Milton Friedman Versus The Business Roundtable: ESG and It’s Place in Corporate Governance
By Arthur Kohn, Skytop Contributor / January 10th, 2022
Arthur Kohn has practiced law since 1986, focusing on compensation and benefits matters, including executive compensation, pension compliance and investment, employment law, corporate governance and related matters. In 2021, he was appointed as a fellow to the American College of Governance Counselors.
Arthur is an adjunct professor at New York University School of Law and a regular guest lecturer at Columbia Law School. He frequently speaks and writes about executive compensation, taxation and corporate governance matters. He repeatedly has been recognized for his work by the business and legal press, including Best Lawyers, Chambers USA, The Legal 500, Super Lawyers of New York and others.
Arthur received a B.A. from Columbia University and a J.D. from Columbia Law School, where he was admitted into the Accelerated Interdisciplinary Legal Education program, was appointed a Harlan Fiske Stone Scholar and received Phi Beta Kappa honors.
ESG Capitalism or Socialist Threat
Climate-related and social crises, here in the United States and globally, continued in 2021 to demand the attention of company boards and management. They, managing the pressures of shareholders, customers, employees, activists and politicians, struggled to delineate the proper role and responsibilities of corporations in addressing these issues.
The debate on the merits of inserting ESG in the center of corporate governance considerations remains hotly contested. The challenges seem not close to fading into the background. Rather, companies and their stakeholders are likely to continue to walk down newly paved paths, arguing and navigating the potentially changing role of the company in society.
Because of this, it’s important to reflect on the divergence of perspectives on ESG. The question is as big as how social responsibility of business fits into our capitalist system. I suggest that we pause to separate the forest from the trees; that we step back to step back to acknowledge that there is a threshold philosophical question, and then there are many separate, important implementation questions.
To kick off our review, let’s consider the forest of two contrasting philosophies as laid out in two succinct and starkly contrasting statements, one by Milton Friedman and the other by The Business Roundtable.
Milton Friedman and The Business Roundtable
Consider which of the following two statements seems to you to have greater merit.
The first, from the The Business Roundtable’s 2019 Statement on the Purpose of a Corporation: “While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to . . . investing in our employees, [starting] with compensating them fairly and providing important benefits, supporting them through training and education that help develop new skills for a rapidly changing world, [and] foster[ing] diversity and inclusion, dignity and respect, dealing fairly and ethically with our suppliers . . . [and] supporting the communities in which we work, [including] respect[ing] the people in our communities and protect[ing] the environment by embracing sustainable practices across our businesses.”
The second, from Milton Friedman’s famous 1970 article entitled “The Social Responsibility of Business Is to Increase Its Profits”: “Businessmen believe that they are defending free enterprise when they declaim that business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends; that business has a ‘social conscience’ and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers. In fact, they are—or would be if they or anyone else took them seriously— preaching pure and unadulterated socialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.”
Friedman’s article is worth reading (or re-reading) in full.
His fundamental point is that when a businessman acts, as a corporate executive and not in his personal capacity, out of a sense of social responsibility, “he is in effect imposing taxes, on the one hand, and deciding how the tax proceeds shall be spent, on the other . . . [which] involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce resources” in a society.
He argues that the consequences of that dynamic are bad, even in the face of social exigencies and concludes the article with the following summary:
“The doctrine of ‘social responsibility’ taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collectivist doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means. That is why, in my book ‘Capitalism and Freedom,’ I have called it a ‘fundamentally subversive doctrine’ in a free society, and have said that in such a society, ‘there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception [or] fraud.”
The Business Roundtable’s statement was not accompanied by any attempt to rebut Friedman’s basic theory, much less to put forward an alternative one. It reads basically as a stand-alone conclusion borne of experience.
From 1970 to 2019 –The Debate Continues
Taking The Business Roundtable statement at face value and Milton Friedman’s doctrine as a representative expression of businesses’ sentiment for its time, corporate leaders have evolved a great deal between 1970 and 2019. Of course, neither statement describes the actual uniform conduct of businesses yesterday or today. But there is an underlying philosophical debate that existed in 1970 and continues today. We are still striving to sort out the best fundamental approach to issues involving the greater good.
It’s fair to say that Friedman’s article represents the theoretical or foundational basis for the perspective–still common today–that corporations should not be concerned with eliminating discrimination, avoiding pollution or other social ends.
Back to Limiting Corporations to Profit Making
Note the difference between CEOs speaking out on social issues, and corporations taking prescriptive action.
Surveys and other similar data points seem to suggest a robust consensus (not unanimity, to be sure) today that CEOs should speak out on important social and political issues. However, the data suggests much less consensus when concerning corporate action to further social and environmental ends. To the contrary, there still seems to be a fair amount of support among business executives for Friedman’s bottom line that the only social responsibility of business is to increase profits, notwithstanding the recent proliferation of corporate social responsibility reports and similar rhetoric to the contrary.
For example, in a recent Stanford University survey on company engagement in ESG related issues (here) found that, “General Counsel are wary of the uncertain long-term impact. It is notable that over half of the people who are responsible for balancing the risk and reward of corporate actions advocate dialing back some of these efforts and recommitting to the central strategic and profit-making purpose.”
The survey question started by summarizing for respondents the policy adopted in 2020 by Coinbase, which committed to not engage in causes apart from its core business, including public policy issues, societal issues, and political causes. It then asked whether they would recommend a similar policy to the CEO and board of their company. Over half (52 percent) said they would, while only 48 percent would not.
The affirmative response is a very significant percentage, and one that indicates that, despite the general trend toward ESG, stakeholder capitalism, and corporate activism, the case for corporate action is still unsettled. The respondents, albeit only a smallish sampling of 69 General Counsel, noted that they would “recommend a policy of restricting their company from engaging in causes not directly related to the company’s strategic and financial mission.”
Social Responsibility or Collectivist Abyss?
Every reader will have their own inclinations, but Friedman’s argument doesn’t seem persuasive to me. Maybe part of the reason is dated rhetoric, but it makes common sense at this moment that corporations should play a role in addressing the big societal issues we face.
They should do so because we have serious issues and because companies can play a constructive role because they have resources and influence, and because they operate in the society, not outside it, and therefore have responsibilities to it. They should do so notwithstanding that they aren’t natural persons, which seems beside the point.
I hesitate to be dismissive of Friedman’s concerns, but I will say that I don’t think that view is “pure and unadulterated socialism”, or that it will lead to anything like it. There may be a slope and it may even be slippery, but I don’t think that it’s a cliff, and we in the U.S. don’t seem to be precariously perched teetering at the edge of some collectivist abyss. Witness the fact that the animal spirits have been aggressive enough in the last 20 years to generate four independent business crises: the dot-com crisis, the accounting crisis characterized by Enron, the financial crisis and the recent corporate rescues required by the COVID pandemic. In sum, I for one am willing to take The Business Roundtable at face value.
Maximizing Constructive Engagement
To be certain, there are serious issues concerning how corporations can maximize their constructive engagement. If Milton Friedman and The Business Roundtable and their conflicting philosophies are two versions of the forest, let’s consider engagement and its related issues, the trees, for purposes of this note.
Certainly, the trees are important, but they shouldn’t be confused with the forest. Specifically, the right question to ask about the tree issues is how to maximize the likelihood of constructive action, not should we act at all. Many companies are trying to work that out.
These are not the kinds of problems that are susceptible to being worked out primarily in the abstract, before any of the ideas are attempted in real life, as some suggest. See, for example, “Seven Myths of ESG”, (here), also from a group at Stanford University. We need to debate how we define these issues, shape a response and measure their outcomes.
Until we have results to analyze, these are issues that in large part require experimentation.
Four Additional Points to Note: Point One
First, some argue that it should be the role of government to promulgate laws and regulations to ensure that there is a social consensus about social goals and that businesses act on a level playing field when they sacrifice profits for social responsibility.
It is jarring to hear this argument made by many who usually jump at opportunities to note that government interference in business is fraught. In my area of expertise, executive compensation, practitioners (including me) regularly note the unintended consequences of governmental regulation: golden parachute taxes didn’t mitigate golden parachute arrangements! The $1 million cap on deductibility of executive pay contributed not just to higher executive pay but also to the dot.com bubble!! Compensation disclosure rules contribute much more to spiraling executive pay, based on the Lake Wobegon ratcheting effect, than to any moderation in the rate of executive pay increases!!!
But, still, should we leave it to government alone to fix our big social and environmental issues?
There is a real disconnect in that argument.
Friedman’s article sets out two related arguments.
The first is a strawman argument, to the effect that those who argue in favor of corporate social responsibility do so out of a conviction “that the problems are too urgent to wait on the slow course of political processes, that the exercise of social responsibility by businessmen is a quicker and surer way to solve pressing current problems.”
This is a strawman – not a serious – argument today because ESG advocates also generally advocate for government action. Nevertheless, one can hardly today argue with the point, given the current state of our politics, that putting all our eggs into the basket of government action is a risky bet, whatever your political inclinations.
Still, the fundamental point, made above, is different: that society has good reason to expect that corporations act in socially and environmentally responsible ways. That’s not asking too much; it is implying that responsible conduct is not incompatible with successful competition. The executives of The Business Roundtable, at least, seem to be willing to back that proposition.
The second argument starts with Friedman’s statement that “in an ideal free market resting on private property, no individual can coerce any other, all cooperation is voluntary, all parties to such cooperation benefit or they need not participate” and concludes with his disappointment that “there are some respects in which conformity appears unavoidable, so I do not see how one can avoid the use of the political Mechanism altogether.”
OK, but surely that shouldn’t mean that we should forego private efforts at cooperation among stakeholders to address social and environmental issues, rather than defer to the possibility of governmental coercion and enforced conformity.
Four Additional Points to Note: Point Two
My second additional point concerns the topic of self-interest, starting again with a reference to the Friedman article. Friedman notes that some couch the argument in favor of corporate social responsibility in terms of self-interest and he is decidedly not impressed.
Specifically, Friedman takes on the question of whether socially responsible conduct might be in a corporation’s own, perhaps long-term, self interest. Friedman argues that acting out of self-interest to increase profits without any pretense of concern for the public externalities is righteous, but acting out of self-interest to purportedly advance a public good approaches fraud. Huh? Really. Friedman concedes that “if our institutions, and the attitudes of the public make it in their self‐interest to cloak their actions [as being motivated by self interest, I] cannot summon much indignation to denounce them. At the same time, [I] can express admiration for those . . . who disdain such tactics as approaching fraud.”
That is not very persuasive, for three reasons:
First, the moral argument – that acting always and only in one’s own self-interest is good and acting in the public interest to any extent is bad – does not resonate.
Second, fraud implies gain to the person committing the fraud. What gain is there to a corporation that decides to expend resources for the public’s benefit while saying that it is doing so out of self interest? If it is right about its self-interest there is just reward, not fraud. If it is wrong, even if it is knowingly wrong, about its self-interest, then there is no reward at all. In either case, where is the fraud?
Third, the argument discounts entirely the possibility that a business acting in society’s interest, aside from direct benefit to society from maximizing profits, may in fact be, and may indeed be honestly considered to be, good for a business. Although the point that corporations can contribute to public progress may never be provable, there is at least some theoretical possibility that they can.
It should be readily conceded that executives and boards that purport to be acting out of an interest in the long-term health of their enterprises, supported indirectly by social and environmental progress, and therefore out of self-interest, are not engaged in fraud when they proceed in that way.
Four Additional Points to Note: Point Three
The third point concerns the question of why “governance” got attached to the “E” and the “S” in the corporate social responsibility conversation. This is one of the seven myths noted in the Stanford article referred to above.
The “G” seems not to fit, apparently, and some of the issues that are discussed under the governance heading seem inconsequential compared to the environmental and social issues on the agenda.
The reason that governance does fit, and the way in which it fits, is that it is central to the ability of corporations to address big social and environmental problems. If managers are not responsible to boards, or boards are not responsible to shareholders, or other stakeholder interests are ignored, then big problems can be ignored, left for others to address while the corporation figures out how to insulate itself and to maximize profits in the context in which it finds itself.
The simple point is fleshed out in two comprehensive treatments: “What is the Optimal Balance in the Relative Roles of Management, Directors, and Investors in the Governance of Public Corporations?” (here) and Prosperity, by Colin Mayer (2018).
Four Additional Points to Note: Point Four
Finally, my fourth point concerns whether corporate social responsibility is incompatible with the Delaware law notion (or similar doctrines in other state laws) of shareholder primacy.
Arguments can be made about what “shareholder primacy” means precisely for this purpose (see, for example, the Shareholder Value Myth, Lynn Stout (2012) and note the challenges apparently faced by the American Law Institute’s project on revising the Restatement of the Law of Corporate Governance, at here.). There should be no doubt that publicly-held corporations can expend resources for social and environmental purposes if the independent members of their boards, after appropriate diligence and acting in good faith, authorize such conduct.
For one, the business judgment rule would protect their decisions. Less legalistically, there is a long history of corporate philanthropy (see The Shape of Corporate Philanthropy Yesterday and Today, by Timothy J. McClimon at here) and a robust dialogue about how to do it in a way that maximizes the corporate value created (see The Competitive Advantage of Corporate Philanthropy, by Michael E. Porter and Mark R. Kramer in the Harvard Business Review (2012) (here). The latter note takes on Friedman’s argument explicitly and concludes that “there is no inherent contradiction between improving competitive context and making a sincere commitment to bettering society”.
The Pendulum and Its Swing Offers Insights
A swing of the pendulum back a little bit towards a recognition of corporate social responsibility carries only a very small risk of leading us inexorably to doom (i.e., pure socialism). There’s even a chance that those who argue that it will increase long-term equity values are right.
We should internalize that big picture while searching for the answers to the implementation issues. Certainly, as the world continues to globalize, public companies are faced with addressing the E and S complexities that, irrespective of the arguments for or against, bring in the G of ESG.
Consequently, these issues will continue to land onto the agenda for boards, management, and shareholders to have to sort out, responsibly.