Milton Friedman's "Shareholder" Theory Was Wrong
theatlantic.com
theatlantic.com
""" It is productive—not 100% accurate, but a useful heuristic—to assume that all corporate governance debates in the U.S. are about whether shareholders or managers should have more power to control the corporation. There are other stakeholders, sure, but they are mostly tools in the shareholder/manager fight, not power centers in themselves. 6 So when an association of big public-company CEOs gets together and declares that corporations should serve the community, take care of the environment, and be responsible to employees and customers, not just shareholders, that might be because the CEOs have thought it over and decided that employees and the environment are getting a raw deal, but it is also possible that the CEOs have thought it over and decided that shareholders are annoying. """
[1] https://www.bloomberg.com/opinion/articles/2019-08-19/maximi...
In one sense, Levine's argument is for better tools for making, and costing / pricing in risks and rewards of future activities. Or perhaps he's observing that a bird in the hand wins over two, or four, or four hundred, in the bush, no matter what.
Given that risk, uncertainty, imperfect, and nonuniformly unveiled and available information are givens in the real world, this is a bit of a stumper for economics.
Alternatively, imposing obligatory constraints through other mechanisms -- say, competing and equally-considered stakeholder demands from employees, business partners, government, and community -- might be an alternate approach. Effectively removing some of the near-exclusive power now claimed by shareholders.
CEOs are employees. A group of employees just voted that they aren't responsible to the people that pay their salary, but to their impression of the interests of other people who don't.
You can bet if it was a group of middle managers at any of the firms those CEOs run that made that declaration, they’d very concretely stop being responsible to their employers before the ink was dry.
Which isn't too say that corporations, which are publicly chartered and granted public privileges, shouldn’t be answerable to someone other than the shareholders: they clearly should be accountable to the public by way of the chartering government. But that's not what these CEOs are saying, which is just “We shouldn't be responsible to the only people who are positioned to hold us accountable, to be vague amorphous interests that we interpret for ourselves, and which have no accountability mechanisms.”
A company should be able to state that its mission is (for example) to deliver the best electric cars in the world, and be able to do so without pressure from shareholders to fire the CEO when the CEO focuses on building production capacity instead of maximising quarterly profits.
“A company” is an abstraction. Who is declaring the mission? The shareholders? Or the CEO?
Yes, if the shareholders declare a mission, the CEO shouldn't generally be fired for pursuing it effectively.
If the CEO declares a mission, and the shareholders don't agree that it represents their interests for the firm, they absolutely should create pressure for the CEO to either reverse course or be removed.
vs
> Many business executives realized that wage and price controls would serve their business interest (no doubt by holding down the cost of labor and other inputs) and didn’t care whether they harmed the economy at large.
Those are the same thing. They were short sighted because price controls would serve their business interest in the short term.
"this new philosophy will not likely change the way corporations behave. The only way to force corporations to act in the public interest is to subject them to legal regulation."
Which Hayek was fine with (as shown in The Road To Serfdom).
https://www.dailykos.com/stories/2013/09/27/1241729/-The-Roa...
I don't know if I buy the whole social program thing, but the quote is correct. Reader's Digest: https://mises-media.s3.amazonaws.com/Road%20to%20serfdom.pdf
The costs approach effectively allows a firm to optimise for profits, but changes the weightings of various activities and products or inputs.
This may seem perhaps a pedantic or semantic way of looking at it, but I do think it somewhat gets to the heart of many of Friedman's beliefs regarding incentive structures. By understanding that corporations are ultimately essentially accountable to their shareholders, you can develop a model where the shareholders goals are aligned with the customers'. Some would argue that this is always the case given enough time, others would argue that it isn't and you thus need additional laws to create the alignment of goals (if you go to jail for harming your customers, then your shareholders all of a sudden have the goal of not harming your customers). The main distinction I'm trying to make is that this is a description of where agency lies, vs. pretending corporations have some "decision" as to who they are responsible to. I promise you that if tomorrow they decided they're all actually accountable to me, the CEOs would get fired and that would reverse fairly quickly.
The most interesting place this comes up IMO is in the emergent behavior of collective shareholders. Many people may believe they would tell Phillip Morris to behave a certain way, and yet, without knowing it, they actually indirectly tell them the opposite. If their retirement plan unbeknownst to them is invested in Phillip Morris, and Phillip Morris starts making decisions that are good for customers but lower profits, and thus random people get angry at their retirement fund managers and those managers pull money out of Phillip Morris and into some other venture that is more profitable, without knowing it they have sent a clear signal that "Phillip Morris is ACTUALLY accountable to shareholders, and in particular the money they make". This is the default case without actively doing any extra work. It is absolutely the case that if enough education is employed that people start choosing to tell their retirement funds to not invest in Phillip Morris because they are profitably harming customers, then you can have the more socially desirable effect of forcing them to behave in a way that doesn't harm customers. But again, the goal is to understand that "steady state" of this relationship.
No. Corporations are ultimately accountable to and exist at the pleasure of the state, full stop.
This piece is also the best takedown I've seen so far of Milton Friedman's influential article, "The social responsibility of business is to increase its profits."[a]
Key passages:
> ...if the purpose of a business is to “increase its profits,” as Friedman argued, then it is not only “clear-headed,” but also justifiable for a business to use its political influence to dismantle the free market that Friedman cherished.
> ...the notion that the big public corporations are tribunes for the free market is quixotic. Big corporations are islands of socialism within our market economy: Their bigness protects them from competition for customers and workers.
> ...[Businesses] can (like Facebook) break promises to respect their customers’ privacy. They can (like Twitter and Google) generate ad revenue by facilitating the transmission of hate speech. They can (as Exxon used to do) propagandize against climate science. They can (like Jimmy John’s) use illegal contract terms to deter their low-skill workers from quitting low-paying jobs. They can (like the tobacco companies and now the tech companies) push addictive products onto children, or (like Purdue Pharma) create a generation of drug addicts. And they can engage in corporate lobbying. The biggest problem with Friedman’s theory is that corporations can—and, according to his theory, should—use their influence in Congress to block laws that stop corporations from causing such harms.
> ...Nor was Friedman correct that business executives are the employees of the shareholders. Legally, business executives are employees of the corporation, which—crucially—they, not the shareholders, control. The shareholders have a contractual relationship with the corporation that entitles them to a share of its profits and a vote on certain major corporate decisions. Time and again, CEOs have used their power over the corporation to bat away shareholders when they propose that the corporation should act in a socially responsible way. When an employer says “jump” to an employee, the employee jumps. When shareholders say “jump” to the CEO, the CEO sues them.
The author is Eric Posner.[b]
Go read it.
[a] https://timesmachine.nytimes.com/timesmachine/1970/09/13/223...
Update: this appears to be a LaTeX-generated PDF based on the original column: http://umich.edu/~thecore/doc/Friedman.pdf
(From Matt Levine's Bloomberg article.)
That can be to make money but it doesn't have to be.
I dont agree. Most of them that is probably true. I think the purpose is whatever the founder wants it to be, and after they're gone its whatever the person in charge says it is. Perhaps they've agreed to follow the founders vision too. I think it's up to the one in charge to tell shareholders what the purpose of the company is and if an investor wants to buy in, that would be their informed choice.
Even under that concept, I think most companies would say their purpose is to make money. But what if the purpose of SpaceX really is to colonize Mars? Is that a problem? I think not.
You'll find a form of this expressed in Adam Smith's Wealth of Nations, though he speaks here in terms of the entire field of political economy:
POLITICAL œconomy, considered as a branch of the science of a statesman or legislator, proposes two distinct objects: first, to provide a plentiful revenue or subsistence for the people, or more properly to enable them to provide such a revenue or subsistence for themselves; and secondly, to supply the state or commonwealth with a revenue sufficient for the public services. It proposes to enrich both the people and the sovereign.
https://oll.libertyfund.org/titles/smith-an-inquiry-into-the...
Of incorporated firms -- joint-stock companies -- Smith is markedly less enthused, and limits them to serving in insurance and banking, major civil engineering, and public works projects.
The only trades which it seems possible for a joint stock company to carry on successfully without an exclusive privilege are those of which all the operations are capable of being reduced to what is called a Routine, or to such a uniformity of method as admits of little or no variation. Of this kind is, first, the banking trade; secondly, the trade of insurance from fire, and from sea risk and capture in time of war; thirdly, the trade of making and maintaining a navigable cut or canal; and, fourthly, the similar trade of bringing water for the supply of a great city.
https://en.wikisource.org/wiki/The_Wealth_of_Nations/Book_V/...
This is also the major thrust of Matt Levine's Bloomberg article on the Roundtable announcement commented elsewhere in this thread: https://www.bloomberg.com/opinion/articles/2019-08-19/maximi...
Edit: spelling.
His harshest criticisms were against those concentrations and abuses of power. His strongest and most heartfelt arguments were for the common man. He wasn't some wealth gospel preacher, despite often being portrayed as such. And his attacks on the power and dangers of corporations were well taken.
J.K. Galbraith's The Age of Uncertainty explores this in depth. As does much of the writing of Emma Rothschild. Among many others.