Why Increasing the Wealth of Shareholders and Owners should not be the Primary Objective of Management in a Contemporary Business Firm
Introduction
In 1970, Friedman Milton published one of the most controversial essays on business ethics. In the essay titled “The Social Responsibility of Business is to Increase its Profits” (Friedman 1970), the scholar argues that the primary role of management in a contemporary business firm is to increase the wealth or profits of the owners of the business (or the shareholders). In the article, which was published in The New York Times Magazine, Friedman (1970) argues that ‘in his capacity as a corporate executive, the manager is the agent of individuals who own the corporation (read the shareholders) or (those who) establish the eleemosynary institution’ (paragraph 5).
By eleemosynary institutions, Friedman is referring to the agencies, such as hospitals and schools, which are not established solely to make profits for the investors or the owners. Rather, such agencies are established to render certain services to members of the public. This notwithstanding, Friedman (1970) argues that the primary objective of the business manager is to address the interests of the owners of the business or the shareholders (Ahlstrom 2010).
Friedman (1970) is of the view that the desire of the shareholders is ‘generally to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom’ (paragraph 4). In other words, the most obvious objective of the shareholders is to increase their wealth through their investment. In such a case, and considering that the management is acting in the interest of the shareholders, the primary objective of the business executive should be to increase the wealth of the shareholders and owners of the business entity. This is by making decisions that are likely to increase the price of the shares in the market (which in effect will increase the value of the business entity).
To this end, Friedman (1970) posits that the management should act in accordance with the laid down legal procedures and expectations. This means that the profit maximisation endeavours should be legal and ‘ethical’.
However, I tend to disagree with Friedman. Personally, I feel that the primary objective of the management in a contemporary business entity should not be to increase the wealth of the shareholders and owners. Rather, I am of the opinion that the management should take the interests of the other stakeholders into consideration. Failure to cater for the interests of the customers, the employees, the suppliers, and the community at large is not only hypocritical but also very selfish. It is a fact beyond doubt that contemporary business organisations are operating within a capitalist society which recognises the right to private ownership of property.
However, this does not mean that the rights of some people in the society should be trampled upon in efforts to address the rights of other people. When this happens, the management will be respecting the rights of some people while abusing or neglecting those of the others. This is not only self-defeatist but also fallacious. Friedman’s claim that the profit maximisation endeavours should be carried out in accordance with the society’s basic rules is anything but honest. The claim is meant to act as a balm on the moral sore that is caused by Friedman’s scathing attacks on the society’s moral fabric. I doubt that Friedman himself believes in this statement.
In this essay, I am going to address the question that is raised by Friedman’s provocative article. This is the question of whether the primary objective of the management should be to increase the wealth of the shareholders and the owners of the business or not. Of course, I believe that this should not be the major task for the manager. In this essay, I will provide arguments in support of this position. I will cite relevant literature and arguments made by scholars with similar opinions. In the essay, I will identify and acknowledge opposing viewpoints. I will then demolish these arguments by highlighting their various limitations and weaknesses.
Wealth Maximisation as the Primary Objective of the Management in a Contemporary Business Entity: The Shareholder vs. the Stakeholder Theory
The controversy surrounding the issue of whether or not the primary objective of the management should be to increase (or maximise) the profits (or wealth) of the shareholders boils down to the two competing theories. Those advocating for shareholder primacy subscribe to the shareholder theory of business entities (Beurden & Gossling 2008). On the other hand, those advocating for the integration of the stakeholders’ interests in business decision making processes draw their support from the stakeholder theory of contemporary organisations.
I am a firm believer in the latter. After reading and familiarising myself with the arguments espoused in the two schools of thought, I have come to the conclusion that the shareholder theory is simplistic, individualistic, and self-centred. It is obsessed with the shareholders and their interests and greed for profits, relegating the interests of the other constituencies to the backburner. On its part, the stakeholder theory is broader and more realistic, acknowledging that the business is not solely owned by the shareholders.
The shareholder theorists (led by their indefatigable crusader Milton Friedman) assert that the ‘business of business is business’ (Pfarrer 2010, p. 87). According to them, contemporary and capitalistic businesses are established solely to make money for the shareholders. The need to cater for the social and moral wellbeing of the members of the society within which the entity is operating is a nuisance on the part of the establishment. Social welfare (or what scholars such as Smith [2003], Bejou [2011], and Shaw [2009] refer to as ‘corporate social responsibility’) is far removed from the objectives of the business entity.
Shareholder theorists advocate for what can only be compared to sociologist Emile Durkheim’s division of labour. They are alive to the importance of social and moral development in the society. However, they insist that such development is well catered for by such agencies as the government and NGOs. They alienate themselves from provision of such services in the society by claiming that ‘when (business entities) become involved in (such) issues, (shareholder’s) wealth is diverted to issues outside the core expertise of their managers’ (Pfarrer 2010, p. 87).
This is given that the managers are not sociologists or social workers. On the contrary, the managers are trained to make money and increase the wealth of the organisation for the shareholders (Poitras 1994). The theorists go further and claim that entrusting the managers with the task of providing for social and moral development will not only hurt the business entity but the larger society in extension (Phillips 2003). This is given that the lack of focus on the part of the organisation may lead to losses, disorganisation, and ultimately the collapse of the entity. This will negatively affect the society as a result of increased unemployment, anomie and such other issues.
But I find the arguments made by the shareholder wealth maximisation crusaders both repugnant and repulsive. They are half-hearted justifications for the greedy exploitation of the proletariat and greed for wealth at the expense of the larger society. It is an archaic theory that fails to capture the reality of contemporary society. In today’s global society, alienating the business firm from the larger society is akin to isolating an organ from the human anatomy and expecting the said organ to operate normally and effectively. The organisation and the society are inextricably intertwined.
What I am trying to say here is that an organistic perspective should be adopted when analysing the role of the organisation (and consequently, that of the management) in the society today. The operations of the business entity affect the society on the one hand while the societal dynamics influence the running of the organisation on the other hand (Wilcke 2004). Take the case of the 9/11 terrorist attacks on American facilities.
Analysts, such as Phillips (2003), are of the view that such attacks were precipitated by the isolation and marginalisation of some communities by western corporations. In other words, terrorists are acting out of frustrations brought about by the negligence of global corporations. While the veracity of such assertions is beyond the scope of my essay (and subject to debate), it is a fact beyond doubt that terrorist attacks negatively affects the global economy. For example, many people around the world questioned the safety of American airlines and as a result, tended to avoid them.
Advocates of corporate social responsibility (herein referred to as CSR) are of the view that the business entity should have the interests of the society at heart. To this end, I tend to concur with Freeman who in 1994, as cited in Beurden & Gossling (2008), argued that ‘social performance is needed to attain business legitimacy managers have a fiduciary responsibility to all stakeholders and not just to shareholders’ (Beurden & Gossling 2008, p. 408).
This means that a manager who is pushing for the interests of the shareholders at the expense of other stakeholders is failing in his mandate. This, however, puts the manager in a precarious position. On the one hand, they are expected to increase the wealth of the shareholders and the owners of the business. On the other, the executive is expected to pay attention to the needs and aspirations of other parties involved in the organisation.
Now, I am aware that the two sets of interests may be in opposition to each other. This means that in some instances, it may be hard for the manager to satisfy them both without neglecting one or the other. For example, the manager may find it hard to close down a factory that is not generating or increasing the wealth of the business owners. Taking such a decision will mean compromising the livelihood of thousands of households. However, failure to close down the factory will translate into losses for the shareholders. The management should be aware of the possibility of such scenarios. As such, they should be prepared for them.
In this case, I believe that the management can strike a balance between the interests of the shareholders and those of the employees. For example, the management may retain the employees and utilise their services in another factory owned by the company or that which will be established after the old one is closed down. Alternatively, the management may decide to generously compensate the employees who will be rendered jobless.
Such a severance package will help the employees support their families while looking for an alternative source of livelihood. While such a decision may not be the best in the long run, it is better than leaving the employees with nothing. At least, the rights (and interests) of the employees were not completely disregarded.
The Inadequacies and Limitations of the Arguments made in Support of Shareholder Primacy
As I have already indicated earlier in this paper, the arguments made by supporters of the selfish shareholder wealth maximisation objective of contemporary business organisations are wrought with inherent inadequacies and limitations that render them worthless in a global village. Take the example of Friedman’s argument that addressing the social and moral development of the society will have negative impacts on the society and specifically on the business organisation. Nothing can be further from the truth.
The world is full of successful companies that have taken it upon themselves to promote the social welfare of communities around them. The fact that these companies have embraced corporate social responsibility has not made them any less successful. I will use the examples given by Smith (2003). Smith (2003) is of the view that visionary corporate icons in the industrial revolution established factory towns to provide housing facilities for their workers and families.
The scholar gives the example of Bourneville which was established in 1879 (Smith 2003) to provide housing facilities for employees of Cadburys. It was established by George Cadbury himself. The other is Port Sunlight which was established in 1888 (Smith 2003). The city was developed by William Lever (he of the Unilever Company) and was given the name of the soap that was manufactured in that industry (Smith 2003).
In light of the examples given above, it beats logic how such ‘progressive’ scholars as Cosans (2009) can voice support for Friedman (1970). While the above examples may appear antiquated to some, it is still clear that the provision of housing facilities (as part of CSR) did not lead to the collapse of Cadbury’s and Unilever. If anything, CSR led to a highly motivated workforce and in extension, improved productivity in the factories.
The two companies are some of the most popular MNCs in the world today. Can their prominence in the world today be attributed to luck or fate? I do not think so. It has more to do with the leadership strategies adopted by the management in the two companies (and many other similar companies) today and in the past. Clearly, profit maximisation and increase of wealth for the shareholders is not the sole objective of management in such entities.
Detractors may argue that the provision of social and moral development services by such companies is out of nothing but self-interest (Smith 2003). Proponents of shareholder wealth maximisation maxim may argue that CSR is, in fact, a strategic decision taken by the management to meet the objective of increasing the wealth of the shareholders (Husted & Salazar 2006). For example, George Cadbury and William Lever may have realised that employees whose major concerns, such as housing, have been taken care of tend to be more productive than their counterparts who are struggling to find accommodation for their families.
By providing them with houses and other social amenities, such as education, hospitals, and clean water among others, the management may rationalise that the productivity of employees is likely to increase.
However, I counter this by saying that regardless of the intentions of the management to embrace CSR in making decisions, at the end of the day, the other stakeholders, such as the community and the employees, are likely to benefit. In my measured opinion, there is no harm in making the shareholders happy and other stakeholders even happier. It is a win-win situation for me. My major concern (and that of other humanistic scholars, such as Shaw [2009] and Bejou [2011]) is making the shareholders happy at the expense of the other stakeholders.
Stout (2002) agrees with me that most of the arguments made by proponents of shareholder wealth maximisation objective are nothing but ‘naked assertions’. One such argument was made by Friedman (1970) and harped on by his supporters, such as Cosans (2003) who claims that the contemporary business organisation belongs to the shareholders. Friedman (1970) claims that since the shareholders of the firm are in effect ‘the owners of the business’ (pp. 32-33), the only ‘social responsibility of business (and in effect the management) is to increase its profits (and the wealth of the shareholders)’ (p. 32; Stout 2002, pp. 1190-1191).
I will argue like Stout (2002) in countering this assertion. While Friedman may be an economic doyen (having won himself a Nobel Peace Prize), he is in no way a legal expert. The claim that the business entity belongs to the shareholder is not only superficial but also lacks a legal basis. According to Stout (2002), legally, the shareholders are not the owners of the contemporary business entity. On the contrary, they own what Stout (2002) refers to as ‘corporate security (or) stock’ (p. 1191).
This being the case, their right to wield control over the operations of the organisation is limited. This extends to their right to control the operations and functioning of the management. There are other stakeholders that the management is legally answerable to. This is, for example, the board of directors. This being the case, it is obvious then that the ‘ownership’ claim cannot be used to justify shareholder wealth maximisation as the sole objective of the management in a contemporary business organisation.
Another feeble assertion made by the proponents of shareholder wealth maximisation objective is that ‘while the shareholders of the business entity may not be its owners, at least they are its sole residual claimants’ (Stout 2002, p. 1192).
This assertion is especially made as a response to stakeholder theorists’ critique of the ownership theorem fronted by the shareholder believers. To this end, those who support the shareholder wealth maximisation perspective view the business organisation as an amalgamation of various contracts bringing together different stakeholders (Moyer, McGuigan & Kretlow 2008). Scholars, such as Phillips (2003), categorise the contracts into two broad categories. The first category is that of the contracts entered into by non-shareholder constituencies, such as employees, suppliers, and clients among others. The second category comprises of the contracts ‘between and among the shareholders of the business entity’ (Stout 2002, p. 1192).
The first category of contracts can be conceptualised as explicit in nature. Such contracts clearly states that the employees, the suppliers, and the clients among others are entitled to specified and fixed forms of payments or compensation (Bejou 2011). This is, for example, salaries, interest on loans, and discounts. On the contrary, the second category of contracts (and that which involves the shareholders) is implicit in nature. According to the provisions of such a contract, the shareholders are entitled to that which remains after the business entity has catered for the obligations provided for in the explicit contract (Poitras 1994).
However, a critical analysis of this assertion will reveal its inadequacies and intellectual vacuity. The only time that shareholders can be claimants of the residues of the business organisation is when the entity has filed for bankruptcy (Stout 2002). Otherwise, claims that the shareholders are the sole claimants of the firm’s residue when it has not filed for bankruptcy are misleading. This, in my view, does not justify shareholder wealth maximisation.
Conclusion
In this essay, I expressed my reservations to the claim that the primary objective of management should be to maximise the wealth of the shareholders. I started by providing an overview of wealth maximisation as a concept. I also traced back the concept to Friedman’s writings in 1970. I critically analysed the stakeholder and shareholder wealth maximisation theories, especially highlighting the inconsistencies in the latter. Finally, I highlighted the weaknesses of the various arguments made by those supporting the shareholder wealth maximisation concept.
References
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