Milton Friedman, the famed University of Chicago economist who was Reagan’s economic advisor, even posthumously continues to court controversy. Rand Paul thinks he should chair the Fed in spite of the fact he is dead. Container Store CEO Kip Tindall, on the other hand, felt compelled to write, when he filed his IPO in October 2013, “Milton said the only reason a corporation exists is to maximize the return of the shareholder. Well, with all due respect to Milton, at The Container Store we have found that if you take better care of the employees than anybody else, they really will take better care of the customers than anybody else.” Like Tindall, Simon Sinek, whose book, Leaders Eat Last, I generally adored, also seems to blame Milton Friedman for the current emphasis on increasing shareholder value at all costs, basing his criticism on Friedman’s infamous quote in his book Capitalism and Freedom in 1962 and requoted in Friedman’s article in the New York Times Magazine in 1970:
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 or fraud.
Certainly Sinek ‘s reaction is not surprising. Current corporate executives and boards have used Friedman’s words to justify the use of dead peasant policies, double Irish tax structures, regular pre-year-end layoffs and other socially toxic tactics as ways to boost the bottom line. Friedman has become synonymous with the idea of profit over people.
The thing is, Friedman was not against corporations doing socially responsible things. He was against corporations doing socially responsible things for the sake of social responsibility. As an economist, he was keenly interested in principle-agent problems and, as such, was against corporate executives, in their public role as agents of the corporation, doing anything other than acting in the best interests of the company. He clarified his point:
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. [Emphasis mine.]
In his statement, Friedman was simply highlighting agency dilemma rather than making a statement that it’s wrong to do anything right. His words only look horrifying when taken in a post-Enron/Tyco/Goldman Sachs context, when the thought of a corporation so eager to do good that it acts contrary to its own self-interest seems ludicrous.
Many employees are stock holders by virtue of their compensation plans and, as such, want to see their company’s stock appreciate in value. What employees object to is when they see business leaders making decisions that act contrary to the interests of customers or employees in order to increase their own bonuses. The objection is not to a focus on shareholder value; the objection is, to borrow from Sinek, leaders eating first. Based on his writings, Friedman would object to any CEO who sacrifices the long term well-being of a company’s key stakeholders in order to line his pockets.
Friedman would argue that, no matter what, an executive should act as agent. And therefore if she is making any decision that compromises the long-term sustainability of the company she is not doing her job. Friedman would be just as opposed to executives making poor company decisions for personal gain, as he would be to executives making poor company decisions in the name of social justice. He never would have supported eliminating key jobs, failing to invest in people, allowing morale to sink, treating clients as unwitting counter parties, and hiding poor financial results, as these practices are never good for company sustainability.
Freidman emphasized this point in his essay, The Social Responsibility of Business is to Increase its Profits:
Of course, in practice the doctrine of social responsibility is frequently a cloak for actions that are justified on other grounds rather than a reason for those actions. To illustrate, 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. That 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.
The problem with Friedman’s comments on the role of corporate leadership is not his philosophical point of view. The problem is his profession. Corporate executives are neither principals nor agents. They flesh and bone human beings with hopes and dreams and fears and mortgages to pay and complex brains and endocrinological systems. To see people as theoretical constructs is the classic mistake of management theory and why, after 120 years or so of studying organizations, so little of the theory actually works. Shareholder value creation is a great idea, in theory: if a company is doing well, the stock price will increase. Of course, the stock price will also increase if there is stock manipulation or if an influential analyst changes his rating to a buy or if an executive slashes expenses to increase the value of his options. Looking to shareholder value as a way to measure the success of a company is a radical oversimplification that does not take human behaviour into account. Even Jack Welch, who is best known for his ability to create shareholder value, said, in an interview with the Financial Times in 2009, that focusing on shareholder value as a strategy was “the dumbest idea in the world.”
Sinek simply needed to point out is that, as human beings, we are always principals, even when we supposed to be acting as agents. The only path to long-term corporate survival is for leaders to align our principal and agent selves and work within our human limitations.