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Shareholder Primacy Means Shareholders Are Paid Last

Aaron Brown

(Bloomberg Opinion) -- The Business Roundtable touched off a storm of commentary with its abandonment of the “shareholder primacy” view that the goal of a for-profit business corporation should be to maximize shareholder value. Most people celebrating this move seem to think it means stakeholders such as employees, customers, suppliers and communities will do better if corporate boards and managers treat their interests as equal to those of shareholders. But this betrays a basic confusion.

Shareholder primacy is usually traced to a 1970 New York Times magazine article by Milton Friedman titled “The Social Responsibility of Business is to Increase its Profits” where he was arguing against the views of business managers (the Business Roundtable would take 27 years to accept his arguments, and now 22 years to recant). It was labor leaders who objected to the social responsibility of management “far more consistently and courageously than have business leaders.”

Friedman’s main example was exhortations from the government for businesses to avoid wage increases in order to slow inflation (voluntary and mandatory wage and price controls would be the main anti-inflation policies throughout the economic disaster of the 1970s). Business leaders were fully on board for this campaign; it was labor that successfully fought it. Labor leaders wanted level-playing-field negotiations with profit-maximizing managers, not for paternalistic managers to determine the best interests of workers. In the extreme, it was a literal road to serfdom in which workers exchanged loyalty to bosses for noblesse oblige caretaking.

How well stakeholders are treated depends on their power, not on the process for making decisions. In Friedman’s model, managers working as agents for shareholders hold bilateral negotiations with each stakeholder -workers, customers, suppliers, communities and creditors – and whatever money they have left at the end goes to shareholders. “Shareholder primacy” actually means shareholders get paid last.

The “stakeholder” alternative is for managers to simultaneously negotiate with all groups on a consensus plan that respects everyone’s interests. Managers are disinterested arbiters rather than agents for shareholders. There’s no reason to assume workers or any other group would do better under this system.

Existing stakeholder groups are likely to do much worse because (a) lots of new stakeholders will come out of the woodwork once corporate assets are to be shared “equitably” rather than bid for in tough negotiations, (b) running a company via multilateral negotiation will lead to perverse outcomes and stagnation, and (c) managers will write their own report cards, like politicians, rather than being disciplined by market prices and performance will suffer.

The way to get better outcomes for workers, customers, suppliers or communities is to pass laws giving them more power rather than changing the rules by which they negotiate. More power has predictable effects. Moreover, the laws apply to all enterprises, not just large for-profit corporations with highly developed senses of social responsibility, and are enforceable.

The Business Roundtable committed to five specifics:

Dealing fairly and ethically with our suppliers. No one opposes this. Friedman required “conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom” with respect to everyone, not just suppliers. Supporting the communities in which we work. This is self-interest. Friedman discussed the necessity to provide amenities for the communities in which a firm does business beyond what is required in taxes, and to support good government. Delivering value to our customers. To do otherwise is fraud, and bad business. Friedman listed a duty to engage “in open and free competition without deception or fraud." Investing in our employees. Friedman assumed the social responsibility was to hire hard-core unemployed people at the expense of investing in higher skilled workers. He felt businesses should hire the people who gave the best return on what the company invested in them, not the people who needed the jobs most. Generating long-term value for shareholders. No argument.

It seems the Business Roundtable has not strayed far from shareholder value maximization. It commits only to things that are either legal requirements or business necessities or both.

To contact the author of this story: Aaron Brown at aaron.brown@privateeram.com

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Aaron Brown is a former managing director and head of financial market research at AQR Capital Management. He is the author of "The Poker Face of Wall Street." He may have a stake in the areas he writes about.

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