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Nice firms finish last? Etsy tax woes shows why doing good is a drag

September 29, 2015, 1:38 PM UTC
Courtesy of Etsy

Poor Etsy. The press, customers, and rivals are tarring the crafts company as a tax dodger and a hypocrite—even though it may have done nothing wrong. Etsy, however, may have brought this recent misery on itself by trying to be corporate do-gooder.

Welcome to the paradox of socially responsible corporations in which, research suggests, firms that embrace ideals often get punished for their troubles. And while Etsy (ETSY) is hardly the first feel-good company to get flayed, its current ordeal might be a cautionary tale for the growing list of other firms that want to make social justice part of their business.

Etsy’s surprise tax headache

Brooklyn-based Etsy is best known as a platform for the crafting set, who use it to buy and sell homespun jewelry, garments, and more. It was an unlikely candidate, in other words, to get caught up in a fuss about multi-national corporations and taxes. So how did it happen? (If you know—or don’t like read about taxes—you can skip right to the next section).

Etsy’s ordeal began in August and arose from a most mundane source: A routine SEC filing in which the company described plans to create a subsidiary in Ireland to handle sales from European customers. Such a scheme is hardly unusual.

But soon the criticism rained down. A series of unflattering articles by the Wall Street Journal, the Financial Times and Bloomberg all suggested Etsy betrayed its commitment to transparency and social good. The crux of the complaint was that Etsy is using an Irish address to dodge its fair share of taxes.

Etsy was unlucky in part because corporate tax dodging, real or perceived, is a hot issue right now. Recent reports have exposed how companies like Apple (APPL) and Google (GOOG) employ sophisticated accounting tricks with names like the now-defunct “Double Irish” and the “Dutch Sandwich” to score their revenue in low cost locations. Under these schemes, a company will transfer intellectual property assets to a place like Ireland and then have corporate units located in high-tax places pay to license that same IP—the upshot is companies can claim lower earnings in a high-tax country like the U.S., while parking profits in Ireland or another tax haven.

These practices are part of a global debate over what policy types call “BEPS” (base erosion and profit shifting), which critics say permits corporations to skirt the taxes that governments need for infrastructure or social services. While tax havens like Ireland are part of the perceived problem, another part may lie with a dysfunctional U.S. tax code, which both Republicans and Democrats say needs to be reformed.

So where does Etsy fit into all this? For now, nowhere really. Since its initial earnings reports as a public company, Etsy has failed to post any profit at all. As for its Irish scheme, a person familiar with the company said the purpose of the subsidiary is to record European-based revenue, not to avoid U.S. taxes. It’s also worth noting that the company doesn’t have the sort of intellectual property, namely patents, that other tech companies use to pull off tricks like the Double Irish.

According to the person close to Etsy, who did not want to be named, the company’s plan involves transferring IP related to its website and, over the long term, having the Irish operations expand the proprietary platform. But all this will take place down the road and will not affect Etsy’s tax payments, especially the U.S. ones, for the foreseeable future. Etsy’s CEO, Chad Dickerson, has made the same point:

“While I welcome increased scrutiny as a natural part of being a public company, some of the recent media reports about Etsy’s tax structure have been grossly inaccurate and misleading […] We’re not offshoring or using a Double Irish structure or any other elaborate tax scheme that is out there. This is a simple structure,” wrote Dickerson in a recent blog post.

But this hasn’t stopped Etsy’s detractors. Last week, the website Ars Technica cited a flattering profile of Kickstarter’s plans to do good and, sneeringly compared Kickstarter’s pledge not to use “esoteric” tax structures with Etsy’s current setup.

More virtues, more problems

Etsy is not doing anything different on the tax front than other tech companies (in fact, for now, it is doing nothing at all), and yet it has caught much more grief. A big reason is that the Brooklyn-based company is a “B Corporation,” a special status that a non-profit group bestows on firms that pledge to be ethical.

While this is a boon to the Etsy brand, it also has a downside, according to Jerry Kim, a strategy professor at Columbia Business School.

“Having a reputation as a “good” company is a double-edged sword. On the one hand, there is a halo effect, where consumers love you and are willing to pay a premium to be associated with your brand; on the other hand, you are held to higher standards, and even small violations of trust will attract lots of attention, and will be severely punished by consumers,” said Kim, who also cited Ben & Jerry’s as a brand that has had to walk a fine line in appealing to an ethically-conscious customer base.

Kim also pointed to research on so-called “corporate social responsibility” that draws a surprising conclusion: Doing good can actually harm a company because activists are more likely to go after a firm that embraces ethical standards rather than firms that are indifferent to social justice. The research, set out in a 2012 paper titled “Good Firms, Good Targets” explains:

Rather than buffering a firm from being targeted, these results suggest that a firm’s prosocial activity may make it more vulnerable to being targeted, as activists may seek to impugn the organization’s claims of being socially responsible.

The paper also cites Starbucks (SBUX) as an example of a company that has sometimes paid a price for taking positions on social justice issues.

As for Etsy, the tax imbroglio has so far not led the company to second-guess (in public at least) its positions of being an agent of social change.

“We’re as committed as ever to our mission to reimagine commerce in ways that build a more fulfilling and lasting world. We believe that companies can and should use the power of business to create social good and we welcome being a part of that ongoing discussion,” said an Etsy spokesperson by email.

Meanwhile, more companies are also accepting the burdens that come with social corporate responsibility, and some are even adopting a new legal structure that could make the cost of doing good even higher.

From B-Corp to Public Benefit Corporation

A big reason Etsy landed in hot water over its tax plans is its status as a “B Corporation,” which the company gleefully embraced in 2012, saying the designation meant it could “use the power of business to solve social and environmental problems.”

Today, there are more than 1,400 other “B corps,” including Patagonia and Warby Parker, all of which pledge to abide by “rigorous standards of social and environmental performance, accountability, and transparency.” The B corp designation, however, doesn’t carry any real legal significance, though it can have an effect on marketing and public relations – for better or worse. (An activist group, for instance, is saying Etsy should not be able to re-certify as a B corp if it goes ahead with its Irish tax plan).

All of this is a step beyond the “corporate social responsibility” campaigns that nearly every big company has embraced in the last two decades. Now, the ethical stakes could get higher still in light of a new corporate law option known as a “Public Benefit Corporation,” which is available in states like Delaware.

The Public Benefit Corporation is significant because it can bestow a legal right of action on shareholders if the company breaches its own social justice goals. Few people, however, are sure how this will work out in practice, especially since corporate laws in Delaware (where most companies incorporate) require 2% of shareholders to agree to such a lawsuit.

It’s also unclear how many companies will actually choose to incorporate this way. While Kickstarter says it has reincorporated as a Public Benefit Corporation, it has yet to publish the legal documents outlining its new operations, and says it will only provide details in 2017.

For now, it will be interesting to see if any other companies follow suit. In light of the Etsy experience and the “good company, good target” phenomenon, some executives might ask themselves if the price of doing so is too high.

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