Back in 2019, the Business Roundtable, a nonprofit whose membership comprises most of the US’s top CEOs, issued a statement endorsing the view that the purpose of the business corporation is to deliver value to all stakeholders, not just to advance the interests of shareholders. The World Economic Forum, best known for hosting an annual winter meeting in Davos, Switzerland for bigwigs from business, international politics, and journalism, has also declared its allegiance to the stakeholder approach to corporate governance. Some advocates have celebrated these announcements as a shift toward a more enlightened form of capitalism.
Classical liberals and defenders of free markets are suspicious of stakeholder capitalism–rightly so, in my view. The relationship between a corporation’s management (i.e., its officers and directors) and its shareholders differs in important respects from the relationship between a corporation’s management and its non-shareholder stakeholders. Notably, management has a fiduciary duty to run the firm according to the interests of its shareholders that does not apply to non-shareholder stakeholders. Stakeholder approaches to corporate governance deny this, or at least neglect it.
But market-sympathizing skeptics of stakeholder theory go too far when they insist that the only proper goal for a corporation’s management is to maximize profit for shareholders. In his recent Wall Street Journal op-ed criticizing stakeholder capitalism, Alexander Salter writes that profits “are an elegant and parsimonious way of promoting efficiency within a business as well as society as large.” I agree with that. But Salter continues: “Stakeholder capitalism ruptures this process. When other goals compete with the mandate to maximize returns, the feedback loop created by profits gets weaker.”
It is one thing to claim that the profit motive is an important component of a proper understanding of business corporations, or that management of a corporation owes a fiduciary duty to shareholders. An adequate understanding of corporate purpose clearly needs to account for these facts. However, it is quite another thing to say that corporate purpose boils down to a mandate to maximize returns for shareholders. This is not a defensible claim, and defenders of market institutions and the profit motive should stop making it.
Consider the following cases, which are stylized simplifications of real life situations:
- The e-cigarette company Juul can either (a) maximize profit by maximizing its appeal to potential young smokers, developing flavors and social media marketing strategies that appeal to adolescents and young adults (who, if addicted to nicotine at a young age, are likely to remain customers of nicotine products for the rest of their lives), or (b) settle for less profit by eschewing the younger demographic, and actively seeking market share only among older cigarette smokers for whom e-cigarettes function mainly as a replacement for smoking combustible tobacco.
- River Blindness is a disease caused by a parasitic worm that results in severe discomfort and, eventually, blindness. The drug company Merck has discovered a new drug, Mectizan, that prevents River Blindness. However, Merck knows it will not be profitable to bring Mectizan to market–River Blindness is only common in economically less-developed countries in the tropics, and those who suffer from River Blindness are too poor to pay a price for treatment drugs such that it would be profitable for Merck to produce them. Merck can either (a) maximize profit by not devoting any further resources to developing and producing Mectizan, or (b) settle for less profit by devoting some of its resources to developing, producing, and distributing Mectizan.
It seems to me that there is a strong argument to be made that the right choice in both of these cases is (b), the non-profit maximizing choice. At least, that’s my intuition. Intuitions about cases like these seem to provide reason to doubt that we can reduce business ethics to shareholder value maximization. If I am right, it is not just that there are moral and legal restrictions on what firms can do in pursuit of profit maximization—which I take to be obvious—but that the very idea of profit maximization is misguided way to understand what the purpose of corporations should be.
Of course, when we’re trying to adopt well-justified ethical beliefs, intuitions are more like the first words than last words, and further reflection may prove our intuitions wrong. So let me briefly consider, and respond to, a few objections.
A defender of shareholder value maximization might argue that cases like the Juul scenario can be addressed by adding constraints to the imperative to maximize profit. People who say corporations should maximize shareholder value don’t think corporations can employ just any means at their disposal for the sake of profits: Milton Friedman , for example, in his famous essay in defense of the profit motive, mentions rules “embodied in the law and those embodied in ethical custom” as legitimate constraints on profit-seeing. The US and many other countries already have laws in place prohibiting marketing and selling nicotine products to youth. Those who advocate shareholder value maximization defend pursuing profits within the rules of the game established by the law. So they arguably have the resources to justify choice (b) in the Juul case.
There are a couple of issues with this response. First, it seems to rely on an unduly optimistic picture of laws and law-making processes in the real world. We can’t depend on flawed political systems to establish definitively what kinds of business conduct are beyond the ethical pale—in a world in which some laws are unjust, it’s naive and dangerous to rely too heavily on the law as a minimal baseline for morality. Second, even if there are laws prohibiting marketing and selling tobacco products to individuals under the ages of 18 or 21, that doesn’t mean that it is straightforwardly permissible to attempt to maximize returns by figuring out the most effective ways to get 19 or 22 year-olds addicted to your product. It may be permissible to sell addictive nicotine products to young adults of a certain age—I think it is, at some point—but that doesn’t mean that the right way to approach such transactions is to try to literally maximize the profit they generate. Of course, defenders of shareholder value maximization could follow Friedman and appeal to ethical custom, in addition to the law, as a legitimate source of ethical constraint on profit maximization. But then there’s some serious work to do in specifying the content of these ethical customs. And, of course, the resulting view is going to be pretty different from what most people are likely to understand when somebody says that the only proper purpose of corporations is to maximize profits.
Unlike the Juul case, case 2 involving Merck doesn’t just implicate constraints on how profit may be pursued. Justifying non-profit maximizing choice (b) in the Merck case would seem to require endorsing Merck’s pursuit of a goal other than profit maximization, rather than just endorsing a constraint on how Merck may permissibly pursue profit.
Defenders of shareholder value maximization might say that, while producing Mectizan seems like a nice thing for Merck to do, it’s not the proper function of a shareholder-oriented corporation like Merck to be diverting some of its resources from profitable employments expected to produce returns for shareholders to charitable employments that are not.
I’ve already said that I agree that an adequate normative account of organizations like Merck requires recognizing a fiduciary duty on the part of management to run the organization in a way that’s broadly in the interests of shareholders—we should not expect companies like Merck to mainly pursue charitable initiatives. But what reason do we have for thinking that it is never even permissible for companies like Merck to devote corporate resources to good charitable causes, as a commitment to shareholder value maximization would appear to imply?
Some people think that the answer is found in the law: corporations are under a legal obligation to maximize shareholder value. But that’s not true. Neither state corporate law, nor typical corporate charters, impose a legal duty on corporate managers to maximize returns for shareholders. In fact, corporate law contains a well-established doctrine called the business judgment rule, which holds that courts will not second-guess decisions made by a corporation’s board of directors, even when those decisions predictably reduce profit or share value (as long as the board makes reasonable efforts to become informed and avoids personal conflicts of interest).
Some people think that shareholder value maximization is required because corporations are owned by shareholders. But the legal ownership rights shareholders have over corporations are highly attenuated: (1) they are residual claimants (i.e., if the corporation is wound down, they are entitled to whatever, if anything, is left over after it has met all of its contractual obligations), and (2) they have the right to elect and remove directors. Even these rights are extremely limited: for example, in practice, the costs of mounting a proxy battle for corporate board seats are insurmountable for dispersed shareholders. So it does not appear that shareholders’ ownership of the corporation, such as it is, can justify shareholder value maximization in a way that avoids begging the question.
It may well be permissible to establish and run a corporation that adopts shareholder value maximization as its single goal (provided that the corporation also adopts appropriate constraints on how that goal will be pursued). But defenders of shareholder value maximization argue for something stronger: that it is impermissible for corporations to adopt goals other than maximizing shareholder value. But why should we think that? What is wrong with people voluntarily coming together to participate in a corporate entity that adopts the goal of seeking profit along with other goals (e.g., for Merck, improving “the health and wellness of people and animals worldwide”). It seems, well, illiberal to insist that the only goal that corporations may adopt is maximizing shareholder value. Says who? On what authority?
To return to the point from Salter’s op-ed, it may well be the case that agency costs make it difficult to effectively monitor and control the management of firms that adopt multiple goals, rather than the single goal of maximizing profit. But it’s an empirical question whether some business organizations are able to successfully overcome this impediment to effectively serving their goals. The point about agency costs, though important, does not allow us to dismiss the possibility of an efficient and effective corporation that pursues goals other than just profit a priori.
Critics of stakeholder models of corporate governance are right to highlight how stakeholder views fail to account for the importance of the profit motive in market contexts, or for the special fiduciary duty that corporate management owes to shareholders. But we can recognize these truths without adopting the extreme and untenable position that the only thing corporations should be doing is maximizing the value they deliver to their shareholders.
I would like to dedicate this post to Waheed Hussain, who died recently at a tragically young age. Waheed was a philosopher at the University of Toronto. His writings about business ethics, including an article referenced in the post above, have taught me a lot over the years.
I would also like to thank Andrew J. Cohen for his feedback on an earlier draft of this post.