The anti-CSR position defended by Friedman would be acceptable only under conditions that have never been met by any real-world economy. Furthermore, the notion of the firm as a nexus of contracts is theoretically groundless and legally contradictory.


Editor’s note: To mark the 50-year anniversary of Milton Friedman’s influential NYT piece on the social responsibility of business, we are launching a series of articles on the shareholder-stakeholder debate. Read previous installments here.

In his seminal book Capitalism and Freedom (1962), Milton Friedman considered corporate social responsibility a serious threat to the survival of the capitalist system itself. “Few trends could so thoroughly undermine the very foundations of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible,” he wrote. 

The argument was subsequently reiterated in Friedman’s famous 1970 piece in the NYT, under the suggestive headline The Social Responsibility of Business is to Increase Its Profits. There, he wrote:

“The short-sightedness is also exemplified in speeches by businessmen on social responsibility … Here, as with price and wage controls, businessmen seem to me to reveal a suicidal impulse … There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception and fraud. Corporations do not have responsibilities. Only executives do and their responsibility as agents of their owners is to maximize returns.” (italics added).

The argument is seemingly persuasive, but does it stand? I limit myself to focusing on two specific points. First, the anti-CSR position defended by Friedman would be acceptable if all markets were perfectly competitive (it is not sufficient to say competitive); if income distribution was equitable in the minimal sense, whereby everyone is permitted to play the market game; and if no endogenous changes in the preferences of agents occur. 

As economic textbooks inform us, under such conditions—none of which has ever been met by any real-world economy—the economy will reach a competitive equilibrium, where the notion of corporate responsibility would make no sense at all. However, in an economy of this kind, no profits are made, as Leon Walras first demonstrated back in 1874. So, in order to substantiate his thesis on logical grounds, Friedman has to assume conditions under which, if met, businesses would make no profits at all. A really disturbing paradox indeed!

The second point touches on the substance of Friedman’s argument. The early 1930s witnessed a great debate over the nature and purpose of the public company—a form of enterprise born in America in the 19th century—characterized by the separation of the ownership of the company from its control. In 1932, the Harvard Law Review published a lively debate between Adolf Berle and Merrick Dodd, where the former strongly argued for the primacy of the shareholder, while Dodd argued against this, writing that “The corporation was coming to be seen as an economic institution which has a social service as well as a profit-making function” (italics added). In the end, Dodd’s position prevailed, and Berle acknowledged his defeat.

Only in the early 1960s did we observe a return to Berle’s position. This occurred when Friedman (and other scholars) advocated the contractarian view of the corporation, according to which the firm is a mere nexus of contracts, a view first expressed by Ronald Coase in his pioneering 1937 essay The Nature of the Firm

“The firm can do much more—and better—than solely maximizing profits.”

The problem with this view of corporations is that the notion of the firm as a nexus of contracts is theoretically groundless and legally contradictory. It is a fact that the modern corporation is essentially a public entity, since it has the power to impose its rules on those who operate within it and exercises real power of influence outside of its boundaries, which means that the governance of a corporation is not something that concerns only the shareholders. Yet the contractarian view proceeds on the premise that the corporation is the product of a contract, i.e., of an agreement between private individuals. 

If this were the case, it is obvious that the corporation would have a duty to meet the many contracting parties’ expectations. But this is not true, since the modern corporation has become what it is in virtue of the law, which is designed to safeguard the public interest. Indeed, the privileged position enjoyed by the corporation derives from its legal personality granted by law, not the result of any contract between the parties involved. In other words, the legal personality is not acquired by contractual means, but as a result of a democratic process. Therefore, the claim that a corporation should maximize its profits for its shareholders is devoid of legal meaning.

This conclusion is reinforced by the following consideration. According to Michael Jensen’s and William Meckling’s well-known theory of agency, taken for granted by the contractarian view, shareholders, as the owners of the business, constitute the principal —whose aim is to make the largest profits possible—while directors and/or executives are the agents, whose objective function is to maximize their own utility. 

Is it true that the corporate manager is the agent of the shareholders? Legal doctrine and jurisprudence have no doubts: no. Since the firm is a legal entity, it constitutes the principal in the agency relationship. It follows that if the manager is the agent of the firm, conceived as an independent legal entity that owns itself, they have the duty to maximize the firm’s objective function, and the latter includes the interests of both the shareholders and the other stakeholders.

Basically, according to the contractarian view, the logical shortcomings of the corporation derive from the acceptance of an assumption that is factually false, since the firm is not owned by the shareholder: it owns itself. Shareholders own a share of the stocks of the corporation, based on a contract that they enter into with the latter that entitles them to limited rights. The corporation is controlled by the board, which is vested with all the discretionary powers necessary for such a purpose. Shareholders’ power consists of removing or denouncing the directors (voice option) or selling their own shares (exit option). 

The board, not the shareholders, is the principal and, according to the law, it is the duty of the board to balance the interests of the various classes of stakeholders. This is why nowhere in the world is there a law or set of rules of corporate governance imposing that the firm should maximize shareholder value.

In conclusion, it is unwisely reductionist to characterize the firm as a mere “nexus of contracts” between different parties, attributing to it only one purpose: profit maximization as the only recognized metric of business success. The firm can do much more—and better—than solely maximizing profits. The expanding movement of ideas supporting the “profit-with-purpose corporations” project, such as the Benefit and Social Purpose corporations that have been created in the US since 2010, is a clear testimony to that. Perhaps the time has come to move on from the rhetoric of “doing good by doing well” to one of “doing well by doing good.”