The purpose of a corporation is to seek profits, not popularity. But corporate managers are increasingly under immense socio-political pressure to take stances on controversial issues or commit corporate resources for symbolic effect. For example, so-called “investments” in ESG categories (an acronym standing for environmental, social justice or sustainability and governance issues), put a shine on corporate activity but often have little benefit to shareholders. And they often do not even help much the causes to which those diversions of firm capital are directed.
Under traditional corporate governance rules, little of this is authorized. Such socially conscious, popularity-driven management decisions violate a corporate managers’ duty to focus exclusively on maximizing shareholder value.
Yet, in a strange move two years ago this week, the Business Roundtable gave cover to corporate managers who desire to shirk this duty and succumb to socio-political pressure to appear socially virtuous. The Business Roundtable’s Aug. 19, 2019 “new Statement on the Purpose of a Corporation” embraced a “stakeholder” (rather than stockholder) paradigm for what it admitted “redefines the purpose of the corporation.” Over 180 CEOs made a commitment to “lead their companies for the benefit of all stakeholders – customers, employees, suppliers, communities and shareholders.” And they made this shift illegitimately because nothing about it came with shareholder command or even consent.
This vague and multi-metric standard for defining corporate duties is riddled with problems. First, investments of corporate resources are usually zero-sum. If funds are directed toward funding social causes, those funds are not being returned to the shareholders or invested back into a firm to increase its value.
One of the qualities of a good corporate officer is her ability to focus on duties and hold at bay pressures to deviate from the focus on shareholders. Heads of charities have the luxury to think creatively about doing social good. But corporations are not charities.
Indeed, asking corporations to act like charities is counterproductive. Focusing on shareholder value is the highest social cause because it leads to the greatest amount of wealth creation. As corporations and their shareholders maximize wealth, resources flow into the economy in ways that necessarily increase overall social welfare. This is why the title of Milton Friedman’s 1970 New York Times essay, “The Social Responsibility Of Business Is to Increase Its Profits,” so concisely and effectively summarized these duties.
It is important to consider why Friedman stressed that “The view that . . . corporate officials and labor leaders have a ‘social responsibility’ that goes beyond serving the interests of their stockholders or their members . . . shows a fundamental misconception of the character and nature of a free economy.” Corporations operate under a separation of ownership and control. Shareholders own, while managers control decisionmaking, and seldom the twain shall meet.
Furthermore, shareholders generally have highly diversified portfolios, meaning they exercise oversight as the principals in the relationship over their agent managers through contractual provisions and corresponding legal regimes that impose clearly defined duties for corporate managers.
The risk that managers will pursue interests misaligned with the interests of their principals (the shareholders, who are there to get a financial return on their investment) creates what are known as “agency costs.” To decrease these agency costs and eliminate the need to micro-monitor, something which would defeat the idea of separation of ownership and control and make investment more costly than it is worth, corporate managers are subject to a duty to maximize shareholder wealth. From that focused metric, an effective and low-cost system for evaluating a manager’s performance and for controlling agency costs emerges.
Because shareholders have diverse portfolios, they remain rationally ignorant of day-to-day corporate decisionmaking and have no desire to micromanage the control operations of the managers. Consequently, shareholders rely on the contractual duties and the single metric of share value profit maximization reflected in share price as their guide for determining whether or not corporate managers are doing a good job or need to be replaced. Outsiders too use the low profitability of the corporation or low share price to identify poorly managed firms that are prime targets in the market for corporate control for takeovers and the concomitant benefits for shareholders that follow from replacing underperforming management.
Whether a corporate manager is doing well at achieving ESG goals, for example, is impossible to measure, setting aside that achieving those goals was not why the shareholders invested. Consequently, none of the functions served by the traditional corporate purpose model work under the regime advocated for by the Business Roundtable. Once a variety of vague metrics are introduced to judge allowable, appropriate, or even desirable managerial behavior, with ill-defined modes of measurement to determine whether the manager is doing a good or a bad job, the shareholders’ ability to conduct oversight collapses and managers are left unaccountable.
That is the kind of world that the Business Roundtable’s statement two years ago inevitably welcomes and that would make Milton Friedman cringe. This is not an anniversary to celebrate. Instead, it is one that every year requires ringing a warning bell lest we fall prey to its siren song.
Donald J. Kochan is professor of law and deputy executive director of the Law & Economics Center at the George Mason University Antonin Scalia Law School.