Taking a New View of the ‘Social Responsibility of Business’
How Shareholders and Markets Can Encourage a Shift to Stakeholder Capitalism—50 Years After Milton Friedman’s Essay
By Frederick Alexander
It’s time for a profusion of op-eds marking the 50th anniversary of Milton Friedman’s famous New York Times Magazine article titled “The Social Responsibility of Business Is to Increase Its Profits.” These reflections will herald corporate executives’ rejection of the idea that companies should focus solely on making money for shareholders. The concept is that the doctrine of shareholder primacy is now supposedly being replaced by “stakeholder capitalism,” which holds that companies should be governed so as to serve the interests of workers, society and the planet, as well as those of shareholders. This celebration is exemplified by the Business Roundtable’s Statement of the Purpose of the Corporation, penned by an organization of CEOs who earn salaries around 250 times that of their median employees, and by the Davos Manifesto adopted at this year’s giant party for billionaires held at an exclusive resort in a tax haven. Each of these documents prescribes greater management discretion to balance non-shareholder interests while providing no clear method for holding these managers accountable for protecting those interests.
Don’t trade in your shares for stakes just yet. Here is some advice for the dealing with the platitudinous storm.
Beware of:
- CEOs who criticize Friedman’s emphasis on shareholder value but who also negotiate for eight-figure annual compensation packages that consist primarily of stock. With all that stock, the value of shares is going to overshadow any interest in stakeholders.
- Claims that stakeholder capitalism is working because companies that pay attention to their stakeholders make more money for shareholders than companies that ignore stakeholders. Three reactions to this common refrain:
- No kidding.
- Isn’t shareholder return an odd metric of success for a new version of capitalism aimed at promoting the interests of stakeholders?
- What is the standard for determining whether stakeholders are truly being served, rather than simply allowing management to arbitrarily decide what they need?
- Conflation of “long-termism” with stakeholder interests. This is a not-so-subtle attempt to have it both ways by claiming that if we can focus on the distant future, everyone’s interests will magically align, avoiding the need to make any hard choices at any companies. It is true that sometimes long-term value for shareholders and stakeholders lines up, but it is also true that sometimes it doesn’t: Consider how much money tobacco companies have made addicting children around the globe over the very long time since it was learned that their product is deadly. “Win-win” claims accompanying business proclamations of a new stakeholder model are a clear sign that the purported rejection of shareholder primacy is chimerical; indeed, these claims buttress the doctrine by asserting that profits and stakeholder value go hand-in-hand. To use Friedman’s own words, this is simply “cloaking” profit-seeking activities in “hypocritical window dressing.”
Consider What Has Changed in the Last 50 Years
Since Friedman wrote his article, capital providers have coalesced into large institutions with extremely diversified portfolios. Because of this overwhelming diversification of the market, most investors are generally more stakeholder than shareholder with respect to any single company, because the impact that a company has on society and the environment will affect their entire portfolio. This means that they are in a position to represent stakeholders, at least partially, through the rights they have as shareholders.
These diversified investors will benefit if the companies that they own reduce the externalized costs that burden everyone else, even if those particular companies must surrender profits at the margin. For example, the overall market returns to diversified shareholders will will be protected from the risk of environmental catastrophe and social instability if shareholders insist that companies stop reaping profits from harmful emissions, questionable supply chains and corruption of the political process.
Think Further About the Implications of What Friedman Actually Said
Friedman himself stated that profit was primary only because that is what shareholders demanded in exchange for their investment: If they want to demand something else — like actually looking after stakeholders — that is their right to do as part of the price for access to their capital. His primary belief was that letting markets choose how to allocate resources was a good default rule for society because market participants would make trades to benefit each side, increasing societal wealth overall (i.e., “private vice” turns to “public virtue.”) But free markets do not always equal profit maximization — free market principles allow shareholders to decide what goals companies should pursue in exchange for their invested capital, whether that goal is profit maximization or a low carbon footprint.
Friedman also recognized that sometimes profit maximization by individual companies can lead to bad results, especially where companies can “externalize” costs — he specifically recognized this with respect to pollution. External costs that a company creates are not bargained for; they are unilaterally imposed on others. This means that there is no market force ensuring the gains to the company outweigh the external costs of their activity. Sometimes a vice is just a vice.
What Would Real Stakeholder Capitalism Look Like?
Stakeholder capitalism can be authentic, but it is unlikely to be led by large businesses. Such companies and their leadership are overexposed to company-specific issues and therefore predisposed to undervalue the cost of externalities. In other words, it may always benefit a company like Amazon to avoid taxes, no matter how much tax avoidance in general harms society.
Shareholders themselves, however, are ideally situated to lead a movement for stakeholder capitalism and to “just say no” to companies that refuse to share the load. They can act through institutional shareholders like pension funds and endowments that acknowledge their responsibility for the social and environmental systems that all of their investments are embedded in (and that their beneficiaries have to rely upon without the help of multimillion-dollar salaries).
Keep Some Hard Truths in Mind:
- For individual companies, rejecting the shareholder primacy constructed around Friedman’s market-centered ideas necessarily means sacrificing some return that their shareholders would otherwise receive in favor of actual stakeholder interests, such as workers, society, or the environment. Only then would corporations be deprioritizing shareholders.
- There will be winners and losers in a transition to stakeholder capitalism, and the losers are concentrated in the financial industry (which takes 2 cents of every invested dollar annually) and at the top ranks of corporations, both of which profit from the systemic overemphasis on individual company and portfolio performance.
- Leaders of groups like the Business Roundtable are often opposed to such stewardship from shareholders, arguing that they should be protected from shareholder opinion with dual-class shares and classified boards. This is a decidedly non-market idea and, combined with removal of the profit focus, could give corporate managers free rein to decide how to allocate resources without constraint. This completely removes capitalism from stakeholder capitalism because resources are being allocated without regard to market forces. (And unlike restraints that come from government regulation, this allocation is also being made without democratic constraints.)
Final Thought
Muhammed Ali said that “a man who views the world the same at 50 as he did at 20 has wasted 30 years of his life.” So it should be with the 50-year-old ideas articulated in Social Responsibility, which for too long have driven the belief that maximizing the values of individual companies in a portfolio will maximize the value of the overall portfolio and the broader wealth of society. It is now time to realize that in a complex and interdependent economy, this is too simple a picture. The fact is that unfettered profit-seeking leads to untenable inequality, climate damage, and other harms to all of us, which in turn negatively affect our economy and livelihoods.
But that does not mean we abandon market forces. Instead, we must expand our conception of where markets can operate to put a value on important systems, and recognize that the power that investors wield over private capital creates a corresponding responsibility for stewardship. With this recognition, we can create mechanisms to hold companies accountable for the costs they impose on society and the environment, and require companies to pursue profits earned through efficiency and innovation rather than extraction and exploitation.
Related articles:
- Business Leaders Turn to B Corp Values to Meet the Moment: How a Stakeholder Focus Shapes B Corps’ Everyday Practices and Response to COVID-19
- Real Change in Real Time: Benefit Corporations See New Interest: Investors Show They’re Eager to Invest in Responsible Businesses
- Exposing the Faults of Shareholder Primacy: How the B Corp Movement Is Remaking Capitalism
Frederick Alexander is founder and CEO of The Shareholder Commons.
B The Change gathers and shares the voices from within the movement of people using business as a force for good and the community of Certified B Corporations. The opinions expressed do not necessarily reflect those of the nonprofit B Lab.
