Fifty years ago, free-market economist Milton Friedman ushered in the era of “shareholder capitalism” in the United States with an influential essay arguing that the only “social responsibility” of a business is to increase profits for shareholders.
In the year since, top executives at big corporations have tried to demonstrate their commitment to the new “stakeholder” capitalism. In an op-ed for the Wall Street Journal marking the anniversary, Roundtable President Joshua Bolten characterized the short-term investors who dominate trading on Wall Street as a “malignant influence” on business and politics, “undermining public confidence in the free-market system and fueling support for politicians who oppose it.” And last month, revising its somewhat hedged policy on climate change, the Roundtable threw its support behind putting a price on carbon to reduce greenhouse gas emissions by 80 percent by 2050.
Yet there remains considerable skepticism about whether this rhetorical commitment will actually change the way chief executives manage their companies — or whether it was simply a PR stunt. Earlier this month, a watchdog group calling itself the Test of Corporate Purpose issued a report, complete with a ranking of company performance, purporting to show that companies that signed the BRT statement have been no more socially responsible during the coronavirus pandemic than those that didn’t. It was an unconvincing piece of work, methodologically flawed and ideologically driven, that was at odds with other more reliable and objective analyses (here and here) by advocates of a kinder, gentler capitalism. And like much of the news coverage it generated, it revealed a fundamental misunderstanding about what the Roundtable’s statement and stakeholder capitalism is all about.
The Roundtable statement was, first and foremost, a declaration of independence from Wall Street. Beginning in the 1980s, after a decade of negative returns, a group of “activist investors” set out to use the threat of hostile takeovers to impose the single-minded focus on shareholders of publicly traded companies. The 2008 financial crisis exposed the economic folly and moral bankruptcy of a system that relied on bribing executives with stock options to squeeze workers, bamboozle customers, despoil the environment and dodge taxes. Socially conscious workers, customers and investors began to take their talent and money elsewhere, while even lavishly compensated executives came to see that the relentless demand for higher profits and stock buybacks had starved their companies of needed investments, saddled them with too much debt and undermined the value of their brands. The BRT’s message to Wall Street was that Main Street’s new focus would be on creating value for long-term investors by creating value for all stakeholders.
What the chief executives surely did not promise, however, was to run their companies as if the AFL-CIO, Sierra Club, Sen. Elizabeth Warren (D-Mass.) and Black Lives Matter were in charge. Yet if you look at most of the analyses and rankings by the growing number of ESG advocates — that’s shorthand for environment, society and governance — they are rooted in unabashedly liberal criteria and assumptions hidden behind a thick veneer of data and arcane statistical formulas to give them the look of scientific objectivity.
In the recent Test of Corporate Purpose study, companies appear to have been marked down for laying off workers or cutting their pay during the pandemic, no matter how much their revenue had declined. Companies that filed for bankruptcy were favored over companies that furloughed workers, on the dubious assumption that bankruptcy distributes more of the financial pain to shareholders, creditors and suppliers and less to workers. Facebook’s ranking suffered because some of its employees publicly disagreed with the company’s decision not to censor President Trump’s posts. And rather than winning praise for hiring 175,000 workers in the middle of a recession while keeping tens of millions of households stocked with the things people couldn’t shop for in person, Amazon was dinged because too many of those new $15 an hour jobs did not guarantee a minimum number of hours worked.
Other ESG advocates and research groups use better and better formulas, but even theirs wind up being highly subjective and value laden. The Drucker Institute’s ranking of “effective companies,” gives lots of weight to innovation, which explains why Amazon, Microsoft, Apple, Google and Facebook were at the top. Another group, Just Capital, uses a formula derived from public opinion polls that bases 35 percent of its ranking on how fairly and equally employees are treated while giving only a 1.2 percent weight to long-term profitability. That hardly sounds to me like a realistic balancing of stakeholder interests.
Everyone is free, of course, to use whatever criteria they want in assessing the performance of individual companies. But all such models of good corporate behavior are, by their nature, value laden and based on debatable assumptions.
One faulty assumption made by many in the ESG community is that companies never have to choose between business success and social responsibility — that treating workers, customers and the environment well and giving back to the community will always enhance long-term value for shareholders. They even have the data to prove it.
But logic and experience suggest that’s true only up to a point.
Companies can certainly earn a profit while offering generous pay, benefit and working conditions to attract and retain the best talent. At the same time, if they get too far ahead of the market, they can wind up with cost structures that eventually make them uncompetitive. That’s exactly what happened to the unionized auto and steel companies, railroads, airlines and phone companies in the 1980s.
It’s also true that while most companies can remain competitive while eliminating their carbon footprint, not all industries can move toward that goal at the same pace. A software company could easily do it by 2025, but it would be impossible for airlines, truckers, oil refiners and electric utilities to do so without sacrificing sales and market share, to the detriment of both shareholders and workers. What is gained by treating them as corporate pariahs?
And what of Amazon’s ambitious plans to use of robots, drones and driverless vehicles. Over time, this new technology will lower prices and speed delivery for consumers while boosting Amazon’s profits and market share, but it will also put tens of thousands of workers out of a job. What would the ESG crowd say about that? (Amazon founder Jeff Bezos owns The Washington Post.)
Yes, companies can become more socially responsible while still delivering above-average returns to investors, but doing so requires a balancing act that won’t completely satisfy any group of stakeholders or outside critics. The required trade-offs and compromises can’t be made — and shouldn’t be evaluated — simply by collecting the right data and running them through the some one-size-fits all moral algorithm.
It took the better part of two decades for American business to fully embrace shareholder capitalism, and it will take at least that long to transition out of it. Last year’s BRT statement “represented a real reset in terms of intentions and rhetoric,” as Judy Samuelson of the Aspen Institute puts it, but it will take at least a decade to make the necessary changes in incentive pay structures, corporate cultures and government regulations to make stakeholder capitalism a reality. BRT members point to lots of things they have done during the pandemic to demonstrate their newfound social responsibility. The fact that they haven’t fully lived up to norms of corporate conduct that are still evolving hardly makes them hypocrites. Unfairly painting them as such will only discourage them from trying.
The problem with shareholder capitalism was not that some companies were run in a ruthless, profit-maximizing way — human nature being what it is, some of that will always be with us. No, the problem was that it forced all public companies — and plenty of private ones, too — to be managed that way. Now that American business has freed itself (and us) from that straitjacket, it would be a mistake to replace one straitjacket with another.
Under a more flexible version of enlightened capitalism, some companies might choose to make themselves a worker paradise, while others might prioritize customer service or social justice or protecting the environment. Some might aim for modest profitability while others might promise shareholders maximal returns. The only requirement should be that each company clearly define its purpose and goals up front, along with a simple set of metrics by which everyone can assess how well it is achieving them.
Freed from shareholder primacy, American capitalism has the opportunity for companies with different models and purposes to compete for talent, customers and capital. We shouldn’t short-circuit that process by allowing self-appointed ESG activists peddling value-laden rankings to decide which model should prevail. Better to let a thousand flowers bloom and let the markets decide which ones work best.