Manne on Friedman and corporate social responsibility

Henry Manne, writing in today's WSJ in honor of Milton Friedman, talks about the time that he once questioned Friedman's criticism of corporate social responsibility.  Henry, as usual, challenges conventional wisdom, and as usual he has the upper hand. The provoking aspect of Henry's op-ed is that while he says he has changed his mind about corporate social responsibility, he was actually right both times.

Thirty years ago Henry told Friedman that most CSR was just "a profit-maximizing response to business, social or political pressures dressed up to look like something else. For such a strategy to be successful, the behavior had to appear to be nonprofit maximizing. . . " This made it hard to distinguish "social" from profit-maximizing managerial behavior.  Friedman's approach therefore "would invite judges to examine the propriety of a significant set of managerial decisions" contrary to the business judgment rule, "whose principle aim was to prevent judges from even engaging in that kind of examination, which they were perhaps more likely to get wrong than to get right."

Henry says that while Friedman then agreed with him, he (Friedman) was right all along:

[P]roposals for socially responsible corporate behavior, whether they emanated from within or outside the corporation. . . reflect, as well as anything else happening today, the inability of many commentators to distinguish between private and public property -- in other words, between a free enterprise system and socialism. * * * [O]nce these corporate behemoths are "affected with a public interest," they must either be regulated by the state or they must act as though they are owned by the public, and are therefore inferentially a part of the state. This attitude is reflected not merely by corporate activists, but by many "modern" corporate managers. * * *No arguments, weak as they are, about natural monopoly, market failure, government creation of corporations or the alleged government gifts of limited liability and perpetual existence, are required to justify the demands now regularly placed on business entities.

Henry observes that there is nothing about the size of business alone that justifies this attitude or treatment. Firms big and small are just privately financed ideas. "If one apple is a fruit, even a billion apples do not become meat." Instead, "[t]he origins of this transformation lie in the minds of people who do not like or appreciate the genius of capitalist success stories, including always politicians, who will generally make any argument in order to control more private wealth."

Henry was surely right 30 years ago when he said that much "socially responsible" corporate behavior was actually "a profit-maximizing response to business, social or political pressures dressed up to look like something else," and therefore protected by the business judgment rule. I make just that point in my recent Accountability and Responsibility in Corporate Governance. My article is somewhat more charitable, so to speak, toward the behavior, than Henry: I argue that this corporate conduct just shows that markets are working, so we don't need to reform corporate governance as the social responsibility mavens claim.

However, Henry is surely also right when he worries about where all this is going. While the implication of my theory is that shareholder wealth maximization will ultimately get us to something like the socially right result, the social responsibility theorists don't want to stop there. They want to reform the corporation to take the shareholders at least partly, if not entirely, out of the loop. And this, as Henry says, is pernicious.

Moreover, the fact that managerial behavior is "a profit-maximizing response to business, social or political pressures dressed up to look like something else" does not mean that there is no problem – only that we don't solve the problem by imposing liability on managers. Henry may be right that there is too much pressure on managers to behave responsibly, much as this challenges the prevailing wisdom that managers are not responsible enough.

So what is the solution? To begin with, let's try to figure out where the "social or political pressures" Henry refers to are coming from. As Henry says, one source is politicians, who have have a private interest in controlling private wealth.

But it also matters that politicians have help from, "people who do not like or appreciate the genius of capitalist success stories." As I discuss in Wall Street and Vine, this includes filmmakers, whose work displays their general discomfort with capitalism. In other words, filmmakers do not merely cater to the anti-capitalist prejudices of their audience, but to some extent have contributed to creating those views. I'm also starting to develop a theory along those lines for journalists, beginning with my Public Face of Scholarship.

One of the things we have to be thankful this season is our vibrant capitalist system. That is not to say that the system can operate perfectly without law. Among other things, markets operate on the basis of existing endowments, and can't do much about fundamental disparities. But we gain nothing, and stand to lose a lot, if we try to solve such problems by reengineering the firm to make it some kind of a "public" entity. Our system works only because it preserves a substantial private sphere.  That sphere is under attack from the attitudes Henry describes.

Comments

[Paul A. King]

Response to Wall Street Journal Opinion article Mr. Friedman Was Right, 24 November 2006, by Mr. Henry G. Manne, Dean Emeritus, George Mason University School of Law.
By Paul A. King

Both Mr. Friedman and Mr. Manne were right. It was acceptable ten or twenty years ago to make an argument, as Mr. Friedman did, that “…the sole business of managers of a publicly held corporation was to maximize the value of its outstanding shares.”

Mr. Manne has written two eloquent columns on why that was probably the correct way of thinking before about 1984. That was the year that Union Carbide Corporation accidentally released 40 tons of ethyl isocyanate into the nighttime atmosphere near Bhopal, India and instantly killed more than 3,000 human beings, and left up to 15,000 more to die of health effects related to the poisoning. Or, maybe it was still a valid argument in 1989, when the super-tanker Exxon Valdez, commanded by an alcohol impaired skipper ran aground on the Bligh Reef in Prince William Sound, Alaska spilling 10.8 million gallons of crude oil. Maybe it was a good line 1994 when Nike got busted for offshore child labor and sweatshop manufacturing operations. Wait, I think it was still OK to talk about managers sticking to their knitting right up until Worldcom, Enron and the Martha Stewart Living empires went under.

The key word here is public. Public company does actually have the word public in it. Public corporations, as well as private businesses, exist inside of communities. The eventual shareholders, although sometimes several degrees removed, are just me and you. Do I think that my shares are being diluted by managers who have run amuck with altruistic ideals and projects? Not at bit. Managers of public companies, as a group, are smart and experienced businessmen who know how to get a return on everything, even corporate social responsibility. When you are really smart, it actually looks like you are having fun, being nice, and doing something for free.

So lets look at this from another angle. We have occupied planet earth for just a few hundred years as industrial society. For all of that span, no one has paid much attention to the externalities that live downstream from every activity in our commercial and industrial world. Our fuels pollute. Our consumption waste stream pollutes. Our every activity pollutes. Simply, the act of being has negative externalities for every one of us, no exceptions. And, nobody takes much account of the negative externalities, because it would cost money and be inconvenient. Fixing pollution and cleaning up waste is hard work, and its expensive, too. You don’t expect us to do that, do you?

After Bhopal and Exxon and Nike and Martha, investors started asking questions. Boards of directors started asking questions. Regulators started asking questions, too. Leading companies in Europe actually started partnering with NGO’s as a simple brand risk protection scheme. The key word here is brand. According to Business Week, there are 100 Top Global corporations whose brand value ranges from $2 billion to over $65 billion. We aren’t talking about market cap here, just brand. The name Coca Cola is estimated to be worth $65 billion, plus. You had better believe that someone is in charge of protecting that.

When Mr. Manne invokes the esteemed, and recently deceased, Mr. Freidman so he can claim socialism without actually attributing the word to himself, that sound just like a clever lawyer. Its is a new age. We have gone beyond transparency, beyond corporate social responsibility, beyond ethics. We are definitely on the verge of one of the greatest challenges of humankind in confronting the potential of climate change and in addressing the needs of the developing world through the concerted global efforts of the developed economies of the world. This challenge is already being met by corporations working cooperatively with NGO’s and governments to help use management talent, ability and financial resources to get big jobs done right.

Mr. Manne points out “…even a billion apples don’t become meat.” Well, that depends on who eats the apples. If you feed the apples to pigs and cattle, and then we make meat, I would have to take objection to the statement. This brings us to a very good point about apples, and food in general. All food has embodied energy used to plant, irrigate, fertilize and pest-treat, and harvest, and transport to market. Also, apples, like many agricultural products have economic subsidies. What kind of socialism is that? So, there are two glaring externalities associated with the essence of simplicity, the apple: one is energy and the other is economic. Are you sure that a billion apples don’t become meat?

We all have externalities, as individual persons and as organizations and corporations. I think that Mr. Friedman might actually agree with me that having neutral or positive externalities is better than having negative ones, especially if your brand value makes up any part of that outstanding shareholder value.

[Julian Wong]

Paul,
I am in agreement with your comments. I especially like your comments about apples that may be fed to animals and hence become meat. This is in effect what happens to our biggest multinational companies today...their growth is not arithmetic, it is geometric; it is not linear, but nonlinear and exponential, so that the public really is affected.

Henry Manne fails to consider externalities that fail to be imputed to a businenss' costs and decision-making because of both market and legal failures.

Finally, as you point out, believers in free-markets should recognize that a market exists not only for the products and services a company provides, but also its reputation. Paying heed to CSR is paying heed to the call of the market.

I expound on these points in my blog posting:
http://ecopreneur.blogspot.com/2006/12/corporate-social-responsibility.html

[M. Hodak]

I'm having a hard time understanding the core of Mr. King's argument. Is he saying that Union Carbide or Exxon didn't bear any of the costs of those disasters, or were otherwise indifferent to them? Is he saying that Union Carbide's management viewed 3,000 deaths as an acceptable cost of doing business, or that Exxon condoned a drunken captain? Or is he saying that they quickly figured out that those costs do, in fact, get internalized in a big way, and that is the point of CSR--the internalization of cost and risk, which kind of presupposes that chemical or shipping companies previously, stupidly underinvested in safety procedures, therefore undermining their "brand." Perhaps Mr. King is saying that corporations, even when costs are substantially internalized, aren't perfect. But I can't believe that is the point of such a long entry because it's a trivial conclusion.

So, maybe Mr. King's point is about true externalities. He seems to switch to that point so deftly I couldn't quite keep up. Perhaps he is saying that because corporate behavior doesn't account for externalities, or does so imperfectly, that market-based decisions should be subordinated to non-market considerations? Now, that's different from saying that corporations should simply be managing their "brand," which suggests that all those costs somehow get internalized. I suspect that Mr. King is not conflating "brand" with "externalities" because that would render his long entry largely senseless.

So, maybe this very long comment is meant to suggest that non-market considerations become a part of the corporate decision structure. And maybe hidden in all that stuff about apples and meat he provides even the smallest sense of what standard corporate management should apply in making those decisions, aside from the default option of whatever makes them personally look like swell guys to Mr. King.

I really don't get it. Unless that was the point of Mr. King's long, windy post.