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David Hess
  David Hess

Using the Law to Create Socially Responsible Corporations

9/28/2004 --

Management's position on the relationship between law and ethics affects the selection and success of regulatory approaches.

ANN ARBOR, Mich. – Adopting alternative regulatory approaches that offer managers more flexibility than traditional direct governmental intervention may encourage companies to find innovative new ways of improving their social performance, rather than simply complying with mandated duties, says University of Michigan business professor David Hess.

While the success of various experimental regulatory programs has yet to be determined, he believes pressures for corporate accountability and transparency will support efforts to refine and improve them.

"Management's position on the relationship between law and ethics has a significant impact on how the firm views its legal obligations and on the ability of any regulatory system to meet its objectives," says Hess, assistant professor of law at the U-M's Stephen M. Ross School of Business. "Although the law is a necessary condition for creating socially responsible corporations, it is not enough.

"The law must be complemented with sound ethical management. Managers must be motivated and committed to following not only the letter, but also the spirit, of the law in order for it to have any meaningful effect."

The challenge facing regulators is to determine which regulatory approach to use to create the greatest social benefit, Hess says. Since all regulatory approaches have their strengths and weaknesses, it often is necessary to treat them as complementary rather than as substitutes, he says.

Command and control is considered the most intrusive form of regulation since the government removes managerial discretion in certain defined circumstances. Self-regulation, an alternative to direct governmental intervention, encourages firms to develop their own standards of conduct and enforcement, either with or without government monitoring.

Management-based regulation moves beyond pure self-regulation and involves government-mandated policies. The main focus is on establishing a general set of regulatory objectives and requiring firms to develop processes to work toward these objectives. Each firm is responsible for establishing its own systems to meet the goals, with the government serving in a consulting and overseeing role.

Other alternatives include market-based approaches, which utilize taxes, fees and other financial incentives to achieve the most efficient use of the firm's resources for achieving social objectives, and information-based regulation, where companies are simply required to provide stakeholders with the information they need to ensure corporate accountability. Social certification systems, which are used for meeting environmental, child labor and similar requirements, are voluntary efforts based on public assurances that a company has complied with an established standard.

To select the best regulatory process or combination of processes, Hess suggests focusing on the means (how to deploy resources) and the ends (the desired outcomes). In situations where the regulators have a good understanding of both the means and the ends, the simple command and control approaches may work best. For example, when the cause of workplace injuries is known, it makes sense to command corporations to operate in a manner that prevents those injuries.

"If regulators can quantify a specific regulatory objective, but also understand that each corporation knows the best way to achieve that desired outcome, then performance-based and market-based approaches may be most useful" Hess says. "These approaches allow each firm to meet the objective in the way that is most efficient for that firm."

However, when regulators understand the means but not the ends, information-based and technology-based approaches may prove to be more effective, he says.

"Technology-based regulations are useful, for example, when regulators know how to reduce the risks of contamination in the handling of food, but do not have an efficient, effective way to determine if the food is in fact contamination-free," Hess says.

Management-based regulation, he says, is most beneficial when the government has low capacity to measure outputs, and the best way to meet the regulatory objectives is either unknown or varies significantly for each firm.

"Under these conditions, management-based regulation creates the greatest social benefit by taking advantage of firms' information advantage," Hess says. "The success of this approach, however, rests on the ability of regulators to design programs that ensure firms adequately internalize social goals in their planning process and then implement those plans adequately."

Hess' research, "The Role of the Law in Achieving Corporate Social Responsibility," will appear in a new book called Corporate Social Responsibility, published by the European Foundation for Management Development.

For more information, contact:
Bernie DeGroat
Phone: (734) 936-1015 or 647-1847