But business leaders would be well advised to address the public’s distrust of profit maximization.
But business leaders would be well advised to address the public’s distrust of profit maximization.
C orporate managers, according to contemporary critics, must serve not only their investor-employers but also other stakeholders — namely: employees, customers, and suppliers. One offspring of this directive is the ESG movement: “E” for environmental consciousness, “S” for social sensitivity (e.g., workplace safety, treatment of employees, community involvement, and “virtuous” products — excluding such no-nos as tobacco, firearms, and fossil fuels), and “G” for governance (e.g., transparency, accountability, curbs on executive compensation, and boardroom diversity). Fidelity to ESG, so the argument goes, will meld the potentially disparate aims of varied stakeholders.
Nobel laureate Milton Friedman offered a different perspective in his classic 1962 book Capitalism and Freedom: “There is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game.”
Friedman affirmed that principle in a 1970 New York Times op-ed: “A corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility . . . generally will be to make as much money as possible,” while adhering to legal and ethical norms. Profit maximization, argued Friedman, automatically encompasses the interests of other stakeholders and promotes aggregate societal benefits.
On the merits, the Friedman doctrine retains its clarity and essential logic. Though it has been mischaracterized as antithetical to stakeholder and ESG concerns, the opposite is true: Managers seeking to maximize profitability must serve numerous groups that produce and purchase the company’s output. By emphasizing shareholder value — i.e., the discounted present value of future earnings — corporate executives nurture not only stockholders but all parties with a stake in the solidity of the enterprise. That’s why executives are often compensated based on stock-market performance — a manifestation of profit-maximization objectives.
Such arrangements, however, have been roundly criticized by mainstream media and the academic establishment. In response, some Friedman devotees — myself included — suggest that a more nuanced, updated framework might be appropriate, one that highlights long-term value for shareholders while recognizing that a single-minded profit-maximization target can be misinterpreted and misapplied.
For starters, profits and stock-market price may at times be uncorrelated with management performance. Ancillary variables include overall economic strength, industry factors, intellectual-property protection and, especially in the high-tech sector, market power attributable to network effects.
Additionally, short-term profit maximization may enrich managers without redounding to the long-term benefit of shareholders. Reduced research and development, depleted marketing budgets, neglected maintenance, relaxed quality control, increased pollution, and other negative externalities, if prolonged, will harm customers, employees, social welfare, and therefore investors.
Excessive borrowing may temporarily leverage equity returns but generate unsustainable risk. Higher profits and share prices can also emerge from rent-seeking — i.e., manipulating the political process without creating new wealth. Examples include tariffs, subsidies, government loans, and occupational licensing.
A chronic problem for publicly held corporations has been the separation of management and ownership. It’s tempting but unwarranted to conclude that shareholders will monitor their executive hires. Among the problems: lack of information and the cost of oversight.
Moreover, shareholders are protected against downside exposure by limited liability, and they can further reduce risk by diversification and use of derivatives. An active market in corporate control might align investor and manager interests, but that process is complicated by regulatory barriers against mergers, tender offers, and other acquisitions. Finally, a conflict of interest can exist when executives select investment institutions, which may also be shareholders, for lucrative pension-fund-management contracts.
One effect of those disconnects has been an enormous increase in CEO remuneration and a widening gap between top- and bottom-employee income — without corresponding reductions in management compensation when market prices decline. The result has been resentment and hostility toward corporate heads, their companies, and the system that generated the perceived inequities.
If democratic capitalism — history’s most successful governance model — is to be nourished, the capitalism component must be accepted by the body politic. That acceptance, in turn, will depend on encapsulating corporate goals in a form that the public will deem equitable, trustworthy, and economically rewarding. Ergo, the leaders of private enterprise would be well advised to address the public’s distrust of a stark “profit maximization” objective.
In its place, perhaps a more refined and palatable mission statement would be: “Executives should manage land, labor, and capital resources in a manner that increases the return to investors over the long term.” That statement would still focus on shareholder value, it would properly emphasize the long term, it would avoid inflammatory “profit maximization” language, and, at the same time, it would spotlight corporate resources that concern all stakeholders. In today’s world, driven by social media, perception is critical.