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On Profit Maximization as the Social Responsibility of Business

Page history last edited by Alex Backer, Ph.D. 11 years, 1 month ago

Just read a great debate on the role of the corporation between John Mackey, Chairman and CEO of Whole Foods Market, Milton Friedman, Economics Nobel Prize recipient, and T.J. Rodgers, CEO of Cypress Semiconductor. I won't summarize it since you can read it yourself. Contrary to Roger Collins (thanks Roger for pointing me to the debate), I believe John Mackey's argument is the winning one. But I don't think Mackey's words make justice to his argument, so I will pitch in to try to help.

 

Mackey claims that corporations following his multi-stakeholder-pleasing model will eventually prevail in the economic landscape by winning the competitive test of the marketplace. He may well be right. But if he is, that will only prove Mr. Friedman right, who claimed that Mr. Mackey's model and his own profit-maximizing one are equivalent, for surely a model which prevails in the economic landscape maximizes long-term profits. Mackey points out that if they truly are equivalent, his own description has more marketing appeal. But I believe that Mackey's model is more than just marketing and packaging.

 

If we are to look for meaningful differences between the models, we need to look for cases in which a corporation finds a way to maximize value for its multiple stakeholders (Mackey describes his as customers, team members (employees), investors, vendors, communities, and the environment) *without* maximizing profits. Consider, for example, a corporation which systematically spends (reinvests) would-be-profits across its various stakeholders in such a way as to be left with zero profits every month. This corporation could grow and become very valuable, providing a return on investment for its shareholders. And yet it may well become less valuable for its shareholders (investors is the term used in the above-mentioned debate, but only some of the shareholders of a corporations are investors; shareholders typically include entrepreneurs and employees as well) than a sister company that does everything else equal except that it does not distribute (as much of) its profits to non-shareholder stakeholders. For some of the wealth created by the first corporation would have gone to customers, vendors, communities, and the environment. And yet, I would claim, nothing is to say that the profit-maximizing corporation is either more socially responsible or better in any other way. For clearly the value created for non-shareholder stakeholders has non-zero value --even Friedman agrees with this when he says Whole Foods' important contribution to society is to enhance the pleasure of shopping for food. In particular, and just to make the fallacy of profit as the sole measure of corporate success more clear, imagine a case where corporation A systematically makes $1B of profits a year in addition to disbursing $10B a year in value to other stakeholders (customers, employees, community, vendors, environment), while corporation B makes $1.1B in profits a year and generates only $0.1B in value to other stakeholders. All but the most rabid profit-maximizer would concede that it would be fair to call corporation A the more successful, certainly when measured by society (which is, after all, the judge that Friedman was after when he spoke of "social responsibility").

 

Friedman might counter that even more successful would be a corporation C that kept all $11B as profits, for individual shareholders to distribute as each sees fit. But there are at least two fallacies with this. First, that Friedman cites no evidence that individual shareholders are more competent in distributing wealth than corporations are --on the contrary, he mentions that in the real world we live in (a world that is inevitably more interesting to write about than theoretical constructs), tax laws make corporations more efficient at this task (assuming the citation of Adam Smith made by Friedman, "I have never known much good done by those who affected to trade for the public good", holds true of governments, who collect taxes). Second, corporation C may not exist. For the very reason that propels corporation A to generate more value than corporation B might be the goodwill generated by its value-sharing policies among the various constituencies whose cooperation generates the value to begin with.

 

Conversely, a corporation which generates massive profits by selling and dropping hydrogen bombs for the wealthiest individuals on Earth to experience the power that money can buy is surely not a model of socially responsible business. Thus, profit maximization cannot serve as the sole barometer of social responsibility of a business.

 

Capitalism is to me the most complex and fascinating system known to man. Far more complex than a single brain, or than the behavior of distant stars. But what makes the system so powerful is not a dictum that all agents must uniformly seek to maximize profits, but rather the fact that each agent in the market is free to act according to his/her own desires. When commanding all businesses to follow the same rule and optimize for the same metric, Friedman committed the very crime he so faults socialist regimes with: ignoring the power of free markets.

 

Alex Bäcker, Ph.D.

Altadena, California, October 7th, 2006

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