Blackrock CEO Lawrence Fink recently sent a letter to corporate CEOs, which some are arguing is intended to--or at least will have the effect of--undermining Nobel economist Milton Friedman's famous proclamation: “The social responsibility of business is to increase its profits.”
There are any number of things about the letter that bug me. Let's start with its basic error about the nature of Friedman's argument:
Fink's model eschews the short-term focus that he said drives companies’ emphasis on quarterly results and the limitations that annual meetings place on dialog between executives and shareholders. Instead, investors and management should maintain continuous communication “about improving long-term value,” Fink wrote.
Nothing in Friedman's famous essay argues that corporate success should be measured by short-term profit. To the contrary, Friedman implicitly embraces the notion that corporate success is measured by sustainable long-term profits:
To illustrate, it may well be in the long run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community or to improving its government. That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage and sabotage or have other worthwhile effects.
In addition, it seems clear that Fink's approach is not based on neutral principles but rather is driven by personal ideological preferences. As Alicia Plerhoples notes of the general sustainability movement, "measurements of social and environmental benefits play a critical role in determining what constitutes sustainability and the public benefit produced. These measurements often incorporate ideologically liberal values and exclude conservative values." Does it surprise anyone that Fink gave $2300 to Obama? And $30,800 to the DNC in 2012? Or that Blackrock employees disproportionately favor Democrats?
As such, Fink's pressure on corporate CEOs to effectuate his policy preferences is a classic example of how the growing power of institutional investors raises serious agency cost concerns. Like the vast majority of large institutional investors, Blackrock manages the pooled savings of small individual investors. From a governance perspective, there is little to distinguish such institutions from corporations. Among other similarities, managers who focus on "social responsibility" rather than shareholder returns are spending other people's money. As Friedman observed:
What does it mean to say that the corporate executive has a "social responsibility" in his capacity as businessman? If this statement is not pure rhetoric, it must mean that he is to act in some way that is not in the interest of his employers. For example, that he is to refrain from increasing the price of the product in order to contribute to the social objective of preventing inflation, even though a price in crease would be in the best interests of the corporation. Or that he is to make expenditures on reducing pollution beyond the amount that is in the best interests of the corporation or that is required by law in order to contribute to the social objective of improving the environment. Or that, at the expense of corporate profits, he is to hire "hardcore" unemployed instead of better qualified available workmen to contribute to the social objective of reducing poverty.
In each of these cases, the corporate executive would be spending someone else's money for a general social interest. Insofar as his actions in accord with his "social responsibility" reduce returns to stockholders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customers' money. Insofar as his actions lower the wages of some employees, he is spending their money. ...
Adolf Berle famously explained the problem with letting managers spend shareholder money in order to be socially responsible:
I submit that you can not abandon emphasis on “the view that business corporations exist for the sole purpose of making profits for their stockholders” until such time as you are prepared to offer a clear and reasonably enforceable scheme of responsibilities to someone else. Roughly speaking, there are *1368 between five and eight million stockholders in the country (the estimates vary); to which must be added a very large group of bondholders and many millions of individuals who have an interest in corporate securities through the medium of life insurance companies and savings banks. This group, expanded to include their families and dependents, must directly affect not less than half of the population of the country, to say nothing of indirect results. When the fund and income stream upon which this group rely are irresponsibly dealt with, a large portion of the group merely devolves on the community; and there is presented a staggering bill for relief, old age pensions, sickness-aid, and the like. Nothing is accomplished, either as a matter of law or of economics, merely by saying that the claim of this group ought not to be “emphasized.” Either you have a system based on individual ownership of property or you do not.
A. A. Berle, Jr., For Whom Corporate Managers Are Trustees: A Note, 45 Harv. L. Rev. 1365, 1367–68 (1932).
Even if it were not ethically and economically undesirable for managers to pursue social responsibility, it is far from clear that doing so is practicable. Again, consider Friedman's argument:
On the grounds of consequences, can the corporate executive in fact discharge his alleged "social responsibilities?" On the other hand, suppose he could get away with spending the stockholders' or customers' or employees' money. How is he to know how to spend it? He is told that he must contribute to fighting inflation. How is he to know what action of his will contribute to that end? He is presumably an expert in running his company–in producing a product or selling it or financing it. But nothing about his selection makes him an expert on inflation. Will his holding down the price of his product reduce inflationary pressure? Or, by leaving more spending power in the hands of his customers, simply divert it elsewhere? Or, by forcing him to produce less because of the lower price, will it simply contribute to shortages? Even if he could answer these questions, how much cost is he justified in imposing on his stockholders, customers and employees for this social purpose? What is his appropriate share and what is the appropriate share of others?
Fink's letter fails to resolve the question how corporate executives should discharge their social responsibilities, while at the same time shifting the same problem to the level of financial intermediaries. What makes Fink and his ilk experts on social needs?