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Revisiting Milton Friedman’s Critique of Stakeholderism

The Nobel laureate economist argued that CEOs and boards should focus on maximizing shareholder value, not stakeholder value.

Exactly 50 years ago, economist Milton Friedman argued that corporate boards should focus on maximizing shareholder value and not get wrapped up in trying to achieve other objectives. The conventional wisdom in boardrooms today seems to be that Friedman was wrong. In fact, though, a lot of what he wrote was spot on. Sadly, the current emphasis on “stakeholder value” is one part enlightenment, one part public relations, and one part an attempt by corporate directors to get a freer hand to run companies as they personally see fit.

True, as the ESG (environment, social, governance) movement contends, there are legitimate reasons to take into account the interests of stakeholders other than shareholders. But it takes sophisticated reasoning, not just hand-waving, to address the critique of Milton Friedman, the libertarian icon who won a Nobel memorial prize in economics in 1976.

The title of Friedman’s article in the New York Times Magazine on Sept. 13, 1970, was “The Social Responsibility of Business Is to Increase Its Profits” [PDF]. His thesis was as provocative then—the year of the first Earth Day—as it is now. Echoing arguments he’d made eight years earlier in his book Capitalism and Freedom, Friedman wrote: “What does it mean to say that the corporate executive has a ‘social responsibility’ in his capacity as businessman? If this statement is not pure rhetoric, it must mean that he is to act in some way that is not in the interest of his employers.” That, Friedman argued, is unjustified and nonsensical.

In the past few years, 2019 in particular, corporate directors and chief executive officers have moved sharply away from Friedman’s thinking. In August 2019, the Business Roundtable, which had long upheld Friedman’s shareholder primacy, put out a pro-stakeholder statement that was signed by CEOs of 181 companies with a combined market capitalization of more than $13 trillion. It said, “While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders.” The World Economic Forum issued a Davos Manifesto in December, saying: “The purpose of a company is to engage all its stakeholders in shared and sustained value creation.”

The University of Chicago, where Friedman taught for 30 years until his retirement in 1977, is in the middle of taking a closer look at his legacy. On Sept. 10 and 11, the university’s Booth School of Business and its Stigler Center held a virtual conference called “Political Economy of Finance 2020: Should Corporations Have a Social Purpose?” Speakers included Oliver Hart of Harvard, himself a Nobel laureate in economics.

One of the papers presented at the Chicago conference channels Friedman and questions the logic of shareholder capitalism. “The Illusory Promise of Stakeholder Governance” is by Lucian Bebchuk and Roberto Tallarita of Harvard Law School. “Stakeholderism,” it says, “would increase the insulation of corporate leaders from shareholders, reduce their accountability, and hurt economic performance.”

The weak theory of stakeholderism is that taking into account the interests of employees and so forth is ultimately good for shareholders. But that’s so obvious as to be meaningless. Even Friedman said CEOs and directors should take actions that help others if they benefit shareholders in the long run. (And, of course, they should obey the law at all times.)

The strong theory of stakeholderism, which is the only version with enough meat to be interesting, says that CEOs and boards should occasionally take actions that conflict with maximizing the share price. That’s the one Bebchuk and Tallarita disagree with. Boards and managers could use it to justify underperformance by fuzzing up what they’re responsible for achieving. “Indeed, we argue, the support of corporate leaders and their advisors for stakeholderism is motivated, at least in part, by a desire to obtain insulation from hedge fund activists and institutional investors. In other words, they seek to advance managerialism by putting it in stakeholderism clothing.”

By the way, opposing stakeholderism doesn’t imply throwing stakeholders to the wolves. Bebchuk and Tallarita says they are more reliably protected by laws and regulations than by the whims of corporate leaders. “Some of the adverse effects that companies impose on stakeholders raise serious policy concerns and warrant legal and regulatory intervention,” they write.

Luigi Zingales, a professor at Booth who organized the Chicago conference (with Paola Sapienza of Northwestern University’s Kellogg School of Management), says that the intellectual basis for stakeholder capitalism can be rescued. He presented part of his argument in an essay called “Friedman’s Principle, 50 Years Later” for the journal ProMarket introducing the conference, and added some thoughts in a telephone interview.

One pro-stakeholder argument, which Zingales and Harvard’s Hart made in a 2017 paper, is that shareholders care about more than just the bottom line, so it’s perfectly consistent for boards to focus on maximizing shareholders’ overall welfare, not just market value. For example, say one company’s shareholders worry about global warming. It’s cheaper and easier for the company to reduce its greenhouse gas emissions than for its shareholders through their private actions to reduce their emissions by an equal amount, so the company should be the one to do it.

It would be more efficient for the government to force companies to lower emissions through a tax or cap, but government doesn’t always do what’s right, so shareholders sometimes need to take matters into their own hands, Zingales says. Another example is when merchants voluntarily curb sales of firearms beyond what state laws require.

Another line of attack on Friedman’s shareholder primacy is that it becomes absurd in the extreme. Assuming that campaign contributions are legal, says Zingales, “In principle, if you take Friedman to an extreme, I should sue a CEO who doesn’t buy off all the members of Congress.” Not many people would endorse that.

Zingales’s third line of attack on Friedman, and thus a partial justification of stakeholder capitalism, is that companies are not just value-neutral contractual arrangements, but rather have a responsibility to do good for society. “Historically we know that corporations were born as public institutions with a special privilege granted by the state,” Zingales says. “Even today, we do know that the privilege of limited liability, especially with respect to tort claims, is an extraordinary privilege granted by the state. So to what extent does this special privilege bring with it a special responsibility?”
 
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    Bloomberg Businessweek Writer
    Peter Coy
    Bloomberg Businessweek Writer
    Peter Coy is the economics editor for Bloomberg Businessweek and covers a wide range of economic issues. He also holds the position of senior writer. Coy joined the magazine in December 1989 as telecommunications editor, then became technology editor in October 1992 and held that position until joining the economics staff. He came to BusinessWeek from the Associated Press in New York, where he had served as a business news writer since 1985.
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