMAS encourages member states to adopt incentives, but itself concentrates on identifying benchmarks of best practice and creating the infrastructure to verify compliance with the scheme and thus safeguard EMAS’ and participating companies’ credibility. This regulatory approach has been considered as ‘optional regulation’: “The highest grade of influence public institutions exert in developing the contents of voluntary approaches is given in the case of public voluntary schemes. Public voluntary schemes can be defined as programmes “devised by the environmental agency and in which individual firms are invited to participate. Since participation in the voluntary programme is a choice left to individual companies, they can be seen as ‘optional regulations’. Examples are the US programme 33/50 or the Ecomanagement and Auditing Scheme (EMAS).”815

EMAS has also been seen as ‘risk-based regulation’ that may target poor performers and allow for a more efficient use of regulatory resources. EMAS asks member states to consider EMAS registration “in the implementation and enforcement of environmental legislation in order to avoid unnecessary duplication of effort by both organizations and competent enforcement authorities”.816 ‘Risk-based regulation’ allows for a more efficient use of regulatory resources: it reduces the regulatory 815

CERNA, CAVA – Concerted Action on Voluntary Approaches, International Policy Workshop on the Use of Voluntary Approaches, 2001, p. 15, <www.cerna.ensmp.fr/Prog europeens/CAVA/PolicyBrief.pdf>, visited on 14 February 2007. 816 Council Regulation (EC) No. 761/2001, supra note 330, Article 10,

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Chapter 6 resources to ‘better’ sites and targets the monitoring and enforcement effort on sites with inferior performance.817 The ‘social label law’ in Belgium is also a voluntary scheme. The law does not compel a business to seek certification; it is up to businesses themselves to assess the actual market demand for ethically-produced goods. The law does not create incentives through deterrence; it simply assumes that market demand generates the main incentive and proceeds to facilitate market processes by structuring and making credible the whole certification process. The law actively discourages freeriders and deters them from cheating through fines and prison terms. Here public authorities comprehensively identify the standards that cover the area of interest without affording companies a ‘pick and choose’ approach, and regulate the assurance processes for enhanced credibility. The codification is largely driven by public authorities. The enforcement however is not: regulators rely fundamentally on private enforcement. Thus the government lays down the substantive standards and provides public enforcement against free-riders. 6.1.2. Regulations referring to management systems Transparency laws exhibit a mixture of public enforcement of reporting requirements with the private enforcement carried out by actors with leverage on the business. This section refers to a different kind of regulations: those that refer to the adoption of internal management systems. In this case there is a mix of public enforcement with the self-regulatory potential of the business group itself. The difference in strategy lies with having states mobilise the private enforcement in different zones: inside the corporate group itself as opposed to the network of private actors surrounding the business group. This type of private enforcement is less obvious as MNEs can be simply seen as unitary actors liable as a whole for human rights violations; to be precise here we refer to the private enforcement carried out by the controlling entity (i.e. parent company in North or large subsidiary in South) over its business partners in developing countries. The regulations surveyed show that although it is the law that refers to management systems and the public authorities that provide enforcement, law most often limits itself to creating incentives to adopt managerial systems rather than mandate the adoption of such systems. Lawmakers have identified in some detail the elements that make a managerial system effective. However law reveals an explicit flexibility in defining effectiveness. For example, the Sentencing Guidelines refer to the threshold when a system is deemed ineffective: “Such compliance and ethics program shall be reasonably designed, implemented, and enforced so that the program is generally effective in preventing and detecting criminal conduct. The failure to prevent or 817

K. Dahlström et al., ‘Environmental Management Systems and Company Performance: Assessing the Case for Extending Risk-Based Regulation’, 13:4 European Environment (2003) p. 188 <www.environmental-expert.com/articles/article1378/1378.pdf>, visited on 14 February 2007.

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Incremental institutionalisation of CSR regime detect the instant offense does not necessarily mean that the program is not generally effective in preventing and detecting criminal conduct.” 818 Codification of corporate management systems is a rather recent development for the regulatory community. Below we refer to the advantages and drawbacks that come with lawmakers devising regulatory frameworks that open the corporate ‘black box’ and regulate internal processes and structures instead of simply setting desirable outcomes backed by legal liability. Advantages stem from enrolling the private regulatory potential of the parent company and business group to target more effectively subsidiaries and contractors. From a regulatory agency’s perspective the existence of systematised procedures (effective management systems) creates a number of benefits. Due diligence systems save the regulator’s resources (they speed up inspection and reduce its costs) as inspectors verify the system itself rather than the sites; can generate improvements beyond compliance with the law; operationalise vague and general policy objectives; provide a means to make progress in complex and dynamic environments, as outcomes expected from the business (parent company) are not easy to specify from the outset; and have a significant impact in a weak enforcement regime common in developing countries. A report assessing experience with environmental management systems (EMSs) notes that “Advocates argue that an EMS provides both environmental and economic benefits, to the public as well as to the user organization. A facility with an EMS, they argue, can demonstrate more reliable performance and compliance, can document its reporting requirements more efficiently and thus be inspected more quickly, and will have procedures for more consistently reducing the frequency of accidents, spills, and other environmentally damaging events. It may also identify more opportunities to improve its environmental performance beyond compliance, and to reduce unregulated environmental impacts such as energy and water use. It thus reduces its own cost and liability as well as environmental impacts and risks to its surrounding community. At the same time, it reduces government’s inspection and enforcement costs, allowing government to redirect scarce regulatory resources toward higher risk facilities.”819

Bohle and Quinlan observe a regulatory shift toward management systems (MSs) in the Occupational Health and Safety area. They write that MSs provide a means for managing complex and dynamic work environments. MSs also enable agencies to make better use of their limited resources by enabling them to audit the system 818

United States Sentencing Commission, supra note 697, para. 8B2.1(a). (emphasis added) The National Database on Environmental Management, Environmental Management Systems: Do They Improve Performance?, Final Report – Executive Summary, University of North Carolina at Chapel Hill, 2003, p. 1, <www.c2e2.org/documents/complete executivesummary.pdf>, visited on 14 February 2007. 819

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Chapter 6 rather than the entire workplace, as well as targeting employers who eschew using a systems approach.820 The ISO notes the desirability of a ‘system approach’ to promoting CSR: “Given the range of different opinions on what is exactly covered by SR and what are acceptable performance levels related to SR issues such as environmental protection, healthy working conditions, fair wages etcetera, a system approach could be one alternative for organizations to manage their activities in a sound way to maximize societal benefits and minimize negative social, financial and ecological impacts. Processes related to, and being part of, such a system approach might also be subject to standards/guidelines (providing good/best practice), such as stakeholder identification, consultation and involvement, monitoring and assessing results, reporting, identification and assessment of SR issues.” 821

From a regulatory agency’s perspective the existence of systematised procedures (effective management systems) can also create a number of drawbacks. Laying down procedures, as opposed to substantive targets to be reached, is no guarantee for compliance. In connection with this, retreating from stringent command-andcontrol regulation to assess compliance in relation to management systems is troublesome. There are clear dangers of paper compliance. Linked to this is the undermining of rationality in organisations as they may pursue externally-approved templates even though these are counterproductive to the very goals they are meant to achieve. Observers also note the tendency of procedural assessments to depoliticise. In the context of the developed world, there has been a debate about whether regulators should use management systems as substitutes for command-and-control regulation, that is, as a base for regulatory relief. The EMAS regulation is explicit about such a possibility. This raises the possibility of backsliding as the focus moves from outcomes to procedures. A study refers to surveys undertaken by the Swedish environmental protection agency, which concluded that “[T]here is at present too little experience with these systems to warrant any regulatory relief. While the systems may in the long term improve the environmental and regulatory performance of companies, there is no substantial evidence for this as yet, and their implementation is found to require more rather than less regulatory effort, as a substantial amount of advice and written guidance is needed from authorities in the setting up of these systems.”822

820

P. Bohle and M Quinlan, Managing Occupational Health and Safety: A Multidisciplinary Approach, 2nd ed. (Macmillan, South Yarra, 2000) p. 299. 821 ISO Advisory Group on Social Responsibility, supra note 303, para. 299. (emphasis added) 822 Dahlström, supra note 817, p. 197.

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Incremental institutionalisation of CSR regime However, while this holds true for the highly-regulated context of developed countries, the value of management systems in moving businesses towards compliance is higher in a regulatory context characterised by weak enforcement. Thus the same study notes “In the context of relatively weak enforcement, it is perhaps unsurprising that an EMS would have a more significant impact [than in developed countries] on compliance levels. Dasgupta et al. (2000) assessed a range of different factors on enhanced compliance levels and found that the presence of ISO 14001-type systems had the strongest independent impact of all variables examined. However, this work referred to industry in Mexico, where the regulatory context is very different from that in the UK and parts of Europe.”823

The business and human rights area is in its early stages of regulation: it can certainly be considered a weak enforcement context. The presentation of procedural regulations in this study should not be taken as a suggestion that companies should subjected only to procedural regulation instead of more stringent laws imposing liability for harms. Regulators in the host country have to adopt substantive regulations to protect human rights, and there is place for strategies to promote the use of management systems. This study however is concerned with transnational CSR and with ways of influencing the parent companies by their home states. The argument about the CSR of the parent company seems not confronted with a severe problem of backsliding from existent stringent regulations, as is the case in developed countries, because the regulation of corporate groups regarding human rights in developing countries is undeveloped. In this context, a regulatory and policy focus on management systems can deliver important compliance gains. Wood addresses a downside of environmental management systems (EMSs), that is their ‘tendency to technicalise’, which arises from the move to neutral technical expertise and private market transactions. He puts EMSs in a broader context: “EMSs and EMS standards instantiate a broader tendency in contemporary practices of government in the advanced industrial democracies to ‘depoliticize’ certain issues and problems by positioning them either as technical matters to be resolved by the application of neutral expertise or as private matters to be resolved by market forces … By transforming debates over justice, poverty, racism, ecological integrity, animal rights, the intrinsic value of nature, and so on, into matters of managerial expertise and market preference, these technologies both enable relations of inequality and repression to be perpetuated and disguise their own role in that perpetuation…”824

823 824

Ibid., p. 197. Wood, supra note 321, p. 198.

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Chapter 6 Wood suggests that some form of ‘smart regulation’, relying on a mix of state and non-state actors and regulatory tools is appropriate but that a key challenge will be to resist the tendency to ‘depoliticise’. To correct these problems one needs to open spaces for resistance to the depoliticising tendencies: “EMSs can be a very useful tool for organizations internally and in their relations with business partners and market participants, but many (including ISO 14001-based EMSs) provide inadequate guarantees of public consultation and accountability, environmental performance and legal compliance to merit giving them any particular weight in nonmarket relations with governments and the public. Legal tools and strategies should be designed, at a minimum, to insist on these basic public stakes when rewarding or relying on them in state regulatory instruments…” 825

Webb Kernaghan, who has been actively engaged in the shaping of the forthcoming ISO 26000 standard on CSR management, answered Wood’s criticism: “While this muting of significant political issues and perpetuating of inequalities is a distinct possibility – particularly where civil society and governments have no opportunity to meaningfully participate in code development and implementation – an equally plausible scenario is that voluntary codes can act to operationalize vague and general policy objectives, thus providing all parties with practical guidance on how to structure potentially harmful activities and behaviours, in the process moving discussions from high-level policy rhetoric and slogans to more mundane, nitty-gritty action.”826

A brief presentation of the dynamics present in American affirmative action law can place in a historic context the explanation of regulatory strategies that lay down procedural requirements. There are striking parallels with the institutionalisation of CSR (particularly the positive corporate obligations) at international level. Edelman analysed equal employment opportunity laws in the US following the enactment of the Civil Rights Act (1964). He referred to the resulting regulatory framework as following: “(1) [I]t is ambiguous with respect to the meaning of compliance; (2) as construed by the courts, it constrains organizational procedures more than the outcome of those procedures; and (3) its enforcement mechanisms are relatively weak. Each of these characteristics broadens the scope of organizational behaviors that may be considered compliant.”827 In this context, another study remarks that “the effects of US policy on organizations are interesting precisely because 825

Ibid., p. 209, 210. K. Webb, ‘Understanding the Voluntary Codes Phenomenon’ in K. Webb (ed.), Voluntary Codes – Private Governance, the Public Interest and Innovation, Carleton Research Unit for Innovation, 2002, pp. 14, 15, <www.carleton.ca/spa/VolCode/Volcode.htm>, visited on 14 February 2007. 827 L. B. Edelman, ‘Legal Ambiguity and Symbolic Structures: Organizational Mediation of Civil Rights Law,’ 97 American Journal of Sociology (May 1992) p. 1536. 826

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Incremental institutionalisation of CSR regime compliance mechanisms are often worked out between organizations and the state”.828 Edelman notes that the only tangible requirements of the Civil Rights Act cover reporting on workforce, which do in and of themselves necessitate any change in employment policies or practices.829 Subsequent regulation requires organisations to undertake a ‘utilisation analysis’ to determine whether there is underrepresentation of minorities and women in certain work categories and to establish specific ‘goals and timetables’ to remedy any deficiencies found through utilisation analysis. Regulators further clarify that “goals may not be rigid and inflexible quotas which must be met, but must be targets reasonably attainable by means of applying every good faith effort to make all aspects of the affirmative action program work”.830 Additional specification comes from the following provision: “[N]o contractor’s compliance status shall be judged alone by whether or not it reaches its goals and meets its timetables. Rather, each contractor’s compliance posture shall be reviewed and determined by reviewing the contents of its program, the extent of its adherence to this program, and its good faith efforts to make its program work toward the realization of the program’s goals within the timetables set for completion.”831 Such laws “leave more room for organizational mediation than laws that are more specific, substantive, and backed by stronger enforcement”. 832 Edelman writes: “Laws that regulate the employment relation tend to set forth broad and often ambiguous principles that give organizations wide latitude to construct the meaning of compliance in a way that responds to both environmental demands and managerial interests. Organizations respond initially by elaborating their formal structures to create visible symbols of compliance. As organizations construct and institutionalize forms of compliance with laws, they mediate the impact of those laws on society.”833 These laws “set in motion a process of definition during which organizations test and collectively construct the form and boundaries of compliance in a way that meets legal demands yet preserves managerial interests”. 834 Dobbin and his colleagues refer in the same context to an “iterative process in which the state creates broad rules about corporate behaviour and then organizations experiment to find practical strategies that will be acceptable to the courts”.835 While America’s ‘weak’ federal state seldom dictates behaviour to private actors and “the creation of compliance mechanisms is iterative and haphazard…, the mechanisms

828

Dobbin et al., ‘Equal Opportunity Law and the Construction of Internal Labor Markets’, 99 American Journal of Sociology (1994) p. 401. 829 Civil Rights Act, 1964, Title VII. 830 Executive Order 11 246 (1965) and subsequent Orders, quoted in Edelman, supra note 827, pp. 1537, 8. (emphasis added) 831 Ibid., p. 1539. 832 Edelman, supra note 827, p. 1531. 833 Ibid. 834 Ibid., p. 1532. 835 Dobbin, supra note 828, p. 397.

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Chapter 6 that emerge from this process become powerful institutional models, not unlike the solutions directly mandated by ‘strong’ states”.836 For Edelman “[e]qual employment opportunity/affirmative action law influences the legal environment by changing public expectations about employees’ civil rights and providing a basis for criticizing well ingrained patterns of governance that favor whites and males”.837 The danger of ‘paper compliance’ exists as with any procedural regulations. Edelman emphasises the symbolic function of structural changes that can serve as a defence for adopting organisations, even if their effectiveness is doubtful: “[I]f sued, organizations can point to the structural changes as evidence of the non-discriminatory nature of their policies and practices. While failure to look compliant is unlikely to result in an organization’s demise, it does carry an increased risk of legal liability and social disapproval.”838 Thus structural change may be a means of achieving real improvements; affirmative action structures that are ineffective and rules that are repeatedly violated are open to challenge.839 6.1.3. Negligence under tort law The analysis of the law of negligence differs from the two types of procedural regulations previously discussed in some important respects. The duty of care exists in law, and it is courts of law that enforce it (public enforcement). The law operates in a ‘pure deterrence‘ mode favoured in business and human rights law-oriented writings. The causality between legal command and corporate behaviour appears rather straightforward in this case. At a second look the picture changes. Courts assign liability not by a simplistic application of legal principles but take into account numerous factual circumstances and policy considerations. Courts also allow defences based on sound managerial systems which are used as evidence that the defendant exhibited reasonable care and thus cannot be held liable. So even in the case of tort law, the procedural aspects discussed above (i.e. due diligence benchmarks) enter the picture as do several variables that intermediate between legal command and corporate behaviour. The existence and scope of the duty of care are affected by considerations of policy and factual circumstances – both of them being non-legal concepts. Courts do not manage to avoid such matters – also poignant in the CSR discussion – although they are supposed to find guidance in legal precedents and legal principles. In the law of negligence, as in CSR, things are not clear-cut but subject to social choice and clarification. A balancing act is unavoidable; as Cane wrote, the protected interests in tort are those of plaintiffs, but also those of defendants and wider social interests, because tort law is a publicly enforceable set of ethical rules and principles of personal responsibility. This balancing act does not deny the importance of 836

Ibid. Edelman, supra note 827, p. 1535. 838 Ibid., p. 1542. 839 Ibid., p. 1543 . 837

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Incremental institutionalisation of CSR regime victim’s interest, but affects the scope of tort liability.840 The role of factual and policy considerations weigh heavier when liability for omissions is sought as such liability is exceptional in tort law and proximity is harder to establish due to the geographical spread and complexity of operations of the business group. But in principle the parent company may be held liable in negligence for both its actions and its inactions. CSR, as a voluntary application of good business practices, cannot by itself impose a duty of care on indifferent companies. But corporate voluntarism influences the policy environment surrounding the making of the duty of care. In this environment there are diverse arenas for pursuing accountability. Legislating such an explicit positive obligation of parent companies to use due diligence is a possibility, maybe a bit remote at this time. Judicial application of tort law principles is a more likely development. But even now such a duty is on the way of being de facto established through private regulation and enforcement. Companies may need to adopt procedures to prove to investors that due diligence is used in managing new types of risks. Investors interested in benchmarking a company against its peers can rely on CSR practices existing in that respective industry. As it happens in the ‘grey zone’ where the interests of shareholders and stakeholders overlap, effective compliance systems set up in a TNC fulfil both the duty of care directors owe to shareholders and the emerging duty of care the parent company might owe to stakeholders in the South. The very existence of engagement fora and management tools impacts on the definition of ‘reasonable’ conduct. What was considered reasonable prior to the aforementioned CSR developments may become unreasonable once the CSR infrastructure exists and is viable. The disregard of standardised procedures may lead to charges of negligence; conversely following standardised procedures offer management the protection of having acted ‘reasonably carefully’ even if harm occurred. With the availability of CSR management templates, corporate defences based on practical grounds – blameless ignorance, high implementation costs, absence of a workable consensus on what good CSR practices are – can become less persuasive in courts of law and in other accountability fora. This puts in perspective the importance of the practices of leading businesses as well as multistakeholder efforts to systematise (standardise) the various stages of the management of CSR. The existence of due diligence benchmarks facilitates private enforcement. But how does this affect the flexible concepts in the neighbourhood test that courts of law apply? In other words, how is public enforcement affected? Following standardised managerial templates can be used as a defence to counter accusations of negligence as stakeholders can seek to establish both personal and corporate liability for injuries. There is a growing awareness to the indirect effects of corporate voluntarism that manifest themselves in the interaction between CSR and law at the level of ‘reasonable care’. For example, one study looks, for the purpose of evaluating a particular voluntary mechanism, at “what is the impact [of 840

Cane, supra note 776, pp. 66, 91 and 201.

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Chapter 6 voluntary initiatives] on the standard of care for the regulated industry (the issue of due diligence)… Part of the task of promoting voluntary compliance is therefore the necessity of defining due diligence as a concept.”841 Following authoritative procedures can offer a defence of due diligence when injuries occur thus sheltering the defendant from liability. The CSR movement has been developing standards and guidelines of good managerial practice; reliance on them offers a defence that proactive companies can use against charges of negligence made in courts or elsewhere. The availability of this defence can be an incentive for businesses to apply CSR good practices as it offers protection against unrealistic expectations or ideological attacks. For illustration, Freeman and Uriz link the Voluntary Principles on Security and Human Rights with assessments of due diligence. They consider that a company endorsing the Voluntary Principles may be a factor to be taken into account by the court. A company implementing the Principles demonstrates that it has applied a high standard of due diligence to avoid commission of human rights abuses in its operations. This possibility may depend on credible reporting of implementation efforts coupled with informal NGO monitoring or possibly even third-party verification.842 The analysis of tort law highlighted that the concepts of proximity, reasonableness of foresight and fairness (fair, just and reasonable for the law to impose a duty) are subjective concepts not susceptible to precise definitions.843 The CSR movement has accumulated an understanding of impacts business groups have, about the type of issues that affect an industry, issues that vary from one industry to another, and from one country to another. There are also guidance and standards available for reasonably diligent managers to keep themselves informed and how to manage CSR. The growing body of CSR tools and expertise make it feasible and less costly for a company to ascertain and manage human rights risks. The fact that leading companies have already ‘road-tested’ CSR tools could also influence the determination within negligence analysis of what is ‘reasonable’ and what is ‘foreseeable’. Courts or policy-makers could reinterpret elements in the ‘neighbourhood test’ in light of present day circumstances. Thus the duty of care could theoretically be expanded to cover transnational torts (torts of omission by parent company) by using these flexible concepts. Foresight of consequences that a reasonable person should have is the most relevant element for the CSR argument made herein; advancing CSR as an issue of ‘foreseeability’ is distinct from and less value-laden than raising CSR as an issue of ‘fairness’, which globalisation-related discussions have predominantly emphasised. However, the experience of British law in the 1970s is instructive here and tempers somehow the enthusiasm regarding the potential of public enforcement.

841

Commission for Environmental Cooperation, supra note 791, p. 13. B. Freeman and G. H. Uriz, ‘Managing Risk and Building Trust – The Challenge of Implementing the Voluntary Principles on Security and Human Rights’, in Sullivan, supra note 19, p. 257. 843 Jackson, supra note 775, pp. 18, 20 and 23. 842

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Incremental institutionalisation of CSR regime During that period British courts were leaning toward elevating forseeability into an all-embracing test for negligence liability. Reasonable contemplation that carelessness may cause damage would generate a prima facie duty of care. This formula was applied mainly in cases of omissions to prevent a third party to harm another. Howarth refers to “the extraordinary mess the law of negligence fell into in the 1970s as a result of taking foreseeability too seriously... That idea had the effect of suggesting that there should be a massive extension of liability into cases involving foreseeable interventions… the mere fact that harm to another person was foreseeable somehow created a duty of care.” 844 The problem with that proposition was that, even if there was a foreseeable risk liability does not necessarily follow. If there are foreseeable but insubstantial risks, or even where risks are substantial, if the costs, either to the defendants themselves or to others, of reducing the risks to acceptable levels are high, reasonable people do nothing about.845 The question of extent of liability for inaction does raise fundamental issues for the nature of civil liability which emphasis upon forseeability alone cannot resolve; therefore this approach generated criticism that lead to its abolition.846 The correction made in subsequent case-law re-emphasised the importance of ‘proximity’ as an element of the ‘duty of care’. The evolution of British law shows the manner in which the concept of foreseeability has opened the door for courts to address public policy. The vacillation of tort law regimes in allowing judicial activism through using ‘foreseeability’ even when ‘proximity’ was low is instructive of CSR. The clash has been between incremental changes in public policy versus more radical transformations. The tort of negligence imposed an ethical injunction of extremely wide potential scope. The two-stage test (Anns v. Merton Borough Council (1978)) came under criticism because courts should not develop their own policies without reference to settled authorities. In the case Murphy v. Brentwood (1990), Lord Keith recommends an ‘incremental approach’ by reference to decided authorities. This marked the end of the application of the two-stage test for the future; to prevent sudden ‘massive extensions’ of the duty, courts would discuss policy issues only in extreme cases. The three-stage test holds that because proximity and reasonableness are such subjective concepts it is preferable that law should develop new categories of negligence incrementally and by analogy with established categories rather than by a massive extension of a prima facie duty of care restrained only by indefinable considerations which ought to reduce the scope of the duty. 847 However, the courts of Canada and New Zeeland declined to adopt the incremental approach and stuck to two-stage test on grounds of ‘justice/not tolerating injustice’. The picture is not black and white however as in the UK, the House of Lords is quite prepared to take substantial ‘incremental’ steps to achieve a just result.848 844

Howarth, supra note 774. Ibid. 846 Buckley, supra note 778, p. 5. 847 Ibid, pp. 3,4; Cane, supra note 776, pp. 7–10. 848 Jackson & Powell supra note 775, pp. 20, 23. 845

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Chapter 6 Expectations about public enforcement and judicial activism are tempered by the backlash witnessed in tort law. The debate highlights the necessity to adopt a nuanced view on the duty of care and to account for all factors rather than overemphasise one. The Murphy case observed that the two-stage test builds a prima facie assumption that a duty of care exists if it is reasonably foreseeable, and later asks for considerations that would limit the scope of duty or the class of persons to whom the duty is owed. Subsequent decisions approached the problem the other way around; they start with situations where duty exists, and later ask whether considerations of analogy, policy, fairness and justice exist to extend the duty to cover new situations. “It can be said that, provided that the considerations of policy, etc., are properly analysed, it should not matter whether one starts from one end or the other.”849 In New Zealand, Cooke P. said: “A broad two-stage approach or any other approach is only a framework, a more or less methodical way of tackling a problem. How it is formulated should not matter in the end. Ultimately the exercise can only be a balancing one and the important object is that all relevant factors be weighted. There is no escape from the truth that, whatever formula be used, the outcome in a grey area case has to be determined by judicial judgement. Formulae can help organise thinking but they cannot provide answers.”850

The CSR reader notes from decades of judicial proceedings that both tests dealing with the creation of a new duty of care are affected by considerations of policy and factual circumstances, both of them being non-legal concepts. There are strong indications that the scope of positive obligations to exercise reasonable care will be clarified in an incremental manner. The standards developed from within the business community through the CSR regime impact on the concepts of ‘foreseeability’ and ‘reasonableness’ in the law of negligence and thus affect the delicate balance act courts are asked to perform. This serves only to emphasise the importance of grasping non-legal concepts and CSR developments when building a purely deterent argument based on negligence law. Even if liability for negligence will not be decided in courts of law but in other arenas of accountability, the tensions faced by courts and the reasoning they perform are informative for CSR analysis. Finally, it is not clear whether proposals that involve the responsibility of the parent company for the wrongdoing of its subsidiaries are basically based on failure (omission) to oversee and exert influence (fault-based liability) or simple association as part of the same economic entity (strict liability). MNEs have attracted criticism on both grounds. Meeran noted that an international convention might impose strict liability or a legal duty of care on parent companies.851 The European Group on Tort 849

Lord Hoffman (Stovin v. Wise [1996] A.C. 923) quoted in ibid., pp. 26, 27. South Pacific Manufacturing Co. ltd v. New Zealand Security Consultants and Investigations Ltd, 1992, quoted in ibid., p. 28. 851 Meeran, supra note 750. 850

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Incremental institutionalisation of CSR regime Law notes that strict liability should be imposed for abnormally dangerous activities, an activity which “creates a foreseeable and highly significant risk of damage even when all due care is exercised in its management and is not a matter of common usage”.852 In addition to such situations, laws have imposed strict liability on the employer for the acts of its employees. Harpwood cautions that “[s]trict liability is based on no general underlying rationale, but on a series of ad hoc adjustments prompted more by pragmatism than principle. The search for some grand design giving coherence to different areas of tort is misguided and naïve.”853 From a regulator’s perspective, strict liability, as opposed to negligence-based liability, has the advantage that it relieves courts from entering the thicket of determining what constitutes ‘reasonable care’ in a given set of circumstances.854 6.1.4. Intermediary variables – understanding decentralised regulatory regimes The analysis so far contributed to a better understanding of legally-binding frameworks which have been favoured in the business and human rights literature. A multitude of laws do not operate in a ‘pure deterrence’ mode. On the contrary these laws are underspecified in their command and rely on private enforcement. Nevertheless many of these laws have been effective in improving corporate practices. It becomes clearer that the causality between state action through legallybinding instruments and corporate behaviour is more complex, which in turn draws attention to a range of intermediary variables that mediate the effects of law. Once these variables are identified lawyers become better prepared to reassess the value of state actions other than law and, more importantly for this study, the potential of CSR instruments that have targeted the same variables. A clearer picture of the CSR regime will emerge. So far we highlighted the role of private enforcement when procedural regulations were analysed. It constitutes an essential intermediary variable that procedural laws seek to activate. However, private enforcement requires a benchmark against which to assess acceptable corporate behaviour. This brings into focus private standardisation. It serves the function of clarifying and stabilising expectations which is similar to that played by soft law (e.g. codes of corporate governance) or hard law (e.g. regulations regarding the effectiveness of management systems). The previous sections also highlighted the interaction that exists between private and public actors when generally-worded law (e.g. standard of reasonable care) becomes better specified by appeals to evolving industry practice or ISO standards (e.g. ISO 14000 for environmental management systems). In this light, a regulatory perspective on CSR needs to inquire into the implications raised by the CSR movement, which has refined standards, both substantive and procedural, of 852

European Group on Tort Law, supra note 32, Article 5:101. Harpwood, supra note 771, pp. 9, 10. 854 A. Hamdani, Gatekeeper Liability, Discussion Paper No. 442, Harvard Law School, John M. Olin Center for Law, Economics, and Business, 2003, pp. 19–21, <papers.ssrn.com/sol3/ papers.cfm?abstract_id=466040>, visited on 14 February 2007. 853

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Chapter 6 responsible business behaviour, as described in chapter 4. In other words, what is the role of privately developed standards in a more complex, less centralised regulatory regime? Now we turn to discussing ‘standardisation’ and ‘codification’ or more broadly, systematisation and routinisation of CSR as an important intermediary variable. A. Private standardisation as an intermediary variable For purposes of this section, standardisation/codification refers to any benchmark (substantive or procedural) that is contained in a standard stricto sensu (e.g. ISO standards), in industry practice or the ‘custom of the industry’, or in an emerging template ‘road-tested’ by leading businesses. ‘Standards’ can be understood as a basis for comparison, a reference point against which other things can be evaluated. Policymakers can draw on privately developed benchmarks to better specify the law and/or mobilise private enforcement to achieve regulatory goals. We draw on chapters 4 and 5 to identify modalities in which policymakers have related to private standards. States can lay down standards (public standardisation such as the codes of corporate governance or international soft law instruments) or private organisations and networks can develop standards (private standardisation such as the ISO standards). Both public and private standards can be enforced by public authorities (public enforcement) or by private actors (private enforcement). Any of these possible combinations can induce businesses towards compliance and are thus relevant from a governance perspective. Practice shows that states can relate to standards, even if developed by private actors, in a variety of ways starting from allowing them to operate in isolation from public policy, to providing various types of support during their development phase, to quietly take them into account in definitions of ‘reasonable’ business conduct, to directly cross-referencing them in law. This is particularly relevant to CSR as a multitude of multistakeholder initiatives have laid down standards and guidance. Leading businesses and their stakeholders have set in motion since the mid1990s an important process of codification and standardisation. All aspects of CSR, from substantive targets to implementation guidelines to reporting formats, are being systematised and routinised. The emerging standards of good CSR practice offer some authoritative reference points that help a larger section of companies implement CSR in their operations and assist stakeholders in assessing corporate performance. The CSR regime can theoretically evolve in complete isolation from public policymakers. This has not always been the case. The analysis below presents the positions adopted by governments from the early stages of the standard-setting process to the moment when a standard is finalised and ready to be enforced. Instruments ranging from law to soft law to policy have been used. It is important to note from the beginning that bottom-up standardisation of CSR has occurred in multistakeholder fora where leading businesses, professions, NGOs and sometimes governmental representatives participate. Chapter 4 contains numerous examples of this kind while section 5.1. shows how states have used 262

Incremental institutionalisation of CSR regime policy to grant legitimacy to the standard-setting process, convene parties, offer financial support and provide expertise on the substantive issues being discussed. To avoid repetition this section refers only to laws and governmental strategies that highlight the roles of standards in governance. As regulators come to diversify their regulatory strategies to achieve compliance standardisation accrues a special role in governance. In the corporate governance area, the High Level Group of Company Law Experts recommends that the EU should consider a broader use of alternatives to primary legislation (e.g. secondary regulation, standard setting and monitoring, model laws). “Standard setting by market participants, or in partnership between government and market participants, through which best practices can be developed, adapted and applied” is an option.855 In international commerce technical rules and guidelines have an increasingly important role. It was noted that globalisation manifests “tendencies toward worldwide standardisation with minimal intervention of official international politics”.856 The Canadian federal government launched in 2000 the Canadian Standards Strategy through which the government aims to “provide direction and leadership on how to use standardization to best advance the social and economic well-being of Canadians in a global economy”. The Strategy promotes the use of standards as complements to regulation and calls for fuller representation of the broadening range of ‘standardization stakeholders”.857 The government “acknowledges that fiscal restraint and global trade are driving public authorities’ increasing reliance on voluntary standards to achieve public policy goals … The Strategy is expressly based on two assumptions: that (1) standards are becoming a pillar of the new global trade system, and (2) fiscal restraint means that industry and government are struggling to do more with less and standards can offer effective, less costly ways to achieve the objectives of reducing costs, eliminating regulatory burdens and protecting the public interest.”858

The ISO is the main international body for technical standards and also in the area of standardisation of management systems. ISO’s standard-setting evolves largely independently of states. ISO’s standards, a result of an international negotiating process, have however received a boost over national standards, which could be used for protectionist purposes and thus impede international trade, when the GATT laid down in 1994: “Where international standards exist or their completion is imminent, the standardizing body shall use them … as a basis for the standards it develops, except where such international standards or relevant parts would be 855

High Level Group of Company Law Experts, supra note 181, p. 31. G. Teubner, ‘The Kings Many Bodies: The Self-Deconstruction of Law's Hierarchy’, 31:4 Law and Society Review (1997) pp. 763–788. 857 Standards Council of Canada, Canadian Standards Strategy and Implementation Proposals (2000), quoted in Wood, supra note 321, p. 166. 858 Ibid. 856

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Chapter 6 ineffective or inappropriate, for instance, because of an insufficient level of protection or fundamental climatic or geographical factors or fundamental technological problems.”859 Roht-Arriaza interprets this provision as creating a preference for international standards, and a presumption that international rules are consistent with the WTO regime; states are allowed to impose their own standards, but GATT puts the burden on them to justify such departures.860 International standardisation has had the function of facilitating trade, in particular by harmonising an unnecessary proliferation of overlapping national and regional social responsibility initiatives. However, “ISO has clearly stated that it does not consider the role of international standardization to be limited to the harmonization of existing standards. It has also clearly stated that it sees a role for itself in addressing the challenge of pursuing and promoting sustainable development.”861 Furthermore, ISO notes that “[f]rom a public policy perspective, international SR [Social Responsibility] standardization would be desirable if it could help to increase SR actions by i) leading to the development of better SR regulations; ii) helping organizations to implement SR more easily; and iii) help to create economic incentives to undertake SR actions.”862 Once private actors have created authoritative benchmarks of good business behaviour, such formalised standards or merely recognisable industry practices can be enforced by private actors (private enforcement), as briefly noted in section 4.4. above, but importantly also be used by governments as a base for public codification, whether through law or litigation. Standards laid down by governments in the area of corporate governance take years to develop and entail consultations with stakeholders (i.e. opportunities to comment on drafts at various stages). As the British corporate governance instruments show, public codification can draw on practices of leading businesses and seek to generalise them more widely in the business community. In this case, private benchmarks are incorporated in public codification instruments (‘codes of corporate governance’) which are non-legally binding governmental standards. Thus privately developed benchmarks interact with soft law. There can be instances when such codes can draw more formally on private standards: for example the South African King Report II on corporate governance expressly recommends the reporting format developed by the Global Reporting Initiative. The Voluntary Principles on Security and Human Rights developed voluntarily by the extractive industries have been cross-referenced in various instruments. VP were incorporated into the Tangguh contract lead by BP. Similarly 859

WTO, Agreement on Technical Barriers to Trade, Annex 3 ‘Code of Good Practice for the Preparation, Adoption and Application of Standards’, para. F, <www.wto.org/english/docs_e/ legal_e/17-tbt.pdf>, visited on 14 February 2007. 860 N. Roht-Arriaza, ‘Shifting the Point of Regulation: The International Organization for Standardization and Global Lawmaking on Trade and the Environment,’ 22 Ecology Law Quarterly (1995) p. 494. 861 ISO Advisory Group on Social Responsibility, supra note 303, para. 223. 862 Ibid., para 222.

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Incremental institutionalisation of CSR regime in the Baku-Tbilisi-Ceyhan Pipeline Project, the VP were incorporated into the legally binding Host Government Agreements with the governments of Azerbaijan, Georgia and Turkey as well as in the intergovernmental agreement among the three addressing pipeline security arrangements. Furthermore, the World Bank has committed to use the VP as the basis of a conditional standard in its financing of new extractive sector projects. Finally, the OECD Risk Management Tool for Investors in Weak Governance Zones makes explicit reference to the VP.863 The most prominent standards for management systems generated through private standardisation come from the International Organization for Standardization (ISO). It developed the ISO 9000 and ISO 14000 management standards, and is in the process of drafting the ISO 26000 Guideline for Social Responsibility. A report for the ISO noted, “legal regimes in several jurisdictions – implicitly or explicitly – refer to and draw on ISO 9000 and ISO 14000 standards in support of their legislative regimes …”.864 The ISO noted situations when its standards are given force through adoption in national laws: “A certain percentage of ISO standards – mainly those concerned with health, safety or the environment – has been adopted in some countries as part of their regulatory framework, or is referred to in legislation for which it serves as the technical basis.”865 Another instance is the EU regulation EMAS which is cross-referenced with the ISO 14001 standard. Businesses will be deemed in compliance with EMAS requirements for management systems if they follow the privately developed ISO standards. These are examples of formal adoption into law that expressly validate and generalise a private standard. However, at a lower level, courts or regulatory agencies can also specify generally-worded laws by taking into account available private standards. As shown in section 5.3., there are examples of courts that have cross-referenced the ISO 14000 standard when defining the terms of probation for defendant companies, and regulatory agencies that have required an ISO-based management system as a condition for granting environmental permits. Another interesting example comes from the area of misleading advertising law, where regulations can be mandatory but vague and therefore complemented by the ISO 14000 standards. Webb notes that “[s]tandards can also supplement and refine laws, such as the ISO 14020 … pertaining to environmental labels and declarations. Most jurisdictions have general laws banning misleading or deceptive marketing. However, these laws typically lack detail about what types of claims can be made about products. In the absence of such detail, there is potential for confusion among merchants as to what is acceptable, and in turn confusion among consumers. Several jurisdictions have used this standard as the basis for interpretation of deceptive marketing legislation when 863

OECD, Risk Awareness Tool for Multinational Enterprises in Weak Governance Zones, 2006, p. 16, <www.oecd.org/dataoecd/26/21/36885821.pdf>, visited on 14 February 2007. 864 Ibid., para. 296. 865 Overview of the ISO system, <www.iso.org/iso/en/aboutiso/introduction/index.html>, visited on 14 February 2007.

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Chapter 6 applied to so-called ‘green’ claims about products. ISO 14020 provides guidance for government officials, businesses, consumers, and others as to what is acceptable.”866

The ISO 26000 standard on CSR is likely to be an important benchmark for procedural standardisation in the CSR area as it will come from the organisation with the broadest reach in the business community. The ISO commented on the relationship between private standardisation and public codification. “ISO 14000 demonstrates the potential of an international standard to work in a compatible manner with different legal regimes, and that there are no apparent barriers to an ISO SR standard operating in [such a manner], particularly if it were a process oriented standard.”867 Equally important examples of public codification drawing on private practice are the cases when courts define the standard of care in negligence cases by looking at industry practice or the custom of the industry, as shown in section 5.4. The benchmark in these cases may be less formalised than in the preceding ISO case. Moving beyond actual examples where the law achieves greater specification through an interaction with private codification, the regulatory strategy at work is exemplified by the financial sector. Within the framework of the Global Compact, the UN Secretary-General Kofi Annan invited 18 financial institutions from nine countries with total assets under management of over six trillion USD to develop guidelines and recommendations on how to better integrate environmental, social and corporate governance issues in asset management, securities brokerage services and associated research functions. The report reads: “Regulators are invited to shape legal frameworks in a predictable and transparent way as this will support integration in financial analysis. Regulatory frameworks should require a minimum degree of disclosure and accountability on environmental, social and governance issues from companies, as this will support financial analysis. The formulation of specific standards should, on the other hand, rely on market-driven voluntary initiatives. We encourage financial analysts to participate more actively in ongoing voluntary initiatives, such as the Global Reporting Initiative, and help shape a reporting framework that responds to their needs… We believe that regulatory frameworks should require a minimum degree of disclosure and accountability on ESG issues, but rely on market-driven voluntary initiatives to formulate detailed standards.”868

The British regulations of pension funds dealing with CSR reporting impose very general transparency requirements, and funds can even opt-out altogether if they state explicitly that no consideration is given in their investment policies to CSR 866

K. Webb, ‘Standards and the Law: Partners in Protecting Consumers’, 33 ISO Bulletin (February 2002) p. 13, <www.iso.ch/iso/en/commcentre/isobulletin/articles/2002/pdf/law0202.pdf>, visited on 14 February 2007. 867 ISO Advisory Group on Social Responsibility, supra note 303, para. 296. 868 The Global Compact, supra note 286, p. 33.

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Incremental institutionalisation of CSR regime issues. In this case lawmakers have so far relied entirely on private codification and enforcement. The process set in motion by the law could be better characterised as an invitation to join a dialogue and to confer legitimacy to final beneficiaries’ expectations for clearer statements of ethical policies of funds. The law puts CSR on the investment fund’s agenda and expects incremental private codification of what CSR entails in this specific context. It cannot be excluded that private standardisation will be later followed by standards laid down by the government itself. A report tracking the effects of the law recommended for the government to promote a formal code of best practice for pension funds in dealing with social, ethical and environmental issues.869 The presentation so far highlighted cases where governments took an interest in private processes of standard-setting and also where public authorities specify the law with an eye to privately-developed benchmarks. As a result, a mixture of private and public regulation converges on companies. But states can regulate intermediary actors instead of companies or design policies to assist such actors in order to facilitate private enforcement by those with leverage on companies. The regulatory regime may become even more decentralised in such instances, with even more actors and variables involved. States can deliberately target ‘gatekeepers’ instead of each and every business. A regulatory strategy along these lines is proposed by the California Global Corporate Accountability Project: “Rather than rely only on command-and-control methods, a new policy agenda should … help to empower investors, consumers, company managers, affected communities, advocacy groups, and workers who are seeking to encourage and reward better company performance. Our findings suggest that an immediate role for government is to improve the quality and quantity of public information about the impacts of corporate activity. Information is a public good and is key to making markets work. Information must be generated, standardized, provided, managed, verified, and disclosed to the public to fulfill its central role in making markets work efficiently and in encouraging ethical corporate behavior.” 870

The information infrastructure is equally important to ensure the credibility of corporate disclosures. Without credible auditing private enforcement is hampered: “Government can play a role in strengthening the credibility of third party verification by establishing standards for the accreditation of verifiers. Government, or government-private partnerships, can set out rules for training, areas of expertise, independence, competency, and licensing, much as is now done with other financial professionals. In Europe, companies use private bodies to certify their compliance with EMAS, but

869 870

Gribben and Faruk, supra note 445, p. 3. California Global Corporate Accountability Project, supra note 19, p. xix.

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Chapter 6 these private verifiers are subject to public accreditation in their home country.”871

This section highlights the importance of codification as an intermediary variable in complex regulatory regimes. It also emphasises that important benchmarks are not necessarily contained in a hard law, but are the result of legally non-binding initiatives – soft law instruments or private schemes – producing standards, principles or guidance. Interestingly enough, benchmarks generated in this way may, or may not, find their way back into hard law. While not legally binding, CSR instruments are of an enabling kind, and it is the choice and responsibility of others to act upon the codification thus achieved. However, as shown in the company law context, the distinction enabling-mandatory is a fairly crude one: the more elaborate and costly the opt-out procedures the closer the rule is to being, in effect, mandatory.872 And opt-out procedures are a function of both public and private enforcement. Mandatory rules require doing something or refraining from doing something. Enabling rules operate by way of default where parties have not negotiated other agreements; default rules have a facilitative role as they reduce transaction costs. Multistakeholder CSR initiatives and the instruments they have produced offer standardised templates of good practice. CSR standardisation is ‘enabling’ as it has the function of reducing transaction costs when good CSR practices are diffused to other companies and when stakeholders make their assessments of corporate performance. As an OECD report noted: “The purpose of management standards is to lower the cost of implementation for companies (since they can take a management system ‘off the shelf’) and to increase the credibility to external stakeholders of firms’ efforts to achieve appropriate environmental standards (since their environmental practices are then recognised as being standard).”873 In the last decade, significant progress around responsible business practices has happened around an emerging shared understanding among stakeholders on how to effectively implement and communicate CSR performance while still remaining a profitable business. The clarification and better understanding of the ‘grey area’, where the interests of shareholders and stakeholders are simultaneously pursued, is particularly amenable to private codification and soft law pronouncements. They should not be dismissed just because they are not backed by legal sanction. They are crucial steps towards codification in the ‘grey zone’. And, “notwithstanding their voluntary nature, standards are properly regarded by policy makers as an instrument of governance”.874 To sum up, at the development stage of private standards governments can adopt either a passive or active position. Most simply, states can ignore the fact that 871

Ibid., p. 173. E. Ferran, ‘Company Law Reform in the UK’, 5 Singapore Journal of International & Comparative Law (2001) p 563. 873 OECD, supra note 314, p. 15. 874 Wood, supra note 321, p. 161. 872

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Incremental institutionalisation of CSR regime some private actors are developing a standard to guide their exchanges with other private parties. However policymakers can follow such endeavours and grant legitimacy to the standard-setting process, emphasise the role of private benchmarks in governance, convene parties, offer financial support and provide expertise on the substantive issues being discussed. Once finalised, standards enter the enforcement stage. Privately developed standards can be acted upon solely by private actors. Or states can incorporate them into their regulatory strategies in a variety of ways, either when states lay down their own standards in a public codification effort and when they enforce the law, or when they design their capacity-building policies. Regarding public codification, the most obvious case would be formal adoption into law that expressly validates and generalise a private standard; governments could also rely partially on private benchmarks (e.g. available industry practices) and modify such standards to suit public policy. Public codification can occur less obviously when generally-worded laws are enforced; it is the courts or regulatory agencies that specify the law by taking into account available private benchmarks. In both these cases, private standards acquire force through public enforcement. However, states can relate to private standards by using policy rather than law and rely on private enforcement to make the standards consequential. This is the case with policies that finance intermediary actors such as watchdogs and other entities that collect and process information related to a standard. Or states can regulate intermediary actors instead of companies in order to facilitate private enforcement by actors with leverage on companies. Through policy and regulation states can reinforce the infrastructure that takes a standard from aspiration to practical implementation. States facilitate private enforcement in this case. B. Norms as an intermediary variable Standards are often accompanied by guiding and explanatory documents to help assist companies implement them. This needed guidance is often technical but a different type of necessary guidance may have to deal with belief systems and norms that guided behaviour before a new standard appears. If the new standards, or even laws, clash with entrenched and conflicting norms they can be rendered ineffective in practice. Therefore, policy makers might need to deliberately target norms as another intermediary variable in a complex regulatory regime. In the CSR context, standards need to be accompanied by an adequate understanding of how they fit with the broader corporate objective of pursuing business success. Public or private enforcement could force CSR standards on corporate managers, but if Friedman’s recipe to business success, as described in chapter 3, proves resilient, the dangers highlighted by procedural standardisation – ‘paper compliance’ meaning formalistic adherence to process with no improvements in performance – are likely to materialise. An alternative understanding of how to pursue the corporate interest emerges from the CSR movement. This understanding which avoids needless dichotomies and unwarranted simplifications is important both for managers to properly receive and apply CSR standards, and also for 269

Chapter 6 stakeholders to grasp CSR benchmarks in their regulatory dimension. Bellows follows an overview of instances when states have used the law to target norms, or belief systems, to move companies towards compliance. Chapter 2 discussed the managerial duty of care under company law. The UK Company Law Review Steering Group noted: “[W]e do not accept that there is anything in the present law of directors’ duties which requires them to take an unduly narrow or short-term view of their functions … There is nevertheless considerable evidence that the effect of the law is not well recognised and understood.”875 The reformulation of managerial duties to take into account stakeholders’ interests “was particularly prompted by evidence that the obligation to look beyond the short term was not widely recognised by directors or members”.876 The concern of British lawmakers is that “current arrangements lead to directors neglecting the long term, often under (actual or perceived) misguided pressure from shareholders”.877 Through the statutory clarification of the managerial duty of care lawmakers aim at “clarifying the law, to ensure recognition of a proper long term perspective and inclusive approach to business relationships”.878 The British review of company law, particularly the duty of care, can be understood as a deliberate attempt of lawmakers to clarify the norm used by management; the law promotes a more inclusive way to approach due care and complexity. The law in this case aims to shape behaviour by altering the norm used by directors rather than by strengthening judicial enforcement. The judicial enforcement of the duty of care is not expected to increase markedly for reasons explained in chapter 2. Private enforcement is an indispensable ingredient that must accompany the combination of ‘weak’ laws and norms to move companies towards compliance. The idea that law deliberately targets a social norm in order to ultimately achieve a change in behaviour is not foreign to corporate governance. For example, Eisenberg discusses the effectiveness of laws: “Although legal standards of conduct are characteristically accompanied by liability rules or other enforcement regimes, even a legal standard of conduct that is unaccompanied by such a regime may be effective because of its impact on social norms.”879 He suggests that even a combination of ‘weak’ laws and norms can lead to changes in behaviour. Thus the law’s softer functions (i.e. the expressive and clarifying functions as separated from the function of imposing liability) can target norms. “Legal rules may also serve to clarify social norms by providing focal points for their meaning. The clarifying function of legal rules has obvious relevance to the duty of care, because one function of the cases that clarify the meaning of that duty, especially in a directorial context, is to tell directors how to play their directorial role.”880 Eisenberg’s argument illustrates a less direct causal mechanism through which law can operate. 875

Company Law Review Steering Group, supra note 181, paras. 5.1.19, 5.1.20. Company Law Review Steering Group, supra note 183, para. 3.18. 877 Developing the Framework, supra note 48, para. 3.54. 878 Ibid., para. 2.14. 879 Eisenberg, supra note 224, p. 1270. 880 Ibid., p. 1269. 876

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Incremental institutionalisation of CSR regime In the context of directorial duty of care, Eisenberg makes the distinction between obligational norms and non-obligational norms. He observes that until recently there has been a non-obligational norm regarding managerial practice that insulated inactive directors from criticism and self-criticism. The author shows that “[a] focus on obligational norms overlooks that nonobligational norms may have an important effect on conduct by permitting and preserving certain behavior”.881 Thus obligational norms are not the only kind of social norms that can affect human conduct. Eisenberg notes a tendency in the legal and economics literature concerning social norms to focus on obligational norms. If Eisenberg’s argument is applied to the CSR case, Friedman’s criticism of CSR proposes in fact two norms. The obligational norm (i.e. directors should pursue solely the interests of shareholders) has as its corollary a non-obligational norm (i.e. corporate directors do not have to track at all the wider impacts of corporate activity as recommended by CSR because it is the exclusive responsibility of states, and of the rest of us, to protect stakeholders through law and ethical custom). The disregard of CSR that Friedman promotes largely stems from the non-obligational norm, which isolates corporate directors from accounting more fully for business impacts. From here results the Friedmanite strategy of pursuing the narrow corporate self-interest. If it appears that the host state systematically fails to protect its inhabitants, the manner of pursuing business success promoted by the obligational norm would be harder to defend. Once the corollary non-obligational norm is weakened, the obligational norm to narrowly pursue shareholders’ interests is less compelling. The nonobligational norm is very consequential for obtaining, or not, corporate compliance; it justifies to managers to stick to narrow indicators and strategies and isolates directors from opening up to more sophisticated assessments of their business environment and more sustainable pursuits of corporate self-interest. From this angle it is important for states to target norms, as British lawmakers have done, even when no public enforcement is immediately envisaged. While the British company law clarified managerial duties and is explicit in targeting the ‘grey zone’ where shareholders and stakeholders’ interests overlap, many regulations discussed in this study hint in the same direction: the necessity for managers to display higher standards of care. As seen in chapter 2 courts dealing with the managerial duty of care under company law have begun to review the decision-making process in a stricter manner than the decision itself; courts thus encourage the adoption of sound management systems as a defence against charges of carelessness. ‘Codes of corporate governance’ emphasise the importance of risks management systems that enable business executives to account for qualitative and forward-looking data. This encourages companies to assess a wider range of risks, including CSR risks, which have to be competently managed to ensure business success in a complex economy. Where these instruments refer to stakeholders they do not seek a reorientation of managerial duties away from the company’s (and its shareholders’) interests or a revolutionary change in the purpose of the company; 881

Ibid., p. 1262.

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Chapter 6 they simply suggest the necessity for higher standards of care in the ‘grey area’. Furthermore, new regulations of pension funds seek to promote through transparency requirements a more systematic way to handle CSR issues in investment decisions. Such an approach stimulates thinking of developing policies that are both financially sound and socially responsible. By legitimising investors’ interventions on CSR issues, policymakers aim to incrementally develop sound practices in the ‘grey zone’. Finally, states put financial and other resources into capacity-building efforts to help private actors understand and act on benchmarks of good business practice. These are non-regulatory ways of enhancing private pressure aimed to induce sound internal managerial practices and improvements in corporate performance. It appears that regulations and policies discussed in this study hint in the same direction; they preserve a degree of managerial discretion in handling CSR aspects but also aim to change the belief system of managers. Company law shall not be simplistically interpreted as backing Friedman’s norm which states that the pursuit of business success should be guided solely by clear-cut legal and market signals with deliberate disregard to emerging issues. Also the abovementioned regulations emphasise the role of systematised approaches to help managers account for broader risks and pay attention to CSR for reasons of enlightened self-interest. In fact, what for regulators is the ‘grey area’ where CSR is instrumental for achieving the longterm success of the company is for business executives a matter of ‘enlightened selfinterest’. The challenge to the business norm articulated by Friedman comes from policymakers targeting the ‘grey zone’ and from leading businesses articulating the business case of CSR. On one hand, lawmakers have created a range of regulations aiming at higher standards of care and guided managerial discretion (not using ‘pure deterrence’). On the other hand, leading companies have started a process of clarification and simplification in the ‘grey zone’ that rationalises CSR expenses in terms of long-term corporate self-interest (rationalisation of CSR), and contributed to the accumulation of expertise within market actors, civil society groups and governmental bodies to work with CSR (institutionalisation of CSR). Self-interest is susceptible to different interpretations depending on the short- or long-term perspective taken, on the ability to identify viable alternatives, on the actions of other actors in the environment, etc. Rational choice theory, on which much legal and economic writers draw, rightly emphasises the importance of self interest as a guide for behaviour. Especially relevant to arguments that try to reconcile corporate self-interest with CSR and that pay attention to the actual conditions where decision-makers operate, is the idea of ‘bounded rationality’. It highlights the limits upon the ability of human beings to adapt optimally, or even satisfactorily, to complex environments.882 Individuals adopt a “behaviour that is intendedly rational, but only limitedly so”. In our case the “bounded rationality perspective emphasizes the limited ability of corporations to achieve the goals they 882 H. Simon, ‘Bounded Rationality and Organizational Learning’, 2 Organization Science (February 1991), p. 132.

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Incremental institutionalisation of CSR regime desire. Busy managers have neither the time, capability, knowledge, nor information required to maximize corporate utility, but rather ‘satisfice’ by choosing familiar alternatives that are good enough for the current situation.”883 Building on Simon’s insights, North observed: “Our preoccupation with rational choice and efficient market hypothesis has blinded us to the implications of incomplete information and the complexity of environments and subjective perceptions of the external world that individuals hold. There is nothing the matter with the rational actor paradigm that could not be cured by a healthy awareness of the complexity of human motivation and the problems that arise from information processing.”884

In the CSR context, in order to grasp how corporate self-interest comes to be defined, one needs to account for various groups (e.g. membership in associations, professional communities, informal gatherings) that intermediate between oneself and others and define problems and available solutions. By economising on information costs, mediating institutions simplify complexity and contextualise information for people, not only so that they can make better decisions, but also so that they can become informed by a reliable source about what is best for them. In the process, mediating institutions can actually shape the preferences of participants by defining the context in which people make decisions and by providing a source of pooled values and opinions to which they can defer.885 Increased interaction in various stakeholder fora offers new opportunities to shape understandings. A report of Danish businesses engaged in CSR wrote that managers all agreed that the process of discussing the problems and possible solutions contributed to the evolution of their thinking about and their willingness to join government efforts to end unemployment. Research has thus documented that the degree to which a corporation is involved with external business groups and networks that link the company to the larger community of policy ideas is one of the determinant factors for a corporation joining partnerships.886 Leading businesses implementing CSR pursue their self-interest and simultaneously redefine it. The relationship between mediating institutions and self-interest can have an ambiguous logic. Arguments have been made for both the ability of mediating institutions to help members transcend their own self-interest, and also for such 883

J. T. Scholz, ‘Corporate Misconduct – Enforcement Policy and Corporate Misconduct: The Changing Perspective of Deterrence Theory’, 60 Law and Contemporary Problems (Summer 1997) p. 256. 884 North, supra note 266, p. 111. 885 J. R. Macey, ‘Packaged Preferences and the Institutional Transformation of Interests, Mediating Institutions: Beyond the Public/Private Distinction’, 61 University of Chicago Law Review (Fall 1994) p. 1451. 886 C. J. Martin, ‘It Takes Two to Tango – Corporate Decisions to Join Social Partnerships’, in C. Kjærgaard and S. Westphalen (eds.), From Collective Bargaining to Social Partnerships: New Roles of the Social Partners in Europe (Copenhagen Centre, 2001) pp. 71, 72.

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Chapter 6 institutions to act as devices by which people can express their own self-interest more effectively. Regarding the latter, although mediating institutions sometimes take positions that are clearly inconsistent with the interests of at least some of their members, sacrifice does not equal subjugation. “As long as the sacrifice is compensated for by the presence of benefits in other aspects of the relationship, it is false to say that membership in a mediating institution involves the subjugation of individual preferences to those of a group.”887 In another context, Ruggie observed that international organisations affect only occasionally and at the margin how interests and preferences of states come to be (re)defined. The 20th century project of international organisations has been a matter of how to stretch states interests and preferences, temporally and spatially, so as to produce collective goods in greater quantities. Ideational factors are a critical means by which this stretching is achieved.888 It is particularly important in these conditions to employ an interpretative epistemology to avoid needless dichotomies being perpetuated in a new context. Ruggie shows that such an epistemology is not needed in circumstances that require little interpretation by actors, such as when the environment is placid, shared knowledge prevails or coercion determines outcomes.889 Strikingly, the ‘business and human rights’ area features none of these characteristics. So far the analysis concentrated on the challenge of promoting higher standards of managerial care. Regulatory strategies and policies used by policymakers were discussed as well as the practices of leading businesses implementing CSR. These were interpreted as promoting a new norm in response to Friedman’s norm, as discussed in chapter 3. As CSR practice clearly shows, to effectively implement CSR requires very often collaboration with stakeholders rather than ‘go-it-alone’ strategies. In other words, for companies to actually act on the new norm and to display higher levels of due care it is necessary to have cooperating stakeholders. Similarly, the type of regulations mentioned herein needs the participation of private actors to deliver results. The complex, decentralised regulatory regime that promotes the stakeholder norm (i.e. higher standard of managerial care owed to the company) requires a fresh look at the belief systems of several private actors. As defined in chapter 3, norms can be defined as a set of attitudes, beliefs and guidance for how to approach complexity; they can be seen as a “tendency for individuals to adopt a particular strategy or pattern of behavior within a broader social context”.890 As CSR is a rather new phenomenon that has evolved rapidly from not very commendable beginnings (i.e. a mere ‘window-dressing’ corporate strategy), there is a general lack of nuanced understanding and analysis of corporate voluntarism and regulatory strategies from a governance perspective. As described in chapters 1 to 3, NGOs and many law-oriented writers have tended to concentrate narrowly on regulations operating in a pure deterrence mode. At the same time many business managers 887

Macey, supra note 885, p. 1470. Ruggie, supra note 45, p. xii. 889 Ibid., p. 101. 890 E. Talley, supra note 229. 888

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Incremental institutionalisation of CSR regime follow Milton Friedman and summarily dismiss CSR. For nuanced assessments of CSR and smoother collaborations it is necessary to develop a deeper understanding of CSR dynamics, as emphasised by practitioners dealing with partnerships between businesses and civil society groups. What is still in short supply is a capacity to break free from the established norms of the past and to account properly for new contexts in need of new norms. Specialists in multistakeholder partnership have clearly identified the lack of this type of capacity as one of the practical challenges to partnership initiation and maintenance. Establishing and maintaining partnerships is a complex undertaking and certainly it is not cost-free, especially when partners work together for the first time. Partnerships require more time up front in the exploration and formative stage, but should deliver faster and better results once the shared purpose and operating rules are established. Transaction costs among parties arise from the need to determine responsibilities, working procedures and coordination, and are dependent on the parties’ ability to respond to change, mistrust and difference of frames of reference. These transaction costs can be positively or negatively affected by the facilitating or obstructing environment in which the partnership is undertaken, and can thus make the difference between its success and failure.891 We draw lessons from ‘partnerships’ which can be understood not simply as concrete joint undertakings but also as a shortcut for the idea of seeking change by working pragmatically and jointly instead of arguing exclusively for a ‘pure deterrence’, over-deterministic mechanism of social change. World Bank’s Business Partners for Development (BPD) noted that some key capacities are in need to be strengthened: ƒ understanding how partnerships can create a strategic advantage; ƒ developing some understanding of partners’ characteristics (such as roles, incentives, internal conflicts) and learning how their capacities can be put to best use in the partnership; ƒ listening to the concerns of the other partners as well as their own obstacles and thinking laterally about how these can be solved, rather than thinking in terms of how they can be dismissed; and ƒ understanding that a partnership based on an unequal footing is fundamentally unstable and ultimately unsustainable.892 Nelson and Zadek place tri-sector partnerships in a governance context. The following three factors were considered especially important to make partnerships a success: visionary and empowered leadership combined with pragmatic operational processes; capacity building by developing new skills and changing attitudes in business, government and civil society organisations; and rigorous evaluation and 891

A. Fiszbein and P. Lowden, Economic Development Institute of the World Bank, Working Together for Change – Government, Civic and Business Partnerships for Poverty Reduction in Latin America and Caribbean, 1999, p. 15, <www.worldbank.org/wbi/fultext/worktog .pdf>, visited on 14 February 2007. 892 Business Partners for Development, supra note 393, p. 25.

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Chapter 6 learning for experimentation to be useful.893 For the authors the challenge is to perceive the fluid nature of the issue at hand and have the skills to make it more likely that the positive dynamics will prevail. “Governance is today increasingly about balancing the roles, responsibilities, accountabilities and capabilities of different levels of government – local, national, regional and global; and of different actors or sectors in society – public, business and civil society organisations... The emerging forms of governance therefore present both a potential threat to participative democracy and a real opportunity to strengthen meaningful citizen involvement in decision-making and service delivery… New social partnerships can be effective at both the local and strategic level, but will not necessarily be so. The challenge is to make it more likely that the positive dynamics will prevail.”894

BPD observed that it is an endearing myth that “extending benefits from the partnership requires scaling up or replicating successful partnership experience”, while the enduring truth is that “extended benefits from the partnerships are most likely where there has been growth in participants’ own abilities to work across sectors, and where the abilities are recognised and rewarded”.895 Expectations are important in the CSR area, a new field where mistrust runs high. On ‘trust’, a term often used in CSR discussion, it was noted that “[m]anagers are often wary of the idea of ‘trust,’ and view it as a fuzzy, intangible concept. Trust becomes a more tangible and less abstract notion when it is seen in its cultural context and when it is associated with predictability.”896 Similarly, Ken Caplan commented: “Perhaps more useful efforts can be placed on ensuring that there is an understanding and hence respect for what partner organisations can deliver and the obstacles that they face in either partnering in the first place or delivering what they said they would deliver. Individuals may or may not trust each other. Perhaps they trust their partners to behave in a certain way, rather than that they will trust their partners to always put the partnership first. The distinction is an important one, again given how we frame our expectations of our partners.”897

893

Nelson and Zadek, supra note 390, pp. 63, 64. (emphasis added) Ibid., pp. 55, 63. 895 Business Partners for Development, Endearing Myths, Enduring Truths: Enabling Partnerships between Business, Civil Society and Government, 2001 p. 11, <www.bpdweb .com/endearing_myths.pdf>, visited on 14 February 2007. (emphasis added) 896 Corporate Engagement Project, Stakeholder Consultation, Issue Paper, 2004, <www.cdainc.com/publications/cep/issuepapers/cepIssuePaperStakeholderConsultation (november 2004).pdf>, visited on 14 February 2007. (emphasis added) 897 K. Caplan, ‘The Purist's Partnership: Debunking the Terminology of Partnerships’, in Copenhagen Centre supra note 26, p. 33. (emphasis added) 894

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Incremental institutionalisation of CSR regime These observations about the necessity for a more cooperative attitude from various stakeholders highlights the timeliness of more a nuanced analysis of complex mechanisms of social change that law might come to steer and facilitate. However it is neither possible nor desirable to mute criticism in the name of cooperation. It was noted in a rather similar context of seeking the accountability of international organisations through procedural safeguards inspired from administrative law: “Defenders would probably argue that global administrative law seeks to improve current institutions and, by making them more accountable, might lay the seeds for a future empowerment of those currently underrepresented and excluded. Critics, however, might claim that the strategy of global administrative law is far too limited; that even if it succeeds, it would only scratch the surface of the current institutional injustice. Moreover, it would at the same time help legitimate the current order and thus stabilize it, whereas radical change is actually needed. This would recall the classical and intractable debates between reformers and revolutionists, in which both sides are probably right in some way. But it would also point to the need for thinking about distributional issues and ways to achieve greater accountability of global administration to those who are the most excluded today.”898

The participation of stakeholders in the implementation of CSR has grown in recent years against a background of participatory democracy models. Christian Aid refers to the consultative approaches that BP undertook after the British Labour Party in 1997. Labour embraced the principles of ‘open government’ and ‘engagement with civil society’ like no previous UK government and actively encouraged business such as BP to adopt similar consultative approaches with a broad range of stakeholders. “The BP negotiations also demonstrated that NGOs lack the resources to maintain the level of lobbying, monitoring and scrutiny required to have a sustained impact on a multinational’s operations. In the long run, international NGOs may be more effective by throwing their collective weight behind the drive for international regulation than by tying up their scant resources in bilateral dialogues.”899 A report highlighted how NGO criticism can support CSR implementation efforts: “CSR managers acknowledge the instrumental role that advocacy NGOs play in raising important points to a company’s senior management. Frequently, these are the same issues that CSR managers are raising themselves within the company, but for which they are finding little support since the issues are about emerging societal expectations that are not yet apparent, or directly threatening, to the company. Advocacy 898 B. Kingsbury et al., ‘The Emergence of Global Administrative Law’, 68 Law and Contemporary Problems (Summer/Autumn 2005), p. 52 <www.iilj.org/global_adlaw/ documents/TheEmergenceofGlobalAdministrativeLaw.pdf>, visited on 14 February 2007. 899 Christian Aid, Behind the Mask - The Real Face of Corporate Social Responsibility, 2004.

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Chapter 6 NGOs can help increase the leverage of CSR managers by, independently, supporting the arguments of the CSR managers so that ‘I’m not the only one putting the important issues on the CEO’s desk’.”900

This section concentrated on the role of norms (the stakeholder norm) as an intermediary variable in decentralised regulatory regimes. It highlighted the role of CSR voluntary initiatives of leading businesses and of regulatory strategies that both promote higher levels of managerial care. At the end reference was made to the attitudes of private actors which may not be conducive to furthering the new norm because of insufficient analysis of the complex mechanism of social change at work. In the regulatory regime presented herein, the law targets deliberately a social norm to obtain compliance. The reverse case is a law failing to have its intended effects because of a divergence between social norms and the law. The importance of norms for law can be highlighted by the case of work councils in France. Here the law establishing this organisational structure was rendered ineffective because it was not aligned with prevailing norms. It was noted that “[d]espite having been the object of many legislative reforms, works councils in France have not been as successful as in Germany or the Netherlands … [T]here is a tacit agreement between employers and unions that it is not appropriate to jointly regulate the workplace.”901 6.2. DUE PROCESS CONSIDERATIONS IN ADMINISTRATIVE LAW This study adopted a particular perspective on CSR and the emerging regulatory regime accompanying it. The argument for expanded corporate responsibilities has not used moral argumentation, as often done in business ethics writings, to have stakeholders’ interests trump profits. Nor did it make a case for pure deterrence. Instead the choice was made to advance CSR concerns by focusing on the ‘grey zone’ where corporate and stakeholders’ interests overlap. The aim was to draw attention to this grey zone and modalities to expand its flexible contours by looking at new CSR managerial tools, new regulations and the social environment surrounding businesses (where we noted the role of private codification and enforcement). Drawing attention to ‘regulatory mixes’ attempted to alter perceptions of the available range of regulatory options. The institutionalisation of the positive obligations of controlling entities (parent companies in the North or large subsidiaries in the South) is basically a matter of guiding corporate discretion rather than eliminating it altogether. As the CSR regime is in its early stages of development, controlling entities currently have the discretion of doing nothing regarding human rights (the case of indifferent businesses) or discretion to choose their own way – possibly not a well thought through way – where companies decide 900

Corporate Engagement Project, Corporate - NGO Relationships, Issue Paper, 2004, <www.cdainc.com/publications/cep/issuepapers/cepIssuePaperNGORelations.pdf>, visited on 14 February 2007. 901 C. Lahovary, ESRC Centre for Business Research, University of Cambridge, ‘Employee Representation, Codetermination, and Business Performance’, in Literature Survey on Factual, Empirical and Legal Issues, undated document, p. 10.

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Incremental institutionalisation of CSR regime to act on CSR (the case of proactive MNEs). Currently, MNEs are largely perceived to have and abuse their discretion regarding their human rights impacts. Far too often, MNEs have acted on the presumption that their positive economic impacts confer them legitimacy without considering CSR (the case of indifferent businesses) or that the implementation of CSR without stakeholder participation and transparency confers legitimacy (the case of some proactive MNEs). This presumption has not fared well as the companies appeared as outright irresponsible, and respectively engaged in window-dressing exercises devoid of credibility. Host states develop their economies by competing to attract for FDI and competing in global markets, and in the process strive to create favourable conditions for business. This often results in preoccupation to cut ‘red tape’. Also because of the significant impacts their operations have or can have on host countries and their populations, MNEs have a de facto authority that increasingly needs to be legitimised. Wherever an organisation has discretion, be it a governmental agency or a company, there are social pressures to demonstrate that its exercise of authority has been legitimate. The World Commission on the Social Dimension of Globalization noted the growing lack of public trust in global decision-making. “Globalization has made public opinion a potent political power in its own right. It now presses insistently on all established political institutions – ranging from national States and political parties to international organizations – creating new tensions between representative and participative democracy.”902 Sound procedures are essential for legitimising the exercise of discretion by the centres of power in society. Indeed, from administrative law we know that due process requirements are standard ways through which regulatory agencies have increased their legitimacy. The tenets of regulatory and CSR strategies that emphasise higher standards of care are more compelling when they are placed in a larger context. Krisch and Kingsbury looked at many areas of global governance to analyse the accountability of global regulatory decision-making and wrote: “The structural similarities between many of these disparate phenomena are striking: they testify to a growing trend of building mechanisms analogous to domestic administrative law systems to the global level; transparency, participation, and review are central among them.”903 “In order to boost their legitimacy and effectiveness, a number of regulatory bodies not composed exclusively of states – hybrid public-private, and purely private bodies – have also begun to adopt administrative law [-inspired] decisionmaking and rulemaking procedures.”904

902

World Commission on the Social Dimension of Globalization, A Fair Globalization: Creating Opportunities for All, 2004, p. 4, <www.ilo.org/public/english/wcsdg/docs/report .pdf>, visited on 14 February 2007. (emphasis added) 903 N. Krisch and B. Kingsbury, ‘Introduction: Global Governance and Global Administrative Law in the International Legal Order’, 17 The European Journal of International Law (February 2006), pp. 1–13. 904 Kingsbury et al., supra note 898.

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Chapter 6 An analogy can be drawn with administrative law and how it handled the discretion acquired by regulatory agencies. Ziamou writes that very early in the history of US administrative rulemaking it was perceived that the main danger came from abuse of political discretion. This was so particularly in the 1970s when legislative activity increased, laws became more complex and rulemaking by regulatory agencies expanded significantly. In the US, agencies are regarded as being politically independent, staffed with technical experts. However, the latter had difficulty in establishing legitimacy due to their insufficient political accountability. As a difference from US, agencies in Europe are not regarded as being politically independent. Their legitimacy comes not from the decisions they make but is automatically acquired through the mode of selection. It is therefore in the US that an ideology of process and participation has developed. There, agencies acquire legitimacy by abiding to rules for disclosure, judicial review, participation and empowerment of interest groups.905 In Europe participation of citizens in rulemaking is avoided because of the constitutional doctrine that in a representative democracy decisions should reside directly or indirectly with the elected representative. Participation has been granted in a piece-meal fashion and only in some areas. However Ziamou observes an interest all over Europe in reducing the distance between citizens and decision-making centres as the existing forms of legitimation of administrative rules cannot realistically be considered adequate when the executive holds power over legislature and regulation grows increasingly complex.906 The US experience of obtaining legitimacy through provisions for due process deserves a closer look in a CSR study.907 Pursuing accountability in light of administrative law experiences “focuses in particular on administrative structures, on transparency, on participatory elements in the administrative procedure, on principles of reasoned decision-making, and on mechanisms of review”.908 The unavoidable presence of discretion for the decisionmaker and designing ways to cope with its exercise are a recurrent theme in administrative law and in CSR. The difference is in the decision-makers. In our case it is the company (i.e. its directors) that is granted discretion in balancing the interests of its stakeholders. In public administration it is the regulatory agency to which the legislators have delegated authority and therefore discretion for implementing and specifying the law. As in the case of administrative law, corporate legitimacy in the CSR arena can be enhanced through a combination of transparency, participation and employment of sound processes (to be reviewed in courts or other private arenas). Corporate legitimacy is in doubt when no CSR action 905

T. T. Ziamou, Rulemaking, Participation and the Limits of Public Law in the USA and Europe (Ashgate, Aldershot, 2001) pp. 69, 230,231, 234. 906 Ibid., pp. 2, 3, 251. 907 For an introduction to the US system, see R. B. Stewart, ‘U.S. Administrative Law: A Model for Global Administrative Law?’, 68 Law And Contemporary Problems (2005) <www.law.duke.edu/journals/lcp/articles/lcp68dsummerautumn2005p63.htm>, visited on 14 February 2007. 908 Kingsbury et al., supra note 898.

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Incremental institutionalisation of CSR regime is taken, or where the company has decided to act within the CSR arena but sticks to ‘closed processes’. Closed processes can be internal to the company which implements its policies in secrecy, or internal to an industry association implementing its self-regulation commitments away from the public eye. The discretion acquired by regulatory agencies is the result of increased legalisation. Stewart remarked “the dysfunctions and normative depreciation caused by the expanded use of prescriptive regulation. This expansion has required delegation of vast power and discretion to federal administrators responsible for specifying and enforcing those prescriptions.”909 Orts notes: “The expansion of substantive command-and-control [regulation] occurs by (1) legislating increasing numbers of detailed statutes and, at the same time, (2) delegating increasing discretion to administrative agencies. This legal expansion increases the separation of lawmaking from the democratic procedures that contribute to the legitimacy of the system… [T]emptations mount to assign administrative agencies greater discretion to make and enforce the law. This strategy raises well-known questions of democratic legitimacy because it results in administrative agencies exercising legislative power.”910

Baldwin and Cave discussed regulation by specialist independent agencies and identified five criteria for legitimising intervention (all of them necessary but present to a greater or less degree in each case): 1. Is the regime supported by legislative authority? 2. Is there an appropriate scheme of accountability? 3. Are procedures fair, accessible, and open (due process)? 4. Is the regulator acting with sufficient expertise? 5. Is the regime efficient?911 Particularly relevant for our discussion are discussions about due process. Baldwin and Cave showed that procedural fairness is important for regulators; due process has a legitimacy-enhancing effect. Regulators can legitimate themselves with strong claims to operate fair procedures when there are uncertainties about mandates and regulatory ends.912 Public support is merited because the regulator uses procedures that are fair, accessible and open, which allow the participation of the public and affected parties. However, this criterion in itself is insufficient to establish legitimacy; it has to act in conjunction with the other four criteria. Also this criterion is limited as a guiding principle because further questions must be answered: who should be able to participate, and in what manner? What mode of participation (formal or different arrangements)?913 Finally, placing legal procedural

909

R. B. Stewart, ‘Reconstitutive Law’, 46 Maryland Law Review (Fall 1986) p. 102. E. W. Orts, ‘Reflexive Environmental Law’, 89 Northwestern University Law Review (Summer 1995) p. 1259. 911 R. Baldwin and M. Cave, Understanding Regulation: Theory, Strategy and Practice (University Press, Oxford, 1999), p. 77. 912 Ibid., p. 314. 913 Ibid., p. 79. 910

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Chapter 6 requirements upon regulators may increase costs and delays, and make it easier to mount legal challenges by those adept at manipulating such challenges.914 All these observations sound familiar to CSR readers. There are uncertainties about the allocation of human rights responsibilities between businesses and governments. CSR proponents expect business to open up, consult with stakeholders and publicly report on their CSR performance. Adherence to due process alone may be insufficient to provide legitimacy and protection to a company as exemplified by the Brent Spar incident in which Shell attempted to sink an obsolete oil rig; there Shell used rigorous scientific standards, its original studies were sound, the guidelines of the International Maritime Organization also permitted deep-sea disposal, the practice was accepted in the US where environmentalists do not oppose this method, while Greenpeace presented grossly overstated figures of oil pollution for which it later apologised.915 Stewart noted the large residual discretion that regulatory agencies have acquired following broad statutory delegations. To deal with this discretion administrative law has assumed both ‘negative’ (power checking) and ‘affirmative’ (power directing) functions. Regarding the latter it was noted: “[A]dministrative law has assumed the affirmative task of ensuring that regulatory agencies exercise their policymaking discretion in a manner that is informed and responsive to the wide range of social and economic interests and values affected by their decisions, including the beneficiaries of regulatory programs as well as those subject to regulatory controls and sanctions.”916 Seidenfeld discusses the hard look doctrine of judicial review which courts have imposed under the ‘arbitrary and capricious’ standard of review. The courts get focused on the administrative decision-making process and require explanations on how the discretion was exercised. Seidenfeld writes: “Essentially, under the hard look test, the reviewing court scrutinizes the agency’s reasoning to make certain that the agency carefully deliberated about the issues raised by its decision … Courts require that agencies offer detailed explanations for their actions. The agency’s explanation must address all factors relevant to the agency’s decision. A court may reverse a decision if the agency fails to consider plausible alternative measures and explain why it rejected these for the regulatory path it chose. If an agency route veers from the road laid down by its precedents, it must justify the detour in light of changed external circumstances or a changed view of its regulatory role that the agency can support under its

914

Ibid., p. 315. D. Vogel, The Market for Virtue: The Potential and Limits of Corporate Social Responsibility (Brookings Institution Press, Washington D.C, 2005), pp. 112–114. 916 Stewart, supra note 907. (emphasis added) 915

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Incremental institutionalisation of CSR regime authorizing statute. The agency must allow broad participation in its regulatory process and not disregard the views of any participants.”917

It was noted that “[h]ard look review of agency rulemaking currently requires an agency to demonstrate that it has engaged in a deliberative regulatory process, including examination of the relevant data, careful consideration of statutorily relevant factors, consideration of all important aspects of a problem, and provision of a satisfactory explanation for its action”.918 Sunstein also wrote: “All of these [hard look doctrine] developments can be understood as an effort to ensure that the agency’s decision was a ‘reasoned’ exercise of discretion and not merely a response to political pressures.”919 Seidenfeld explains the function of the hard look doctrine. “[It] helps to ensure that agency decisions are determined neither by accommodation of purely private interests nor by surreptitious commandeering of the decisionmaking apparatus to serve an agency’s idiosyncratic view of the public interest … Hard look review encourages agencies to obtain and coordinate input from various professional perspectives. By doing so, hard look review discourages rules that reflect a biased or parochial view of the public interest.”920

According to Stewart, “[b]ecause of the heavy emphasis placed by reviewing courts on the requirement that agencies address and respond to the material submissions of all participating interests and provide a reasoned justification for the balance struck among them, this aspect of administrative law reflects a deliberative conception of democracy”.921 Law “seeks to fill this gap by creating a surrogate process of representation through legal procedures rather than through electoral mechanisms and to expand the scope of judicial review to include close scrutiny of agency exercises of discretion”.922 The analysis so far highlighted the emphasis administrative law has placed on reasoned exercise of discretion. Requirements of due process, transparency and participations are the common means towards this goal. But a risk that international regulatory strategies aiming at sound procedures carry relates to the risk as overburding them. “In domestic settings, standard elements of administrative law, such as procedural participation and judicial review, perform particular, limited functions, and most of the burden of ensuring accountability lies with the electoral processes that check parliamentary law-making as well as governmental action. 917

M. Seidenfeld, ‘Demystifying Deossification: Rethinking Recent Proposals to Modify Judicial Review of Notice and Comment Rulemaking’, 75 Texas Law Review (February 1997) pp. 491, 492, (footnotes omitted). 918 M. P. Vandenbergh, ‘The Private Life of Public Law’, 105 Columbia Law Review (2005), <papers.ssrn.com/sol3/papers.cfm?abstract_id=729363>, visited on 14 February 2007. 919 Quoted in ibid. 920 Ibid., pp. 491, 510. (footnotes omitted). 921 Stewart, supra note 907. (emphasis added) 922 Ibid.

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Chapter 6 Once this electoral anchor is lost, as it is on the global level, administrative law-type mechanisms risk being overburdened by the demands made on them.”923 According to Aman, “[a]dministrative law, traditionally conceptualized, deals primarily with the way in which state entities exercise and explain the use of their discretion”.924 The author reflects on the dynamics of globalisation and the delegation of public functions to private actors. He sees that there are mainly two ways to assess an increased reliance on markets and the private sector. On one hand such developments appear to provide opportunities to minimise the role of the state (a laissez-faire approach). On the other hand, delegation is not a step away from the state but an extension of the state. “Rather than directly resisting global processes, the delegation of public functions to private actors represents new ways for states to carry out their responsibilities. From this perspective, markets are a form of regulation and not simply the substitution of a wholly private regime for what once was public. Public law values such as transparency, participation, and fairness remain relevant … [I]t is important to understand deregulation and privatization as often being extensions of the state, thereby requiring new ways of assuring transparency and public participation.”925

An example of a CSR-stimulating regulation is the EU’s Eco-Management and Audit Scheme (EMAS). It makes clear to corporate applicants that requirements of transparency and participation need to be fulfilled. Overall EMAS provides in great detail the procedural benchmarks that organisations should observe to obtain certification. However, organisations implementing EMAS “shall be able to demonstrate that the management system and the audit procedures address the actual environmental performance of the organisation”.926 Further “[o]rganisations shall be able to demonstrate an open dialogue with the public and other interested parties including local communities and customers”.927 Finally “employees shall be involved in the process aimed at continually improving the organisation’s environmental performance”. 928 Organisations shall also take note of Commission guidance on best practice in this field. Mentioning this certification scheme also draws attention to the issue of judicial review, which plays a crucial role in domestic administrative law. Stewart notes that “for most global regimes for the foreseeable future, administrative law will probably have to be built without the presence of strong reviewing courts or similar bodies”.929 In these circumstances, essential are arrangements for public access to 923

N. Krisch, ‘The Pluralism of Global Administrative Law’, 17:1 The European Journal of International Law (2006) pp. 247–278. (emphasis added) 924 Aman, supra note 932, p. 382. 925 Ibid. 926 Council Regulation (EC) No. 761/2001, supra note 331, Annex I(B). 927 Ibid. 928 Ibid. 929 Stewart, supra note 907.

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Incremental institutionalisation of CSR regime information, mechanisms to promote decisional transparency and participation. Even in the absence of a strong, independent reviewing authority “[t]hese mechanisms might provide a substantial degree of informal responsiveness… It would be exceedingly parochial to think that there can be no genuine system of administrative law without the sort of judicial review that has been the centrepiece of U.S. and, increasingly, European models of administrative law.”930 In this respect, the EMAS system mentioned above is enforced by external auditors which are accredited by each member EU state. Braithwaite and Drahos conducted a comprehensive study on regulatory dynamics in more than a dozen of international business areas and note: “NGO imagination about how they can achieve the enforcement end of global regimes tends to be limited to traditional state enforcement. In the global arena, this leads to despair when NGOs realise that many regulatory authorities are corrupt, uninterested, underresourced, captured or incompetent. The commonest remedy … is to design into the regime a requirement that regulated actors pay for gatekeepers to audit their compliance, and those gatekeepers are monitored in a way that insures that competence, integrity and diligence are the best way for them to flourish.”931

In administrative law, courts have reviewed the exercise of discretion by the regulatory agencies. Aman notes that the judicialisation of administrative procedure has been a persistent trend in administrative law over the years.932 The author observes the drawbacks that accompany excessive proceduralisation: “Informal rulemaking itself has become so proceduralized as to spawn a literature that refers to such issues as rule ossification. Various forms of risk-benefit assessments have been imposed, often in such demanding and complex ways as to justify criticism of the administrative process as a form of ‘paralysis by analysis.’ Indeed, given the complex and excessive costs that over-proceduralization can cause, deregulation takes on added force as a regulatory reform.”933

For example, impact assessments are a due process requirement often mandated on regulatory agencies, and increasingly expected from businesses adhering to CSR. Orts refers to the US National Environmental Policy Act (NEPA) which requires federal agencies to prepare and disclose environmental impact statements before taking actions significantly affecting the quality of the human environment. The effects of this requirement have been open to debate: 930

Ibid. J. Braithwaite and P. Drahos, Global Business Regulation (Cambridge University Press, Cambridge, 2000), p. 619. 932 A. C. Aman, Jr, ‘The Limits Of Globalization and the Future of Administrative Law: From Government to Governance,’ 8 Indiana Journal of Global Legal Studies (Spring 2001) p. 393. 933 Ibid., p. 393. 931

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Chapter 6 “Arguments in favor of NEPA stress that it aims ‘to provoke thought and promote open and well-informed decisionmaking.’ The Supreme Court is ‘almost certain’ the procedural requirements of an environmental impact statement ‘affect the agency’s substantive decision.’ But other observers are not so sure, suggesting that agencies often jump through NEPA’s procedural hoops only after they have reached a decision. If this ‘defensive’ attitude toward NEPA prevails, then the ‘long, often boilerplate, discussions’ of environmental impact statements, which often amount to thousands of pages, contribute to overburdening administrative law.”934

A troublesome dilemma arises when regulators open up the corporate ‘black-box’ (or the administrative agency ‘black-box’ and any bureaucracy for that purpose) and focus on procedures to limit discretion and achieve compliance with law’s goals. On one hand, the motivation underlying the adoption of procedures is to assure that the exercise of authority is not arbitrary and capricious, and to ensure consistent, replicable decision criteria. The use of externally validated procedures can deliver gains: “It is objective, it is a predictable and stabilizing force, it facilitates coordination and planning, and it enhances the fairness of organizational decision making by depersonalizing decision making.”935 This is Weber’s conception of legalisation which highlights the beneficial aspects; he argued that administrative systems obtain legitimacy from conformity to a set of rules promulgated by a properly constituted authority. Legalisation of organisations has been defined as the diffusion of legalistic reasoning, procedures and structures as a means of enhancing the legitimacy of the organisation with critical internal and external constituencies. On the other hand, Sitkin and Bies explain that the legalistic perspective stresses mimetic institutional processes that lead to symbolically useful, but instrumentally dysfunctional, adoption of bureaucratic/legal procedures. More attention would be paid to what is legally defensible rather than to what is organisationally or interpersonally sensible. When organisations go beyond rationally responding to changes in the legal environment, organisations are driven by the symbolic value inherent in adopting easily recognised and readily acceptable legal forms. There is a possibility that decision-making and procedures are increasingly concerned with assuring legal acceptability at the expense of other important criteria: economic and humanistic.936 This institutional, legalistic view accounts for the adoption of legitimacy-enhancing legal forms and foresees that organisations will respond to threats to legitimacy with increased use of legalistic features (formal decision criteria or due process procedures).937 It was noted that “legalization imposes rules on behavior, but whether the rules result in mindless conformity and passivity or 934

Orts, supra note 910, p. 1274. S. B. Sitkin and R. J. Bies, ‘The Legalization of Organizations: A Multi-Theoretical Perspective’, in S. B. Sitkin and R. J. Bies (eds.), The Legalistic Organization, (Sage, London, 1994) p. 34. 936 Ibid., pp. 20, 21. 937 Ibid., pp. 21, 22. 935

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Incremental institutionalisation of CSR regime support mindful intelligence and activism should be determined by empirical observation, not by theoretical presumption”.938 An example of unproductive legalisation appears when organisations may bury stakeholders in data or procedural detail that meets legalistic expectations for openness/formal procedure while effectively obscuring key information. There is a “well-known use of elaborate information-processing routines as an important vehicle for managing perceptions of competence and responsibility, in that the mere adoption of formal or elaborate systems taps the symbolic acceptability of the careful collection, analysis, documentation, and availability of evidence used in decision making”.939 The disclosure strategy adopted by the UK authorities for the Combined Code and the Business Review is explicit about the dangers of ‘boilerplate’ reporting which would turn it into “a mechanical exercise resulting in bland statements or public relations driven disclosure”.940 Also the US Supreme Court employed a similar reasoning when it decided to set the standard of materiality for disclosures high enough to prevent an overabundance of information that was seen “simply to bury the shareholders in an avalanche of trivial information – a result that is hardly conducive to informed decision-making”.941 Bohle and Quinlan note potential problems with the regulatory shift toward management systems. There is always a danger of ‘paper compliance’. In the occupational health and safety area, the active participation of workers has been critical to avoid this. Management systems are no magic bullet and attention needs to be given to the infrastructure required. Law created two significant mechanisms for workers involvement at workplace level: health and safety committees, and employee health and safety representatives.942 Sitkin and Bies write that “legalization has been heralded by regulators and workers advocates as a primary mechanism for fostering rational choice and constraining managerial abuse of discretion…”.943 However legalisation has its own paradoxes. The power paradox says that: “While legalization may arise to protect the less powerful, its actual effect can be the opposite: those in power are protected as long as they adhere to the letter rather than the spirit of the law. Thus, while legalization is frequently an intended positive force, it can paradoxically undermine the very social goals it was designed to further.”944 Closely linked is the justice paradox where highly formalised legalistic procedures may legally protect managers and organisations. There is also the rationality paradox of legalisation which cautions that “an inflexible, procedural authority rooted in formal rules, and an

938

R. W. Scott, ‘Law and Organizations’, in ibid., p. 12. (emphasis added) Sitkin and Bies, supra note 935, p. 25. (emphasis added) 940 Department of Trade and Industry, supra note 557, para. 3.6. 941 Basic Inc. v. Levinson, supra note 523. 942 Bohle and Quinlan, supra note 820, pp. 299, 300. 943 Sitkin and Bies, supra note 936, p., 43 944 Ibid., p. 29. 939

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Chapter 6 obsessive consistency in applying those rules, can supersede the adaptive, flexible positional authority of managers”.945 In these circumstances, “[t]he challenge is to identify mechanisms for managing or regulating legalization; to identify the less useful forms of legalization, while retaining the beneficial aspects that first drew attention to legalization as an important mode of organization (efficiency-related) and social (fairness-oriented) reform”.946 Administrative law treatments of discretion dovetail with what leading businesses are already doing regarding CSR. Leading businesses have gone a long way in demonstrating due process and obtaining legitimacy. Chapter 4 made a presentation of good CSR practices developed in multistakeholder fora; they all tend to stress transparency and participation of stakeholders in the process. Administrative law and CSR promote a reasoned exercise of discretion and an informed, responsive style of decision-making that makes careful consideration of available alternatives. As leading businesses and their stakeholders lay down substantive and procedural CSR standards, set up collaborative fora and interact with partners with CSR expertise, new dynamics for accountability appear. Other businesses find it easier to set targets and implement sound CSR processes. Also stakeholders acquire the necessary benchmarks to make assessments of corporate performance. The precepts of due process that in administrative law are enforced by courts are to be enforced in the CSR area through a mix of private and public enforcement. Prescribing management systems does not guarantee compliance, but they have a crucial role in systematising complex tasks. Zadek writes: “There are no magic bullets that will create civil corporations. There are no standard systems that substitute for real-life, messy solutions made up of cocktails of unusual leadership, coincidence and luck, and really hard work. But the effective systematization of such cocktails is, nevertheless, a critical ingredient of longer-term success, both in developmental and in commercial terms. Many systems aimed at aligning core business strategies and processes with elements of social and environmental aims and outcomes have emerged in the last ten years.”947

As policymakers come to view CSR as a public policy option, business executives and policymakers increasingly interact. For CSR sceptics from the civil society this interaction often feels as a worrisome development with policymakers being captured by powerful business interests. The avowed CSR commitments jointly forged by business and governments may as a result be weak and ineffective, and also pre-empt the adoption of strong regulations. NGOs have voiced concerns that the rapprochement between the UN and business leads to capture, the UN being rendered impotent to effectively regulate MNEs. The UN Global Compact has been at the centre of this debate in the last eight years. In all these contexts, the remedies 945

Ibid., p. 30. Ibid., p. 43. 947 Zadek, supra note 425, p. 11. 946

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Incremental institutionalisation of CSR regime developed within administrative law to handle closed processes are highly relevant. The environmental arena has witnessed voluntary approaches which involve direct negotiation between industry and regulators. With their closed-door negotiations, these approaches appeared to make regulatory agencies more vulnerable to ‘capture’ by the regulated industry. However it was noted: “Without a doubt, the arena of policy-making knows how to combat the disadvantages associated with closed processes. In fact, the public participation and transparency laws that have developed in public and administrative law stem directly from the same concerns in the regulatory process.”948 6.3. OBSERVATIONS FROM REGULATORY THEORY The analysis so far highlighted some of the variables that intermediate between law’s goals and corporate behaviour. The challenge is to comprehend how these variables could combine to move corporations toward compliance. A general work of this kind cannot offer prescription on how these variables should be arranged to obtain compliance in a specific case. However highlighting the variables and their interactions is a necessary preliminary step; issues that previously were deemed legally irrelevant suddenly become indispensable for understanding the legal mechanism at work. The chapter continues the discussion of regulations, which tend to operate not in a pure deterrence mode, with some broader theoretical remarks drawn from regulatory theory where authors have accounted for various forces that can influence corporations. The main issue discussed is that of compliance, which is linked to concepts such as ‘regulatory space’ and ‘regulatory mixes’. This study dedicated ample space to understanding the context where law operates. We looked at company law to understand the legal duties that bind managers and at corporate governance systems to grasp some dynamics that surround the governance of large corporations. Then chapter 3 caught a glimpse of a battle of ideas and sought to present the longstanding clash of norms; the incumbent norm is sceptical of CSR and discourages managers from analysing corporate impacts on human rights. Chapter 4 had a look at business practice and how it actually departs from Friedman’s prescriptions. The overview of cases about the collaboration of leading businesses with their stakeholders revealed how private actors create new CSR tools and examples of reconciling business success with the protection of human rights. The regulatory strategies discussed in chapter 5 can be properly understood only after comprehending the ‘regulatory space’. The OECD wrote that “[a] proper understanding of compliance and regulation therefore involves not just an understanding of regulators’ strategy, but of the ‘regulatory space’ in which government regulation operates… A central question in research on the role of third parties in regulation is whether governments can work in partnership with third parties to improve compliance with 948

CERNA, supra note 816, p. 11.

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Chapter 6 substantive policy outcomes, and if so, how to do that. This is a huge question for research since a comprehensive answer requires a comprehensive understanding of how markets and societies work.”949

Using law to support the institutionalisation of the CSR regime puts a premium on understanding the concrete circumstances where law will operate. We have seen that lawmakers can employ ‘regulatory mixes’ that combine public codification with private standardisation, legally binding and non-binding instruments, and public and private enforcement. The complex causality between law’s objectives and corporate behaviour (compliance) forces us to identify intermediary variables that lawmakers can target. As the OECD noted: “A central theme of much of the current research on regulation is the idea that in order to understand compliance, we must understand how government regulation interacts with other forms of ‘regulation’. In particular, scholars are using the concept of ‘regulatory pluralism’ to draw attention to the fact that the state is not the only source of ‘regulation’. This interest in looking at the different forms of ‘regulation’ that may affect potential targets of government regulation has lead researchers to look at a number of new areas including the role of internal corporate compliance systems and self-regulation, the role of standards in affecting business conduct, the role of third parties as ‘enforcers’ of policy objectives and the possibility of using incentives for compliance leadership.”950

Scott writes that “[l]egal frameworks and rule systems were earlier assumed to command compliance, to exercise efficient control. Now, it is more widely understood that regulative systems often exert only weak effects and may bring about change not by exerting coercion but by stimulating other institutional mechanisms such as normative and identity processes.”951 Avoiding needless, but deeply rooted dichotomies is indispensable before one can begin a deeper analysis of the variables that effect compliance in the specific context of transnational CSR. Wood observes that “the political vocabulary structured by oppositions between state and civil society, public and private, government and market, coercion and consent, sovereignty and autonomy and the like, does not adequately characterise the diverse ways in which rule is exercised in advanced liberal

949

OECD, Reducing the Risk of Policy Failure: Challenges for Regulatory Compliance, 2000, pp. 77, 82, <www.cccp.anu.edu.au/Published_OECD_Report2.pdf>, visited on 14 February 2007. 950 Ibid., p 76. 951 W. R. Scott, Institutions and Organizations, 2nd ed. (Sage, Thousand Oaks, California, 2001) p. 209.

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Incremental institutionalisation of CSR regime democracies. What is needed is an alternative way of thinking about government that avoids the limitations of these dichotomies.”952

Wood thus describes the ‘hybridisation of law and market, state and non-state’: “[W]hat emerges is a range of heterogeneous, shifting links among a variety of public and private authorities, through which these authorities pursue their goals not so much by domination and control as by exercising subtle and unpredictable influences upon the interests, beliefs and choices of firms and individuals.”953 The concept advanced to account for this state of affairs is that of ‘smart’ or ‘responsive’ regulation. This discourse proposes that “most ‘regulation’ is already in the hands of actors other than the state and uses this insight to propose a new conception of the regulatory process that transcends sterile regulation-deregulation and market-state dichotomies. It proposes new regulatory strategies that combine state, market, private and public actors and forms of regulation and enlist nonstate resources and mechanisms such as self-regulation, EMSs, ecolabeling schemes, environmental reporting and industry-community agreements in furtherance of ‘governing at a distance’.”954

While there are merits to regulatory schemes that stick to clear fault lines, the premium in some fields is on ideas to overcome the aforementioned dichotomies. Teubner develops powerful characterisations of the task of regulators in modern societies. Teubner’s theory cuts through the regulation-deregulation debate in innovative ways. His concept of reflexive law is grounded in systems theory. Reflexive law aims at external stimulation of self-regulating processes. Its basic unit is legal communications; these encompass not only the legal discourse on norms or organised actions like the decisions of courts and legislatures, but also any human communication which has reference to legal expectations. Reflexive law stems from the limited ability of the law in a complex society to direct social change in an effective manner and therefore aims to promote self-regulation and guide behaviour. Instead of directly regulating behaviour to reach predetermined outcomes, reflexive law attempts to influence decision-making and communication processes with required procedures.955 It supports social autonomy and relies on ‘invisible hand’ mechanisms; still, it aims at regulated autonomy: to shape the system’s procedures of internal discourse and also their methods of coordination with other systems. It aims to create the structural premises for a decentralised integration.956 Reflexive law, which is primarily procedural law, serves as the necessary integration mechanism for society. It does not lead to delegalisation; with the increasing 952

Wood, supra note 321, p. 188. Ibid., p. 187. 954 Ibid., p. 206. 955 D. Hess, ‘Social Reporting: A Reflexive Law Approach to Corporate Social Responsiveness’, 25 Journal of Corporation Law (December 1999) p. 51. 956 G. Teubner, ‘Substantive and Reflexive Elements in Modern Law’, 17:2 Law and Society Review (1983) p. 255. 953

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Chapter 6 autonomy of subsystems, the trend toward increasing legalisation will continue, Teubner says.957 The resulting regime can be characterised by ‘enforced selfregulation’, a situation in which self-regulation is subject to governmental structuring or oversight.958 Teubner applies his insights from self-referential systems to CSR. Teubner’s starting point is the high degree of functional autonomy attained by the economic system. Therefore the major problem is: “[H]ow can the social integration of the economy be carried out without losing the advantages of a high degree of differentiation?”959 Teubner views CSR as an integrative device in a society characterised by extreme functional differentiation. He proposes a procedural approach to CSR focusing on disclosure, audit, justification, consultation and organisation of internal control processes. The functional conception of CSR needs no a priori definition of the substantive goals to be achieved, while the law should systematically strengthen reflection mechanisms within the economic system. His proposal is to construct duties toward stakeholders along these lines. 960 Teubner did not write in a context where leading businesses institutionalise bits of these duties; this context was mostly inexistent at that time (1984). Teubner’s interest was not, and could hardly be, in looking at the practices of leading businesses, and their interaction with the legal system, in an evolutionary perspective. But Teubner’s diagnosis and orientation are as valuable now as then. Reflexive law theory focuses attention on intermediary variables which are likely to prove important in the emerging CSR regime. A focus on belief systems and norms, as done in chapter 3 of this study, animates researchers belonging to cultural strands of institutionalism. They look, as Baldwin and Cave explain, at the influence of informal rules, procedures, conceptions, ideologies, theories, shared values, beliefs, expectations and understandings. More particular concerns are cognitive processes, cultural frames of perception, relationships between ideas and practical responses. In emphasising the self-productive aspect of institutions such cultural approaches are consistent with systems theory and the idea that the differentiated functional systems into which society is divided are autopoietic. Each system has its own rationality.961 Reflexive law strategies count on intermediary actors; however the impact of these actors cannot simply be understood as private enforcers and regulators, but because of internal tensions in their own roles, they may simply have a role as facilitators of regulatory dynamics and communicators of meaning. Institutional investors taking a longer-term perspective are one such intermediary actor. Trade associations are another. Rees evaluates the Responsible Care (RC) initiative adopted by the chemical industry in the wake of the Bhopal disaster in 1984. The 957

G. Teubner, ‘Autopoiesis in Law and Society: A Rejoinder to Blankenburg’, 18:2 Law and Society Review (1984) p. 300. 958 Baldwin and Cave, supra note 911, p. 39. 959 Teubner, supra note 208, pp. 161, 162. 960 Ibid., p. 166–172. 961 Baldwin and Cave, supra note 911, p. 31.

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Incremental institutionalisation of CSR regime trade association is confronted with a basic tension in its implementation efforts. As an industry association, it can promote implementation of public policy goals because it understands industry’s needs and concerns, receives intelligence from members and uses its own channels of implementation. However, as a regulator, it must acquire enough independent authority to restrain its members. RC needs the means to bind members to its goals (industry’s collective goals), and the means to isolate itself from corrupting industry pressures (capture) and safeguard its integrity. How do we evaluate Responsible Care then? For sceptics, RC has hollow commitments because the industry body, as a consensus organisation, lacks authority to enforce them. But according to Rees, this is a too selective indictment: “Responsible Cares’s ethical framework, thanks to the new expectations and demands its public commitments generate, has set in motion a normative structure that encourages a posture of criticism of existing industrial practices.” RC generates expectations of accountability.962 More broadly it was noted that multistakeholder partnerships that develop standards and norms structure business conduct in the global economy. “While generally not enforceable, such standards create reference frames that define acceptable behavior.”963 Rees further puts in an interesting historical context the Responsible Care initiative. He refers to ‘associationalism’ – a current of American social thought – which envisioned a regulatory system built around associations of all kinds, including trade associations, as a middle way between governmental regulation and laissez-faire prescriptions. Its overall aim is to encourage socially responsible selfgovernance of functional groups. Trade associations functioned in an associationalism mode in the US from 1925 to 1935 when it died out, partly because it was overwhelmed by the Great Depression, and partly because of the Supreme Court’s decision to strike down the New Deal’s National Recovery Act as an unconstitutional delegation of government authority to trade associations and other corporate groups.964 Similar charges against the legitimacy of a regulatory scheme relying excessively on collective self-regulation are likely to be made in our days by critics of CSR from both the left and right ends of the political spectrum. In this context it can be noted an important facilitative role that regulators can play in CSR: calm the antitrust concerns of companies willing to join forces with other businesses and thus implement CSR more effectively.965

962

J. Rees, ‘Development of Communitarian Regulation in the Chemical Industry’, 19 Law and Policy (October 1997) pp. 30,36. 963 J. M. Witte and W. H. Reinicke, Global Public Policy Institute, Partnerships: Opportunities and Challenges of Partnering with the UN, 2005, <www.partnershipnetwork .org/mainpages/public/objects/object.php?object_id=56&PHPSESSID=3d042e54fba40e9a92 0bcbb95c2bbe20>, visited on 14 February 2007. 964 Ress, supra note 962, pp. 5, 6. 965 See United States Department of Justice, Antitrust Division, Re: Request for Business Review Advice - Fair Factories Clearinghouse, 2006, <www.usdoj.gov/atr/public/busreview/ 216720.htm>, visited on 14 February 2007; S. Murray, ‘Alliances Heed Antitrust Traps’,

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Chapter 6 Ougaard articulates a particularly insightful prediction regarding where CSR may evolve in the broader governance picture: “In principle the current pattern of loosely organized networks, voluntarism, private codes and self-regulation can continue for a long time. But three factors in combination – the limits of private initiatives and the moves towards standardization and authoritativeness – pull in the direction of a closer connection to political authorities, nationally, regionally and none the least globally. Given the current realities of global governance structures… it is not likely that this will imply a movement towards traditional firm regulation by political authorities. Much more probable is a move towards … ‘regulated self-regulation’, i.e. a pattern in which outer boundaries of acceptable behaviour as well as stipulations of acceptable procedures for defining codes and standards are determined by public authorities, thus creating a space of variation in which state and non-state actors bargain and cooperate to set more detailed rules and standards.”966

Regulators come to rely on the regulatory potential of private actors. These could be actors with leverage in the operating environment of a business, as discussed in the preceding paragraphs, or the business group itself employing its own internal procedures and systems. The OECD noted regarding the self-regulatory potential of business: “[M]any systems of criminal and civil law, in considering some matter, ask that companies be able to demonstrate that ‘due care’ has been exercised in the performance of the activity under consideration. In some countries, this creates powerful incentives to identify major risks and to devise systems of internal control designed to manage such risks. These often include codes of conduct and supporting management systems and practices. In particular, some member countries have explicitly incorporated consideration of compliance and risk management practices into their approach to regulatory enforcement and to punishing and correcting illegal corporate activity. This creates powerful incentives for companies to adopt credible management practices in this area. This partial shifting of the focus of legal and regulatory enforcement onto the internal practices of companies can be an attractive law enforcement option for many types of potential corporate misconduct.”967

Financial Times, 5 January 2006; J. Freeman, ‘The Private Role in Public Governance’, 75 New York University Law Review (2000) p. 543. 966 M. Ougaard, ‘The CSR Movement and Global Governance’, in S. Singh–Sengupta (ed.), Business –Social Partnership: An International Perspective (Aalekh Publishers, Jaipur, 2004) pp. 142–158. (emphasis added) 967 OECD, Public Policy and Voluntary Initiatives: What Roles Have Governments Played?, Working Papers on International Investment 2001/4, OECD Directorate for Financial, Fiscal and Enterprise Affairs, 2001, p. 6, <www.oecd.org/dataoecd/45/30/1922814.pdf>, visited on 14 February 2007.

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Incremental institutionalisation of CSR regime Grabosky draws attention to the fact that when governments use leverage to achieve regulatory compliance rather than using direct command and control techniques it can raise potential problems of accountability, market failure, gatekeeper failure, undue influence on government policy, conflicts of interest and lack of policy coherence. This means that governments will have to develop greater capacities for strategic intelligence, oversight and co-ordination.968 Demmke similarly notes that “[d]ecentralisation and delegation has many advantages but entails new problems as well: coordinating the activities of all the players in a decentralised landscape and producing accountability and legitimacy of decentralised and delegated actors. Another difficulty is to define the limits of decentralisation, since any form of organisation requires at least a minimum of hierarchy as well.”969 This study is not dedicated to soft law instruments per se, but to corporate voluntarism, its interaction with law and public policy, and to regulatory mixes that employ both hard and soft law. The purpose below is to highlight some functions of soft law in the evolution of regimes, and to suggest that soft law can enhance – depending on a favourable or inhibiting context, which itself needs analysis – the protection of human rights. Soft law instruments are used in corporate governance (in the form of codes of corporate governance); soft law has also been widely used in international human rights law and for guiding MNEs regarding their social responsibilities. The legal nature of a provision – resulting from its consecration in hard or soft law – is important, but does not in itself determine the effectiveness of the instrument. As the UN stated, “the effectiveness is more linked to other factors than its formal legal nature, for instance, the widest possible adoption by Governments of the Code, the consistency and efficiency of its application, the support by all parties concerned, and the evolution of the instrument in the future”.970 Soft law can also trigger legal developments. For example, the role of an international code of corporate conduct – soft law – was envisaged by the UN Commission on TNCs as such: “[T]he Code may become a springboard for legally creative action by national courts and other authorities, and even by transnational corporations themselves, to the extent that the latter may help shape pertinent legal principles through their continuous application.”971 Chinkin concisely clarifies the importance of soft law instruments: “The programmatic, educative and evolutionary functions are among the benefits of 968

P. Grabovski quoted in OECD, supra note 949, p. 83. C. Demmke, Towards Effective Environmental Regulation: Innovative Approaches in Implementing and Enforcing European Environmental Law and Policy, Jean Monnet Working Paper 5/01 ,2001, p. 23, <www.jeanmonnetprogram.org/papers/01/010501.rtf>, visited on 14 February 2007. 970 Quoted in J. Blair, ‘A Business View on the Implementation of Codes of Conduct’, in Horn supra note 553, p. 312. 971 ‘Certain Modalities for Implementation of a Code of Conduct in Relation to Its Possible Legal Nature’, UN Doc. E/C.10/AC.2/9, 22 December 1978, quoted by H. W. Baade, ‘The Legal Effects of Codes of Conduct for MNEs’, in Horn, supra note 553, p. 15. 969

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Chapter 6 recording consensus in soft form.”972 Soft law needs assessments on its own terms and not necessarily against expectations generated by hard law. This assessment orients one on a functionalist path for dealing with soft law. Functionalists do not discard soft law pronouncements and say that utility should be judged in context. A resolution of the UN General Assembly is not necessarily devoid of legal significance simply because it is not formally binding. Functionalism holds that the authoritativeness of a process or outcome be judged by reference to actors, relationships, interests involved in each situation rather than by reference to a preconception based on the status of the text or the form of the action. 973 Chinkin further comments on the work of Koh974 which sees the international law-making process as complex and deeply layered, a ‘brave new world’ of international law where transnational actors, sources of law, allocation of decision function and modes of regulation have all mutated into fascinating hybrid forms. Drawing the distinction hard/soft law is less important than understanding the process at work within the law-making environment and the products that flow from it.975 In the field of human rights, non-binding instruments in the form of declarations occupy a prominent place precisely because binding agreements are difficult to conclude. In a politically sensitive area such as human rights, significant progresses have often been triggered through non-binding instruments. However, the context plays a decisive role: a favourable environment can turn (parts of) a non-binding instrument such as the Universal Declaration of Human Rights into international customary law or facilitate further legal developments, while an unfavourable context may render somehow irrelevant a document such as the ILO Declaration of 1977 or the OECD Guidelines of 1976. One needs therefore to look at other factors gravitating around the issue of TNCs and human rights: state measures at national levels, decisions of national courts, activities of civil society actors, attitude of corporations themselves, public awareness to CSR and human rights issues, etc. The human rights case against TNCs is not new, as witnessed by the instruments negotiated in the 1970s and 1980s,976 but takes now place in a significantly changed context. This context has been presented in chapter 4 and is discussed throughout the book as ‘regulatory space’. A counterpart to soft law is corporate voluntarism; while the former is summarily dismissed due to comparisons with hard law, so the latter gets neglected 972

C. Chinkin, ‘Normative Development in the International Legal System’, in D. Shelton (ed.), Commitment and Compliance: The Role of Non-Binding Norms in the International Legal System (Oxford University Press, Oxford, 2000), pp. 30, 31. 973 Johnston, supra note 43, pp. 44, 30–31. 974 H. H. Koh, ‘A World Transformed’, 20 Yale Journal of International Law (1995) p. vii. 975 Chinkin, supra note 972, p. 23. 976 OECD, supra note 41; ILO, supra note 41; World Health Organization, The International Code of Marketing of Breastmilk Substitutes, Resolution of World Health Assembly, WHA 34.22 ,1981,; U.N. Commission on Transnational Corporations, United Nations Code of Conduct for Transnational Corporations, U.N. Doc. E/1990/94, 12 June 1990. Latest version, shelved in 1992.

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Incremental institutionalisation of CSR regime as it does not carry the legal weight of a contract. Still both have roles in the rulemaking process. Gordon undertook one of the few analyses of how synergies between voluntarism and policy/law unfold. Synergies derive from the fact that both systems draw on the same intangible resources: consensus (or ‘social capital’ understood as the widespread agreement on how things ought to be done) and expertise (human capital). The corporate code movement provides a valuable institutional channel for consensus building and sharing of expertise. While voluntary efforts may not be perfect control systems, they “have made important contributions to building up the intangible assets – social consensus and expertise – that are required to make any kind of social control possible. In this sense they are complementary to and synergistic with binding systems of rules.”977 The OECD Guidelines for MNEs have also noted: “Many enterprises have responded to these public concerns by developing internal programmes, guidance and management systems that underpin their commitment to good corporate citizenship, good practices and good business and employee conduct. Some of them have called upon consulting, auditing and certification services, contributing to the accumulation of expertise in these areas. These efforts have also promoted social dialogue on what constitutes good business conduct …”978

Writers in international law have presented views of international legal regimes that depart from a rigid formalism. They work on the observation that “the world is a much more poly-centric place than it was in 1945 and that she who sees the world essentially through the prism of ‘State’ will be seeing a rather distorted image as we enter the twenty-first century… None of this is to suggest that the state is not important, let alone endorse the more extreme versions of the ‘state is dead’ thesis.”979 Such works can assist one in the task of linking businesses to statecentred implementation mechanism, and voluntary approaches to legal instruments that protect rightholders. The result is a more relevant and subtle understanding of law-making at international level. Specifically on business and human rights, Ratner observed: “International law, including human rights law, is invoked, interpreted, and applied in diverse arenas. Some norms based on the principles of international responsibility will be incorporated by businesses themselves under economic pressure from interested shareholders and consumers, who serve as private enforcers of the law. Some claims will be addressed in domestic fora as legislators and government officials draft statutes, regulations, or governmental policy. Some prescription and application of 977

Gordon, supra note 465, p. 5. OECD Guidelines, supra note 41, preface, para. 7. (emphasis added) 979 P. Alston, ‘The “Not-a-Cat” Syndrome: Can the International Human Rights Regime Accommodate Non-State Actors?’, in P. Alston (ed.), Non-State Actors and Human Rights (Oxford University Press, Oxford, 2005) p. 4. 978

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Chapter 6 law will take place in international arenas as diplomats, perhaps prodded by NGOs, prepare treaties or nonbinding legal instruments. And both domestic and international courts and other dispute resolution bodies may play a role. But excessive focus on the activities of courts diverts attention from the principal venues in which international legal argumentation is made and matters.”980

Koh proposes an international law theory of transnational legal process to capture the complexities of achieving compliance in the non-hierarchical world of sovereign states. He purposively makes place in his framework for non-state actors and norms to affect the compliance outcome. “Transnational legal process describes the theory and practice of how public and private actors – nation-states, international organizations, multinational enterprises, non-governmental organizations, and private individuals – interact in a variety of public and private, domestic and international fora to make, interpret, enforce, and ultimately, internalize rules of transnational law.”981 Teubner reflects on the traditional sources of law and the dynamics of globalisation. He refers to channels that achieve international coordination with only a limited intervention of states: “[I]nternal legal regimes of multinational enterprises are a strong candidate for global law without the state. A similar combination of globalization and informality can be found in labour law; in the lex laboris internationalis, enterprises and labour unions as private actors are dominant law-makers. Technical standardization and professional selfregulation have developed tendencies toward worldwide coordination with minimal intervention of official international politics.”982

Long before Koh and Teubner have attempted to focus our attention on underresearched variables that affect the operation of law, McDougal and his colleagues showed the necessity, in certain situations, to move beyond a formalist stance. They wrote: “To conceive of law as a specific type of rule emanating only from highly organised institutional structures is not likely to facilitate the observation of complex patterns of authority and control in unorganized situations … The Austinian frame, for all its syntactic elegance … afford[s] a peculiar inept focus … in communities in which patterns of authority and control

980

Ratner, supra note 4, p. 451. H. H. Koh, ‘Transnational Legal Process – The 1994 Roscoe Pound Lecture’, 75 Nebraska Law Review (1996) pp. 183, 184. 982 G. Teubner, ‘Breaking Frames: The Global Interplay of Legal and Social Systems’, 45 American Journal of Comparative Law (Winter 1997) p. 157. 981

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Incremental institutionalisation of CSR regime are relatively unorganized and shifting constantly, or in which structure is coarchical rather than hierarchical...”983

From an international relations perspective, Ruggie highlights the interaction between CSR and state action. He explains that efforts such as the UN Global Compact “draw on elements of state authority, and mingle them with whatever thin layers of international authority that can be mustered to produce little pockets of global governance. They range in form along the entire spectrum from creating shared understandings among relevant social actors to new treaty obligations … What we are beginning to experience at the global level is the emergence of post-modern forms of governance, resulting in a de-totalization of authority – if there is such a word – a mixing and mingling that is, at one and the same time, functionally less inclusive than the state, but spatially and socially more so.”984

He concludes his address to the audience: “This is a messy world we are moving into. It is full of contradictions and moral dilemmas. It requires a high level of tolerance for ambiguity and a willingness to experiment.”985 In his recent capacity as UN Special Representative on business and human rights, Ruggie coined his approach as ‘a principled form of pragmatism’.986 He later said: “In my work and in my reports, I plan to address the entire array of governmental responsibilities in relation to business and human rights – not just as law-makers and enforcers, but also as enablers, facilitators and partners. I also plan to address the broad array of mechanisms for achieving corporate responsibility; not only legal compliance, but also the role of social norms, moral considerations and strategic behaviour. It's important to acknowledge that these are radically different spheres of human activity, and not to try to subject them all to a single approach or instrument. There are different structures of incentives and disincentives, and if we're going to make a difference we have to learn how to use the different levers in different spheres. There are no silver bullets.”

This section highlights that the emerging CSR regime may employ private and public codification, private and public enforcement, laws or legally non-binding instruments to move companies toward compliance. By varying the assumptions 983

M. McDougal et al., ‘Theories about International Law: Prologue to a Configurative Jurisprudence’, 8 Virginia Journal of International Law (1968) pp. 246,253. (footnote omitted). 984 J. G. Ruggie, Distinguished Visitor’s Lecture in International Studies, University of Wisconsin, Madison, 23 April 2001. 985 Ibid. 986 J. Ruggie, Draft Interim Report of the Secretary-General’s Special Representative on the Issue of Human Rights and Transnational Corporations and Other Business Enterprises, Harvard University, John F. Kennedy School of Government, 2006, para. 81, <www.bsr.org/ meta/BSR_Ruggie-Interim-Report_200603.pdf>, visited on 14 February 2007.

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Chapter 6 concerning actors, one can see how the dynamics nurtured by a regime can converge on certain factors that affect compliance. Young has developed a useful scheme. Actors are initially deemed unitary and rational, and compliance considered either simply a matter of cost/benefit calculation or a calculation that accounts for the compliant or non-compliant behaviour of others. Then the full rationality assumption is relaxed, to make place for incomplete information and for the need to obtain legitimacy by following widely accepted norms. Eventually the unitary assumption is discarded to account for various fractions within the organisation and design compliance incentives attuned to what is happening inside the organisational ‘black box’.987 Young notes that because rational choice models are more developed, one can start analysis with utilitarian models (the first two below) and supplement them with the remaining models.988 1. Self-interested utility maximisers change their behaviour when institutional arrangements alter the costs/benefits that individual actors attach to welldefined options (regimes as utility modifiers). In the business and human rights area, purely deterrent strategies illustrate this case as they aim to magnify sanctions, that is increase their size sanction and likelihood; potential costs increase to a level where prohibited behaviour does not pay off. Conversely the creation of legal incentives (e.g. tax breaks, regulatory relief, reductions of fines) would increase the benefit side of the calculation. 2. The same assumptions apply to the situation when it would be rational for individuals to change their behaviour if not for the collective action problem. This case captures cases where compliant behaviour would be rational, but free-riding by other actors makes individual compliant behaviour irrational. Collective action obstacles are generated by the noncompliant performance of others (regimes as enhancers of cooperation). In CSR discussions, free-riding by laggards has been widely recognised as an inhibiting factor for aspiring responsible TNCs. Binding regulation has often been justified because of its ability to ‘level the playing field’; if regulation, and this is a big if, is uniformly enforced on all players it would solve the free-riding obstacle. Schemes such as the Belgian social label law contain sanctions to discourage free-riders. 3. The assumption of full rationality based on costs/benefits calculations can be relaxed. Actors may comply without engaging in detailed calculations and rely on social norms rooted in legitimacy/authoritativeness. For individuals this may be the result of socialisation while for collective actors routine simplifies cost/benefit calculations (regimes as bestowers of authority). 987

O. R. Young and M. A. Levy, ‘The Effectiveness of International Environmental Regimes’, in O. R. Young (ed.), The Effectiveness of International Environmental Regimes: Causal Connections and Behavioural Mechanisms (MIT, Cambridge, Mass./London, 1999) pp. 22–28. 988 O. R. Young, ‘Regime Effectiveness: Taking Stock’, in ibid., p. 263.

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Incremental institutionalisation of CSR regime 4.

The same assumptions hold as in case 3, but here they illuminate the learning process on which rational decisions are based. Regimes generate new facts that reduce uncertainty or produce a more accurate picture, prompt actors to reassess their roles and values, and lead to redefinition of interests. By shaping identities and roles, regimes operate at a constitutive level (regimes as learning facilitators).

The assumption of the unitary actor can be relaxed to highlight modalities of influencing its behaviour. This encourages a look at the internal dynamics of collective entities. Regimes affect behaviour by creating new constituencies or shifting the balance among factions/subgroups. Regimes thus strengthen the hand of one subgroup to deal with others in the group (regimes as agents of internal realignments). For example, the oil pollution regime expanded the role of port states in contrast to flag states and allocated new roles to insurers and classification societies in ensuring compliance. The regime exploits internal forces within the business community: ship builders, ship owners, insurers, and classifiers. Their role as gatekeepers proved essential and it could not be acted upon unless the regime conferred legitimacy to them.989 From a social science perspective the complex rulemaking process surrounding CSR can be seen as ‘structuration’. Lawmakers will have to relate somehow to this unfolding process: “The notion of organizational field thus draws heavily upon the social constructionist account of reality. Collective beliefs are seen as emerging from processes of repeated interactions between organizations. Organizations develop categorizations (or typifications) of their exchanges, which achieve the status of objectification and thus constitute social reality. Organizations, initially at least, behave in accordance with this socially constructed reality because to do so reduces ambiguity and uncertainty. Reciprocally shared understandings of appropriate practice permit ordered exchanges. Over time, these shared understandings, or collective beliefs, become reinforced by regulatory processes involving state agencies and professional bodies, which normatively and/or coercively press conformity upon constituent communities. Regulatory processes thus both disseminate and reproduce coded prescriptions of social reality. Deviations from such prescriptions cause discomfort and trigger attempts to justify (that is, legitimize) departures from the social norm. The notion of ‘structuration’ … captures this process of gradual maturity and specification of roles, behaviors, and interactions of organizational communities.”990

Sparrow plastically referred to the regulators’ challenge: 989

Ibid., pp. 262, 264. R. Greenwood et al., ‘Theorizing Change: The Role of Professional Associations in the Transformation of Institutionalized Fields’, 45 Academy of Management Journal (February 2002) pp. 58–80. (references in text ommitted) 990

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Chapter 6 “Regulators, under unprecedented pressure, face a range of demands, often contradictory in nature: be less intrusive – but more effective; be kinder and gentler – but don’t let the bastards get away with anything; focus your efforts – but be consistent; process things quicker – and be more careful next time; deal with important issues – but do not stray outside your statutory authority; be more responsive to the regulated community – but do not get captured by industry.”991

This reality provides an added incentive for regulators to search for new, more effective and also cost-efficient ways to achieve compliance. The search for innovative regulatory methods is fuelled by concerns for the effectiveness of law: do laws actually lead to compliance or not? The OECD observed that “[s]cholarly interest has turned towards research that evaluates alternatives to traditional ‘command-and-control strategies’ that relied on a simple theory of deterrence. In particular this research takes a more holistic approach towards regulation and examines the effectiveness of mixes of regulatory strategies that will utilise the complexity and variety of motivations underlying compliance … The result is a more outcomeoriented approach to the study of regulatory compliance. The emphasis is on the substantive policy objectives of the regulation, and whether the regulatory policy instruments chosen are capable of accomplishing those objectives, not on compliance with rules that may or may not be effective at achieving the desired result.”992

6.4. INCREMENTAL INSTITUTIONALISATION OF CSR REGIME The CSR regime in which private actors have been interacting is incrementally institutionalising the responsibilities of corporations. Ruggie referred to the “dynamic interplay between civil society organizations and transnational firms in the area of corporate social responsibility [which] has become institutionalized in the sense that it involves readily identifiable players who employ shared practices and engage in fairly predictable patterns of interaction”.993 The developments triggered by leading businesses and their stakeholders can be understood as a regime in its incipient stages of development. Understanding the broad dynamics of regimes can help assess more fully the effects of CSR as well as the opportunities for lawmakers to regulate a network of actors.

991

M. Sparrow, The Regulatory Craft – Controlling Risks, Solving Problems, and Managing Complience (2000), quoted in External Advisory Committee on Smart Regulation, Smart Regulation – A Regulatory Strategy for Canada, Report to the Government of Canada, 2004, p. 16, <www.smartregulation.gc.ca/en/08/rpt_fnl.pdf>, visited on 14 February 2007. 992 OECD, supra note 949, pp. 73, 74. 993 J. G. Ruggie, ‘Reconstituting the Global Public Domain – Issues, Actors, and Practices’, 10 European Journal of International Relations (December 2004) p. 519, <ejt.sagepub.com/ cgi/content/abstract/10/4/499>, visited on 14 February 2007.

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Incremental institutionalisation of CSR regime 6.4.1. Functions and dynamics of regimes Regimes are social institutions that define practices, assign roles and guide the interaction of occupants of such roles within given issue areas.994 Slaughter referred to international regimes as closely related to the idea of international governance. The latter can be defined as “the formal and informal bundles of rules, roles and relationships that define and regulate the social practices of state and nonstate actors in international affairs”.995 The concept of regime captures the multitude of actors and instruments that subtly constrain participants and simplify complexity by illuminating new means for them to pursue their interests. Young notes that regimes often launch programmatic activities in contrast to laying down regulatory prescriptions. Over time regimes become more influential as the issues achieve political prominence and the evolution of the regime itself enmeshes participants in a web of institutionalised activities from which they cannot easily extricate themselves. Regimes draw participants “into a normatively grounded social practice that they can no longer ignore in political terms”.996 Dunoff and Trachtman write: “[M]arkets are understood to arise out of the activities of individual persons or firms. These individuals seek to further their self-defined interests through the most efficacious means available. While each individual acts for himself, ‘[f]rom the action of like units emerges a structure that affects and constrains all of them. Once formed, a market becomes a force in itself, and a force that the constitutive units acting singly or in small numbers cannot control.’”997

Suchman and Edelman comment on DiMaggio and Powell’s definition of an ‘organisational field’ as “those organizations that, in the aggregate, constitute a recognized area of institutional life: key suppliers, resource and product consumers, regulatory agencies, and other organizations that produce similar services and products”.998 The former authors further write that “[a]lthough the practices of organizational fields are initially indeterminate, ‘professional projects’ and ‘institutional entrepreneurship’ can engender a cascade of isomorphism, in which actors making rational decisions construct around themselves an environment that constrains them in later years”.999 994

R. O. Young, quoted in O. S. Stokke, Fridtjof Nansen Institute, The Interplay of International Regimes: Putting Effectiveness Theory to Work, 2001, p. 2, <www.fni.no/pdf/ 01-14-oss.pdf>, visited on 14 February 2007. 995 A. M. Slaughter et al., ‘International Law and International Relations Theory: A New Generation of Interdisciplinary Scholarship’, 92 American Journal of International Law (July 1998) p. 371. 996 Young, supra note 988, pp. 266, 267. (emphasis added) 997 J. L. Dunoff and J. P. Trachtman, ‘Economic Analysis of International Law’, 24 Yale Journal of International Law (Winter 1999) (references omitted) p. 13. (emphasis added) 998 Suchman and Edelman, supra note 803, p. 926. 999 Ibid. (emphasis added)

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Chapter 6 Eisenberg did not comment on regimes per se, but his remarks captured some important dynamics that may occur in CSR regimes. He referred to Jellinek’s phrase ‘the normative power of the actual’. Practices often take on a certain ‘oughtness’ which is partly due to a respect for tradition and partly to expectations. “Many practices give rise to expectations that they will continue to be followed. If these expectations seem justified to those who hold them, then a failure to follow the practice will be treated as a defeat of justified expectations … Thus ‘is’ easily becomes ‘ought’, and what begins as a practice may easily end as an obligation.”1000 In the context of CSR, as presented in chapter 3, the clash is between emerging expectations of stakeholders that companies should adopt CSR, and the incumbent Friedmanite norm of pursuing business success traditionally employed. In as much as business managers subscribe to Friedman’s norm due to respect for tradition, the emerging CSR norm has to overcome tradition. Eisenberg writes: “That respect need not be irrational. Traditional practices may be ways that have worked, that have stood the test of time, even if we are not entirely sure why any given traditional practice works.”1001 Meidinger reviews three ‘private environmental regulatory programmes’: the Forest Stewardship Council’s forest certification programme, the ISO 14000 and the American Forest and Paper Association’s Sustainable Forestry Initiative. “In general, the systems also show a pattern of increasing stress on credible application and monitoring of standards (certification, auditing, verification, etc.). Based on the experiences of public regulatory bureaucracies in trying to maintain public credibility, this is a tendency that can be expected to continue.”1002 Meidinger observed that the operation of other non-governmental forestry programmes presents a potential means of amplification. He writes: “It seems clear that some other forest certification programs have been spurred into existence by the FSC initiative. Although they may have been partially intended to fend off what were seen as overly stringent standards, the other programs are still caught in a dynamic that pressures them to make their systems credible, and that dynamic has led to more serious standards and verification systems over time.” 1003 Meidinger also usefully places in context the evolutionary perspective adopted throughout this thesis; he reflects on the prospects of these private environmental regulatory programmes: “Whether one applies a policy evolution, political power, or transaction cost perspective significantly affects how one sees the future prospects of the private environmental regulatory programs. Viewed from a benign evolutionary perspective, the programs are essentially complementary, all sailing down the same broad river of public discourse which no doubt flows toward sustainable development and social justice. As noted above, competition is not inconsistent with this thesis, since it is a common way of defining public ideals. From political power and transactions costs 1000

Eisenberg, supra note 225, p. 1261. (emphasis added) Ibid. 1002 Meidinger, supra note 803, p. 220. 1003 Ibid. (emphasis added) 1001

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Incremental institutionalisation of CSR regime perspectives, however, the systems are competing not just to define norms, but to become long-term institutions for shaping public policy.”1004

It appears that various literatures agree, although using different terminologies (e.g. regimes, markets, organisational field), on the constraints that voluntary participation generates as the regime incrementally institutionalises its working. It is typical to regimes where participation is voluntary (not mandated by law in a pure deterrence mode) to incrementally create pressures for compliance. The voluntarism of leading businesses is driven by their decision to manage effectively CSR risks and to project a credible image with their stakeholders. Starting with the 1970s, civil society has seen corporate codes of conduct, drafted sparsely in-house and enforced internally in a deficient manner, as mere ‘windowdressing’ that brought them into disrepute. Often the statement of policy (code of ethics) was publicly unveiled as indication of good intentions; later corporate reports containing general and unverified information were issued to further substantiate good intentions and efforts. This corporate strategy has backfired. With time, with the development of management tools at all stages of CSR management, and with the accumulation of experience from applying those tools, the management of CSR is these days evolving from in-house, low profile operations toward participative implementation of commitments and publicly reported activities. The search for credibility places voluntary initiatives on a path leading to more transparency and external participation. Various degrees of accountability of self-proclaimed responsible businesses can be negotiated in various settings as external pressure remains for these companies to stick to good practices relating to transparency, stakeholder participation and due process. So far it was noted the incremental pressures that the CSR regime exercises on willing participants (as they open up to scrutiny and dialogue); we now turn to the companies that stand on the margins and try to explain the pull force that the CSR regime exercises on free-riders. There is a tendency to discard CSR altogether because voluntarism, by definition it seems, is unable to influence free-riders. How could the voluntarism of leading MNEs affect the majority of businesses less concerned with CSR? We need to understand the mechanism of social change triggered and amplified by the voluntarism of leading TNCs: how does the ‘business case’ of leading businesses help to make the ‘business case’ for the rest of them? This requires a study of the ‘social change case’. John Ruggie, one of the designers of the UN Global Compact, notes: “A learning model has no direct leverage over determined laggards. They require other means, ranging from legislation to direct social action … The hope and expectation is that good practices will help to drive out bad ones through the power of dialogue, transparency, advocacy and

1004

Ibid.

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Chapter 6 competition. The accumulation of experience itself is likely to lead gradually to a desire for greater codification.”1005 The CSR standards or benchmarks developed within the CSR regime have a dual function. On one hand they facilitate implementation by willing companies. The availability of CSR benchmarks and stakeholders’ capacity to handle CSR facilitates corporate problem-solving; implementing CSR and demonstrating results becomes feasible and less costly. For businesses there are thus gains in implementation costs as well as gains in transaction costs of getting the message across to external audiences. On the other hand CSR benchmarks facilitate evaluation of performance and comparison with peers. Stakeholders can then assess not only the performance of leading companies (against own performance in previous years, and against peers), but also make a stronger case against indifferent businesses (by showing the availability of managerial tools road-tested by other businesses and the creeping regulatory dynamics that will create new incentives for compliance). Currently much of the efforts in the CSR community seek to standardise and systematise good practices in implementing and demonstrating CSR. Once a standard exists and proves viable, enforcement can shift from one category to another: from exclusively private enforcement to a mixture of private and public or even exclusively public enforcement. The example of the financial industry shows the evolution towards accountability that can arise from rigorous benchmarking. According to a report, fund managers have the task of “optimizing clients’ financial returns, which is typically defined in their contracts relative to certain benchmark indices, at specific levels of risk, and/or with respect to pre-defined peer groups. The need for demonstrable compliance creates a burden of proof on the part of the fund manager, which at best heightens managers’ sensitivity towards risk-taking and at worst encourages inertia around ‘tried and true’ approaches that are easily defensible. This high level of regulatory awareness and scrutiny, combined with the widespread use of benchmark indices and clients’ gradually shrinking time horizons for performance evaluation, is a powerful driver of conservatism among fund managers with respect to innovation. Today, these indices are ubiquitous, so much so that what began as a means of more rigorously measuring fund managers’ performance has gradually become a constraint on fund managers’ discretion. While there are exceptions, the empirical evidence is that the average manager’s propensity to assume risk relative to their respective

1005

J. G. Ruggie, ‘The Theory and Practice of Learning Networks, Corporate Social Responsibility and the Global Compact’, 5 The Journal of Corporate Citizenship (March 2002) p. 33.

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Incremental institutionalisation of CSR regime benchmarks (a statistical measure called tracking error) has declined over time, leading to greater clustering of fund managers’ returns.”1006

Governments can in order to move corporate groups towards compliance either reduce the costs of behaving responsibly or increase the sanctions for not doing so. Although the US and the UK have made their courts available to overseas plaintiffs trying to prove transnational torts and thus increase the costs of wrongdoing, the basic governmental strategy currently is that of reducing costs. For proactive businesses this is done through various policies that create engagement opportunities with stakeholders, and encourage multistakeholder efforts delivering CSR managerial tools. This strategy of reducing costs for aspiring responsible TNCs aims to broaden the legitimacy gap for businesses sitting on the margins, and thus to indirectly raise their costs of indifference. Leading businesses have a crucial role in broadening the legitimacy gap, but various social actors have an indispensable role in promoting good practices and actually exploiting the legitimacy gap. It is conceivable that governments in the North will use policies and laws as described in chapter 5 to broaden this legitimacy gap even further. The CSR regime highlights a rule-making process in its early stages of evolution where a combination of regulatory, market and social forces aim to move indifferent businesses toward compliance. For a legal perspective that adopts an evolutionary perspective counting on incremental gains, it is essential to look closer at corporate voluntarism and understand better the systemic effects of CSR. Furthermore, there are incentives for increased interaction between private and public actors in the rule-making process. This interaction between CSR and law/public policy has surprisingly been better articulated by sceptics of CSR from the right. Basing his criticism of CSR on economic efficiency considerations, Henderson wrote: “A final reason for concern is this. In so far as ‘socially responsible’ businesses find that their new role is bringing with it higher costs and lower profits, they have a strong interest in having their non-conforming rivals compelled to follow suit, whether through public pressure or government regulation. In particular, large firms have an interest in ensuring that smaller rivals do not escape the net, while firms in rich countries have a similar incentive to see to it that their competitors in developing countries are made subject to the same pressures and regulations that bear on them. The effect of such enforced uniformity is to limit competition, narrow economic opportunities and worsen economic performance.”1007

1006 World Economic Forum and AccountAbility, Mainstreaming Responsible Investment, 2005, pp. 30, 31 <www.weforum.org/pdf/mri.pdf>, visited on 14 February 2007. (emphasis added) 1007 Henderson, supra note 259. (emphasis added)

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Chapter 6 Though CSR theory has very rarely analysed in depth the positive implications of CSR on governance, some practitioners realised the implications of their work for rule-making: “By now, almost every self-respecting large corporation has a code of conduct. But the codes are highly controversial. Proponents generally see them as a valuable way to get corporations to buy into new norms of behavior without the need for government intervention, making them attractive to corporate leaders who want to fend off government regulation. More ambitious proponents see them as a means of gradually achieving consensus around standards of behavior that can be tried out volunatrily, then eventually adopted and enforced by governments. Detractors portray them as mere fig leaves.”1008

Even voices from businesses hint at this function of CSR: “We support the view that CSR is a stepping-stone. A temporary phenomenon that is useful and necessary until all governments are willing and able to implement and enforce international standards.”1009 Lyon looked at various drivers identified in the environmental literature on CSR. First, CSR leads to cost reductions because “perhaps pollution is symptomatic of broader production inefficiencies, and pollution reduction and cost reduction go hand-in-hand to create ‘win/win’ opportunities in today’s economy”. Second, CSR is the corporate response to a “new generation of green consumers willing to pay higher prices for clean product”. However as Lyon explains, “both explanations offer hope that markets are gradually supplanting regulation as the driver of environmental improvement… [E]ach of those theories has some merit, but the evidence suggests the roles of cost-reduction and green marketing are modest. Instead, it is the opportunity to influence regulation that makes corporate environmentalism profitable.”1010 Lyon exemplifies cases when another driver seems at work: “Corporate environmentalism is a new form of non-market strategy that is more subtle than traditional tools like making campaign contributions, hiring high-powered lobbysts, or creating artificial grassroots groups. It involves making real changes in environmental performance in order to shift the point from which traditional competition departs… [T]here is a great difference between coordinated actions by industries seeking to 1008

A. Florini, ‘Business and Global Governance’, 21:2 The Brookings Review (Spring 2003) p. 4. (emphasis added) 1009 P. Thagesen, Danish Industries, ‘The Voluntary Nature of Corporate Social Responsibility’, in International Commission of Jurists, Report from the “Business and human Rights” Conference, Danish Section of the ICJ and Danish Peace Foundation, 2005, , visited on 14 February 2007. 1010 T. P. Lyon, ‘“Green” Firms Bearing Gifts’, 26:3 Regulation (Fall 2003) p. 36. (emphasis added)

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Incremental institutionalisation of CSR regime protect themselves from regulatory threats, and action by individual firms seeking competitive advantage.” 1011

The CSR regime is characterised by incrementalism and therefore it is important to grasp the evolution of CSR along a continuum from internal problem-solving to external accountability. This incrementalism allows lawmakers nuanced interventions to seamlessly press for the adaptation of the business system to higher levels of care regarding their social and environmental impacts. Chapter 4 presented good corporate practice at each stage of CSR. It is important to grasp the nuances, the variety of options at each stage of CSR management. Good practice in CSR now asks companies to allow some form of external participation (at any of CSR stages) and/or to report credibly on their performance. They both bring external parties into the management of CSR which results in creating openings for accountability to be negotiated contextually and enlarged incrementally. Each stage where external participation is possible creates a spectre of options, which allows spaces for corporations to open up gradually. Once elements of external participation and disclosure are incrementally added, codes of conduct evolve along a continuum between internal guidance (i.e. help for managerial problem-solving) and external accountability (i.e. help for external evaluation). There is thus a possibility for an incremental evolution of CSR toward accountability. Internal guidance can be supplemented in various degrees with elements of internal and external accountability: ƒ guidance for staff developed in-house (normal problem-solving), ƒ guidance for staff developed with external participation (i.e. in an industry association or a multistakeholder body) (problem-solving), ƒ guidance + internal sanctions/rewards (corporate self-regulation), ƒ guidance + internal sanctions/rewards + oversight from the trade association (industry self-regulation), ƒ guidance + internal sanctions/rewards + independent verification (i.e. NGOs or accounting firms) (self-regulation with third party oversight), and ƒ guidance + internal sanctions/rewards + independent verification + public disclosure (self-regulation in seek of reputational rewards). Regimes provide, in addition to constraints on behaviour, a more specific context to a corporation attempting to understand and manage its environment. CSR proposes that managers should use new approaches to achieve the necessary simplification of complexity. Regimes have an important function in this respect. Gunningham and Rees focus in their analysis of corporate self-regulation on the organisational field which is a bridge between the organisational and societal levels and which exercises powerful forces on participants.1012 Even in the absence of binding regulation, the efforts of leading businesses and their stakeholders have already had a significant 1011

Ibid. N. Gunningham and J. Rees, ‘Industry Self-Regulation – An Institutional Perspective’, 19 Law and Policy (October 1997) p. 373.

1012

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Chapter 6 impact precisely in the ‘organisational field’. This intermediary level between company and society provides simplifications in terms of ƒ other businesses to which a company can compare its performance (i.e. competitors, but also other businesses outside the relevant market confronted with CSR issues), ƒ criteria for assessing CSR performance (used by market players who adopt an industry-based methodology for assessing performance and other stakeholders that carry assessments), ƒ actors relevant to the implementation efforts of a business (e.g. professionals, specialised NGOs, UN agencies, governmental agencies, etc.), ƒ specific human rights issues that recurrently appear in that industry, and ƒ networks which bring into the organisational field some society-level norms and concerns in a manner that advances workable simplifications attuned to business realities. For decades numerous pro-CSR arguments have framed the issue in terms of the ‘enlightened self-interest’ of the corporation. Indeed, enlightened self-interest has been an accepted idea in business ethics literature in the 1950s and 1960s,1013 and the few economists who discuss CSR issues conceive it in such terms.1014 However, if CSR argumentation remains at an abstract level, such constructs remain pure semantic elaborations unable to facilitate the adoption of the concept. The difficulty is in finding meaningful simplifications to operationalise the idea and thus moving beyond a concept aptly portrayed as “a crude blend of lung-run profit and altruism”.1015 Without simplifications the ‘enlightened self-interest’ argument hits the wall: virtually any expense can be rationalised in terms of long-run profitability. The struggle of leading businesses implementing CSR is a struggle with metering aspects not encountered traditionally in the business world. Sinclair and Galaskiewicz write that “[m]eterability is important for any rationalizing process. Being able to evaluate benefits is tantamount to holding the transaction accountable... Meterability thus is critical in making and evaluating strategic decisions and decision-makers.”1016 It was noted that “[h]igh meterability implies confidence in the ability to distinguish or cognitively differentiate among outcomes. Low meterability implies that evaluators have difficulty in ranking, ordering, and judging the benefits of one outcome as opposed to another.”1017 However, the 1013

“Most managers were able to assimilate this response to the question “Why be ethical?” fairly easily under the heading enlightened self interest.” Stark, supra note 40, p. 43. 1014 Jensen, supra note 184. 1015 J. W. McGuire (1963) quoted in J. Galaskiewicz, ‘Making Corporate Actors Accountable: Institution-Building in Minneapolis-St. Paul’, in Powell and DiMaggio, supra note 268, p. 302. 1016 M. Sinclair and J. Galaskiewicz, ‘Corporate-Nonprofit Partnerships: Varieties and Covariates’, 41 New York Law School Law Review (Spring-Summer 1997) p. 1066. 1017 Ibid.

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Incremental institutionalisation of CSR regime Association of British Insurers suggests ordinal ranking if cardinal ranking is unavailable: “CSR threats are difficult to attach precise monetary values to, but it should be possible to estimate an order of magnitude or range of possible outcomes. But attaching qualitative indicators (such as High, Medium, Low) should be possible, and is important for deciding priorities and allocating management resource.”1018 This presentation of the emerging CSR regime has underlined several aspects. The regime has a guiding function as well as a constraining function. It opens a path towards accountability that affects both participants in the regime as well as exerts a pull force on non-participants. The institutionalisation of this regime is happening incrementally and progress toward accountability will be likewise incremental. The regime creates a multitude of options for companies willing to move to more credible ways of implementing CSR. This in turn creates a broad range of nodal points that policymakers can stimulate through law or policy; the opportunities for regulatory intervention multiply. At this point it is necessary to clarify the corporate responsibilities that the CSR regime promotes or in other words the social expectations to which the regime tries to respond. 6.4.2. Specifying positive obligations (‘support’ human rights) The UN’s Global Compact has articulated a responsibility for businesses to respect human rights, avoid complicity in abuses and support human rights.1019 This formulation captures widespread expectations from business to not harm, directly (respect) or indirectly (no complicity), but also to reach out and help where possible (support within sphere of influence). A business can support human rights through partnerships for development and charitable contributions; however this cannot be a substitute for the responsibility to avoid harms. The responsibility to respect is the base, while to support is a desirable add-on; ‘respect’ human rights is a negative obligation (‘do not harm’), while ‘support’ is a positive one (‘reach out and help’). However some distinctions are in order when discussing the responsibilities of MNEs, that is, of business groups. Which entity in the group has the negative obligation to respect human rights: the company in the South, the controlling company in the North or the group as a whole as an economic entity? First comes to mind the company in the South because it is rightholders in the South that are unprotected. Violations can occur in the workplace or in the neighbouring community, directly by the hand of the business or indirectly by the hand of government actors associated in the project or other associated businesses. The controlling entity in the North can violate human rights in the South although it has no physical presence there. At issue is a negative obligation (responsibility) of the parent company to refrain from producing harm. One situation, litigated in the UK under tort laws, involves transfers of hazardous, outdated technology prohibited in rich countries to subsidiaries in poorly regulated 1018 1019

Association of British Insurers, supra note 294, p. 38. UN’s Global Compact, supra note 270, Principles 1 and 2,

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Chapter 6 countries. Another example refers to industries involving labour-intensive methods of production, where the supply chain can operate in such a manner that subcontractors down the chain are squeezed to give priority to price-cuts and tight supply schedules over labour rights considerations. Only recently have buyer companies come to understand and acknowledge the full impact that their own practices have on the respect of labour standards by its suppliers in the South. Finally a negative obligation arguably arose for pharmaceutical MNEs who defended their patents in a way that foreclosed access to life-saving medicines (HIV/AIDS). In all these three cases, the parent company is directly linked to the harms occurring in the South. Indirect harms can arise from the mere decision to invest in a pariah country controlled by an oppressive government (e.g. Burma, Sudan or South Africa during the apartheid years). This situation leaves investors open to charges of complicity in human rights violations committed by governmental actors. However the heated debates about globalisation refer to the human rights abuses perpetuated by some ‘multinationals’ in far away places. Blame is laid in such cases on a unitary actor, the ‘TNC’. Regulatory proposals aim to find ways to hold ‘transnational companies’ legally accountable. However discussing the responsibility of the business group as it was a unitary actor does not help clarifying the types of obligations imposed on different entities within the TNC. In fact there is a bundle of negative and positive obligations. There are the two negative obligations of the parent in the North and the subsidiaries or contractors in the South. Nevertheless, because the company in the South is more or less integrated in a multinational business group or network, the controlling company arguably has, beside the responsibility not to cause harm through its own actions (negative obligation), a responsibility to oversee its partners in the South (positive obligation). The latter is based on the special relationship companies have within the business group. The buyer company may have an oversight responsibility for labour rights in its supply chain. Even when the relationship is purely contractual and no ownership connection exists, the buyer company may still exert significant influence over the supplier, for example if the latter is locked in a business relationship with the former. The scope of the positive obligation needs however to be qualified by the degree of influence and control the parent has over its partner in the South. Courts adjudicating tort law cases have also dealt with such issues; thus courts that were asked to find liability of the parent for torts linked to subsidiaries’ operations have investigated the degree of control on a case by case basis and take into account a variety of factors (e.g. ownership, board structures, managerial processes). Proposals for increased accountability of multinationals draw of course on the standards contained in international human rights law (IHRL). This provides the necessary normative orientation. However if an obligation can be derived from the authoritative minimum standards laid down in IHRL, that is, the obligation to not harm other individuals (or to interfere with state efforts to fulfil their obligations). Like any other private entity or individual, businesses can at least be expected to acknowledge the internationally sanctioned human rights and to abstain from 312

Incremental institutionalisation of CSR regime violating them. In the case of MNEs, this observation needs to be qualified: while both subsidiaries and parent companies should acknowledge negative obligations, CSR arguments directed at the whole business group actually imply that the parent company should also accept a positive obligation to oversee its subsidiaries. The difficulty lies with defining positive obligations (of the parent company especially) and their scope cannot be deduced from international human rights standards. We cannot jump from the existence of authoritative human rights standards in IHRL to deducing the correlative positive obligation of non-state actors. Defining the outer boundaries of corporate responsibilities is one of the most challenging issues in CSR currently. It helps in this endeavour to acknowledge that for a business group to ‘respect’ human rights (negative obligation) necessarily entails for the controlling company to ‘support’ human rights by overseeing its business partners (positive obligation); the controlling company can be the parent company in the North or a large subsidiary in the South. Identifying the relevant issue as one of specifying positive obligations of the controlling entity can draw on the challenges that regulators have encountered as well as the solutions they have tried. Expectations regarding the responsibility of the parent company for the activities of their business partners have converged on the idea of due diligence. For example, the UN Norms on the Responsibilities of Transnational Corporations defined the first and general obligation of business: “Transnational corporations and other business enterprises shall have the responsibility to use due diligence in ensuring that their activities do not contribute directly or indirectly to human abuses, and that they do not directly or indirectly benefit from abuses of which they were aware or ought to have been aware.”1020 The Danish Centre for Human Rights writes: “Violations which are committed by business partners are commonly called ‘indirect’ violations. Most companies maintain numerous business partners, and as a result, risk being indirectly connected to literally hundreds of violations. Clearly companies cannot always be held responsible for the practices of their partners; they do not have reasonable foreseeability and the ability to control bad practices in all cases. Ultimately what is expected is ‘due diligence’ – ensuring that all reasonable measures are undertaken to avoid complicity in violations… we advise companies to inform local partners of their concern for good human rights practices, and if necessary, reinforce the message with

1020

Commission on Human Rights, Sub-Commission on the Promotion and Protection of Human Rights, Commentary on the Norms on the Responsibilities of Transnational Corporations and Other Business Enterprises with Regard to Human Rights, E/CN.4/Sub.2/2003/38/Rev.2, 26 August 2003, Commentary 1(b) p. 4, <www.unhchr.ch/ Huridocda/Huridoca.nsf/0/293378ff2003ceb0c1256d7900310d90/$FILE/G0316018.pdf>, visited on 14 February 2007. (emphasis added)

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Chapter 6 regular questionnaires, standard human rights clauses in contractual agreements and/or on-site monitoring.”1021

The emphasis on due diligence responds to the challenge that regulators recurrently face when having to ex ante specify positive obligations in a comprehensive way. As a difference from negative obligations that can be enforced through pure deterrence methods, regulators here employ procedural benchmarks to guide discretion rather than replace it. As seen in the preceding section, lawmakers have used regulatory mixes to specify the positive obligation to use ‘reasonable care’; they rely on nonbinding strategies, or they might use binding but generally-worded instruments. At the same time, enforcement of higher levels of care draws on a combination of private and public actors. In such cases, private codification of the positive obligation and private enforcement will complement state action. At this level of due process becomes most evident the interaction between CSR benchmarks and law, between the discretion that private actors retain and the guidance that lawmakers provide. The widespread dichotomy between CSR and law needs to be reviewed in light of new CSR development and of recent regulatory strategies that emphasise the importance of sound management systems. A feature of law-oriented proposals for corporate accountability highlights the inadequacy of corporate voluntarism. CSR is often summarily dismissed as ‘window-dressing’, at worst, or as a commendable philanthropic contribution, at best. In both cases it is only the law that can ensure compliance with human rights standards. However, the relationship between CSR and legal compliance needs to be clarified by taking into account the special circumstances of transnational CSR.1022 On one hand, in developed countries, with their strong regulatory regimes, CSR is often defined as desirable corporate behaviour exceeding compliance, which is a given minimum expected from any business. CSR appears as a matter of ‘beyond compliance’; this corporate behaviour may be socially desirable but is almost legally irrelevant. If CSR is not beyond compliance and simply reaffirms the principle of ‘do not harm another’, CSR turns out to be synonym with legal compliance and becomes a redundant concept. On the other hand, in developing countries laws are sometimes inadequate and often not enforced. In that context, compliance with law or international standards is important to discussions looking for additional incentives to modify corporate behaviour. It was noted that “a narrow starting point of CSR as ‘beyond compliance’ does not make sense in the context of developing country economies where tools to encourage compliance with minimum legislation can be understood as a significant element of the CSR agenda”.1023 In this context it 1021

Danish Institute for Human Rights, Human Rights Impact Assessment, 2005, para. C242 (freedom of association and assembly). (emphasis added) 1022 See also the introductory remarks to chapter 5. 1023 T. Fox et al., World Bank, International Institute for Environment and Development, Public Sector Roles in Strengthening Corporate Social Responsibility: A Baseline Study, 2002, p. 1 <www.ifc.org/ifcext/economics.nsf/AttachmentsByTitle/CSR-CSR_interior.pdf/$ FILE/CSR-CSR_interior.pdf>, visited on 14 February 2007.

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Incremental institutionalisation of CSR regime is important to mobilise the regulatory potential of the MNE and use the influence that the controlling entity has within the MNE group. The parent company is nevertheless currently under a very uncertain, if any, positive legal obligation to exercise oversight over its subsidiaries and contractors. It appears that while the situation of subsidiaries and contractors is clearly about compliance in the weak regulatory environment in the South, the positive responsibilities the parent company is expected to assume appear as ‘beyond compliance’ at this moment in time. As the legal obligations of the parent company are under construction, and the regulatory frameworks in the South are bound to be strengthened, CSR is neither irrelevant, nor redundant when discussing legal compliance, but an important ingredient in the enactment and specification of the regulatory regime surrounding MNEs. While states can employ a variety of policy instruments to facilitate the institutionalisation of the CSR regime, law has a unique role: to provide a legal (negative) incentive for parent companies that choose to remain oblivious of their human rights impacts in spite of social and market pressures (or when these pressures do not exist for that particular business or industry). Law (i.e. procedural laws) would thus merely bring more businesses within the CSR regime, which then does not operate in a pure deterrence mode. In the argument proposed here, law goes for ‘breadth’, but law can also go for ‘depth’. For example, the German Council for Sustainable Development wrote: “The Council recommends that, by defining the procedural rules, the regulatory framework of the social market economy should be developed in such a way that enterprises voluntarily undertaking CSR activities reap the benefits in the face of competition.”1024 This regulatory approach is exemplified by the Belgium label and the environmental scheme EMAS. The law would here facilitate social exchange by enabling companies to make credible commitments. In such regulated certification schemes participation is voluntary and incentives come solely from consumers. Thus ‘optional’ laws such as these do not contribute to the legal institutionalisation of positive obligations of parent companies but create opportunities for such companies to exert influence throughout their supply chain by giving preference to certified goods. Furthermore, markets segment themselves easily; if say five percent of consumers demand ethically produced demands, companies abiding to high standards will correspondingly remain limited to that niche market. In this context Vogel also noted the unfulfilled promise of green marketing.1025 Thus the direct protective effects of certification schemes are likely to be modest. Consumer pressure is a contributing factor to the political rule-making process much more than a determinant factor that makes private regulation effective without governmental intervention. CSR is better characterised in political terms rather than market demand.1026 1024

German Council for Sustainable Development, Corporate Social Responsibility: Perspectives and Further Development Corporate Social Responsibility in a Globalized World, Berlin, 2006. 1025 Vogel, supra note 915, pp. 128, 135. 1026 Lyon, supra note 1010.

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Chapter 6 The EC also has rejected a role for law in the legal institutionalisation of positive obligations of European parent companies: “Because CSR is fundamentally about voluntary business behaviour, an approach involving additional obligations and administrative requirements for business risks being counter-productive and would be contrary to the principles of better regulation.”1027 This is a policy choice, more or less defendable in light of available alternatives, but cannot stand as a statement of logical necessity regarding the supposedly-inherent voluntary nature of CSR. The EC approach to how international economic exchanges should relate to human rights in the South emphasises international trade incentives: “The Commission aims to strengthen the sustainable development dimension of bilateral trade negotiations and to pursue the promotion of core labour standards in bilateral agreements. … The Commission is also committed to using trade incentives as a means of encouraging respect for the main international human/labour rights, environmental protection and governance principles, in particular through the new EU ‘Generalised System of Preferences Plus’ that entered into force on 1 January 2006.”1028

The selection of regulations in this study should not be taken as a statement that they are inherently superior to pure deterrence approaches in achieving compliance. It is not that, in the area of human rights, procedural regulations are more effective than substantive regulations. What this chapter aims to highlight is the complex causality in regimes even when legally-binding laws are used. However the complex regime described herein is the only one capable to specify better the positive obligations of controlling entities (i.e. responsibility to exercise oversight within sphere of influence) and eventually facilitate the insertion of a degree of hard law, able to shift the practices of corporate laggards. The scope of positive obligations is hard to define ex ante by lawmakers, as exemplified by the struggle of company law with the managerial duty of care; furthermore ex post, factual circumstances, the specificity on each industrial setting, are heavily weighed in by courts in determinations of negligence as are policy considerations. Indeed, in a transnational CSR context, policy considerations will be a disincentive to the adoption of legallybinding rules, unless they maintain a pronounced procedural character. This makes it almost inevitable that the positive obligations of parent companies will be worked out in a decentralised regulatory regime as described in this chapter. The CSR regime dealing with positive obligations here is an additional layer to another regime where negative obligations could be enforced through purely deterrent methods. Thus general tort law in host countries and specific regulations dealing with specific harms should hold the direct perpetuators of human rights 1027

European Commission, Implementing the Partnership for Growth and Jobs: Making Europe a Pole of Excellence on Corporate Social Responsibility COM(2006)136 final Brussels, 2006, <www.coess.org/documents/com_2006_0136.pdf>, visited on 14 February 2007. 1028 Ibid.

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Incremental institutionalisation of CSR regime abuses accountable. Similarly, deterrent strategies should be employed in home countries where the parent company itself commits abuses (e.g. bribery, other criminal behaviour); British tort law was used to establish the direct responsibility of UK-based companies exporting hazardous technologies. Nevertheless the additional regime can mobilise the oversight potential of parent companies and thus create new incentives for business partners in the South. The responsibilities in the basic regime are clearer (‘do not harm’, by commission/action), and the challenge is to enact the necessary institutions able to enforce the laws. In the additional regime, the scope of responsibilities itself (‘do not harm’, by omission/inaction, which slips into a positive obligation of ‘reach out and help’ or ‘support’ human rights) is unclear, open to clarification in a regime where pure deterrence is not an option, as shown in this chapter. As a report of the United Nations High Commissioner on Human Rights writes: “More complex issues arise in relation to the responsibility to ‘support’ human rights. For example, the responsibility to ‘support’ human rights suggests that business entities carry positive responsibilities to promote human rights. In this context, it is relevant to note that business entities already carry positive responsibilities in other areas of national law, for example in the law of negligence when discharging a duty of care to employees or local communities. This could provide guidance when clarifying the positive responsibilities on business to ‘support’ human rights.”1029

It is beyond the scope of this section to articulate an international human rights law perspective on CSR. But highlighting the role of state actors (and other public interest bodies) and the role of law, is a way of approaching CSR in the tradition of international human rights law while still remaining in touch with the political and economic realities of the time. It is important when devising a CSR model to account for established actors (i.e. states and public-interst non-governmental bodies) and to reinforce their capacity to discharge own responsibilities. Rio Tinto’s position on CSR ably captures the type of reasoning that some leading businesses have come to employ: “The concept of CSR must be considered in the context of what business can do to promote society’s transition to sustainable development; however, social responsibility is not the arena of business alone, all of civil society and government have responsibilities here and must play their parts. The practise of CSR is a continual learning and improving process, which incorporates both legislative and voluntary elements, and which turns principles and policies into measurable action and 1029

Sub-Commission on the Promotion and Protection of Human Rights, Report of the United Nations High Commissioner on Human Rights on the Responsibilities of Transnational Corporations and Related Business Enterprises with Regard to Human Rights, E/CN.4/2005/91, 15 February 2005, para. 31, <www.ohchr.org/english/bodies/chr/docs/61 chr/E.CN.4.2005.91.doc>, visited on 14 February 2007.

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Chapter 6 accountable practise, in as cost effective and as transparent a way as possible.”1030

*** The regulations analysed in this chapter can be understood better in relation to some variables that intermediate between law’s goals and corporate performance. Intermediary variables such as standardisation, norms and private enforcement seem to be at work. States can deliberately target these variables through laws, nonbinding instruments or strategies of capacity-building in private actors. Law can intervene with various degrees of strength, starting with providing incentives, continuing with facilitation through laying down needed infrastructure, to mandating more relaxed or stricter reporting on social and environmental impacts or on management systems able to take such impacts into account, or even mandating sound procedures within companies. Both law and public policy have an impact on intermediary variables which are also targeted by corporate voluntarism within the CSR movement. An interesting interaction between CSR and law/policy occurs as private and public actors work in the same space on converging rule-making processes. Explanations of regulatory mixes and regulatory space develop a compliance model as an alternative to a pure deterrence model based solely on legally-binding codification and state enforcement. The CSR regulatory regime is based on the regulatory potential of private actors. The aim is to induce businesses to exhibit higher levels of care in their pursuit of business success. The emerging duty of care owed by controlling entities to stakeholders is imposed not necessarily through legal fiat, but through a combination of socio-political, legal and market forces, a mixture of public and private regulation. The contents of this duty are specified by a combination of soft law instruments, disclosure and accounting standards, business practices and expectations of intermediary market players (e.g. institutional investors). States have a role in institutionalising this duty of care and can employ various means towards this end. States can employ regulations aimed at management systems as well as disclosure regulations. Both types of regulations draw on the regulatory potential of private actors, and the norms/rules they apply. In both cases states want to enrol the regulatory potential of private actors, be they the business group itself (by having the parent company adopt effective management systems) or the private actors with leverage on the respective business (by having the business disclose information). A duty of the parent company to carefully oversee its subsidiaries/contractors in order to prevent and redress abuses overseas is tantamount to the parent company owing a duty of care to rightholders in the South. The emerging ‘duty’ of care benefiting stakeholders is a qualified duty though: from a business perspective, this 1030 Rio Tinto, Statement Regarding the Green Paper Promoting a European Framework for Corporate Social Responsibility (CSR), 2001, <www.europa.eu.int/comm/employment _social/soc-dial/csr/pdf2/046-COMP_Rio-Tinto_UK_011212_en.htm>, visited on 14 February 2007.

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Incremental institutionalisation of CSR regime duty to exercise due diligence is a subgoal of managers discharging their duties under company law. As long as the responsibility of parent companies to manage carefully the human rights impacts of the business group is not legally binding, the duty of care owed to stakeholders is a means to the end of fulfilling the managerial duty of care owed to the company. The same holds true if new regulations advance CSR as a matter exclusively in the ‘grey zone’ where shareholders’ and stakeholders’ interests overlap, as done by the UK review of company law; the boundaries of the grey zone are flexible and open for negotiation, but this does not alter fundamentally the situation. The regulations targeting the ‘grey zone’ do not override the principle of business as a wealth-generating entity in a functionally differentiated society. While the principle is not challenged, the simplifications customarily performed by businesses are indeed attacked (not through purely deterrent regulations, but through regulatory mixes and a combination of private and public enforcement). This strategy is necessary because, as Williamson observed, “organizations use both simplification mechanisms and specialization mechanisms to help them learn. Such mechanisms nevertheless come at a cost – of which myopic tendencies to (1) ignore the long run, (2) ignore the larger picture, and (3) overlook failures are especially important.”1031 The British government described in detail its regulatory strategy targeting the ‘grey zone’ and challenged the ‘shortcuts’ that no longer serve businesses well in a growingly complex economy.

1031

Williamson, supra note 189, p. 25.

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CHAPTER 7 CONCLUSIONS Economic globalisation has generated heated debates about the social impacts of powerful economic actors. There are persistent discussions about the human rights responsibilities of large companies, about the role of MNEs regarding the protection of human rights in the Global South, even though the role of state actors remains predominant. The scope of MNEs’ responsibilities, for some the very existence of responsibility, are issues yet to be settled. Nevertheless, the force underlying CSR debates is not subsiding; the emergence of new fragmented centres of power means that the individual now perceives authority and repression in a variety of new bodies, as Clapham wrote.1032 This study sought to answer the following questions: 1) How can the relationship ‘business and human rights’ be discussed from a law-oriented perspective without employing an exclusively state-centred, deterrence-based method of changing corporate practices? 2) What are the regulatory dynamics accompanying CSR? 3) What types of intervention can states adopt to strengthen the CSR regime? What role the law can play in the institutionalisation of the CSR regime? 4) If states decide to adopt laws in the ‘business and human rights’ area, what is the causality between law/policy and corporate behaviour? The perspective articulated herein highlights the incentives and effects of corporate voluntarism. Human rights lawyers are confronted with unfamiliar actors – private organisations pursuing profitability – and with the tremendous complexity and fluidity of the market environment. Unpersuaded that voluntarism can stem corporate abuses, legal experts typically approach corporations with a clear understanding of the necessity to establish a legally binding framework doubled by stringent enforcement. The remedy is seen solely in law, uniquely able to bring perpetuators to justice. The assumption is that in order to change the practices of profit-making (profit-maximising) actors, nothing short of applying the deterrent force of law will suffice; often the proposals envisage ‘pure’ deterrence, meaning that it is states that lay down regulations and courts or regulatory agencies that enforce the rules. That would ensure the legal liability of companies for the harms they cause or for their failure to meet a certain standard or obligation. However, the current legal framework for obtaining corporate liability is thin, and political willingness to strengthen seems to be lacking. In the search for corporate 1032

A. Clapham, Human Rights in the Private Sphere (Clarendon Press, Oxford, 1993) p. 137. 321

Chapter 7 accountability, lawyers have fallen back either on the normative substance of human rights or on the role of states as obligation holders under international law. Unfortunately, such writings have often come to argue for immutable concerns that trump others and display a categorical certainty that is alien to the contextual reinterpretation specific to legal professionals. This surprising and undesirable outcome positioned human rights lawyers to extremes, either as unimaginative formalists or as moral philosophers. There is an abdication in both cases from the essential task of legal research to adapt regulatory analysis to a new context (‘multinational businesses and human rights’) and to strive for the institutionalisation of new protective mechanisms. This study aimed to discuss the ‘business and human rights’ relationship from a law-oriented perspective. The challenge has been to do that without succumbing into a ‘pure deterrence’ mode of altering behaviour. Calls for a strong regulatory framework able to hold corporate perpetuators of abuses accountable are without a doubt justified. It is not that a deterrent regulatory framework is undesirable, but there can be both political and conceptual obstacles when the target is multinational enterprises. Furthermore, a single-minded focus on deterrence blinds to the possibility that even in the absence of this ‘purely deterrent’ regulatory regime, a new protective mechanism is emerging, driven by the practices of a limited number of MNEs. The risk of taking an excessively formalist stance is that relevant regulatory dynamics remain in obscurity; the law-making process becomes misrepresented and the causal complexity of the mechanism through which lawmakers shape corporate behaviour remains unexplained. Similarly, from a managerial point of view, an isolationist pursuit of shareholder value aloof of the wider and evolving social and regulatory environment places business executives of large companies in a position where they are unable to identify, much less to manage proactively, emergent threats and opportunities for their business in a complex economy. This research concentrated on the ‘CSR regime’ rather than the self-regulatory practices of a company or even an entire industry. It was a look at the regulatory dynamics CSR generates rather than a study of the merits and drawbacks of business self-regulation in a particular case. The inquiry tried to account for the positive regulatory effects generated by leading businesses as the CSR regime becomes institutionalised. Customarily only negative dynamics have been highlighted. The negative dynamics would see CSR displacing binding regulations needed to protect human rights and to hold companies accountable (CSR as ‘deregulation’), CSR offering more protection to corporations than to rightholders (CSR as ‘whitewash’) and CSR being a first step on a slippery slope towards more intrusive intervention of governments into the market mechanism (CSR as a ‘subversive doctrine’). Sceptics of CSR, from the Left and from the Rght, have voiced these concerns since the 1960s. They cannot be dismissed out of hand and, at the same time, recent developments in corporate management and good governance prompt one to take a closer look at CSR and at private-public regulatory regimes. This study carries implications for both categories of CSR sceptics: the CSR regime can offer a certain 322

Conclusions level of protection to rightholders in a difficult economic and political environment, and at the same time the regulation associated with the CSR regime may be more sensible and less intrusive than feared as it largely draws on good business practice. As Teubner wrote, although the voiced concerns have merits, the crucial point is one of partiality. Some said that CSR would destroy economic rationality, while others said that CSR politicises the economy by depoliticising the political process. Both have a point, but they tend to over-generalise: the question is to what degree and with what effect.1033 It is important when analysing CSR not to default prematurely to the favourite ideological position about controlling mechanisms, be they political or market mechanisms. A review of the evolution of CSR in the last decade points to the numerous multistakeholder standards and guidelines facilitating social impact assessments, management systems for implementing CSR, reporting and auditing CSR performance, and collaboration between businesses, civil society groups and governmental agencies (tri-sector partnerships). Chapter 4 provided a descriptive account of the most visible managerial templates developed in multistakeholder CSR fora. The CSR regime has already developed benchmarks and guidance on the implementation and demonstration of CSR. Good practice in these areas is evolving fast with the voluntary participation of leading businesses. The regime also involves countless specialised organisations and professionals with growing capacity to assist with the substantive and procedural aspects of CSR. This study performed an analysis of the CSR regime in three respects: (A.) it accounted in detail for a new managerial norm that the regime promotes and showed how the responsible business practices of leading companies (CSR regime) clarify and operationalise CSR (the norm); (B.) the analysis briefly indicated that the emerging CSR regime incrementally creates pressures for accountability as private enforcement (by market actors and civil society actors) plays a central role; and (C.) the study insisted on how states, through law and policy, can contribute to the institutionalisation of CSR, that is, can reinforce the emerging CSR regime and bring indifferent businesses within its boundaries. A. Regarding the operationalisation of CSR, this study accounted for the transformative potential of CSR in terms of a ‘norm’ that allows stakeholders’ interests to be better identified and weighted more heavily in the managerial decision-making process. In other words, the norm asks managers to rise to higher levels of care in their dealings with stakeholders. A trade-off seemed unavoidable for an argument promoting the new norm: stronger incentives but ‘weaker’ (less ambitious) norm, or stronger norm but weaker incentives. The choice made here was not to advance the norm as an ethical imperative that would see stakeholders’ interests trump corporate concerns, but to seek that area of ‘enlightened’ corporate self-interest. There is an area of overlap where the company’s interests are better served in the long-run by taking into consideration stakeholders’ interests, a ‘grey 1033

Teubner, supra note 209, pp. 160, 161.

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Chapter 7 area’ between economic and social considerations. The CSR regime where leading businesses and their stakeholders participate occupies this grey area: it encourages companies to account for stakeholders’ interests, and crucially it makes this feasible and less costly by operationalising the new norm. Through CSR benchmarks and guidance, the CSR regime rationalises corporate expenses in terms of corporate utility (i.e. ‘business success’, ‘long-term shareholder value’) and institutionalises CSR through the creation of necessary infrastructure. Still crucial for the new norm getting traction on the ground is to understand the incentives or disincentives at work. What have been the driving forces behind the CSR regime? Initially and fundamentally, pressure from civil society, which in turn highlighted for proactive companies the ‘grey area’; once this area becomes clearer, there are various forces active within the grey area that create new incentives for managers to pay more attention to stakeholders. Such forces are the managerial duty of care owed to the company under company laws and market actors with an interest in long-term sustainable value-creation (e.g. institutional investors). These are the incentives pushing CSR forward as a matter of long-term corporate self-interest and fueling the CSR regime. Thus the norm in the grey zone draws on the diffuse pressure of social expectations augmented by legal pressures (i.e. the emphasis of company law and of other bodies of law on due process/sound procedures) and market pressures (i.e. market actors expecting sound management systems as an indication of competent management able to deliver sustainable shareholder value). The norm can be advanced outside the grey zone, as an ethical imperative, and would draw on the raw force of public conscience augmented by ethical behaviour of market actors (e.g. ethical consumers, ethical investment funds, moral corporate management) and would still require the adoption of new hard law uniquely able to exert coercion. What is the ambition of the norm when it is advanced in the grey zone? The new managerial norm accounts for the increasing complexity of the social environment in which businesses operate and would state that managers are responsible to take a more impact-inclusive and longer-term view of their business in order to manage effectively new business risks and opportunities. The norm proposes that CSR boils down to an emerging duty of care that companies owe to stakeholders; it holds that managers have to abide by a higher standard of managerial care in the discharge of their profit-making mandate. A clarification is warranted. On one hand, when the norm is advanced in the grey zone, the care owed by managers to stakeholders is a subset to the care managers owe to the company under company law. Managers have a legal obligation to exercise reasonable care in their pursuit of the company’s interest/success and, as British lawmakers have clarified, this requires a longer-term perspective and a stakeholder-inclusive manner to achieve business success in a complex economy. In other words, the stakeholder norm requires decision-makers to look afresh at the means they can use in order to achieve their respective goals more effectively. On the other hand, the norm can be advanced outside the grey zone so stakeholders’ interests can be protected even when it is not in the (enlightened) self-interest of the business. Here the duty of care 324

Conclusions is owed directly to stakeholders and not merely as a subgoal in the search for corporate success. This study analyses the norm as a qualified ‘duty’ to exercise reasonable care to stakeholders and focuses on the flexible contours of the grey zone. This area where corporate interest and stakeholders’ interests overlap is far from clear, its limits are defined contextually and evolving, and its contours are informed by the experience of leading businesses. The CSR regime puts the spotlight on the grey zone, helps to enlarge it and to specify what reasonable care entails in that situation. Various dynamics and forces active in the grey zone have been accounted for in previous chapters. The belief system and the respective norm that managers employ is an important intermediary variable between external pressures (law and/or civil society activism) and corporate behaviour. In a sense, this is a study of norms: how a new norm struggles to replace the incumbent norm articulated by Friedman, and how the CSR regime tries to incrementally institutionalise the new norm. The analysis tracked the compatibility of the stakeholder norm with company law and corporate governance regimes (chapter 2); then it discussed how Friedman artificially reinforced his norm through points scored at other two levels of analysis (i.e. the role of business in society, and the duties managers owe) while the shareholder norm got short-changed by deficient argumentation at those two levels (chapter 3); then moved on to noting recent managerial progresses in the CSR area that leading businesses and their stakeholders have made in specifying the stakeholder norm (chapter 4), and finally concluded with a discussion of innovative regulatory strategies and governance mechanisms that emphasise ‘due diligence’ and ‘reasonable care’ and can encourage the diffusion of the stakeholder norm (chapters 5 to 6). As one considers mechanisms to enforce a new norm, one also needs to deinternalise the incumbent norm. This study can be seen as an effort to de-internalise Friedman’s norm. This requires showing the increasing irrelevancy of Friedman’s views for large corporations rather than the incorrectness of Friedman’s norm. One cannot minimise the clash between the two norms. As Bird and Waters wrote, when particular business practices seem not to honour particular standards (e.g. social welfare, justice), it may be wrongly assumed that such actions are guided by no normative expectations whatsoever. In fact such actions may be determined by other moral expectations (e.g. respect for fair contractual relations, efficient not wasteful use of resources, responsiveness to consumer choices). Then business conduct may well be guided and legitimated by other conflicting norms. The authors consider it is an idealistic misconception to suppose that moral reasons by virtue of their logic alone inspire feelings of obligation to adhere to moral standards. Simply attempting to talk more about moral issues in business is not likely to make these conversations more weighty and authoritative. It is preferable to find ways of realistically connecting this language with the experiences and expectations of people involved

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Chapter 7 in business.1034 Stakeholder theory, especially the normative branch, has made limited progress in making this connection realistic.1035 B. Regarding the incremental progress towards accountability that the CSR regime makes, it is important to account for the process of CSR institutionalisation even in the absence of legally binding rules. The mere existence of credible benchmarks to measure due diligence can create important regulatory dynamics. The study proposed that leading businesses, in collaboration with their stakeholders, have laid down indispensable standards and built up institutional capacity in various actors to work with these benchmarks. The availability of standards and the accompanying infrastructure make it easier and less costly for other companies to implement CSR and for stakeholders to measure corporate performance. Companies are now able to demonstrate due diligence and stakeholders get empowered to make comparative assessments of whether companies exhibited reasonable care or not. These benchmarks and institutional infrastructure are indispensable for moving CSR from the level of rhetoric and aspiration to the level of performance delivering results. Taken in isolation, none of the CSR initiatives can deliver corporate accountability, as each remains voluntary. Taken together, these voluntary initiatives appear to create a ladder that containing numerous managerial steps that culminates with credible CSR reports. It is up to corporations themselves to make choices as to how far to advance up the ladder toward external reporting, and how deep to involve stakeholders at each stage. However, businesses are also left with the burden, indeed responsibility, to explain their choices. Such explanations will have to be offered in light of consequences of corporate inaction, against the performance of other corporations in comparable settings and in a context favouring increasing transparency. At the same time, public awareness to corporate impacts in poor countries has grown exponentially, and so have social expectations. As experience generated by the practices of leading businesses accumulates and assessments become more attuned to the business context, the demand for a silent TNC would be to reveal its policy and to explain it. When the managerial tools currently under development have matured enough, continued corporate ignorance and inaction will be proof of irresponsibility that will grow politically harder to refute in this changing context. C. The challenge for the emerging CSR regime is to make its impacts significant (i.e. commensurable with the scale of the problems) and sustainable. In other words, the corporate voluntarism of leading businesses, the standards of good business practice and the accompanying institutional infrastructure, need to be scaled-up. Joint business action (collective action) and state action (law and policy) are two 1034

F. Bird and J. Waters, ‘The Moral Muteness of Managers’, in T. Donaldson and P. Werhane (eds.), Ethical Issues in Business – A Philosophical Approach, 6th ed. (Prentice Hall, Upper Saddle River, N.J., 1999) pp. 181–183. 1035 S. Key, ‘Toward a New Theory of the Firm: A Critique of Stakeholder “Theory”’, 37:4 Management Decision (1999).

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Conclusions mechanisms for scaling-up CSR; this study focussed on the role of states. Actually, a third mechanism is in-built in how this study is defined: it looks at the corporate responsibilities of business groups, especially MNEs. As the controlling entities in a MNE commit themselves through codes of conduct to responsible business practices, the expectation is for them to generalise these good practices throughout the entire business group so that their business partners (i.e. subsidiaries, contractors, joint venture partners) abide by the same high standards. The intragroup linkages become a scale-up mechanism, a channel to exert influence so that the protection of human rights in the South is improved. For that purpose a broader definition of MNEs was used to include not only ownership links (i.e. parentsubsidiary) but also other links that allow a degree of control or influence be exercised (i.e. buyer-(sub)contractor). The aim of governmental support for the CSR regime is twofold: first, to mobilise private enforcement so that the corporate perpetuator of abuses is pressed towards compliance (i.e. companies to abstain from harming), and second, to generalise the use of due diligence efforts of controlling companies able to prevent their business partners from harming (i.e. controlling entities to exercise oversight to prevent harming). Thus states have an interest, and a role, in the institutionalisation of both negative obligations (falling on all entities in a business group) and positive obligations (falling on the controlling entity). In the process of stamping out abuses linked to business activities in the South, (home) states deliberately design their regulatory strategy to mobilise the regulatory potential of private actors with leverage on companies, which can ‘enforce’ both types of obligations. Regarding the negative obligation, the major difficulty is to create accountability mechanisms where private enforcement can be used effectively. Public enforcement remains an option and home states could open up their courts applying tort law principles (civil liability) or criminal law provisions (criminal liability). Regarding the positive obligation of the controlling entity to exercise influence, the difficulty is multiple: besides the enforcement mechanism one needs to specify the positive obligation itself. The CSR regime has yet to achieve clarity on the issue of the ‘scope’ of corporate responsibilities (i.e. limits of CSR) while various legal fields had similar difficulties in specifying affirmative obligations. In this light, the ‘regulatory mixes’ that policymakers have used have thus a double function: first, to draw on private enforcement and act as a substitute for ‘purely deterrent’ regulations, and, second, to achieve greater clarity regarding positive obligations (the legal command is in this case to ‘exercise reasonable care’). An interesting interaction between CSR and law occurs at this level of specifying positive obligations. The CSR movement has helped highlighting new risks and opportunities affecting corporate success as well as diligent ways to handle them. This clarifies the duty of care directors owe to their company. The CSR regime indeed advanced the new norm stating that managers are responsible to take a more impact-inclusive and longer-term view of their business in order to manage effectively new threats and opportunities. The norm implies that managers need to be aware of emerging social issues related to corporate activities, open for partnering 327

Chapter 7 and socially innovative in order to enhance the beneficial impact of corporations. This is the general standard, which is better specified by the emerging good business practices tested for viability by leading TNCs. The CSR regime thus clarifies what is ‘foreseeable’, what is ‘reasonable’, what is ‘negligence’. It is important to note that not only the duty of care under company law is better specified through ‘regulatory mixes’ but also the duty of care a company may owe directly to stakeholders under the general law of negligence. This is relevant to those who prefer not to advance the duty of care in the grey zone, that is, care to stakeholders as a subgoal of managerial care owed to the company; indeed some are more comfortable with an unqualified duty of care. CSR creates benchmarks for what reasonable care to stakeholders entails and can thus interact with the general law of negligence. Lawmakers can use these benchmarks to advance the duty of care owed to stakeholders either outside the grey zone (strong version of the duty) or within it (qualified duty). Defining the outer boundaries of CSR has been notoriously difficult. It helps in this endeavour to acknowledge that for a business group to ‘respect’ human rights (negative obligation) necessarily entails for the controlling company to ‘support’ human rights by overseeing its business partners (positive obligation). Identifying the relevant issue as one of specifying positive obligations of the controlling entity can draw on the challenges that regulators have encountered as well as the solutions they have tried. Pure deterrence is not an option in specifying positive obligations, neither does it seem to be a preferred option for enforcing negative obligations (transnational harms). Regulatory mixes have often been used to fulfil this function. The study looked closely at the regulatory techniques that emphasise the importance of sound procedures. Regulators often settle for specifying procedures when there is insufficient clarity or agreement on the substantive targets to be achieved. This is precisely the case with the positive responsibilities of the parent company (i.e. positive ‘obligations’ to oversee and influence business partners). By not employing ‘purely deterrent’ regulatory strategies policymakers aim to guide discretion rather than replace it. Especially regarding positive obligations, after highlighting the role of regulatory mixes, it appeared useful to draw on administrative law to place the whole discussion about sound procedures in a broader context. Following due process is a way of obtaining legitimacy for administrative agencies, which exercise delegated authority and discretion. As long as companies are not held legally liable for harms produced or for failure to fulfil positive legal obligations, they have some discretion that increasingly needs to be legitimised. The CSR regime, which emphasises transparency, participation and sound processes, appears as part of a larger movement towards participative democracy and deliberative, reasoned decision-making. Writers in the ‘business and human rights’ area have tended to adopt causally simple models of how law can change corporate behaviour. When lawmakers employ deterrence to alter corporate practices where the pursuit of profits has gone astray causality is straightforward. Causality becomes however more complicated when states rely on the regulatory potential of private actors and employ procedural 328

Conclusions regulations for that purpose. Thus if transparency laws are adopted, achieving law’s aims depends on the stakeholders pressuring companies into compliance; if laws force internal management systems upon companies, there is always the possibility of ‘paper compliance’ instead of achieving the desired performance through ‘due diligence’. Once lawmakers mobilise private actors through procedural regulations, a host of new intermediary variables complicate the causality: the regulatory potential of private actors, the standards of responsible business behaviour they apply, the norms and belief systems various private actors use and the supporting institutional infrastructure. Policymakers use a variety of methods to activate these intermediary variables: regulations, but also soft law instruments and capacity building measures have an important role in the emerging regulatory regime. Furthermore, in the CSR regime, leading businesses and their stakeholders have already had an impact on all these intermediary variables. A formalist focus on binding regulations alone obscures these variables and cannot explain how soft law instruments, state policies and corporate voluntarism are all relevant to achieving compliance by activating these variables. The CSR regime could exhibit both deterrent and non-deterrent strategies. Deterrence could be ‘private’ (e.g. commercial actors refraining from doing business with indifferent companies, investors refusing to invest, consumers heeding boycott calls, NGOs pursuing damning media campaigns) or ‘public’ (regulators mandating procedural steps such as social reporting and due diligence requirements). Nondeterrent strategies are important as they reduce a multitude of costs that a business contemplating a credible CSR response may incur. Even without employing deterrence, public and private actors could supply business with some clarification of their expectations (e.g. soft law instruments, guidance, standardisation), help with creating the infrastructure to implement and demonstrate CSR, offer various incentives for adopting sound internal processes and generally help with building the capacity of business and stakeholders to understand the underlying causes of CSR and forge effective collaborations for tackling root causes. The experience accumulated in the fields of corporate governance and environmental protection has seen regulators employ a mixture of regulations and soft law instruments, public and private codification and public and private enforcement. The presentation of procedural regulations was meant to illustrate how lawmakers have mobilised the regulatory potential of private actors. Procedural regulations are key to activating private actors. Chapter 5 referred to two types of procedural regulations. One type encourages companies to employ effective managerial systems. The purpose is to systematise the corporate approach to handling risks (e.g. corporate governance), to pursue environmental due diligence (e.g. environmental protection) and to prevent criminal misconduct (e.g. criminal law). Such sound management systems are indispensable in the CSR area to have parent companies monitor and influence their business partners in the South. Especially in the area of supply chain management buyer companies have recorded progress in monitoring and auditing their suppliers; a host of participative and transparent managerial approaches have already appeared. The laws regarding 329

Chapter 7 management systems are an example of law trying with incentives to determine the scope of positive obligations. It provides due diligence benchmarks. There are both cases were law creates incentives for the adoption of effective management systems (e.g. US Sentencing Guidelines), or even mandate them (e.g. court judgements in environmental tort cases), and cases were laws require reporting on management systems (e.g. corporate governance provisions). In the former case there is public enforcement while in the latter case policymakers rely on private enforcement from various market actors. It should also be noted that laws on management systems promote higher standards of care in the ‘grey zone’ (duties owed to the company, e.g. company law jurisprudence, codes of corporate governance) or outside the grey zone (duties owed to stakeholders, e.g. US Sentencing Guidelines, environmental protection). In all these cases, law sends a message about the desirability of sound procedures and the necessity of creating positive obligations. It also shows the difficulty that comes with specifying positive obligations as when regulators and courts have to decide whether a system is ‘effective’ or not. The other type of procedural regulations requires companies to disclose information regarding their social impacts. Transparency laws empower stakeholders in their interaction with companies. This strategy employs channels of influence present in the corporate environment (i.e. regulatory potential of stakeholders) as a difference from the previous strategy that uses intra-group channels of influence (i.e. regulatory potential of the parent company). Traditionally, disclosure laws have empowered shareholders against underperforming managers, but recently this regulatory strategy has been employed to empower ethical investors concerned about the policies of their investment funds, and local communities affected by the emissions of neighbouring industrial facilities. In the environmental area, transparency regulations have been recognised as a low cost and effective method of improving corporate performance. Also in the ‘business and human rights’ area, the most often heard calls in favour of binding regulation envisage transparency aspects. It appears that transparency laws by definition mobilise private enforcement; they can direct it toward both positive and negative obligations. The case of transparency on due diligence systems was mentioned above. Transparency on harms such as pollutants (e.g. TRI) and on social impacts (e.g. France’s New Economic Regulations) seek to mobilise private enforcement aimed toward the negative obligation of not harming another. Significantly, transparency regulations are least at odds with the principle of legal separation of corporate entities. As Blumberg wrote: “In probably no other area has enterprise law received more general acceptance than in the area of disclosure, where the painful issue of imposition of liability contrary to traditional entity law and limited liability is not involved.”1036 In such complex regulatory regimes employing procedural laws there is a double interaction that transcends the neat separation private-public and law1036

P. I. Blumberg, Multinational Challenge to Corporation Law: The Search for a New Corporate Personality (Oxford University Press, New York, 1993) p. 196.

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Conclusions voluntarism. On one hand, private actors interact with public actors in enforcing corporate responsibilities. On the other hand, the outcome of corporate voluntarism (i.e. CSR benchmarks) interacts with general, flexible legal concepts (e.g. ‘negligence’, ‘reasonableness’, ‘forseeability’). In both cases private actors retain a degree of discretion that law aims to guide rather than override through state coercion. This twofold interaction makes doubtful the accuracy and fruitfulness of the often encountered dichotomy between CSR and law. This study aimed to highlight the complementarity of law and CSR by emphasising their possible coexistence and interaction in complex regulatory regimes. The main purpose of the study has been to supply a law-oriented framework on CSR. That would assist human rights experts, a majority of which have a legal background, to better account for the implications of corporate voluntarism. Also a study of the regulatory dynamics triggered by CSR can inform corporate managers developing strategic responses to their social and regulatory environment. The focus here was the CSR regime as a new protective mechanism that complements the current state-centred system of safeguarding human rights rather than replace it or operate in isolation from it. The analysis deliberately tracked the interaction of companies with governmental entities (e.g. national agencies and international organisations) and other actors able to promote good governance (e.g. civil society groups, trade unions). The CSR movement has contributed significantly to building two sorts of capacities that help businesses to deal diligently with their stakeholders: one for moral reasoning leading to higher awareness to CSR issues, and a technical capacity consisting of CSR management tools. Intermediary actors observe how leading businesses redefine their self-interest and could use such redefinitions to benchmark less proactive companies; these actors act as private enforcers of CSR standards. However to understand the systemic effects of CSR happening in a decentralised bottom-up fashion, a third capacity is needed to advance CSR. This capacity would account for the effects of the interaction of leading businesses with public-interest bodies, for the regulatory dynamics that CSR triggers. In the CSR regime, the participation of stakeholders is increasingly required to make the implementation of CSR credible and effective. However such participation can be sabotaged by inappropriate understandings. An insufficient understanding of the regulatory dynamics in which CSR evolves is a serious gap in a decentralised, communication-based system of accountability. The risk is to obtain a partial if not stereotyped understanding of the roles and capacities of business, and also those of the law in its attempts to shape corporate behaviour. A reframing of the relevant issues is needed to search for evidence that, through their voluntary initiatives, leading companies and their stakeholders have been quietly and incrementally redefining the role of business in regard to governance gaps from a self-interest perspective. Reframing in the area of ‘business and human rights’ should not be a revisionist attempt guided by ideological leanings, but a sensible attempt to understand a variety of contexts where business rationality manifests itself in various ways, and to better grasp the complex process of social change that law aims to facilitate. 331

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INDEX definition .. 3, 76, 79, 97, 137, 167, 172, 311 interaction with public policy… 158, 161, 162, 164, 167, 240, 246, 294, 297, 307, 327, 331 law-oriented perspective on ... 167, 322, 331

A accountability ....3, 82, 159, 188, 200, 201, 207, 230, 257, 277, 295, 305, 309, 311, 321, 331 arbitrary and capricious . 42, 282, 286

B belief system ….70, 88, 89, 91, 269, 291, 325 benchmarks..144, 146, 150, 165, 168, 198, 202, 206, 238, 257, 261, 293

D deterrence...... 16, 110, 151, 153, 171, 242, 245, 256, 261, 274, 281, 300, 302, 315, 316, 328, 329 due diligence……216, 220, 222, 224, 227, 234, 238, 241, 251, 255, 258, 294, 313 due process in administrative rulemaking ...................... 281, 286 duty of care owed to company ... 28, 52, 72, 82, 177, 191, 207, 234, 270, 328 owed to stakeholders ...... 231, 234, 236, 318, 328 standard of care ...... 44, 66, 70, 71, 221, 234, 256, 257, 258

C capacity-building……12, 18, 22, 84, 110, 170, 275, 318 certification..124, 126, 131, 140, 156, 163, 224 collective action, of business ...... 127, 128, 155, 300 company. .....54, 58, 64, 81, 190, 195, 207 interest of ....31, 34, 65, 69, 79, 81, 86, 200 reputation 32, 39, 79, 99, 100, 106, 107, 157, 186, 203, 210, 216, 246 role in society....73, 74, 77, 85, 87, 88, 94, 100, 136, 175, 292, 319 competition.......................... 198, 307 anti-competition...... 103, 128, 293 competitive advantage ... 5, 69, 98, 160, 308, 315 compliance...128, 148, 164, 203, 206, 215, 222, 225, 245, 255, 289, 300 “beyond compliance”...... 251, 314 paper compliance ... 183, 190, 192, 256, 286, 287 complicity.........9, 101, 136, 232, 313 courts judicial activism...................... 259 judicial restraint 29, 41, 44, 52, 71 CSR

F Foreseeability...... 233, 236, 238, 258, 259, 260, 313

G Global Compact .... 98, 119, 145, 156, 158, 159, 169, 170, 174, 266, 288, 299, 305, 311 Global Reporting Initiative . 143, 173, 176, 199, 264, 266

H human rights .................................. 21

367

Index

I ILO Declaration concerning MNEs ........................................ 169, 296 incrementalism ....115, 170, 259, 267, 302, 305, 309, 326, 331 industry practice ..120, 190, 193, 202, 222, 224, 238, 239, 240, 248, 252 influence in business group .. 19, 145, 174, 222, 251, 312 institutional field............ 92, 303, 309 institutionalisation of CSR.. 161, 164, 255, 302, 311, 316

J justice.......20, 90, 106, 156, 184, 210, 218, 236, 237, 253, 259, 277, 287, 304

L labelling ................142, 215, 218, 249 leadership.....106, 116, 139, 275, 288, 290, 303 learning........157, 170, 171, 276, 301, 305, 310 legitimacy .............279, 281, 301, 307 of business ..78, 85, 171, 277, 286, 288 of CSR .........63, 77, 171, 269, 293

M management systems ........... 165, 256 compliance systems ........ 114, 227 effectiveness ...115, 120, 199, 217, 221, 223, 227, 229, 250 environmental management systems.......117, 120, 139, 173, 224, 238, 253 information systems…45, 71, 83, 92, 223 regulatory strategy ... 47, 168, 198, 203, 216, 221, 229, 242, 251, 287, 294, 329

368

risk management systems....... 150, 229, 230 management, corporate accountability to shareholders.. 27, 57, 64, 67, 83, 87, 108 decision-making. .... 40, 44, 48, 63, 65, 72, 74, 84, 88, 90, 107, 191, 193, 207 discretion.... 38, 41, 52, 53, 61, 62, 75, 167, 190, 278, 306, 328 duties ..... 28, 39, 41, 51, 60, 82, 90 judgement... 43, 49, 54, 59, 64, 68, 72, 91, 191, 192, 194 knowledge .... 45, 49, 85, 153, 174, 233, 236, 238, 273, 297, 326 loyalty ............... 29, 36, 58, 67, 82 market .... 63, 161, 163, 290, 303, 308 globalisation of markets ..... 55, 97, 174, 201 market demand for CSR..... …119, 151, 250, 315 market discipline ............... 83, 156 market economy ..... 31, 34, 77, 86, 188, 284, 315 market for corporate control..... 38, 62, 179 market institutions... 246, 247, 248 market valuations ... 28, 56, 58, 62, 67, 76, 85, 184, 253, 267 materiality of information ... 143, 148, 177, 178, 182, 183, 185, 189, 190, 191, 193, 194, 199, 200, 249, 287 monitoring... 100, 121, 124, 125, 127, 128, 152, 163, 170, 277

N negligence ..... ..28, 44, 230, 233, 234, 256 norm..................... 304, 323, 325, 327 importance of social norms ...... 91, 247, 271, 278, 292, 299, 300, 301

Index way of approaching complexity ...71, 72, 75, 78, 83, 87, 88, 93, 98, 269

O obligations of companies negative (‘respect’ human rights ................................... 122, 311 positive (‘support’ human rights .....16, 122, 123, 125, 167, 237, 254, 257, 260, 312, 313, 315, 316, 327, 328 obligations of states positive (‘protect’ human rights..5, 157, 160 OECD Guidelines for MNEs.. ...... 19, 169, 296, 297 Omissions…46, 47, 231, 234, 235, 237, 257, 258

P participation of citizens in administrative rulemaking….279, 280, 281, 283, 287 of stakeholders in CSR .. 111, 113, 114, 116, 119, 121, 129, 134, 136, 144, 146, 147, 162, 163, 164, 216, 274, 309, 331 partnership .....98, 103, 129, 158, 162, 170, 171, 174, 175, 263, 275, 289 peers ......43, 148, 154, 155, 182, 190, 219, 222, 257, 306, 310, 326 philanthropy..136, 139, 161, 311, 314 profit ........31, 41, 58, 80, 81, 88, 203, 214, 307 protectionism ................... 6, 172, 263

R reasonableness .....227, 236, 239, 241, 257, 260 reflexive attitude....91, 152, 185, 196, 202, 282, 286, 287, 319, 331

regulation “comply or explain” approach ... .192, 202, 204, 205, 206, 248 co-regulation ................... 100, 163 deregulation...... 22, 157, 163, 167, 284, 285, 291 functions of law...71, 164, 256, 270, 295 opt-in clauses........................... 249 opt-out procedures... 248, 249, 268 regulatory mixes...... 290, 302, 327 regulatory space ..25, 70, 289, 295, 296 self-regulation .. 98, 100, 111, 130, 131, 156, 163, 290, 292, 294 soft law..... 70, 169, 202, 246, 248, 254, 264, 268, 295 risk...59, 173, 186, 189, 192, 233, 236, 259, 294, 306 CSR risks.... 68, 80, 100, 107, 114, 129, 150, 189, 201, 202, 203, 311 risk assessment................ 124, 136 risk-taking ................... 29, 53, 106 role of state.. 162, 169, 172, 175, 176, 267, 284, 293, 299, 307 rule-making process .... 297, 301, 307, 318

S scaling-up CSR ...... 22, 164, 276, 326 self-interest.... 22, 272, 300, 303, 308, 310 shareholders ... .27, 36, 38, 52, 65, 67, 81 activism ........................... 151, 153 ethical investor ...... .150, 177, 180, 185, 207 reasonable investor..177, 179, 180, 182, 183 standardisation .... 191, 192, 210, 239, 240, 262, 290, 298

369

Index

T temporal perspective long-term ..32, 33, 38, 40, 90, 100, 104, 121, 128, 135, 136, 143, 151, 191, 198, 277, 310 short-term........31, 59, 63, 80, 161, 270 transparency.........134, 279, 280, 284, 285, 288, 330 trust.............................. 275, 276, 279

U UN Norms on the Responsibilities of TNCs........................... 7, 169, 313 Universal Declaration of Human Rights...........2, 114, 126, 169, 296

V,W voluntarism, corporate…….3, 94, 98, 163, 164, 173, 190, 274, 305, 314, 318 effects......154, 156, 157, 159, 257, 296, 305, 322, 326

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Göran Melander (ed.): The Raoul Wallenberg Institute Compilation of Human Rights Instruments ISBN 0 79233 646 1 U. Oji Umozurike: The African Charter on Human and Peoples’ Rights ISBN 90-411-0291-4 Bertrand G. Ramcharan (ed.): The Principle of Legality in International Human Rights Institutions; Selected Legal Opinions ISBN 90 411 0299 X Zelim Skurbaty: As If Peoples Mattered; Critical Appraisal of ‘Peoples’ and `Minorities’ from the International Human Rights Perspective and Beyond ISBN 90 411 1342 8 Gudmundur Alfredsson and Rolf Ring (eds.): The Inspection Panel of the World Bank; A Different Complaints Procedure ISBN 90 411 1390 8 Gregor Noll (ed.): Negotiating Asylum; The EU Acquis, Extraterritorial Protection and the Common Market of Deflection ISBN 90 411 1431 9 Gudmundur Alfredsson, Jonas Grimheden, Bertrand G. Ramcharan and Alfred de Zayas (eds.): International Human Rights Monitoring Mechanisms; Essays in Honour of Jakob Th. Möller ISBN 90 411 1445 9 Gudmundur Alfredsson and Peter Macalister-Smith (eds.): The Land Beyond; Collected Essays on Refugee Law and Policy ISBN 90 411 1493 9 Hans-Otto Sano, Gudmundur Alfredsson and Robin Clapp (eds.): Human Rights and Good Governance; Building Bridges ISBN 90 411 1776 8 Gudmundur Alfredsson and Maria Stavropoulou (eds.): Justice Pending: Indigenous Peoples and Other Good Causes; Essays in Honour of Erica-Irene A. Daes ISBN 90 411 1876 4 Göran Bexell and Dan-Erik Andersson (eds.): Universal Ethics; Perspectives and Proposals from Scandinavian Scholars ISBN 90 411 1933 7 Hans Göran Franck, Revised and edited by William Schabas: The Barbaric Punishment; Abolishing the Death Penalty ISBN 90 411 2151 X Radu Mares (ed.): Business and Human Rights; A Compilation of Documents ISBN 90 04 13656 8 Manfred Nowak: Introduction to the International Human Rights Regime ISBN 90 04 13658 4 (Hb) ISBN 90 04 13672 X (Pb) Göran Melander, Gudmundur Alfredsson and Leif Holmström (eds.): The Raoul Wallenberg Institute Compilation of Human Rights Instruments; Second Revised Edition ISBN 90 04 13857 9 Gregor Noll (ed.): Proof, Evidentiary Assessment and Credibility in Asylum Procedures ISBN 90 04 14065 4 Ineta Ziemele (ed.): Reservations to Human Rights Treaties and the Vienna Convention Regime; Conflict, Harmony or Reconciliation ISBN 90 04 14064 6

18. Nisuke Ando (ed.), on behalf of the Committee: Towards Implementing Universal Human Rights; Festschrift for the Twenty-Fifth Anniversary of the Human Rights Committee ISBN 90 04 14078 6 19. Zelim A. Skurbaty (ed.): Beyond a One-Dimensional State: An Emerging Right to Autonomy? ISBN 90 04 14204 5 20. Joshua Castellino and Niamh Walsh (eds.): International Law and Indigenous Peoples ISBN 90 04 14336 X 21. Herdís Thorgeirsdóttir: Journalism worthy of the Name Freedom within the Press under Article 10 of the European Convention on Human Rights ISBN 90 04 14528 1 22. Bertrand G. Ramcharan (ed.): Judicial Protection of Economic, Social and Cultural Rights: Cases and Materials ISBN 90 04 14562 1 23. Gro Nystuen: Achieving Peace or Protecting Human Rights? Conflicts between Norms Regarding Ethnic Discrimination in the Dayton Peace Agreement ISBN 90 04 14652 0 24. Maria Deanna Santos: Human Rights And Migrant Domestic Work – A Comparative Analysis of The Socio-Legal Status of Filipina Migrant Domestic Workers in Canada and Hong Kong ISBN 90 04 14527 3 25. Ragnhildur Helgadóttir: The Influence of American Theories of Judicial Review on Nordic Constitutional Law ISBN 90 04 15002 1 26. Jonas Grimheden and Rolf Ring (eds.): Human Rights Law: From Dissemination to Application Essays in Honour of Göran Melander ISBN-13 978 9004151 81 9 ISBN-10 90 04 15181 8 27. Brian Burdekin, assisted by Jason Naum: National Human Rights Institutions in the Asia-Pacific Region ISBN-13 978 9004153 36 3 ISBN-10 90 04 15336 5 28. Jonathan Power: Conundrums of Humanity The Quest for Global Justice ISBN-13 978 9004155 13 8 ISBN-10 978 9004155 13 8 29. Nina-Louisa Arold: The Legal Culture of the European Court of Human Rights ISBN 978 90 04 16067 5 30. Hans Morten Haugen: The Right to Food and the TRIPS Agreement With a Particular Emphasis on Developing Countries’ Measures for Food Production and Distribution ISBN 978 90 04 16184 9 31. Joakim Nergelius (ed.): Constitutionalism – New Challenges European Law from a Nordic Perspective ISBN 978 90 04 16348 5