Brad M. Barber and Ayako Yasuda of the University of California at Davis and Adair Morse of UC Berkeley looked at investment in certain venture-capital funds to explore just how much pecuniary value investors might be willing to give up. They find that investors in dual-purpose VC funds (which aim to have a positive social impact as well as generate financial wealth) willingly sacrificed returns for the sake of creating social benefit.
Barber, Morse, and Yasuda analyzed investments by nearly 3,500 investors in more than 4,600 VC funds, 159 of which they identified as dual-purpose or impact funds. They find that impact funds realized an internal rate of return that was 4.7 percentage points lower than that of traditional funds. However, they also find that investors in impact funds were willing to pay for the opportunity to provide social impact. How much they were willing to pay varied considerably across investors—North Americans exhibited a lower willingness to pay for impact than European, Latin American, and African investors, for instance, perhaps reflecting regulatory differences in what factors investors such as pension funds are allowed to consider—but the researchers find that on average, the impact investors were willing to give up 2.5 to 3.7 percentage points on the internal rate of return when they made their investments.
Drawing the conclusion that shareholders’ desires “generally will be to make as much money as possible” may be too broad, the research suggests. But acknowledging shareholders’ competing priorities comes with its own set of problems—namely, if companies aren’t evaluating themselves solely on the profits they generate, how can they gauge whether they’re truly serving the interests of their shareholders?
One advantage of focusing on shareholder value is that it is relatively easy to quantify. When analysts start trying to evaluate a business along social or environmental dimensions, their assumptions quickly become murkier.
“Once you leave shareholder value, it’s a morass,” argues Kaplan, who is skeptical of the array of standards. “People are saying we should care about these other things, but they have no way to measure their value nor trade them off against
Money managers who review companies according to ESG factors have many approaches. Some of the most popular standards come from organizations such as the Global Reporting Initiative and the Sustainability Accounting Standards Board, which help businesses measure their impact on issues such as climate change and human rights. But there are many other reporting frameworks, and new ones are being developed all the time.
Despite these efforts to develop rigor, the competing measurement systems hold back investors. In its 2020 Global Sustainable Investing Survey, BlackRock finds that more than half of clients surveyed cited “the poor quality or availability of ESG data and analytics” as the largest barrier to broader adoption of sustainable investing.
However, an analysis conducted by Booth’s Rustandy Center for Social Sector Innovation suggests the metrics around corporate environmental and social performance may be gradually coalescing. Rustandy Center research professional Jingwei Maggie Li, Booth PhD student Shirley Lu, and Rustandy’s Salma Nassar examined the 2017 CSR disclosure reports for each of the 327 companies in the S&P 500 that released one, hand-collecting information about what data the companies disclosed. After dividing the metrics into nine subcategories (such as diversity, energy use, greenhouse gas emissions, and safety), they find that seven of the nine featured at least one metric disclosed by 100 or more companies. They also find evidence that companies are more likely to disclose information about the areas of CSR for which their industries have a larger negative impact: a far greater percentage of companies in the utilities, shipping containers, and automobiles/trucks industries disclosed metrics on their greenhouse gas emissions than did companies in the insurance or retail industries. The researchers conclude that the analysis shows that for each social or environmental category, companies are agreeing on a few key metrics. (For more on this research, see “How do companies measure their CSR impact?”)
In July 2020, researchers at Harvard added a new resource, publishing their assessment of the environmental impact of 1,800 companies as measured by the Impact-Weighted Accounts Project. They find that nearly all companies in environmentally intensive industries such as airlines, paper and forest products, and electric utilities would lose more than a quarter of their earnings before interest, taxes, depreciation, and amortization if they were financially responsible for the environmental harm they create from their operations. In some industries, such as chemicals, apparel, and construction materials, the researchers find a significant correlation between greater environmental damage and lower stock-market valuations—tying their results to the effect on shareholder value.
Government and the law
In laying out his doctrine, Friedman made a sharp distinction between the role of business and the role of government. It’s the government’s function to identify social priorities and craft fiscal policies to achieve them, he argued. When executives levy de facto taxes on shareholders or other stakeholders by making suboptimal decisions that may reduce profits, raise prices, or lower wages, “they are seeking to attain by undemocratic procedures what they cannot attain by democratic procedures.”
“The main thing that Friedman is worried about is that we would not want to be in an environment where the CEOs of companies, just because they happen to be the CEOs, are deciding for us as a society, as an electorate, which social objectives we care about and which we don’t,” Chicago Booth’s Marianne Bertrand said at a 2018 event hosted by the Rustandy Center and Booth’s George J. Stigler Center for the Study of the Economy and the State. She explained:
We hope that we have a political process in place where the preferences of the electorate about spending on schools or spending on alleviating homelessness would be expressed through the political system, but I think there is a concern that without some guidance as to what social goals companies should be pursuing, especially when those social goals are no longer fully aligned with long-term valuation, we might give corporations too much power.
However, there is reason to think that, in their concern for their bottom line, companies are subverting the government’s role in another sense. Corporations spend billions each year lobbying to change the regulators and the rules in their favor. Even when they break the law, harming employees with wage theft or customers with unsafe products, they are rarely criminally prosecuted, instead paying fines assessed through opaque out-of-court settlements, notes Anat Admati of Stanford. She points to the striking example of PG&E, a California utility, which pleaded guilty to 84 manslaughter charges for its role in a 2018 fire that destroyed a town. Its penalty? The company paid the maximum fine under California law of just $4 million.
With her colleague Greg Buchak, a Chicago Booth PhD graduate, Admati is gathering data to analyze how corporations fare in the justice system depending on the type of law, offender, harm, or jurisdiction, among other factors. “Friedman effectively presumes that law enforcement works properly,” Admati wrote in an October 2020 article for ProMarket, which was later published in a ProMarket e-book consolidating perspectives on the Friedman doctrine. “If enforcement outcomes depend on such factors as the identity of the perpetrator or the victim, then the administration of justice is perverted and the rules do not achieve their intended goal.”
Friedman in the 21st century
Friedman freely acknowledged in his Times essay that executives may make decisions that are mutually beneficial to the business and to its stakeholders. He gave the example of a small-town company:
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 or to improving its government. That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage and sabotage or have other worthwhile effects.
He argued, though, that ascribing those decisions to “social responsibility” was simply “a cloak for actions that are justified on other grounds.”
What’s wrong with applying a little marketing spin to self-serving corporate decisions? To Friedman, the effects of such disingenuous gloss couldn’t be more detrimental: “The use of the cloak of social responsibility, and the nonsense spoken in its name by influential and prestigious businessmen, does clearly harm the foundations of a free society,” he wrote.
His concern for free society, and how the notion of corporate social responsibility could undermine it, reflects the Cold War era in which he was writing. In September 1970, socialism still loomed as free markets’ most pernicious competitor, creating extraordinary political and military tension. In China, Mao Zedong was still chairman of the Chinese Communist Party; in Cuba, the missile crisis was still a fresh memory; in Vietnam, the US was still fighting a war to prevent Communism from expanding its influence. It was in this context that Friedman fretted that to suggest business had a social responsibility was to preach “unadulterated socialism.”
However, 30 years after the fall of the Berlin Wall, the menace of Communism is much diminished. “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,” writes Booth’s John Paul Rollert in a 2019 essay for Chicago Booth Review. “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.”
Today, Rollert wrote, “the greatest threats to capitalism come from within.” The contemporary era is one of numerous systemic concerns—climate change, inequality, and global pandemics, to name a few—and the free-market system is often blamed for many of them. Engaging with them may not only be good for individual businesses, but for capitalism itself.
In 2018, Marc Benioff, the CEO of Salesforce, wrote an op-ed in the New York Times advocating for a proposed tax on big business in San Francisco, which would be used to help the city’s homeless population. “Companies can truly thrive only when our communities succeed as well,” he wrote. “The business of business is no longer merely business. Our obligation is not just to increase profits for shareholders.”
At a time of widespread crisis, companies may not have to choose between shareholders and the community. In the 21st century, enriching one may require boosting the other.