For whom should corporations be run?

In the midst of economic calamity and the pandemic, capitalism is under fire. Present important debates over inequality of opportunity and outcomes, reinvigorating communities, and addressing challenges from globalization to technological change to climate change to broader social justice come together in questions for our economic system: What should businesses and their leaders be doing? For whom is the corporation run? For whom should it be?

Emotions are running high on these questions. One recent salvo came from the CEO-led Business Roundtable (BRT) in 2019. After acknowledging “Americans deserve an economy that allows each person to succeed through hard work and creativity…” and the “vital” role businesses play, the CEOs committed their firms’ allegiance to stakeholders. Those stakeholders are customers, employees, suppliers, communities, and shareholders. Seemingly different from the organization’s 1997 affirmation of shareholder primacy, the new statement elicited praise and howls when it emerged. The current environment of social and political discord only highlights the pressure on companies.

To some, the BRT’s restatement struck a chord. Intones Darren Walker, the influential president of the Ford Foundation: “It will require that corporations operate, in the words of the BRT, ‘for the benefit of all stakeholders…” Politicians from Senator Elizabeth Warren to Senator Marco Rubio have joined the stakeholder chorus. By contrast, writing with former Secretary of State George Shultz, Stanford economists Michael Boskin, John Cogan, and John Taylor recently wrote: “The [BRT] statement lends credence to an incorrect view of the way American business operates in today’s economy… and it fails to consider the practical, real-world, adverse consequences of demoting shareholders’ interests…”

And now for something different: “… 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…” Front and center in this fight for the future of the capitalist corporation — or, at a minimum, the elephant in the room — is the late Nobel laureate in economics Milton Friedman, who famously uttered these words against earlier stakeholder views 50 years ago this year. Shareholders rule.

But, while these issues are important, Friedman’s argument still has stood the test of time well — with a few twists — 50 years on.

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Busy buzzing about what firms should do was present in Friedman’s day, too, and motivated him to weigh in. What is the ‘purpose’ of the corporation? Whose interests are corporate leaders — managements and boards — supposed to advance and maximize? How do corporate leaders trade-off interests of stakeholders in making business decisions? Is the corporation the right vehicle for addressing social concerns?

There’s a back story here: Departing from the owner-managed enterprises of earlier times, capitalism in the twentieth century featured managers as leaders of large corporations with many diverse shareholders. Managers run the corporation on behalf of shareholders represented by a board of directors. Without proper monitoring and rules of the road, managers may pursue other objectives than the long-term value of the enterprise for its owners — shareholders. Such concerns rose to prominence among both economists and business leaders in the 1960s and 1970s.

It was against this backdrop that, seeking to re-center the debate over the corporation’s objectives, Milton Friedman fired a broadside not from an esoteric academic outlet but from the Sunday Magazine of The New York Times. Essentially, the business of the corporation is maximizing its value for shareholders. Managers and boards owe a duty to shareholders, full stop, to maximize their value in the firm. Of course, shareholders could use the profits of the corporation for social purposes if they wished, less wastefully than if management pursued such activities with, perhaps, more self-interest on its part. (For example, Bill Gates, having founded a very successful company, Microsoft, now uses his share of the profits from this company to engage in significant philanthropic activities across the globe.) And, other stakeholders — workers, customers, suppliers, and the broader society — must be treated equitably to ensure their willingness to engage with the firm — and government policy still constrains the corporation’s use of assets and business practices.

Friedman insisted that the corporation should focus on doing just one thing. The economist in us sees a more nuanced picture with trade-offs. What if a corporation has one goal, but that goal is multi-faceted? What if shareholders want the corporation to maximize profit, but they also care about corporate social responsibility? For example, what about corporate sponsorship of non-profit and charitable activities in neighborhoods populated by the company’s employees? The corporation should embrace that corporate social responsibility if by doing so it can trade-off profits and social good better than individual shareholders can. That becomes a way to unlock hidden value for shareholders. A fair point, but a minor change to Friedman’s basic one.

Less fairly, Friedman’s shareholder focus has been taken to mean a focus on ‘short-term’ value alone. One can imagine actions Acme Co. may take to bolster its short-term value at the expense of the long-term value or viability of the enterprise. But that wasn’t Friedman’s intent. Interpreting Friedman as emphasizing the maximization of the long-term value of Acme Co. for its shareholders gives the board of directors the leeway to evaluate management on its stewardship and growth of the firm’s value over time. While excessive managerial ‘short-termism’ in corporations is the subject of disagreement, nothing in Friedman’s dictum precludes a focus on the long term for shareholder value maximization.

Also unfair is the idea that a focus on long-term shareholder value maximization means poorly treating other stakeholders or, worse, taking away value rightfully theirs. Friedman acknowledged these points explicitly: “… it may well be in the long-run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community…” He goes on to explain that resulting social goodwill is “… a by-product of expenditures that are entirely justified in [the business’] own self-interest.”

There are, to be sure, legal or regulatory constraints on what corporations’ leaders and boards of directors can do. But going further, managers and directors acting in shareholders’ interest will want to preserve valuable relationships with employees, customers, communities, and the public.  They will do so when the firm and shareholders can capture the value of those relationships. So today’s critics overstate the tension — we can square the circle of Friedman’s advice and calls for stakeholder capitalism.

Yes, but: What if the value of these relationships can’t be fully captured by the firm investing in them? For example, what if an employer makes major investments in training its employees only to see them leave to accept a job at a competing firm? What if a corporation’s investments in its community are met by free-riding by other firms? OK, but we can fix these twists by subsidizing training in the tax code, just as we do for R&D, which also generates spillovers. And corporations can band together in communities, working with, say, a local community college on training. These are not problems completely solvable by an individual corporation on its own.

Even when the corporation can’t capture value in all trade-offs among stakeholders, it’s not usually in shareholders’ interest. Friedman realized that the very existence of the modern corporation and its freedom to engage in commerce are in social constructs. Caring about broader social concerns is not just an exercise in ‘corporate social responsibility,’ as meritorious as that activity may be, but a realization that a lack of such concerns can weaken social support for corporations’ economic foundation. Today’s anti-capitalism protests highlight that idea for corporate leaders.

So how do Friedman’s arguments look 50 years on? Answering calls for stakeholder corporate governance, Friedman today might pause with an ‘Ahem.’ The first rejoinder is practical. It is difficult to maximize more than a single objective. Consider the stakeholder perspective of “delivering value to our customers.” A company like Apple can improve value to current customers by selling its high-quality products at a fraction of current prices, to higher market share and happier customers. In the long run, if Apple continues to maintain or increase the quality of its products, it may face financial difficulty. In other words, focusing on just the short-run value to customers is not a long-term sustainable practice.

The second goes to the core of governance? Who monitors the stakeholder monitor? It is this concern that animated Friedman’s 1970 contribution: “The whole justification for permitting the corporate executive to be selected by the stockholders is that the executive is the agent [employee] serving the interest of his [or her] principal [the shareholders].  This justification disappears when the corporate executive imposes taxes and spends the proceeds for ‘social purposes’…  If they are to impose taxes and make expenditures to foster ‘social’ objectives, then political machinery must be set up to guide the assessment of taxes and to determine through a political process the objectives to be served.” Friedman, and later Shultz and colleagues, invoked the ‘s’ word — socialism — in response to this stakeholder challenge.

Is it really so simple? Well, yes and no (We are economists, after all!). Yes, Friedman anticipated these arguments; his idea of shareholder value maximization generally works just fine despite them. But no, today’s complex markets and rules require more qualifications. Differences arise mainly from a lack of competitive product or labor leadersmarkets or from different time horizons among stakeholders.

Friedman had competitive labor and product markets in mind when recommending shareholder value maximization. When labor markets are competitive, companies must compensate their employees fairly at market levels and treat them well, else the employee will go elsewhere. Companies with a reputation for recruiting and treating their employees well (poorly) will find it easier (more difficult) to attract and retain higher caliber employees. Similarly, in competitive markets for the firm’s products or services, companies will lose customers to competition (and, ultimately go out of business), if they are not able to provide those customers with attractive products or services.

What if shareholders or managers place greater emphasis on short-term corporate performance? Stakeholders, especially those concerned about the environment, may be more focused on the long-term impact of a company’s actions. Even here, the remedy does not have to wander far from shareholder value maximization if we add a wrinkle: The long-term negative impact on the environment could lead to a negative impact on the company’s long-term share price via costs of litigation and adverse effects on its reputation. If managers’ and directors’ incentive pay is appropriately focused on the long-term share price, then managers and directors will be discouraged from engaging in actions that impair long-term shareholder value.

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These thoughts take us to perhaps the biggest question in today’s debates: Which problems should companies try to solve? We’ve seen that many stakeholder interests, including shareholder interests, can be accomplished by a board of directors engaged in maximizing long-term shareholder value. Directors may use their business judgment to allocate value to non-shareholder stakeholders if directors believe that so doing will enhance long-term corporate business success, value, and reputation. As an example, openness to all talent and concern for communities almost certainly serves shareholder interests as well as social justice.

Martin Lipton, a founding partner of corporate law giant Wachtell, Lipton, Rosen & Katz, and colleagues push back that the shareholder-value maximization model of corporate governance is politically and commercially unsustainable in view of the acute challenges confronting this generation. Yet Lipton’s own corporate “new paradigm” would allow corporate boards the wide latitude to advance the long-term interests of the firm we described above.

There is a rub, and Friedman anticipated it: While long-term shareholder value maximization can balance trade-offs among other corporate stakeholders, it can’t address all problems faced by the firm. Some social problems are even more complex than Friedman imagined. Climate change, for example, poses significant challenges for societies and businesses to reduce carbon in the atmosphere and greenhouse gas emissions, as well as to adapt to evolving changes in surface temperatures. Investors could and should press corporations to disclose more information about the exposure of their long-term value to climate change, and corporations may act to reduce emissions and increase their adaptability in service of a focus on long-term value maximization.  That step is an extension of a market process and response. But that step alone will not resolve climate change. Significant changes to combat climate change require public policy changes in the United States and abroad— a carbon tax or alternative-energy technology subsidies, for example. Turning more to corporations alone simply because the political process seems broken and makes little progress won’t do.

Friedman recognized this very point, referring to “problems … too urgent to wait on the slow course of political processes, that the exercise of social responsibility by business[people] is a quicker and surer way to solve pressing problems.” In his view, such an appeal is undemocratic. Of course, this deference to democratic politics does not mean that corporations and their leaders shouldn’t focus on their firms’ sustainability as BlackRock’s Laurence Fink and Bank of America CEO Brian Moynihan have recently and persuasively observed in the context of climate change.

There are other instances when public policy is required to alter what’s in the interest of shareholders. Examples include laws to limit abuse of market power; rules to enhance firms’ competition for employees and eliminate discrimination; and tax policy to affect corporate profitability, location decisions, wages, or incentives to invest. These policies address social objectives that would not, in some cases, be pursued by individual firms. But even in such cases, public policy interventions complement, not substitute for, long-term shareholder value maximization.

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The modern corporation has been an enormously productive societal and organizational invention. Milton Friedman credited that success with the corporate objective of maximizing the company’s shareholder value, while conforming to applicable laws and regulations. That capitalism needs to be inclusive in its benefits is also true, and invites a public policy agenda for opportunity — one in which business leaders’ voices should be present. But 50 years on, Friedman’s shareholder primacy — long-run shareholder value maximization — remains the right place to start, even if it is not the end.

Sanjai Bhagat is a professor of finance at the University of Colorado. R. Glenn Hubbard is a visiting scholar at the American Enterprise Institute and dean emeritus and the Russell L. Carson Professor of Economics and Finance at Columbia Business School.

Sanjai Bhagat is a professor of finance at the University of Colorado.