Many are praising a recent Business Roundtable announcement suggesting that corporations should serve stakeholders as well as shareholders. On the surface, this may seem like a historic reversal of the status quo that has held since Milton Friedman put forth his famous “shareholder primacy” theory in the ’70s. But it’s not that simple.
On this episode of the Capitalisn’t podcast, hosts Kate Waldock and Luigi Zingales lay out the long history of this theory, revealing that it’s really been around for as long as we’ve been asking one of the most fundamental questions in business: what is the purpose of a corporation? They explore that question, and interrogate the possible underlying motives behind the Business Roundtable’s decision.
Luigi: Last week, an organization that rarely makes it into the headlines released a statement that rocketed it to the front page.
Speaker 2: The nearly 200 CEOs that make up the Business Roundtable are redefining corporate responsibility. Earlier this week, the BRT released a new statement about the purpose of a corporation, stating that shareholder value is no longer the main focus of a business.
Speaker 3: This group led by Jamie Dimon, they said in a statement yesterday that “while each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders.”
Kate: You might be thinking, stakeholders, shareholders, what’s the difference? Why is this so important, and why are we hearing this now?
Luigi: From the University of Chicago, this is Luigi Zingales.
Kate: And from Georgetown University, this is Kate Waldock. You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.
Luigi: And, most importantly, what isn’t.
Kate: On today’s episode, we’re going to dispel the notion that this stakeholder/shareholder primacy debate is something that’s just bubbling up now or something that bubbled up in the 1970s. In fact, it has a much longer history than that.
Luigi: And we’re also going to dispel the notion that the Business Roundtable really changed the view that they had of the corporation, and that this is making everybody better off.
The Business Roundtable is trying to define something that is actually very important in today’s modern economy: What is the goal that corporations try to achieve? Most of today’s economies are run by corporations. The large corporations, in particular, shape the way we work, the way we live, the way we eat and how we travel. Understanding how these companies are run is very important to understand the way we live and to understand our capitalist system.
Kate: Which is to say that corporations are run by managers—CEOs, CFOs, et cetera—and on top of them there’s a layer of management over the managers called the board of directors. So, who are these people accountable to? When we asked the question, what’s the purpose of a corporation, it’s pretty similar to saying the manager and the board of directors, who are they responding to? Who is their boss?
As long as we’ve had business entities, we’ve had this question. It’s impossible to say necessarily that we can get down to its exact origins, but there was an interesting case in 1919 between the Dodge brothers and Henry Ford. Henry Ford at the time wanted to make really cheap cars, right? This is what he was famous for, and the Dodge brothers, who were shareholders in Ford, got a little pissed and sued him.
Luigi: It’s a technical term.
Kate: Got a little pissed?
Kate: Yeah. This is Delaware Chancery court official verbiage—
Luigi: The lawyers say in their brief, they say pissed.
Kate: They sued Ford, and the idea behind the lawsuit was that he can’t just underprice cars so that everyone can have a car, because that’s not being responsible to the shareholders of the firm. Henry Ford should have been pricing cars so that the company would be maximizing profits. At the end of the day, the Michigan Supreme Court ended up finding that the purpose of a business corporation is primarily for the profit of shareholders.
Flash forward to the 1920s, the Great Depression, and in 1932, this crystallized in a very important debate, one that’s still cited a lot, particularly by legal scholars today. And the debate was between two legal professors, Adolf Berle and Merrick Dodd.
Luigi: Adolf Berle was one of the most prominent legal scholars of the time. He argued in favor of the idea that a corporation should be run in the interest of its shareholders. So, he actually is one of the first to push for the idea that now goes under the name of shareholder primacy.
Kate: Merrick Dodd, on the other hand, argued in favor of the idea that corporations should be accountable to stakeholders. I think that this term stakeholders causes some confusion. Rightly so, because it sounds pretty similar to stockholders, which is the same thing as shareholders, and it’s also not necessarily very well defined.
What do we mean by a stakeholder? Well, it can refer to a number of groups, right? It can refer to customers, to employees, to the community at large in which corporations operate. It can refer to creditors. It can refer to a number of different groups, some of which I’m probably leaving out here. But Dodd’s main point was that there’s a community at large in which these corporations are operating. The corporation itself is made up of managers as well as laborers. They’re part of a big entity that’s part of society, and the corporation should be accountable to society.
Luigi: If you think that a corporation is simply a group of individuals who decide together how they want their business to be conducted, going in the direction of shareholder primacy is pretty obvious. If you think that the corporation is a superior entity that is given a superior power, the power of limited liability by special permission of the state, then it’s a completely different business, because you can argue that the government has a right to demand some greater goal for a corporation, because with greater power comes greater responsibility.
Kate: One of your favorite phrases, Luigi.
Luigi: Actually, it’s Spiderman.
Luigi: This debate on the purpose of a corporation has greatly influenced the way managers have seen their role. And so, the Business Roundtable, which by the way is the association of the CEOs of the largest companies in the country, has changed its position over time. In 1981, the Business Roundtable recognized that corporations operate within a web of complex, often competing relationships, which demand the attention of corporate managers. It wasn’t going as far as saying we have to pay equal attention to all stakeholders, but it was very much in that direction.
Kate: A lot of people claim that this was in direct response to a 1970 article written by Milton Friedman, in which Friedman argues pretty strongly that managers that act according to a social conscience are fundamentally subversive. He says that corporate executives should be seen as employees of a corporation, which is to say that they are employees of shareholders. And so, to act in a way that’s accountable to anyone other than shareholders would be like shirking your primary responsibility as an executive.
Luigi: But I think that most people misinterpret what Friedman says. In a sense, Friedman is not saying that a good company should not take care of employees, should not take care of customers, should not take care of the environment. He only says that they shouldn’t give away money for free to these constituencies. Implicit in his idea is that if you are an employee, you can choose to work for this company or go somewhere else. And if the company does something that is bad for you, you can leave the next day. If you’re a customer and you are in a competitive market, and the company does something you don’t like, you can move and go to a different company. As an employee or as a customer, we can actually choose and penalize companies we don’t like.
If you invested your money in a stock, there is nothing you can do, because, yes, you can sell the stock, but somebody else has to buy, so you can’t withdraw your money from the company if you don’t like what they’re doing. Except in some extreme circumstances that are anticipated by the law, you cannot get your money back if you don’t like the company. And that is the reason why you should have a voice, and that voice is through your vote to appoint the board members. So, the board members are accountable to shareholders and shareholders only, not because shareholders are more important, but because in a sense they are the weakest ones of all the stakeholders.
Kate: The Business Roundtable convened again in 1997, and this time they reversed course from the 1981 decision and said something much more aligned with what Berle or Friedman would have suggested, which is, “The Business Roundtable wishes to emphasize that the principal objective of a business enterprise is to generate economic returns to its owners.”
Luigi: And honestly, this is not just the position of the Business Roundtable, but my understanding—as a preamble, I’m not a lawyer or a legal scholar—but my understanding of the law of the land in the United States, the prevailing view in the legal profession, is that the corporation should respond to the shareholders. They should be accountable to the shareholders. And you mentioned earlier the famous Dodge brothers case, but there is a recent case, actually, of eBay suing Craigslist that led to a very similar decision by the Delaware court.
eBay, which is a shareholder of Craigslist, was complaining about the fact that Craigslist was trying to benefit society at large by providing a service and not by trying to maximize profits. The Delaware court said that the moment that you choose a for-profit corporate form, this binds directors to a fiduciary duty that accompanies that form.
Those standards include acting to promote the value of the corporation, I’m citing, for the benefit of a stockholder. The “Inc.” after the company name has to mean at least that. Now, interestingly, there are different rules you can be bound to. In Delaware, as in most states, today you can choose a benefit corporation that does not have profits as the main objective and does incorporate other objectives, like other constituencies, as a factor. And so, if a company can choose to become a benefit corporation, as long as they remain a standard corporation, they have to follow standard rules, and the goal is that they have to act according to the desires of their constituency, i.e. the shareholders.
Kate: Yeah, and at the end of the day, shareholder primacy does go, in some sense, hand in hand with capitalism defined broadly. I’m not saying that I necessarily agree with this, but the idea is that if you let shareholders decide what decisions are made within corporations, then that will lead to the efficient allocation of capital. That will lead to the allocation of capital to growing profitable businesses that will in turn boost innovation, that will in turn create employment and lead to the growth of society overall. Economically, that will benefit everybody.
And if you don’t have this, if you have companies that are trying to maximize a very complicated set of objectives, some of which involve, say, donating to charitable causes, then maybe that will make the cost of that company’s good increase relative to its competitors. Maybe society will end up bearing those costs, right? Customers will have to pay increased prices, or maybe laborers won’t get paid as much, because companies are contributing to charities that the CEO picks. Maybe the quality of their product suffers because the company didn’t invest enough in quality control. So, the idea is that if funds aren’t being diverted to the most economically efficient investments, which are consistent with what shareholders want, this can actually end up hurting labor, it can hurt society overall, and it can hurt consumers.
All of this brings us to today, to Jamie Dimon, who’s heading up the Roundtable, and their decision to announce that they’re reversing course again, and, in fact, America’s largest CEOs, or the CEOs of the largest companies, are interested in maximizing stakeholder value or at least considering the objectives of stakeholders when making their corporate decisions.
Luigi: On the one hand, this could be seen as a major publicity stunt, in the sense that they didn’t make any real commitment to change, because they’re not saying, from now on we are going to pay fewer stock options to the CEOs, or from now on, our bonuses will be based on environmental performance measures and not stock price measures. They don’t say any of that. They have a generic statement that we share a fundamental commitment to all our stakeholders, which at some level is good management. If you want to run a successful corporation, you have to take care of your customers, you have to take care of your community.
The contribution of employees is crucial to the success of the company, so I don’t think that the way you maximize your value is by being stingy and minimizing what you pay your employees. Because we know in economics there is a theory of so-called efficiency wages that by paying more, you get a better outcome. It is not by mistreating your customers that you can be successful. Taking care of your stakeholders is definitely a very important aspect of every successful corporation. Whether you want to maximize their value or you want to cater to them in spite of catering to their shareholders, that’s the real question. And I think that statement is vague enough that it doesn’t really commit one way or another.
Kate: Not only did the Business Roundtable decision encompass the idea that companies can act in ways that benefit society and employees and customers, but also have that be consistent with shareholder value maximization. I think that that statement itself is an example of one that is consistent with shareholder value maximization. I think that today a lot of big companies are worried about rhetoric coming from people like Bernie Sanders.
Bernie Sanders:Let me be very clear. Greed is not good. If Wall Street does not end its greed, we will end it for them.
Kate: Like Elizabeth Warren.
Elizabeth Warren: So, you know how the American economy worked for decades—shoot, for centuries—and that was that the biggest companies in this country had multiple responsibilities. Responsibility to their shareholders, to their employees, to their customers and to the communities that they were involved in, and it worked.
Kate: And this may have just been a response to that, which is to say, we don’t need laws that place any restraints on what managers can do because we’re going to do it ourselves, right? We’re going to be good corporate citizens. So, there’s no reason to constrict our actions. As a piece of evidence for this, this was sent to me by Sam Long, in an article that he wrote. There’s a billionaire named Seth Klarman. He’s a graduate of HBS. And in speaking to the HBS class, he said, “With an overly narrow focus on the near-term maximization of corporate profits and share price, business leaders leave themselves vulnerable to criticism and harsh regulation.” And then he goes on to talk about the Accountable Capitalism Act that was proposed.
So, Klarman is saying managers, in excessively being concerned about only shareholders, were actually hurting shareholders because they opened themselves up to too much regulation. And so, in order to better benefit shareholders, they have to pretend, or at least appear, that they are not going to be acting in the interest of shareholders. Which is all convoluted, but if you think about it, it makes sense from a game theory perspective.
Luigi: So, you are saying that this is a Machiavellian move, that they really are maximizing the value of their stock options by pretending they don’t.
Kate: Exactly. I think one way of framing this is not necessarily this idea that shareholders are in the middle and that society surrounds them and shareholders are acting in their own best interests. I think it’s actually managers of corporations who are at the center of what a corporation does, right? They’re the ones making the decisions. It’s actually a little bit of a myth that shareholders are, I guess, prime, or shareholder primacy is a myth. I think the real ones with power are the managers, and in many ways, they can act in a way that extorts money from shareholders. There are a lot of hidden downsides, so the possibility of empowering managers to act in the best interest of stakeholders that aren’t really getting enough attention.
People underestimate how difficult it is for managers to make decisions, right? If you’re the CEO of Johnson & Johnson or some large public company in the US, how do you decide what to do? How do you decide what plants to open or what new products to launch? Right now, they have, for better or for worse, a somewhat straightforward way of doing this. It’s taught in business school that’s aligned with shareholder value maximization. You have to project cash flows and discount them back to today and see whether an investment is worthwhile. But if we lose the objective of maximizing shareholder value, then how do you make a decision as a CEO? How do you decide whether it’s more valuable to spend $100 million creating jobs in a poor community or in launching a new product using a manufacturing facility in China?
You could say, who cares, as long as at the end of the day they’re doing things to benefit communities or society at large, but if you give managers free rein to do whatever they want to benefit whatever stakeholder constituency they want, then you also lose the ability to police them in any meaningful way. Now we can say, “Oh, you guys, managers lied about something or they distorted some numbers and so this hurt shareholders.” But if we don’t really know whose objectives they’re maximizing, it becomes a lot harder for regulators to step in and be like, “This is something that you did that hurts this particular constituency who you’re supposed to be accountable to.” And so, I’m worried at the end of the day that this would just give them free rein to not be regulated at all.
Luigi: Yeah. So, I think that this is the worst hypothesis, if the move of the CEOs was not a marketing ploy to reduce regulation, if it was actually an active move to gain power at the expense of shareholders and society at large, because in this way, they are accountable to none, and that increased their ability to do whatever they want. Certainly, there is a tension between managers and shareholders. However, especially in today’s modern society and complex society, there are a lot of questions that managers have to answer, which are pretty tricky.
Let me ask you the following question. Ed Stack is the CEO of Dick’s Sporting Goods. He admitted that after every mass shooting in America, he was there praying, saying, “I hope that the gun that killed all those people was not sold in my store,” and then after a while, he said, “Wait a minute. I can do a bit better than praying. I am the CEO. I can say, let’s stop selling assault weapons in Dick’s Sporting Goods.”
Ed Stack: Those kids talk about, “enough is enough,” and we had meaningful conversations about this with our team, and we concluded that if these kids are brave enough to organize and do what they’re doing, then we should be brave enough to take this stand, and that’s what we’ve done.
Luigi: A bit like Henry Ford. He was actually pretty honest, because he went in front of the board and did not try to say, “We’re doing that because this will maximize the long-term value for shareholders.” He said, “Actually, I don’t really care what the financial implication is. I want to stop this.” And he did it.
Ed Stack: Well, the hunt business is an important part of our business, no doubt about it, and we know there’s going to be some backlash.
Luigi: Now, how do you interpret this decision, Kate?
Kate: I think it goes back to a concept that I struggled with when I was first entering grad school, which is this idea of utility. Now, in the context of the shareholder debate, one of the reasons that managers are supposed to be maximizing shareholder value is because it’s pretty easy to see what shareholder value is. You can just look at the stock market. If your stock price went up, then that’s a good sign. If the stock price went down, that’s a bad sign. So, you’ve got this very liquid market that’s a good way of aggregating a bunch of people’s opinions as to what value is.
But that doesn’t necessarily mean that that’s everything for the shareholder. I, as a shareholder, yes, I like money. Yes, I want the price of my stock to go up, but at the same time, I have other feelings. I might not like guns. I might not like pollution. And so, there’s this question of, what does the shareholder really want, and how much of the manager’s responsibility is to maximize just value or maybe other things that shareholders want?
Luigi: That’s an excellent point you’re raising, Kate, because Milton Friedman, who was very careful when he was writing, when he wrote the piece that the only social responsibility of business is to maximize profits, he basically stated, and I quote, “conduct the business in accordance with their stockholders’ desires,” which generally will be to make as much money as possible while conforming to the basic rule of their society, both the one embodied in law and those embodied in ethical custom. He says generally it’s making as much money as possible, but individuals, as you say, don’t only live off money, they have other things that they care about.
So, if I really love to live in a happy community, I might decide to use a company’s money to improve the value of that community, because I care deeply about the community and that’s my utility. Now, the problem is that when a company becomes publicly traded, it is very difficult to aggregate these utilities. People tend to go for the minimum common denominator, and as you said, the minimal common denominator is just money.
Kate: But that doesn’t necessarily mean that just money is an accurate reflection of what shareholders or people’s desires are. So, going back to the Stack case, a company might make a decision about not selling guns that doesn’t actually maximize shareholder profits. It might hurt the stock price, but it might make almost every shareholder better off in terms of their utility of owning a share of that corporation. If we accept this idea that shareholder primacy is correct, even within that there’s ambiguity. Should managers be maximizing stock prices, or should they be maximizing the overall welfare and utility of their shareholders?
Luigi: So Oliver Hart and I claim that they should maximize shareholders’ welfare, not value, which is the utility of their shareholders. Now you might ask the question, how do you know what they want? I think the answer is pretty simple. You ask them. In modern society, it is not that difficult to try to aggregate their opinions through a vote, for example. While I personally like what the CEO of Dick’s Sporting Goods did, I think that he should have asked his shareholders. If most of the shareholders of Dick’s Sporting Goods are gun fanatics, and they do want to sell AK-47s in their stores, I think it would be kind of taxation without representation for Ed Stack to decide in their place.
Kate: But don’t shareholders already have a voice? It’s a law in the US that if you’re a public corporation, you have to have an annual shareholder meeting. And at this annual shareholder meeting, shareholders are allowed to propose votes on whatever they think is important. And actually, an interesting fact is that increasingly, these vote proposals have been in the areas of environmental justice, of social justice, of better governance. And so, shareholders are caring more about companies doing good, and this is being reflected in annual meetings.
Luigi: Yes and no. First of all, let me be very honest here. The election of corporate directors in the United States is the closest thing to Soviet elections in the modern world, because you have a number of candidates that is equal to the number of seats available. These candidates are selected by the incumbent. You don’t have privacy in voting, so you know who you vote for, and the new CEO can retaliate against you if you voted against. And ironically, you can only vote yes or withdraw your vote because you have no alternative. It is an election with only one candidate, and a study shows that even if you don’t reach a majority and so you’re not elected, the other board members will co-opt you because you need to have, by statute, enough directors as per statute. And so, because the candidates are equal to the number of seats, if one candidate is not elected, you need to replace one candidate. And surprise, surprise, you’re going to replace it with the one who was not elected.
So, number one, shareholders have very little influence on who is a director. Number two, there is an arcane Securities and Exchange Commission rule that says that companies are required to put up for a vote a shareholder proposal unless this shareholder proposal deals with ordinary business matters. So, a shareholder of Walmart tried to do what basically Dick’s Sporting Goods did, i.e. trying to restrict sales of assault weapons by Walmart. What happened is Walmart actually asked the SEC to block this, and the SEC blocked it. The Walmart shareholders appealed, Walmart management went up to the court of appeals, where they won, and then the Walmart shareholder gave up.
Now, in part they gave up because Walmart was forced by consumers to stop selling assault weapons. So, they got what they wanted, but they got what they wanted because consumers expressed their desire, not because shareholders are allowed to vote. I am in favor of changing those rules so that shareholders can have a say on things that are important, like, for example, impacting the environment or selling dangerous guns like assault guns.
Kate: Yeah. I think that that ordinary business exception could easily be modified to say that if shareholders are bringing a vote because they think that this affects the community, that the actions of a business affect the community, then that can’t be excluded based on the ordinary business exception.
Luigi: And I think there is something even more important, because when Friedman wrote his famous piece in 1970, that the only goal of business should be to maximize profit, he was a colleague of George Stigler. The next year, the following year, in 1971, Stigler wrote an important piece saying that, actually, corporations greatly impact regulation for their own interests. So, now you have a little bit of a conundrum here. If you are a corporation, are you required to distort regulation to make more profit, even if this regulation damages the very people that are your shareholders?
Kate: Well, whether or not it’s a requirement, I think that that’s what’s being done now. That is exactly what that Business Roundtable announcement was. I think that it was meant to distort regulation or prevent regulation that would better align the objectives of corporations with the community at large. So, I think that at the end of the day, we can’t expect companies to ever consistently do something that will be in the benefit of society, in the benefit of consumers or employees, that hurts shareholders unless this were mandated.
Luigi: I completely agree with you. I think that a shareholder vote could limit in part this problem. There are some shareholders who are trying to force corporations, for example, to reveal who they donate money to and put to a vote who they donate money to in political contributions. I think that that’s an important step that corporations are trying to avoid, and it actually would have been nice for the Business Roundtable to declare, we are most serious, and we are going to voluntarily disclose all the money we give in campaign donations and to whom. That would have been a step forward. I think eventually some of this stuff needs to be imposed by regulation, but if the law is done by corporations or is shaped by corporations for their own interest, how do we trust the government to act in a way that is in the interest of society and not just in the interest of corporations that tend to finance electoral campaigns?
Kate: Yeah. I think this deserves repeating or rephrasing in a way, which is that a lot of people who support the idea of stakeholder primacy rather than shareholder primacy think that corporations should be forced in some way, either through some governmental charter or with more explicit mandates, to benefit other elements of society. But those things already exist. They’re called laws that corporations have to comply with.
Luigi: And they’re also called corporate taxes. They’re now much lower than they used to be, but corporate taxes are a benefit to society at large if they are paid.
Kate: Right. It’s incumbent on the government, the people making those laws, to make sure that they do a good job. And I think that that’s where the criticism should be, that we didn’t do enough in the period, I guess, in the 50 years prior to now in protecting employee rights, in protecting jobs in the United States. I don’t think that we should necessarily be blaming companies for that. I think that we should have had a stricter set of laws that would have incentivized companies to keep those jobs here, and I think that we should have had better job retraining programs so that people could have easily been more mobile in the labor force.
Luigi: So, Kate, do you think that the Business Roundtable statement is an example of capital-is or capitalisn’t?
Kate: I looked at the S&P 500 futures around the time of the Roundtable decision and you barely could see a change, right? Actually, the S&P 500 futures increased a little bit. I think if anyone took the announcement seriously as a shift or a realignment of objectives away from shareholders and towards stakeholders, you would have seen at least some sort of immediate drop. But there wasn’t any, which is to say that I think that this is all a publicity stunt. I think that it is CEOs acting in the best interests of shareholders by saying that they’re not acting in the best interest of shareholders. And I think that that is, at the end of the day, perfectly consistent with the way that things should be. But we shouldn’t read too much into this, and I don’t think that much will actually change.
Luigi: So, you think it’s just marketing, not capitalisn’t?
Kate: I think it’s a marketing stunt, but I also think that, look, we’re here because we support capitalism. We’re not trying to undermine it. I think that CEOs should be acting in the best interest of shareholders, but I think that we need more government regulation to rein them in.
Luigi: For once, I agree with you, Kate.
Kate: Luigi, we always agree. What are you talking about?