It seems to have become the accepted belief that businesses exist to make as much money as possible for their owners. Indeed it is especially convenient for those responsible for economic policy to think that, where they can, businesses will therefore want to grow and consequently both employ more people and pay more taxes. But where does this idea come from and what is, or should be, the purpose of a business? asks Prof Simon Bridge
In 1970 the influential economist Milton Friedman wrote an article for The New York Times Magazine headlined “The social responsibility of a business is to increase its profits”. If this wasn’t actually the source of this thinking, his apparently authoritative pronouncement certainly helped to establish the belief that businesses exist to make profits.
Indeed it has even been suggested that, for incorporated business in the USA, maximising profit is their legal duty – or, as Lynn Stout: a professor a professor of corporate and business law at Cornell University, has put it: “by the end of the 20th century a broad consensus had emerged in the Anglo-American business world that corporations should be governed according to the philosophy often called shareholder primacy”’.
This was the idea that companies should be run to deliver what their shareholders wanted which was maximising their shareholder value – but Stout goes on to state that this is “an abstract economic theory that lacks support from history, law or empirical evidence”.
Take history to start with and look at the way business started in win-win exchanges to maximise mutual benefit. Early human society was based on hunter-gathering or self-sufficient agriculture – but eventually elements of specialisation emerged when it was more productive for some people, because of their skill or access to raw material, to concentrate on particular tasks.
Echoes of that can even be seen in this description, taken from the introduction to a book by James McPherson on the American Civil War, of life in the USA just two centuries ago: “As late as 1815, Americans produced on their farms or in their homes most of the things they consumed, used, or wore.
“Most clothing was sewn by mothers and daughters, made from cloth that in many cases they had spun and woven themselves by the light of candles they had dipped or by natural light coming through windows in houses built of local materials from a nearby sawmill or brickyard by local carpenters or masons or by the male members of the household. Shoes were made by members of the family or by the village cordwainer from leather cured at a local tannery. Blacksmiths forged the tools and farm implements used in the community.
“Even firearms were built with handicraft skill and pride by a nearby craftsman. In larger towns and cities, master tailors or shoemakers or cabinetmakers or wheelwrights presided over small shops where they worked with a few journeymen and an apprentice or two who turned out fine custom or ‘bespoke’ goods for wealthier purchasers. In an age of slow and expensive overland transport, few of these items were sold more than twenty miles from where they were made.”
A dozen occupations are listed in this piece which were in essence businesses, albeit small ones: sawmill, brickyard, carpenter, mason, cordwainer, tannery, blacksmith, craftsman, tailor, shoemaker, cabinetmaker, wheelwright. But how many of them would have had the prime aim of maximising profit for themselves?
Instead, by each specialising on what they were good at and trading with others who were good at other things, they were able to be more productive than if they had each tried to do everything for themselves. Of course money was involved, but as a means of facilitating trade not as the aim of it. They might well have liked more profit if they could get it but that was not the main driver – which I suggest was fitting into a community by supplying a needed speciality on a win-win basis.
When it comes to big businesses it is also clear that many corporations formed in the late eighteenth and early nineteenth centuries were created specifically to develop large commercial ventures like roads, canals, railroads, and banks. Investors in these early corporations were often also customers and they structured their companies to make sure the business would provide good service at a reasonable price – not to maximize investment returns value.
Lynn Stout, the author quoted earlier on ‘shareholder primacy, has not only reported that in the USA there is no law mandating a profit focus but also points out that shareholders are not the owners of an incorporated business, which is a separate entity which owns itself. What shareholders own are shares which give them limited legal rights and so the business has a contractual obligation to them but also to other stakeholders such as its employees and customers.
So neither history nor the law suggest that businesses must be profit focussed. Of course, to survive, they need to bring in enough money to sustain their existence and businesses might like to make more profit – but for how many is that actually their first priority?
Instead how many, like the local American businesses listed by McPherson, want to fit in with the community, or ‘eco-system’, in which they work. Are they like the plants Nicholas Harberd studied which, rather than growing whenever they could, had growth inhibitors in their DNA, called DELLAs.
While in some conditions the plants produced hormones which negated the effect of these inhibitors, the DELLAs actually helped the plants to survive by restraining the rate of growth to a degree consonant with the conditions within which plants find themselves:
”I’m beginning to see the growth of plants as a metaphor for our times. … Lacking DELLAs, a plant becomes insensitive, brash, a fast-liver that is unable to exercise appropriate restraint, and that dies young. The appropriateness of restraint is a message that we ourselves need to heed.”
Therefore, instead of accepting Friedman’s verdict that the responsibility of a business is to maximise profits, a better guide I once heard enunciated is that ‘an enterprise is a goal realisation device’: a statement which allows for different enterprises, including businesses, to have different aims.
But have we, instead, allowed economists and economic policy to influence what we think – that the goal has to be more money? Economic policy makers would like businesses to make more profit so that the economy is stronger and the tax revenues higher – but have they therefore started to believe that businesses ought to be trying to grow and to make more money and have we in turn copied that thinking?
What for many businesses people is success – not the maximum profit they could possibly get but the delivery of a satisfactory return? Does it Involve a combination of one or more of money (sufficient to maintain a lifestyle), practicing a skill, enjoyment, excitement, a sense of achievement, team-work, helping others, leaving a legacy. And for those who do try to maximise profits -why? Instead of trying to get more money for its own sake (who actually needs more billions?), is it to get the highest possible recognised score for their effort – which is measured in money?
As Lynn Stout has also pointed out, if shareholder primacy theory is correct, corporations that adopt such strategies should do better and produce higher investor returns than corporations that don’t – but, she notes: “researchers have spent decades and produced scores of studies seeking to prove that shareholder primacy generates superior business results. Yet there is a notable lack of replicated studies finding this.”
Instead, as John Kay has observed: “The most profitable businesses are not the most profit oriented” and “Paradoxically … visionary companies make more money than … purely profit driven companies”.
Milton Friedman, The social responsibility of a business is to increase its profits, (The New York Times Magazine, 13 September 1970)
Nicholas Harberd, Seed to Seed: The Secret Life of Plants (London: Bloomsbury, 2007
John Kay, Obliquity (London: Profile Books, 2010)
James McPherson, Battle Cry of Freedom, (London: Penguin, 1990)
Lynn Stout, The Shareholder Value Myth, (Cornell Law Faculty Publication, Paper 771, 2013)
