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One of the most influential articles on the role of corporations in society is Milton Friedman’s “The Social Responsibility of Business is to Increase its Profits.” Written in 1970, the article argues that the only responsibility corporate executive have is to their bosses: the shareholders of the firm. Friedman argues that it would actually be unethical for corporate managers to divert company resources away from shareholders towards societal interest. This idea had a tremendous impact on the field of management, laying the groundwork for the concept of shareholder value in the 1980s, popularized by business leaders such as Jack Welch.
Since the 1980s, many people including Rebecca Henderson, Lynn Stout, Ian Mitroff, and R. Edward Freeman, among others, have challenged Friedman’s thesis. Instead, they have argued in favor of stakeholder value, or that executives do not simply have a responsibility towards shareholders, but other groups such as employees, customers, suppliers, and members of the communities in which firms operate. Legally, corporate managers have broad discretion in how they operate the firm, and can justify taking into account societal interests to protect the long-term value of the company. Recently, this idea has become quite prominent as a result of the famous “BlackRock memo,” written by CEO Larry Fink. As a major institutional investor, BlackRock stated that it would be taking into account corporate social responsibility in investment decisions because “profits and purpose are inextricably linked.”
Despite the increasing prominence of ideas related to stakeholder value, shareholder value remains the beacon that guides most business decisions. Why is this the case, given that most ordinary people demand more of big business than to simply return value for shareholders?
I’ll offer three reasons. First, the share price is a clear, tangible metric of a company’s performance that is realized from numerous transactions between buyers and sellers in a financial market. Second, in contrast to a share price, it is much more difficult to measure impact on stakeholders. Benefits to stakeholders are not traded in markets and are often not reported on financial statements. Companies rarely have the incentives or resources to adequately measure impact via randomized controlled trials. Third, although taking into account the interests of multiple stakeholders sounds good in theory, in practice we are not equipped with universally accepted frameworks to manage tradeoffs between stakeholders. For instance, what if a corporate action is good for employees or bad for consumers? Or good for suppliers but bad for the environment?
This is why much of the focus on stakeholder value has focused on “win-win” opportunities since no one can argue with these. For instance, an influential article on “shared value” by Michael Porter and Mark Kramer argues that companies are missing out on many opportunities to build value chains that benefit people, profit, and planet. Maybe that’s the case, maybe it isn’t. But even if it is, there still remains the deeper question of how firms should conduct themselves, because there will always be underlying tradeoffs between the well-being of various stakeholders. Unfortunately, the shared value framework provides no guidance on how to manage such tradeoffs, which is important if this theory is to displace shareholder value as a model for thinking about the role of corporations and society.
So how do we displace shareholder value as the be-all, end-all metric? We have to address the issues outlined above to create metrics that rival the share price in terms of their intuition and clarity. How do we measure impact? Even if we can measure impact, how do we assess and manage tradeoffs? Answering these hard questions is important. Focusing on the easy questions related to “win-wins” will not move the needle very far.
Moreover, although it may seem to be obviously a good idea for companies and investors like BlackRock to have a sense of purpose while maximizing long-run profits, this approach should be deeply frustrating to people on both sides of the debate over companies’ social responsibility. Devotees of Friedman should be worried that vague claims about future profits will inspire executives to take actions that conform to their own intuitions about what is good for society, but reduce their companies’ long-run profitability. And people who strongly disagree with Friedman and believe that companies have a higher goal than just profitability should be irritated when business leaders espouse societal objectives but are unwilling to specify when and how they are willing to forego some profits in order to promote those objectives.[This article was written in collaboration with Kenneth Shotts, The David S. and Ann M. Barlow Professor of Political Economy]
April 16, 2019 at 01:19PM
Forbes – Entrepreneurs