The Social Responsibility of Business is to be Socially Responsible

When I hear economists speak eloquently about their distaste for social responsibilities of business in a free-enterprise system, I am reminded of the wonderful line from the profiteering firm of Scrooge and Marley, “it’s only business”. These economists believe that they are defending free enterprise when they exclaim that business is “solely” concerned with profit for profit’s sake; that business has a “social conscience” only in this regard as the upholder of all that capitalism stands for, and in turn as the core tenant of everything that is “accretive to earnings” or whatever else may be the catchwords of the contemporary crop of capitalists. In fact they are — or would be if they or anyone else took them seriously — preaching pure and unadulterated plutocracy. Businesspeople who talk this way are unwitting puppets of the oligarchs that have been undermining the basis of a free society these past decades.

The discussions of the “profit-first responsibility of business” are notable for their analytical looseness and lack of rigor. If the intent of profit is to benefit stockholders as surmised, it would be near enough impossible for a firm to achieve such profit maximization without the full attention of all its stakeholders to that task. We could hardly imagine the firm that treated its employees unfairly, it’s customers as though they were dispensable, or it’s environment as though it was a dumping ground, being a leading firm and profiting to the maximum extent possible. Yet the followers of this doctrine claim precisely that any decision taken by the firm which is not directly accretive to earnings is an irresponsible misappropriation of stockholder money.

But, what does it mean to say that “business” has no responsibilities beyond profit for its stockholders? All people have responsibilities beyond profit, including those working for the corporation. And as strange as it sounds to consider that a corporation is an artificial person itself, as some economists conjecture, if we do consider it such then it certainly has responsibilities beyond profit, as all persons do. To gain clarity in understanding the doctrine of the social responsibility of business we can ask precisely what it implies for whom.

Presumably, the individuals who are to be responsible in their actions as and for the corporation are businesspeople. The discussion of social responsibility is directed far beyond just limited liability corporations, so in what follows we must consider all forms of enterprise in the free-enterprise system. We must consider businesspeople including individual proprietors, partners, as well as corporate executives (together referred to herein as “executives” or “corporate executives” for simplicity) having a role in social responsibility.

In a free-enterprise, private-property system, corporate executives are contractual employees of their corporations, not directly of the owners of their businesses. They have direct responsibility to their Boards of Directors (or equivalent), and indirectly to all of their stakeholders. History has shown that any group of stakeholders can have the power to oust the executive if the executive underperforms that group’s expectations — just ask CBS, Uber, or BP. Those expectations are centered around the conduct of the business in an ethical, profitable, just, and productive manner (“stakeholder value”), for an infinite life. A focus on stakeholders and not just stockholders is required to create and enhance, or otherwise destroy, that value for all of them. In fact, it has been demonstrated time and again that the only way to accomplish the objective of maximizing stockholder value is to seek the maximization of value for all stakeholders — firm “health”. We have seen decades of these examples, from the outperformance of the S&P 500 ESG companies, to, by contrast, the underperformance of environmentally irresponsible companies suffering from the “Divest” movement.

The plethora of stakeholder desires will often appear to be competing in the short-term, requiring the corporate executives to balance the operations of their businesses between making as much money as possible in the short-term (i.e., earnings accretion) and improving firm health as much as possible over the long-term. They must perform this balancing act while conforming to the basic rules of society, both those embodied in law and those embodied in ethical custom, as well as incorporating the effects of their operations on stakeholders, which ultimately reverberate on the corporation’s health. Of course, in some perverse cases stakeholders may have a different objective than maximizing firm health, such as maximizing short-term earnings. However, even a group of persons that might establish a corporation for an eleemosynary purpose — for example, a hospital or a school — would strive for maximizing the health of their corporation as determined by their executives.

In any case, the key point is that in their capacity as corporate executives, the managers are the agents of the corporations for which they work and their primary responsibility is to the corporation. They are not agents, by contract or otherwise, of the individuals who own the corporations or establish the eleemosynary institutions.

Needless to say, this does not mean that it is easy to judge how well they are performing their duties. Nor does it mean the criterion of performance are straight-forward, given the health of the corporation may be difficult to assess in the immediate short-term. But at least the persons among whom there is a voluntary contractual arrangement to seek this health are clearly defined.

Of course, the corporate executives are also persons in their own right. As a person, each may have many other responsibilities that they recognize or assume voluntarily — to family, conscience, charity, church, clubs, community, country, or alma mater. Each may feel impelled by these responsibilities to devote part of their income to causes they regard as worthy, to refuse to work for particular corporations, even to leave their jobs, for example, to join their country’s foreign service. We would clearly not wish to refer to some of these “personal social responsibilities” as “corporate social responsibilities”, because in these respects the executive is acting as a principal, not an agent; spending their own money or time or energy, not the money of their employers or the time or energy they have contracted to devote to their purposes. If these are “personal social responsibilities,” there are equally similar “corporate social responsibilities” of business necessary to ensure the long-term maximization of corporate health. It is the role of the executive to determine which socially responsible decisions to take in that pursuit.

What does it mean to say that the corporate executive has a “social responsibility” as a businessperson? It would be unsound to think this statement was pure rhetoric, and that it meant an executive was to act in some way that is not in the interest of the corporation. Clearly, the interests of the corporation are fully aligned with social responsibility to the firm’s stakeholders. As economists know, for example, the executive would never refrain from increasing the price of the product unless that was in the balance the best decision for long-term health, because attempting to prevent inflation in this way is not in the interests of the firm nor society. On the whole, economists agree that targeted levels of inflation are necessary for the good functioning of a capitalist system. Or that the executive is to refrain from making expenditures to reduce pollution, including beyond simply what is required by current law, in order to contribute to the social objective of improving the environment on which the corporation is symbiotically reliant for its long-term health. Or that recognizing, just as the great capitalist Henry Ford did, incurring the short-term expense to hire unemployed and train them for appropriate positions in the firm, not only contributes to the social objectives of reducing poverty, reducing income inequality, and improving the general health of society, but actually creates customers. All of those factors in turn can improve the long-run outlook for the corporation in those communities and with its stakeholders.

In each of these cases, the corporate executive would be spending the corporation’s money for a social interest that reverberated on to the corporation and its health. Insofar as their actions in accord with their “social responsibility” and enhance returns to stakeholders, including stockholders, then they are spending the corporation’s money wisely. Insofar as their actions raise the price to customers, they are spending the customers’ money, and so long as that improves long-term health that decision in the balance is right for all stakeholders. Insofar as their actions lower the compensation of some employees, but in doing so improve the health of the firm for all stakeholders including employees on balance, they are also appropriately spending their money. For example, the executive may decide that facing recessionary pressures a reduction in variable pay bonuses in accordance with numerous other decisions such as lowering prices, requesting cost reductions from suppliers, reducing executive compensation, consolidating operations, and so forth is necessary. While difficult decisions, continuing to produce goods and services for customers, backed by suppliers, at reduced short-term profits for stockholders, may be the right decision for all stakeholders. These are the long-term decisions — balancing the desires of many stakeholders — where executives earn their keep.

The stockholders or the customers or the employees may be able to separately spend their own money on particular actions if they wished to do so, but could unlikely achieve the same economies of scale and scope as the corporation could. In making good long-term decisions, the executive is also exercising a distinct “social responsibility” in the best interests of the corporation and its stakeholders, rather than separately trying to serve as an agent of the stockholders, then the customers, then the employees, in pursuit of the same objectives.

If the executives do this effectively, they are in effect not imposing onerous taxes, but rather deciding how the corporation’s proceeds shall be spent in the best interests of that firm’s health, as they are compensated to do.

This concept may raise political questions on two levels: principle and consequences. On the level of political principle, the pursuit of long-term corporate health necessarily accompanies societal benefits, for one cannot exist without the other. We have established elaborate constitutional, parliamentary and judicial provisions to control governmental functions in pursuit of societal benefits, in accordance with the preferences and desires of the public. The corporation can likewise pursue societal benefits that correspondingly improve its own long-term health — after all, “Ask not what your country can do for you. Ask what you can do for your country.” was one of the greatest rallying calls to direct the future of America since the American Revolution. In government, when functioning effectively as the Founding Fathers intended, we have a system of checks and balances to separate the legislative function (e.g. imposing taxes) from the executive function (e.g., administering expenditure programs) and from the judicial function of interpreting the law.

However in business, the executives are intended to be simultaneously legislator, executive and jurist of their firm’s business decisions. They are to decide whom to tax and by how much for the purpose of benefiting the corporation’s health, and they are to spend the proceeds — all this guided by specific exhortations from on high to act as appropriate for the health of the corporation. Such decisions may include limiting the inflation of prices, improving the environment, fighting poverty and so on and on, as determined by the executive in their role to manage to this health objective.

The whole justification for permitting the corporate executive to be selected by the Directors is that the executive is an agent of their corporation serving the long-term interests of that corporation. Only by addressing all stakeholders of the corporation can this pursuit be realized favorably for the stockholders too. Stockholders understand that this justification does not disappear when the corporate executive imposes so-called taxes and spends the proceeds for “social” or stakeholder purposes, because they have seen clearly in example after example (such as, McDonald’s elimination of Styrofoam containers, or Ben & Jerry’s commitment to living wages, or Novo Nordisk’s decision to build its own solar power facility) that a wider focus on stakeholders, including society, is ultimately in their best interests too. The executive does not become in effect a public employee, a civil servant, but rather the executive remains in name an employee of a private enterprise seeking the best long-term outcomes for that enterprise. On grounds of political principle, it would be intolerable to deem such corporate-centric decisions as being those of civil servants — insofar as their actions in the name of social responsibility are real and not just window-dressing. If they are believed to be mere civil servants, then they would be elected through a political process. If they are to impose taxes and make expenditures solely to foster “social” objectives in opposition to the corporation, then political machinery must be set up to make the assessment of taxes and to determine through a political process the objectives to be served. Fortunately, corporate executives are not civil servants, and in turn should make their decisions regarding all manner of pricing, expenditure, hiring, and so on, in the best long-term interests of the corporation, completely synchronously with those of the society in which they function.

This is the basic reason why the doctrine of “social responsibility” involves the acceptance of the capitalist view that market mechanisms are intertwined with other mechanisms (e.g., regulatory and societal). This entanglement governs the appropriate way to determine the allocation of scarce resources to alternative uses.

On the grounds of consequences, can corporate executives in fact discharge their stated “social responsibilities”? On the one hand, suppose they could get away with spending the corporation’s money for the benefit of just one group: stockholders or customers or employees. Not only would such a decision demonstrate their incompetence in knowing how to spend it, but if the attempt was to increase short-term stock prices, rather than attempt to run their companies — in producing a product or selling it or financing it — to improve the health of the corporation, they would be demonstrating a lack of expertise in understanding how stock prices are derived — i.e., from the later, not the former. Will, for example, the executives’ decision in isolation to increase the rate of their dividends increase stock prices? Or, would any increase in stock price be a reflection of the signaling effect of the multitude of decisions taken for the long-term health of the company, including “socially responsible” actions? By focusing solely on a single stakeholder, such as the stockholder, the executive is in fact doing harm to all stakeholders because the executive is doing harm to the long-term health of the company. If the executive decides that increasing dividends — or offsetting carbon emissions, and so on — is a cost justified to impose on customers, employees, and other stakeholders, then that is the result of their expert analysis of the appropriate share to distribute so as to maximize the health of the corporation.

And, whether they want to or not, can they get away with spending their stockholders’, customers’ or employees’ money unwisely? Will not the Directors fire them? (Either the present ones or those who take over when their actions in the name of shunning social responsibility and the interconnectedness of stakeholders have reduced the corporation’s profits and the price of its stock.) But what of the free-rider problem? Why not pay no attention to social responsibilities and just allow others to do so, riding their coattails for the same benefits? Again, in practice we see the error of this thinking as customers and employees and suppliers and investors desert those firms stuck in the anti-social responsibility realm for other producers and employers more scrupulous in exercising their social responsibilities.

For the corporate executive “social responsibility” as a doctrine means taking account of all stakeholders, their interactions with the company, and vice versa, and consequently making decisions that reflect their expert assessment of the best outcome for the company. There is no conflict of interest between making decisions that are in the whole good for the company’s stakeholders and maximizing the health of that company. The consequence of doing otherwise may well include wildcat strikes, rank-and-file revolts, destruction of the very environment necessary for the corporation’s health and the emergence of strong competitors. Indeed, the corporation that shuns social responsibility can be foreseen to impart on a path of self-destruction — losing out on top talent, losing customers, seeing investors “divest”, suffering the consequences of climate change on their operations, writing off once valuable assets as worthless, and so on.

Exercising “social responsibility” is challenging, and hence the executive is held in high regard, and compensated accordingly. This illustrates, of course, the great virtue of private competitive enterprise — it forces people to be responsible for their own actions in pursuit of the corporation’s objectives and makes it difficult for them to “exploit” other stakeholders for either selfish or unselfish purposes. They must do “good” for the long-term benefit of the corporation — and do so at the corporation’s expense.

Many a reader who has followed the argument this far will understand that there is a role for Government to impose taxes and determine expenditures for certain “social” purposes beyond the corporation, unfortunately often addressed too slowly in the course of political processes. However, with respect to the corporation acting in a socially responsible manner in its own best interests, the businessperson can be a quicker and surer way to solve pressing problems.

Aside from the question of fact — I share Adam Smith’s skepticism about the benefits that can be expected from a doctrine that ignores corporate social responsibility. As he states, “No society [and within that therefore no company or stakeholder] can surely be flourishing and happy, of which the far greater part of the members are poor and miserable.” Ignoring corporate social responsibility amounts to an assertion of obliviousness by those who favor the taxes and expenditures in question belonging solely to government to execute in the best interests of the corporation, after decades of trial and error. A majority of their fellow citizens have seen their real income and wealth decline, not flourish as Smith suggests would be the determination of success for any economic system. Indeed, the doctrine of “profits first” has demonstrated what oligarchs can seek to attain by wielding democratic political power over an economic system that lacks the checks and balances necessary to ensure a free society is governed so that it is hard for “evil” people to do “evil,” — and let us not confuse that “one man’s good is another’s evil”, as Smith himself clearly understood the difference when drafting his foundational works.

I have, for simplicity, concentrated on the special case of the corporate executive. But precisely the same argument applies to stockholder activists who seek to require corporations to exercise social responsibility (the recent crusade to remove assault rifles from Dick’s Sporting Goods, for example). In most of these cases, what is in effect involved is some stockholders trying to get other stockholders (or customers or employees) to recognize the effect (positive or negative) of “social” causes on the corporation. Insofar as they succeed and the analysis is supported by the executives, they are again enhancing the health of the corporation for all stakeholders.

The situation of the individual proprietor is no different. If she acts to reduce the returns of her enterprise in the short-term in order to exercise her “social responsibility,” in ways that benefit the long-term health of the enterprise, she is spending her own money wisely, not someone else’s. If she wishes to spend her money on such valid purposes, that is her personal responsibility and I cannot see that there is any objection to her doing so. In the process, she, too, may impose costs on employees and customers, but would be wise to do so if the resultant long-term enhancements for stakeholders are meaningful. While she is far less likely than a large corporation or union to have monopolistic power, influencing the whole economy, given that sole proprietorships are the most common form of business in America, the potential for material benefits to the economy over the same long-term horizon are significant.

Of course, in practice the doctrine of social responsibility is too infrequently invoked, supplanted by the profit-first mantra that acts as a cloak for self-serving actions that are justified on other grounds rather than a long-term business reason for those actions.

Even Friedman understood that “it may well be in the long-run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community or to improving its government.” Such social responsibility “may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage and sabotage or have other worthwhile effects.” Or the corporation may charge an affordable rather than a maximum price for its product because that product is a necessary medicine. In so doing, the firm may establish itself as a long-run viable producer of pharmaceuticals, which require significant government and societal support to develop. Or it may be that a corporation which invests to reduce its carbon emissions — and entices, partners with, and lobbies other firms to do so as well — will benefit by seeing the worst effects of global climate change mitigated on their stakeholders, and in turn realize a healthier business for many more years.

In each of these — and many similar — cases, there is a clear, scientific rationale to these actions as an exercise of “social responsibility”, jointly in the interests of the company and society. In the present climate of opinion, there is a widespread aversion to “capitalist-driven-inequality”. Socially responsible actions are one way for a corporation to demonstrate that it recognizes how interconnected its own health is with the people that have been left “poor and miserable” as a by-product of expenditures that were inevitably contrary to its own self-interest.

It would be inconsistent of me to call on corporate executives to understand their role in the infinite health of the company and refrain from the hypocritical window-dressing of quarterly earnings calls because it harms the foundation of their companies. That would be to call on them to ignore the capitalist apparatus of the stock market because it is inefficient in pricing, in part because of an inability to account for “social responsibility”! If our institutions, and the attitudes of the public make it in their self-interest to hold quarterly conference calls with analysts in this way, I cannot summon much indignation to denounce them. At the same time, I can express admiration for those executives or owners or stockholders who disdain such tactics as approaching fraud given their responsibility to the long-term corporate health.

Whether blameworthy or not, the use of the cloak of managing to quarterly earnings, and the nonsense spoken in its name by influential and prestigious businesspeople, does clearly harm the foundations of a free capitalist society. I have been impressed time and again by the schizophrenic character of many businesspeople, investors and analysts. They are capable of being extremely far-sighted and clearheaded in matters that are internal to their businesses. They are incredibly short-sighted and muddle-headed in matters that are specific to external measures of short-term profitability, adversely affecting the possible survival of business in general. This short-sightedness is strikingly exemplified in the calls from many businesspeople for the elimination of the Minimum Wage and indeed for their policies to pay below a Living Wage. There is nothing that could do more in a brief period to destroy a healthy company and replace it with a landscape of unemployment, shuttered businesses, lost customers, governmental deficits, mass offshoring, and growing inequality than losing sight of the long-term purpose of the company.

The short-sightedness is also exemplified in speeches by businesspeople on quarterly earnings. This may gain them kudos in the short run, particularly with stock analysts. But it helps to strengthen the already too prevalent view that the pursuit of profits is in opposition to the pursuit of social responsibility. Once this view is adopted, the external forces that govern the market will not be the social consciences, however highly developed, of the pontificating executives; it will be the iron fist of stockholders that seeing their investments waver over the long-run, become fed up and divest. Here, businesspeople seem to me to reveal a suicidal impulse.

The political principle that underlies the market mechanism is influence. If there was an ideal free market, no individual could coerce any other, all cooperation would be voluntary, all parties to such cooperation would benefit or they need not participate. While there is no ideal in practice, there are clearly shared values and social responsibilities of such cooperation by stakeholder individuals in practice. Society is a collection of such stakeholder individuals and of the various groups they voluntarily form.

The political principle that underlies the political mechanism in a free society could be mistaken for conformity — it is not. The individual serves their own long-term interests just as the corporation does, and also just as similarly, is interested to serve the social interest — conformity may be the objective of a cult or a dictator or a tyrannical majority, but not of the free society. The individual retains a vote and say in what is to be done, can act to change the course of norms, but must live within the generous bounds of values and laws of the society more akin to unanimity. Those are the rules of a free society, but it would be a stretch to conclude that doing so was an attempt to force the individual to conform to a singular, robotic state.

While unanimity is not always feasible, given millions of individual voices in a society, the generous bounds of values and laws tend to work to facilitate progression. That progress is rarely without conflict, disagreement, and changes in course over time, but the free society enables all of that within its bounds and laws.

But the doctrine of “social responsibility” taken seriously could extend the scope of the political mechanism to every human activity. It differs in philosophy from the most explicitly collective doctrine, specifically because it espouses choice, opinion, and the interconnectedness of human activity. It differs by professing to believe that collectivist ends can be attained with collectivist means. That is why, when Friedman called it a “fundamentally subversive doctrine” in a free society, and said that in such a society, “there is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits [by shunning its responsibilities to all stakeholders other than stockholders]”, he was missing the point. Maximizing stockholder profits can only come by maximizing firm health — a focus on stakeholders of the corporation. The notion is not that all corporations should set out as a matter of urgency to philanthropically solve all societal ills despite their corporate mandate — that is not corporate social responsibility. The point is that all corporations should understand their interconnectedness to their stakeholders (e.g., employees, customers, suppliers, the environment, and so on) and expertly use their eyes and ears to address those stakeholders’ utility as part of their own corporate profit-seeking for their long-term health. Once again, the corporation that refuses to act to mitigate its effects on climate change, or on income inequality, or the health and wellbeing of its employees, and so on, is running itself head-on into a dead end that will by definition not maximize value for any stakeholders.

As even the Chairman of Scrooge and Marley ultimately concluded, “Can you forgive [me] for having no eyes to see with and no ears to hear with all these years?”

Note. This article is written in the style of, and in response to, an article by Professor Milton Freidman titled “The Social Responsibility of Business is to Increase its Profits”, published in September 1970.