Opinion

Time to abandon Friedman Doctrine?

R Krishnan | Updated on September 22, 2020 Published on September 22, 2020

Profit maximisation is not the sole purpose of business. Morality, not necessarily the market, should guide enterprises

“Man is the only animal that blushes. Or needs to..”

— Mark Twain

This month, half a century ago, Milton Friedman wrote a landmark essay in The New York Times that is keenly contested in policy and business circles even today. The essay was a clarion call for free-market capitalism influencing a generation of executives and political leaders. “The social responsibility of business is to increase its profits” became the oracle on shareholder value, with Friedman offering unsure CEOs an easy guiding principle: When in doubt, maximise profits. The communities outside the corporate world? Not your problem.

What are corporations for? The question is so fundamental that it is hardly asked or, when asked, the Friedman Doctrine is provided as the answer. Every business school curriculum begins with the premise that the goal of business is to maximise shareholder value, and the rest of the course follows from that.

What has this obsession with profit maximisation for shareholders brought us? Terrible racial, economic, and health inequalities, climate change catastrophe, short-termism, hostile takeovers and junk-bond financing. The creation of a billion-dollar corporation on the back of an idea involving few people, fewer computers, minimum space, and next-to-no capital (‘intangibles’) stands in stark contrast to the earlier ages of the corporation with their armada of ships, hordes of labourers, smoke-billowing factories, and dazzling multinational headquarters of far-flung corporate empires.

Foxes guarding chicken?

Stephen Hawking had warned of the harmful repercussions of removing humans from control of AI and making us no longer masters of our minds. We have already done that by allowing markets to become masters of our mindful corporations. In Friedman’s view, as long as a company operates within the law, it is free to maximise profits. What he ignored is that a savvy CEO can maximise profit by influencing those who create the laws, bending the system to his will.

Capitalism’s improbable messiahs are the activist investors (the new corporate raiders) who strike terror into the boards of public companies by buying bulk shares and demanding board seats to shake out their non-performing management — an example of blatant self-interest with foxes guarding chicken coops.

For Adam Smith, the corporation was infested with conflicts of interest between management and shareholders to the point that negligence and profusion must always prevail more or less, in the management of the affairs of such a company”. We are still grappling with the problem — 250 years after it was first identified.

The ‘financialisation’ and ’securitisation’ of corporations have metastasised them into rent-extraction vehicles benefiting current generations of owners to the detriment of the future. We must extricate the corporation from the shackles of the Friedman Doctrine to free man of the shekels expected by its principals.

Bring in humanity

In the eyes of law, the company is a legal personality distinct from its shareholders. Its directors owe a fiduciary responsibility to the members of the company (shareholders), but in so doing the directors should balance the long-term interests of various parties in pursuit of the prosperity of the company.

The purpose of a company is to address the problems confronting us as suppliers and shareholders, customers and communities, employees and retirees. In the process, it generates profits, but profits are not the purpose of companies per se. They are the product of their purposes.

Humanities have been systematically eradicated from the study of economics and business. Adam Smith carefully balanced the importance that he attached to markets in The Wealth of Nations with morality in The Theory of Moral Sentiments. But that balance has been lost in the next 250 years while reinforcing economic efficiency over ethics. We need to correct that urgently and bring humanity and humanities back in business.

In English and Italian, company and compagnia originate from cum panis ‘sharing bread together’; in Swedish, naringslivet comes from ‘nourishment for life’. Corporate property was defined as res universitatis, universal property belonging to all the citizens of a town or municipality, different from individual property. The genesis of business is thus to promote life through a collective endeavour, contrary to the Friedman goal. It is only in the 20th century that we find the corporation losing its public sense of purpose and becoming a rudderless vessel, ill-equipped for voyages into uncharted seas to prosperity.

Modem finance theories demonstrate the benefits of a well-diversified portfolio, despite their inability to distinguish between a bluechip stock and the charlatans of the world. This has led to multitudes of people with little investing knowledge (using Robinhood and Zerodha) plunging into equity markets. The average shareholding period has plummeted from eight years (seven decades back) to four years (three decades ago) to a few months now.

Bad money

Money and morals are not natural bedfellows. It is easy to say that one does well (make profits) by doing good (being socially responsible), but one often does a lot better by doing bad. Studies show that if one invests in portfolios of purposeful and socially-minded corporations and has a long-term view, one can easily outperform their less-enlightened counterparts. However, one is equally successful with instant gratification investing in ‘sin stocks’ — alcohol, gambling and fossil fuels. While goodness may be rewarded in heaven, sinning seems to offer quicker gains closer home.

Einstein said, “Many of the things that you can count don’t count; many of the things that you can’t count really count.” The costs of maintaining human, natural, and social capital should be subtracted from corporate profits as a maintenance charge equivalent to that on material capital. Unless there is recognition of the costs incurred in improving employees’ education or cleaning up rivers, there will be little incentive to undertake them. No wonder we are in a mess with neck-deep-in-debt corporations and lack of patient long-term investors with avaricious shareholders exploiting other stakeholders.

Last year, the Business Roundtable, a collective of US-based CEOs, agreed to repudiate a single-minded focus on the interests of shareholders and pledged to “deliver value” to all stakeholders — a giant step forward given it had earlier maintained that stockholders’ interests were “paramount”. This is a strong indicator of its political will to address the conflicting interests of various stakeholders. CEOs must walk the talk and follow up with concrete action to ensure that this is not mere window-dressing.

The corporation is a creature of company and cooperation. Emerging from the body politic, merging with an enterprise entity, it has seamlessly morphed into a money monster. Its real purpose is to profit for, not from, its people and planet.

The writer is a Harvard alumnus and works for an investment bank in Mumbai. Views are personal

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Published on September 22, 2020
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