Economically Reprehensible Behavior, or Benefits and Risks of Morality? (2 of 2)

I. Introduction

second article in the series first identifies past assumptions of the
traditional investment model.  Possible additional benefits and
drawbacks of morally responsible investing (MRI) as compared to the
traditional model are pointed out along the way.  Finally, future legal
issues that MRI may raise are identified, and the court’s likely
treatment of such issues is hypothesized. 

II. Getting Past Those Assumptions

Several assumptions from traditional economic theory and law
seemingly hinder MRI.  However, the premises underlying these
assumptions are not on as solid footing as once perceived.  Some of
these assumptions include A) the decreased profitability of MRI, B) the
legal doctrine that a director’s sole responsibility is to maximize
profits and C) the gap between ownership and control in the public
corporation cannot be closed. 

Assumption A.  Traditional economic theory assumes that MRI is
less profitable than traditional instruments because profit
maximization is not the only goal of MRI.
The Amana
Growth fund mentioned in the previous article provides an example to
contradict the blanket assumption that moral preference hurts the
bottom line.  Amana Growth showed a rate of return from 2003-2005 that
“crushed” the S&P 500 by 11 points per year. [1]  This
is not merely an exception, but an example of the success moral funds
can achieve, a success much doubted by traditional economists.  One
example does not establish that the assumption is completely incorrect,
but it does go to show that MRI and profitability are not mutually
exclusive concepts. 

On the other hand, arguably maximizing profit indeed allows the
satisfaction of the moral needs of investors.  Since investors in any
public corporation or investment fund likely come from varying
religious, cultural and socio-economic backgrounds, investors within
the same investment will have very diverse moral preferences. [2]  By
maximizing profits returned to each investor, the traditional model
does allow each individual to use those profits more discretely to
reach their own diverse moral preferences.  Thus, by returning the
maximum profit to the investor, the investor’s moral preferences are
more directly addressed. 

However, this argument overlooks key practical factors.  The
argument assumes that investors will in fact have the time and know how
to use those maximized profits to satisfy their social preferences. 
But the antitheses of these assumptions are the reasons for
establishing corporations and mutual funds.  Investors lack the time
and sophistication to investigate business opportunities and
investments, so they trust their money to managers, both corporate
directors and fund managers.  Investors knowingly relinquish some
control to managers in return for expertise and decreased time
commitment.  Thus, these practical factors weigh in favor of further
promoting managers to exercise socially responsible business decision
making where investors seek such a preference. 

Assumption B. Corporate law imposes on managers a duty above all others to maximize profits.

Traditionally, corporate directors have been assumed to have one duty, maximize profitability.  Dodge v. Ford is often cited for this proposition. [3] 
However, the same Court did not disagree with the proposition that a
corporation could carry on charitable works for the benefit of society
incidental to the corporation’s main business. [4] Thus, the legal paradigm does provide wiggle room for corporate directors to be morally conscious. 

Further, the relationship between directors and shareholders is a
contractual one.  The law allows for contracting parties to come to
mutually agreed to relationships.  Such a relationship could be based
on shared business and moral preferences and thus would be within the
freedom to contract. 

C.  Because of the structure of the public corporation, a gap will always exist between ownership and control. 

Ownership lies with the investors, while control remains with the
directors.  Owners do exercise control by voting for directors, or
instead by selling their stake in the investment.  Even with this
voting ability, investors lack the ability to take part in day to day
decision making.

MRI can bridge this gap.  By selecting investments where directors
share similar social goals for the corporation, investors are able to
select directors with similar moral preferences.  Thus, although
investors are not directly participating in business decisions,
investors are assured that directors will make decisions in line with
the investors’ moral preferences.  For these investors, profit is not
the only consideration when making a decision.  Similarly, by allowing
directors to allow moral preferences to guide business decisions, the
investors’ desires are more completely fulfilled. [5Thus,
MRI does help to close the gap between ownership and control that
remains in the traditional for-profit corporate structure. 

III. Possible Future Developments

Basing a contractual relationship in this setting on MRI principles,
however, may raise a new legal claim: the shareholder derivative action
for the failure to remain socially responsible.  This would be in
contrast to the traditional shareholder derivative action for failure
to maximize profits.  The courts have deferred to the management-biased
business judgment rule concerned that courts are not most capable to
make business judgments and out of fear of hindsight decision making. 
Analogously, courts would likely continue to defer to managerial
business decisions fearing the same concerns where social benefit,
rather than profit, has been agreed to as part of the goal of the
corporation.  However the courts handle such a claim, the freedom of
contract does and should continue to allow investors and managers to
establish relationships based on moral preferences.

[1] Kimberly Lankford, Funds Get Religion, Kiplinger’s Personal Finance Magazine,, (Dec. 2005).

[2]  E.S. Adams and K.D. Knutsen, A Charitable
Corporate Giving Justification for the Socially Responsible Investment
of Pension Funds: A Populist Argument for the Public Use of Private
, 32 Dayton L. Rev. 275, 286 (1995). 

[3] Id. 

[4] Dodge v. Ford Motor Co., 170 NW 668 (Mich. 1919).

[5]  J. Nusterek, Corporations, Shareholders and Moral Choice: A New Perspective on Corporate Social Responsibility, 58 U. Cin. L. Rev. 451, 466 (1989).