Milton Friedman Versus Stakeholder Capitalism
Yves here. Jomo Kwame Sundaram continues his takedown of Milton Friedman’s legacy. Note that I’m not keen about the expression “stakeholder capitalism”. However, the prevailing view among economists and even corporate executives themselves prior to the concerted effort to move US values to the right was that companies were responsible to the broader communities in which they lived. This attitude may have resulted in large measure due to the fact that American companies, even public ones, were smaller than they are now. Their top executives were leaders in the towns in which they were headquartered and thus wanted to be respected by other local notables.
The flaw with “corporate social responsibility” as a way to get companies to behave better, as opposed to the fear of not being admitted to the best country club in town, is that it relies on shareholders to discipline companies. As we’ve written at some length, based on the foundational work of Amar Bhide in his article Efficient Markets, Deficient Governance, the price for liquid and readily tradable stocks is a monster corporate governance. Unhappy shareholders will simply sell and move on rather than do the hard and not profitable work (in terms of return on their effort) of getting companies to shape up. The sole exception is activists who find particularly promising targets and accumulate enough shares to be a credible threat. The overwhelming majority of institutional investors have legal or commercial reasons not to operate that way.
By Jomo Kwame Sundaram, a former economics professor, who was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought. Originally published at Inter Press News
Friedman’s monetarist economics is now widely considered irrelevant, if not wrong, especially with the low inflation associated with ‘unconventional’ monetary policies following the 2008-2009 global financial crisis.
Nevertheless, Friedman’s ‘shareholder capitalism’ doctrine remains influential in most financial markets, especially emerging ones in the developing world.
His doctrine, prioritizing short-term profit maximization, has long dominated Anglo-American corporate governance despite chatter about ‘stakeholder capitalism’ and ‘corporate social responsibility’ (CSR).
Chicago University’s Raghuram Rajan claims that long-term share value maximization can advance almost everybody’s long-term interests.
But even Glenn Hubbard acknowledges that long-term shareholder-value maximization cannot address many problems faced by firms, let alone societies. Having served George W. Bush’s conservative administration, he recognizes the need for public policy interventions.
Friedman’s shareholder primacy principle can also become absurd. Rajan’s former co-author Luigi Zingales argues, “if you take Friedman to an extreme, I should sue a CEO who doesn’t buy off all the members of Congress”.
More importantly, Zingales points out that corporations have duties as public institutions with special privileges granted by the state such as “limited liability, especially with respect to tort claims, is an extraordinary privilege granted by the state”, implying reciprocal obligations.
Friedman’s manifesto insisted that companies focus on making money, leaving ethical matters to individuals and government. US law enshrines shareholder rights as owners able to challenge or replace boards whose members stray from their fiduciary duty.
Friedman vehemently opposed stakeholder capitalism, whose proponents argue that companies have responsibilities to all stakeholders, not only shareholders, but also employees, customers, society and even nature.
He argued that ‘stakeholders’, typically ill-defined, will insulate directors from shareholders, reduce their accountability, and compromise corporate performance. This would allow executives to pursue their personal priorities or cover up their own failures.
Straying from Friedman’s singular focus on profit maximization would mean that corporate executives are no longer loyally and exclusively serving shareholders, worsening the ‘principal-agent’ problem.
For Friedman, government and other stakeholders should not be allowed to interfere with shareholder corporate governance in any way, or worse, undermine incentives for investors to risk their capital. In his doctrine, profit alone should be corporations’ sole motive.
Joseph Stiglitz has noted that US courts have ruled that firms are obliged to maximize profits and shareholder value, excluding all other objectives. Hence, ‘stakeholder capitalism’ is not rooted in US law as corporate executives are not accountable by law to the communities in which they operate, or even to society at large, let alone to nature.
What a Wonderful World?
Friedman also presumed market imperfections did not exist, or would be fully taken care of by regulation. However, the rule of law has never really been adequate to such challenges.
Thus, he effectively gave companies ‘moral cover’ to be ruthless, free and unregulated to pursue their own interests, at the expense of the public good, while not worrying about society’s larger interests.
Friedman also criticized business leaders for straying from maximizing profits and worrying about their public image, the social good and public welfare.
While dismissing talk of stakeholders as attempts by company directors to be free to run companies as they like, and for public relations, Friedman approved of companies that “generate good will as a by-product of expenditures that are entirely justified in its own self-interest”.
But he was conspicuously silent about business interests lobbying, rigging elections, making campaign contributions, compromising research and public discourse, while reputation laundering with philanthropy and public relations.
Friedman’s world view is remarkably simplistic, typically ignoring broader, ‘longer term’ consequences. For him, business efficiency — due to shareholder primacy, not undermined by company directors, managers, government taxes and regulations — can and will solve all problems.
Friedman’s neoliberal ‘doctrine’ shaped major economic reforms the world over from the 1980s until the 2008-2009 global financial crisis. Lacklustre growth since then has given rise to various new challenges to shareholder capitalism, not least in the name of other stakeholders, and appeals for corporate governance reform and CSR.
Multi-millionaires, even some billionaires and chief executive officers (CEOs), have joined the dissent, whom influential businessman writer Andrew Ross Sorkin would have us believe represent the future.
To be sure, many have undoubtedly turned away from Friedman’s thinking in recent years.
In 2019, the influential Business Roundtable, which had long advocated shareholder primacy, issued a pro-stakeholder statement. It replaced its Friedmanite Statement on the Purpose of a Corporation with “a fundamental commitment to all of our stakeholders”.
A few months later, the World Economic Forum issued a similar 2020 Davos Manifesto, embracing stakeholder as well as environment, social and governance (ESG) principles.
Nevertheless, legendary investor Warren Buffett remains sceptical of ‘purpose-over-profit’ stakeholder advocacy. “In representing your interests, business-savvy directors [will] seek managers whose goals include delighting their customers, cherishing their associates and acting as good citizens of both their communities and our country.”
Meanwhile, most advocating a stakeholder approach to corporate governance argue that considering the interests of employees or other stakeholders is good for company profits and shareholders. Yet, they privately acknowledge that profits must come first, even if they feel constrained to say so in public.
Corporate Social Responsibility?
Some argue they are defending capitalist free enterprise in the long term by having a ‘social conscience’ and taking responsibility for providing employment, avoiding pollution and pursuing other trendy CSR reforms, ostensibly in companies’ ‘enlightened self-interest’.
Others insist that many contemporary problems are too urgent for slowly meandering political processes. Instead, they argue, CSR “is a quicker and surer way to solve pressing current problems”.
CSR is said to be a useful, if not necessary complement to government policy and regulation. Friedmanite critics object that CSR involves spending shareholder money for a typically vague public interest, reducing company returns and spending ‘other people’s money’.
Friedman warned that the doctrine of ‘social responsibility’ would take over if not checked. But the converse is more true today as ‘greed is good’ and the ‘short-termist’ shareholder mentality is clearly hegemonic.
Others object that CSR involves the ‘socialist’ view that political, not market mechanisms are better for allocating scarce resources to alternative uses. But CSR has also been invoked to justify wage curbs against trade union demands, ostensibly for some higher public purpose.
CSR has also been invoked when philanthropy and charity have been abused to minimize tax liability, and for public relations and marketing, e.g., by ‘greenwashing’ products and services.
Embarrassingly, US corporations that signed the ‘stakeholder capitalism’ statement have been more likely to lay off workers in response to the COVID-19 pandemic, and less likely to donate to relief efforts.
With growing opposition to neoliberal capitalism, ‘stakeholderism’ and CSR have been invoked to save capitalism by offering a more sensitive ‘human’ face.
As capitalism may well be the only ‘show in town’ for some time to come, popular demands for more thoroughgoing reforms, checks and balances are likely to grow as the realities of stakeholder capitalism and CSR become increasingly apparent.