Since the 1980s, the central debate in business theory has been about who the manager of a company—chief executive officer, chief operating officer, whoever makes the decisions—should be working for.
In Milton Friedman’s famed “shareholder theory,” the manager’s sole responsibility is to develop profits for those who own shares of the company. But in the “stakeholder theory,” put forth by business ethics professor R. Edward Freeman in 1984, managers are responsible for shareholder profits and also for the interests of the larger group with “stake” in the company: employees, customers, even members of the neighboring community.
The problem with the second theory is that it’s an obvious contradiction of interests. If you believe corporations should focus on shareholder profits, then they can’t focus on profits and anything else. It’s a logical fallacy, right? But new research in an area called “social capital” points to a reconciliation between the two theories.
Similar to the concept of “human capital”—essentially, added benefits that corporations get by using human labor, which includes the actual labor itself, but also murkier positives like creativity and stock of personal knowledge—social capital is defined as “the quality of the relationships that a firm, and its executives and employees, have built with other stakeholders.”
“It could be the relationships that individual employees have with each other, with other parties, it could be the social network of where did he or she go to school,” says Henri Servaes, a finance professor at the London Business School. “It’s relationships that he or she has built there, and those relationships may be beneficial for the corporation as it is trying to do something.”
This foggy mix of relationships has actual and real effects on company sales.
In the paper, “The Role of Social Capital,” Servaes and his co-authors suggest that one way to build social capital is by using the efforts that “fall within the umbrella of Corporate Social Responsibility,” or CSR. These are ways that a corporation self-regulates beyond governmental controls, initiatives that present them to consumers as “sustainable,” “green,” or “ethical.” A number of studies have linked high CSR to higher profits, one even showing that customers are willing to pay a slight premium for a product created by a company with high social capital.
Why would social capital increase profits? Servaes examined the fallout from the 2008–09 financial crisis, and found that, after the crisis, firms with “high” levels of social capital had stock returns that were 4 to 7 percentage points higher than those firms with low levels. Why would this affect stocks? As Servaes writes in a review of social capital literature:
The financial crisis was characterized by an erosion of trust in firms, markets, and institutions. In such a period, a firm’s social capital, and the trust that it engenders, paid off.
But how do corporations build trust? They can develop a culture that respects their workers, perform the proper due diligence in building an ethical supply chain, and solicit and use input from the communities where they physically reside. But the key to turning those CSR strategies into actual realized profit is dependent on how much the customer knows about these actions. If a corporation does something “good” and no one knows, did it actually happen?
(Photo: London Business School)
“There’s this gap between firms who could really benefit, but the customer doesn’t know much about it,” Servaes says. “In companies that are more advertising intensive, we found that CSR is positively related to corporate value, to profitability, to growth. But in businesses where there is little advertising, the relationship either isn’t there, or it’s negative.” (There is, however, the ancillary effect of overspending on advertising. “If I advertise more in general, I’m more in the public domain, and people know more about me,” Servaes says. “Which means they know more about the good stuff, but also they know about the bad stuff.”)
The benefits from added social capital also seem to have a ceiling. Companies can invest in strategies to add social capital, and alert consumers about their actions, but those efforts can’t continually be ramped up with the expectations of similar profit scaling.
“There are benefits to [research and development], but you don’t want to do too much, because it doesn’t pay off anymore,” Servaes says. “Same thing with social capital. There must be some limit [where it] doesn’t get return anymore.”
At some level, the effectiveness of social capital is embedded in our understanding of human-to-human interactions: Be nice to others, and they’ll help you in return. It’s not surprising that corporations have found ways to exploit it for profits.
