Milton Friedman created the Friedman doctrine. It’s been at the core of business theory for the better part of half a century. In its purest form, it espouses that the only purpose of the corporation is to increase shareholder value. Of course, the theory is a bit more nuanced than that. It was really a theory about social responsibility and the argument being that shareholders are the ones who should determine what the social responsibility of the corporation was going to be, not the CEO. There are books written on this topic as the concept is a bit like communism, it’s great in theory but it falls apart in practice. In reality, because of the size of the corporations, the number of shareholders, and the complexity of the world, the only thing that everyone can agree on is that profits are the most important thing. Consequently, organizations only care about one thing, profits. People, including the employees who work at the company, don’t really matter, the communities the organizations operate in don’t really matter, and what’s best for the country or the world doesn’t matter. Profits are the driving factor. It’s why we see corporations always and forever fighting for what is in their own best interests no matter whoever else suffers. So, if the Friedman doctrine is flawed, then what should be the driving force of the company? I think I have the answer.
The Friedman doctrine, like many flawed theories, makes sense if you read it. The argument is that the CEO is the agent of the shareholders and if he acts in any other way than in their best interests, then he is acting like a socialist government agent without the benefit of the political process.
We have, in part because of the general acceptance of the Friedman Doctrine as fact, maintained a laissez-faire attitude towards business which allowed modern corporations to become unique entities in the history of the world. Overtime they can, and typically do, achieve a state where they are monopsonies, oligopolies and monopolies with tremendous power. All of these are situations where individuals and communities and even countries lose the power of self determination due to the influence of the corporation.
So who can have oversight of the corporations, or more specifically anything related to corporate social responsibility? Government can’t do it. In this, I agree with the late Mr. Friedman. We’ve called this Socialism, Communism, and other names. No matter if the theory is old and vilified, or new and exciting, central planning of business doesn’t work as there are too many factors that can’t be accounted for. For a business to be successful it has to operate in part, with its own interests in mind and its interests should go beyond just the shareholders.
So who should the driving force behind the company be? To me, it’s a simple word swap. Instead of ‘shareholders’ it should be ‘stakeholders.’ The argument could be made that there are virtually unlimited stakeholders for any corporation. For example, it could be said that a two-man powder coating company in Kentucky could have stakeholders who are farmers in rural China. If the two-man company is using an outsized amount of fossil fuels to keep their equipment going, then in theory they are having a, however infinitesimal, negative effect on the world environment vis-à-vis additional global warming. This would technically affect the livelihood of the China farmers. So, the line must be drawn somewhere.
To draw the line, I would argue it’s only those most directly affected by the company who should be guiding its actions. To me there are four groups. Shareholders, Employees, Customers and Communities. Three of these groups should always have some form of representation on the company’s board of directors, with customers having a seat at the table as well if the company has any form of a monopoly or is anything like a utility. Telecom fits into this category.
If a company action is bad for Employees, Customers, and the Community, say like closing a profitable factory in a rural location and moving it overseas to increase profits an additional 20%, then why would anyone in their right mind do it? That 20% isn’t worth it if so many people suffer yet that’s what a shareholder controlled board would do and has done uncountable times as we’ve dismantled our manufacturing sector over the last several decades. Another example is the rural telephone company which refuses to invest in fiber because their customers have nowhere else to go. This led to America having the highest cost and worst performing internet in the developed world.
Let’s look at the different groups of stakeholders. The first and most obvious group is the shareholder. The person or persons who ‘owns’ the company. Companies can’t do great things without investment. The Shareholder is investing expecting a return. That’s reasonable. Unfortunately, many investors dream of, and often demand, outsized and unrealistic returns. This is the root cause of bad corporate behavior. Reasonable and sustainable growth is not the objective, so reasonable and sustainable practices are often not part of the corporate culture. One look at how private equity destroys long-term stability for short-term gain through financial machinations illustrates my point. My favorite, and when I say favorite, I mean vile but easily understood, example of this type of short-term thinking is when a new private equity owner will sell a building owned free and clear by the company just to lease it right back at market rates. By selling the building a huge pile of cash is returned to the investors quickly, but now the company in question has an ongoing burden of ever-increasing rent they must pay. This has a hugely adverse effect on other stakeholders including customers, employees, and the community at large as the company now has even greater operating costs yet they still must ‘meet the numbers’ and modifies its operations in negative ways to do so.
I’ll agree with Friedman. The shareholder is most likely the most important stakeholder. Unfortunately, the bottom line is right now 100% of the focus of business is on shareholder value and there are no checks and balances to this as government, at least in the United States, is ineffective at reigning in bad behavior of big business. These checks and balances to shareholder driven tyranny can come from the other stakeholders.
The second most affected group by corporate decision making is the employees. The company really can’t exist without employees. There is much to be said about the gig economy and the way companies are trying to reclassify what used to be traditional employees into independent contractors. For the purpose of this exercise, we’ll count anyone who does work for the company and receives payments from the company as employees.
There is no question that rank-and-file employees should have representation on any board of directors. This approach has been proven to work in other countries. It also has the knock-on effect of enhancing company operations as the frontline employees tend to know the business operations the best. Going back to the telecom example, I knew some front-line employees from my local communications company back when I was getting a paltry 500kbps with my supposedly high-speed internet service. I had become friendly with the techs as my line was so buggy they had to come out a few times a year to try and service it. Although putting in fiber was a huge undertaking and unrealistic at the time, one local technician told me about another option. We had a good conversation about how a few strategically placed DSLAM’s, the equipment that provides DSL service, could take 90% of the county to 20+ megabit service. It would be a tiny investment with massive returns in customer service. But even a tiny investment wasn’t approved as it would provide no enhanced shareholder value. We had no other options as customers so why invest? If the company decided to put in the equipment, the tech knew that less money would be spent on service calls and service provisioning would go through the roof. Now imagine if customers were also on the board of the communications company as, no matter what the political climate is, an land line internet telco is a utility. There wouldn’t be a question about short term investment to get people basic internet connectivity and long-term investment into reasonable internet connectivity via fiber. Additionally, the industry wouldn’t be fighting the commonsense reclassification of 100 megabit service as being the minimum to be considered broadband as they are currently doing so aggressively.
As I mentioned earlier, the customers only need to be on the board when there is a situation of limited competition. In this way the customers can demand quality service, or influence the company to not stymie competition.
The next group is the community at-large. This can get tricky as corporations are large and touch so many communities. Also, communities can be very diverse. It would take people who are more well versed than I am in community representation systems to find an equitable solution to this challenge. I’m sure someone can come up with a plan that would allow community members a voice on the board of directors of a large corporation. No matter the selection mechanism, someone who’s just as concerned about the company’s effect on the communities it operates in as it is its profitability needs to be part of the board of directors.
If you look at all this, it sounds very political, almost like I’m saying treat companies like government entities. Have varying parties with different agendas that all have to come together to compromise on the best way forward. There is some truth to that only because some companies, especially the larger ones, are as complex as some national governments. According to Friedman, we don’t need this because this type of oversight should be left to elected government officials. Unfortunately, as we’ve seen, our government can be hugely ineffective and is too big to really dig into the machinations of any single company. That’s why I’m espousing that we change the very foundation of corporate governance to one where all affected parties have a voice. I only have one challenge with this theory and that is I don’t know the ratio of representation. Should it be 50/50 between shareholders and other stakeholders? What about everyone having a 33% say? I would say that in this split customers and communities would share a third in the instances where customer representatives are on the board. I believe the problem here is that shareholders would not invest in a company that is controlled by other stakeholders, well at least not in the near or medium term. As the culture changes, and this governance model becomes the standard, I think investors would be more willing as that’s just how things are perceived to be done.
For now, I would say that shareholders should have somewhere between 40-49% of the seats on any corporate board with the rest of the seats being split by employees and community and/or customers. In this way the shareholders can be vetoed if they are moving in a direction that would harm everyone else except themselves. In the end as long as two out of the three groups are ok with whatever big decision is being made, then the most egregious actions of a shareholder led board will be kept in check. Additionally, in a well functioning board, the big strategies will always be developed in a way that enhances all the stakeholder groups.
Friedman was a very intelligent man who came up with the shareholder value theory that led to a great experiment in modern business. Perhaps unsurprisingly, the only people who benefited from that theory were shareholders much to the detriment of everyone else who was in any way involved with the company. Now it’s time for a new experiment.
The whole thing reminds me of when my daughter was planning to get married. She was running around happily picking out vendors and venues with bullheaded determination in what she wanted. She was also getting upset at me and my wife because we were not engaged in the process to the extent she would have liked us to be, i.e. we didn’t offer to finance any of the wedding as she expected. In a moment of frustration, she blurted out “Are you going to pay for any of this?!?” We, of course, were waiting for the question and had our answer ready. We simply said “if we pay, we have say”. She didn’t like that answer, because it meant she wouldn’t get exactly the wedding she wanted because we refused to let her put us in a financial commitment we didn’t want to be in. Shareholder led companies have that same sense of entitlement as a young bride-to-be. They both have experienced decades of being enculturated that they can have anything they want no matter what effect it has on others. It’s time for all the stakeholders to remind the large companies that they don’t exist in a vacuum and when the company makes a big decision, there is always a price that is paid by everyone involved in some way or other. To that end, just like the response we gave my daughter, I firmly believe that the rule should be the same for the stakeholders: “If they pay, then they should also have say.”
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