Fifty years ago this year, Milton Friedman, later to be a Nobel laureate in economics, famously argued that corporate governance should focus solely on shareholder value maximization, while conforming to applicable laws and regulations. That view was controversial then. After years of dominance as a governance idea, shareholder primacy is once again controversial. We argue that it is more or less still correct.
Recently, the Business Roundtable’s Statement on the Purpose of a Corporation commits the board to other stakeholders as well — including customers, employees, suppliers, and communities the company operates in. But importantly, if labor markets and product markets are competitive, the shareholder primacy and stakeholder paradigms would lead to identical corporate policies. When these markets are not competitive, differential time horizons and differential risk exposures of various stakeholders could lead to differing corporate policies; these are bright lines justifying public policy interventions. But such public policy interventions are a complement to, not a substitute for, long-term shareholder value maximization.
To strengthen the prospects for success of long-term shareholder value maximization, we suggest steps to align shareholder wealth maximization with stakeholder interests. First, antitrust policies should be vigorously enforced to maintain and enhance competition in product markets and labor markets. Second, management and board compensation should be reformed to focus on creating and sustaining long-term shareholder value. Third, the Business Roundtable and other organizations should reconsider their policy of applying direct and indirect pressure on corporations to focus on non-shareholder priorities. Because public corporations are more susceptible to such pressure, it could prompt companies to go private or not go public. Recent evidence suggests fewer public companies leads to more concentrated product markets, with the increased likelihood of diminished competition in these product markets.
Clarity in objectives and governance facilitates accountability of corporate leaders and boards of directors and shapes the contours of corporate activities. Pursuing objectives too broad and diffuse complicates accountability, limits the value creation by corporate businesses, and may lead to a decline in the use of the corporate organizational form for business enterprises. Pursuing objectives too narrow can lead to conflicts among shareholders and between shareholders and non-shareholder stakeholders. Corporate focus on long-term shareholder value maximization remains the best way to enhance value and the broader corporate contribution to society.
That long-term shareholder value maximization can balance trade-offs among other corporate stakeholders — assuming a value-maximizing focus by corporate managers and boards — does not imply that long-term shareholder value maximization will address all problems faced by the firm. First, for many problems, corporations do not represent the appropriate level of action to solve the problem. Consider, for example, the free-rider problem for certain corporate investments in employee training or communities. Training support could be enhanced by tax credits to offset the externality and by partnerships among companies with community colleges or universities in a geographic area. Support for communities could be enhanced by corporate partnerships coordinated by local business organizations or economic development agencies. Some aid for communities and particular workers in those communities is better accomplished by government though economic development funds or augmenting support for earnings from work in areas with high levels of structural unemployment.
Other social problems are even more complex. Climate change, for example, poses significant challenges for societies and businesses to reduce carbon in the atmosphere and greenhouse gas emissions and adapt to evolving changes in surface temperatures. Investors could and should press corporations to disclose more information about the exposure of their long-term value to climate change and corporations may act to reduce emissions and increase their adaptability in service of a focus on long-term value maximization. That step is an extension of a market process and response. That step alone will not, however, resolve negative externalities from effects of business activities on climate change. But significant changes to combat climate change require public policy changes in the United States and abroad — a carbon tax or alternative-energy technology subsidies, for example. Turning more to corporations because the political process seems broken and makes little progress won’t do.
There are other instances in which direct policy action is required to alter shareholder value maximization. Examples include antitrust laws to limit exploitation of product market power, anti-monopsony rules to enhance competition for employees, and corporate tax policy to affect levels of corporate profitability, location decisions, wages paid to workers, or incentives to invest. These explicit policies address social objectives that would not, in some cases, be achievable by individual firms and would not otherwise receive the same level of attention in an unconstrained long-term shareholder value maximization by the board of directors. Even in such cases, it is important to note that the above public policy interventions are a complement to, not a substitute for, long-term shareholder value maximization.
Will public policy play this needed role? While some of this concern reflects populist opposition to big business in the aftermath of policy responses to the 2007-2009 financial crisis, the concern’s roots may deepen given the unprecedented and devastating economic impact of the ongoing Covid-19 pandemic. With political dysfunction, social challenges are going unmet, so why not turn to corporations and their leaders for progressive action? Simply put, broad social challenges involving externalities and spillovers require government intervention. While business leaders can individually or collectively champion such interventions, corporate actions alone will not meet the challenges. Political polarization does not make the corporation the logical alternative for action. Frustration with the state of political discourse around social problems does not change this point. And altering the purpose of the corporation away from long-term shareholder value maximization risks vagueness that can disrupt the wealth-producing and job-creating power we take for granted from the modern corporate enterprise.
This post comes to us from Sanjai Bhagat, the Provost Professor of Finance at the University of Colorado and an independent director at ProLink Solutions, and from R. Glenn Hubbard, the Russell L. Carson Professor of Finance and Economics at Columbia Business School and a research associate at the National Bureau of Economic Research.