ESG for Lawyers

For years, I believed that companies could do well by doing good—that businesses prioritizing people, the environment, and all stakeholders would naturally thrive financially. But recent insights have challenged this belief.

You can read the paper here ispollutionvaluemaximizing.pdf .

The Profit in Externalizing Costs

The unsettling reality is that when companies can offload negative costs onto society, be it through pollution, human rights abuses, exploitative labor, or animal cruelty – they often see improved financial returns for shareholders. This practice of externalizing costs can lead to significant profit margins.

Checks and Balances: Why Don’t All Companies Exploit?

If such practices boost profits, what prevents every company from adopting them? Several mechanisms serve as deterrents:

• Regulatory Restrictions: Laws and regulations that set boundaries on harmful activities.
• Litigation: The threat of legal action and associated penalties.
• Reputational Risks: The potential backlash from consumers and the public.

However, these safeguards are not infallible. In their comprehensive study, Shapira and Zingales analyze how these checks can fail and propose avenues for improvement.

The Core Issue: Information Asymmetry and Delayed Consequences

A significant challenge lies in information asymmetry—the disparity between what companies know and what the public or regulators can access. When a corporation engages in harmful practices, the financial benefits are often immediate, while the adverse effects may take years to surface.

Even with stringent laws and hefty fines, companies might suppress information long enough to profit before facing repercussions. Ironically, increasing penalties could incentivize deeper concealment of malpractices.

Real-Time Reputational Risk: A Potent Deterrent

An intriguing deterrent is the fear of real-time reputational damage. Consider the historical case of C8 pollution, which occurred when news dissemination was controlled by a few major outlets. Local environmental issues often remained underreported for extended periods.

Today, the landscape has transformed:

• Decentralized News: Social media and independent platforms can amplify local incidents to a global audience swiftly.
• Increased Demand for Content: Numerous platforms seek diverse stories, including local events.
• Instantaneous Reaction from Public, Employees, Business Partners: Companies now face immediate public scrutiny, leaving little room to hide unethical practices. The internet has mobilized people, the millennials and Gen Z are expecting more from their employers, and business counterparts are watching.

This evolution suggests that the threat of immediate reputational harm may now be a more effective deterrent than protracted legal processes. At least in the short term immediate scene which is much needed.

Cultural Insights: The Influence of “What Will People Say?”

In many cultures, particularly Asian societies, the question “What will people say?” serves as a powerful behavioral check. Social reputation profoundly influences individual and corporate actions.

In our current global context, where traditional regulatory mechanisms may lag, public scrutiny and the potential for instant reputational damage could play a pivotal role in ensuring corporate accountability.

Evolving Capitalism: Adapting Deterrence Mechanisms

As highlighted by Shapira and Zingales, “An effective system to deter companies from externalizing their costs is essential to the proper working of a capitalist economy.” This system must continuously adapt to changing societal and technological landscapes.

Presently, the components of deterrence are shifting, with real-time reputational risk becoming increasingly significant.

I invite you to reflect on this: How influential do you believe reputational risk is in shaping corporate behavior today?

Stay informed,

Samarpita

All opinions are personal