STOP BLAMING MILTON FRIEDMAN!(shareholder primacy model)

• Date: 01 August 2021
• Author: Cheffins, Brian R.
• Published date: 01 August 2021
• Author: Cheffins, Brian R.

ABSTRACT

A 1970 New York Times essay on corporate social responsibility by Milton Friedman is often said to have launched a shareholder-focused reorientation of managerial priorities in corporate America. The essay correspondingly is a primary target of a rapidly growing group of critics of the present shareholder-centric approach to corporate governance. This article argues that it is erroneous to blame (or credit) Milton Friedman for the rise of shareholder primacy in American corporations. In order for Friedman's views to be as influential as has been assumed, his essay should have constituted a fundamental break from prevailing thinking that changed minds with some alacrity. In fact, what Friedman said on corporate purpose was largely familiar to readers in 1970 and his essay did little to change managerial priorities at that point in time. The shareholder-first mentality that would come to dominate in corporate America would only take hold in the mid-1980s. This occurred due to an unprecedented wave of hostile takeovers rather than anything Friedman said and was sustained by a dramatic shift in favor of incentive-laden executive pay. Correspondingly, the time has come to stop blaming him for America's shareholder-oriented capitalism.

TABLE OF CONTENTS INTRODUCTION I. FRIEDMAN'S ESSAY AS "SPECTACULARLY INFLUENTIAL": KEY ASSUMPTIONS II. A BREAK WITH THE PAST? A. Managerial Priorities c. 1970 B. Why Did Friedman Revisit Corporate Purpose? III. A TURNING POINT? IV. SHAREHOLDERS RISE TO THE TOP OF THE PRIORITY LIST: WHEN AND WHY A. When? B. Why? V. FRIEDMAN AND SHAREHOLDER VALUE CONCLUSION INTRODUCTION

John Maynard Keynes, a pre-eminent twentieth century economist, observed "[t]he ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else." (1) A "spectacularly influential" (2) 1970 New York Times essay by Milton Friedman, another distinguished economist, seemingly provides convincing proof of Keynes' adage. In an article the New York Times entitled "The Social Responsibility of Business Is to Increase Its Profits," Friedman harshly criticized those in the business community who maintained that private enterprises had a mission to promote desirable social ends. (3) What the Times labelled a "Friedman doctrine" (4) reputedly would become "a seminal turning point in corporate legal theory." (5) In particular, Friedman's essay has been credited with--or blamed for--launching a still ongoing era of "shareholder primacy" where corporate executives have assumed their job is to maximize shareholder value. (6)

A "Great Debate" about whether public companies exist to deliver returns for shareholders or in service of a broader constituency has been underway for decades. (7) The question "in whose interests should the corporation be run?" and its close corollary "what should [a corporation's] managers ... strive to achieve?" have duly sparked debate in several academic disciplines, including law, economics, political science, and management. (8) The general consensus in corporate America since the late twentieth century has been that shareholders are top of the managerial priority list. (9) The shareholder-first orientation has generated serious misgivings, however. (10) Critics of the status quo maintain that managers should forsake their single-minded focus on stockholders so that the corporate sector can operate in accordance with a sustainable model that creates a bigger pie over time as business is conducted in a financially, environmentally, and socially responsible manner. (11)

Milton Friedman has been a star player in this "Great Debate" over corporate purpose. His 1970 essay has been described as "the classic statement" of the shareholder oriented view of the corporation (12) that set a standard destined to be widely followed. (13) Shareholder primacy nay-sayers have accordingly bemoaned the essay's malign impact and sought "to drag down and bury Friedman." (14) Critics have characterized Friedman's "infamous 1970 polemic" (15) as an "intellectually incoherent" piece that conjured up "a magical world" and advanced "the world's dumbest idea." (16) Regrettably, the reasoning goes, Friedman's "wild fantasy obtained widespread support as the new gospel of business." (17) "[O]ne of the most ... economically destructive articles in history" (18) reputedly "has had a catastrophic impact upon US business," (19) "and the consequences of the mistaken thesis have been mounting environmental and social problems around the world." (20) As Oxford management theorist Colin Mayer has said of "the Friedman doctrine," "[f]ew social science ideas are both so significant and misconceived as to threaten our existence." (21)

Opposition to the shareholder-centric vision of the corporation that has prevailed in corporate America has been growing recently. (22) This has meant, according to the Wall Street Journal, that "[t]he hottest debate in corporate America asks whether a public company exists for the enrichment of shareholders or in service of a broader constituency, including employees and customers." (23) Most notably, in 2019 the Business Roundtable, a trade association of chief executives of leading American corporations, issued a 300-word "Statement on the Purpose of a Corporation" that stressed "a fundamental commitment to all of our stakeholders" and did not specifically mention "shareholders" until the second-to-last paragraph. (24)

The Business Roundtable's statement has been "interpreted as a schism between business and the Friedman Doctrine." (25) Similarly, it has been said that as unease with shareholder oriented capitalism has grown over the past decade "the challenges to Friedman's model have been gathering momentum." (26) Indeed, finance professor Alex Edmans suggests that "[t]o declare that you reject the Friedman doctrine has become almost a requirement for acceptance into polite society." (27) The New York Times joined the chorus when the fiftieth anniversary of the publication of Friedman's essay rolled around in September 2020. As a Wall Street Journal columnist said shortly thereafter, "[a]lmost as penance for publishing the original, the Times recently printed an eight-page supplement nitpicking Friedman's article." (28)

This all presumes that Milton Friedman deserves substantial blame (or credit) for the ascendance of shareholder value in public companies. He does not. While it is generally believed that intellectuals substantially affect legal and economic change, their influence tends to be taken for granted rather than being explained theoretically or proven empirically. (29) Certainly in the case of Milton Friedman's 1970 essay, its actual impact does not match up to the hype.

Part of the reason the reality does not match up with the Friedman doctrine/shareholder primacy hype is that rhetorical flourishes deployed to describe his 1970 essay have set the bar very high. Economists Oliver Hart and Luigi Zingales have argued Friedman's article can "be seen as providing the intellectual foundation for the 'shareholder value' revolution." (30) A Newsweek columnist suggested in 2019 that "for almost 50 years, American CEOs have loosely followed what is known as the Friedman Doctrine." (31) Harvard Business School professor emeritus Malcolm Salter likewise maintains that with Friedman's 1970 essay his "voice rang loud and clear throughout the business community and continues to resonate today in many classrooms and boardrooms." (32) Similarly, law professor Margaret Blair has suggested that "leaders of corporations" have been told for decades "that they should focus their attention solely on 'maximizing shareholder value,' as instructed by University of Chicago economist Milton Friedman." (33) It strains credulity that an entire school of academic thought could have this sort of impact, let alone a single newspaper essay that was not even 3,000 words in length.

More prosaically, as this Article will show, the historical evidence does not tally with the hype. In particular, those who ascribe to Milton Friedman substantial responsibility for American companies prioritizing shareholder interests make a series of implicit erroneous assumptions about his essay and subsequent developments. For instance, while Friedman's essay has been characterized as a standard-setter, whatever emphasis he placed on the bottom line was hardly novel. Instead, it was widely accepted at the time he wrote that generating profits was a core corporate mission. Moreover, for more than a dozen years after Friedman's essay was published his reasoning did little to change managerial priorities. Present-day shareholder primacy only began to take hold in the mid-1980s when corporate America was in the grip of a wave of hostile takeovers. In addition, while Friedman did tell executives they should try "to make as much money as possible," (34) he failed to make any sort of plea that managers should obsess over earnings or share prices in the way they would subsequently.

Friedman's essay has been described as "one of the most influential op-eds of the 20th century" (35) and it may have been the most cited piece ever published in the New York Times. (36) Friedman's 1970 article no doubt was consequential. (37) As this Article will show, however, the essay was not nearly as pivotal as those assigning blame for the supposed corruption of the priorities of corporate America have suggested.

The Article is organized as follows. Part I canvasses the assumptions underpinning the contention that Milton Friedman's 1970 essay was "a seminal turning point." Part II places the 1970 essay in the context of the time that Friedman wrote it and in so doing casts doubt on the notion that his essay was a fundamental break from the past. Part III draws attention to the essay's failure to change minds with any alacrity. Part IV...