There's a post on naked capitalism by Yves Smith entitled How Milton Friedman Fomented the Barmy “Corporations Exist to Maximize Shareholder Value” Myth making the rounds, which I find wholly unpersuasive. Let's parse (quotes from Smith are in blue for clarity):
If you review any of the numerous guides prepared for directors of corporations prepared by law firms and other experts, you won’t find a stipulation for them to maximize shareholder value on the list of things they are supposed to do. ...
In my book, The New Corporate Governance in Theory and Practice (2008)
Although some claim that directors do not adhere to the shareholder wealth maximization norm, the weight of the evidence is to the contrary. A 1995 National Association of Corporate Directors (NACD) report, for example, stated: “The primary objective of the corporation is to conduct business activities with a view to enhancing corporate profit and shareholder gain,” albeit subject to the qualification that “long-term shareholder gain” may require “fair treatment” of nonshareholder constituents. A 1996 NACD report on director professionalism set out the same objective, without any qualifying language on nonshareholder constituencies. A 1999 Conference Board survey found that directors of U.S. corporations generally define their role as running the company for the benefit of its shareholders. The 2000 edition of Korn/Ferry International’s well-known director survey found that when making corporate decisions directors consider shareholder interests most frequently, albeit also finding that a substantial number of directors feel some responsibility towards stakeholders.
So Smith's claim is, at best, overstated.
So is Smith's next claim:
[Shareholder wealth maximization is] not a legal requirement.
Yes, it is. In my book, The New Corporate Governance in Theory and Practice (2008)
The classic statement of the shareholder wealth maximization norm remains the Michigan Supreme Court’s decision in Dodge v. Ford Motor Co. Henry Ford embarked on a plan of retaining earnings, lowering prices, improving quality, and expanding production. The plaintiff-shareholders, the Dodge brothers, contended an improper altruism toward his workers and customers motivated Ford. The court agreed, strongly rebuking Ford:
A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the non¬distribution of profits among stockholders in order to devote them to other purposes.
Consequently, “it is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary purpose of benefiting others.” Dodge’s theory of shareholder wealth maximization has been widely accepted by courts over an extended period of time. Almost three-quarters of a century after Dodge, the Delaware chancery court similarly opined: “It is the obligation for directors to attempt, within the law, to maximize the long-run interests of the corporation’s stockholders.”
For more on the relevant law see this post from February 2014 and this one from May 2012.
Back to Smith:
Directors and officers, broadly speaking, have a duty of care and duty of loyalty to the corporation. From that flow more specific obligations under Federal and state law. But notice: those responsibilities are to the corporation, not to shareholders in particular…
Wrong again. In Much Ado about Little? Directors' Fiduciary Duties in the Vicinity of Insolvency, I explained that directors have some duties that run to the corporate entity and some that run to shareholders: "This distinction is what differentiates direct from derivative shareholder litigation, after all. See Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, (Del. 2004) (“The stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation.)." I went on to further explain that:
In addition to being doctrinally questionable, the notion that directors owe duties to the corporate entity is inconsistent with the dominant contractarian theory of the firm. The insistence that the firm is a real entity is a form of reification—i.e., treating an abstraction as if it has material existence. Reification is often useful, or even necessary, because it permits us to utilize a form of shorthand—it is easier to say General Motors did so and so than to attempt in conversation to describe the complex process that actually may have taken place. Indeed, it is very difficult to think about large firms without reifying them. Reification, however, can be dangerous. It becomes easy to lose sight of the fact that firms do not do things, people do things.
In other words, the corporation is not a thing to which duties to can be owed, except as a useful legal fiction. The distinction between direct and derivative shareholder litigation is one area in which that fiction long has been thought useful.
Back to Smith again:
Appelbaum and Batt trace the origins of the managerial model of capitalist enterprise to the New Deal securities laws. They helped institutionalize dispersed shareholding, and with it, a separation of ownership and management. From the 1930s onward, there was an active debate between two schools of thought. Adolf Berle and Gardiner Means were concerned that this new approach neglected shareholder interests. By contrast, Harvard law professor Merrick Dodd contended that large-scale corporations had broader social aims, including providing employment and useful goods. By the early 1950s, the Dodd view had clearly prevailed.
So many errors in so few words. First, as a matter of historical accuracy, the separation of ownership and control long predates the New Deal. In my book Corporation Law and Economics (2002)
... it’s important to remember that the separation of ownership and control has proven to have significant survival value. Professor Walter Werner aptly referred to the Berle and Means account as the “erosion doctrine.” According to their version of history, Werner explained, there was a time when the corporation behaved as it was supposed to:
The shareholders who owned the corporation controlled it. They elected a board of directors to whom they delegated management powers, but they retained residual control, uniting control and ownership. In the nation’s early years the states created corporations sparingly and regulated them strictly. The first corporations, run by their proprietors and constrained by law, exercised state-granted privileges to further the public interest. The states then curtailed regulation . . . , and this Eden ended. The corporation expanded into a huge concentrate of resources. Its operation vitally affected society, but it was run by managers who were accountable only to them¬selves and could blink at obligations to shareholders and society.
The erosion doctrine, however, rested on a false account of the history of corporations. Werner explained that economic separation of ownership and control in fact was a feature of American corporations almost from the beginning of the nation: “Banks, and the other public-issue corporations of the [antebellum] period, contained the essential elements of big corporations today: a tripartite internal government structure, a share market that dispersed shareholdings and divided ownership and control, and tendencies to centralize management in full-time administrators and to diminish participation of outside directors in management.”
In addition, it's worth noting in passing that Alfred Marshall had explored the separation of ownership and control as early as 1890, as did William W. Cook in 1891, which inferentially supports the argument, made above, that ownership and control had separated well before the New Deal.
Second, as another matter of historical accuracy, the corporate social responsibility debate significantly predates the Berle-Dodd debate in the 1930s.
Third, and most important, Dodd did not win his debate with Berle. As I explained in Interpreting Nonshareholder Constituency Statutes:
Surprisingly, Berle himself believed that his argument with Dodd “ha[d] been settled (at least for the time being) squarely in favor of Professor Dodd’s contention.” This concession appears to have been motivated in large part by the New Jersey Supreme Court’s decision in A.P. Smith Mfg. Co. v. Barlow, which upheld a state statute authorizing corporate charitable giving. In doing so, the court broadly endorsed the corporate social responsibility doctrine. As described infra ..., however, Barlow’s result is not inconsistent with the profit maximization theory and, in any event, it remains in the minority among the decided cases. ...
A.P. Smith Manufacturing Co. v. Barlow, [FN43] the most frequently cited example, upheld a corporate charitable donation on the ground, inter alia, that “modern conditions require that corporations acknowledge and discharge social as well as private responsibilities as members of the communities within which they operate.” [FN44] Ultimately, however, the differences between Barlow and Dodge have little more than symbolic import. As the Barlow court recognized, shareholders’ long-run interests are often served by decisions (such as charitable giving) that appear harmful in the short-run. [FN45] Because the court acknowledged that the challenged contribution could be justified on profit-maximizing grounds, its broader language on corporate social responsibility is arguably mere dictum. [FN46] In any case, Barlow and its ilk are still in the minority. [FN47]
As Dalia Tsuk points out in 30 Law & Soc. Inquiry 179 (2005), even Dodd recognized that Berle had won:
Berle proclaimed that Dodd had won the debate; he concluded that “modern directors [were] not limited to running business enterprise for maximum profit, but [were] in fact and recognized in law as administrators of a community system” (Berle 1960, xii; 1954, 169). Surprisingly, there was little evidence to support this argument. As Joseph L. Weiner commented, “[t]he thesis . . . that corporate powers [were] held in trust for stockholders could not be established by decisions of the 1920's, but [could] hardly be contradicted [in the 1960s]” (1969, 1466; Israels 1964). This was also Dodd's assessment in 1942, when he wrote that the New Deal legislation had made his ideal of managers as trustees for workers, consumers, and the community irrelevant for corporate law. According to Dodd, corporate law became fixated on the relationship between managers and shareholders (546-47).
I am not going to try defending Milton Friedman's famous article, which Smith takes great pains to harshly criticize, both because that article is indeed so deeply flawed that it makes an easy straw man for people like Smith to debunk.
But I trust I have persuaded you that Smith's claim that "'maximizing shareholder value' is an idea made up and promoted by economists, starting with Milton Friedman and his Chicago School cronies," is BS. It is the law and has been for at least a century.
