INSUBCONTINENT EXCLUSIVE:
Once again, we're debating the purpose of corporations
On one side, progressives such as Sen
Elizabeth Warren argue that companies - given broad rights in court decisions such as Citizens United v
Federal Election Commission - must also accept broad social responsibilities such as paying attractive wages and protecting the
environment.On the other side are many corporate leaders and business school professors (who train future leaders), who continue to believe
in the Business Roundtable's position in 1997 that "the principal objective of a business enterprise is to generate economic returns to
its owners." Such views echo free-market economist Milton Friedman, who emphasized nearly half a century ago that a business has only one
responsibility, to maximize shareholder value.Exhortations for corporations to do much more will get louder in advance of the 2020
presidential election, and the silent resistance will increase proportionately
I believe there's a middle path
While corporations cannot, and should not, take on responsibilities that are properly those of the government or the local community, they
can do better for themselves and for society by explicitly identifying core stakeholders - financial investors, no doubt, but also workers,
customers and suppliers who make significant investments in the business - and publicly committing to enhance their collective value.There's
merit still in many of Friedman's concerns
At the time, he was particularly outraged at the growing clamor in the United States for corporations to forgo raising prices as part of
their supposed "national duty" to help fight inflation
He rightly didn't believe it was the job, or even within the abilities, of companies to control inflation
Moreover, price-fixing would prevent the free market from sending the right signals about shortages.Friedman also deemed the push for new
corporate social responsibilities profoundly undemocratic
Activists who could not get laws passed in Congress were using the bully-pulpit instead to shame corporations into changing behavior.His
critics today complain that decisions by a corporate management focused solely on profits are harsh, give the corporation too short a time
horizon, and favor an overly narrow group, the shareholders
The first two don't hold up to scrutiny.The private corporation's fundamental contribution to society is to make products efficiently and
offer consumers affordable choice
In a competitive market, profits show how well it does this.Share prices reflect the value of profits over time
Since companies looking to maximize the value of their shares will care about profits over the long-term, most will train workers where
needed and foster lasting customer relationships instead of ripping off employees or customers.Put differently, even if CEOs do focus
primarily on share prices, that doesn't mean the market only rewards actions that boost this quarter's earnings
Public companies such as Amazon.com Inc
have thrived despite investing in their businesses without showing much in the way of profits
At the extreme end, pharmaceutical companies and aircraft manufacturers take investment bets that won't pay off for decades.Critics are
right, however, in asking why management should maximize only shareholder value
Friedman's theoretical rationale was that shareholders get what is left over after fixed claimants such as debt holders and workers are
By maximizing shareholders' "residual claim," management maximizes the overall corporate pie, since the rest are fixed claims on that pie.In
practice, though, many of what are thought of as fixed claims are actually variable over time
Long-term employees, for instance, invest in developing firm-specific skills
This means they are no longer commodity labor, paid a wage determined in a competitive market
Instead, they get a negotiated wage which fluctuates with the company's fortunes.No less than shareholders then, such workers become
residual claimants on the firm's value
Companies that are dependent primarily on them - think of an accounting or consulting firm - often recognize this by making their employees
equity partners.Management should work to enhance the value of these stakes - for instance, by helping long-term workers maintain their
Such a commitment will make employees more willing to put out for the firm, and thus also enhances shareholder value.Corporations will still
have to take tough decisions from time to time, including letting workers go when absolutely necessary
But job cuts that boost shareholder value aren't warranted if they reduce the value of other core stakeholders more.Some critics worry that
if boards start focusing on goals other than maximizing shareholder value, it will be hard to monitor and control their performance
Yet United States courts have repeatedly decided not to second guess the "business judgment" of boards, thus protecting them from
shareholder review except for the most egregious failures
Moreover, a majority of states have passed "constituency" statutes that allow board directors to consider the interests of non-shareholder
constituents such as creditors or workers.Given the considerable leeway corporate boards already have, it would be a step in the right
direction for them to specify whose interests, including workers', they are protecting
That would allow investors to better gauge the trade-offs a board will make
It would also give core stakeholders greater confidence to invest in the corporation.Most important in these populist times, corporate
boards can also then avoid unnecessary political flak by identifying their core stakeholders - those who make financial or other long-term
real investments in the firm
That would not just circumvent progressive critics, it would also be the right thing to do.(Raghuram Rajan is professor of finance at the
University of Chicago Booth School of Business
He was previously governor of the Reserve Bank of India.)Disclaimer: The opinions expressed within this article are the personal opinions of
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