Efficiency of Cost-Benefit Analysis in Business Regarding Environmental Issues

Economical term cost-benefit analysis means to evaluate a business activity by calculating the net gain for a company. It generally helps companies to assess whether a decision is appropriate to make monetarily.

However, with rising of severe environmental issues in modern world, business activities take certain responsibility of negative impact on environment. That makes people question the validity of traditional cost-benefit analysis in business. Since the concept of cost-benefit analysis is a human centred, if a company only exercise cost-benefit analysis, it will not help the company to build better business ethics. There are also rising of new ideologies on business ethics like Buddhist economics and deep ecology which disagree with human centred functioning of business. In this essay, I will be explaining the development of business cost-benefit analysis, and how a new moral framework can impact both business and environment.

Firstly, the competition between companies in free market makes businessman developed an idea that social responsibility and employees’ responsibility are separable. Milton Friedman (1970) suggests that employees’ responsibility to the company it to maximise the profit for company. He demonstrated his points by using the model of a corporate executive. Since he is hired by stockholders, his responsibility in business is to full fill the desire of stockholders which is to maximise the profit. The process of maximising profit is allowed as long as it obeys the law and basic rules of society, Friedman suggested. In his model of business, a person cannot exercise his social responsibility and responsibility for stockholders at the same time which suggests an absolute separable relation between social and business responsibilities. It is equally unfair as “taxing without representing”, Friedman said since the action of using business money for society is not voluntary for stockholders and he believed that society problems are for politicians to solve instead of businessmen.

The process of profit maximisation involves the use of pure cost-benefit analysis. Since the cost-benefit analysis only calculates the net profit for a company, it is supposedly to include nothing about social impact. In Friedman’s example, a corporate executive is selected by stockholders to serve for better interest for the company. As he takes social responsibility of company into account of cost-benefit analysis, he becomes an employee of the society instead of an employee of the company which he is expected to be, said Friedman. Friedman’s arguments are based on the economic condition for capitalism, since the growth of economy of a country depends on free market which leads companies focus on their own wealth growth. Maximising profit is the purpose for every company in capitalism economics which is achieved by traditional cost-benefit analysis. Social responsibilities like environmental concerns are not placed in consideration for cost-benefit analysis. Friedman even argued that businessmen who are promoting social responsibilities in business are poisoning the very foundation of free market. The business in his work looks rather robotic and aiming one and only purpose of profit generation.

Because of the effectiveness of how Friedman’s idea helps companies accumulate wealth, it was generally agreed in capitalism society. However, the rising of social and environmental issues around world in 21st century makes people concern more about their social responsibilities, and they stared to doubt the validity of traditional cost-benefit analysis. Certain modification was suggested to business cost-benefit analysis. A new term Corporate Social Responsibility is introduced, which means to contribute goods into society that is beyond the expectation of basic rules of society and laws as Friedman stated. Taking corporate social responsibility is an effective way for companies to gain reputation from the society. People are more likely to invest their money to the brands which has positive image among society. Joshua Graff Zivin and Arthur Small (2005) built up a new model for cost-benefit analysis model which involves the profit gaining from corporate social responsibility. They suggest that the corporate social responsibility companies conducted can have a positive long-term effect on its wealth accumulation so that it is considered a profit building activity. Since taking social responsibility depends on if an individual is voluntary to contribute, individuals who have desires to exercise their social responsibility can invest their money to companies that have the same thoughts. Then the company can gain profit from investors and investors can full fill the desire of exercising social responsibilities through companies. Therefore, the modified cost-benefit analysis helps businessmen to see the potential profit in corporate social responsibilities and take responsibility of contributing to the society.

However, the shift from traditional pure business cost-benefit analysis to modified cost-benefit analysis which involves taking social responsibility as a method of profiting company itself does not change the fact that cost-benefit analysis is a human benefit centred process. Cost-benefit analysis itself is always a monetary analysis which separates money making and social issues. When companies exercise social responsibility as a part of money-making process, they are over simplifying business ethics. If social responsibility is always taken as a support for profit maximising process, then social issues as well as environmental issues will never have serious attention from firms. Social responsibility is taken perfunctorily just as a side effect of money maximising process. Therefore, cost-benefit analysis for companies is not enough to achieve a better business ethics as well as social responsibility.

A new term “economism” developed by Ove Jakobsen and Stig Ingebrigsten (2006) cited by Knut Johannessen Ims and Laszlo Zsolnai (2006) is defined to describe the concept of maximising business profit without carrying social responsibilities. For maximising profit, companies ignore the effect they have on environment. As Knut Johannessen Ims and Laszlo Zsolnai stated that companies enjoy the short-term achievement and willing to achieve profit maximisation by sacrificing the environment. The rising of environmental issues caused by business practices develops new ideologies of Buddhist economics and deep ecology.

A concept of self-realisation in environmental perspective is developed (Naess,1989) cited by Knut Johannessen Ims and Laszlo Zsolnai. It requires people to realise the status of themselves in nature. Naess suggests that human interests are as important as any other beings in nature. The concept of considering human as an equal part of other beings is called deep ecology. If deep ecology is applied to business, the cost-benefit analysis would have to take the interest of environment into account and profit maximisation cannot be achieved. Instead, the business profit shares the same level of importance as environment interest.

One similar concept “Buddhist economics” is introduced by Laszlo Zsolnai and Knut Johannessen Ims. It argues that the development of economics should not do any harm to the environment. The product of business including its wastes and pollution should have minimum negative effect on environment.

Deep ecology and Buddhist economics disagree with the common concept of traditional business practices. Traditional business practices agree with human profit centred concept while deep ecology and Buddhist economics bring human profit and environmental interest to the same level. They suggest a complete reshape of current business framework in capitalism economy.

The concept of deep ecology and Buddhist economics seems to be friendly to the environment, but the fact that they both shifted the centre of business from human to the surrounding environment makes them difficult for public to accept. According to Richard Welford (2006) as cited by Jason McLeod Monson (2010), letting people accept the concept of deep ecology is rather radical under capitalism economics. Indeed, the shift is a challenge to the very basis of free market. Those concepts also need support from large population while rich people in capitalism countries are unlikely to agree. Therefore, the complete reshape of our moral framework on business would be unrealistic under the condition of capitalism.

Oliver Hart and Luigi Zingales (2017) opposed Friedman’s proposal of separating fiduciary duty and social responsibility. They suggested money-making and ethics are inseparable. They also argued that the process of maximising shareholders’ profit is can be understood in two separate parts: maximising shareholders’ welfare and maximising company’s market value. Friedman’s idea was for corporate executives to exercise their fiduciary duty by managing to maximise company’s market value, however, the fiduciary duty of corporate executives is towards the shareholders’ welfare. This concept allows businessmen exercise their social responsibility if the shareholders instruction is on maximising their utility. Since the ultimate decision is on the shareholders, their sense of social responsibility determines whether a company can exercise business practices as both company-beneficial and environmentally friendly.

In conclusion, the cost-benefit analysis does have irreplaceable importance for maximising profit in business. With the rising of social and environmental problems, new modifications base on company reputation and long-term benefit are made. Although the modifications seem to be beneficial to the society, it is still a business profit analysis which means that it is a money and human centred exercise. A pure monetary analysis is not going to reach a better business ethics since it barely considers the consequences on social and environment. Deep ecology and Buddhist economics suggest that business should create an equal status between profit and environments. Since the concept that they introduce are rather radical and challengeable to the basis of capitalism economics, they are not likely to be accepted by majority of the society. Without the support of large population, those concepts are less effective to the society. Therefore, the application of these new moral frameworks in business is ideal but not necessarily practical.

Finally, the redefinition of fiduciary duty carried out by Oliver Hart and Luigi Zingales gives an idea that employees’ fiduciary duty is to maximise shareholders’ welfare instead of market value. It gives shareholders power to decide whether to exercise their social responsibility. After all, the exercising of social and environmental responsibilities of a company completely depends on the shareholders will if employees strictly exercise their fiduciary duty. The business negative impact on environment can therefore be solved by having company shareholders understand the equal status between profit and environment.