Monday, September 04, 2006

Should Corporations give to Charity?

When I was in business school, a bunch of people interviewed with some company. There was a question that went something like this: if you were managing the company, and made an unexpected profit windfall (like you discovered oil on otherwise worthless property), what would you do with the profits? The answer they were looking for was that you should give 10% to charity.

I've always wondered why corporations should give money to charity. After all, it's not really their money: it's the shareholders', and shouldn't the shareholders have the right to decide? I'm all for compassion, but for me, compassion means donating your own money or time, not someone else's (this is why I don't think that governments can be compassionate: it's just redistribution. It may in times be necessary, but that doesn't make it compassionate).

There are a few times when I think a corporation should give to charity. The first is if it's not really charity: on the surface, it looks like charity, but so much good will is generated, that it's a win-win. Sponsoring a little league team may bring the company free advertising or it may boost employee morale (if many of the workers' children play for the team). In other instances, charity may help source more employees (such as giving to a local tech school). Donations to certain public policy think tanks may result in more favorable laws being passed. These activities are obviously in the shareholders' best interest.

The second type of charity that I'd support is if a corportion were trying to reverse an earlier wrong. Even without the PR benefit. (For instance, if a record company distributed a CD that advocated cop killing, which is within the first amendment rights, but then someone followed the advice. The corporation may not have acted illegally, but it certainly didn't act responsibly).

Finally, I'd support general charity to whatever organization if the board truly believed that the shareholders wanted to give to these charities. This is obviously easier to ascertain when you have only a few shareholders. The reason for this is taxes. For instance, if a company has five shareholders, and they all think that Planned Parenthood (or the National Right to Life) is great, then the corporation giving away the money is more efficient from a tax perspective. If the corporation gives $100 to the organization, it actually only costs about $66 less in profit because taxes will be less now that income has dropped by $100.

If however, the corporation keeps the $100, then it pays $33 in taxes on it. Then it has $67. IT distributes this to the shareholders, who have to pay 20% tax on the dividends received, so they're left with about $54 (donating this will then bring them a tax benefit, but in a 33% bracket would be about $18).

However, in most cases, I would not support corporate charity. It's not really charity. Under most circumstances, large corporations with a diverse shareholder base have no business giving away their shareholders' money. Let the shareholders do that.


Anonymous said...

Your analysis on the tax effect is wrong. A corporation does not have any tax incentive to donate to charity. Simply put, the donation is worth more than the tax savings that would derive from the donation. If the corporation were to donate $100, you could effectively discount the cost by the applicable tax savings but the tax savings itself is only incidence of the action itself. In one regard however, if the corporation were to make a donation to a charity that promotes a certain cause or public policy conducive to the viability of the corporation than the donation would probably generate more value than the donation itself.

GMR said...

The cost of giving to charity will always exceed the tax benefit, yes. However, it still makes sense for corporations to give to charity if they believe their owners would give to charity. Obviously, if there is one owner of the corporation, this is a lot easier.

Suppose a corporation is owned by one guy. This corporation has $1,000 in pre-tax profits. The guy wants to pocket $350 for himself and give the rest to charity.

If the corporation takes the $1,000 and then pays taxes on it at 35%, it'll have $650 left. It then dividends out the $650. The guys gets this dividend, pays 20% taxes on this, or $130. He's left with $520. He then donates $260 to the charity, leaving him with $260. He gets a tax break on the $260 he donated, or $91, so his net gain to himself is $351.

Now, take the next scenario. Company has $1,000 in pre-tax income. It donates $300 to the charity. It has $700 left. Taxes are $245. It then dividends out $455. The recipient gets that, pays 20% dividend tax and ends up with $364.

So in the second case, the charity gets more money and the guy gets more money.

Now, if you have one owner, it's quite easy for the corporation to figure out how to donate money. If you have 50 owners, not so much. Note that donating money doesn't make you wealthier. The only thing I was trying to point out is that in some cases, it's better for the company to donate than to dividend the money out so the owners can donate, but only if the company is convinced it knows how the owners would want to give. This can really only be achieved with a small ownership structure.