prior probability

Thus far, we have reviewed in great detail the first five paragraphs of Professor Friedman’s classic essay on business ethics. In the court of popular opinion, these first few paragraphs constitute Friedman’s “opening statement” about the proper role of business in society. Now, before we proceed any further, we want to pause to make some additional observations about Friedman’s opening statement. One of our observations is somewhat trivial. The other, however, is more weighty.

Our minor quibble is this: what’s up with Professor Friedman’s word choice — elitist or erudite, depending on your point of view — especially in the fourth and fifth paragraphs of his essay, where Friedman deploys the fancy word “eleemosynary” to refer to corporations devoted to charitable ends: “A group of persons might establish a corporation for an eleemosynary purpose.” Although this distinction between for-profit corporations and non-profit ones is essential to Friedman’s argument, why not use a more simple word like “charitable” or “philanthropic” in place of the more old-fashioned term “eleemosynary” to refer to non-profit business entities? Or to paraphrase the great North American writer Mark Twain, Why use a five-dollar word when a five-cent word will do?

Our next observation is more serious, for it concerns the underlying logic of Friedman’s “greed is good” argument. Friedman’s profit-max thesis applies only to for-profit corporations, but then he adds yet another caveat in the fourth paragraph of his essay. According to Prof Friedman, although corporate managers have an ethical duty to make as much money as possible, they must do so, and we now quote Friedman, “while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.” That is, corporations must always play by the rules, both legal and ethical! But this critical caveat opens a veritable Pandora’s box of delicate questions. One problem is that Friedman does not bother to say which theory of ethics should apply to business decisions. Virtue ethics? Kantian ethics? Or consequentialist ethics? Take your pick! In addition, as our friend and colleague Haskell Murray has asked, what about firms doing business in places with loose legal rules, and along these lines we would add, what about situations in which there is no relevant law on the books?

Even more importantly, doesn’t this “law and ethics caveat” make the profit-maximization thesis self-refuting? After all, if corporate managers are not only supposed comply with the law but must also act ethically when making business decisions, then why don’t such managers have a broad legal and ethical duty to act in a socially-responsible way all the time? Put another way, if managers are to be constrained by both law and ethics, then isn’t Friedman’s profit-max theory too narrow? Rest assured, we will return to these difficult questions as we continue our review of Friedman’s essay …

Source: Marvel Comics

[Note: We have revised the third paragraph of this post.]

Thus far, we have revisited the first two paragraphs of Professor Friedman’s scathing critique of corporate social responsibility or CSR. (To sum up: we dismissed the opening paragraph as pure hyperbole, but at the same time, we concluded that the criticisms set forth in the second paragraph must be reckoned with.) Prof Friedman concludes the second paragraph by asking, to whom does CSR apply? Do all business firms and businessmen have a moral duty to act in a socially responsible way? Having now set the stage, so to speak, Milton Friedman devotes the remainder of his essay to this key question. In particular, he defines the scope of his inquiry in the third paragraph of his classic essay as follows: “Most of the discussion of [CSR] is directed at corporations, so … I shall mostly neglect the individual proprietor and speak of corporate executives.”

Although this clarification might seem like a minor caveat, it is a major strategic move on Professor Friedman’s part. Why? Because most business firms consist of sole proprietorships, i.e. firms that are owned and operated by an individual. In this particular case, it makes sense to talk about the social responsibility of business, since the firm and its owner are one and the same. (It’s also worth noting that, today, many small business are organized as limited liability companies (LLCs), privately-owned ventures that are often operated directly by their owners, who are called “managers” or “members” depending on their level of involvement in the firm, and many LLCs are single-member LLCs. Yet, as our friend and colleague Haskell Murray has pointed out to us, although LLCs are common today, this type of business entity did not exist in 1970, when Milton Friedman published his classic essay. For the record, Wyoming became the first State to recognize LLCs in 1977.)

But as Prof Friedman notes in the fourth and fifth paragraphs of his classic essay, managers of a corporation occupy a different legal and moral position than sole proprietors or LLC members. In Friedman’s own words, “the [corporate] manager is an agent of the individuals who own the corporation [i.e. the shareholders], … and his primary responsibility is to them.” Indeed, legally speaking, corporate managers have a broad fiduciary duty to act in the best interest of the owners of the corporation, the shareholders. Therefore, unless the shareholders themselves (or at least a majority of them) want the corporation to promote “social responsibility” — however this fuzzy term is defined — corporate managers have a legal and ethical duty to maximize the value of the shares owned by the stockholders.

Before proceeding any further, this counter-intuitive aspect of Friedman’s profit-maximization theory of business ethics is worth repeating. According to Friedman, greed it good, for corporate managers not only have a legal duty but also an ethical duty to maximize profits! But how can such a counter-intuitive theory be right? And even if this profit-max theory of business ethics were true, what time horizon should corporate managers consider when making business decisions? Stay tuned; we will proceed with our review of the remainder of Friedman’s essay in our next post …

Really?

Now that we have brushed off the outlandish first paragraph of Professor Friedman’s classic essay on business ethics (see our previous post), let’s turn to the second paragraph. Unlike the ad hominem nature of the first paragraph, this second paragraph does contain some powerful opening salvos against corporate social responsibility or CSR.

The first of Prof Friedman’s criticisms is that CSR is just cheap talk or window dressing, or in the eloquent words of Friedman himself, “The discussions of the ‘social responsibilities of business’ are notable for their analytical looseness and lack of rigor.” It turns out that this “cheap talk” critique of CSR will not only be much harder to brush off; this critique still bedevils the CSR approach to this day. In brief, although business ethicists have tried to operationalize CSR by identifying those discrete “stakeholders” who are affected by the decisions of business firms and by imploring firms to take the interests of such stakeholders into account, the problem with stakeholder theory is that the interests of such stakeholders are often diffuse and conflicting, and no version of CSR or stakeholder theory that we know of actually attempts to assign any specific or concrete weights to these stakeholders. And forgive us for sounding so cynical, but in practice, few if any stakeholders, aside from management, have ever been appointed to a single seat on a single board of directors of any major U.S. corporation.

We now turn to Prof Friedman’s other major criticism of CSR, which appears in the form of the following rhetorical question:

What does it mean to say that ‘business’ has responsibilities? Only people have responsibilities. A corporation is an artificial person and in this sense may have artificial responsibilities, but ‘business’ as a whole cannot be said to have responsibilities, even in this vague sense. The first step toward clarity in examining the doctrine of the social responsibility of business is to ask precisely what it implies for whom.

In other words, CSR is an incoherent concept, for it is one thing to treat a natural person as a moral agent, but it makes little logical sense to treat a collective entity like a corporation as a separate or discrete moral agent. After all, an artificial legal entity cannot engage in moral reasoning. Had Friedman stopped here (immediately after the full second paragraph of his essay!), his strong opening salvos would have soundly defeated the CSR view of business ethics via a technical knockout, for CSR is logically incoherent (since firms are collective entities) and lacks analytical rigor (since the interests of stakeholders are diffuse and unweighted). But he does not stop here. Instead, he will devote the remainder of his essay to defending his hardcore “profit maximization” view of business ethics. We shall thus proceed with our review of Friedman in our next post …

Source: Punch (24 June 1914), p. 496.

Now that we have introduced Milton Friedman’s classic essay on business ethics (see our previous post), let’s jump right in, shall we? Professor Friedman’s first paragraph is by far his weakest one, for it contains some outlandish and sensational claims. In particular, he begins his 1970 essay by claiming that proponents of corporate citizenship or corporate social responsibility (CSR) are “preaching pure and unadulterated socialism” and that such CSR proponents are “unwitting puppets of intellectual forces that have been undermining the basis of a free society these past decades.”

Such claims, however, are irresponsible, if not just plain wrong! After all, a socialist system is one in which business firms are strictly regulated or owned by the government outright, and as I noted in my previous work, the concept of a “free society” is a fuzzy one, since all societies have rules, and since such rules by definition impose limits on our freedom to do as we please. Nevertheless, in fairness to Friedman, we should put his essay into its proper historical context. At the time he published his essay in 1970 (almost fifty years ago!), the world was divided into two great ideological camps – the free world (led by the USA) and the socialist bloc (led by the USSR) – and both sides were engaged in a fierce and worldwide struggle of heroic proportions. The idea of free markets was under siege and in retreat across the globe. In fact, within a year after publishing his essay, President Richard Nixon, a Republican (!), would issue a draconian executive order (Number 11615) on 13 August 1971, imposing a 90-day freeze on wages and prices, the first time the U.S. government had enacted wage and price controls since World War II!

Given this historical context, it’s possible that Milton Friedman made his melodramatic claims about CSR simply to grab the attention of his readers. That said, however, Friedman did himself no favors by equating CSR with socialism and as incompatible with freedom. As a result, we are going to overlook this first paragraph and focus instead on the remainder of his essay in our next few blog posts, for the rest of his essay not only passes the test of time; it contains far more cogent and powerful arguments than his introductory paragraph …

Milton Friedman (1912-2006) made one of the most provocative arguments on the role of business firms in society almost 50 years ago. In a now-famous essay published on 13 September 1970 in The New York Times Magazine, Professor Friedman (pictured below) argued that a firm’s main purpose is to maximize the profits of the firm. His short (3000-word) essay expands on a brief digression he made in his 1962 book Capitalism and Freedom (Friedman, 1962, pp. 133-136), where the late economist wrote: “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.”

Is Professor Friedman’s “Smithian” view of business ethics correct? In light of such recent events as the introduction by Senator Elizabeth Warren of “The Accountable Capitalism Act” (S. 3348) as well as the recent amendment (SB826) to California’s General Corporation Law requiring women to be included on companies’ boards of directors, today is an ideal moment to revisit Friedman’s classic essay and explore anew the strengths and weaknesses of his arguments. Although I have been highly critical of Professor Friedman’s normative and empirical assertions in Capitalism and Freedom in some of my previous work, I will review Friedman’s 1970 essay and defend his profit-maximization theory of business ethics in my upcoming posts.

Although there are no “sick days” on the Internet, we’re going to take the day off as we’re feeling under the weather today …

That is the title of the “cookie art” pictured below. Check out Judith G. Klausner’s entire collection of “Oreo Cameos” here. (Hat tip: Cliff Pickover.)