CS Lewis, the famed author of The Chronicles of Narnia, once discussed the distinction between advancing ethics and advancing knowledge of facts. In Lewis’ view, ethics changes remarkably little over the years. What changes, and changes rapidly, is our knowledge of how the world works. This advancement of knowledge informs our application of ethical norms, and it is advancing knowledge of facts, argues Lewis, not ethics, that tends to change through time.
Maximizing Shareholder Value
With respect to the operation of businesses, it was famed economist Milton Friedman who laid down the foundational ethic: Businesses should seek to maximize shareholder value only. Working toward any other end, asserts Friedman, is an unjustified exercise in “spending other people’s money.” It is hard to argue with his logic (executives are the employees of shareholders, after all) and the empirical data. Capital tends to seek the greatest return, and economies that structurally reduce returns tend to see capital—and economic growth—flee. For societies that want to improve people’s lives, such a result is a net negative.
Executives maximize shareholder value through an application of the golden rule, not just a focus on quarterly profit.
But our knowledge of both economics and corporate management has advanced over the years. Through experience, we have learned that a singular focus on quarterly profits makes for unhealthy long-term businesses, which is bad for shareholders. Perhaps the world’s greatest shareholder, Warren Buffett, famously opposes extreme executive compensation largely on the grounds that it misaligns incentives and reduces shareholder return. We have learned, through experience, that pollution has a real monetary cost, and it is often paid by shareholders. Desperate and destitute employees, we have learned, are considerably less productive, an opportunity cost to shareholders. As it turns out—and this should be no surprise—treating people as we would like to be treated is just good business.
For all these reasons (and others), I regularly see investment clients consider corporate responsibility in their investment decisions, and so-called SRI (socially responsible investing) has been widely studied and adopted by investment managers. The standard-bearing CFA Institute includes SRI in its candidate body of knowledge. All of this has not been accomplished through a political process but through the imbuing of values to the investment process, the natural result of shifting cultural values.
A Revolution of Business Ethics? Not Quite
When viewed through this lens, the recent Business Roundtable’s “Purpose of a Corporation” statement—which listed several other corporate commitments ahead of generating long-term value for shareholders—represents not some revolution nor advancement in the ethics of business. Rather, it simply reflects our advancing knowledge of the facts. Executives maximize shareholder value through an application of the golden rule, not just a focus on quarterly profit.
In free markets with efficient prices, social values are business values. Small businesses, without the cloak of high finance and managerial detachment, have long demonstrated this fact.
That this is a shock to anyone should be surprising. Despite the caricature, most businesses are not corporate behemoths. The overwhelming majority of businesses (99.9 percent, according to the SBA) are small, and they tend to operate within and support their local communities. It is these businesses that have long provided for local school booster clubs, contributed to community fundraisers, and given scholarships to local graduates. Not to mention, they employ almost half of all workers in the US and are responsible for the creation of 1.2 million net new jobs in 2018 alone. These leaders have long realized that maximizing shareholder value cannot be done with a sole focus on next quarter’s profit. It is only done in cooperation with the community.
Quite frankly, it is about time that corporate executives got the memo from their small business brethren. Changed executive behavior, with a dedication to longer time horizons, is fundamentally good for shareholders.
To be clear, all of this isn’t to advocate for an abandonment of the for-profit incentive. Capitalism works, in large part, because scarce resources can flow to their highest social good. The inefficient use of those resources is a detriment to society, not a benefit. The beauty of the free market system, however, is that businesses are direct products of the social fabric in which they operate. Employees, customers, and even the business structure itself all operate within a society of people, and while people demand goods and services, they have intangible values, as well. To the extent individuals are willing to sacrifice for those values, businesses will align their products and services with those values.
The ethic is still the same: corporations should maximize shareholder value. We are simply witnessing a shift in the execution of that ethic.
This is the magic of the price system. People communicate with businesses, directly and powerfully, through prices. People with a concern for the plight of the textile workers in Bangladesh can pay more for a shirt made in socially conscious ways. More demand for such responsible manufacturing leads to more supply. In the limit, this leads to an elimination of poor working conditions—all without new regulation. For those who are unconcerned or unable to make the sacrifice, free markets allow for that, too. We should be careful, then, in our calls for new regulation. After all, if you are unwilling to make the marginal sacrifice required to express your value with your own money, how can we hope to make the required sacrifice at scale? Prices are, in effect, a mirror to society. Though we may find the mirror’s display distasteful, the problem is not solved by breaking the mirror.
A Shift in Execution of an Ethic
In many ways, then, the Business Roundtable statement is a textbook example of free markets operating as they should. In free markets with efficient prices, social values are business values. Small businesses, without the cloak of high finance and managerial detachment, have long demonstrated this fact. That corporate executives have only now realized shareholder value is maximized through more than a focus on their next quarterly bonus is rather embarrassing for them. Even so, as their employer, we should celebrate their newfound awareness of our long-term well-being! Good businesses, much like governments, are intergenerational entities. And just like governments, we could do with more long-minded statesmen who look to the horizon.
There are those who trumpet the Business Roundtable's statement as some revolutionary shift in the ethic of capitalism. There are those who may use this as an “admission of guilt” by the evil corporatists. In reality, neither are true. The ethic is still the same: corporations should maximize shareholder value. We are simply witnessing a shift in the execution of that ethic.
This is, in the end, a lesson in Lewis’ distinction between advancing ethics and advancing knowledge of facts.