Abstract
In response to the growing criticisms to shareholder primacy, Oliver Hart, a Nobel Economics Prize recipient, and Luigi Zingales, a very well-known finance professor, have offered a revision to Milton Friedman’s dominant account. Seeking to incorporate social and moral concerns into the objective function of the firm, they have proposed that managers should maximize shareholder welfare instead of shareholder value. Their account has been highly influential and reflects many of the substantive and methodological assumptions of corporate governance scholars within the law and economics literature. In this paper, we engage closely with their account from a normative perspective, unearthing and criticizing the implications of many of these assumptions. In doing so, we also formulate a set of principles necessary to ensure the ethical legitimacy of any proposal that puts shareholders at the center of the firm’s objective function.
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08 February 2024
The original online version of this article was revised: Missing book titles were added to references Mejia 2023 and Mejia 2024.
Notes
In this article, we will use “ethical” and “moral” as interchangeable terms (c.f., von Kriegstein 2022).
Following the economics literature, we will use “manager” to refer to the individuals within the company with decision-making authority (typically the board of directors and the chief executive officer).
To simplify the use of pronouns, we will use the feminine pronoun for managers and the masculine for shareholders.
Hart and Zingales assert that the apparently minor change from “shareholder value” to “shareholder welfare” is very significant:
To a casual observer, the difference between shareholder welfare and shareholder value might seem small. Yet it is on the basis of the shareholder value principle that corporate boards and courts of law reject the ability of shareholders to influence corporate policy on social issues that shareholders care about. (...) Moving from shareholder value maximization to shareholder welfare maximization may be a small step for theory, but it could trigger a leap forward in the way our corporations are run (Hart & Zingales, 2017b).
In fact, tolerance is, itself, a moral stance grounded on normative arguments, “tied to an appreciation of the richness of different cultures and different life experiences, to a respect for others, and to a willingness to take their perspectives and arguments seriously” (Hausman et al., 2017, pp. 11–12).
Selling tobacco to minors is still legal in several countries. Moreover, as of 1989, it was still legal in several states in the United States.
Because this section will echo some relatively well-rehearsed arguments from the literature on economics and philosophy, we will discuss them briefly. For an expanded exposition, see Mejia (2024).
We are indebted to Waheed Hussain for this example.
Even if Hart and Zingales are improving on the received understanding of Friedman, some passages in his influential New York Times essay make one wonder whether Hart and Zingales are adding much to what Friedman had already written.
Friedman has been read as stating that managers should focus only on maximizing profits. But what Friedman actually wrote was that the responsibility of managers was “to conduct the business in accordance with their [i.e., shareholders’] desires, which generally will be to make as much money as possible” (Friedman, 1970, p. 33).
This statement suggests that maximizing profits is the objective of the firm only when this is what shareholders want. Friedman is careful to point out that a group of investors “might establish a corporation for an eleemosynary purpose—for example, a hospital or school. The manager of such a corporation will not have money profit as his objective but the rendering of certain services” (Friedman, 1970, p. 33). Focusing on passages like this would lead one to argue that, according to Friedman, if shareholders want a for-profit business to pursue prosocial initiatives that are profit-sacrificing, the manager is obligated to pursue such initiatives.
The mathematical model Hart and Zingales provide in Hart and Zingales (2017a) avoids this problem by fiat. According to this model, the extent to which a shareholder is willing to sacrifice profits to do the socially efficient thing is determined by a real number \(\lambda\), where \(0\le \lambda \le 1\) (0 means that the shareholder only cares about profits; 1 means that he always chooses the socially efficient outcome). This means that, within Hart and Zingales’ model, shareholders can be more or less prosocial. But because \(\lambda\) can not take negative values, there is no room to characterize an anti-social shareholder that may be willing to sacrifice profits to promote socially inefficient outcomes. Once you grant that \(-1\le \lambda \le 1\), you can no longer conclude that the results of maximizing shareholder welfare will be socially superior to the “Friedman outcome.”
Henceforth, we will use the locution “basic norms of society” instead of “basic rules of society” to avoid the legalistic and formulaic undertones around the notion of “rules.”
There are good reasons to think that Friedman would not cash out this notion adequately. Friedman concludes his essay by arguing that the manager should maximize profits provided that she “stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud” (Friedman, 1970, p. 124). The caveat he uses here (“stay within the rules of the game”) appears as a reformulation of the original caveat (“conform to the basic rules of society”). But this second caveat leaves us with a conception of shareholder primacy that would not pass muster. There are, after all, many additional ethical norms beyond “don’t lie” and “don’t defraud” that ought to constrain the corporate activities of managers.
Personal communication, July 09, 2021.
The claim that we should not engage in moral philosophy because of its messiness is one that economists are poorly positioned to make.
The field is confronted with foundational and unresolved substantive and methodological disagreements. For instance, whether financial markets are efficient and rational is a substantive question that has been unresolved for decades (Fama, 2014; Shiller, 2014)
On the methodological side, there have been long-standing controversies on whether proper empirical economic analysis can be achieved through structural econometrics or requires randomized trials and natural experiments (Angrist & Pischke, 2010; Nevo & Whinston, 2010).
Hart and Zingales, personal communication, July 09, 2021.
The work of economists can be particularly valuable here. As Schmidtz (2019, p. 555) argues, “economies exhibit a certain logic. To ignore the logic of human economy is to ignore the logic of human ecology and thus to ignore the logic of ecologies where humans are a keystone species.’
Economic models and theories have actually contributed valuable insights on several normative issues (Hausman et al., 2017, ch. 13–15). Economists are particularly talented in identifying collective action problems and unintended consequences of apparently well-meaning policies. Their use of mathematical tools and the deductive nature of many of their theoretical contributions sharpen the analysis’ clarity and rigor. And while rational choice theory has been criticized for failing to describe human beings in all their complexity (Pirson, 2017, Chap. 1, 2), it would be a mistake not to recognize that this framework has proved very insightful and productive in thinking through many human interactions (Williamson, 1996).
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Acknowledgements
Research on this chapter was possible thanks to the generous sabbatical support from Fordham University and the Institute of Humane Studies. Research on this Article was also partly funded through a Fordham University’s Faculty Summer Research Grant. Hannah Daru contributed to this article with valuable editorial support while Ying Yang, Priyank Singal, and Rebeca Rozenbaum provided helpful research assistance. We would like to express our gratitude to the audiences of Wharton’s Legal Studies and Businesss Ethics department Colloquium, the Business Ethics in the 6ix conference, and the University of British Columbia’s W. Maurice Young Centre for Applied Ethics workshop. We would also like to thank for their conversations, ideas, and feedback Brian Berkey, Carson Young, Daryl Koehn, David Silver, Hasko von Kriegstein, John Boatright, Julian Jonker, Luigi Zingales, N. K. Chidambaran, Oliver Hart, Rob Hughes, Rob Mass, and Sareh Pouryousefi. Special gratitude goes to Tae Wan Kim, who encouraged the first author to write this paper. All opinions expressed in this article are our own, and all errors should be attributed to us.
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Mejia, S., Bonaldi, P. Maximizing Shareholder Welfare: A Normative Examination of Hart and Zingales’ Corporate Governance Account. J Bus Ethics (2024). https://doi.org/10.1007/s10551-023-05551-5
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DOI: https://doi.org/10.1007/s10551-023-05551-5