Courtesy of Kanksha Mahadevia Ghimire
The United Nations Environment Programme issued a bulletin in 2013 highlighting the prevalent existence of corruption (fraud, bribery, abuses of power, etc.) in emissions trading, specifically the European Union’s Emissions Trading Scheme (EU ETS). Corruption undermines the emissions trading mechanism and weakens its chances to act as an effective incentive for entities to reduce greenhouse gas (GHG) emissions. It is unfortunate that regardless of what mechanism is implemented, it becomes a victim of corruption, despite the use of methodologies to identify and curtail corruption.
Equally worrisome, is that while some corporations may not indulge in outright corrupt activities to bypass schemes such as the EU ETS, they may attempt to game the system. Gaming occurs, for example, when corporations manipulate the law to adhere to its letter but not its intent. Gaming activities are usually ‘technically legal’ and entities cannot be penalized for these acts, even if they are detrimental to society.
If technically legal, then why is gaming a problem? Salter argues, “gaming crosses the line of acceptability and becomes institutionally corrupt when such institution-sanctioned behavior subverts the intent of society’s rules, thereby harming the public interest, or weakens the capacity of the institution to achieve its espoused goals by undermining its legitimate procedures and core values.”
Since gaming can have such a serious detrimental impact on society—similar to corruption—it is imperative that corporations be incentivized to forgo gaming, and instead strive to comply with the spirit of law and not only its letter. But when gaming is not an illegal activity (unlike corruption), what role can law play in incentivizing corporations in achieving this objective?
Balancing Private Profits and Societal Interests: A Proposal On Positive Point System (PPS)
In my paper, I propose a system that legally obligates corporations to find the ‘right’ balance between profits (personal gain) and the interests of society, as opposed to the current scenario where many corporations are in a constant race to maximize profits at the expense of society.
Inspired by Adam Smith and Amartya Sen, the proposed mechanism is unique because it does not rely on a corporations’ benevolence, contraexisting systems like corporate governance and corporate philanthropy. Rather, the proposed mechanism incentivizes corporations to adhere to the spirit of law by playing upon their vices. My proposal uses corporations’ self-interest; namely, their ambition of acquiring the “respect and admiration of mankind” and praise, for the betterment of society. To the smallest degree, it also appeals to the sympathy of people.
The underlying rationale for the proposal is theneed to implement a system where the success of a corporation is not just linked to it profits and financial strength, but also to its ethical business practices and active participation in the betterment of society. Hence, I propose a positive point system (PPS) under which incorporated entities are awarded points based on their contribution to society. To receive points, the entity would have to demonstrate that:
(a) Its actions promote the spirit of law;
(b) Such actions benefit society; and
(c) The entity has taken a financial hit, e.g., its profits were reduced to a certain extent because of implementing technology to reduce emissions or investment in renewable energy.
Through competition, creativity, transparency, and distribution of information, an organization will arrive at schemes beneficial to itself, its board, its shareholders, and society. The race to maximize profits is replaced by finding the ‘right balance’ between the interests of entities/directors/shareholders and society.
When PPS commences, each incorporated entity starts with zero points. The aim for each entity is to increase its points. Zero points reflects that the entity is in compliance with all laws and no judicial authority has passed a final binding order against it to the contrary. A proven violation of law culminating in a final judgment (with no appeal being possible) would result in negative marking.
In order to win points, the applicant entity is required to submit a report. Points are awarded if the applicant is able to:
- Highlight loopholes in law and specify how the applicant has chosen not to profit from such loopholes, although such profiteering would be legal.
- Demonstrate that instead of maximizing profits, it has reduced its profits and such reduction has benefited society, e.g. a cleaner environment or better working conditions. This reduction could be a comparison with what it was previously earning, or it could legally and practically earn. The latter can be evidenced by the applicant submitting studies similar to those on which business plans and budgets are prepared.
The points awarded depends upon the extent of the monetary hit taken and the benefit provided to society. The aim is to inspire healthy competition in pursuit of points amongst entities within sectors. Thus, an applicant can “win” if it successfully implements a scheme that is superior to their competitors, thereby providing maximum benefit to society and resulting in significant, or maximum financial loss (Optimal Scheme).
Additionally, in the event an Optimal Scheme is ‘copied’ and implemented by other entities, such entities are entitled to points. However, the originator of the Optimal Scheme (evidenced through records maintained with the PPS Department, discussed below) is entitled to bonus points.
Points can also be awarded for whistleblowing, which culminates in a final binding judgment. Entities can report the illegal activities of other entities. Usually, entities in the same, or similar industry, are intimately aware of the possibilities of corruption in that field. Thus, the PPS provides an incentive to reduce corruption.
Implementing the PPS
The PPS would be regulated by a specific regulatory department (PPS Department) set up by the government. The PPS Department would be responsible for:
- Maintaining a repository consisting of the names of all incorporated entities;
- Analyzing the schemes filed by applicants;
- Determining the extent to which the scheme has been successfully implemented by the applicant and whether it achieves what the applicant claims it has achieved;
- Awarding points;
- Making points, and the rationale for awarding or deducting them, available to the public; and
- Ensuring (with the assistance of other regulatory authorities e.g. competition commission) that entities do not indulge in cartelization and consequently undermine the PPS.
The points awarded would fall between 1 and 100. An entity that is awarded 100 points is not a perfect company, but, amongst its peers, the entity has found the best balance between its own interests (profits) and that of society.
The PPS is meant to be dynamic and fluid. Each applicant would be judged against the schemes and activities of its peers, i.e., entities that are in the same or similar industry and are of comparable size. This is crucial for a scheme where points are awarded based on the extent to which an applicant forgoes its profits for the benefit of society (by reducing emissions beyond what it is legally required to or paying taxes over and above what it is legally required to) as a multi-national corporation (MNC) is capable of sacrificing significantly more than a start-up company.
At the same time, to promote healthy competition, an Optimal Scheme implemented by an applicant (whether a MNC/start-up/mid-tier company) in a particular industry is compared to schemes implemented by all other entities within that industry, regardless of size. Of course, the magnitude of benefit greatly differs and depends upon the size of the entity; however, the sprit with which it is implemented is comparable.
The objective of the PPS is not for an entity to obtain say, 90 points and remain there. Rather, the idea is for market competition to lead to the constant pursuit of new permutations and combinations that find the right balance between the interests of the entity and society. Thus, the points reflect where an entity stands against its peers at any particular time. Thus, 90 points in 2014 is different from 90 points in 2024. Over a decade, ‘the right balance’ will have considerably evolved.
In order to ensure that entities do not reach a score and stagnate, I propose that when a scheme is awarded points, the entity is entitled to enjoy that score for a specific period of time (the period would vary based upon several factors, like size and sector). However, when the approved time expires, e.g. 7 years, (presuming that the entity has not made any significant changes in implementing that scheme and hence, not applied for new points) the entity is automatically judged against its peers (regardless of size but same sector) and its points are adjusted accordingly. Points can be upgraded (if it is the Optimal Scheme) or downgraded.
Calculating Points and Resolving Disputes
In order to make the PPS work, the PPS Department must provide a detailed list of criteria, permutations and combinations, and the range of points that are awarded for each. This is done by industry as well. Account needs to be taken of the differing sizes of entities (start-ups, MNCs etc.). This includes information like the energy needs of certain industries. Further, all schemes are judged against other schemes (as discussed above). Thus, at the commencement of the PPS, the first criteria and proposed benchmarks of permutations and combinations are derived from an extensive study of existing businesses. This criteria and related points evolve over time, and over the decades, the accumulation of points will carry different implications for the entities.
An element of subjectivity in decision-making always remains, as each business is different at some level and there are countless issues that need to be taken into consideration. But such subjectivity can be tackled with transparency, i.e., the reasoning behind an award or the reduction of points by the PPS Department is detailed and made publicly available.
To resolve disputes between entities and the PPS Department in respect of the award or reduction of points, a special tribunal may be appointed whose decision is final and binding. All information provided to the tribunal, as well as the debates, reasoning, and decisions of the tribunal, will be open to the public.
Giving Teeth to the PPS
It is in the self-interest of shareholders and directors to maximize profits, as profits provide for dividends and executive compensation. For the focus to shift from profits to maximizing points under the PPS, the PPS must also directly impact the ability to receive dividends and bonuses.
Thus, if a company has zero points, no dividend or bonuses can be paid. The profits should be deposited with the PPS Department, and the entity will not receive interest on their deposit. However, the entity will be entitled to receive the profits (part or total) depending upon the points obtained. Simply described: if the entity obtains 50 points, it is entitled to receive 50% of the profits and distribute it how they wish.
Moreover, points should also impact stock prices. When acquiring shares, potential shareholders will carefully study the points awarded under the PPS in order to identify the probability and extent to which they would be entitled to receive dividends. If the points are high, and it is entitled to enjoy the same points under the scheme for 10 more years, the potential shareholder will be happy to invest. However, if the points are low, and no proposal for a new scheme is in the pipeline, investors will be more wary. The lack of points problem is not as alarming as it may seem, because the point system is based on the market and it should be fairly easy for entities to obtain points, as many are already engaged in corporate social responsibility.
Through creativity, this system needs to be woven more intricately into the fabric of our commercial world. For example: entities having a high point, like 80 and above (High Point Entities), can be given certain benefits. These benefits could come from other entities in the form of cheaper raw materials or services. Entities that provide cheaper raw material/services to such High Point Entities are entitled to obtain points as they are promoting and assisting entities that put society first. However, it is imperative to ensure that such service/product providers and consumers are not part of the same group; otherwise it is easy to manipulate the system. If the points of a High Point Entity fall under the agreed threshold, all such benefits go away.
As another example, in a supermarket, consumer products are stacked in a segregated manner. Therefore, products from High Point Entities could be stacked entirely separate from all others, so the consumer can easily identify products from companies that are benefitting society more than others. The company owning the supermarket can claim points under the PPS for this categorization. This system has the added benefit of getting consumers to increase their purchases of products made by High Point Entities.
Typically, self-interest dictates that consumers select the cheapest product regardless of how the manufacture of the chosen product affects society. However, self-interest can be tempered by playing to the need for praise and sympathy. If products are kept in this segregated manner, it is easy to identify people who assist High Point Entities and thereby award them in creative ways.
Media is an extremely powerful tool as well. If media companies are able to demonstrate they are providing services at lower rates to High Point Entities, or marketing the services or products of High Point Entities, then they can both claim points and significantly influence consumers to be part of this growth.
The PPS does not foresee an increase in the price of goods/services sold, because in order to receive points, the applicant must show a hit to profits. Over a period, the loss of profit is compensated to a certain degree by an increase in the demand for products/services from such High Point Entities. Further, the prices of goods/services of such High Point Entities may even become extremely competitive as, in addition to an increase in demand, they would have additional advantages, such as acquiring raw material/services from other entities at cheaper rates.
It can be expected that if one or two countries implement the PPS, entities may shift their operations to other jurisdictions where they can continue legally profiteering at the expense of society. Thus, for the PPS to be truly effective it needs the mutual consent of all major trading countries. This can be achieved by way of an international agreement executed at an international forum.
Society Before Profit: A Legal Duty
In The Theory of Moral Sentiments, Smith ponders whether to prevent a, “paltry misfortune to himself” a man will be “willing to sacrifice the lives of a hundred millions of his brethren….” He remarks that such a thought is horrifying and this horror is felt not because of humanity or benevolence, but because of reason, principle, and conscience guiding each man. Any man who prefers himself as to cause such harm is abhorred by society.
Thus, it is the responsibility of governments, commerce, and civil society to advocate and implement a system, no matter how difficult it may seem at first, where society is placed ahead of personal gain. Businesses and their directors, officers, and shareholders must be legally obligated to put society’s interest before profits. It should be their legal responsibility to find the ‘right’ balance between their personal interests and the interests of society.