Corporate governance, strategic philanthropy, and public policy

Corporate governance, strategic philanthropy, and public policy

Corporate Governance, Strategic Philanthropy, and Public Policy Thomas A. Hemphill E very year, thousands of companies across America reach into the...

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Corporate Governance, Strategic Philanthropy, and Public Policy Thomas A. Hemphill


very year, thousands of companies across America reach into their treasuries to contribute funds to their favorite charitable organizations. The impact of corporate philanthropy, however, has traditionally been considered of minor importance to the organizational success of a company. In general, the charitable corporate decision-making process was considered non-controversial, and often the same philanthropic endeavors were funded year after year simply because of a chief executive'.s affinity for a cause. But the era of benign corporate philanthropy is now coming to a close, The corporate movement involving charitable giving and reflecting the highly competitive environment of the 1990s has been termed "strategic philanthropy." It involves corporate giving that serves a dual purpose: contributing n e e d e d funds to charitable causes while simultaneously benefitting the firm's financial bottom line and enhancing business political legitimacy. According to Giving USA (Kaplan 1998), an annual report issued by the AAFRC Trust for Philanthropy, an arm of the American Association of Fund-Raising Counsel, corporations in 1997 donated $8.2 billion, or 5.7 percent of the $143.5 billion in total contributions to American charities. Many companies now view their portion of this multi-billion dollar expenditure as a strategic investment reaping an economic return to the firm, although few expect political dividends from the investment. David P. Baron, the William R. Kimball Professor of Business, Economics, and Environment at Stanford University, maintains that corporate strategy involves both a market and a nonmarket component. His integrated approach is a useful guide to illustrate how philanthropy fits into the strategy formulation process. Corporate Governance, StrategicPhilanthropy, and Public Policy

Strategic Philanthropy: Market Strategy The modern theory of competitive strategy requires that business strategies be developed around the structure and dynamics of the market environment and the core competencies of the firm. Formally defining the parameters of a market strategy is the first order of business. According to Baron (1995), a market strategy is: a concerted pattern of actions taken in the market environment to create value by improving economic performance. The market environment includes those interactions between the firm and other parties that are intermediated by markets or private agreements. These interactions typically are voluntary and involve economic transactions and the exchange of property. From a market strategy perspective, a firm's charitable investment is focused on areas that match its products or services with its customer base. This product extension strategy reinforces the image of the product (and the firm) with positive benefits to the intended consumer. Beginning in the mid-1980s, many CEOs began linking their corporations to social causes, strategically viewing these arrangements as a way to differentiate their products to consumers. This 57

market strategy has met with some success; today, says Lesa Ukman, president of Chicago marketing survey firm lEG, Inc., "companies are aligning furiously with non-profits" (Kadlec 1997). Whirlpool, whose customers are primarily women, contributes its charitable giving to child care programs and job training for women. Avon Products, a cosmetic manufacturer and distributor, donates funds for medical research to assist in finding a cure for breast cancer. Kimberly-Clark, a personal paper products manufacturer, helps fund the building of playgrounds in economically depressed neighborhoods. A corporate image is bolstered through the firm's identification with contributions targeted to the local communities in which it operates and its employees reside. Post Cereals contributes one p e n n y to local food banks for every box of its cereals purchased at Waldbaum's supermarket. Dayton Hudson, the Minneapolis-based retailer and founder of the Twin Cities Five Percent Club, whose members donate this level of annual pretax profits, used to employ a low-key approach to charitable giving. Today, its Target discount stores often place stickers on products informing consumers that 5 percent of its pre-tax annual profits "goes directly back into Target communities across the nation" (Sloan 1997). In a 1998 survey conducted by The Chronicle of Philanthropy (Blum and Gray 1998), corporate officials representing America's largest compan i e s - b a s e d on revenue rankings compiled by Fortune magazine--were asked to rate their philanthropy on a scale of I to 10 in terms of its relevance to their company's "financial success." A ranking of "1" meant that philanthropy was "not at all significant" to financial success, whereas a score of "10" meant it was "extremely significant." Results were mixed. Of the 72 firms responding to the survey, 34 ranked corporate philanthropy somewhere between 6 and 10, while 38 ranked it somewhere between 1 and 5. What is noteworthy about this survey result is not that 53 percent of the respondents answered that corporate philanthropy was not relevant to their firm's financial success, but that nearly half of them believe it is. If this question had been asked of corporate management even ten years ago, many fewer respondents would have answered that corporate philanthropy was impor58

tant to business success. Pfizer Inc, a major pharmaceutical company that responded to the survey, rated its philanthropy a "9." To reinforce the strength of its organizational convictions, Pfizer included philanthropy in its new set of written corporate values in 1997. Its new approach to charitable giving-what management calls "venture philanthropy"-is a philosophy based on risk-taking, innovation, and entrepreneurial spirit. According to its Corporate Philanthropy Report of 1996-97, the company's Community Venture Fund supports local organizations seeking to combat chronic poverty by bringing jobs, commerce, and opportunity to economically depressed neighborhoods, and fostering self-reliance, creative problem-solving, and personal responsibility in the individuals they assist. ARCO, a major oil producer, was the only respondent to award a "10" to corporate philanthropy. Russell Sakuguchi, president and executive director of the ARCO Foundation, describes philanthropy as contributing to the firm's overall strategy. He says it plays an important role in h o w the company manages "relationships with employees, suppliers, opinion makers, and community groups" (Blum and Gray 1998). As its 1997-98 report Building Relationships states, the ARCO Foundation, which spent $13.8 million on grants in 1997, has a grant-making strategy intended to support the company's business objectives through community leadership, partnerships, and charitable investments that continue the strong tradition of active corporate citizenship where ARCO has facilities and a concentration of employees. This strategy includes targeting a limited number of grant-making program areas of deepest concern to ARCO communities and the company's business operations, such as local community (40 percent of all grants), education (31 percent), and arts and humanities (22 percent).

Strategic Philanthropy: Nonmarket Strategy In the market environment, corporate actions are voluntary and produce private benefits. In contrast, corporate actions in the nonmarket environment often (though far from exclusively) provide public benefits that affect a broader constituency. Baron defines a nonmarket strategy as a concerted pattern of actions taken [by the corporation] in the nonmarket enviBusiness Horizons / May-June 1999

ronment to create value by improving its overall performance. The nonmarket environment includes those interactions that are intermediated by the public, stakeholders, government, the media, and public institutions. These institutions differ from those of the market environment because of characteristics such as majority rule, due process, broad enfranchisement, collective action, and publicness. Baron explains that interactions in the nonmarket environment may be voluntary, as between the firm and a stakeholder, or involuntary, as when government regulates the firm's operations. In the public policy arena, corporations are actively lobbying their positions on issues at the firm, industry, cross-industry, and general business levels of organization. Corporate resources are strategically focused where they can benefit the firm both politically and economically. But whether such forethought and planning is used when corporations designate philanthropic contributions is less evident. This is especially true when such contributions are targeted to special interest advocacy groups and "think tanks." The Capital Research Center (CRC), a Washington. D.C. nonprofit education and research organization, has been measuring corporate philanthropy to public interest and advocacy groups since 1986. Fulk (1996) reports that since its organizational inception in 1984, the CRC has focused its efforts on "reviving the American traditions of charity, philanthropy, and voluntarism." For 1994, the most recent year for which data are widely available, the CRC found that major American corporations on the Forbes 250 list (ranked by sales revenue) gave almost $27 million of a total of $35.78 million to advocacy groups that actively promote public policies leading to higher taxes, more regulation, and less economic freedom for corporations. According to CRC, for every dollar corporations gave to right-of-center and pro-free markel groups, they gave $3.43 to liberal and leftof-center groups promoting expanded government. How does this ratio compare over the years? In 1986, the ratio was $1.64 contributed to liberal adw)cacy groups to $1 contributed to conservative groups. Over the following years, the ratio rose steadily, reaching $3.42 to $1 in 1992. During 1993. the first year after President Clinton's election, the ratio spiked to $4.07 to $1 before subsiding the following year. Why would corporations support nonprofit adw)cacy groups whose public policy agenda is contrary to that of the business community? The CRC believes there are three possible reasons for this financial support. First, CEOs and managers Corporate Governance, Strategic Philanthropy, and Public Policy

of grant-making departments may simply be ignorant of the agendas of nonprofits applying to them for grants. Second, they may distribute relatively small contributions as tribute money to buy time and avoid harassment. Finally, some corporations may conclude that their well-being ultimately depends on the administration in power. But why should companies invest significant resources in trade associations, ad hoc political coalitions, political lobbyists, and public affairs departments, and simultaneously provide financial resources to nonprofit advocacy groups espousing political agendas at cross purposes to their own? The answer is, they should not. This is an area of corporate governance that has been inadequately scrutinized by management or boards of directors and has now attracted the attention of Washington legislators.

Corporate Governance and Public Policy On March 5, 1997, Representative Paul E. Gilmor (R-Ohio), vice-chairman of the House Committee on Commerce, introduced two bills concerned with charitable contributions and designed to amend Section 14 of the Securities and Exchange Act of 1934, The first bill, H.R.944, is co-sponsored by Representative Michael G. Oxley (R-Ohio) and Representative Thomas Manton (D-New York) and would require all publicly traded companies to disclose annually to shareholders the charities they contributed to and the amount of each contribution. The second bill, H.R.945, would require all publicly traded companies to allow shareholders to decide what charities should receive contributions from the firm and the amount of each contribution. Both bills, however, exempt gifts of personal property (products manufactured by the donor company) and donations to educational institutions and local charities. Representative Gilmor was motivated to sponsor this legislation based on his lengthy experience as a corporate board member and private investor. While actively involved in these roles, he had noticed instances in which management had ignored shareholder concerns about certain charitable contributions. He believes shareholders have a right to know how management is distributing corporate resources, and that such disclosure would discourage contributions to their "pet" charities. "~9

At the request of the House Committee on Commerce (the committee in which the proposed legislation was assigned), the Division of Corporate Finance of the Securities and Exchange Commission was contracted to study the feasibility of both bills and analyze the costs of imposing their legislative requirements. As part of its evaluation, the SEC issued an invitation to institutional and individual investors, companies, charitable organizations, and other interested people to comment via traditional mail or e-mail on the potential effects of H.R.944 and H.R.945 on charitable


giving. The original comment period was to expire on December 15, 1997, but was unofficially extended into 1998. A sampling of some 200 letters received by the SEC from corporations and nonprofits reveals strong criticism of both bills (see the sidebar). In general, managers of most companies and many nonprofits believe mandatory disclosure of charitable contributions is a costly undertaking and would encourage unnecessary scrutiny from special interest groups and shareholders. Most respondents believe both these factors could have a chilling effect on corporate giving. However, the position of the National Society of Fund Raising Executives (NSFRE) is that "there should be complete disclosure with as few exemptions as possible" (Lewis 1997). According to the NSFRE, "if disclosure is beneficial for the not-for-profit sector, its donors, and the general public, then even this sort of limited disclosure under H.R.944 should also prove helpful to shareholders and other interested parties." The corporate and nonprofit response to H.R.945 was far more negative than for H.R.944. Some respondents were adamant in their belief that decisions regarding charitable contributions are a management prerogative. Other corporations reported that the cost of shareholders voting for corporate contributions could rise into the hundreds of thousands of dollars and would be a logistical nightmare to implement. Overall, there was strong support for the position that both bills would do little to encourage corporate philanthropy and much to discourage publicly traded firms from contributing to controversial or "cutting-edge" charities. The opinion of many experts in the field of corporate law is that companies should disclose their charitable contributions. According to Charles M. Elson, a law professor at Stetson University, "the problem with today's corporate philanthropy is that it sometimes functions to promote and aggrandize corporate management, who generally take credit for the donations" (Bryant 1998). Moreover, says Elson, w h e n there is no clear benefit to the company, "it is a waste of corporate property and constitutes self-dealing." In other words, it personally benefits executive management. Under current law, shareholders have the right to request charitable contribution information from a publicly traded company, but nothing requires the company to release the information. According to the Conference Board, in the top 300 corporations, less than 40 percent of their philanthropy is awarded through corporate foundations. Although the foundations are required to list donations by recipient in their tax filings, which are available to the public, most corporate charitable contributions are donated directly to Business Horizons / May-June 1999

nonprofits, which have no legal requirement of public disclosure. The National Committee for Responsive Philanthropy (NCRP) offers an example of h o w responsive publicly traded companies are to requests for information on charitable contributions. The Saint Paul, Minnesota nonprofit research and public education organization has conducted a seven-year project researching corporate grants for racial/ethnic populations. In 1996, NCRP researchers asked 174 corporations with foundations to provide very basic information on their grant-making programs. Only 47 of the 174 corporate foundations surveyed (27 percent) responded with concrete data on their grant-making practices. As poor as this response was, NCRP researchers found that companies with foundations were much more accessible than those without. Allowing shareholders the right to vote on which charities to contribute and how much each charity should receive is a complex issue at best. Berkshire Hathaway, whose chairman is Warren E. Buffet, allows its shareholders to choose annually which charities will receive their respective share of the philanthropic allocation the company sets aside each year. But even Representative Gilmor recognizes that unlike the more closely held Berkshire Hathaway, a publicly traded company like Hewlett Packard, with approximately 100,000 named shareholders, might find a similar arrangement unworkable. With the demise of the 105th Congress, Representative Gilmor plans to introduce a revised version of his disclosure bill, and possibly his shareholder voting bill, in the 106th Congress. Under this scenario, the SEC will solicit comments on the revised disclosure bill before issuing a report next year. Representative Gilmor has stated that his primary legislative focus is on the disclosure bill. With this in mind, his new bill may address two criticisms of his earlier proposal: (1) defining what a "local charity" is, and (2) establishing a minimum donation to be disclosed. As for his shareholder-voting bill, "I just wanted to get the debate started," said Gilmor. "I don't expect it to go anywhere" (Goodman 1998).

The Case for Strategy in Philanthropy Corporate management is responsible to boards of directors---and ultimately shareholders--for decisions regarding the distribution of company assets. On average, although 1.1 percent of pretax income may appear to be relatively insignificant, its impact should not be underestimated. Moreover, there are many firms, like Dayton Hudson, who contribute up to the 5 percent allowable under Section 170 of the Internal Revenue Code. Distributing corporate assets is at the Corporate Governance, Strategic Philanthropy, and Public Policy

core of management strategy. As Baron explains, that strategy is both of a market and nonmarket variety. Management must be accountable for its decisions regarding philanthropic contributions within this strategy context. According to the NCRP (Paprocki 1997), corporate grant-making and charitable practices have b e c o m e fully integrated into corporate life: inventory, employee time, marketing, and even litigation. Stockholders of these corporations must become more aware and better educated about the use of charitable giving as a business practice. Shareholders should have the right to challenge these management decisions at annual board meetings on the basis of how the philanthropic contributions benefit the firm in the economic and socio-political-legal environments. According to the Interfaith Council on Corporate Responsibility, charitable giving and grant-making was one of the five most c o m m o n issues in nonmanagement-related stockholder resolutions. A specific example of the growing importance of strategic philanthropy to market strategy is "cause-related marketing." This involves corporate sponsorship of a cause that includes an expensive marketing and advertising campaign promoting both the company and the cause or social issues. American Express was the first corporation to use cause-related marketing nationally in a campaign linking credit card usage with a corresponding company contribution. In 1983, it contributed $1.7 million for the restoration of the Statue of Liberty. Cause-related marketing has continued to ascend in popularity. Since IEG began publishing its Sponsorship Report, says Kadlec (1997), the level of corporate cause-related marketing sponsorship dollars expended nationally has risen from $75 million in 1988 to $485 million in 1996, and is projected to reach $535 million in 1997. Nonmarket strategy has become an area of increasing importance for strategic philanthropy. According to the NCRP, this nonmarket strategy can have a significant impact on the future business success and political legitimacy of the firm or industry: In 1987, Dayton Hudson Corporation was able to fight off an unfriendly takeover bid by Dart Corporation on the strength of its generosity to nonprofits in its home state, Minnesota. Without a generous and widely disclosed record of corporate giving, neither the state legislature nor many of Dayton Hudson's institutional stockholders would have supported leg61

islation which virtually eliminated any unfriendly takeovers. Similarly, the insurance industry has invested hundreds of thousands of dollars tracking insurance company grants to all types of charitable organizations, and used the industry's giving record in litigation, legislative arenas, and in community advertising campaigns, as evidence the industry fully supports the communities in which they do business. (Paprocki 1997) he legal support for disclosure is significant; however, the case for reducing the business costs of implementing disclosure is legitimate as welt. To meet these business expense criticisms, Representative Gilmor's proposed revised bill could mandate that each charity and the amount of each contribution is placed on the company's Web site. Information on the location of this information can be included with the annual board meeting notification mailing, with a phone-in option for those shareholders without Internet access w h o may request a hard copy of the Web site information. Such an approach should significantly reduce the business expense of printing and mailing this information to shareholders. In the final analysis, shareholders need full disclosure of corporate charitable contributions. Through such disclosure, they can exercise their right to effectively evaluate the impact of these managerial decisions on firm strategy. [D


Adam Bryant, "Companies Oppose Idea of Telling How They Contribute to Charities," The New York Times, April 3, 1998, p. A1.

Building Relationships, ARCO Foundation Annual Report, 1997-1998. Austin Fulk, Patterns of Corporate Philanthropy.. Funding Enemies, Forsaking Friends, Capital Research Center, Washington, D.C., Studies in Philanthropy #21, 1996. Beverly Goodman, "Nonprofits Fear Decline in Corporate Donations," The Nonprofit Times, March 1998, p. 4. Daniel Kadlec, "The New World of Giving: Companies Are Doing More Good and Demanding More Back," Time, May 5, 1997, pp. 63-64. Ann E. Kaplan (ed.), Giving USA 1998: The Annual Report on Philanthropy for the Year 1997 (New York: AAFRC Trust for Philanthropy, 1998). Patricia E Lewis, President & CEO, National Society of Fund Raising Executives, letter (via e-mail) to Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, Washington, D.C., November 12, 1997. Steven Paprocki, National Committee for Responsive Philanthropy/Minnesota, letter (via e-mail) to Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, Washington, D.C., November 12, 1997.

Pfizer Philanthropy, Corporate Philanthropy Report 1996/97, Pfizer Inc. & the Pfizer Foundation Inc. Allan Sloan, "Can Need Trump Greed?" Newsweek, April 28, 1997, pp. 34, 36.


David P. Baron, "Integrated Strategy: Market and Nonmarket Components," California Management Review, Winter 1995, pp. 47-65. Debra E. Blum and Susan Gray, "Big Business Means Big Philanthropy," The Chronicle of Philanthropy, July 16, 1998, p. 1.


Thomas A. Hemphill is a fiscal officer with the New Jersey Deportment of State, Trenton, New Jersey.

Business Horizons / May-June 1999