It's been 50 years since Milton Friedman laid out what would come to be known as the “Friedman Doctrine,” arguing that the only social responsibility of business is to increase profits. Since the 2008–09 financial crisis, that view has been increasingly challenged. On this episode of the Capitalisn’t podcast, hosts Luigi Zingales and Bethany McLean revisit Friedman’s legacy with New Yorker staff writer and author of Transaction Man Nicholas Lemann. Together, they explore what Friedman got right and what he got wrong about shareholder vs. stakeholder capitalism.
Luigi: While everybody is waiting for the results of the election, we want to give you a break by talking about something that is important no matter who the president will be, by looking at how the view of the corporation and capitalism has changed over time. And we take advantage of the fact that this year is the 50th anniversary of the publication of a famous piece by Milton Friedman. And so, today’s episode is about how this idea changed the world.
Bethany: I’m Bethany McLean.
Speaker 3: Did you ever have a moment of doubt about capitalism and whether greed is a good idea?
Luigi: And I’m Luigi Zingales.
Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.
Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.
Speaker 5: First of all, tell me, is there some society you know that doesn’t run on greed?
Luigi: And, most importantly, what isn’t.
Speaker 6: We ought to do better by the people that get left behind. I don’t think we should have killed the capitalist system in the process.
Bethany: It has been called the world’s dumbest idea.
Speaker 7: In all systems, whether you call them socialism, capitalism, or anything else, people act from self-interest.
Bethany: It’s been blamed for every evil of Western society.
Speaker 8: Because they were repelled by the idea of people pursuing their own interests rather than some broader interest. Yet, if you look at the results, it’s clear that the results go the other way around.
Bethany: Love it or hate it, the piece that Milton Friedman wrote in The New York Times 50 years ago should be considered one of the most consequential ideas of the 20th century.
Luigi: What he says in his 1970 article is, there is one and only one social responsibility of business, to increase its profit, so long as it stays within the rules of the game. The idea is very simple. It is for the government to set the rules properly, so that the players, the companies, can focus only on one activity: to increase the size of the economic pie they generate.
Bethany: Luigi, let me ask you, I know from a business journalist’s perspective why this idea matters so much. From an economist’s perspective, why was Friedman’s essay so important?
Luigi: I think for two reasons. First of all, the question of how companies should be run is really central to the type of capitalism we live in. Much of capitalism today is corporate capitalism. Number two is Friedman came exactly at the right time. It’s hard to establish causation. But the prevailing view was that boards should be guardians of all the interests which the corporation affects and not merely the servants of the shareholders. It was a very, very different perspective.
Bethany: It’s interesting that you say that, because when I started in the business world, first working in investment banking and then in journalism, the idea that shareholders had primacy was such a part of the very water that we drank that it never even occurred to me there was another way of thinking about business. It just became so accepted that the idea that there was ever another way of thinking about things went away.
I think it’d probably be helpful for a lot of our listeners to summarize what the anti-Friedman point of view was.
Luigi: The anti-Friedman point of view is exactly what we now call stakeholder capitalism. That was the dominant point of view, that boards should be the guardians of all the interests which a corporation affects and not merely the servants of, as we say, its absentee owners, which are the shareholders.
Bethany: In a sense, the famous Business Roundtable proclamation of 2019—
Speaker 8: 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.
Bethany: —led by JP Morgan CEO Jamie Dimon, isn’t so much something new as it is a return to a much older definition of what a company was for.
Bethany: Luigi, I’ve heard you say that Friedman’s doctrine is more valid than detractors claim but more wrong than supporters would like. Can you explain that?
Luigi: Yes, there is one point that Friedman makes that is extremely valid, which is that corporations are arranged in such a way that most of the cost is borne by the shareholders. So, if you make more money, the shareholders make more money. If you make less money, the shareholders make less money, but the debtholders, the workers, the suppliers are paid a fixed amount.
The point that Friedman made in 1970, and clearly said, “Look, if you decide to engage in activities that are very laudable, like charity and so on, you do it basically with somebody else’s money.” It’s not that the workers are making less money, it’s not that the suppliers are not getting paid on time. Shareholders, at the end of the day, are going to get less dividends. He said, there is nothing bad about charity. In fact, it’s a good activity. But why don’t you let the shareholders do it on their own? And he appeals to the American principle of no taxation without representation to say, you don’t want to do that without a shareholder deciding that that’s the right thing to do.
Bethany: But isn’t that a way too simplistic way of looking at things, in the sense that if a company engages in charity, it’s often charity with a purpose? In other words, it’s charity that helps the corporation do better, in the sense that it may be brand building for the corporation. It often is brand building for the corporation. It seems to me that that argument doesn’t deal appropriately with the complexities of modern business.
Luigi: No, I think that this is unfair to Friedman. He had no problem with charity that was for a different purpose. Let’s face it, unfortunately, most of the time companies, when they engage in a lot of charity, they’re engaging as a preventive way to cover their behinds in case of a major disaster. So, like an oil company providing charity because they know that eventually there will be an oil spill, and they know that they’re going to be punished less if they have this good brand reputation. The point that he makes is, if you are a bleeding-heart, liberal that wants to donate all your money, it is much better for the corporation to maximize profits, give you the profits, and you distribute the profits.
If I am the Gates Foundation, I say, I want to maximize the return on mining diamonds, and then I take this money, and I give it for charitable purposes. The irony of the world is that the Gates Foundation that does so much to relieve poverty in Africa invests in companies that in Africa are sort of bribing people, stealing money and destroying the country in order to make more money. So, Friedman said that’s where—
Bethany: And therein lies the paradox of the modern world.
Luigi: If there is no difference in terms of efficiency of doing something at the corporate level or at the personal level, his argument is absolutely right. So, if you and I donate money or IBM donates the same amount of money, there is no comparative advantage for IBM to donate that money, OK? It’s equally efficient for us to donate or for the corporation to donate. And that’s where Friedman is very clever, because he presents this example, he kind of makes you believe that that’s the truth.
The moment you walk away from that and you go to any practical example, think about pollution, OK? It is much more expensive to clean up pollution than to avoid pollution. Or think about the damage of corruption in Africa. It’s not that if you get the money you can undo the damage of corruption. It’s much more difficult to undo the damage than to avoid the damage.
Bethany: To take away the moral point, just the economic point would be, it’s kind of crazy to spend a lot of money attempting to clean up the mess you made in the first place.
Luigi: Exactly. In that situation, it’s not efficient to let the companies do whatever they want and then clean up. In that situation, you have to have the shareholders express their opinion on what they want to do. And so, this is the point that Oliver Hart and I make in a paper a couple of years ago, in which we say, “Look, this suggests that you need to restate the principle: not shareholder value maximization but shareholder welfare maximization.” Because if I, for example, care about pollution, it is stupid to have a company that maximizes profits and pollutes, and then I use that money to give it to the Sierra Club to undo the pollution. That’s really not efficient. I want to fix this from the beginning.
Bethany: And, even more often, it makes you feel good about yourself while you’re doing it.
Luigi: Yeah. But this is his more theoretical point, with gigantic policy implications . . . because this is saying that, number one, endowments should all of a sudden recognize that, for example, they don’t want to invest in oil companies and not just for the oil, for the CO2, but for the fact that they bribe all over the place. This point is so important and so potentially game-changing that the Trump administration actually is, listen to this, using regulation to shut up shareholders. The Department of Labor, under Eugene Scalia, son of the more famous Antonin Scalia, has issued a regulation that purports to say that, as an asset manager, you have to only pay attention to financial returns. You cannot pay attention to anything else, even if your shareholders or your investors say, we want to pay attention. So, imagine you are a pension fund of workers who all live in a town in California and that there is a company that pollutes that town. Those workers cannot say anything. They have to take the money and die of pollution. They can’t express their opinion. That, to me, is crazy.
Bethany: But, on the other hand, to play devil’s advocate on that, could it be . . . and I’m giving lots of credit where credit might not be due. But could it be that the Department of Labor is trying to protect against companies that are stewards of investors’ money from engaging in their own pet projects with the shareholders’ money and then leaving workers, who are depending on those returns to finance their retirement, without the returns that they need?
Luigi: Absolutely. I think that that objective is a very laudable objective, but it could be better accomplished simply by letting your investors vote on what they want to do. In a very interesting paper in the Netherlands, they actually ask the investors in a pension fund—most of them were workers—to what extent are you willing to sacrifice a bit of your return for, for example, less pollution? And the majority of them said, we’re willing to sacrifice a bit. Not all of it, of course, but not zero. So, investors do care about things other than just money. And we basically are trying to prevent them from expressing their desires. It’s a very strange situation.
Bethany: I think that might be more true in the Netherlands and there might be more validity to its being true. What I mean by that is that the Netherlands has a social safety net that is nicer than we in this country have. Meaning you can argue that there’s more flexibility in the system, there’s more resilience for shareholders to care about something other than returns. In our system, where there isn’t much for employees to fall back on—other than the returns in their 401(k) plans, especially as defined-benefit plans have been gutted—there’s less resilience in the system to care about these things. And, believe me, I’m someone who thinks we should care. I just see the contradiction.
Luigi: Yeah, but I don’t see any contradiction, because let them decide. And if you are right, they’re going to say we only want to maximize profits, I have nothing against that. But if they have other objectives, I don’t know why we should force them to say, you shall not have any other objective in your life. Let the workers choose.
Bethany: I think you give shareholders more credit than I’m willing to give them.
Luigi: But there is a third point that is very dear to me that I don’t want to miss. And this is where I think that Friedman is wrong and is wrong in a way that is problematic. And I will explain to you why.
He’s very careful in saying companies should maximize profits provided they follow the rules of the game. In one version, he says, basically, the law and the custom of society, and in the other, he says, the rules of the game, a fair competition, and so on and so forth. He’s completely ignoring something, which is that corporations massively influence regulation. Now, what is funny is that this article was written in 1970. In 1971, his colleague, George Stigler, the namesake of the center I direct, wrote a piece where he actually introduced the concept of regulatory capture, i.e., that corporations actually buy out regulators. Buy out is a bit strong, but influence, capture regulators to have them do what is in their own interest, not in the interest of the regulated and the consumers.
This is paradoxical, the fact that the two were colleagues, but they never reconciled this point, because if my duty as a CEO is to maximize profits, and I can change the rules of the game by lobbying and bribing in ways that are legal to bribe, do I have a duty to do that? Not only can I do it, in Friedman’s view, my social responsibility is to basically destroy the EPA to my best advantage. And that’s clearly wrong, something that we cannot tolerate, something that needs to be fixed.
Bethany: That’s interesting. I did not know that Stigler had made that argument back in 1971. Because I was actually going to defend Friedman and say that back at the time when he wrote his essay, you could not possibly have seen the role that money and lobbying were going to play in shaping the rules under which corporate America supposedly operates.
Luigi: Not only did Stigler make it, but he was a colleague of Milton Friedman. So, it was impossible for Milton Friedman not to know what he was doing. I like to say Milton Friedman meets Stigler, because it’s ironic they met every day in the corridors, but they never, as far as I know, discussed this particular aspect.
Bethany: Well, that’s because it’s no fun if you have a perfect pure idea to let some complexity get in the way of it, right?
Luigi: I thought that it was only journalists who said, never let the facts get in the way of a good story.
Bethany: Never let the facts get in the way of a good story. Then, it seems like that was Friedman’s . . . Maybe for economists, the way is, never let conflicting evidence get in the way of a good economic theory.
Luigi: I think that’s a nice translation. Yeah.
If you want to know more about the academic debate on Milton Friedman, ProMarket, which is a publication of the Stigler Center, had a very interesting debate and now has an ebook that is coming out with the various positions of this debate.
What we want to do here is look more, from a historical perspective, at why Milton Friedman’s idea became so popular after it was published in 1970. And we’re going to do that with the help of somebody who not only has lived through that period but is also a writer and a scholar about that period, Nick Lemann. He is a professor of journalism at Columbia, he’s a staff writer for The New Yorker, and he is the author of Transaction Man, which tries to describe the evolution of certain ideas over the course of the end of the 20th century and the beginning of the 21st.
Bethany: I’d love to get started just by talking about the effect that that Friedman essay had, from your perspective, given that you’ve thought about it so much.
Nick Lemann: This is the problem with doing intellectual history. It’s tempting but not warranted to say that one article was published, and the whole world changed as a direct result of that. Things that end up being very influential usually have timing going for them. Things were already sort of moving in that direction as they were, when Friedman published that article, I think. It’s important to understand the left was also moving in a sort of promarket direction, and in particular was losing faith with sort of old-fashioned, New Deal liberalism. And this is a conceptual question, it’s interesting, who gets to define what stakeholder capitalism is? Peter Drucker and many people in the ‘50s would say, it’s very simple. There must be labor unions, there must be defined-benefit pensions. It was very much in terms of the economic compact with employees, both blue-collar and white-collar.
Today’s version is much more likely to be about things like gay marriage, climate change, those kinds of issues. One of the reasons it’s a sort of slippery concept is it doesn’t enter the realm of the state’s ability to set priorities in a more formal way. It’s voluntary.
Bethany: When you think back to that old definition of stakeholder capitalism, which was grounded in the specificity of economic parity of sorts, or at least of economic concern, and then you think about today’s version of stakeholder capitalism, which perhaps is in squishier social metrics, what are the pros and cons of each one?
Nick Lemann: Well, I’m going to go to a sort of big theory here. Somebody like, say, Tim Cook of Apple signed the 2019 Business Roundtable statement. He’s clearly identifying stakeholder capitalism in a different way from the old General Motors in the 1950s way, where you want to unionize companies and so on. So, there’s this idea out there, at least in some circles—more among white people, I would say—that there was this wonderful world that used to exist. And I do think the 1950s version of the sort of corporate welfare state is maybe not what people are consciously thinking about but are emotionally thinking about when they have that nostalgia about a vanished world.
The current version doesn’t really propose, as I see it, to recreate that. It’s more the idea of corporations being good for their communities, devoted to good causes and not overly oriented toward quarterly earnings reports. It’s a little squishy.
Luigi: But isn’t it a form of trying to get the money where the money is? Corporations, especially some corporations today, are extremely profitable. As a result, there are a lot of stakeholders that try to get a share of those profits. In the ‘70s, America was in a much worse situation. There was a competitive challenge. I see the ‘70s as the first time in which the American dominance of the world is called into question.
Nick Lemann: Yeah, I agree with you.
Luigi: And from 1945 to 1970, it was not even funny. America ruled the rest of the world, not only militarily but economically. By the 1970s, Germany, Japan, and Europe in general have caught up, and all of a sudden, you actually need to think about competition and restructuring. And I think that the unique feature, when you said that Friedman came at the right time, in a sense he came at the right time because there was this pressure of restructuring. If you have a very stable company that has internal growth, organic growth, it is very easy to get everybody aligned. If I grow, my employees get richer, the shareholders get richer, the community gets richer, you don’t have to face any tradeoffs.
In the 1970s, especially with the oil crisis, et cetera, and the stagflation, you had to face tradeoffs. And that’s the moment in which you have to decide whether you are on one side or the other and who you should prioritize. That’s the message, in my view of Milton Friedman. If you want companies to grow, to be competitive, et cetera, you need to have a clear set of priorities. In this set of priorities, the shareholders should come first.
Nick Lemann: Right. I agree with everything you said, and the emergence of meaningful economic competition, often from this country’s principal enemies during World War II, really changed the atmospherics around all these issues. But I think that we, from a political rather than an economic standpoint, I don’t think we fully realized at the time, including liberals like me, how much was being stripped out of the corporation, this older version of social responsibility, which was much more about how you treated employees, and what a big sort of hole that would leave in the social fabric of the country.
Now, what could have been done instead, we can argue about that. But I can tell you, as one who was enthusiastic about this at the time, I didn’t like labor unions. I thought, these are the guys who are in favor of the Vietnam War and against the civil rights movement. They’re featherbedded and all that stuff. They didn’t seem like what liberals were fighting for. I think people like me, on the left, failed to understand how much dissatisfaction would be caused when this older social order was dismantled.
And going back to today, in this debate, I don’t hear a lot of people saying we have to bring back stakeholder capitalism in the form it had in the 1950s, because it’s so expensive. So, it sort of takes more of the form of endorsing Colin Kaepernick, which doesn’t cost the corporation anything.
Bethany: But then does it accomplish what its goals maybe should be? It obviously accomplishes a lot that’s important, but how much does it accomplish? And maybe, to ask the question differently, can you have true stakeholder capitalism without strong labor unions?
Nick Lemann: And can you have strong labor unions without strong federal labor laws? I mean, the strong labor unions were created, in my view, by the Wagner Act of 1935. And wouldn’t have been strong without that and started to weaken after the Second World War, when Taft-Hartley and many other state and federal laws passed.
The average person who loves that 2019 statement that Jamie Dimon organized doesn’t think of it as proposing a worker-oriented, labor-oriented role for the corporation. Instead, I think the average person thinks, “Well, I’m against Wall Street greed, also. And I care about climate change, and Tim Cook and Jamie Dimon also care about climate change.” It’s really quite a different vision. Also, it’s hard to tell, at this point, what this would amount to. How do we know when it actually has happened? Also, legally, they have a responsibility, a fiduciary responsibility to their shareholders. I don’t know how far they can get away from that just because they want to and because people think it’s a cool idea.
Luigi: But, if I may say, I don’t think that the liberals did not understand what was going on. What was going on, in my view, was necessary at the time, and the liberals did not put the right limits on this reaction. I think Friedman’s reaction was completely justified given the time and, in my view, it has gone too far. If I may say, it’s gone too far because the other side had completely given up on unions, had completely given up on representing workers, in the sense that what you’re describing as negative attitudes about unions as basically full of mafioso people and stuff like that is what characterized the post-Watergate left that is more interested in civil rights than in actual economic rights and prefers to represent all the aspects of identity rather than represent the economic interests of the people left behind.
Nick Lemann: I agree. The liberals let this go too far because they were not focused on these issues at all.
Bethany: Going back to this question, can you have a stakeholder capitalism that matters if you’re not sharing the spoils? And maybe this is too much of a math major question, but if we aren’t incorporating some old-fashioned view of sharing the economic spoils, i.e., the profits, into this new definition of stakeholder capitalism, does it go far enough? Is it what we need, given that then it may address other injustices, but it’s not addressing income inequality? Isn’t it a perpetuation of the same thing, in other words?
Nick Lemann: Well, I would say, this particular movement, in my opinion, toward stakeholder capitalism is not going to be recorded in the history books as the thing that solved the inequality problem and the politics of populism and nationalism that have grown out of that. This is the big event in the politics of the developed world in the 21st century. And I don’t want to stray into history repeats itself. But it reminds me somewhat of the early 20th century, when you had a very big series of economic changes that created a lot of inequality, dislocation, disruption, new problems, et cetera, where the first reaction was kind of emotional. William Jennings Bryan, remember, was the Democratic nominee for president three times, losing all three times, and his idea, which was going to a silver standard, nobody thinks would have actually addressed the problem.
Then there was this sort of second generation of work, more policy-oriented types, figuring out how to turn the populist emotion into progressive policy. I think we’re at the very, very beginning of that, and you’re seeing a more—Donald Trump is so weird, it’s hard to sort of say this with a straight face. But Joe Biden is running on a more left economic platform than about the last five Democratic nominees in a row. And that’s not because he suddenly went there. It’s because the times demanded it, because Bernie Sanders gave him a run for his money. So, I think that action is going to be in public policy and the state role and politics more than it’ll be in voluntary changes instituted by corporate CEOs.
Luigi: I’m sorry, I think that the analogy with the beginning of the 20th century is perfect. But I disagree with the interpretation, in the sense that I think that, actually, William Jennings Bryan had a great idea on the bimetallism. He wanted to create inflation, and it would have worked fine for the farmers of the West. So, his ideas were not emotional. Maybe they were conveyed in an emotional way, but they were actually very good economic ideas. He lost. Why? He lost because the Republican Party at that time, invented, basically, money in politics as we know it today. Mark Hanna was saying, there are two important things in politics, one is money, and the other, I forgot.
And he’s the first one that went and shook down all the CEOs of the major corporations to have them sort of support the Republican Party. And then what happened is there was a major scandal, in which Theodore Roosevelt was also involved, which forced the passage of a law to reduce the amount of money in politics. And that really, in my view, is what changed the situation. And where there is responsibility here, especially for the left, is the left not only discovered the beauty of business, it discovered even more the beauty of the money of business. The money of large corporations goes almost equally to Republicans and Democrats. They run the show. Until we break this aspect, I don’t think there can be a solution to the problem.
Nick Lemann: Yeah, I agree with that, you really can’t say anymore, and this is the kind of remarkable fact right now, that the Republicans are the party of business and the Democrats are the party of labor or the plain people or something like that. To remind you of how complicated and weird a country this is, the act that created campaign-finance reform for the first time was called the Tillman Act, named after Pitchfork Ben Tillman, who even by the standards of the time was a notorious racist from the South. Racism and economic populism get pulled together a lot worldwide, really, in racism and nativism. So a lot of people in the world I live in on the Upper West Side, and maybe the world you live in, in Hyde Park, don’t understand what’s going on now as an economic phenomenon, but instead as a racial phenomenon, when, in fact, it’s both. It’s hard to pull apart.
There’s an amazing statistic. All 10 of the 10 richest congressional districts in the country since the 2018 election are represented by Democrats. Forty-two of the 50 richest are represented by Democrats. Silicon Valley, which is home to the five highest-market-cap companies in the country, is clearly Democratic-affiliated and has become a big whipping boy of the Republican Party. Jamie Dimon, who put together the stakeholder capitalism statement, is a registered Democrat and big Trump enemy. So, I don’t think it’s clear which party’s going to own this, really. It’s really interesting to look at that. I’ve just been frustrated that the sort of elite liberal community, I think, at this moment still doesn’t really get the economic story. It’s not there in their gut.
Luigi: But so, going back to Friedman, in my view, the idea that corporations engaging, especially in charitable activities and stuff like that, without the consent of their shareholders, is a form of taxation without representation. Where I think Friedman fails is that he does not recognize the limit of his own saying, because he claims that corporations should maximize profits within the rules of the game.
if I am a corporation that maximizes profits, and I can basically alter regulation to my advantage, then is the social responsibility of a corporation to lobby to death and to subvert the political system to maximize profits? I think any reasonable human being would say, no. This contradiction is not clear in Friedman, and maybe it’s too much to ask. But I have to say, it’s not clear to a lot of followers of Friedman. As you said, Friedman created a school of thought that is particularly prevalent in the field I’m in, which is finance. And all these schools of thought ignore this aspect, which, in my view, is important. And, to me, the real battle is not just a battle about stakeholders, because one of the biggest stakeholders are workers, and most of the workers of US corporations are not Americans.
So, when Elizabeth Warren wanted to impose codetermination, she forgot the fact that maybe Walmart is going to be run by Mexicans. Are we prepared for that? It would be interesting to see. The real dimension is to what extent corporations are left alone to subvert the system to their own advantage. And we should impose some social limit on that. And I’m a little bit more optimistic than you are, Nick, because I don’t think we necessarily need a constitutional amendment. It would be nice. But we could have a movement of the shareholders themselves that says, “Wait a minute, we don’t actually want these companies to subvert the system.” So we want to compel these companies to disclose what they’re doing and to be accountable to us on how they lobby and how they subvert the system.
And all the investors who are portfolio investors that buy an index, they have an interest in supporting these ideas. And I think that this idea is so close to coming to fruition that the Department of Labor under Trump has started to introduce regulation to prevent the shareholders from saying what they think about these issues. Because they’re afraid that this is going to be subversive. So, what started as a freedom revolution by Friedman ends up as a repressive revolution by Trump that basically forces shareholders out of their own company.
Nick Lemann: Well, that’s interesting. I guess, I need to think about that, my instant reaction would be to be less optimistic that shareholders could drive this kind of revolution and impose it on companies. And I think it’d be more likely to come from the state than from shareholders. But I think the issue is teed up enough that something’s going to happen. That’s what I am optimistic about. I don’t think the consensus or what seemed to be a consensus around 2000 . . . That’s played out. There’ll be a kind of rearrangement. I just don’t know what the rearrangement would be.
Luigi: But you know, Nick, the shareholders are you and me and Bethany.
Nick Lemann: No, I know.
Luigi: The large corporations are controlled by Vanguard, Fidelity, and BlackRock, and those companies have our money. Our pension money is in there. And when Larry Fink sends a letter about what they should do, the first responsibility of Larry Fink is to vote for every shareholder’s proposal that says, “You should disclose lobbying, you should disclose campaign financing. You should be transparent on all these things.” That’s Larry Fink’s responsibility. What I would like to do is write a letter as a shareholder to Larry Fink to tell him what he should do.
Bethany: Except . . . but I think, Luigi, I agree with Nick and his lack of optimism, because your optimism flies in the face of shareholders’ relative inaction in the face of however many years of inequity, whether it’s on executive pay or on a multitude of other issues. The truth is, big shareholders don’t act like stewards of our money in the way that we would want them to. And for all sorts of reasons, including conflict with managing corporate 401(k) plans, including their own short-term interest in seeing stock prices go up. But I think that your optimism is theoretical. But if you look at what’s actually happened over the last 20 or 30 years with shareholders and their relative inaction, it wouldn’t give you much cause for optimism.
Nick Lemann: You’re right to point out people like BlackRock and Vanguard and Fidelity as the people in the system who have the real leverage. That’s a really important point.
Bethany: But they failed to use that leverage over the years.
Luigi: And, Bethany, the big change has been in the last 20 years. The fact that now we are all indexed, we all invest in indexes, or at least we should, and the vast majority now does. And so, now we internalize the collective good more, because if I have invested in American Airlines, and American Airlines spends money just trying to destroy United through regulation, at the end of the day, I end up losing, because I am well-diversified.
So, I think it is in my interest as an investor to have an end to this lobbying. And the possibility exists, if we move with our feet, if we say, “Larry Fink, either you vote on these proposals, or we move the money to another index fund.” We’re not going to lose much, because they’re all indexed, they all have the same performance. But Larry Fink wants to have our money. So, he’s going to change.
Bethany: I agree with you, theoretically, you’re absolutely right. Except the practical reality of what has happened over the last few decades would say you’re absolutely wrong.
Nick Lemann: And the irony is Peter Drucker, who, as you can see, I’m sort of obsessed with, wrote a book in the ‘70s, he left these dramatic pronouncements. And he wrote a book saying, the United States is now the first really socialist country in the world, because of the power of the pension plans in the markets. And so, he said, “See, the workers own the means of production. This is a great system.” Essentially, I’m oversimplifying, but it could never lead to the kind of thing you were just talking about, Bethany, and private equity didn’t really exist then, because of the quiescence of shareholders. The pensions are never going to actually demand that corporations institute worker-friendly policies. And I don’t think he saw, and many people didn’t see, how worker-unfriendly things were going to get in the shareholder-oriented economy.
Luigi: Yeah. But this is where, sorry, this is where I want to bring up a point you raised earlier, Nick, which is the concept of fiduciary duty. At the moment, all these investors, and particularly pension funds, have a very narrow definition of fiduciary duty, where they basically have to maximize the financial return for their investors. This is where, in an article with Oliver Hart, we wrote that the objective should be to maximize the welfare of their investors, not necessarily the financial return.
If I am a group of workers living in California, having a situation in which I have a lot of money, but my state is completely burned, is not really maximizing your welfare, it is maximizing your financial return. The real battle, intellectual and political, is in changing this perspective. In academia, we have made the first steps, and now we need to transform these steps into political action and ideas, first, generalized ideas and then political action.
Bethany: I think this is changing. I think pension funds are becoming aware of a lot of the power they have and are actually insisting on, when they give private-equity firms money, that private-equity firms engage in worker-friendly practices. At least the bigger pension funds are getting very, very sophisticated about this and even questioning whether they should continue to keep giving money to private equity. So, I think the change that I speak about is actually starting to happen, or the change that I’m skeptical about is starting to happen.
Nick Lemann: Yeah, I’m torn about that. I just don’t have the data to know how politically plausible it is. The phenomenon of where you stand is where you sit is pretty powerful. I and my colleagues all have these TIAA-CREF accounts, I notice that they notice how well their account is doing, only measured in monetary value and not in social value. And these are people who like to think of themselves as oriented towards social value.
I’m on a board of a foundation called the Russell Sage Foundation, which funds social-science research and is hugely all about these problems in the economy that we’ve been talking about. But it definitely puts a portion of its endowment into private equity, on the argument that, well, we can do more good, we can fund more research about how to build a better world, if we put some of our endowment into private equity. So, it’s not easy, once you get people thinking like investors, to get them to not think in such a unitary way.
Luigi: But Nick, you touched on the right point, because what I think is the longest-term consequence of the Friedman piece is exactly this separation that also applies to foundations. Actually, Friedman being very smart in his article, he kind of tried to preempt this, because he said, “If shareholders only care about money, this is what happens.” But if you are a foundation, by definition, you shouldn’t care only about money, because you have a bigger purpose. So, this separation between what I call the assets and liabilities, managing the assets separate from your mission on liabilities, is a derivative of the Friedman piece. And this is what Oliver Hart and I show to be theoretically wrong. So, I’m happy to send you that article so that now that you’re in the Russell Sage Foundation, you should tell them that they should consider a different benchmark.
Nick Lemann: OK.
Bethany: Thank you, Nick.
Nick Lemann: Thanks. And this was fun. And, you know—
Bethany: See you soon, I hope, Nick, somewhere, sometime.
Nick Lemann: Thanks for having me.
Bethany: Before we let this go, I do think we want to come back to this idea, because I think it is really, Luigi, our key disagreement in this, which is, I think you have better expectations of shareholders than I do. Why are you optimistic about shareholders?
Luigi: I’m more optimistic about voting and democracy in general. I do believe in democracy in the political realm. And I do believe in shareholder democracy in the corporate realm. I am very much afraid of a situation in which you say, “Oh, we the experts know better, and we are going to decide for you.” Maybe because I come from a country that experienced a terrible dictatorship where somebody would say, let the ruler decide because he knows best, and it was a freaking disaster. So, I’m allergic to everybody who says that, in the political arena and in the corporate arena as well.
In particular, I think that people are mixed, because it’s true that we hire managers because they’re more competent, and we should let them run. And so, I’m not there to second guess what is the best advertising strategy. But when it comes to values, we’re not hiring the CEO because he shares our values. We hire the CEO because he’s good at designing the marketing policy. And whether I have some moral objection to ads that have naked people, for example, is none of the business of the CEO, it’s the business of the shareholders.
If I don’t want to make money putting naked pictures on the screen, it’s my right to have the ability to influence the CEO and say, we want to put on this limit, because this is, if you want, a moral limit, it is not an economic limit.
Bethany: I agree with all of that. But I think I agree with you theoretically. I think practically what has happened would point in a different direction. I think shareholders are far too quiescent, so they don’t speak up. There are a few reasons for that. I think one is that shareholders are every bit as short-term- return oriented as corporations are. They, too, are getting their bonuses paid based on whether a stock does well, so they are incentivized toward seeing a company deliver profits as much as management is, because that’s where their money comes from. And in the pension system, those returns are everything for underfunded pension plans.
It would almost take an anthropologist to look into this, but I think there is a huge cultural barrier for shareholders really raising hell, particularly with big companies. And it gets back to a concept I thought about, but this is my own invention. But I’d like to think of this as implicit corruption, which is not explicit, that somebody’s paying somebody else off. But you’re in a system where everybody thinks the same things matter and are important. The people running the big shareholders are as likely to be wealthy and unconcerned with the plight of the workers as the executives of the companies themselves. They all believe in the same thing. And so, I think when you look over the history of the last 20, 25 years, you’ve seen shareholders not speak up very often on many issues that they should have spoken up on. So, I agree with your theory 100 percent. I just think the practicalities get in the way of shareholders exercising the power they should.
Luigi: In honor of the 50th anniversary of Friedman, we had a conference on these topics, and there were a number of papers that were fascinating, showing exactly the opposite. One was the impact that the activists of the New York Public Pension Fund had, not on abstract metrics of ESG that can be manipulated, but actual pollution quantity in the air around the plants of the companies they invested in. That shows that when shareholders speak, you have a difference.
And then there was another paper, even more fascinating, looking at private prisons. And this paper shows quite clearly that private prisons are worse than public prisons, in the sense that people commit suicide more in private prisons than in public prisons. However, private prisons where there are large institutional investors are better than the typical private prisons. So, institutional investors seem to have a positive impact on the way that companies are run.
These are small tokens, I agree, but it is the beginning of the possibility of change. And at the end of the day, the shareholders are you and me. And so, if we can actually influence Larry Fink, we are done, because Larry Fink writes very beautiful letters about what other people should do. I want to write a letter to Larry Fink to say what he should do for me, because he invests my money, and I want him to vote on certain issues. For example, disclosure of corporate lobbying, he has to vote yes, yes, yes. And if he doesn’t vote yes, I want to withdraw my money from BlackRock.
Bethany: Well, I absolutely agree with you, when shareholders speak, they can have a huge impact. I don’t think they speak enough. I do think you’re right, and I think that is beginning to change. And I hope we see more of that in the future, but in the past, I think there’s been a big divide between what we the people would like to see shareholders who harvest our votes doing with our voice, and what they’ve actually done.
And I do think there is some hypocrisy in all of us as well, in that we may say, we want these beautiful things. But when we look at our returns, and we think about our retirement, we want the investment that went up 15 percent, not the investment that went up 8 percent. And so, I think there also has to be some reckoning with our own hypocrisy as we move forward.