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Oliver Hart: Should Social Responsibility Drive Corporate Behavior?

Sunday, January 12, 2020
Paula Klein

Classic corporate tenets are under attack.

In 1970, famed economist Milton Friedman shaped clear guidelines for corporate responsibility: Within ethical and legal norms, create as much wealth as possible for the company and its shareholders.

A century later, this wealth-creation business principle has drawn fire from economists, shareholders, business leaders, and the public. New debates have been sparked: Should social responsibility drive corporate behavior? What is the appropriate function of a firm—particularly, a public company?

Friedman was a key proponent of Shareholder Primacy and authored the influential essay, “The Social Responsibility of Business Is to Increase Its Profits.” At the time, he addressed the issue of charitable work and whether corporations should fund it. In Friedman’s view, it would be better to pay higher dividends and let shareholders decide where to spend their profits. The idea was that creating a bigger pie and making shareholders richer would benefit the economy as a whole.

Today, Oliver Hart, Harvard economics professor and a 2016 co-recipient of the Nobel Prize in economics (in photo above), sees some merit to Friedman’s stance, but he adds several caveats and exceptions. At a recent MIT IDE seminar, he said companies should usually act on behalf of shareholders versus stakeholders, workers, consumers--but that doesn’t have to preclude social responsibility.

New Considerations at Play

Friedman’s argument breaks down once social and economic needs are inseparable, according to Hart. Companies don’t have to get involved in charity if it’s outside the business, but if it’s directly related to their moneymaking business, new considerations are at play.

In the case of Walmart, it may make more sense to shareholders who are concerned about gun control for the store to ban certain ammunition outright versus transferring profit to shareholders to spend on lobbying.

Hart said that maximization of shareholder welfare is not the same as maximization of market value, and he proposed that company and asset managers should pursue policies consistent with the preferences of their investors. While corporate shareholders and investors are concerned about profits, they have ethical and social concerns, too, Hart said. Consumers are willing to buy electric cars, use less water, or buy more expensive free-range chicken or fair-trade coffee, for example, so why not require the companies they invest in to take social factors into account as well?

When shareholders vote on corporate policy, social goals may often be realized.

University of Chicago Booth School of Business Professor Luigi Zingales also has noted that firms and asset managers need to expand their profit maximization objectives and pursue policies that reflect what investors want. In 2017, Hart and Zingales co-authored two papers on the topic, Serving Shareholders Doesn't Mean Putting Profit Above All Else, and Companies Should Maximize Shareholder Welfare Not Market Value.

Business Roundtable Turnabout

Last year the discussion heated up with a statement by the Business Roundtable revising how it defines the purpose of the corporation. The organization and its member CEOs committed to leading their companies for the benefit of all stakeholders, not just their shareholders.

It’s not clear yet whether this shift is motivated by public relations considerations or signals a true change in business practices, but it renewed the discussion and fueled the debate about corporate social responsibility (CSR).

The best approach may be to encourage more shareholder votes on policy directions for the corporation, but only those policies with major social consequences. “That’s acting on behalf of shareholders,” Hart said, and it’s not breaching any fiduciary duties. Moreover, if investors engage in business decisions instead of pulling out of companies they disagree with, they may wield more clout.