Special Report - Behave responsibly, by order of the law!

<em>Corporate Social Responsibility</em> - Should companies be legally required to consider social a

A little group of accountants and other experts is currently beavering away at a tiny detail of the new Companies Bill. It might seem like a footnote in the painfully lengthy history of this extremely dry legislation, but, in fact, it is central to what this government understands by "corporate social responsibility" (CSR), and its conclusions will have a huge impact for many years to come on how the boards of large companies attempt to meet their responsibilities.

The immediate job of this materiality working group, which will report next month, is to propose how company directors should decide which social and environmental issues to include in their annual reports. Its deliberations, however, are enmeshed in the fundamental CSR question that the government has repeatedly sought to duck: what are the responsibilities of big business beyond making as much money as possible for shareholders?

The fact (as opposed to the law) is that businesses, especially big businesses, are held responsible for what they do to people and the environment. The food industry may escape legal liability, even in the US, but it is discovering that it cannot escape opprobrium for damaging people's health with excessive doses of fat, salt and sugar. Similarly, arms manufacturers get a bad press for selling their products to nasty regimes - even though governments grant licences - or for making products such as cluster bombs. Banks are pilloried for shutting branches in isolated areas, shunning disadvantaged communities, and financing destructive dams and other major projects. Supermarkets are accused of antisocial behaviour - such as not paying farmers enough.

These examples show what CSR is all about: the extent to which public companies' actions are not just in the interests of their shareholders but of the wider society.

CSR, then, means more than good works around the periphery, such as giving money to charities and letting employees do some volunteering. Company responsibilities have wider implications, especially in the eyes of the NGOs which act as opinion-formers in these things - and which, in great numbers, supported Linda Perham's private member's bill on corporate responsibility.

The government has struggled with this wider, deeper interpretation. It got off to a good start by appointing the world's first minister for corporate social responsibility in 2001 (except that it was Kim Howells). But it has been hampered by a failure, until recently, to connect CSR with wider work on sustainable development; and by the mantra that CSR is necessarily voluntary.

Voluntarism inevitably leaves CSR on the periphery, unless you swallow the "business case" argument - that shareholders benefit from corporate responsibility because it makes a company more attractive to employees, customers, suppliers, communities and socially responsible investors.

There is no doubt that there can be business benefits, but the impact that these "stakeholders" can make is limited. Having good employee relations is likely to reduce labour turnover, and to boost productivity and innovation. Avoiding scandals such as child labour protects reputation and brand. Using energy and other resources more efficiently saves money as well as being good environmentally. And so on.

But there are also plenty of examples where shareholders would lose out if companies did the really responsible thing, such as supermarkets paying farmers more, car companies withdrawing gas-guzzling 4x4s, or drug companies giving away products to poor people.

This is where voluntarism ends and some kind of intervention is necessary - which brings us back to company law.

The simplest solution would be to end the legal pretence that all companies are merely vehicles for shareholder investment; and to give directors of the larger companies broader duties in law, so they would have to weigh their responsibilities to all stakeholders.

That revolutionary organisation the Environment Agency embraces this radical view: indeed the agency wants company directors to have a statutory duty of care for the environment.

But such a "pluralist" approach was far too radical for the Department of Trade and Industry, which quickly killed the suggestion early in the company law review process that began the long and winding road to the Companies Bill. The result is that the government now has to achieve its aim of making companies more responsible to other stakeholders within the legal straitjacket of directors being responsible only to shareholders.

This leads to a great deal of twisting and turning, as can be seen when the companies' annual reports are published.

The main purpose of an annual report is to publish the directors' report and accounts for shareholders. But the accountancy profession figured out long ago that it is not just shareholders who are interested in what companies get up to, and that even shareholders need more than a set of figures and a few desultory comments from the board. Ten years ago, it suggested that UK companies follow US practice and publish an operating and financial review, giving a fuller account of what the company was up to and the issues it faced.

The Companies Bill will make such a review a legal requirement, but the question is how far it should stray from financially oriented issues of strategy and performance, and how much should be included about social and environmental issues.

Ministers have harangued companies for years about publishing reports on their social and environmental impact. (Most of the big ones now do so, although few are rigorously prepared and independently scrutinised.) Yet once again, the Company Law Review backed away from the obvious and said directors need only report what they consider to be "material". And now the materiality working group is preparing to pronounce on how companies should decide what that means.

The first question is: "material to whom?" The obvious answer, given the wide audience for social and environmental information, would be materiality to significant stakeholder groups. That is how companies decide what to put into social reports. But given the insistence that company law can only be interested in shareholders, materiality has to be defined for them.

It is obvious to most shareholders, and to their trade bodies such as the Association of British Insurers and the National Association of Pension Funds, that the risks and opportunities they base their investment decisions on include social and environmental matters, as well as core business issues such as markets, capital investment and labour relations. Two years ago, the insurers' association published guidelines recommending that companies report such risks and how they manage them.

The problem is that most companies - unless they are Shell, BP or Rio Tinto - have little idea of what controversy their practices or products may be courting. This is one area where the new law could help: it will, one hopes, espouse "stakeholder dialogue", the notion that you only know what people think if you talk to them.

There are many in the business world who just wish the government would tell them what it wants, so they could get on with it. But that smacks of regulation, which leads to a tortuous process and a half-cocked solution. At least the new law will make clear to company boards that they have to understand social and environmental matters - even if they still only really have to worry about the shareholders.

Roger Cowe is a writer on corporate responsibility and sustainability. His latest book, No Scruples?, will be published in paperback by Spiro Press in July