The Social Responsibility of Business is...
Rethinking today's supposed tradeoff between shareholders and stakeholders
One of the real joys of being a global generalist is that I constantly interact with people from different backgrounds across varied industries and numerous geographies. In the past six months alone, I’ve spent time meeting, speaking, or advising companies and individuals in Australia, Hong Kong, Canada, The United States, Panama, Colombia, Brazil, and the United Arab Emirates. I’ve spoken with executives and leaders in finance, agriculture, raw materials, professional services, transportation, construction, energy, and the education sectors. Unsurprisingly, the folks I’ve met have had a wide range of views on an even wider range of topics. Given the breadth of my exposure to diverse perspectives, it’s rare for me to hear thoughts that genuinely shock me.
Yet that’s exactly what happened this month when a senior leader whom I’ve known for years suggested it was problematic for me to have shared Nobel prize winning economist Milton Friedman’s New York Times article from 1970 about the social responsibility of business. I had shared it with a small group of leaders as we had been discussing the growing ESG focus in corporate America. My intent was to spur thinking around an important topic and to suggest there were alternative ways to think about the prevailing convention. And frankly, many of Professor Friedman’s ideas are as relevant today as they when he wrote them more than fifty years ago.
The opening paragraph of the article, “The Social Responsibility of Business Is To Increase Profits,” eloquently lays out the problem that Professor Friedman had with the pursuit of social goals:
Friedman goes on to note how management is merely executing a plan on behalf of owners, and that actions that take money away from shareholders can be better understood as a tax. He goes on to suggest a few examples:
What does it mean to say that the corporate executive has a “social responsibility” in his capacity as businessman?… It must mean that he is to act in some way that is not in the interest of his employers. For example, that he is to refrain from increasing the price of the product in order to contribute to the social objective of preventing inflation, even though a price increase would be in the best interests of the corporation. Or that he is to make expenditures on reducing pollution beyond the amount that is in the best interests of the corporation or that is required by law in order to contribute to the social objective of improving the environment. Or that, at the expense of corporate profits, he is to hire “hard core” unemployed instead of better qualified available workmen to contribute to the social objective of reducing poverty. In each of these cases, the corporate executive would be spending someone else's money for a general social interest. Insofar as his actions in accord with his “social responsibility” reduce returns to stock holders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customers’ money. Insofar as his actions lower the wages of some employes, he is spending their money.
A better solution, he notes, is for businesses and their leaders to focus on maximizing shareholder returns over the long term so that shareholders might be free to do what they wish with their profits. Not doing so, Friedman suggests, is an act of management taxing stakeholders without representation.
It’s stunning to see the parallels of Friedman’s piece with today’s environment. One argument I often hear is that today’s challenges are simply too difficult to overcome via market mechanisms alone. The problems are too urgent to wait for political or cultural change, the argument goes, and therefore businesses must play a role in addressing these social challenges by being more “responsible.”
Consider what Friedman wrote in 1970: “the problems are too urgent to wait on the slow course of political processes, that the exercise of social responsibility by businessmen is a quicker and surer way to solve pressing current problems.” He goes on to note that this logic is an admission that society appears unwilling to institute such social change, and social activists are “seeking to attain by undemocratic procedures what they cannot attain by democratic procedures.” He goes on to admit “in a free society it is hard for ‘good’ people to do ‘good,’ but that is a small price to pay for making it hard for ‘evil’ people to do ‘evil,’ especially since one man’s good is another’s evil.”
Friedman concludes his piece with a quote from his book, Capitalism and Freedom: “there is one and only one social responsibility of business— to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” Professor Friedman’s logic is the case for shareholder capitalism, a governance structure that focuses on profit.
The alternative to a pure profits objective is offered by stakeholder capitalism. While shareholder capitalism focuses on generating returns for the owners of a business, a stakeholder focus considers everyone who is impacted by the decisions of a business (employees, the community, the environment, etc.).
A clear and succinct articulation of the case for stakeholder capitalism was made by World Economic Forum founder Klaus Schwab in a post called The Davos Manifesto 2020; in it, he stated “a company serves not only its shareholders, but all its stakeholders – employees, customers, suppliers, local communities and society at large.” The stakeholder logic is a governance structure that tends to focus on purpose.
Thus, the debate over the social responsibility of a business seems to be an either-or choice. Either profits or purpose. Either stakeholders or shareholders. I really believe the very framing of shareholder vs. stakeholder is counter-productive. It presents the interest of many stakeholders as being at odds with shareholder return. Perhaps the actual problem is one of short-termism?
In the long run, a business that fails to treat its employees well will not have employees, or a business. In the long run, companies that pollute will hurt the very environment in which executives raise their families. And in the long run, every business leader I know wants harmonious relations with their local community, because they live in those communities. It’s only in the short-run that some of these matters become tradeoffs. This leads me to conclude that a long-term orientation is the ultimate best path forward.
Corporate boards work for the shareholders, but increasingly, they understand that their responsibility is to focus on the long-term. The Commonsense Principles for Corporate Governance, originally published in 2016 and updated in 2018, provides a framework for how they can do so. The Principles stress the importance of having directors who represent long-term shareholders. Specifically, the Principles call for “Creation of shareholder value, with a focus on the long term. This means encouraging the sort of long-term thinking owners of a private company might bring to their strategic discussions, including investments that may not pay off in the short run.”
It may also be a matter of semantics. If diversity efforts are intended to identify the best possible professionals to fill a job, is that any different than just good human capital strategy? If a company is responding to a customer’s desires for lower carbon emission in its supply chain, isn’t that designing an offering that is attractive to customers? Isn’t it just “good business” to find the best talent and meet customer needs?
Ultimately, I’ve come to conclude that the social responsibility of business is to increase its long-term profits and that by articulating the components of a good long-term strategy, there is no false choice between shareholders and stakeholders. Unfortunately, however, the focus of boards is too often on the short-term. It’s time to take a step back, dismiss false trade-offs, and restore a focus on maximizing long-term profits with purpose.
VIKRAM MANSHARAMANI is an entrepreneur, consultant, scholar, neighbor, husband, father, volunteer, and professional generalist who thinks in multiple-dimensions and looks beyond the short-term. Self-taught to think around corners and connect original dots, he spends his time speaking with global leaders in business, government, academia, and journalism. LinkedIn has twice listed him as its #1 Top Voice in Money & Finance, and Worth profiled him as one of the 100 Most Powerful People in Global Finance. Vikram earned a PhD From MIT, has taught at Yale and Harvard, and is the author of three books, The Making of a Generalist: An Independent Thinker Finds Unconventional Success in an Uncertain World, Think for Yourself: Restoring Common Sense in an Age of Experts and Artificial Intelligence and Boombustology: Spotting Financial Bubbles Before They Burst. Vikram lives in Lincoln, New Hampshire with his wife and two children, where they can usually be found hiking or skiing.