Despite their promises to change the world for the better and remedy social ills, the truth is that corporations are rarely designed to solve social problems, such as poverty and economic distress. If we want corporations to help alleviate social problems like inequality, we need to find a legal structure that ensures they truly have a stake in pursuing social goals.
The debate over corporate purpose is back in fashion. Managers, investors, and the public demand that corporations solve social problems. With the turmoil surrounding social inequalities, the Covid-19 pandemic, and the growing concern about climate change, this pressure on corporations will likely persist.
This plea for corporate action is not only an old one, but it repeats itself every few years. It usually ends with an all-encompassing round of big promises followed by disappointment.
Take, for example, the recent IPO of the tech-savvy insurer Lemonade. The firm markets itself as having “social impact embedded in its very foundations,” and it does appear to engage in corporate giving. But can Lemonade and other companies reasonably be expected to solve social problems? In 2004, Google claimed that its charitable arm, Google.org, would have greater world impact than its ordinary business. But years later, its social mission has mostly evaporated. While Google continues to donate generously to charitable organizations, it has long foregone its mission to use its engineering prowess to solve global ills, and it is now even criticized as a harmful monopoly.
Why does it have to be this way? The simple fact is that corporations are rarely designed to solve social problems, such as poverty and economic distress. Despite Lemonade’s and Google’s big promises, social impact is unlike profit, in that it is difficult to measure. This makes it easy for corporations to make expansive statements about social impact, knowing that appearing to be socially responsible is probably lucrative, and that it is virtually impossible for the public to verify these statements. Even if investors wanted to give up stock returns or consumers wanted to pay extra for the benefit of a disadvantaged group, it would be difficult for them to monitor how their money was deployed, and they would run the risk that managers might misuse the latitude to pursue social missions.
It is true that some firms (such as Lemonade) are incorporated as public benefit corporations. But as I and others (here and here) have argued, the benefit corporation is ultimately based on laws that give managers greater power without providing a genuine commitment to social missions.
Although there are different versions of benefit corporation statutes, they typically require that the corporation serve a “public benefit” enshrined in certificate of incorporation. All this sounds good, but such “public benefits” are generally vague and difficult to measure, and in “considering” the interests of other stakeholders, managers may take actions specifically to elude shareholder discipline and entrench themselves. Benefit corporations do not necessarily live up to the hype of changing the world for the better, and some may even have a dubious track record on social impact.
Just look at Laureate Education, a for-profit university chain that went public as a benefit corporation in 2017. Although it touts its status as a benefit corporation and its commitment to “create a meaningful, positive impact on society,” only a few years ago, Laureate was mired in various regulatory investigations across the globe and has had a questionable record on student indebtedness.
Of course, other benefit corporations (or any corporation) may do better, but it is hard to see how the social mission of an insurance firm, such as Lemonade, however innovative its insurance model is, is much more than an excellent way to market its products. Ultimately, like any profit-oriented firm, Lemonade has a strong financial interest in treating its consumers fairly and donating to charity, but its contribution to society depends mostly on the quality of its products for consumers—not on its ability to solve broader social problems.
If we want corporations to solve social problems, they need to have a genuine stake in solving them. In my recent article, Designing Business Forms to Pursue Social Missions, I explain how corporations can be designed to accomplish development missions. The key mechanism for doing this is for corporations to commit to transacting with disadvantaged people (for a formal model, see here). An excellent example is the Greyston Bakery, a bakery that employs workers from low-income communities, including people with no employment track record or with prior convictions. Since the bakery relies on these workers to run its business, it has a stake in their development and career progression. Moreover, because of its daily interactions with the workers, the bakery is well-placed to know how to help them meet these goals.
But is Greyston different from other firms that employ individuals with lower income, such as Walmart? The difference is that firms like Walmart interact with their employees on standard commercial terms. Greyston, on the other hand, hires people on a first-come-first served basis, irrespective of its ability to evaluate their attributes (for example, because they are ex-convicts or have no work history), or the fact that some of them may lack the skills the job requires. Greyston commits to hiring workers who are unlikely to find work with standard commercial firms, getting to know them, and training them as necessary (for analysis of commitment devices, see here). Given this commitment, the firm has a financial stake in its ability to train its workers and help them develop. In this way, it helps address the problem of systemic unemployment in low-income communities.
Can this model be replicated across a wide array of corporations? To some extent, it already is. Community Development Financial Institutions (CDFIs) are certified and subsidized by the government to provide capital and financial services to distressed communities. Unlike ordinary financial institutions, CDFIs must direct, at minimum, 60 percent of their financing activities to areas that meet federal thresholds for economic distress. Because such a sizable portion of their business derives from distressed communities, these firms have the incentives and expertise to identify good projects in low-income communities that would otherwise not be funded by standard commercial banks, and help their clients’ project thrive so that they can repay their loans. Studies (here and here) suggest that CDFIs have a positive impact on increasing access to capital in distressed communities.
But financial services alone are not enough to achieve development. Why not extend the same model by certifying and subsidizing other types of firms that pursue development missions? The legal regime for CDFIs can be extended to firms that employ disadvantaged people (such as Greyston), small minority-owned businesses, and firms that provide low-cost essential products, such as health services or, indeed, insurance, to low-income people. This model doesn’t need to be limited to low-skilled individuals—for example, a high-tech firm could commit to employ a majority of its engineers from underprivileged backgrounds and train them to the point where the firm is competitive.
How do we fund these social enterprises? Do we extend public subsidies to numerous firms? Perhaps some subsidies may be needed. However, research shows that consumers and investors are willing to subsidize firms by paying premiums over market prices or accepting below market returns. In fact, even high-profile companies, such as Google and Jack Dorsey’s Square, have recently pledged to make investments in CDFIs and similar organizations that focus on underserved minority communities.
However, even better candidates for investing in social enterprises are private foundations, which are sitting on hundreds of billions of dollars. These foundations can make these investments as program related investments (PRIs), which are meant to be investments in businesses with a social purpose. Paradoxically, there are many legal hurdles to making PRIs. Creating a legal form for corporations that commit to transacting with disadvantaged groups (certified similar to CDFIs) could serve as a vehicle for channeling these investments and mobilize large amount of capital to resolve social problems.
Does this mean letting big corporations off the hook? Barely anyone these days believes that corporations should not take stakeholders, such as employees and the community, into account in their operating decisions. But to make a big difference in resolving social problems, corporations need a built-in incentive, such as that which exists in businesses that are legally committed to relying on disadvantaged communities to be productive, whether through employment, investment, or sale of products.
Corporations can be mobilized to change the world. But to do this, we need to ensure that they truly have a stake in pursuing social goals.