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Confronting the critics Confronting the critics Ella Joseph and John Parkinson Responses from Will Hutton and Martin Wolf 1 Confronting the critics Contents About the authors 3 Confronting the critics Ella Joseph and John Parkinson 4 Response Martin Wolf 21 Response Will Hutton 28 Endnotes 32 All of the opinions expressed are those of the authors and are not necessarily shared by IPPR, its staff or trustees. These papers were written for discussion at the IPPR debate Confronting the critics held at The Institute of Materials on Friday 18th January 2002. IPPR would like to thank BBA and KPMG for their support of this event and the work programme A new agenda for business? And Simmons and Simmons for their initial support of this research. 2 Confronting the critics About the authors Will Hutton After starting his career at stockbrokers Phillips & Drew, Will Hutton pursued a media career, fulfilling roles as Producer/Director of The Money Programme, Economics Editor of Newsnight and reporter for Panorama. In 1990 he joined Guardian Newspapers as Economics Editor and became Editor in Chief of The Observer in 1996. He has written five books, including the best selling The State We’re In and presented several topical television and radio series. Will joined The Industrial Society in January 2000 as Chief Executive. Ella Joseph Ella is a Research Fellow at IPPR where she is currently leading the project on corporate social responsibility: A new agenda for business. Prior to this Ella was a member of the Secretariat for IPPR’s Commission on Public Private Partnerships where she specialised in PPPs for local service delivery and regeneration. She is the joint editor of two CPPP publications: Finding the Right Partner: Diversity in local PPPs and Right Up Your Street: partnerships for local policy making and delivery (IPPR 2001). Before she joined the Commission’s Secretariat Ella conducted research into small businesses’ support local communities and is the author of A Welcome Engagement: SMEs and social inclusion (IPPR 2000). John Parkinson John Parkinson is a Professor of Law at the University of Bristol and an Honorary Research Fellow of the Political Economy Research Centre at the University of Sheffield. Before entering academic life he was, briefly, a solicitor in the City. His main publications are in company law and corporate theory and include Corporate Power and Responsibility: Issues in the Theory of Company Law (OUP, 1993). John was a member of the Company Law Review Steering Group set up by the Department of Trade and Industry in 1998 to oversee a fundamental review of core company law. He chaired two of the Review’s working groups: The scope of company law and The needs of small and closely-held companies; and Corporate governance: the purpose of the company and the role of the directors. Martin Wolf CBE Martin Wolf is Associate Editor and Chief Economics Commentator at the Financial Times, London. He was awarded the CBE in 2000 for services to financial journalism. He is a visiting fellow of Nuffield College, Oxford University, and a special professor at the University of Nottingham. Martin was joint winner of the Wincott Foundation senior prize for excellence in financial journalism for 1989 and again for 1997 and won the RTZ David Watt memorial prize for 1994. In 1971 he obtained the Master of Philosophy in economics from Oxford University and joined the World Bank as a Young Professional. In 1981, Martin joined the Trade Policy Research Centre, London, as Director of Studies. He joined the Financial Times as Chief Economics Leader Writer in 1987 where he was promoted Associate Editor in 1990 and Chief Economics Commentator in 1996. 3 Confronting the critics Confronting the Critics Ella Joseph and John Parkinson 4 Confronting the critics Introduction An indisputable fact of life is that private sector activity has significant ramifications for the realisation of the public interest.1 Companies, in pursuing their own interests, sometimes act in ways that detract from ‘social goods’ such as clean air and water or social cohesion and equity. They may cause unacceptable levels of pollution, for example, adopt unfairly discriminatory employment practices, or mislead their customers. There are also areas in which positive engagement by business is necessary for the fulfilment of public or collective goals. Participation in initiatives to reduce disproportionate levels of unemployment among certain ethnic and demographic groups is one instance. Another is reducing social exclusion by ensuring that goods and services are accessible to the whole community. The traditional means of aligning corporate behaviour and societal interests has been to impose a legally binding regulatory framework or occasionally to employ fiscal incentives. Beyond that, the hope is that there will be a voluntary business response, perhaps out of a sense of social responsibility. However, many commentators now accept that there are limits to what can be achieved through traditional forms of government intervention. 2 At the same time many of the issues at stake are too important to be left to the vagaries of managerial discretion. In recent years this space between law and pure voluntarism has begun to be occupied by what might be termed ‘soft’ or ‘civil’ regulation.3 The influence that non-governmental groups have on corporate behaviour is no longer confined to high profile, single-issue NGO campaigns against specific companies (Shell and Brent Spar and Nigeria; Monsanto and genetically modified organisms; clothing retailers and employment conditions in supplier factories). Civil regulation is also now taking on a more generalised, ‘codified’ form. The increasingly systematic reaction of business to this external pressure can be interpreted as a defensive response to the increased risk of reputational damage, and consequent damage to profits, posed by greater public awareness of, and sensitivity to, the social and environmental performance of business. Indeed, many companies have sought to ‘put their house in order’, and to assure outside audiences that they have done so, by adopting corporate codes of conduct, reporting on their wider social impacts and, as part of these processes, encouraging a dialogue about their business practices with interested parties: their stakeholders. As well as company-specific codes of conduct, codes 5 Confronting the critics are also being devised at industry level (e.g. the chemical industry and Responsible Care), in recognition of companies having a collective interest in safeguarding the reputation of the industry in which they operate. A further development is a movement towards acceptance of external participation in standardsetting, reporting and monitoring. This can provide additional assurances of sincerity of purpose, through recognising the views and expertise of legitimate interest groups. Thus, some companies are negotiating performance standards with NGOs and providing for NGO, or independent third party oversight. Companies and business representative bodies are also cooperating with a variety of groups such as NGOs, trade unions, and United Nations agencies in developing industry schemes and principles that apply across the business sector (e.g. the Forest Stewardship Council and the Coalition for Environmentally Responsible Economies, Social Accountability 8000, the UN Global Compact, respectively). These responses to external pressure are a means of giving content to, and enforcing, the concept of corporate social responsibility (‘CSR’). The amorphous notion of corporate social responsibility is bedevilled by numerous definitions. However, generic ‘corporate responsibility’ themes have emerged. Most definitions signal agreement that responsible companies will act above and beyond their legal obligations to ensure various combinations of the proper treatment of employees; ethical conduct in the market place including relationships with competitors, suppliers and customers; minimising environmental damage and maximising the sustainable nature of production; supporting local communities; and promoting human rights. In ideal cases, such activity can be broadly summarised as working in the public interest to promote social and environmental or sustainability objectives.4 Beyond encouraging compliance with codes, civil regulators can promote CSR by publishing information on corporate behaviour to explore (and make publicly known) which companies are working against their definition of the public interest. This trend is encouraged by recent developments in the investment industry, such as the Association of British Insurers guidelines for companies’ disclosure of their social and environmental risks in annual reports, the launch of FTSE4 Good, and the Pensions Act disclosure requirements on ethical investment policy. These initiatives are welcome if they do align public and private interests. They also raise a timely 6 Confronting the critics question for policy-makers about the extent to which corporate social responsibility and the processes that lie behind it can be relied upon as an alternative or supplementary form of regulation to harmonise corporate behaviour and social interests. Across much of the political spectrum there is agreement that the role of government in shaping business behaviour is twofold. First, it is the duty of government, from which it should not resile, to create a framework of legally enforceable standards of business conduct that reflect core, nonnegotiable values. Second, it is desirable that government should ensure that there are wellfunctioning mechanisms by which other groups can articulate their demands and hence play a part in formulating and enforcing a wider notion of the public interest. How far voluntary corporate action will protect the public interest depends on the regulatory capacity of civil society and the sensitivity of the private sector to this non-governmental pressure. If this combination is insufficient, then it is necessary to explore how government action of the second form could manipulate and enhance these processes (through ‘soft’ intervention such as disclosure requirements). An exploration of the effectiveness of this type of intervention – to complement traditional regulation or replace it – would be a critical factor in establishing whether changes of the first (more prescriptive) type are required. However, government intervention will have to be premised on the fact that ‘voluntary’ demonstration of corporate social responsibility is both possible and desirable. Prior to any investigation of appropriate changes in government policy, it is first necessary to question the very notion of CSR. This paper sets out in summary form, and makes a provisional response to, the principal objections to CSR. The first set of objectors are the ‘critics’, that is, those critical of the notion that companies should regard it as part of their function to respond, except in a very limited way, to social and environmental issues. The second set are the ‘sceptics’, those who doubt that companies will take sufficient account of social and environmental factors given the current (and proposed) framework of company law, and believe that a more radical rethink of corporate governance is required. A positive response to these objections provides a rationale for a formal exploration of the extent to which soft intervention can indeed be relied upon to promote the public interest. 7 Confronting the critics The critics There is a longstanding objection to corporate involvement in social and environmental issues which might be summed up as ‘the business of business is business’. A well known statement of this position is that by Milton Friedman, who argued that ‘the social responsibility of business is to increase its profits’ and that the suggestion that it is socially responsible to do other than maximise profits within the ‘rules of the game’ shows ‘a fundamental misconception of the character and nature of a free economy’.5 A central virtue of this ‘free economy’ is said to lie in its ability to allocate resources with optimal efficiency, a property that depends on the existence of a market in which utility-maximising agents make exchanges in response to ‘correct’ market signals. Acceptance of a social responsibility ethic involving disregard for these signals would result, it is argued, in the sub-optimal use of resources and cause the signals themselves to become blurred and distorted. Further charges that social and environmental engagement will damage efficiency are that it constitutes a distraction from running the core business and that to the extent that it lowers shareholder returns it will reduce the attractiveness of equity investment. In so far as social responsibility reduces profits, it constitutes an improper transfer of wealth from shareholders to other groups. The objections are not only economic. Critics also argue that it is illegitimate for issues of social policy to be decided by companies. The argument points to the public character of social responsibility issues and contends that it is inappropriate for them to be resolved in a private forum: in matters of social or environmental policy, companies should defer to the cumulative effect of individual preferences expressed through the market and to collective judgements expressed through the political process. If obeying the market produces undesirable results, it is the role of the state and not of companies to correct for defects in the behavioural signals. A separate point questions the competence of managers to make social policy choices, as well as the legitimacy of their making them. Finally, there is an underlying fear that if it is accepted that companies should have a policy role, it will not be long before there are demands that managers be made publicly accountable and chosen by ‘public techniques of election and appointment’: corporate social responsibility is a ‘fundamentally subversive doctrine’6 and in some of its forms ‘pure unadulterated socialism’.7 8 Confronting the critics The position recently adopted by David Henderson8 and supported by Martin Wolf in the Financial Times9 might be regarded as an updating of these views. However, a clear departure by the modern critics is their more expansive reading of the ‘rules of the game’. They reject the idea that managers are prohibited by their role from exercising independent moral judgement. Henderson notes that both shareholders and boards of directors may be willing, and arguably should be willing, to risk or forgo profits at the margin for such causes as ensuring product safety, disclosing possible safety risks, reducing harmful pollution, eschewing bribery, or dealing fairly with other parties, even where no legal obligations are in question.10 This is an acknowledgement that even in countries with well functioning legal systems, laws may lag behind events and cannot be expected to provide for all contingencies. A limited degree of level of responsible activity is therefore acceptable and even desirable.11 The modern critics reserve their attack for the more radical ‘CSR’, the acronym being depicted as something more sinister than the benign ‘traditional’ practice of behaving ethically to supplement sluggish laws. The followers of CSR are said to subscribe to the view that ‘businesses today should make explicit commitments to uphold accepted values and goals, and to take account of the views and interests of a range of stakeholders; and they should demonstrate through their actions that these commitments are genuine’.12 Unlike traditional corporate social responsibility, CSR gives expression to the concept of sustainable development, understood in a broad sense, embracing the achievement of economic, social, and environmental goals (in line with the ‘public interest’ set out above). Modern critics interpret CSR as the acceptance of the idea that the well-being of society is the primary concern of business, though profitability retains its importance for operational reasons. That CSR has been taken up by some businesses is in part attributed to external pressure, particularly that orchestrated by NGOs. It is this external dimension that led to the updating of the Friedmanite position. If at least on the face of things, business is just responding to a new set of market pressures, Friedman’s objections of a misallocation of resources scarcely apply. 9 Confronting the critics However, critics are doubtful that there is a broad societal consensus in favour of CSR or a strong body of public opinion that wants and expects companies to endorse sustainable development (itself an inherently indeterminate concept) and run their affairs in close conjunction with a disparate array of stakeholder groups. This is particularly so given that CSR is likely to result in higher costs and hence prices for the goods and services companies offer.13 That some managements and business organisations have nevertheless accepted the precepts of CSR is explained either as appeasement of campaigners or evidence of fellow-travelling by managers who also subscribe to the vision that business should serve the true interests of ‘the planet and its people’, rather than simply those of the shareholders.14 Having said this, it is accepted that there are some genuine pressures on companies to respond to popular expectations about social and environmental issues. Ignoring public attitudes is likely to reduce long-term profitability through loss of reputation and associated damage in consumer and labour markets. What is not appropriate is for managements to treat this limited pressure as a justification for a more fundamental reassessment of the role of business, for which there is little general support and which is necessarily costly. The ‘business case’, which portrays a whole-hearted commitment to CSR as a route to maintaining and increasing profits, therefore rests on a serious distortion of reality. It is also stressed that even where there are business benefits from responding to external pressure for improved social and environmental performance, there are also costs to the business and hence an impairment of the efficient operation of the economy. These costs result from the increased complexity of decision-making, the delay and expense inherent in taking account of stakeholder views, and the direct costs of complying with standards higher than those set by law. So even where CSR does not reduce profitability, either because the private benefits (improved or protected reputation) exceed the costs or the company is able to pass on the costs to customers, the adverse effects on economic performance remain. CSR is thus likely to make people in general worse off.15 It is suggested that this effect is particularly acute where there are attempts to apply common standards internationally. Countries, particularly those that are ‘developing’ by northern standards, lose their competitive advantage if required to comply with higher environmental or 10 Confronting the critics labour standards than those set by local law. Inward investment may well be reduced. More generally, restricting freedom of contract and the free operation of the market means that mutually advantageous exchanges may be precluded. A further argument is that those companies that voluntarily incur the costs of CSR have an interest in ensuring that their competitors incur them also, so that they are not at a competitive disadvantage. The former therefore have an incentive to press for ‘hard’ regulation in order to level the playing field. CSR thus contributes to a ratcheting up of the formal, as well as the informal, regulatory burden. The implications of these arguments are clear. Far from embracing CSR, rational companies should recognise it as being inimical to their interests and (in aggregate) the proper functioning of markets. There will be occasions when it makes good business sense in terms of the management of reputation to respect public preferences on social and environmental issues, but what is warranted is a minimalist response from business, not one that involves collaboration with NGOs to create a new kind of capitalism. The implications for public policy are also clear. CSR is damaging to the efficient operation of markets and hence to society as a whole. The state should not adopt policies designed to encourage the practice of CSR or facilitate the imposition of external pressure on companies for that purpose. The sceptics The ‘sceptical’ position is that in a system in which directors are required by law to regard shareholder interests as overriding and are formally accountable only to their shareholders, business behaviour will not change sufficiently to satisfy social and environmental imperatives and ensure that the public interest is realised. What is needed is a fundamental rethink of corporate objectives and accountability mechanisms. Without a more ‘pluralistic’ system of corporate governance, any demonstration of CSR will inevitably fall short of levels of behaviour that the public (collectively) requires. 11 Confronting the critics For the purposes of exposition it is helpful to identify two models on the spectrum of pluralist thought. The first endorses a fully-fledged stakeholder model of the company. The goal of maximising shareholder wealth is replaced by one of serving the interests of the company’s stakeholders collectively. Rather than being overriding, the interests of shareholders are just one group of interests that must be weighed in the balance in achieving the best, realisable outcome. Such a model may be advanced on the ground that it is likely to be more efficient than the traditional shareholder model,16 that it is more ethically defensible,17 or that it can be designed to respond to the democratic principle that those who are significantly affected by decisions should participate in making them, implementing a direct form of accountability. Implementation of such a stakeholder model would require more than the adoption of pluralist directors’ duties, in accordance with which shareholders would no longer enjoy automatic priority. Beyond this, there would be a need to sever shareholder control over the board. The current ability of the shareholders to remove the board, alongside a focus on profits due to pressures from the market for corporate control, would severely inhibit the operation of a decision-making process in which shareholder interests have not to be afforded automatic priority. Attenuation of shareholder control would in turn necessitate the adoption of alternative accountability mechanisms, as well as forums for stakeholder participation. Possibilities include some form of stakeholder board representation or, as Roger Cowe has recently suggested, the substitution of a council of stakeholders for the shareholders’ general meeting.18 The second, less radical variant of pluralism does not seek to replace profit maximisation as the operational goal of the company, but holds that there should be more extensive constraints on the manner in which that goal is pursued. Accordingly, it should be the duty of directors in company law, or at the least they should have discretion, to respond to pressing social or environmental issues, even at the expense of shareholders. As distinct from the stakeholder view, this does not envisage that concern for non-shareholder interests should be potentially unbounded. Rather, the position is that management needs greater space than an exclusively shareholder-centred model of the company allows in order to pursue policies that are defensible in terms of their social and environmental outcomes. This position can be viewed as essentially a regulatory one rather than one that envisages a transformation of the nature of the enterprise. 12 Confronting the critics From the standpoint of either of these positions, any activity to promote corporate social responsibility within an ultimately shareholder-dominated framework of company law and governance, will inevitably fall short of that required to promote the public interest. While it will sometimes be in the commercial interests of companies to respond to external pressures to improve their social or environmental performance, this will be at best a partial solution. By definition, commercial drivers will not achieve the balanced outcomes and true stakeholder participation that pluralism intends to achieve. Nor, sceptics argue, will civil regulation be capable of being as effective a form of regulation as its more enthusiastic advocates suppose. This diminishes the significance of the notion of corporate social responsibility. Even assuming an adequate disclosure regime were to be put in place, the capacity of market pressure to align corporate behaviour and the public interest is limited. Accordingly, while CSR might be an important issue for large, high profile companies, there are doubts about how deeply into the corporate sector the movement reaches. As to the role of institutional investors, these have long been criticised for their failure to intervene where portfolio companies are under-performing in accordance with purely conventional financial criteria and so expecting them to take on a wider monitoring function seems unrealistic. NGOs do not have the resources or necessarily the inclination to act as monitors of corporate social and environmental performance on a routine basis and across the board. Further, the success of NGO activity depends largely on the reaction of consumers (and of course many companies do not trade in consumer markets) to perceived corporate shortcomings; the possibility of an adverse consumer response is also a significant part of the rationale for investor concern with corporate social and environmental performance. But consumers may be unwilling to take action against offending companies. Although there is evidence of a growing ‘ethical’ marketplace, rational consumers will avoid products which are potentially injurious to themselves, but they will not necessarily boycott products, which may entail some personal cost, where the beneficiary of their action is a third party. They might be indifferent to the issues involved, or even if concerned, be conscious of the inherent collective action problem: boycotting a company is worthwhile only if one can be sure that many others will join in rather than free-ride on their personal sacrifice. These considerations suggest that there will inevitably be a gap between the standards that social pressure is capable of enforcing and realisation of the public interest. 13 Confronting the critics The relative merits of CSR operating within the company law framework of shareholder primacy, as against the adoption of some version of pluralism, were examined in the recent review of company law sponsored by the DTI. The Review, widely expected to result in a White Paper in 2002 and subsequently a new Companies Act, has recommended the adoption of an ‘inclusive’ model of company law. The two complementary elements of this model are: a statutory statement of directors’ duties in inclusive form and wider disclosure in a mandatory (for large public companies) operating and financial review (‘OFR’). The proposed statutory duty does not depart from the current duty of directors to give priority to shareholders, but it would make explicit their obligation to take account of the company’s relationships with its employees, customers and suppliers, its social and environmental impact, and the preservation of its reputation, as factors relevant to achieving commercial success.19 The aim is to clarify the existing law, which is apparently widely misunderstood by directors; the statement spells out, for example, that directors must take account of the long-term as well as the short-term consequences of their actions. The OFR would among other things help to make companies more transparent and hence accountable to their stakeholders regarding their decisions and subsequent impact on social and environmental issues. In deciding in favour of inclusivity, the Company Law Review rejected the alternative ‘pluralist’ position, that is, one in which shareholders do not enjoy automatic priority, which it had set out for consideration early in the consultation process. A number of groups, notably the TUC and much of the NGO community, would clearly have preferred some form of pluralist solution. Such criticisms of the inclusive approach were often supplemented by concern that the OFR proposals are insufficiently radical, especially in failing to make reporting mandatory in all cases in relation to employment, environmental and social policy issues. That is, as a second best option, transparency would not be sufficiently enhanced under the proposed framework. In general, the concerns of the sceptics will still apply following the adoption of the Review’s proposals for company law. 14 Confronting the critics The response Although objections to the notion that CSR is both possible and desirable cannot be necessarily pigeonholed politically (critics on the right, sceptics on the left) there are some elements of this debate that are a matter of political judgement. What sort of society do we aspire to live in? Should those organisations that detract from the social good (within legal confines) be encouraged to rectify this damage? Should we value the economic, social and environmental development of countries equally? However, beyond these issues that clearly rest on subjective judgement, a number of the premises and conclusions supported by critics and sceptics lend themselves to more concrete analysis. Sympathy must be stated for the view that it is in the public interest to have a strong and growing economy. At a micro-level this requires companies to invest, innovate and employ and yes, be profitable. However, within commercial constraints and through ‘core’ business practices such as recruitment and production, they can and should promote the public interest. The initial charge of modern critics such as Henderson is that there has been too ready an acceptance of CSR on the part of business: in practising it, companies are doing more than bowing to market pressure. Henderson admits that it is unclear just how widespread the adoption of CSR is and how deep the commitment to it runs, since expressions of support may simply be good public relations, but he argues that the tendency is increasingly towards submission. This description of current business attitudes and behaviour is difficult to accept, however. At a time of ever greater pressures on firm-level competitiveness and after a decade or so of emphasis on shareholder value maximisation the proposition that large numbers of managers are adopting policies that (according to this analysis) significantly increase costs without promising at least commensurate returns seems implausible. Aside from the lack of obvious incentives for managers to behave in this way (and assuming the absence of a transformation of managerial ethics), there are objective limits set by product market competition and the market for corporate control to practicable levels of discretionary spending. 15 Confronting the critics A more plausible explanation of business behaviour is that it constitutes a tactical response to external threats. While it is unlikely that companies are adopting CSR (as defined) as a package, this is not to say that the response is necessarily purely cosmetic or cynical. There is evidence to suggest that some companies are recognising that significant organisational change is needed to protect against reputational risk and thereby to secure the company’s long-term interests.20 Accordingly, they are not merely adopting policies to address current areas of sensitivity, that is, those on which NGO and popular pressure are already focused, but are seeking to identify and guard against all potential sources of reputational damage throughout the company’s operations. Similarly, companies are taking positive steps to build up their reputational capital, which, as well as being a possible source of competitive advantage in its own right, is likely to be of value in protecting against the damage to profits that may result if some unrelated aspect of the company’s behaviour comes under attack. That some companies appear to be adopting more than a policy of minimum response to social and environmental issues, therefore, does not necessarily signify that they are departing from an objective of longterm shareholder wealth maximisation. Whether companies are merely reacting rationally to external pressures or not, however, this does not answer the critics’ more fundamental charge that increased social or environmental responsibility is damaging because it raises business costs and impairs the efficient functioning of the economy. In reply, it may be noted first that socially or environmentally responsible policies may sometimes lead to direct cost savings, as for example where energy conservation measures are introduced. While in such instances there is a straightforward business case, companies may fail to recognise it, or be unwilling to bear the start-up costs, in the absence of an external stimulus. Second, where private costs are increased, this does not necessarily represent a reduction in efficiency overall, but rather may involve the internalisation of a cost previously imposed on third parties or society as a whole. And third, even if there are adverse efficiency effects, ‘responsible’ business policies might serve other values that society ranks more highly in particular circumstances. These points simply summarise the case for business regulation. Of course, in reality regulation may fail in its objectives or its objectives may be achieved at too high a cost. It might be argued 16 Confronting the critics that these adverse results are particularly likely where the form that regulation takes is that of informal external pressure spearheaded by NGOs, the cause of much current CSR activity on which the modern critics focus. ‘Civil’ regulation of this kind does not undergo the cost-benefit analysis to which conventional regulation would normally be subject and may have an irrational or arbitrary ‘flavour of the month’ quality. Such charges are important and warrant further investigation,21 but it should be noted the risks that regulation will in fact undermine the public interest are significantly reduced for civil regulation as it has a built-in self-limiting mechanism: since they ultimately depend for their effectiveness on market pressure, NGO campaigns (at least, lawful ones) and soft regulatory controls such as codes of conduct are likely to be effective only where they have substantial support from consumers or other market participants. The need for this support means that efforts to alter company behaviour that are too far in advance of popular values are liable to fall flat. Furthermore, civil regulation is increasingly a collaborative process. Rather than characterising business involvement in designing and implementing the governing principles as appeasement, it is better understood as constructive engagement to ensure that the principles meet external expectations but do so in a way that avoids the imposition of unnecessary costs. As to the charge that applying uniform standards across international boundaries is likely to do more harm than good, especially to those it is designed to protect, the answer is surely that ‘it depends’. Standards might be set at a level that deprives developing countries of cost advantages, but it does not follow from this that all regulation is counterproductive; some global concerns can only be addressed by raising standards multilaterally. Similarly, the argument about the ratchet effect, that those who voluntarily accept higher standards will press for equivalent legislative standards across the board, is alarming only if regulation is regarded as inherently undesirable. Some will regard the operation of the process by which good practice gradually becomes pervasive and eventually solidifies into law as a sign of social progress. Indeed if CSR is understood as voluntary activity (above and beyond legal requirements) then it will inevitably be organic. We should not lament the fact that addressing basic employment, health and safety and environmental concerns is no longer left to the vagaries of managerial discretion. 17 Confronting the critics The contention above is that to the extent that companies have accepted an ethic of increased responsibility, it is largely a tactical response to external pressures. Given this, Friedman’s arguments that social responsibility is inefficient because it involves a disregard for market signals, constitutes an arrogation of social decision-making power, and results in an illegitimate transfer of wealth from shareholders, have limited salience. It is useful to note that Friedman and his contemporaries were responding to the doctrine of ‘benign managerialism’. This doctrine, that the purpose of companies should no longer be regarded as purely economic and that they should take on a wider social role, had attracted some support in the US business community in the conditions of limited competition and attenuated shareholder control that large corporations enjoyed in the middle decades of the last century. 22 But these are not the conditions in which companies operate today. Having said this, companies’ behaviour in relation to social and environmental, and indeed any other questions is not simply dictated by market forces: managers do have discretion about the most appropriate course of action to take. In that sense, in deciding how to address social and environmental issues they could be described as performing a policy role. Current practices as regards commitment to higher standards than those imposed by law, the adoption of corporate or industry codes of practice, and engagement with third parties in devising standards, however, hardly constitute the usurpation of public functions. Society has a positive interest in the business sector actively seeking solutions to the problems that its operations create and helping to deliver public policy objectives that depend on business co-operation. What is at issue here is not an unlimited business discretion to pursue privately determined social policy goals. The ‘sceptics’ argue that in the current and proposed framework of company law it is unrealistic to expect companies to adopt socially and environmentally responsible policies that add significantly to their costs without compensating benefits. It does not follow, however, that the most that companies will deliver in the absence of radical reform is tokenistic gestures that fail genuinely to engage with the issues. The expectations of customers, employees and investors create pressures that change the profit-maximising course of action for a company. If consumers are going to rebel, for example, it may no longer be in the company’s interests to dump toxic waste. Market pressure thus increases the cost to companies of anti-social behaviour, and 18 Confronting the critics rational companies will seek to reduce these costs by improving performance in line with public expectations. Pluralists might concede that civil regulation can be an effective force for change notwithstanding the duty of directors as a matter of company law to put the interests of shareholders first. But they argue that such pressure would be more effective if the company law duty were changed. As against this however, it should be noted that in reality the current law presents few obstacles to socially responsible conduct. Given the importance of reputational considerations, most policies that reflect a concern for the social or environmental impact of a company’s activities could with little difficulty be presented as ones designed to further the company’s, and hence the shareholders’, long-term interests. The adoption or otherwise of a pluralistic directors’ duty is therefore not a key issue. What is likely to be of much greater importance to effective civil regulation is recognised standards for behaviour accompanied by transparency enforced by a robust reporting regime. There will not always be a sufficient market response to behaviour that is contrary to the public interest, because of continuing problems about information or indifference on the part of market participants to the issues at stake. High-profile companies that operate in consumer markets are also more susceptible to market pressure than smaller and less exposed ones. In relation to some issues and some companies civil regulation will therefore not always work, or work well. It does not follow, however, that in other areas civil regulation cannot be an effective means of securing the public interest. Civil regulation is just one of a range of regulatory techniques and the challenge is to employ these techniques in the right mix. 19 Confronting the critics Conclusion In the course of their activities companies frequently cause harm to the interests of others or otherwise act contrary to the public interest. There are also public policy objectives that depend on the active co-operation of business for their fulfilment. Conventional forms of state intervention, including fiscal measures and other economic instruments, are of fundamental importance, but there are limits to what they can achieve. Expecting companies to address public interest concerns when this is not in their economic interests, on the other hand, appears unrealistic. Civil regulation, which relies on market pressure to induce a favourable corporate response, has become a significant, additional means of harmonising private and public interests. Developments in the civil regulatory field have so far largely come about without state intervention. A key question for policy-makers is whether there is a need for state support and if so what form it should take. Addressing this will undoubtedly involve an examination of the implications for the behaviour of private actors, particularly NGOs and institutional investors, as well as companies themselves. A decision to take positive action – through soft intervention – will need to be premised on the idea that it is both possible and desirable for companies voluntarily to give effect to public interest concerns. 20 Confronting the critics Response to Confronting the critics Martin Wolf 21 Confronting the critics Corporate Social Responsibility is an idea whose time has come. This paper is a reflection of that fact. The authors are trying to defend the modern notion of CSR as a benign form of “soft” or “civil” regulation, against two sets of opponents. The first are the “critics”, who believe it is not the business of business to deliver social goals beyond those inherent in their economic functions and those mandated by law. The second are the sceptics who believe that the shareholdermaximising corporation can never “change sufficiently to satisfy social and environmental imperatives and ensure that the public interest is realised.” Sceptics demand a fundamental rethink of corporate objectives and accountability mechanisms. Critics believe companies should, by and large, behave as usual. Since I fall into the category of critics, I will focus on whether the paper answers the criticisms I and others before me have made.23 I believe the paper’s arguments can be reduced to the following five propositions: first, there exists a well-defined and generally agreed notion of the public interest; second, this notion of the public interest can be identified largely with the pursuit of “social and environmental objectives”; third, the public interest may not be best served by imposing a legally binding regulatory framework or set of fiscal incentives; fourth, a body of “soft” or “civil regulation” already serves as a way of inducing corporations to promote the public interest; and, finally, this body of soft regulation has much merit and should be developed further. Let me start by indicating where I agree with the paper. First, its description of what is happening seems to be correct. Largely in response to pressures upon them from groups who often describe themselves as “civil society”, companies have adopted codes of conduct, both at an individual and industry-wide levels. In the process companies negotiate performance standards with non-governmental organisations that often include some form of monitoring. These responses are, in the words of the paper, “a means of giving content to, and enforcing, the concept of corporate social responsibility”. Second, I also agree with the paper on the focus of these demands for “responsible” behaviour by business. The World Business Council for Sustainable Development has, for example, defines CSR as “the commitment of business to contribute to sustainable development, working with employees, their families, the local community and society at large to improve their quality of life”. 22 Confronting the critics At its limits, the modern notion of CSR takes the form of the “triple bottom line”, which corresponds to the three facets – economic social and environmental – of sustainable development. If this notion of the triple bottom line is to be taken seriously, not viewed as pure window dressing by business, it does, in the words of Shell, one of the companies that has taken the idea furthest, “demand a deep shift in corporate culture, values, decision-making processes and behaviour”. Third, I believe the paper has provided a reasonably fair statement of the position of what it calls the modern critics. To repeat what the paper says: “far from embracing CSR, rational companies should recognise it as being inimical to their interests and (in aggregate) to the proper functioning of markets. There will be occasions when it makes good business sense in terms of the management of reputation to respect public preferences on social and environmental issues, but what is warranted is a minimalist response from business, not one that involves collaboration with NGOs to create a new kind of capitalism. The implications for public policy are also clear. CSR is damaging to the efficient operation of markets and hence to society as a whole. The state should not adopt policies designed to encourage the practice of CSR or facilitate the imposition of external pressure on companies for that purpose”. Where I disagree, however, is with the paper’s refutation of this position. To indicate the nature of my disagreements I will set out the clearest possible elaboration of my version of the critical position, indicating, in the process, some of the points on which I disagree with the paper. First, I would underline the proposition that the chief social value of companies is to generate income for society by seeking out opportunities for making profit. In a competitive economy, this profit-seeking activity will raise the price of the inputs and lower those of outputs. Innovation is, of course, one of the ways in which this process works. The paper accepts this role of the profitseeking business, but very grudgingly, stating that “it is in the public interest to have a strong and growing economy. At a micro-level, this requires companies to invest, innovate and employ and yes, be profitable.” This grudging view fails to recognise what may be at stake. The 20th century should be regarded as the century of the modern joint-stock corporation. It was also the most economically successful century in human history – world population rose four-fold and world 23 Confronting the critics output per head rose six-fold. The core profit-seeking function of the company remains as essential as ever. Second, the corporation has the same moral obligations as those of individuals. The precise content of moral behaviour is, of course, controversial. But most people would accept the fundamental principle of the golden rule – do unto others as you would be done by. From this follow principles of honest-dealing and voluntary obedience to the law even where it may be possible to evade it. Since companies are institutions set up to serve the interests of their owners, they have an obligation to be transparent in what they do. In addition, since companies are more powerful than individual employees or customers, they have a particular obligation to take that imbalance of power into account in their relationships. Third, the profit-seeking corporation will often find it in its interests to accommodate pressures for what people believe to be socially responsible behaviour. As the paper notes, reputation is an important corporate asset. What its own employees, customers, governments and the public think of the corporation is a determinant of its viability as a business. Placing CSR explicitly within the objectives of the company may well allow it to focus better on long-term concerns relevant to its success. Thus CSR may sometimes be a genuine contribution to long-term corporate profitability and success and, as such, be something companies should adopt, in their own interests. Fourth, it does not follow that the behaviour of CSR-driven companies does, in fact serve the public interest. Contrary to the assumptions of the paper, the notion of public interest is difficult to define in substantive terms. The paper’s biggest weakness is that it makes no serious attempt to define it. Let me give just a few examples of behaviour that advocates of CSR might consider to be in the public interest, but may not be. • Is it in the public interest for a company to do experiments on animals, or not? Is this an area in which “civil regulation”, as in the case of Huntingdon Life Sciences, promotes the public interest, or damages it? 24 Confronting the critics • Is it in the public interest for companies to commit themselves to staying in a given locality, even if it is not the most profitable place in which to produce? What would such behaviour, if generalised, mean for the ability of up-and-coming regions and countries to attract investment? What would such an obligation do for the willingness of companies to invest in the first place? • Is it in the public interest for multi-national companies to pay workers in developing countries above the opportunity cost of their labour? What would this do to induce excessive internal migration and unemployment, as people queue for such highly desirable jobs? What would be the benefit if MNCs end up employing fewer people than they would otherwise do? • How beneficial is the free operation of labour unions in labour-surplus economies? Is there not a danger of creating or exacerbating economic dualism? • Is it in the public interest for MNCs to employ children in very poor developing countries? Is it better for children to have work no work? What are the alternatives for such children – school, prostitution or starvation? • Is it necessarily desirable for activities to be “sustainable”? How can a resource-extraction industry be sustainable? Is it always desirable, for example, to recycle rather than discard? Fifth, even if the public interest can be defined, why would a process of bargaining between publicity-seeking, single-issue NGOs and profit-seeking companies necessarily reach the right outcome? The process that generates the CSR outcome is blackmail and concession. This may produce the socially optimal outcome. But why one would expect this? Sixth, large corporations dominate production in some sectors, but not in others. Similarly, companies that are concerned with particular aspects of their reputation are more important in some sectors than in others. For this reason, the implementation of CSR is bound to lead to inconsistent implicit valuations of the relevant outcomes across the economy. Seventh, political processes in which decisions are made by publicly accountable people, not by self-appointed representatives of civil society, are the legitimate way to reach decisions both on what the public interest is and on how to enforce it. It is also the only way to implement a reasonably consistent set of values. Neither companies nor pressure groups are entitled to define 25 Confronting the critics the public interest. It is a modern form of corporatism to assume that they are. True, political processes do not exist at the global level. But this is a reflection of the reality of national sovereignty, itself an important value. Eighth, while companies may be willing to achieve objectives that support profits, there is a strict limit on what they can do at the expense of profits. Moreover, this is truer the more competitive is the industry in which they operate. A competitive company cannot afford costs that are not borne by its competitors. The move towards a more competitive economy is, for this reason, incompatible with the ability of companies to pursue costly social goals, even if society did agree on what those goals were. The old AT&T monopoly had, in Bell labs, one of the most significant research establishments in the world. The competitive AT&T can no longer afford this. Ninth, for this reason, the only way to achieve social goals that impose uncompensated costs on individual companies in competitive industries is through the imposition, via law, of regulations and taxes. Should a company feel obliged to accept costly responsibilities, it will find need to impose those costs on its competitor and will normally lobby to achieve that outcome. If those costs are incurred in pursuit of socially worthwhile goals, that is no problem. But if the costs are not justified by the gains, then the result will not be an improvement in overall social welfare, but a reduction in it. This may happen if, for example, companies operating in developing countries are forced to accept costs that do not generate equal social benefits. In such circumstances, CSR will be socially harmful, not beneficial. Where then do I disagree with the authors of this paper? I agree that private companies should behave morally. I also agree that companies may find it in their interest to promote what is deemed socially rewarding behaviour. I agree that such behaviour may also further the public interest where that can be satisfactorily defined. But I would also argue that the public interest is, in fact, difficult to define and may conflict with generally accepted views of CSR, particularly as the concept has broadened and become more radical. Furthermore, profit-seeking companies in competitive industries will be unable to achieve social goals that undermine their profitability, even where to do so would be in the public interest. But CSR would even be counterproductive – that is, reduce social welfare – if it led to the spread of costly regulations that were not 26 Confronting the critics conducive to the social welfare, as companies forced or persuaded to adopt CSR, tried to impose the costs on their competitors acting, in their view, as free riders. Ill-defined, probably otiose, ineffective and dangerous – these are the adjectives I would use to describe, in turn, the notion of public interest, the adoption of CSR as a profit-maximising strategy, the acceptance of costly burdens by profit-seeking companies and the attempt to spread those burdens to competitors through regulation. If we want to pursue social goals, the right way is openly, though the political process where the pros and cons can be argued out explicitly. CSR will either achieve little or do harm. Which one it will be, I do not know. But I do know the right response is one of profound scepticism. Martin Wolf 27 Confronting the critics Response to Confronting the critics Will Hutton 28 Confronting the critics Society needs its economic requirements serviced efficiently and expediently. It privileges privately owned organisations - lets call them companies - to marshal human, physical and financial capital to meet its needs. They get rights to trade and make profits which over time we have learned are best prosecuted in a market economy, and in return they are privileged to hold patents, their directors to be indemnified for no personal liability when companies go bankrupt, and to borrow and invest our savings etc. It is a complex balance of rights and obligations struck between the need for society to have a well functioning economy that services its needs, and the needs of companies to have as much freedom to produce the outcomes that they and society want. This should be an uncontroversial statement, yet over the last twenty years it has become loaded with political meaning. A powerful business lobby has emerged that has insisted that the maximisation of business efficiency can only be achieved around the single-minded goal of the maximisation of shareholder value. All obligations to the wider society in which business trades – to pay taxes, to be regulated, to acknowledge minimum standards for the treatment of workers – are characterised as burdens which inhibit wealth generation. Society, if it wants a functioning economy, must minimise the demands it makes of business. This is of course self-serving and specious, but supported by institutional investors in the equity markets especially in the US, the business press, boards with a personal stake in the proposition via share option schemes and “ free market “ economists it has taken remarkable root. In my view the results of this revolution in thinking about the role of business have been thin. As the dust settles after the long American boom some of the wilder claims about a productivity upsurge have had to be sharply revised downwards; at a micro level the evidence is that the majority of merger and take-overs driven by so-called shareholder value maximisation fail in promoting profits, turnover or productivity. Moreover shareholder value driven firms may deliver some short term wins, but the absence of a mission other than profitability in the medium to long term undermines their organisational rationale. For example Boeing, having changed from a firm pledged to engineering excellence to build the world’s best planes to maximising shareholder value, first lost organisational focus – and now market share. It is in retreat before Airbus even though the degree of subsidy via export tax rebates and military contracts equals or surpasses the subsidy 29 Confronting the critics now available to Airbus. Examples of the same phenomenon are legion – in Britain the sad story of Marconi is one of the best. The Corporate Social Responsibility movement needs to be understood within this framework. The argument that business has responsibility to the society of which it is part is not new; indeed it is the foundation of the idea of the company, and I would argue central to corporate success within its own terms. To build on the Boeing example, this was a great company when it understood that its core organisational mission was to serve society’s need for great planes out of which it aimed to make high profits. Once it abandoned that mission and said that all it was about was to make profits, it has lost its organisational way. As did Marconi. My own championing of CSR is thus not to find a surrogate way of socialising business or load on to it regulation that it adopts voluntarily rather than through obligation to the law – and which opens up opportunities for free-riding and competitive abuse. Rather it is to persuade business that its first obligation is to sustain itself as an organisation; that its obligation is to do, to serve an economic and social need and that it is from that conception that it will best survive as a high profit organisation rather than to say its sole purpose is profit maximisation. Within the terms of the IPPR paper this means that I would be defined as an advocate of the inclusive (as opposed to pluralist) approach to corporate governance. I strongly support the direction outlined in the Company Law Review, which attempts to move the fundamental terms in which companies interpret themselves while avoiding some of the clumsier constitutional obligations that some have advocated. I would not favour the multi-stakeholder council argued for by Roger Cowe for example as the supreme source of governance of a company. The case for a German style supervisory boards is not because they offer constitutional pluralism; rather it is that they are the custodians, under German company law, of the company’s core economic and social purpose. Some advocates of Anglo-Saxon capitalism will reply that this is an utterly foreign conception to the US and Britain. Wrong. Incorporation in the US until very recently required companies to have a founding organisational purpose to which company officers had to swear loyalty. The idea that such an obligation is fuddy-duddy and obstructs efficiency has only come in the wake of the long upsurge in American conservatism. Equally early charters for company incorporation in Britain 30 Confronting the critics were explicitly about society privileging groups of merchants or founding investors to trade in return for explicit economic and social benefits to the society of which they were part. The notion that companies are independent private fiefdoms that must be free to do whatever they want to maximise profits is a cultural and historical aberration. Thus the CSR movement is, in a sense, no more than civil society fighting back – that we should put the public back in conceptions of public limited corporations and that business must earn its licence to trade. Critics of CSR are right however to warn that it is in danger of becoming a catch-all for every kind of pressure group to load its particular interest or lobby; this is potentially dangerous, although the risk is greatly overstated. But equally the idea that CSR is passing fashion is also wrong. There would not have been the Hampel, Turnbull, Greenbury and Cadbury reports had not British business felt it needed a more coherent account of best corporate governance practice before growing public and customer scrutiny. Business is part of the society in which it trades however much it may irk those who lead it – something Enron’s Ken Lay and the senior partners of Arthur Anderson have come to learn. This needs to become part of our business culture, for the good of business as much as civil society. Will Hutton 31 Confronting the critics Endnotes 1 In adopting this terminology we are setting aside arguments over whether there can be such a thing as an ‘objective and knowable’ public interest as distinct from the aggregate of private interests that only individuals can define (for a discussion see Andrew Gamble and Gavin Kelly ‘The Politics of the Company’ in John Parkinson et al eds The Political Economy of the Company Hart, 2000). However, it is argued here that in the extreme the realisation of the ‘public interest’ would ensure the economic, social and environmental well being of society and the sustainability (creation and protection) of the requisite societal goods. The component elements of this collective interest can be articulated in a number of ways; the stated goals of an elected government is one such mechanism. The notion that companies work in the public interest therefore implies that overall they add to rather than detract from social well being through their corporate activities. 2 Traditional fiscal and regulatory policy ‘tools’ often fail to create an attitudinal shift, do not utilise the market pressure that already exists for companies to promote change and often only lead to a tokenistic response. For a good account of the limitations of traditional forms of intervention see C Stone Where the law ends: the social control of corporate behaviour (1975, New York.) and for an discussion of the relative advantages of different regulatory techniques see Neil Gunningham and Peter Grabosky Smart Regulation: Designing environmental policy (Oxford, 1998). 3 It is possible to conceptualise government intervention along a spectrum: from no intervention at all to the use of traditional hard fiscal and regulatory mechanisms. The former relies exclusively on the use of ‘civil’ regulatory constraints on business behaviour, those that emanate from non-governmental sources; elements of civil society such as NGOs and issue-led local campaigns. As there is no mandatory element, any reaction by business to this type of pressure is considered voluntary. However, between these two extremes are different types of ‘soft’ government intervention. Soft intervention is defined as the deliberate use of a variety of instruments to achieve defined objectives without recourse exclusively or primarily to legislative changes or fiscal incentives. However, these policy instruments may be used to enable soft intervention to succeed by encouraging a non-mandatory response by companies: they can create the context within which the actual impact is primarily the result of civil pressure. In general, soft intervention is often either non-outcome prescriptive or is based on non-governmental frameworks and can be subject to a variable degree of government input. Activity induced by soft regulation is therefore likely to be considered ‘voluntary’ if the relevant government demands are non-prescriptive as to outcomes and non-governmental demands do not have the force of law behind them. 4 Sustainability may be best defined as the ‘capacity for continuance into the long term future’ (www.projectsigma.com). The most widely used definition of sustainable development is that which ‘meets the need of the present without compromising the ability of future generations to meet their own needs’ (The Brundland Report, 1987). The Government’s definition combines four objectives: social progress that recognises the needs of everyone, effective protection of the environment, prudent use of natural resources and the maintenance of high and stable levels of economic growth and employment (Sustainable Development Strategy, 1999). 5 Milton Friedman, ‘The Social Responsibility of Business is to Increase its Profits’, New York Times Magazine September 13, 1970 and Capitalism and Freedom (Chicago, 1962), at 133. See also F A Hayek, ‘The Corporation in a Democratic Society: In Whose Interests Ought it and Will it be Run’, in H I Ansoff (ed), Business Strategy (Harmondsworth, 1969). For a more detailed discussion of these issues see J E Parkinson, Corporate Power and Responsibility: Issues in the Theory of Company Law (Oxford, 1993) Ch 10. 6 Friedman, Capitalism and Freedom (above), at 133. See also Hayek, ‘The Corporation in a Democratic Society’ (above), at 238-39. 7 i.e. where corporate social policy-making contradicts the verdict of the market: Milton Friedman, An 32 Confronting the critics Economist’s Protest (Elen Ridge, 1972), at 177. 8 David Henderson, Misguided Virtue: False Notions of Corporate Social Responsibility, New Zealand Business Roundtable (Wellington, 2001). 9 Martin Wolf, ‘Sleepwalking with the Enemy’, Financial Times 16 May 2001. 10 Henderson, Misguided Virtue (above), at 3. 11 For a similar view from business perspective, see Allen Sykes, Capitalism for Tomorrow: Reuniting Ownership and Control (Oxford, 2000), at 104-06. 12 Henderson, Misguided Virtue (above), at 4. 13 Henderson, Misguided Virtue (above), at 39-40. 14 Henderson, Misguided Virtue (above), at 43. 15 Henderson, Misguided Virtue (above), at 64. 16 See e.g. Margaret M Blair, Ownership and Control: Rethinking Corporate Governance for the TwentyFirst Century (Brookings, Washington, 1995); John Kay and Aubrey Silberston, ‘Corporate Governance’, (August, 1995) National Institute Economic Review 84. 17 See e.g. William M Evan and R Edward Freeman, ‘A Stakeholder Theory of the Modern Corporation: Kantian Capitalism’, in Tom L Beauchamp and Norman E Bowie (eds), Ethical Theory and Business (4th ed, Englewood Cliffs, NJ, 1993). 18 Roger Cowe, Stakes not Shares: Curbing the power of the corporations (London, 2001). 19 Unlike the pluralists’ duty, this would not entitle the directors to subordinate shareholder interests to those of other groups or in accordance with social or environmental imperatives. 20 Recent policies adopted by big oil producing companies - such as Shell and BP – in an inherently unsustainable sector to portray themselves as good ‘corporate citizens’ is one example of this. 21 See also Ethan B Kapstein, ‘The Corporate Ethics Crusade’, Foreign Affairs, vol 80 no 5, Sept-Oct 2001. 22 See e.g. J K Galbraith, American Capitalism (Oxford, 1956). There were also echoes in the UK: see C A R Crosland, The Future of Socialism (London, 1956). 23 See “Sleep-Walking with the Enemy”, Financial Times, May 16 2001 and David Henderson, Misguided Virtue, False Notions of Corporate Social Responsibility (London: Institute of Economic Affairs, 2001) 33