Toward a foundational business ethics

One thing that bugs me is that intellectuals are generally pretty uninterested in the business world. This is really bad for two reasons. (1) It means a lot of business ideas lack intellectual rigor, since they haven’t been subjected to sufficient scrutiny. (2) The human/social world is mostly the business world—business is what most of us spend most of our waking hours doing, it’s how most of our needs are met, etc. It seems a little crazy that modern moral philosophy is more frequently used to set a foundation for political theory, as opposed to business ethics, given that in modern global capitalism, private firms control far more of our resources and are just generally responsible for more of the activity going on in the world. If we want to create an ethical society, then, it would seem more immediately urgent to elucidate the ethical obligations of businesses than governments.

So this post will just be a little preliminary sketch, where I’ll try to link up some fundamental moral philosophy to some ideas about the obligations that firms in the private sector have. This sketch will be (naturally) sketchy, but I hope it will provide a sort of skeleton that later, more specific discussions could flesh out.

 

All of moral philosophy, in brief

Most of the contention in contemporary moral philosophy boils down to, essentially, the trade-off between deontological moral obligations and consequentialist moral obligations. We usually elucidate this trade-off using a lot of grotesque thought experiments involving fat men on train tracks, brains in vats, etc. But I want to use some less unpleasant thought experiments involving pie.

Suppose you have a piece of pie which you cannot divide, and you have to give it to one of two people. These two people are pretty similar, with one exception: Adam is absolutely crazy about pie—he just goes wild for pie. Brian likes pie alright, but he’s not crazy about it. To whom should you give the pie? Clearly, you should give it to Adam. He’ll get more pleasure and happiness from it. The sum total of human happiness rises more when Adam has the pie, and you might infer our moral obligation is to promote the ‘greatest happiness for the greatest number’ of humans and other sentient creatures. This is a ‘consequentialist’ justification for giving Adam the pie. Suppose now that you have to choose between giving the pie to Cecily and Delilah. They both like pie an equal amount, but the main difference between them is that Cecily is poorer and hungrier than Delilah. Clearly this time you should give the pie to Cecily—because her basic needs have not been met as well as Delilah’s, she’ll get more extra marginal happiness from the pie. So this is, again, an argument from the ‘consequences’ on total human welfare and happiness. Or suppose now that you have to choose between giving the pie to Edward and Frederick, who are equal in every way, and this time you can divide the pie. The ethical choice would seem to be to split the pie in half, both out of respect for fairness, and because there are ‘diminishing returns’ of happiness for each extra bite of pie you eat, so you achieve the most total happiness by giving each person half.

In each of these cases the ethical choice seems to make sure that pie gets allocated to people in a way that maximizes human happiness. This is our ‘teleological’ or ‘consequentialist’ moral obligation. So does ‘be ethical’ just mean ‘maximize the sum total of human happiness’?

Not always. Let’s change up the first thought experiment. Now this time, you’ve already promised that you would give the pie to Brian. You would still maximize the sum total of human happiness by giving the pie to Adam, but this would require violating your promise, and we intuit that this is intrinsically wrong. Or suppose this time, Brian has a piece of pie on his desk, which you have the ability to steal and give to Adam. Since Adam likes pie more than Brian does, this theft would increase the sum total of human happiness and welfare in the world. But should you do it? Most of us would say no. We intuit that this theft would be intrinsically wrong in itself, as a violation of Brian’s natural rights, and that the moral obligation to respect Brian’s property and rights overrides the moral obligation to maximize human happiness. In short, the means don’t justify the ends. In modern moral philosophy, we call these restrictions on the means we can employ in achieving an end our ‘deontological’ obligations.

BUT (!) then again, there are also times when ‘consequentialist’ factors get so big that they override ‘deontological’ concerns. For example, if you’ve promised the pie to Adam, but Brian is literally starving, then you clearly should, in this case, violate your promise in order to save Brian’s life.

Most of modern moral philosophy, it seems to me, is just one long continuation of this endless series of thought experiments that seek to clarify when, where, and how strongly we put deontological overrides on consequentialist obligations and vice versa.

 

What is a firm?

How does this foundational moral philosophy link up to businesses? There are two basic ways you can think of this. First, a business is a human institution, and its decisions are ultimately decisions made by real people—people’s fundamental moral obligations qua people don’t go away the moment they assume a professional role. Second, a corporation is also, in a sense, a tool of its owners (investors), and since tools are extensions of our agency, we’re responsible for what our tools do in the world. For example, if I make a robot as a tool to fetch my lunch every day, I can’t disclaim all moral responsibility if the robot runs an old lady over and kills her on the way back to my office. I can’t say, “the robot did it, not me!” because I was the moral agent behind its deployment in the world, and I should have taken steps to make sure it was safe before I started using it. In the same way, if I as an investor make a corporation as a tool to double my wealth, I can’t disclaim total responsibility for what this tool does to the world.

So firms’ moral obligations have to be linked up, somehow, with our obligations as human beings. I would argue that it’s that simple. Just like people, firms have deontological obligations to keep promises, respect contracts, and not violate any human rights; and just like humans, firms have consequentialist obligations to maximize human welfare whenever this is consistent with not violating their deontological commitments; and, just as with humans, there are a lot of tricky spaces where deontological obligations come into conflict with consequentialist obligations, and it’s not clear what’s right.

I want us to keep that paragraph, above, in mind. But now I’m going to go off on a brief discursion about two common arguments I’ve heard about corporate social responsibility and business ethics which I think don’t stand up to analytical scrutiny. So after I’ve disposed of those, I’ll go back to the above paragraph and explore its implications.

 

Some unsound arguments

(1) One argument I’ve heard recently is that corporations’ fundamental moral obligations—or, to use vogue term, Corporate Social Responsibilities (CSR)—derive from their ‘agency relationship with society.’ Business-school academics like to put it this way, because we commonly talk of the ‘agency relationship’ between stockholders and firms. That is, we conceive of a corporation as a collection of stockholders getting together and pooling their savings together to take ownership of a firm, and then hiring a management team to run the firm in a way that will maximize the value of their shares. Because managers are agents of the stockholders, and the capital the company deploys actually belongs to the stockholders, managers are obligated, by their very acceptance of their employment, to serve the stockholders’ financial interests rather than their own.

If a business does have an ‘agency relationship with society,’ where does it come from? Business academics often rely on the argument that corporations are legal entities that are chartered by state governments, which then privilege the corporation with the rights it requires to make its profits. So because the government—which is an agent of society—endows a business with the things it needs to exist, a corporation is an agent of society in addition to its stockholders. That’s the idea.

This argument sounds nice, but I don’t think it’s analytically sound. First, the argument is fundamentally circular. For example, it’s easy to imagine a world in which things exactly like corporations existed, but weren’t chartered by state governments. In this world, private companies that wanted to raise capital from the public could go directly to private stock exchanges, and these private stock exchanges would have an incentive ( in order to protect their own reputations as good places to trade) to require the private companies to adopt certain internal controls that would protect their prospective shareholders. So a corporation qua corporation in the abstract does not itself require a state charter in order to exist; rather, companies pursue state charters precisely because the government legally requires them to do so in order to list publicly. So the argument ‘because corporations require state charters from the government, they become agents of society,’ is circular, because it is the government that requires public corporations to get state charters in the first place. This would be like the government requiring you to register for permission to breathe, and, having generously granted you that permission, inform you that you have consented to military conscription—“after all, were it not for us, you would not be able to breathe.” I, for one, would argue that I had a right to breathe prior to the government’s generous permission.

Second, the argument has troubling implications. If firms’ obligations come from being chartered by governments, do sole proprietors have no moral obligations to society? After all, a sole proprietor’s business is not legally distinct from her self. There’s no charter, or anything, involved here. Does this mean that we as a society have no right to expect a large sole proprietorship to, say, internalize the costs of its environmental externalities? I think the answer is clearly no, and so my foundational argument—that businesses have moral obligations because they are made of people who have moral obligations—is a much firmer basis for thinking about corporations’ obligations.

(2) Another line of argument I hear frequently hearkens back to Adam Smith, who famously wrote,

“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

In other words, firms do good things—satisfying our needs and wants—by pursuing their own ‘selfish’ profit-motive and so, given that, it’s stupid to get all romantic about their moral obligations. People go from this to say something like, ‘the obligations of firms are economic, not moral.’ (This statement, of course, is self-refuting (‘obligation’ and ‘moral’ mean the same thing), but people say it.)

I think Smith’s basic idea is descriptively true. By and large, firms engage in economic transactions between consenting adults, and compete to do a better job meeting our needs and wants—all terrific moral things that are directly coincident with their economic interests. This is by and large true. The problem is that this argument does not say anything about foundational ethics, and so it does not provide any guidance for what we should do in the cases where this is not the case. For example, it does not tell us what to do about a firm that pollutes the air I breathe (which I do not consent to), nor does it speak to my intuition that, actually, sometimes I do rely on the benevolence of private firms—for example, in my hope that a firm will not immediately fire me if my productivity declines due to an unpredictable illness or pregnancy, even when this would be the ‘economically rational’ thing to do.

 

My argument

So I think both the ‘agency relationship with society’ and the ‘moral language is not useful for understanding and directing business activity’ arguments are analytically unsound. So what do I propose as a better approach? Very simply, it’s that people’s moral obligations don’t disappear when they take on a management role or invest in a company, and so figuring out what companies should do just involves figuring out how to properly apply, in a business context, the fundamental moral obligations that the people involved (managers and investors) already have as people. I’m going to try to make some fundamental applications clear with some thought experiments, and then see how that applies to some real things.

Suppose you agree to a business arrangement with a friend wherein she gives you $100, and you promise to walk across the river and put the money into a machine that magically makes it into $200. You’ll return the money to her, and she’ll give you cut of the profits—$20. You’ve made this promise—a contract. Now suppose that as you cross the river, you encounter a graduate student who asks you for the money—and he’s a lot less rich than your friend, so actually $100 would make him a lot happier than $180 would make her. Do you have an obligation to give him the money? I don’t think so. Being a poor graduate student sucks, but it doesn’t suck enough to compel you to violate your promise to your friend and give away her money without her consent. If you think the graduate student’s case that he deserves the money is really strong, you have another option. You could go to the money machine, get the $200 bucks, bring it to your friend, claim your $20 fee, and try to convince your friend to give away some money herself—and even throw in some of your fee.

Now suppose that, as you cross the river and approach the money machine, you see a burning building in which three children are trapped. You know that if you try to rescue them, the cash will get singed and be unusable. Do you rush in? Of course you do. This is a no-brainer. Three innocent freaking lives versus your promise to bring $200 to your rich friend.

As you can sense, I’m trying to make this a close parallel to the relationships between stockholders and the firms they own. Individuals place their own money under control of the firm’s managers, delegating to them the task of producing a good return. And this act gives the management a deontological responsibility to make good on their implicit promise to shareholders, but it does not negate their responsibility to caveat that when the consequences are high enough. This means, in short, that a firm should not just go around doing every good deed imaginable, considering itself  personally responsible for the happiness of local graduate students, but nor can it stand by while innocent people to come to physical harm while it pursues superior profits. When the costs and/or benefits to humanity are sufficiently high, a corporation is obligated to sacrifice its investors’ interests—but it shouldn’t otherwise be a busy-body do-gooder.

In between those extremes, there’s a lot of ethical fuzziness, just as there is for people. And, just as with people, the way for firms to approach these situations is to try to figure out what to do by conversing empathetically, openly, transparently, and rationally, and with thought experiments.

So let me think about a trickier situation. Suppose now that, having finally crossed the river and arrived at the money machine, you realize it is more complicated to operate than you had presumed. You realize you’ll need to hire somebody to help you. Unfortunately, there’s a lot of unemployment in town right now, so people are quite desperate for work. You know that you could find someone to do most of the work in cranking the money machine for $1—5% of your total fee. This raises two ethical questions. First, how much are you obligated to pay your hire? This is unskilled labor, in higher supply than demand, meaning it’s cheap—but it’s also not pleasant labor. Your sense of fairness might compel you to want to roughly split the fee–$12 and $8 or something. Then again, maybe you wouldn’t have taken the job if you’d known you’d only come away with $12, and you know that you alone can’t really do much about the plight of the poor and unemployed in the town—who are the responsibility of society as a whole—so you consider paying your hire only $2.50. If you go through with this, how do we evaluate your choice? It surely wasn’t grossly immoral—the hire agreed to work for $2.50, so surely she believed she was being made better off. But what seems worst in this arrangement isn’t just that the worker gets so little, but that you and your friend get so much from it. Have you done a moral wrong? And second, has your investor-friend, who hired you for this job, been morally implicated in the exploitation of this worker?

As you can sense, this parallels a lot of the really tricky issues in management compensation–tricky both for the people who set compensation in the firm, and for investors in firms with grossly unequal payscales. Economic inequality in the U.S. has risen to truly unseemly levels; exploitation of workers is easy in periods of long, sustained unemployement. And compensation practices for senior management at major firms are seriously morally problematic—boards of directors sign off on the bonus recommendations of compensation consultants who used skewed and self-fulfilling samples of peer compensation and who have themselves been hired by management, and, incredibly, these same managers may sit, or expect in the future to sit, on board that sign off on the bonus packages at firms where their directors serve as managers. In short, compensation for senior managers at major firms in the U.S. often looks less like a competitive market for extremely skilled leaders, and more like a self-serving insiders’/old boys’ club. There’s a lot of work to be done for shareholders’ rights activists to make executive compensation actually competitive.

But it’s not clear what can be done, on the other end, for the bottom of a firm’s compensation scale. If you as a shareholder or manager try to get your company’s workers paid a lot more, and your competitors don’t, the extra cost could put you out of business—no favor to your employees. If the government tries to raise the minimum wage too high, it could potentially accelerate outsourcing, or incentivize firms to substitute more capital for labor. Again, no good for your workers. One option would be for workers to try to unite in solidarity internationally, but I’m not sure that’s always worked out in the past… The best option would be for deeply ethical managers to willingly accept modest salaries,with offsetting boosts to their workers’ wages. But the problem with this is that “people should willingly choose to make enormous personal sacrifices for those less fortunate than themselves” is theoretically a great solution to every problem. In other words, it doesn’t happen.

So the point of these thoughts on compensation is there are some basic, clear ethical things we can say about businesses, and then there are some areas where all the implications of these basic things get bewilderingly complicated. The basic clear thing maxim is, “a corporation should devote most of its effort to meeting its commitments to its owners, by earning a profit through the sale of goods and services to meet customers’ demands. But in the process, it may not effect any gross outrages against human dignity, and it should try to do what good it can, when this is consistent with its primary obligations.”

 

Implementing business ethics

So now that we’ve sketched the underlying theory about fundamental obligations, let’s keep progressing toward more realistic thought experiments. Suppose you’re a major shareholder in a major corporation. Suppose you’re from a second-tier rust-belt city where the company has some plants, and you really love and romanticize your hometown. Does it make sense for you as a shareholder to use your votes to get the firm to make some big community-effort push to revive your city? I would say: certainly not. And there’s a very simple reason for this. The cost of any charitable effort like this would inevitably come out of profits, which ultimately belong to shareholders, including yourself. So what makes most sense—not as a matter of fundamental moral theory, but just a matter of practicality—is for you to encourage the company to return as much value to shareholders as possible, then pocket your dividends and capital gains, and lead the charitable effort to revive your downtown yourself. This is the most moral and practical thing to do. First, other shareholders in the company might have good reasons for not thinking that a hopeless attempt to revive your city’s downtown is the world’s highest moral priority, and you should respect that view; second, the company’s management doesn’t live in your city and so they have less local knowledge about the city than you do, so they’re less well-positioned to invest wisely in its revival.

The point of this thought experiment is that it is strange, for me, to hear shareholders encouraging firms to give more to charitable causes. After all, the cost of that charity has to come, eventually, out of shareholder equity, and so it would just make more sense for the shareholders to demand that management go about maximizing that value, while letting the shareholders themselves choose to which charitable uses they wish to put it. And a big takeaway from this line of reasoning is that a lot of unambiguously-good sounding exhortations to firms to “do good!” don’t actually make a lot of sense when you think about their underlying economics.

When does it make sense for a firm to do something charitable? I would say there are a couple of conditions under which it makes sense. The first is whenever a charitable effort is consistent with improving shareholder value—if sponsoring an arts festival improves your brand image enough to compensate you for its costs, that’s win-win. You did a good thing that also returned more value to your shareholders, who can do their own good things with it.

The second condition is when your company is, due to either its expertise or position, uniquely well-positioned to do a particular charitable good deed—i.e., when the company can do a charitable thing that its shareholders would not be able to do if the money were in their own hands. In these case, you could borrow from the language of trade economics to say the firm has some ‘comparative advantage’ in a particular ethical task. For example, I think savings and financial literacy are really important for low-income people. Unfortunately, I lack the ability to set up my own charity to provide financial education and special high-incentive bank accounts for low-income people. In this case, it makes a lot of sense for me as a shareholder in any given bank to use my vote to encourage them to set up a pro-bono division that provides those services. Since finance is their line of business, they’re the best people in the world to provide this kind of education. Similarly, it makes a lot of sense for an operations consultancy to do pro-bono work on disaster relief, since they’re highly expert in supply chains, etc. It makes sense for a coffee company in Colombia to pay above-market wages if they can, since we shareholders, located mostly in the U.S., have a lack of charities that could boost Colombian workers’ wages more directly…

But otherwise, I shouldn’t expect a corporation to do lots of charitable good deeds and donations. I should expect it to give me my dividend, and I should do them myself.

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One thought on “Toward a foundational business ethics

  1. Yes. Ideally, you should take your dividends and do the good deeds yourself, but then over and beyond the outsourcing of labor for the purposes of profit, there is also the outsourcing profit to those “shops” in Bermuda (and the like) for the purposes of evading the taxes that could potentially fix up your downtown. In these uncertain economic times the “greater good” takes a back seat to hoarding. You don’t need to upgrade your own downtown when you have your own private estate. I think the sense of scale you address is quaint and you need to look past the entity of the corporation and address the phenomena of corporate cartels and their enmeshment with global politics. Your thought experiment is incomplete if it doesn’t address this very real concentration of power in today’s global economy.

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