Stakeholder Theory for Libertarians:

A Rothbardian Defense of Corporate Social Responsibility

by Roderick T. Long

DRAFT – WORK IN PROGRESS

I. Friedman’s Famous, Unknown Argument

In an influential article for the popular press, published in 1970 and reprinted in numerous business ethics textbooks since,[1] economist Milton Friedman argued that when corporate managers allow considerations of social responsibility to influence their decisions, they violate their fiduciary obligations to the corporation’s owners, the shareholders.

In a free-enterprise, private-property system a corporate executive is an employee of the owners of the business. … [I]n his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation … and his primary responsibility is to them. … What does it mean to say that the corporate executive has a “social responsibility” in his capacity as businessman? … [I]t must mean that he is to act in some way that is not in the interest of his employers.[2]

Therefore, if a corporate manager forgoes an opportunity for profit-maximization in order to promote some socially worthy cause – Friedman mentions “providing employment,” “eliminating discrimination,” and “avoiding pollution” as examples[3] – then she is using the shareholders’ assets in a manner to which the shareholders have not agreed. It is as though you were to hire me to mow your lawn, giving me the use of your lawnmower for the purpose, and I, prompted by altruism, were to take the opportunity to mow every lawn in the neighbourhood, free of charge, with your lawnmower, returning it to you with its blades chipped and dulled from overuse. If I wish to be charitable with my own property, that may be fine and commendable; I have no right, however, to be charitable with your property, but must use it in only such a manner as is consistent with your purpose in granting me its use. Since shareholders presumably invest in a corporation in order to make money, the primary responsibility of a corporate manager is to maximize returns to shareholders, and any socially worthy goals whose promotion would conflict with that primary responsibility must be forgone. The corporate manager may be as charitable as she pleases, on her own time and with her own money; but she violates her contractual obligations to the shareholders as soon as she allows such considerations to sway her decisions in her capacity as corporate manager and so diverts shareholder resources to purposes incompatible with their wishes.

Such, in essence, is Friedman’s argument – at least at first glance.

It seems natural, from today’s perspective, to view Friedman’s 1970 article through the lens of more recent disputes between two theories with momentous implications for business ethics – stakeholder theory and libertarianism. Stakeholder theory claims that corporate decisions should be guided by concern for the interests not only of shareholders, but of all those groups (e.g., employees, customers, the local community) whose interests are vitally affected by the corporation’s actions – all those who “have a stake” in the outcome of corporate decisions.[4] Libertarianism, at least in the deontological version defended by Murray Rothbard and Robert Nozick, claims that actors in the market have the right to do with their property as they please, and to enter into any contractual arrangement they like with other consenting adults, so long as they do not violate the similar rights of others.[5] Since Friedman regards contractual obligations to owners as legitimately overriding broader concerns with social responsibility, his position is easily viewed as being in harmony with libertarianism and in opposition to stakeholder theory.

In fact this interpretation of Friedman is quite wrong. To begin with, Friedman’s position itself turns out, on closer examination, to be a version of stakeholder theory! While Friedman starts out with an argument that seems to grant special status to shareholders on the grounds that that they are the owners of the company, as he develops the argument it becomes apparent that Friedman thinks it desirable for corporate managers to act as agents not only of the shareholders but also, in certain respects, of the employees and the customers.

[T]he corporate executive [who pursues social responsibility] would be spending someone else’s money for a general social interest. Insofar as his actions in accord with his “social responsibility” reduce returns to stockholders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customers’ money. Insofar as his actions lower the wages of some employees, he is spending their money. … The executive is exercising a distinct “social responsibility,” rather than serving as an agent of the stockholders or the customers or the employees, only if he spends the money in a different way than they would have spent it.[6]

Friedman appears to mean quite seriously the claim that the corporate manager who pursues social responsibility is illegitimately spending the money of these constituencies, for he goes on to describe her as in effect “imposing taxes” on them. The group being unfairly “taxed” appears to include not only the shareholders but also employees and customers. In short, Friedman’s article is not a defense of shareholder rights against those of stakeholders, but of stakeholder interests against those of society at large. The manager’s obligation to her shareholder employers is simply, it seems, a special case of her obligation to the stakeholders in general.

Further evidence of Friedman’s allegiance to stakeholder theory comes in his explanation of why his critique of corporate social responsibility does not apply to individual proprietors. Friedman says:

The situation of the individual proprietor is somewhat different. If he acts to reduce the returns of his enterprise in order to exercise his “social responsibility,” he is spending his own money, not someone else’s. If he wishes to spend his money on such purposes, that is his right, and I cannot see that there is any objection to his doing so.[7]

So far this is just what we should expect Friedman to say if he upholds the rights of shareholders against other stakeholders. Managers must abide by the will of the owners; when manager and owner are the same person, the manager may pursue any social goals she pleases, but otherwise not. But notice what Friedman immediately goes on to say:

In the process, he, too, may impose costs on employees and customers. However, because he is far less likely than a large corporation … to have monopolistic power, any such side effects will tend to be minor.[8]

In other words, the reason it is permissible for individual proprietors, and not for corporate managers, to “impose costs” on their stakeholders is that individually owned companies are smaller and less influential, and so their imposition of costs doesn’t do enough harm to be a matter of concern. The clear implication is that if an individually owned company were large enough to have an influence comparable to that of a major corporation, then it would be illegitimate for the individual proprietor to pursue socially worthy goals in such a way as to lower wages or raise prices. The interests of employees and customers turn out to have comparable weight, on Friedman’s view, to the interests of shareholders. What is this if not a version of stakeholder theory?

It is, of course, an extremely strange version of stakeholder theory; for Friedman never says – and there is every reason to think he would deny – that corporations are under a general obligation to avoid lowering wages or raising prices. Apparently, the imposition of such costs on employees and customers counts as an illegitimate tax only if it is the result of pursuing social responsibility, not if it is the result of ordinary profit-seeking activities. (One suspects confusion or inattention on Friedman’s part here. Friedman’s expertise lies in economics, not in moral philosophy; when venturing into an unfamiliar field, it is easy to get oneself into a muddle without realizing it.)

Not only is Friedman’s argument not opposed to stakeholder theory, it’s not clear that it has any particular affinity with Rothbardian or Nozickian libertarianism.[9] Friedman does not explicitly say that corporate managers should be required to refrain from imposing these costs on their stakeholders, but his language – his talk of using other people’s money, of illegitimately imposing taxes, and so on – suggests as much.[10] And if, as it seems, Friedman is committed to imposing such a legal requirement even on individual proprietors, should their companies be of sufficient size, then he is certainly at odds with the Rothbardian’s or Nozickian’s commitment to the sanctity of private property.

Why has Friedman’s article been so consistently misinterpreted? I think it is because, given his reputation as a proponent of the free market, readers have naturally assumed that he must mean something different from what he literally says, and so they give his arguments a libertarian gloss which the text does not justify. In fact Friedman’s article is not at all what it is often thought to be: an anticipatory libertarian critique of stakeholder theory. If anything, it would be more accurately described as a stakeholder theorist’s critique of libertarianism – though I doubt that this is exactly what Friedman intended.

However, the argument that Friedman is widely thought to have given is actually made by a number of contemporary libertarian critics of stakeholder theory.[11] One example is Douglas Den Uyl, who is in broad agreement with Rothbardian and Nozickian libertarianism, and who dismisses stakeholder theory as “socialism with a vengeance!”[12]

Den Uyl presents an elegant restatement of Friedman’s argument, in a form that leaves behind the odd pro-stakeholder, anti-libertarian implications of the original version:[13]

1. Corporate managers are fiduciaries of the corporate owners (stockholders) ….

2. Corporate owners have only one interest and reason for hiring managers – to maximize profits.

3. Therefore, corporate managers would violate their fiduciary trust by engaging in actions that are unrelated to (or that consciously minimize) profit maximization. …

[4.] Acts of corporate charity (“social responsibility”) lessen the amount of profits the firm and/or owners receive. …

[5.] If corporate managers act to lessen profits (as in the preceding statement), they violate their contractual responsibilities to owners.

[6.] A call for managers to be “socially responsible” is a call for them to violate their contractual obligations.

[7.] Thus managers should not direct their firms into “socially responsible” activities.[14]

There does exist, then, a Friedmanesque libertarian argument against stakeholder theory, although it is not Friedman’s. It is this argument (call it the Shareholder Argument) that I wish to challenge.

II. Inadequate Responses to the Shareholder Argument

The Shareholder Argument – usually (though, I have argued, mistakenly) attributed to Friedman – has already come under a fair amount of attack. But I think many of the standard responses are guilty of changing the subject.

One such response is what I shall call the Strategy Response. According to the Strategy Response, corporations ought to engage in socially responsible activities because even if these activities curtail profits in the short run, they are likely to increase profits (and thus returns to shareholders) in the long run, through enhancing the corporation’s reputation, promoting employee morale, and the like. In other words, the most efficient way to promote the interests of the shareholders may be to do so indirectly, by looking after the interests of the stakeholders instead.

As general policy advice, this argument is plausible as far as it goes; but if it asks us to suppose that the goals of stakeholder welfare and shareholder profits never come apart, it strains credulity. We must suppose that at least in some cases the goals will conflict, and then we are faced with the question of whether, in such cases, sacrificing shareholder profit to stakeholder welfare is permissible or not.

One reply to the Strategy Response is what might be called the Strategy Counter-Response. While the former regards concern for stakeholders as the best strategy for (indirectly) benefiting shareholders, the latter regards concern for shareholders as the best strategy for (indirectly) benefiting stakeholders. (Friedman’s article occasionally gestures in the direction of this Strategy Counter-Response.) The argument is that profits are achieved by finding better ways to serve the customer, and since all stakeholders are customers of some firm or other, all stakeholders benefit from a system in which each firm does all it can to maximize profits. Since market interactions provide corporate managers with clear signals concerning their success or failure at benefiting the customer, while effective feedback is less available in the case of charitable activities, businesses are likely to be more effective at promoting stakeholder interests in the first way than in the second. While the Strategy Response and the Strategy Counter-Response each contain some truth, both as they stand seem overstated. It is hard to believe that there are no cases in which a corporation could bring about directly a clear and easily discernible benefit to stakeholders that would not be outweighed by a corresponding indirect harm.

Another response to the Shareholder Argument we may call the Threat Response. This response maintains that corporations would be well advised to adopt socially responsible policies voluntarily, for if they do not, it is likely that a public backlash will lead to laws mandating such policies.[15] But this appeal ad baculum fails as a critique of the Shareholder Argument, for it makes no effort to refute the claim that corporate managers have an obligation to refrain from socially responsible policies; it is no argument in favour of a wrong action to say that if you don’t commit the wrong voluntarily, you might be forced to do so by governmental edict.