BlackRock cofounder Sue Wagner joins Chicago Booth’s Marianne Bertrand, Robert H. Gertner, and Luigi Zingales to discuss the business of business.Should Public Companies Do More Than Maximize Profits?
Martin León Barreto
A few years back I heard a mischievous remark about the comparative achievements of Friedrich Hayek and Milton Friedman, the Nobel Prize–winning economists who had an abiding passion for free markets, free people, and the free thinking that goes on at the University of Chicago, where the two men were colleagues:
Hayek was a good economist and a great philosopher, while Friedman was a great economist and a good philosopher.
The verdict still makes me grin, and if it emphasizes Friedman’s shortcomings as a philosopher, a vocation that vacillates between subtlety and hairsplitting, it inadvertently points to another achievement: his legacy as a preeminent public intellectual. Hayek was courtly, soft-spoken, and reserved to the point of reticence, but his younger colleague had a taste for intellectual combat and welcomed any opportunity to grind the ax of his ideas. For nearly 50 years, he posted feisty op-eds to preeminent newspapers, butted heads with better-known adversaries, and even hosted a popular television series whose pithy title captured the libertarian bent of his contentions: Free to Choose.
Today, nearly a dozen years after Friedman’s death, the most enduring of his arguments remains one of the least considered, a claim that long ago slipped the bonds of debatable assertion and ascended to the oxygen-deprived heights of truism: “The Social Responsibility of Business Is to Increase Its Profits.”
This is the title of Friedman’s essay as it appeared in the New York Times Magazine in fall 1970. At the time, an editor helpfully appended “A Friedman doctrine,” an addition warning readers that what followed was nothing less than a radical pronouncement.
Nobel Laureate Oliver Hart of Harvard and Chicago Booth’s Luigi Zingales reject the view that shareholders care only about money.
Today, the idea that a company has no social responsibility other than maximizing shareholder returns is unremarkable, even commonplace, but when Friedman first made it, it would have seemed as provocative to his readers as if I made the suggestion to you that Microsoft be nationalized. In fact, the latter contention was much closer to mainstream thought than Friedman’s was when he penned his essay, which is one reason he presented his views so pugnaciously. “Businessmen believe that they are defending free enterprise when they declaim that business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends,” he wrote at the beginning of his essay. “In fact they are—or would be if they or anyone else took them seriously—preaching pure and unadulterated socialism.”
The “social ends” Friedman cites—“providing employment, eliminating discrimination, [and] avoiding pollution”—are hardly exceptional concerns, even today, and such bluster underscores two important points about the essay, one a misconception it made common, and the other a historic development it largely ignored.
A legal opinion
The misconception Friedman made common is that his thesis is actually a legal mandate. Contrary to what many people think, the law doesn’t require corporate directors to run a company consistent with maximizing the wealth of shareholders. Yes, they have a fiduciary duty not to recklessly mismanage a company, but nearly apart from instances of pilfering and outright fraud, judges are loath to play chairman of the board and dictate to companies the terms of prudent management.
Consider Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919), a dispute that ostensibly illustrates a company unlawfully prizing its own concerns over the interests of shareholders. Near the end of World War I, Henry Ford concluded that, rather than pay a $60 million dividend to shareholders, he would reinvest these profits in order to expand production and further cut the cost of the Model T for consumers. Explaining his decision, Ford maintained: “My ambition is to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes.”
The automotive magnate had already become a poster boy for industrial paternalism with his “Five-Dollar Day,” an initiative that rewarded workers the said amount if their home life (on review of the company’s “Sociological Department”) lived up to Mr. Ford’s vision of happy, healthy living. Still, an abject pronouncement that the company would pursue policies that held profits in lower regard than the philanthropic ambitions of its founder appeared something apart from previous efforts, and the court seemed to signal that Ford had flouted his responsibilities as a fiduciary for the company.
“There should be no confusion,” the justices of the Michigan Supreme Court wrote in the section of their decision that has been a touchstone for corporate law classes for nearly a century. “A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of the directors is to be exercised in the choice of means to attain that end, and does not extend to . . . other purposes.”
This passage appears to provide a legal underpinning for Friedman’s thesis. Then again, if it did so effectively, coming nearly 50 years before his essay was published, there would have been no reason for him to issue his broadside. As the late legal scholar Lynn A. Stout observed, Dodge v. Ford is “a doctrinal oddity largely irrelevant to corporate law and corporate practice.” More importantly, she continued, “courts and legislatures alike treat it as irrelevant.”
As Stout noted, the most famous passage in the court’s ruling is actually dicta, lawspeak for parts of a decision that are incidental to the holding. Ford’s failure was not that he refrained from maximizing his own company’s profit, but that he clearly chose to do so to the detriment of John Francis Dodge and Horace Elgin Dodge, minority shareholders who together controlled 10 percent of Ford’s stock.
The second-largest shareholders of the company, the Dodge brothers were correctly suspected by Henry Ford of wanting to use their dividends to establish a rival motor company. Ford hoped to thwart those ambitions by withholding the dividends that would underwrite their efforts, a motivation, the court held, that was in conflict with the duty of good faith he owed minority investors.
Why executives might embrace a broader notion of a corporation’s ‘social responsibility’ is a matter that Friedman barely addresses.
Legally speaking, therefore, the problem with Ford’s decision was not profit maximization per se. Indeed, the court went out of its way in the ruling to acknowledge the lawfulness of “incidental humanitarian expenditure of corporate funds for the benefit of the employés [sic], like the building of a hospital for their use and the employment of agencies for the betterment of their condition.”
While Henry Ford made a sport of such “incidental” activity, his own company was hardly the only one that engaged in undertakings that appeared to enrich the broader community at the apparent expense of shareholders. Friedman was aware of such behavior—if anything, the philanthropic propensities of publicly traded companies had only grown stronger in the subsequent half century—and in his essay, he wavers in respect to them. “It may well be in the long-run interest of a corporation that it is a major employer in a small community to devote resources to providing amenities to that community or it improving its government,” he writes. “That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage or sabotage or have other worthwhile effects.” And yet, Friedman resisted a full-throated endorsement of such endeavors, which, he said, were more often the consequence of a temptation to rationalize an “exercise of ‘social responsibility’” than a determination of what the bottom line requires.
Friedman well understood the permissive posture of the courts in respect to such matters. Under the auspices of the so-called business judgment rule, courts were, and remain, willing to uphold almost any decision made by a board of directors so long as it is framed in terms of the best interests of the company. Given his enthusiasm for limited government, the great economist could not have wanted the judiciary to take an active hand in managing companies, and his own ironclad commitment to individual liberty was not explicitly contradicted by corporations engaging in socially responsible behavior, however trifling and ill-considered, as long as a company’s decisions were transparent to shareholders. Nobody puts a gun to anyone’s head to buy shares of Crate and Barrel; and if a shareholder is outraged by a decision the company makes, the beauty of the stock market is that, unlike if she owned a Mondrian, she may liquidate her interest at most any time she pleases.
Friedman was hardly oblivious to such matters, so the frustrated tone of his essay had nothing to do with a mistaken assumption that corporate boards were refusing to abide by the laws (or that courts were failing to enforce them). Rather, it was an allergic reaction, intellectually speaking, to a sentimental drift among corporate chieftains who, in the way they ran their companies—too often preferring civic-mindedness to simple profit motive—were choosing to do precisely the wrong thing.
Why executives might embrace a broader notion of a corporation’s “social responsibility” is a matter that Friedman barely addresses, writing off such activities as the fruits of ignorance and a guilty conscience. The swift dismissal makes for the essay’s most dissatisfying moment. It seems crude, a little callow, and altogether inconsistent with someone who dedicated so much of his life to celebrating the wisdom of individuals who freely make their own decisions.
It also omits the historical developments that help to explain why the heads of so many major companies were, to Friedman’s eyes, so consistently misbehaving.
Nowadays we often forget what a recent phenomenon publicly traded companies are. Consider that, in 1800, there were only 335 profit-seeking companies in the United States, nearly all of which had been organized in the previous decade. In terms of manpower, these were relatively small initiatives, most involving only a few shareholders, almost all of whom worked for the company. The first substantial manufacturing enterprise, the Boston Manufacturing Company, wasn’t even organized until 1813. Ten years after its incorporation, the textile firm had only 11 stockholders. By 1830, it had 76. And by 1853, a whopping 123.
It wasn’t until the second half of the 19th century, with the arrival of heavy industries that required the kind of investment no single person or family could shoulder, that joint-stock companies began to proliferate. Consistent with that development was a growing complexity in business enterprise. As Harvard historian Alfred D. Chandler Jr. noted in The Visible Hand: The Managerial Revolution in American Business, his Pulitzer Prize–winning work of history, “Before 1840, two or three men could administer all the activities of any enterprise involved in the distribution of goods might be called upon to handle.” Yet, even with the rise of the railroads, the first multiunit industry that required intense capital investment and a complex corporate bureaucracy, it would be decades before the widespread development of the essential sociological characteristic of any major public company: a hierarchy of salaried middle managers.
It is hard to overstate how profound all of these changes were to American capitalism, but Chandler gave it his best shot. “A businessman of today would find himself at home in the business world of 1910,” he wrote, “but the business world of 1840 would be a strange, archaic, and arcane place. So, too, the American businessman of 1840 would find the environment of fifteenth-century Italy more familiar than that of his own nation seventy years later.”
Rather than isolated spheres of activity, Hayek understood, corporations are creatures of civilization, and therefore their actions should reflect what qualifies as civilized behavior.
These changes, and their implications for business and American society in general, were not lost on the men and women who came of age between World Wars I and II. In Concept of the Corporation, a landmark study of General Motors first published in 1946, the sociologist and management guru Peter F. Drucker called the modern company the defining institution of American life. “[T]he large corporation,” he wrote, “has emerged as the representative and determining socio-economic institution which sets the pattern and determines the behavior even of the owner of the corner cigar store who never owned a share of stock, and of his errand boy who never set foot in a mill.” As such, he concluded, “the character of our society is determined and patterned by the structural organization of Big Business, the technology of the mass-production plant, and the degree to which our social beliefs and promises are realized in and by the large corporation.”
How well do major corporations reflect the highest aspirations of American society? Economists, politicians, public intellectuals, labor leaders, and business executives alike wrestled with that question for decades before Friedman effectively told them they needn’t bother. “What does it mean to say that ‘business’ has responsibilities?” he sniffed. “Only people have responsibilities.”
This is a rhetorical sleight of hand and Friedman at his most philosophically obtuse. Whether we’re discussing Standard Oil, or for that matter the Rockefeller family or the University of Chicago, we frequently talk without any confusion about the mission, character, and responsibility of complex associations. There may be good reason, however, for not doing so, which is really what Friedman was after. His essay was written at the height of the Cold War, when one might reasonably conclude that casually speaking in collectivist terms provided unwitting intellectual support to the claims of Karl Marx. For Friedman, talk of corporate social responsibility, by business executives no less, posed just such a danger.
“I have been impressed time and again by the schizophrenic character of many businessmen,” he wrote near the end of his essay. “They are capable of being extremely far-sighted and clearheaded in matters that are internal to their businesses. They are incredibly short-sighted and muddle-headed in matters that are outside their businesses but affect the possible survival of business in general.”
Fair enough, but a contemporary reader might reply, “Professor Friedman, it’s no longer 1970.”
Past, present, and future
This year marks the 30th anniversary of the fall of the Berlin Wall, the most outrageous monument to the failed experiment of Marxist expansionism. If the specter of global Communism stiffened Milton Friedman’s spine, and gave him good reason for being intellectually mulish, the shade has departed, and to suggest that it remains in any manner that remotely resembles the world Friedman knew is to trivialize the devastation it visited.
Today, only a person committed to plugging his ears against the appeals of history would suggest that the threats to capitalism of Friedman’s day remain our own, which may be one reason Friedman’s vision of the place and purpose of a company is losing adherents. Some, notably Harvard’s Oliver Hart and Chicago Booth’s Luigi Zingales, have attempted to update Friedman’s thesis by providing a more complicated vision of what constitutes the “self-interest” of shareholders. (See “It’s time to rethink Milton Friedman’s shareholder value argument,” Winter 2017/18.) Others, such as billionaire Marc Benioff, the founder and chairman of Salesforce, have taken on Friedman directly. “Unfortunately, some CEOs still embrace this myopic view and believe that they have a duty to shareholders alone,” he wrote in the New York Times in October 2018. “I contend that business must have a purpose beyond profits, and that such purpose can, over time, benefit both stockholders and stakeholders.”
Ironically, in some ways, Benioff, Hart, Zingales, and others are lurching toward the conclusions of Friedrich Hayek. He shared his friend’s fear and loathing of Communism, and he largely agreed with the spirit of Friedman’s thesis. “Unless we believe that the corporations serve the public interest best by devoting their resources to the single aim of securing the largest return in terms of long-run profits, the case for free enterprise breaks down,” he wrote a decade before Friedman’s essay. And yet, this did not mean that “in the pursuit of this end [companies] ought not to be restrained by general legal and moral rules.” In fact, he continued, “certain generally accepted rules of decency and perhaps even charitableness should probably be regarded as no less binding on corporations than the strict rules of law.”
Rather than isolated spheres of activity, Hayek understood, corporations are creatures of civilization, and therefore their actions should reflect what qualifies as civilized behavior. How precisely companies might discharge this mission is a tricky matter, one inevitably subject to dispute, and if a wayward board of directors should decide to do nothing—nothing, that is, beyond satisfying their shareholders—this would be a bad choice, Hayek believed, but one they should be free to make.
A willingness to tolerate fairly poor decisions is the practical upshot of “free to choose,” a commitment to human liberty that is stress tested by actions that appear like folly to wisdom’s eyes even when wisdom is willing to honor them. Wisdom still honors Friedman’s austere vision of corporate social responsibility nearly 50 years after it was first articulated, but in an age when the greatest threats to capitalism come from within, rather than from without, increasingly it seems like folly to embrace it.
John Paul Rollert is adjunct assistant professor of behavioral science at Chicago Booth.
- Oliver Hart and Luigi Zingales, “Companies Should Maximize Shareholder Welfare Not Market Value,” Journal of Law, Finance, and Accounting, November 2017.
- Lynn A. Stout, “Why We Should Stop Teaching Dodge v. Ford,” UCLA School of Law law-econ research paper, January 2008.
More from Chicago Booth Review
We want to demonstrate our commitment to your privacy. Please review Chicago Booth's privacy notice, which provides information explaining how and why we collect particular information when you visit our website.