Stop Blaming Milton Friedman!

Brian Cheffins is S. J. Berwin Professor of Corporate Law at the University of Cambridge. This post is based on a recent paper by Professor Cheffins. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); and Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).

In a much-cited, much-discussed 1970 article the New York Times entitled “The Social Responsibility of Business is to Increase its Profits” the renowned economist Milton Friedman harshly criticized those in the business community who maintained that private enterprises had a mission to promote desirable social ends. What the Times labelled a “Friedman doctrine” reputedly constituted a major turning point in corporate legal theory and corporate governance. 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. In my working paper Stop Blaming Milton Friedman! I show that the historical evidence does not tally with the hype.

Economists Oliver Hart and Luigi Zingales have argued Friedman’s article can “be seen as providing the intellectual foundation for the ‘shareholder value’ revolution.” (The citation for their paper and for all other sources canvassed in this post are available in my working paper.) A Newsweek columnist suggested in 2019 that “for almost 50 years, American CEOs have loosely followed what is known as the Friedman Doctrine.” Oxford management theorist Colin Mayer, a staunch shareholder primacy critic, has said of this “doctrine” “(f)ew social science ideas are both so significant and misconceived as to threaten our existence.” 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 3000 words in length. At the very least, 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.

Those who treat Freidman’s New York Times essay as the launching pad for a reorientation of managerial priorities in corporate America implicitly assume the essay was a plea for maximization of shareholder value that constituted a marked and highly influential departure from the prevailing wisdom. This interpretation is incorrect in at least three ways.

First, what Friedman had to say about corporate priorities in 1970 was in tune with traditional orthodoxy. During the 1950s and 1960s the dominant image of public company leadership was that executives were exercising corporate power in a self-restrained and socially responsible manner. Still, public company executives had not written off either profits or shareholders. The Michigan Supreme Court’s shareholder-friendly analysis of corporate purpose in its 1919 decision in Dodge v. Ford Motor Co. was widely presumed to be good law and renowned management theorist Peter Drucker said in 1954 “(m)anagements in America are nothing if not ‘profit-conscious’.”

What prompted Friedman, then, to chide executives who claimed “that business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends”? The answer is a charged atmosphere in which the corporate sector was operating as the 1970s began. Public confidence in business was plummeting as environmentalists, civil rights leaders and consumer advocates vociferously criticized corporate behavior and lobbied hard for new constraints on large corporations. In this fraught context Friedman wanted executives to swear off invoking a rationale of “social responsibility” to defend decisions taken because doing otherwise would “strengthen the already too prevalent view that the pursuit of profits is wicked and immoral and must be curbed and controlled by external forces.”

Second, Friedman’s essay failed to change many minds, at least right away. In 1974, the New York Times remarked upon “the heightened sense of social responsibility that now characterizes many corporate managements.” The chairman of the Business Roundtable said in 1981 “(t)he simple theory that management can get along by considering only the shareholder has been left behind in old economic dissertations.” A 1983 study of top executives at a dozen leading corporations by Harvard Business School professors Jay Lorsch and Gordon Donaldson found that senior managers were not particularly concerned about stock prices. Their main concern instead was the long-term health and survival of their companies.

Hostile takeovers that reached a frenzied pace in the mid-1980s acted as the true corporate priority game-changer. The CEO and chairman of the board of consumer products giant Procter & Gamble said in 1987 that “(w)idespread hostile takeover activity has made maximizing immediate shareholder value appear to be the basic purpose of a business enterprise.” The takeover frenzy ended abruptly as the 1990s began, prompting doubts about what would motivate public company executives to focus on generating healthy returns for shareholders. The solution: performance-oriented executive pay. The proportion of CEO compensation in large public companies that was equity based surged from 20 percent in 1990 to 60 percent in 1999. Chief executives in turn cared about share prices—a lot.

Third, Friedman’s 1970 essay did relatively little to presage the nature of a shareholder-first ethos that would move to the forefront as the 20th century drew to a close. While Friedman supposedly was a pioneering proponent of “shareholder value” and “shareholder primacy”, he did not refer to either concept in his essay. This is hardly surprising. Neither term was in common usage in 1970.

What Friedman did say in his 1970 essay makes it clear his article was no more than an indirect forerunner of the shareholder-first mentality that would subsequently prevail in corporate America. Friedman talked at length about what executives should not be doing—spending their corporations’ money in accordance with supposed social responsibilities. He said very little, on the other hand, about what management should affirmatively seek to achieve, whether with respect to shareholders or otherwise. While the title of Friedman’s essay indicated a business should “increase its profits” he only referred to the point once in the main body of his article, namely when he quoted a passage from his 1962 book Capitalism and Freedom. Friedman did assert in his book that corporate executives had no “responsibility other than to make as much money for their stockholders as possible,” which is a sentiment akin to maximizing shareholder returns. There was no such invocation in his New York Times essay.

Critics of corporate America’s stockholder orientation are on something of a roll right now. This is exemplified by the Business Roundtable’s 2019 “Statement on the Purpose of a Corporation,” which stressed “a fundamental commitment to all of our stakeholders” and generally gave shareholders short shrift. Still, it is open to question whether a major shift in corporate priorities beckons, given that the most potent managerial incentives—pay and job security—remain tied to stock performance. To succeed in upending the shareholder-oriented status quo critics would be better served trying to change minds about pro-shareholder governance structures than assailing a half-century old essay substantially removed from today’s concerns.

The complete paper is available for download here.

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  1. Heather
    Posted Thursday, April 16, 2020 at 3:55 pm | Permalink

    Wasn’t the NYT article a public-facing digest of views he put forward, at length, in his book, Capitalism and Freedom? I’m not saying Friedman should or shouldn’t be blamed (I have no idea) but suggesting that those who do blame him do so on the basis of a single NYT article seems like strawmanning.

  2. Alan
    Posted Thursday, June 25, 2020 at 1:48 pm | Permalink

    Laws: We know what they are, and what they are worth! They are spider webs for the rich and mighty, steel chains for the poor and weak, fishing nets in the hands of government.

  3. Rolando Medeiros
    Posted Wednesday, September 2, 2020 at 1:34 pm | Permalink

    Were not hostile takeovers and equity-related top management incentive programs a result of what is known as Friedman Model? Friedman´s article may have intended to prevent CEOs from indirectly favoring the concept that demonized profit generation, but what its result
    oriented businesses towards Shareholders profits in a way that was not seen before. In other words, should not Milton Friedman be blamed for being the intellectual father of stock options?