Milton Friedman Was Right About Shareholder Capitalism

(Bloomberg Opinion) -- My Bloomberg Opinion colleague Joe Nocera is a onetime believer in Milton Friedman’s doctrine who has changed his mind. He explains why here.

Fifty years ago this month, the economist and Nobel laureate Milton Friedman published his famous essay in the New York Times Magazine arguing that, as the headline writer put it, “The social responsibility of business is to increase its profits.”

This view — that business leaders should focus on creating as much value as possible for the owners of their company rather than on improving outcomes for a broader set of stakeholders like workers, suppliers and society as a whole — is now under attack. But it is well grounded in solid economics, common sense and practical considerations. It is often misunderstood, and it admits nuance and a role for public policy. Corporations that have publicly moved away from this position are inadvertently demonstrating its durability.

Friedman’s characteristic bluntness makes his ideas easy to caricature, even though he was (more or less) correct. It’s understandable that many readers tend to miss the subtleties when he instructs executives that their responsibility “generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”

In a speech in July, Democratic presidential nominee Joe Biden said: “It’s way past time we put an end to the era of shareholder capitalism. The idea the only responsibility a corporation has is with shareholders, that’s simply not true. It’s an absolute farce.” The Business Roundtable, an association of chief executives representing many leading U.S. companies, retreated from “shareholder capitalism” a little over a year ago, with a statement signed by 181 CEOs “who commit to lead their companies for the benefit of all stakeholders — customers, employees, suppliers, communities and shareholders.”

But the case for shareholder capitalism is simple, and was well articulated by Friedman in 1970. “A corporate executive is an employee of the owners of the business” who has a “direct responsibility” to his employers, Friedman wrote. Shareholders own the business, just as I own the computer I am using to write this column and the chair I am sitting in. Executives’ responsibility is to run the business according to the wishes of its owners, which will typically be to make as much profit as possible.

As a matter of practicality, asking CEOs to make society better — the environment cleaner, working conditions safer, compensation higher — is beyond their competence and ability. It also invites inconsistencies. For example, doubling workers’ wages would make them better off, but it would require raising prices, making customers worse off. And if stakeholder capitalism has any teeth, it must mean that executives should on occasion act against the interest of their company’s owners. How is that a defensible management strategy? Should union members, Friedman reasonably asked, tolerate leaders who don’t fight for better wages and working conditions to keep prices lower for customers?

Shareholder capitalism is widely misunderstood. It does not argue for businesses to pursue maximum profit in the absence of any constraints, legal or ethical. Friedman himself was careful to make that point. Companies that break the law to pursue profit aren’t adhering to shareholder capitalism, they are engaging in criminal behavior. If businesses fund junk science to beat back regulation — for example, arguing that nicotine isn’t addictive — they are behaving unethically. Incidentally, this type of behavior also reduces long-term value by putting the company’s reputation and future in jeopardy.

More generally, shareholder capitalism does not argue for the pursuit of short-term value over long-term value. There is much debate over the appropriate time horizon for business decisions and the extent to which companies are excessively focused on short-run profits, but putting long-term value ahead of immediate gains is perfectly consistent with shareholder capitalism as a management strategy.

To maximize value over longer time horizons, corporations must treat workers, customers and suppliers fairly. Some corporations may have enough market power to earn monopoly profits and to mistreat workers. But the extent to which these are problematic is exaggerated. Especially over a longer time horizon, it is in a corporation’s interest to treat close stakeholders well.

There is more nuance here than meets the eye. Remember, Friedman was addressing executives, not shareholders. The real insight behind shareholder capitalism is that executives should manage companies according to the goals of their owners. If owners want companies to make profit and to engage in socially beneficial activities — say, cleaning up a park in a neighborhood where many employees live — then shareholder capitalism argues that managers should do both. If owners want to sacrifice some profits for a cleaner environment, then managers should make that trade.

Maximizing shareholder value over the long term does sometimes mean engaging broader social and political issues. I wish the business community had been more outspoken over the past several years during periods of social unrest, in part because basic social stability is necessary for a productive business climate. Businesses should defend the liberal international order against attacks, including from the White House. Those institutions, norms, and culture have been a bedrock of prosperity for seven decades.

In addition to treating workers well, it may be in business’ long-term interest to invest more in worker training than is standard practice. Some businesses — for example, Walmart — are paying workers more and building their skills in part because it might increase their profits. These experiments, if successful, could lead to better management practices that help workers and are consistent with shareholder capitalism.

Business policy can help align shareholder capitalism with broader social objectives. As a way to align management decisions with long-term, rather than short-run, corporate and social interests, economists Sanjai Bhagat and Glenn Hubbard suggest compensating senior corporate executives with shares of stock that can’t be sold, and with options that can’t be exercised, until a year or two after executives leave their company. Shareholders could also require managers to study how issues like climate change affect long-term value to improve business decisions in a way that could also benefit the environment.

Long-term value is shaped by public policy. A carbon tax would lead to fewer carbon emissions and would make it more profitable for companies to move away from carbon. More rigorous antitrust enforcement could make it more profitable for corporations to treat customers and suppliers better by increasing market competition. Business tax credits for worker training could lead more companies to invest in their workers.

There is more debate about what corporations should do than about what they are doing. But I suspect that many corporate leaders who are announcing a move to stakeholder capitalism are doing so for one reason: Given the preferences of their customers, this corporate branding will increase their profits. That irony helps prove the rule.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and Arthur F. Burns Scholar in Political Economy at the American Enterprise Institute. He is the author of “The American Dream Is Not Dead: (But Populism Could Kill It).”

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