The Volokh Conspiracy
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"The Profit Motive: In Defense of Shareholder Value Maximization"
From my UCLA colleague Prof. Stephen Bainbridge.
I asked Prof. Bainbridge whether I could cross-post this from Corporate Finance Lab, and he kindly agreed:
What is the purpose of a corporation? Is it, as Nobel Economics laureate Milton Friedman famously claimed, "to increase its profits"?[1] Or is it, as the Business Roundtable—a group of approximately 200 mostly USA corporate CEOs— claimed in 2019, "generating good jobs, a strong and sustainable economy, innovation, a healthy environment and economic opportunity for all."[2]
In the academic sphere, the weight of scholarly opinion has tilted substantially towards stakeholder capitalism in recent years.[3] The late law professor Lynn Stout dismissed shareholder value maximization as a mere myth, albeit a powerful one she claimed "causes companies to indulge in reckless, sociopathic, and socially irresponsible behaviors."[4] Canadian law professor Joel Bakan went even further by condemning the business corporation itself as a "pathological institution" whose relentless pursuit of profit has psychopathic attributes.[5] In making such arguments, they reflect a widely shared narrative that "corporations are powerful, evil, malevolent, bad-actors intent on profit-making at the expense of the health, safety, and well-being of individuals."[6]
In the investing world, there long have been so-called socially responsible investors, who structured their portfolios using various social justice filters that excluded companies believed to have negative social and environmental impacts. Although it was claimed that socially responsible investing was a profitable strategy, it was primarily justified by moral and ethical arguments.
Today, however, as investor interest in ESG metrics has grown, there has been a distinct shift in recent years from moral and ethical justifications to financial justifications. Although many ESG investors likely are still motivated by traditional socially responsible investor concerns, ESG investing is explicitly premised on the belief that ESG oriented portfolios provide superior risk-adjusted returns to traditional portfolios lacking ESG or social responsibility filters. Hence, for example, the three largest institutional investors—asset managers BlackRock, State Street, and Vanguard—all claim to have embraced ESG because they believe that ESG factors are positively correlated with firm performance. They offer investment funds that supposedly invest exclusively in firms that score highly in ESG measures and that exercise their voting rights as shareholders to support ESG policies. ESG-focused investors thus are supposedly pushing both asset managers and portfolio companies to be more ESG friendly.
In light of these developments, what the present moment requires is a defense of shareholder value maximization that takes those developments into account. Or, to paraphrase William F. Buckley, what the moment needs is for someone to stand athwart the tracks of corporate governance and yell "stop" as the stakeholder capitalism train pulls out of the station.
Which is precisely what my new book, The Profit Motive: In Defense of Shareholder Value Maximization, does.
Three major themes animate the project. First, any conception of corporate purpose that embraces goals other than creating value for shareholders is inconsistent with the mainstream of U.S. corporate law. Second, directors do—and should—have wide and substantially unfettered discretion as to how they go about generating shareholder value. Although many commentators claim that those statements are inconsistent, in fact they both reflect fundamental normative principles deeply embedded in U.S. corporate law. Third, a shareholder-centric conception of corporate purpose is preferable to stakeholder capitalism.
The reader may well ask: Why should we care about corporate purpose?
Put simply, corporate purpose matters because corporations matter. Corporations are "far wealthier and far more able to negatively affect our individual lives than virtually any local government or even most Federal agencies."[7] Worse yet, like elephants crashing through a forest, corporations can trample individuals and communities underfoot without even meaning to do so. Indeed, the corporation has aptly been called "the perfect externalizing machine."[8] By incorporating a business, it becomes possible for the owners of the business—whether intentionally or not—to externalize substantial costs and risks onto corporate constituencies such as employees or creditors and society at large.
The externalities problem has been around since corporations were first vested with limited liability. As corporations grew ever larger in the wake of the industrial revolution, however, the scope of the problem likewise grew. In an industrial economy, limited liability is of particular concern because it may encourage overinvestment in hazardous activities. Because the shareholder can externalize some part of the risks associated with such activities, those activities could have a positive value for the investor even though they have negative net social costs.
Having said that, however, the corporate purpose debate goes beyond simply the negative externalities inevitably resulting from corporate activities. It also asks whether corporations should be managed so as to generate positive externalities. Should managers conduct the corporation's business so as to generate benefits to stakeholders and society in general? Advocates of stakeholder capitalism commonly contend that the profit motive discourages corporate directors and managers to ignore not just the social costs of corporate activities but also the potential for corporate activities to generate social benefits.
In many cases, however, corporate actions that benefit stakeholders—such as employees—help the firm become more profitable and thus redound to the benefit of shareholders. When the corporation faces a true zero-sum decision, however, one must make a choice between the competing interests of stakeholders and shareholders. In such cases, the law requires directors to prefer shareholder interests. The Profit Motive defends that claim as both a descriptive and normative matter.
If executives such as those who signed the Business Roundtable's 2019 statement on corporate purpose really tried to run their companies according to the altruistic principles laid out therein, they would find it an impossible task. Developing the set of objective and quantifiable metrics necessary to operationalize stakeholder capitalism will prove an intractable problem. Even if the requisite set of metrics could be designed, managers cannot reasonably be expected to balance the huge number of competing factors necessary to account for the varied interests of the firm's many constituencies.
Worse yet, stakeholder theory inherently carries with it a serious conflict of interest. While corporate social responsibility empowers honest directors to act in the best interests of all the corporation's constituents, it also empowers dishonest directors to pursue their own self-interest. There is a very real risk that directors and managers given discretion to consider interests other than shareholder wealth maximization will use stakeholder interests as a cloak for actions taken to advance their own selfish interests.
The case for shareholder value maximization is not just a negative one. Pursuit of shareholder value maximization leads to more efficient resource allocation, creates new social wealth, and promotes economic and political liberty. To be sure, there will always be externalities. Just as pursuing profit is baked into the corporation's DNA, so is externalizing costs. There is no such thing as a free lunch. The theory and evidence recounted in The Profit Motive, however, suggests that the balance comes down strongly in favor of shareholder value maximization.
Readers interested in still more information about The Profit Motive may wish to watch my video, in which I discuss the arguments in the book at greater length.
The blog of the author ProfessorBainbridge.com, was named by the ABA Journal as one of the Top 100 Law Blogs of 2007, 2008, 2010, 2011, and 2012.
Stephen M. Bainbridge
William D. Warren Distinguished Professor of Law
UCLA Law
[1] Milton Friedman, The Social Responsibility of Business Is to Increase Its Profits, N.Y. Times, Sept. 13, 1970, § 6 (Magazine), at 32, 33.
[2] Business Roundtable, Our Commitment (2019), https://opportunity.businessroundtable.org/ourcommitment/.
[3] See Martin Petrin, Beyond Shareholder Value: Exploring Justifications for a Broader Corporate Purpose 4 (Nov. 1, 2020) (explaining that "leading scholars are discussing concepts such as the need for 'purposeful' corporations, and, generally, there seems to be a broad consensus that pure shareholder value thinking has become outdated"), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3722836; Christina Parajon Skinner, Cancelling Capitalism?, 97 Notre Dame L. Rev. 417, 418 (2021) (observing that "scholarly antipathy toward capitalism (and its instantiation in corporate profit-seeking) has become more fervent over the past eighteen months").
[4] Lynn Stout, The Shareholder Value Myth vi (2012).
[5] Joel Bakan, The Corporation: The Pathological Pursuit of Profit and Power (2004).
[6] Linda S. Mullenix, Ending Class Actions as We Know Them: Rethinking the American Class Action, 64 Emory L.J. 399, 407 (2014).
[7] Daniel J.H. Greenwood, Essay: Telling Stories of Shareholder Supremacy, 2009 Mich. St. L. Rev. 1049, 1072 (2009).
[8] Lawrence E. Mitchell, Corporate Irresponsibility: America's Newest Export 53 (2008).
