Paradigms for Sustainable Development: Implications of Management Theory

Corporate Social Responsibility and Environmental ManagementCorp. Soc. Responsib. Environ. Mgmt. 19, 1–10 (2012)Published online 14 March 2011 in Wiley Online Library(wileyonlinelibrary.com) DOI: 10.1002/csr.259

Paradigms for Sustainable Development:Implications of Management Theory

Saurav Dutta,1 Raef Lawson2* and David Marcinko31University at Albany, SUNY

2Institute of Management Accountants3Skidmore College

*Corres

Copyrigh

ABSTRACTWe provide a framework for examining the trade‐offs between socio‐environmental,organizational, and managerial goals. Using this framework we examine managementchoices under agency and stewardship theories. We advance a theory of social stewardshipto explain behavior inconsistent with both agency and stewardship. We illustrate that socialstewardship behavior by managers and principals, while best from a societal perspective, isnot a viable management approach under current business and regulatory conditions. Thisconclusion is vital to public policymakers who seek to foster socially desirable behavior bypublicly traded companies. Copyright © 2011 John Wiley & Sons, Ltd and ERP Environment.

Received 27 February 2010; revised 15 June 2010; accepted 21 January 2011

Keywords: agency theory; corporate social responsibility; public policy; stewardship; sustainability

Introduction

ORPORATIONS HAVE INCREASINGLY BECOME CONSCIOUS OF THEIR SOCIAL RESPONSIBILITIES (EPSTEIN, 2008; CALLAN

and Thomas, 2009). This is in stark contrast to the predominant viewpoint of the 1970s and 1980s that
C ‘businesses that have social conscience ….are preaching pure and unadulterated socialism’ (Friedman,1970). This shift in business paradigm has been both chronicled and analyzed. One of the critical
empirical finding is that market forces typically do not penalize companies that are high in corporate socialperformance, making it possible for management to act in a socially responsible manner (Orlitzky et al., 2003).

Organizations that want to ‘go green’ may initially pursue low‐hanging fruit, implementing initiatives thatgenerate financial savings in addition to having positive environmental and social impacts. Benefits may come notonly from increased profitability through reduced direct costs but also through reduction of insurance or expectedliability costs or from benefits generated through improving a company’s image with regulators or consumers (Whiteet al., 1993). Pursuing such initiatives is within the purview of traditional environmental management, which hasbeen defined as the development and implementation of management practices that address environmental goalswhile furthering corporate interests (Levy, 1997; Purser et al., 1995).

While these win‐win situations enhance profitability and simultaneously lead to greater social benefit, they areincreasingly limited. The cost of pursuing environmental initiatives is increasing for two reasons. First, due todiminishing returns, reducing pollution beyond a certain threshold becomes technically more difficult (Hart, 1995;Walley andWhitehead, 1994). Second, while the earlymoversmay capitalize on their image through commoditization

pondence to: Raef Lawson, Institute of Management Accountants, 10 Paragon Drive, Montvale, NJ 07645 USA. E‐mail: [email protected]

t © 2011 John Wiley & Sons, Ltd and ERP Environment

2 R. Lawson

of ‘greenness’, such opportunities are not available for late adopters. In addition, subsequent adoption reduces thevalue of the green veneer for the early adopters, thereby increasing the cost of being green (Levy, 1997).

While some believe that companies should undertake only those green initiatives that produce financial gain andnot for ‘moral’ reasons (Siegel, 2009), others take a dim view of such corporate motivations, labeling these asgreen‐washing; (Stauber and Rampton, 1995). In the ‘real world’, there are corporations whose actions go beyondsolely pursuing wealth maximization. These companies demonstrate a genuine concern for reducing negativeexternalities by pursuing environmental and social initiatives despite their having a negative economic impact. Forexample, Prakash (2000) documents Eli Lilly’s spending of $100million on overhead storage tanks even though itcould have modified underground tanks at a cost of $40million and been in compliance with EPA regulations.Even though such actions are desirable from a societal perspective, the motivation for such actions lies outside therealm of traditional management theories. While there have been recent attempts to address negative externalitiesinto commonly used management tools (Dutta et al., 2010a; 2010b) such approaches have been sparse due to therelative newness of this concept. Furthermore, motivation and ramifications of such actions by management andowners have not been critically analyzed from the perspective of extant management theories.

In this paper we review two prevalent theories ofmanagement behavior: agency and stewardship.We then propose asocial stewardship theory which hypothesizes that managers will pursue sustainable and socially responsible initiativesthat need not lead to financial gain. Firms are classified as to whether managers and owners prefer a relationshipgoverned by agency, stewardship, or social stewardship.Management choices as those relate to social initiatives are thenanalyzed within these classes. We demonstrate that environmental policy choices are predictable when managers andprincipals preferences are congruent. The paper concludes by examining public policy implications.

Theories of Management Behavior

Modern business firms, especially those organized as corporations, are characterized by the separation of ownershipand management functions. Shareholders often have little interest in or knowledge of the operating activities of thecompanies they own. Rather they retain the services of a group of professional managers who are charged with theresponsibility ofmaking decisions that enhance the wealth of the shareholders. This arrangement has been described asthe classic principal–agent relationship. In such circumstances, the managers (agents) may be expected to operate thefirm in their own self‐interest. To the extent that management’s self‐interest diverges from that of the principals(shareholders) there is the potential for conflict between the two parties to the relationship (Jensen andMeckling, 1976).

An explanation of this apparent conflict – agency theory – is prominent in the accounting and finance literature.This literature has been periodically reviewed and assessed (Sundaramurthy and Lewis, 2003; Eisenhardt, 1989;Watts and Zimmerman, 1986; Baiman, 1982). The basic assumption of this theory is that managers act aseconomically rational individuals in that each individual aspires to maximize his own expected utility. Williamson(1985) postulates that a manager’s utility depends on salary, the number of staff personnel who report to themanager, the extent to which the manager is able to make decisions regarding the investment of the firm’s resources,and the perquisites the manager receives that are not strictly necessary to the operating activities of the firm, alsoreferred to as ‘management slack’. Managers attempt to maximize their utility subject to the constraint that the firm’sreported profits are above a minimum threshold enabling the management to retain control of the firm.

Byrd et al. (1998), Eisenhardt (1989), and Watts and Zimmerman (1986) define the moral hazard or effortproblem as the incentive for managers to expend less effort than expected by shareholders. In the presence ofinformation asymmetries, the level of effort expended by a manager can be cloaked from the principals. The typicalremedy for the effort problem is a contract that ties compensation to desirable outcomes rather than effort.

An alternative explanation of managerial motivation is offered by stewardship theory (Davis, et al., 1997;Donaldson and Davis, 1991; Donaldson, 1990). Like agents, stewards enjoy higher monetary rewards and are averseto risk and effort. However, unlike the agent the steward is also driven by a need to achieve, ‘to gain intrinsicsatisfaction through successfully performing inherently challenging work, to exercise responsibility and authority,and to thereby gain recognition from peers and bosses also experiences utility from pro‐organizational collectivisticbehaviors’ (Donaldson and Davis, 1991, p. 51) Agency conflicts are reduced under stewardship theory because the

Copyright © 2011 John Wiley & Sons, Ltd and ERP Environment Corp. Soc. Responsib. Environ. Mgmt. 19, 1–10 (2012)DOI: 10.1002/csr

3Paradigms for Sustainable Development: Implications of Mgmt. Theory

steward attaches positive marginal utility to the pursuit of organizational collective ends. Unlike the agent, thesteward faces a trade‐off between personal needs – shirking and perquisites – and organizational objectives. Utilitymaximization for the steward will require less shirking and reduced consumption of perquisites than an agentunder similar circumstances. ‘Stewards believe that their interests are aligned with that of the corporation and itsowners’ (Davis et al., 1997, p. 25).

Extending to Social Stewardship

As corporations have grown and become globalized, their influence and power have increased. Along with thisincreased influence has come a realization of the need for greater responsibility. Stakeholder theory has evolvedover time to offer new insight into the nature of corporate social responsibility (Jamali, 2008; Jonker and Foster,2002). It has been argued that the needs of shareholders cannot be met without addressing the needs of otherstakeholders including local communities and the environment (Foster and Jonker, 2005; Simmons, 2004). Cragg(2002) concludes that corporations, because of their nature as legal artifacts, are accountable to their shareholdersfor meeting their obligations to multiple constituencies including the courts, governments, and communities.Hence, corporations will increasingly opt to act in a socially responsible fashion and formally adopt mechanisms topromote responsible corporate behavior not only in response to financial and regulatory pressure but also as amatter of informed corporate governance. As these organizations broaden their perspectives, there is a need tobroaden management theories to incorporate such a holistic perspective. In this section we extend stakeholdertheory to include social dimensions. In particular, following Cragg’s (2002) argument, we posit that local and globalcommunities ought to be considered primary stakeholders whose costs and benefits need to be explicitly consideredin making management decisions regarding trade‐off of resources.

Social stewards, both managers and principals, are inclined to not only further their personal interest and that oftheir organizations, but do so while limiting adverse social and environmental impacts. In other words, the socialsteward derives negative utility from social and environmental damages. Hence, social stewards may voluntarilyengage in actions that limit societal and environmental damages without necessarily enhancing the value of theorganization or personally benefitting the manager. Such actions are inconsistent under both agency theory whichis self‐centric, and stewardship theory, which is org‐centric. In the following sections we discuss the motivationsthat would lead managers and principals to adopt this model of behavior.

Motivations for Agents to act as Social Stewards

Much of stewardship theory is rooted in a model of man proposed by Maslow (1970). Consistent with this model,the agent as a steward experiences greater utility from acting in a pro‐organizational manner than in a self‐servingway. Such individuals are functioning at Maslow’s highest level of need – the need for esteem and self‐actualization. Esteem within the larger society in which the organization functions may depend on actions taken forthe benefit of not only the organization’s primary stakeholders but also the entire society and community in whichthe business operates.1 Managers so motivated may actively engage in the reduction of negative externalities causedby the operations of their firm and further the positive externalities caused by its actions. These may include actionsto enhance the quality of life in their communities due to a desire to enhance the esteem in which they are heldwithin that community.

Acting as a social steward may be an effective leadership style in the evolving business environment with itschanging social priorities. Virtue ethics implies that moral managers are those who are perceived to possess traitssuch as honesty, fairness, and benevolence (Moberg, 1997). As society at large assigns greater value and respect to thepursuit of such values and broader objectives, managers may adopt a similar outlook to gain respect and allegiance oftheir subordinates (Backhaus et al., 2002, Turban and Greening, 1997). In these instances, behavior is better

1For example, Abrams (1951), the Chairman of Standard Oil, called for businesses to act as a trustee of social well‐being. Similarly, JosephWharton founded the first business school in the USA and JRD Tata founded the Indian Institution of Sciences (IISc).


4 R. Lawson

understood not within the stewardship model but within a more expansive model of man where utility is experiencedfrom actions that benefit the society in which the organization functions. Blending elements of stewardship with abroader view of social responsibility yields a model of a manager best described as a social steward.

Why an Owner would be a Social Steward

Owners also experience the hierarchy of needs described by Maslow. Their need for income and security will beaddressed at least in part by the financial performance of the organizations in which they invest. That financialperformance hinges in part on an organization’s ability to raise needed capital from investors and creditors. Thegrowth of socially responsible investing will increasingly restrict access to capital to those firms that are able toreport positively on their social performance. Additionally, there are supply chain pressures on firms to seek socialor environmental certification (Cashore, 2002). For example, some banks and insurance companies haveimplemented environmental risk criteria in evaluating corporate and project lending (Labbat and White, 2002).Additionally, there is a positive link between corporate social performance and reputation (Turban and Greening,1997) which can be leveraged as marketing strategy to impact financial performance (Sen and Bhattacharya, 2001).It has been estimated that ExxonMobil’s attitude toward climate change could jeopardize as much as $50 billion ofits market value due to the effect of its poor reputation on staff motivation and political access (Harrington, 2003).

An organization which implements policies that address environmental and societal issues also creates apotential competitive advantage in the market for goods. Apart from benefitting society, implementing suchprograms can reduce the risk exposure of a company in areas such as pollution, the use of child labor, and theharvesting of non‐renewable resources by proactively addressing these concerns (Waddock, 2002). Additionally,being perceived as a socially and environmentally responsible company may reduce the cost of capital because suchfirms have lower business risks (Orlitzky and Benjamin, 2001). This, in turn, will help increase the returnsgenerated by these firms in the long‐run. Thus, owners will choose to behave as social stewards in part becausedoing so satisfies their need for adequate risk‐adjusted returns on invested capital.

Being perceived as a socially responsible and environmentally friendly corporation may also enable firms toattract and secure talent. This would significantly reduce the cost of high turnover and the difficulty in filling vacantpositions. The need for talented and skilled employees is becoming an evermore important characteristic in thegrowing knowledge‐based economy, where attracting and retaining talent is critical to business success. Companygoodwill, image, and reputation go a long way in attracting and retaining talented employees (Backhaus et al., 2002;Greening and Turban, 2000).

Like managers, owners will also respond to higher level needs for esteem and self‐actualization. These needsmay even better explain the impetus for socially responsible investing (Barnett and Salomon, 2003) or ethicalinvesting (Mackenzie and Lewis, 1999). The loss of reputation and goodwill may so damage an owner’s self‐esteemthat they withdraw from the organization. However, owners will often push their organizations, through the Boardof Directors, to engage in socially responsible behavior.

Multiple Criteria Decision‐making under the Alternative Management Theories

In the previous sections we discussed three types of managers: agents, stewards, and social stewards. Thedeterminants of utility of the three types of managers differ. The agent has a self‐centric utility function whichassigns positive utility to monetary payoffs and negative utility to risk and effort and zero utility to organizationaland societal outcomes. The steward’s utility function encompasses that of the agent and assigns positive utility tofavorable organizational outcome. The social steward’s utility function is the broadest in that it assigns utility tosocietal and environmental outcomes in addition to individual and organizational outcomes. In other words, theutility functions of the agent and the steward are special cases of that of the social steward.

We now analyze the implications of the various manager types on social initiatives pursued. Actions oforganizations typically affect three stakeholders: the manager, the organization, and the society/environment. Inthe framework provided in Figure 1 the effects on each of these three stakeholders is presented on one of the axes.


Key A=action taken ~A=action not taken A*= ambiguous situation, requiring analysis of trade-off Blank cell indicates indifference regarding action

+ = positive impact; 0 = no impact; - = negative impact

Manager’s Utility

Soci

etal

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(a) Actions based on Agency Theory

~A

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(b) Actions based on Stewardship Theory

∼A

∼A

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∼A

A*

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(c) Actions based on Social Stewardship Theory

A

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Figure 1. Manager’s choice model


For simplicity, we have limited each dimension to three values: positive (+), neutral (0) and negative (‐). The positiveclassification indicates increased managerial utility, greater organizational value, or superior societal outcome.

There are 27 possible combinations of manager/organizational/societal value outcomes, each denoted in Figure 1by a cell. Possible actions by managers can be assigned to one of these 27 cells based on their effect on the manager,the organization, and on society. The choice of action will vary across the type of manager. These choices areillustrated in the three panels of Figure 1. The reactions are categorized into four choices: action taken (A), action nottaken (~A), ambiguous situations requiring analysis of trade‐off (A*), and indifference (denoted by blank cells).

For example, Panel (a) of Figure 1 shows that an agent, who conforms to the assumptions of agency theory,would take action on all the cells that increase a manager’s utility. This includes all of the cells denoting the positiveattribute on the right‐hand side of the panel. Similarly, the agent would not take action (denoted as ~A) for all thecells in the leftmost column of all the planes as they indicate a negative impact on the manager’s utility. Finally, theagent will be indifferent to actions denoted by the center column in each plane as those cells do not affect themanager’s utility. The choice of action or inaction by the agent is independent of the effect on the society or theorganization.

Panel (b) of Figure 1 shows the decision‐making of a steward. The steward will take action in situations whichincrease either the manager’s utility or the organizational utility while leaving the other unaffected. However, thechoice is ambiguous (A*) in the cells where the manager’s utility is increased and the organization’s utility isreduced, or vice versa. Under such conditions, the steward would have to further assess the trade‐offs for thatparticular situation. As can be seen by comparing Panels (a) and (b), while the agent displayed no ambiguity in anyof the cells the steward displays ambiguity in six of the 27 cells. Similarly, Panel (c) of Figure 1, shows that a socialsteward experiences ambiguity (A*) in 12 of the 27 cells.

Manager type does not affect action in only 9 of the 27 cells. Action is unanimously taken in the four cells wherethe manager’s utility is increased without adversely affecting either organizational utility or the societal outcome.Action is unanimously not taken in the four cells where the manager’s utility is reduced and neither theorganization’s value nor the societal outcome is benefitted, and one cell is indifferent across all manager types.


6 R. Lawson

Hence, in 18 of the 27 cells the decision outcome would depend on the type of manager. In the next section we willanalyze the principal’s role and its effect on managerial action.

Exploring Conflicts in Various Frameworks

Compatibility between principal and manager type is important in order to reduce conflict and to minimize agencycosts. As illustrated earlier, the decisions made and actions taken by a firm will be influenced by a manager’s style(agent, steward, or social steward). The principal, however, determines the type of relationship in which he or shewishes to engage the manager. The principal could engage in an agency relationship by instituting controls andrestricting a manager’s choice. The principal could engage in a steward relationship and impose less restriction on amanager’s actions while expecting those actions to be in the best interest of the organization. Finally, the principalcould engage in a social steward relationship, allowing a manager to make decisions that are in the best interests ofthe organization and also of the broader society. The interaction between manager type and the relationship inwhich the principal wishes to engage can lead to harmony or to conflict. In the following paragraphs we explorebehavioral implications of these relationships using the framework in Figure 2.

The three rows in Figure 2 describe the manager’s approach to the relationship with the principal (owner) and thethree columns depict the principal’s approach. The relationships between principal and manager can be classified inthe nine cells depicted in the figure. In six of the nine cells the manager and owners choose different approachesresulting in conflict that leads the firm into disequilibrium.2 In the short run, policy choices will leave one partydissatisfied, resulting in eventual replacement of owners ormanagers. In the remaining three cells, along the diagonal,manager and principal choose similar approaches to the relationship resulting in equilibrium. In the following, weanalyze the resulting interaction between manager and principal and its implications for environmental initiatives.

Mutual Agency Relationship

A mutual agency relationship between principal and agent is depicted in Cell A of Figure 2. In such a relationship,both the manager’s utility and the owner’s utility are derived from self‐centric economic variables of risk, reward,and effort. Further, as both parties anticipate each other’s choices they strategize appropriately. Thus, while themanager attempts to minimize risk and effort; the principals anticipating such behavior institute controls that betteralign the manager’s interests with their own. In an effort to control management’s opportunistic behavior, theprincipals continue to invest in controls and contracting, so called agency costs, until the marginal costs outweighthe marginal losses due to management’s excesses. The principals eventually reach a position where agency costs areminimized. At this point, managers are effectively constrained from further opportunistic behavior because, giventhe control system, it is no longer in their self‐interests. The organization thus reaches a position of equilibrium.

In this situation, environmental initiatives will be viewed symmetrically by both parties. For example, considerthe case of a manufacturing company which is determining the extent to which it should treat the pollutingeffluents that result from its production processes. Spending on remediation efforts will be undertaken if and onlyif it improves the return to both managers and principals, i.e. if it increases the profitability of the firm. This is thecase of the ‘low‐hanging fruit’. The principal benefits from an improved return on invested capital andmanagement benefits through higher compensation tied to the financial performance of the firm. However, ifenvironmental costs are external, there is no perceived benefit of remediation to either principal or manager; henceremediation initiatives will not be undertaken.

In such situations not only is there an internal equilibrium but such a firm performs well in the current businessenvironment. Managers of such firms obtain positive utility only through individual characteristics, such asmonetary compensation and risk and effort aversion. Owners tie the manager’s compensation and risk to the firm’s

2In practice, social steward owners may incentivize agent managers by including social and environmental goals into the compensation contract.Since 2008, as disclosed in its Proxy statement, Intel computes annual bonus for its employees based on measures such as carbon footprint,product energy efficiency, reputation for environmental leadership, etc. (http://blogs.hbr.org/cs/2010/04/compensation_and_sustainabilit.html).


Principal’s Choice

Agent Steward Social Steward

Agent (A)

Minimize Potential Costs

Mutual Agency Relationship

(D) Agent Acts

Opportunistically;Principal is

Angry/ Betrayed

(G) Principal is Frustrated/ Betrayed

Steward(B)

Principal Acts Opportunistically;

Manager is Frustrated/ Betrayed

(E) Mutual

Stewardship Relationship

(H) Possible Principal

Frustration/ Betrayal

Manager’s Choice

Social Steward

(C) Selectively

choose initiatives whose costs are

borne exclusively by mgrs.

Mgr. increasingly frustrated

(F) Monitor Possible Manager

Frustration/ Betrayal

(I) Mutual Social

Stewardship Relationship

Figure 2. Principal‐manager choice modelAdapted from Davis et al. (1997), p. 39


profitability through extensive contracting. Thus tied in to overall organizational goals, the manager pursuesavenues to maximize the firm’s profitability without consideration of social and environmental initiatives notexplicitly contracted. A firm managed thus would be highly profitable and extremely competitive. However, withincreasing regulation and social awareness, such a strategy may no longer be optimal.

Mutual Steward Relationship

When both the principal and the manager choose to behave as stewards and trust each other to fulfill the stewardobligation, the situation results in a harmonious relationship that is beneficial to the organization. The managergains additional utility from co‐operative behavior that advances the goals and objectives of the organization.Recognizing the manager’s preference for actions that benefit the organization, the principal acts to create asituation that empowers management. When both the manager and owner act as stewards, there is a compatibleand trusting relationship. Firms in which this situation exists are more efficient as contracting and monitoringcosts are reduced. Those cost savings can be equitably shared between the manager and the owner, enhancing theutility of both parties. Additionally, each party obtains positive utility from mutual co‐operation and fulfillment oftheir respective social needs. Risk avoidance and a‐priori mutual distrust may prevent the parties from reaching thissituation. If attained, however, there is no reason for the organization to depart from this position.

The environmental and social outcome for stewards will differ from those of agents in situations where themanager’s compensation contracts do not capture all drivers of firm value. However, a steward would engage indecision‐making that is compatible with increasing the long‐term value of the firm. A steward would exert effortand invest in activities that he or she believes are in the long‐term interests of the firm, even if those actions orconsequences are stipulated in the contract. Hence, the steward will voluntarily partake in social initiativesconducive to the long‐term interests of the firm.

Mutual Social Steward Relationship

With both the principal and manager being social steward (cell I in Figure 2) there is little conflict between the two.Since both the manager and the owner are social stewards they operate in harmony and monitoring costs are


8 R. Lawson

significantly reduced. The manager engages in decision‐making which balances the profits of the firm with thewell‐being of the society. As the principal has a similar philosophy, he or she does object to such resource allocationdecisions made by the manager. As a result, the manager feels empowered, obtains positive utility from thisrelationship, and is content.

However, since both owner and manager are similarly inclined, the check and balance mechanism oninvestments in social projects may be lacking. It is possible for such a firm to over‐invest in social projects at a costof lower profitability which in turn may lead to lower returns for the principal and lower compensation for themanagers. A publicly traded firm acting in such a manner would either fail or be taken over by another firm whichcould then discontinue the costly social projects in order to increase profitability.

Public Policy Implications

Increasing social awareness may mitigate the eventuality outlined above but protection through regulation may alsobe necessary. As more and more principals increasingly value socially responsible behavior, they will invest incompanies that share those values and divest from others. Once that occurs, the market value of companies wouldhave a higher correlation with their social behavior. Currently, however, empirical evidence only suggests thatfinancial markets do not penalize companies for their social investments (Orlitzky et al., 2003), in part becausethese firms tend to also have better financial performance (Callan and Thomas, 2009). Investment strategiescurrently exist which are used to eliminate firms that engage in irresponsible behavior (such as tobacco companies,firearm producers, etc.) from investment portfolios (Mackenzie and Lewis, 1999). Such investment strategies donot marginally reward companies engaging in initiatives that go beyond the minimum. Consequently, companieswhen adopting environmental policies are more influenced by ‘obligatory regulations’ coming from institutionalforces than by ‘voluntary regulations’ (Kusku, 2007). In the current and foreseeable business environment,increased social awareness of principals motivates corporations to meet minimum regulatory requirements.However, investment beyond the minimum is perhaps driven by ulterior strategic motivations (Siegel, 2009).

Consequently, there is a need for regulatory protection of social stewards to be able to engage in a sociallyresponsible manner without suffering adverse ramifications. Such regulation could be designed in the form ofpenalties or rewards or a combination of both. Regulations could increase penalties through stricter enforcement,higher fines, or increased taxes for polluters and companies that over‐utilize natural resources without a plan forreplenishment. These types of regulatory actions would be most appropriate if the culture of the firm is characterizedbymutual agency andmutual stewardship. This is because the nature of the compensation contract within such firmswould provide an incentive for managers to internalize social costs and adjust their behavior accordingly.

Additionally, regulation could prevent turning back environmental initiatives undertaken by a company when anew management team takes over its operations to protect continuation of social initiatives instituted by socialstewards.

Conclusion

This paper has focused on the behavior of managers and principals interacting within the firm to help explain howfirms might respond differently to the same external stimuli. Principals and managers have been viewed aspossessing a preference for the nature of their relationship. Each party may wish the relationship to be governed byagency, stewardship, or social stewardship. When owner and manager preferences are congruent, an equilibriumexits and choices regarding environmental policies are unambiguous and predictable.

When both actors prefer the agency relationship, any policy that meets established profitability criteria will beacted on, as will any policy mandated by law that imposes high costs for non‐compliance because all such actionshave positive marginal utility for both the manager and the organization. Policies that go beyond compliance andare unprofitable will be unambiguously rejected because they reduce the utility of both the manager and the



organization, despite the fact that they may have positive marginal utility from the point of view of society. Whenstewardship is preferred by both managers and owners some policies that would be rejected under agency becomeambiguous and require that the manager trade‐off gains in organizational utility against reductions in personalutility while in other instances owners are required to assess similar trade‐offs. Finally, when both parties opt forsocial stewardship, actions that go beyond compliance and are also unprofitable may be undertaken if their positivemarginal social utility is sufficiently large.

This perspective of the behavior of the firm has relevance for public policy. The outcome of a policy prescriptionfor environmental externalities will vary across firms, even those in the same industry. The policy‐maker must takethe predominant culture of firms into account in order to understand the response to policy alternatives. Firms with adominant agency culture will respond to policies that impact earnings, shareholder value, and therefore managementcompensation. Such policies might include regulations with high penalties and strict enforcement action. If, instead,the firms are predominantly stewards, significant penalties may not be necessary provided that there is strictenforcement and mandated disclosure of failures, with consequent adverse reputational effects. Finally, if firms arepredominantly social stewards, punitive regulatory measures and costly enforcement may not be necessary. Instead,efforts can be better expended in educating managers on social and environmental ramifications of their actions.

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Paradigms for Sustainable Development: Implications of Management Theory