Sustainable Corporate Finance

Author(s): Aloy Soppe

Source: Journal of Business Ethics, Vol. 53, No. 1/2, Building Ethical Institutions for
Business: Sixteenth Annual Conference of the European Business Ethics Network (EBEN)
(Aug., 2004), pp. 213-224
Published by: Springer
Stable URL: http://www.jstor.org/stable/25123294 .
Accessed: 23/05/2011 11:39

Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at .
http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless
you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you
may use content in the JSTOR archive only for your personal, non-commercial use.

Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at .
http://www.jstor.org/action/showPublisher?publisherCode=springer. .

Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed
page of such transmission.

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of
content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms
of scholarship. For more information about JSTOR, please contact support@jstor.org.

Springer is collaborating with JSTOR to digitize, preserve and extend access to Journal of Business Ethics.

http://www.jstor.org
Sustainable Corporate Finance Aloy Soppe

ABSTRACT. This paper presents and illustrates the

interpretation during United Nations conferences
of sustainable finance. is a in the 1970s and 1980s. This
concept corporate Sustainability paper treats sustainable
well-established in the of environ as a multi-attribute
concept disciplines corporate finance
(SCF) ap
mental economics and business ethics. The paper uses a
proach in which financial, social and environmental
broader definition of what is called "the firm" to
pinpoint elements are interrelated and
to the finance literature. The of
integrated. The key
sustainability concept
concept of sustainability is that an explicit connec
sustainable finance is to traditional and
compared
tion should be made between present and future
behavioral finance. Four criteria are used to
systematically
First on is generations. Because of its discounting capacity, the
analyze the basic differences. the order the
of the firm: the definition of the firm is recon character of finance is specifically suited to store
theory
sidered behavioral and present and future developments. A major problem,
by integrating aspects by expand
ing financial analysis
to a three-dimensional
goal setting. however, is the relevance of the assumptions on the
a closer look is taken at the assumed behavior behavior of economic Whereas mar
Secondly, agents. capital
of economic agents and its consequences for the applied ket theories can be analyzed as positive theories
The shareholders is discussed based on rational human financial
methodology. paradigm strictly behavior,
against the background of growing stakeholder impor cannot
management be value-free because of the
tance. the fourth criterion deals with the different
Finally, of the choices of economic
consequences agents.
ethical framework and its for financial
implication This discusses the new concept of
paper extensively
behavior.
sustainable corporate finance, benchmarked to the
existing concepts of traditional finance and behav
KEY WORDS: sustainable corporate finance, of
theory
ioral finance.
the firm, the ownership paradigm, virtue ethics
Sustainability is a well-established concept in the
discipline of environmental economics. This papers
Introduction contribution is to pinpoint sustainability to the fi
nance and business ethics literature. By comparing
the of sustainable finance to tra
Sustainability as a phenomenon is rapidly entering
concept corporate

the economic and the financial literature.

ditional finance, we
and behavioral systematically
Initially,
the concept was launched in the environmental analyze basic differences by means of four criteria. A
major goal of this paper is to reconsider the under
lying assumptions of financial theory against the
Aloy Soppe has MS degree in General Economics from the background of sustainability. The paper concludes
University ofGroningen. Since 1981 he has beenworking at that finance as a discipline requires a multifaceted
the Department of Finance and Investments of Erasmus approach instead of the present one-dimensional risk
University inRotterdam. In 2000 he joined theLaw Faculty and return focus.
as an
of Erasmus University assistant professor to teach
The second section deals with the relevance of
Financial Ethics at the Department of Fiscal Law. His
sustainability in financial theory. Next, the applied
publications include: "Capital interest and ethics: some a
methodology is introduced by short overview of
an ethical to economic
empirical explorations of approach
the distinguished theoretical schools in financial
growth" RIBES Report No. 9824, Erasmus University
"Finance and Ethics" Erasmus Uni theory. Four are criteria
then presented in order to
Rotterdam, 1998,
2000 and "Is ethics at the describe the concept of sustainable corporate fi
versity Rotterdam, prices
Amsterdam Stock Economische Statistische nance. All of these elements are discussed subse
Exchange?"
Berichten, nr. 4280, November 2000. quently in separate sections. The third section deals

^*
Journal of Business Ethics 53: 213-224, 2004.
r* ? 2004 Kluwer Academic Publishers. Printed in theNetherlands.
 214 Aloy Soppe

with the theoretical background of the firm, and understandable that in the recession of a competitive
stresses the normative character of (sustainable) fi economy accounting rules are
easily stretched in

nance as a discipline. The fourth section briefly order to gain time for future policy measures,
accentuates the difference between selfish and co financial short-termism will be proven unsustainable
operative behavior of our virtual economic agents. sooner or later. In the long run, sound accounting
The fifth section explores the question of who is the discipline and full disclosure of relevant information
optimal residual risk taker in the company, and the of the company are basic requirements of the real
sixth section emphasizes the ethical framework of economic process.
the three distinguished perspectives. The seventh In order to typify the new sustainable finance
section concludes with comments on the the four criteria, and bench
approach concept, paper applies
of sustainable corporate finance as a discipline. marks these to a traditional and behavioral
approach
of finance. First, we refer to the "theory of the firm"
in order to define the identity and the goal(s) of a
Sustainable corporate finance, its criteria and company (criterion 1). Then, we take a closer look
the methodology applied at the assumed human nature of economic actors

(criterion 2), which has consequences for the own

The half of the 20th century can be char
second ership paradigm and the methodological approach of
acterized by and large as a period of strong economic finance as a discipline (criterion 3). Finally, we
growth. After a recession in the mid-1970s and a analyze the ethical framework to exemplify the re
(relatively small) stock market crash in 1987, a strong newed points of departure from a business ethical
bull market followed until March 2000. With the perspective (criterion 4). Table I summarizes the
collapse of the Internet hype in the subsequent criteria.

period,
we entered a serious bear market (or
a time The following sections (third to sixth) extensively
spread stock market crash )with numerous reported discuss each of the criteria and benchmark the SCF
(more or less serious) fraud cases. Under such cir concept against the background of two distinguished
cumstances, it is hardly unexpected that concepts general schools in finance: traditional finance and
such as sustainability, social responsibility and busi behavioral finance. Before proceeding, we will
ness ethics have drawn much attention. elaborate a little on
these schools by recalling the
The foundations of all of these concepts, how highlights in their developments.
ever, were laid already long before fraud the major In the first part of the 20th century, the school of
cases erupted. The best-known definition of traditional finance utilized primarily a descriptive
general
sustainable growth, for example, is the one given by methodology. This period was characterized by a
the World Commission on Environment and strong emphasis
on
accounting information. Ratio

(WCED) in Our Common Future analysis became well established as the theoretical
Development
(1987): "Sustainable development is a development background
for securities analysis. Important repre
that meets the needs of the present without com of that period are Berle and Means
sentatives (1932),
promising the ability of future generations to meet and the "Investment Bibles" of Graham and Dodd
their own needs". (1934, and many updated editions later on, e.g. 1940,
Applying this sustainability concept to finance as a 1951). In the second part of the century, financial
discipline, we may note two aspects that emphasize
the relevance of this study. First, there is the storage
TABLE I
function of money and capital, which implies that The criteria sustainable finance
describing corporate
finance is very well suited to realize (or not to
realize) "future generations" needs'. Pension fund The criteria are:
distinguished
policy is amajor example of this aspect. Secondly, if
are to (1) Theory of the firm/goal variables
financial processes assumed reflect underlying
nature economic actors
(2) Human of
real economic processes, rather than a goal in itself, it
to stress a financial aimed at (3) Ownership paradigm
is important policy
run. Although (4) Ethical framework
integrity and trust in the longer it is
 Sustainable Corporate Finance 215

theory began to lean heavily on neoclassical eco are older itself as a discipline. Vromen
than finance
nomic theory. In that period, financial theory (1994) speaks of an "old" and a "new" theory ofthe
evolved rapidly by means of positive mean-variance firm. The debate on the "old theory of the firm"
equilibrium models such as the Capital Asset Pricing takes place at a higher aggregated level (industry),
Model (CAPM) ofMarkowitz (1990),Lintner (1965) and deals with the selection arguments ofthe neo
and Sharpe (1964), and the Arbitrage Pricing Theory classical "marginalism controversy". The "new"

(APT) of Ross (1976). The inherent risk/return theory of the firm breaks open the black box char
paradigm dominated financial theory for many dec acter ofthe firm and deals with contractual behavior,
ades. Using the efficient market hypothesis (EMH) of property rights and agency costs of the individual
Fama (1970), agency theory (Jensen and Meckling, participants.6 Especially the latter debate is relevant
1976) and the option pricing model (OPM) of Black for the financing decisions in the firm.
and Scholes (1973), traditional finance built a strong Boatright (1999, pp. 170-172) distinguishes be
theoretical foundation to explain the dominance of tween three different theories ofthe firm. First is the

capital markets in the economy of the last quarter of property rights model, where the owner of the firm is
the former century. From this financial perspective, the stockholder who chooses to do business in
the company is a technocratic entity where cash flows corporate form. In this
"right to
situation, the
are maximized and economic agents act from a
incorporate" is purely
private and, therefore, there is
strictly rational and selfish perspective. The value of no incentive or necessity to fulfil any social purpose
the firm and its capital structure became explicitly (see Friedman, 1970). The second theory ofthe firm
dependent on the market mechanism and the func is the social institution theory, which holds that the
tioning of the capital markets. "right to incorporate" is a privilege granted by the
The second approach we distinguish is a more state, and has, therefore, inherently a public aspect.
institutional approach of financial markets that is Thirdly, there is the modern midway between the
called behavioral finance. This school emerged in a former two:
contractual rights theory, in which the
rather dispersed manner in the economic literature, private corporation is sanctioned by the state to serve
and started approximately in the mid-1970s. Inspired the general welfare. This approach is derived from
by concepts such as information asymmetry (Akerlof, transaction cost economics (see e.g. Coase, 1937;

1970) and bounded rationality (Simon, 1955), the Williamson, 1975, 1979) and has been extended in a
persistent deviations from equilibrium models (called way such that organizational hierarchies are inter
anomalies) became institutionalized.
Encouraged by nalized in the
economic process together with
a growing tested anomalies, costs use
body of
empirically external (social) by of implicit contracts (see
game theoretic approaches gained popularity in e.g. Cornell and Shapiro, 1987; Donaldson and
financial research. At the same time, adjacent Dunfee, 1999, 2002; Kaptein andWempe, 2002, pp.
disciplines such as psychology, sociology and busi 208-217). Boatright (1999) states that in contrast to
ness ethics started developing alternatives for the the property the contractual
rights theory, rights
strict assumptions of the neoclassical equilibrium theory does not hold that the firm is the private
models. property ofthe shareholders: "Rather, shareholders,
In order to distinguish sustainable corporate fi along with other investors, employees, and the like,
nance (SCF) from the aforementioned traditional each own assets that they make available to the firm.
and behavioral finance, we will discuss this new Thus, the firm results from the property rights and
concept by applying the four criteria of Table I in the right of contract of every corporate constituency
the third section through sixth section. The seventh and not from the shareholder alone1'7 (Boatright, 1999,
section concludes. p. 171).
The central question at hand is the normative
choice on
the preferred theory of the firm. The
Theory of the firm traditional finance approach is based on the private
property theory of finance in which the company
The questions surrounding the genesis and the the maximizes the shareholders' value without giving
oretical evolution of the economic entity called firm consideration to social and environmental aspects.
 216 Aloy Soppe

The primary goal is to optimize the expected return transferring information among agents, (c) agency
in relation to the lowest risk. Attaining social goals costs and (d) organizational rules of the game. The
should be the research topic of politicians, as they are second, third and fourth major areas concern,
the specialists in that field, but is not an objective for respectively, the residual claims, the compensation of
economists (see Friedman, 1970; Jensen and its participants, and the divisional performance
Meckling, 1976). Because financial contracts concern measurement and total quality management. This
only the consequences of the contracting economic broadened the theory of the firm from a one
agents, the impact of these contracts on third parties dimensional transaction costs approach to a complex
(e.g. employees, environment) or on the welfare of and multidisciplinary theory.
the total society is considered to be the subject of The sustainable finance
also emphasizesconcept
analysis of other disciplines. The resulting cash flow the importance of behavioral premises ofthe modern
approach in finance just emphasizes that there "is no economic agents, but explicitly extends the goals of
such thing as a free lunch". By accepting the efficient the company. Using transaction costs as a
guiding
market hypothesis (EMH), traditional finance creates mechanism, the concept chooses three goals of the
the illusion that markets are pricing the financial as company. Next to the necessary risk/return objec
sets properly and completely. In other words, tive, a company in its financing should also
policy
financial theory has no room for gifts, unselfish consider future environmental and or social claims to
behavior, irrational behavior or external effects for be the core company activity. There are two reasons

parties other than the

contracting
ones.
Only
con for this normative choice; one is that reducing a
tracts that are priced in markets or which can company to a cash-flow
generator is not in accor

potentially be priced by replicating (synthetically) dance to the moral

responsibility of the company in
assets are
topics of research. Therefore, the restric the civil society. For example, Kaptein and Wempe
tions of the traditional finance literature arise from its (2002) make a strong case for moral responsibility at
definition and its assumptions alike. As long as the both the individual and the company level. We will
goal of the company is reduced to a mechanical postpone the discussion of this argument to the sixth
maximization of the cash-flow generating process, section,but accept it at this stage as amotivation for a
traditional finance theory is too narrow to answer the paradigm shift. The second reason for the normative
major financial management questions. choice involves a long-term historical observation.
Also behavioral finance emphasizes expected risk Consider the traditional economic production
and return. The major difference, though, is in the function in which wealth is a function of Nature,
assumptions regarding human behavior and the Capital and Labor. Note that labor was the key value
(non) acceptance of the efficient market hypothesis. driver in the second half of the 19th century and the
The overreaction hypothesis of De Bondt and first half of the 20th. Capital showed itself to be a
Thaler (1985) was the first major attack on the dominant value driver in the last decades of the 20th
previously generally accepted idea that markets were century. Considering the environmental and moral
information efficient. Their research preceded a rich problems ofthe last decade, itmay be time for nature
and ongoing literature on the "anomalies" in fi to be the dominant value driver of the near future.
nance. Haugen's New Finance' (1995) more or less Nature is represented in this perspective not only by
established this "new paradigm" that markets are not the physical quality ofthe environment, but also by
informationally efficient, as was the generally be the mental and moral environment ofthe economic
lieved until that time. This micro-economic impulse agents. In other words, if the existence ofthe firm is a
to beat the market undermined the "black box" a
result of multidisciplinary process (as suggested by
character of the traditional firmconcept, and behaviorialists), then the goals of that very firm
strengthened the theoretical building blocks for a should also be multidisciplinary. A sustainable
new and much broader
and multidisciplinary theory financial policy can therefore be defined as a policy
of the firm. Jensen and Meckling (1994) distin optimizing a three-dimensional goal variable. The
guished four interrelated areas. The first area in sustainable expected return (or capital cost) is then a
cludes fundamental building blocks: (a) the nature of result of optimizing long-term financial, social and
human beings and their behavior, (b) the cost of environmental variables.
 Sustainable Corporate Finance 217

Human nature of economic actors Oeconomicus" to become a and

caring evaluating
individual, and a resourceful maximizer with
In the traditional finance discipline, where eco unlimited wants (the so-called REMM model). It is
nomics is defined as a strict allocation problem, the important to notice, however, that behavioral
behavior of economic actors is assumed to be selfish models recognize the opportunistic and bounded
and purely rational. Human behavior itself is not an rationality elements of behavior, but do not accredit
element of economic research, but is displaced to any morality aspects to their economic agents.

adjacent disciplines such as psychology and sociol The sustainable finance concept embraces the
ogy. The problem, however, is that the behavior and behavioral developments, but expands the economic
character of economic actors is an essential input agent to a moral human being, as advocated in the
variable for financial modeling. The traditional business ethics literature. This implies that the
financial models are based on the "rational expec identity ofthe company cannot be reduced to a one
tations" concept and the "Homo Oeconomicus" dimensional financial and cash-generating institute,
perspective of human behavior. In financial theory, but needs to be extended to a multidimensional
this resulted in concave utility functions, where perspective. Zsolnai (2002a) extensively evaluated
expected utility was driven by expected return the ethical and behavioral literature and arrived at an

(2?[f*/]) and its expected risk (_?[an-]). The rational economic is a "calculating person whose
agent who
expectations hypothesis already produced a great behavior is determined
by the moral character ofthe
deal of criticism for the U.S. macroeconomic policy agent and the relative cost of ethical behavior" (pp.
in the 1970th 1983, Ch. 6). The tra
(see Sheffrin, 52?53). "Moral economic man" is assumed to be at
ditional asset pricing models, based on the strictly the foundation of the sustainable corporate finance
rational and atomistic behavior of the "Homo concept. This individual that acts rationally, but aims
Oeconomicus", resulted in many anomalies in the at cooperation and trust because of the higher ex
subsequent years and are basically the pioneers of pected utility in terms ofthe multi-dimensional goal
what we call behavioral finance. function of the company. Table II summarizes the
The behavioral finance models recognized the different perspectives until now.
behavior of economic agents as the most vulnerable
feature and developed many alternative, often game
theoretic, models. Thaler (1991, Ch. 7-9), in The ownership paradigm
cooperation with Kahneman and Knetch, developed
quasi-rational economics by introducing the psy Shareholders differ from other constituencies of the
chology of choice to refine the behavioral assump firm primarily by virtue of being residual risk-bearers
tions of traditional finance. Also Tvede (1990) and and therefore residual claimholders. The crux ofthe
Sheffrin (2000) developed strong evidence against shareholders' wealth paradigm is that shareholders
the traditional "Homo Oeconomicus" approach. are considered optimally suited to maximize the
After their path-breaking 1976 article on agency wealth of society
through their natural ability to
cost, also Jensen and Meckling (1994) acknowledged discipline management. In this major model, which
the shortcomings of the traditional finance concept is the foundation of Anglo-Saxon finance literature,
of human behavior and allowed the "Homo corporate direct investment decisions are separated

TABLE II
Key elements of sustainable corporate finance

Traditional Behavioral Sustainable

Criteria

"Theory of the firm"; the Black Box Hierarchic set of rules Multi-attribute optimiser
company as: (Profit, People and Planet)
Human nature actors Selfish Selfish and/or cooperative Cooperative/trust
 218 Aloy Soppe

from the individual stockholders' preferences for will be the monitor of the members of the team".
consumption. paves This the way for the establish And: "to discipline team members and reduce
ment of the separation of ownership and manage shirking, the residual claimant must have power to
ment in the larger firms (Berle and Means, 1932). So revise the contract terms and incentives of individual
we see that shareholders own the corporation and members having to terminate
without or alter every
demand that managers maximize their wealth by other input's contract" (Alchian and Demsetz, 1972,
investing in all possible positive net present value p. 84). The necessary monitoring of the individual
(NPV) projects. Agency theory, however, assumes inputs, therefore, should be the task of the residual
that managers act in their own interest, and describes risk-bearer because they alone have an additional
this process. It is thereforenecessary that monitoring motive not to shirk themselves.
and bonding costs be effectuated in markets to dis Ifwe accept analysis, we then raise the
the former

cipline the manager. Because every executive is as central question of this section: who is the optimal
sumed to be selfish, the incentive for managers to act residual claimant from an economic perspective?
according to the shareholders' interest is subse There is no a priori reason to assume that the "spe
quently based on the bonding and monitoring abil cialist" in the Alchian
and Demsetz analysis must be
ities ofthe shareholder. the stockholder. In the property rights model, as dis
The problem, however, is that this does not tinguished in the third section on the theory of the
automatically answer the question of who should firm, itwas simply a choice based on property rights.
own the residual risk. Boatright (1999) makes a case The question at hand, though, is whether the
against the shareholderunique as
company the stockholder is "optimally suited" to discipline all the
owner and residual risk-taker. He argues that the claimants of the firm, including the employees. Or,
shareholder can easily diversify his portfolio of stocks in terms of Alchian and Demsetz, are the stock
to eliminate idiosyncratic downside risk. The highly holders the specialists to hold that residual claim in
skilled employee, on the other hand, who develops the most economical way?
valuable firm-specific human capital, may possibly In the sustainable finance concept, the answer is a

assume considerably more residual risk. The labor clear no. First, there is the limited downside
market is far less efficient and flexible
compared to (financial) risk, as argued by Boatright in the second
the financial markets. Moreover, the interest of the paragraph of this section. But, far more important,
environment must also be considered to be a however, is the fact that ever since the separation of
stakeholder. As long as relevant NGOs are not in the management and ownership became widely ac

position to act efficiently on behalf of the environ cepted in the modern economy, stockholders are no
ment, the production factor nature has only the longer "specialists" in gathering information
government as its representative. regarding shirking behavior in the company. Man
In the discipline of behavioral finance, the ques agement is far better positioned, but so do employ
tion of who owns the company is not relevant. As a ees, suppliers, customers, financial analysts
etc. But

game theoretic extension of traditional finance, who the management?

monitors One good candi

focusing primarily on human behavior and market date would be the shareholders, but they are far too
the shareholder is generally accepted as dependent on the efficiency of information flows,
efficiency,
the ultimate owner of the company. Nevertheless, that are provided by all the different stakeholders,
we think that the ownership question may be the each with their own utility functions. So it must be

key to optimal human behavior. Alchian and concluded that the shareholder, although residual
Demsetz (1972) specify the classical firm as a pri claimant because of legal ownership, is not the most

vately owned internal market competing for infor efficient economic monitor of the economic pro
mational advantages of specialists based on team duction process that is called "the firm". If we

production processes. In their analysis it is essential integrate this into the three-dimensional goal func
to appoint one claimant that is optimally efficient in tion of the company (as set in the third section), the
realizing a reduction of shirking (which is assumed to inclusion of moral aspects in the behavioral approach
occur if two or more people cooperate). We quote: (as set in the fourth section), we propose a multi
"the "specialist" who receives the residual rewards stakeholder residual risk-bearer in the sustainable
 Sustainable Corporate Finance 219

argue that if the residual risk is individual economic in relation to the defi
finance approach. We agents
allocated among different stakeholders, then also the nition of the firm.
financial interest will be allocated among those Kaptein and Wempe (2002) observe that an

parties to a similar extent. This responsibility and important problem inherent to

applying general
potential financial gain aligns up the interests of the ethical concepts and theories to corporations is the
stakeholders. The agency costs will therefore de individualistic (atomistic) nature of the dominant
crease. On hand, the monitoring
the other respon theories (p. 106). Since the 17th and 18th centuries,

sibility in this approach

is decentralized and may moral judgments have focused on (actions) of natural
therefore lose efficiency and create some new agency persons, who have consciences and act
voluntarily.
costs. The cooperative human nature should lead to This they call an "atomistic orientation"
is what in
a positive balance in the former trade-off. Table III ethics, and it cannot be directly applied to corpo
summarizes the sustainable finance concept
as dis rations. Kaptein and Wempe distinguish three
cussed until now. positions on the question of the localization of the
moral responsibility of corporate activities. First is
the amoral model, which does not acknowledge cor
The ethical framework of sustainable porate moral responsibility at all. Secondly, there is

corporate finance the functional model of corporate responsibility, which

acknowledges that the organized character of actions
The necessity of introducing an ethical framework within the organizational context results in respon
into sustainable corporate finance can be explained sibility, but reduces it to the individual responsibility

by the character of finance as a discipline. If of company representatives. Finally there is the

economics is defined as the allocation process of autonomy model, which portrays the corporation as a
real goods and income, then financial transactions social entity with a corporate responsibility separate
are by definition intermediate, because they are from the individuals that represent the company
not an end in themselves in the real economic (Kaptein and Wempe, 2002, p. 110). After an

process. Money are primarily

and finance instru extensive review of the literature on these company
mental in reaching the end of the optimal allocation responsibilities, Kaptein and Wempe conclude that
of physical goods. Under this definition, the mon both the amoral rely on a
and the functional models
etary system should be neutral in the economic form of ontological individualism. In these models,

growth process. If so, the technical equihbrium the company does not exist and can therefore not

approach of the traditional finance methodology is act. The corporation is nothing more than the sum
clearly justified. Empirical research, on the other of a number of individuals. Kaptein and Wempe
hand, reveals substantial evidence to refute the state that ontological individualism is more radical
claim. At this point we will not refer to the sub than methodological individualism, which recog
stantial macro and monetary literature,1 but will nizes the existence of social reality, although
restrict ourselves to the moral character of the understood as an expression of individual actions.

TABLE III
The key elements of sustainable corporate finance

Traditional Behavioral Sustainable

Criteria
ofthe firm"; Black Box Hierarchic set of rules Multi-attribute
"Theory optimiser
the company as: and
(Profit, People Planet)
Human nature actors Selfish Selfish and/or Cooperative/trust
cooperative

Ownership paradigm Shareholders Shareholders "Portfolio" of stakeholders

 220 Aloy Soppe

TABLE IV
The key elements of sustainable corporate finance

Traditional Behavioral Sustainable

Criteria
ofthe firm"; Black Box Hierarchic set of rules Multi-attribute
"Theory optimiser
the company as: (Profit, and Planet)
People
Human nature actors Selfish Selfish and/or cooperative Cooperative/trust
Shareholders Shareholders "Portfolio" of stakeholders
Ownership paradigm
Ethical Framework Utilitarian Duty ethical/rule based Virtue-ethical/integrative

They then make the case for an organizational telian Perspective. The shortcomings of "Rational

ontology; the whole is more than the sum of the Economic Man" are extensively described, and the
parts. They propose an "integrated corporate moral case is made that in order to provide a meaningful

practices" theory, which perceives the company as a explanation of economic behavior, four moral
moral entity. capabilities (Commitment, Emotion, Deliberation
A more classical philosophical approach to human and Interaction) must be added to economic mod
behavior is based on the virtue ethics as developed eling.
by the Greek philosophers Socrates, Plato and In Table IV we
that the ethical framework
claim
Aristotle. Virtuous behavior is a balanced position of sustainable is basically
finance a virtue-ethical
between a virtue and a vice. It is a mature and ra
approach, extended to the Kaptein and Wempe
tional choice somewhere in the middle between self (2002) integrative methodology as applied to what is
interest, and the choice
by made and a realistic called the "balanced company". This is in contrast

practical other person (Aristotle, Book 2, pp. 55?72, to the strict utilitarian and "rational economic man"
1999). In particular, four cardinal virtues can be approach that is applied in traditional finance. The
considered important in establishing coherent lead behavioral approach evolved from strict rationality
ership based on freedom and excellence (see Kessels to "bounded rationality", and incorporated adjacent
et al., 2002, pp. 27?29, 221). These are temperance, into the financial framework. This re
disciplines
courage, prudence and justice (the latter being the sulted in a wide variety of game theoretic, mostly
most important of all). For example, in a company it rule-based, models. These models are unable to

is important to restrict greed (temperance), to take explain the various fraud cases that have recently
calculated risks (courage) and to rationalize human surfaced. Our normative choice for a moral concept
acts to a well thought-out level (prudence). Bal of the company is an implicit result from the chosen

ancing these three virtues, in such away that justice is theory of the firm (see also Soppe, 2002). The
being done, could be called the "art of doing busi virtue-ethical as in the sustain
approach, proposed
ness". A strong proponent of this line of argument is able corporate finance concept, connects
smoothly
Dobson (1999), in what he calls the post-modern to the "specialists" concept of Alchian and Demsets
He asserts that the
post-modern approach (1972) from 30 years ago. Basically, SCF reintro
approach.
business as a type of aesthetic duces12 the Aristotelian concept of justice as
emphasizes activity,
rather than as a strict science. Dobson advocates portrayed in Book 5 of the Nicomachean Ethics
virtue ethics and derivatives thereof such as "cor into the behavior of economic subjects. The

porate soul craft" (Johnson, 1997) and "craftsman method to measure the results will be a multi

ship ethics" (Klein, 1998). The Aristotelian

approach attribute model to measure economic performance.
was also firmly supported by Van Staveren (1999) in Table IV summarizes the Sustainable Corporate
her dissertation: Caring for Economics, An Aristo Finance concept.
 Sustainable Corporate Finance 221

Conclusions Table IV and Appendix 1 summaries the four cri

teria by using catchwords for the three distinguished
The traditional finance approach is rational and approaches.

intuitively attractive in the sense that it enhances

operational efficiency and theoretical simplicity. On
the other hand, requiring financial agents to act in
Appendix 1. On the neutrality of money
conformity with homogeneous expectations results
in nothing more than a description of a unique case
Discussions to the monetarist
referring neutrality question
in an entire range of alternatives on human behavior sector are rare
of the financial in financial these
theory
in financial transactions. One problem with this
days. Early work on this topic (functional finance) by
one-dimensional is that it the
approach encourages Koopman,13 Hicks (1939) and others is dated in the
belief that finance is a sheer positive science in second quarter of the former century. Modern economic
which rational behavior automatically optimizes literature features different perspectives
to look at the
theoretical between the real economic and
efficiency. relationship
The behavioral the financial sectors. From this literature, a distinction can
approach explicidy acknowledges
be drawn between a m^cro-economic and a micro
the caveats of traditional finance theory and extends
economic All contributions of the
the models in such a way that the behavior of approach. original
macro-economic including the monetary liter
economic agents becomes a subject of analysis in approach,
ature, coincide in suggesting that there is a strong positive
direct relation to financial markets. The resulting correlation between the extent of financial development
game theoretic
approach is theoretically rich, but and economic Both
growth. approaches emphasize only
complicates financial modeling because of the
different channels of transmission. For example, the work
numerous possible games of the economic agents. It of McKinnon (1973) and Shaw (1973) provided the first
is argued that agency costs remain high, as long as theoretical basis for in favor of the liberaliza
arguments
the preference function of each participant is tion of financial markets as an essential step in the

exclusively dependent on individual money maxi development process of developing countries. They state

mization. that freely interest rates influence in

fluctuating growth
In the concept of sustainable the economy their effects on and invest
corporate finance, through saving
ments. More recent models of e.g. and Smith
the (normatively goal of the financial policy
chosen) Bencivenga
(1991) focused on cases where the marginal
is sustainability, specified as a policy of caring for productivity
of remains These
future generations. This choice results in a multi capital always positive. "endogenous
models tend to conclude that the introduction of
to financial policy growth"
attribute approach and theory.
financial intermediaries shifts the composition of savings
This may complicate financial modeling even more,
toward intermediation to be
capital, causing growth
but encourages an empirical approach of the market
promoting.
process from which normative human and eco The micro-economic and finance literature back
goes
nomic can be deducted. Prediction of to the Fisher separation theorem
guidelines (1930) at the beginning
market behavior is less relevant than measuring of the 20th century. It was concluded that, under perfect
economic results from institutional and behavioral market conditions, the investment decision and the
rules. From that perspective, we describe sustainable financing decision can be taken independently. The

finance as "a financial policy that strives for triple optimal growth of the real economy (the marginal
bottom-line measurement with productivity of direct investments) is dependent on the
performance human
risk-free interest rate, the cost of
actors that opt for maximizing multi-dimensional being opportunity
Extensions of this such as the introduction
functions". The a case capital. theory,
preference approach makes taxes
of and side effects, generate an interaction between
for a company owned by different stakeholders,
finance and investment decisions in later of
publications
rather than by shareholders alone. SFC aims at long
DeAngelo andMasulis (1980) andModigliani andMiller
term financial goals reflecting a credible and reliable
(1958, 1963). In essence, conclude that the intro
they
picture of the underlying company. In a way, it is a duction of debt the investment
enlarges capacity of firms
reintegration of social values into economic theory. and hence the of the real
growth economy.
 222 Aloy Soppe

Appendix 2. Schedule 1: Sustainable Corporate Finance

as a concept in finance

The criteria distinguished are:

1. Theory of the firm/ goal variables;
2. Human nature of economic actors;
l
3. Ownership paradigm;
4. Ethical framework.

TRADITIONAL
FINANCE
|
1. Black Box & Max {E(riCTri)}
2. Selfish
?
3. Shareholders' paradigm
4. Utilitarian

V_J

II| SUSTAINABLE
FINANCE
_ 1. Multi-attribute optimizer
B_UMIIAn4l "\
_,_1A_,__ based on Profit & People &
f BEHAVIORAL FINANCE Planet
1' "
a^cs*oUu*es& ISlioTstakeholders
o _V^- u ,. 5" 9 4. Virtue-ethical/integrative
2. Selfish and/or cooperative I
3. Contractual relations V_s
4. Duty ethical/ rule based

v_ ) ^^_^

Notes The theoretical financial models assume the existence

of markets atomistic no trans
perfect (e.g. competition,
See the 1972 Declaration ofthe UN Conference on action or costs, and
bankruptcy complete perfectly
the Human Environment in Stockholm, Preamble and transparent markets, homogeneous expectations, absence

13. Sustainable is defined later on of taxes, etc.). This reduces the of

principle development, explanatory capacity
in 1980, in the world conservation of the the models.
strategy
International Union for the conservation of Nature and This is in accordance with bottom line" of
"triple
Natural Resources (IUNC), and in 1987, in Our Elkington (1997).
Common Future of the World Commission on Envi This is in line with the Aristotelian perspective (see
ronment and Development (WCED). Meikle, 1995), which came to a similar conclusion from a
2
In the period from March 2000 until March 2003, the philosophical perspective.
U.S. and stock markets on See Appendix 1 for a short overview of some classical
European dropped average

approximately by 40 and 60% respectively! literature on this

topic.
Enron, WorldCom and Ahold. It is easily that the of the "fathers"
E.g. forgotten analysis
4
Especially Thaler (1991, 1993, 1994) brought together of the market economy, like Smith and Keynes, unmis

the articles in economics and had a similar of

leading quasi-rational takably point departure.
behavioral finance. See Fase et al. for an extensive selection of the
(1982)
The "marginalism controversy" deals with the ques major work of J.G. Koopmans (1900-1958).
tion of whether the size of the firm does or does not

depend
on the equality of marginal costs and marginal References
returns.

In the old theory, the firm was identified with the Akerlof, G. A.: 1970, The Market for 'Lemons'; Quali
entrepreneur only. tative Uncertainty and the Market Mechanism',
7
Italics by AS. Quarterly Journal of Economics 84, 488-500.
 Sustainable Corporate Finance 223

Alchian, A. A. and H. Demsetz: 1972, 'Production, Graham, and Dodd: 1934, Securities Analysis (McGraw
Information Costs and Economic Organization', The Hill, New York).
American Economic Review 62(2), 777-795. Haugen, R. A.: 1995, The New Finance; the Case against
Aristotle: 1999, Nichomachean Ethics, Dutch Translation Efficient Markets (Prentice Hall, London).
by C. Pannier and J. Verhaeghe (Historische Uitge Hicks, J. R.: 1939, Value and Capital; An Inquiry into some

verij, Groningen). Fundamental Principles of Economic Theory (Clarendon

Bencivenga, V. R. and B. D. Smith: 1991, 'Financial Press, Oxford).
Intermediation and Endogenous Growth', Review of Jensen, M. C. and W. H. Meckling: 1976, of the
Theory
Economic Studies, 195-209. Firm: Managerial Behavior, Costs and Own
Agency
Berle, A. A. and G. C. Means: 1932, The Modern Cor ership Structure', Journal of Financial Economics 3(4),
poration and Private Property (Macmillan, New York). 305-360.

Black, F. and M. J. Scholes: 1973, 'The Pricing of Op Jensen, M. C. and W. H. Meckling: 1994, The Nature of
tions and Corporate Liabilities', Journal of Political Man'', Journal ofApplied Corporate Finance Summer(2),
Economy 81 (3)(May), 637-654. 4-19.

Boatright, J. R.: 1999, Ethics in Finance (Blackwell, Johnson, E. W.: 1997, 'Corporate Soulcraft in the Age of

London). Brutal Markets', Business Ethics Quarterly(4), 109

Coase, R. H.: 1937, 'The Nature ofthe Firm', Economica 124.

9, 386-405. Kaptein, M. and J. Wempe: 2002, The Balanced Company

Cornell, B. and A. Shapiro: 1987, 'Corporate Stake (Oxford University Press, Oxford).
holders and Corporate Financial et al.:
Finance', Management, Kessels, J., E. Boers, 2002, Vrije Ruimte; Filosoferen
5-14. in Organisaties (Amsterdam, Boom).
Cyert, R. M. and J. G. March: 1963, A Behavioral Klein, S.: 1998, 'Don Quixote and the Problem of Ide
Theory
ofthe Firm (Englewoods Cliffs, New York). alism and Realism in Business Ethics', Business Ethics

DeAngelo, H., and R. W. Masulis: 1980, 43-64.

'Optimal Quarterly-(8),
Capital Structure under Corporate and Personal Tax Lintner, J.: 1965, The Valuation of Risk Assets and the
ation', Journal of Financial Economics 9, 3-30. Selection of Risky Investments in Stock Portfolios and
De W. F. M. and R. H. Thaler: 'Does the Review
Bondt, 1985, Capital Budgets', of Economics and Statistics
Stock Market Overreact?' Journal of Finance XL(3), 47(February), 13-37.
793-807. Markowitz, H. M.: 1990, 'Normative Portfolio Analysis:
Dobson, J.: 1999, 'Defending the Stockholder Model: A Past, Present, and Future', Journal of Economics and
Comment on Hasnas and on Dunfees' Mom', Business Business 42(2), 99-103.
Ethics Quarterly 9, 337-345. McKinnon, R. L: 1973, Money and Capital in Economic

Donaldson, T. and T. W. Dunfee: 1999, Ties that Bind: A Institute, New

Development (Brookings York).
Social Contracts Approach to Business Ethics (Harvard Modigliani, F., and M. H. Miller: 1958, The Cost
University Business School Press, Cambridge, MA). of Capital, Corporate Finance and the Theory
Donaldson, T. and T. W. Dunfee: 2002, 'Ties That Bind in of Investment, American Economic Review, 261
Business Ethics: Social Contracts and Why They Mat 297.

ter',Journal ofBanking and Finance 26(9), 1853-1865. Modigliani, F., and M. H. Miller: 1963, Corporate In

Elkington, J.: 1997, Cannibals with Forks: The Triple Bot come Taxes and the Cost of Capital, American Economic
tomLine of 21st Century Business (Capstone, Oxford). Review, 433-443.

Fama, E. F.: 1970, 'Efficient capital markets: A Review of Meikle, S.: 1995, Aristotle's Economic Thought (Clarendon
Theory and Empirical Work', Journal of Finance 25, Press, London).
383-417. Ross, S. A.: 1976, The of Capital Asset
Arbitrage Theory
Fase, M. M. G., et al.: 1982, Neutraal Geld (Neutral Pricing', Journal of Economic Theory 13(3)(December),
Money), (Leiden-Antwerpen, Stenfert Kroese). 341-360.

Fisher, I.: 1930, The Theory of Interest,- as Determined

Sharpe, W.: 1964, 'Capital Asset Prices: A Theory of
by Impatience to Spend Income and Opportunity to Market Equilibrium under Conditions of Risk',
Invest it- (August M. Kelly Publishers, Reprint of Journal of Finance 19(September), 425-442.
economic classics, Clifton). Shaw, E.: 1973, Financial in Economic
Deepening Develop
Friedman, M.: 1970, 'The Social Responsibility of ment (Oxford University Press, Oxford).
Business Is to Increase Profits', New York Times Mag Sheffrin, H.: 1983, Rational Expectations (Cambridge
azine (33). University Press, Cambridge).
 224 Aloy Soppe

Sheffrin, H.: 2000, Beyond Greed and Fear; Understanding Williamson, O. E.: 1979, Transaction-Cost Economics:
Behavioral Finance and the Psychology of Investing (Har The Governance of Contractual Relations', Journal of
vard Business School Press). Law and Economics 22(2)(October), 233?261.
Simon, H. A.: 1955, 'A Behavioral Model of Rational Williamson, O. E.: 1985, and
'Employee Ownership
Choice', Quarterly Journal of Economics 69, 99?118. Internal Governance: A
Perspective', Journal of Eco
Simon, H. A.:
1997, Models of Bounded Rationality, nomic Behavior and Organization 6(3), 243-245.

Empirically Grounded Economic Reason (MIT Press, Williamson, O. E. and M. H. Riordan: 1985, 'Asset

Cambridge). Specificity and Economic Organization', International

Soppe, A. B. M.: 2002, 'Ethical Theory ofthe Firm', in Journal of Industrial Organization 3(4), 365-378.
Zsolnai (2002), pp. 81-203. World Commission on Environment and Development

Thaler, R. H.: 1991, Quasi Rational Economics (Russel (WCED): 1987, Our Common Future (Oxford Uni
Sage Foundation, New York). Press, Oxford).
versity
Thaler, R. H.:
1993, Advances in Behavioral Finance Zsolnai, L.: 2002a, The Moral Economic Man, in Zsol

(Russell Sage Foundation, New York). nai, L., 2002, pp. 39-58, Chapter 3.

Thaler, R. H.: 1994, The Winner's Curse (Princeton Zsolnai, L.: 2002, Ethics in the Economy (Peter Lang,
University Press, New Jersey). Oxford).
Tvede, L.: 1990, The Psychology of Finance (Norwegian
University Press, Oslo),
van Staveren, I.: 1999, and Aristotelian
Caring for Economics,
Erasmus University Rotterdam,
Perspective (Eburon, Delft).
Vromen, J. J.: 1994, Evolution andEfficiency:An Inquiry into the P.O. Box 1138,
Foundations ofNew InstitutionalEconomics (Eburon, Delft). 3000DR Rotterdam,
Williamson, O. E.: 1975, Markets and Hierarchies: Analysis The Netherlands,
and Antitrust Implications (Free Press, New York). E-mail: soppe@few.eur.nl