Review of Friedman (part 6): theory choice

We now proceed to paragraph six of Milton Friedman’s 1970 essay on business ethics. Whatever theory of business ethics you subscribe to (profit-maximization or stakeholder theory), this short paragraph is perhaps the most important one of the entire essay, so it deserves to be quoted in full:

Needless to say, this [the principal-agent nature of the relationship between shareholders and managers] does not mean that it is easy to judge how well he [a corporate manager] is performing his task [i.e. maximizing profits]. But at least the [profit-max] criterion of performance is straight-forward, and the persons among whom a voluntary contractual arrangement exists are clearly defined.

In other words, to be useful, a theory of business ethics should satisfy the following two criteria: (1) the scope of the theory should be well-defined, i.e. we should be able to tell to whom does the theory apply; and (2) compliance with the theory should be easy to measure, i.e. we should be able to tell when a corporate manager is acting in a way that is consistent or not with the theory. 

Let’s agree with Friedman (for the sake of argument) that these criteria of theory choice are good ones. Alas, stakeholder theory is weak on both counts. Why? Because as Friedman has already noted, CSR’s “analytical looseness and lack of rigor” make it difficult to circumscribe its scope or measure compliance. 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 stakeholder approach does not even come close to satisfying any of the two criteria listed above: (1) scope or (2) measurement.

To begin with, it’s not always clear who the relevant stakeholders of a corporation are. The employees of a firm are no doubt essential stakeholders, as are the customers of a firm (or the users of its products). But do these stakeholder groups also include potential consumers and future employees? Either way, how far beyond these two core groups of stakeholders does CSR extend? Business ethicists often like to include nature (the environment) as well as the local communities in which a firm’s employees and customers work and live, but in the case of large multinational companies like Google and Facebook, with billions of users across the globe, such “local communities” would extend to the entire planet! Worse yet, what happens when the interests of the various stakeholders collide? Do the interests of consumers trump the interests of employees? Or vice versa? In short, the main problem with CSR or stakeholder theory is that business ethicists refuse to assign any specific or concrete weights to the various stakeholder groups. Without such weights, it is impossible to measure the level of compliance of corporate managers with CSR theory. Instead, CSR becomes mere window dressing or cheap talk …

But wait up! Are these criteria of theory choice the right ones? Even if they are, what about Friedman’s “greed is good” theory of business ethics? Is the profit-maximization approach able to satisfy either of Friedman’s two criteria of usefulness? We shall further explore these key questions when we proceed with our review of Friedman’s essay in the next day or two …

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