In 1970, Nobel prize winning economist, Milton Friedman, published an article in the New York times
where he outlined why he believed business should stop caring about being socially responsible and start focusing on maximizing shareholder value. Friedman states that:
“There is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits.”
Friedman argued that corporations valued social responsibility too much. He held that their overemphasis on providing jobs, fighting pollution and reducing discrimination in society caused inefficiency and they instead should consider the shareholder more.
In the article, Friedman promulgates the belief that executives should be seen as people independent of the business. He writes:
“ As a person, [the executive] may have many other responsibilities that he recognizes or assumes voluntarily—to his family, his conscience, his feelings of charity, his church, his clubs, his city, his country. He may feel impelled by these responsibilities to devote part of his income to causes he regards as worthy, to refuse to work for particular corporations, even to leave his job, for example, to join his country’s armed forces. If we wish, we may refer to some of these responsibilities as “social responsibilities.” But in these respects he is acting as a principal, not an agent; he is spending his own money or time or energy, not the money of his employers or the time or energy he has contracted to devote to their purposes. If these are “social responsibilities,” they are the social responsibilities of individuals, not of business.”
These beliefs inspired the sentiment of his former student, Michael Jensen. In 1976, Jensen published a work entitled Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure where he outlined the idea that shareholders should be seen as principals of a business who hire board members that, in turn, function as agents responsible for hiring executives.
Note: In case you didn’t know, in economics, the principal-agent concept always refers to a situation in which a principal hires an agent to behave on their behalf. To illustrate this, Investopedia cites an example of an investor buying shares through a fund manager. The former represents the principal while the latter is the agent. As the agent, the fund manager is tasked with managing the investment so as to maximize returns for the investor the best they can considering the investment’s level of risk.
Friedman’s thoughts on maximizing shareholder value and Jensen’s furthering has resulted in the evolution of the way today’s businesses are typically run. The philosophy has created interesting results that some people haven’t been happy with. Jensen himself is quoted saying, “Has it happened the way I wanted it to happen? Eh, probably not, there’s always going to be some people who take it too far. And then cause damage.”
Why maximizing shareholder value took hold
According to Rick Wartzman, author of the Pulitzer Prize winning book The End of Loyalty, the business model of the 1970s was struggling to stay afloat due stagflation.
Stagflation was previously thought impossible. It’s a situation where there is high unemployment, slow economic growth and high inflation.
But besides this, it seems that the reason is because the philosophy of maximizing shareholder value is really good for business in terms of earning money.
For instance, Jack Welch became the CEO of General Electric in the 1980s. Under his leadership, the firm downsized more than 100,000 workers in five years, cut entire divisions and plants and demanded that his managers either “fix it, sell it or close it.”
G.E. was transformed from a $14 billion to one that earned more than a $400 billion. Welch himself made nearly a billion dollars. A similar example occurred at IBM.
In the 1990s, IBM’s CEO, Louis V. Gerstner Jr, cut about 60,000 workers and outlined eight principles the company would begin implementing for success. The company’s primary “measures of success” were shareholder value and customer satisfaction.
Someone who spent about $16,000 buying 1,000 shares of IBM in 1980 would now be sitting on more than $400,000 worth of stock, a 25-fold return.
The philosophy of maximizing shareholder value is still around today. Indeed, it’s many businesses’ Modus operandi. There are definite implications for the belief. Cornell law professor, Lyn Stout, thinks it’s led directly to scandals including Enron, the BP oil spill and the 2007-08 financial crisis. Surely, others might say the economic outcomes outweigh potential risks. We at Thought Force do not intend to proselytize one way or the other. We are simply sharing the idea for you to consider. If you’d like, share your take on the subject in the comments section below.