Which approach to business ethics claims that the social responsibility of business is to increase profits so long as the company stays within the rules of law?

The question of how ethics and morality can be applied to human experience is a vexed one. Though philosophers have discussed abstract ethical dilemmas for most of recorded history, there appears to be no universal answer to resolve ethical problems. The varied works of philosophers have led to the development of ethical frameworks that may be applied to any particular situation. This essay discusses the views of Milton Friedman on corporate social responsibility.

The answer to an ethical question may differ depending on which moral framework is used. For this reason, taking complex and abstract ethical theories and applying them to the decision-making processes of company directors can lead to unresolvable arguments in boardrooms, restaurants, shareholders meetings, scholarly journals and, of course, the media. Milton Friedman proposed a guiding principle for business ethics in a New York Times article, provocatively titled: “The social responsibility of business is to increase its profits”:1

… there is one and only one social responsibility of business to use its resources and engage in activities designed to increase its profits so long as it stays in the rules of the game, which is to say, engages in open and free competition, without deception or fraud.

This statement raises the question of whether directors can act in any way to increase profits. Although Friedman is clear that directors as agents of the business have to play within the rules of the game, this still leaves room for unethical behaviour. Does this mean that directors can act in any way to increase profits?

A further question raised by his article is whether corporations should engage in socially responsible activities. In this essay, Milton Friedman's view is discussed and contrasted with the socio-economic view of Corporate Social Responsibility. It will be argued that directors cannot act in any way to increase profits and that corporations should engage in socially responsible activities as it can be shown that they at least have an indirect positive effect on organisational performance.

Milton Friedman and Corporate Social Responsibility

Friedman argued for a direct form of capitalism and against any activity that distorts economic freedom.2 Socially responsible activities conducted by a corporation are, according to Friedman, distorting economic freedom because shareholders are not able to decide how their money will be spent. Friedman thus argues that corporations should focus on those activities that are causally related to company profit, effectively excluding charitable activities that do not directly generate revenue:3

…[there] has been the claim that business should contribute to support charitable activities and especially to universities. Such giving by corporations is an inappropriate use of corporate funds in a free-enterprise society.

Another principle expressed by Milton Friedman is the need to stay within the rules of the game, explicitly avoiding deception and fraud. This principle is further clarified when he writes:4

A corporate executive … has direct responsibility to conduct business in accordance with[shareholder] desires …[i.e.] to make as much money as possible while conforming to their basic rules of the society, both those embodied in law and those embodied in ethical custom.

This quotation implies that Friedman does not proclaim that directors can act in any way to maximise profit as they have to abide by the law and follow ethical custom. He, however, excludes explicitly charitable activities as they do not directly contribute to profit. A good corporation in Milton Friedman's view is not one that undertakes activities only because they are ethically sound, but because they are economically viable. One of Friedman's main arguments for excluding Corporate Social Responsibility from business stems from his views on the ethical spending:5

• Your money on yourself—spent wisely;
• Your money on others—spend wisely but challenging;
• People's money on yourself—little incentive to economise;
• People's money on other people— the role of government and Corporate Social Responsibility programs.

Friedman argues that it is not appropriate for a corporate executive or director to embark on socially responsible programmes because there is little incentive for prudent expenditure, mainly when one is spending money owed to the shareholders through dividends.

Friedman proclaimed that a corporation is a morally neutral legal construct with maximising returns for shareholders as its single purpose. Directors and executives of a corporation are employed to achieve this sole objective. The only moral responsibility of directors and executives is to meet shareholder expectations, which is to maximise their return on investment.

Friedman's view is akin to social Darwinism, applying the survival of the fittest principle to the market to ensure the best of all possible outcomes. Friedman interprets this principle as the corporation with the highest return to shareholders. When the issue of an electric company that cut supply to a customer for non-payment upon which the customer died as a consequence was presented to Friedman, he applied the Kantian view to justify their actions. He argued that a utility company that does not cut off electricity to non-paying customers would perish as there is no reason for customers to pay their bills. In Friedman's view, disconnecting non-paying customers has to be regarded as a universal maxim, regardless of the specific outcomes. He considers this as ethical because the directors have a moral duty to ensure the survival of the corporation.

Socio-economic School

The counterpoint to Friedman's view is developed in the socio-economic school of Corporate Social Responsibility. One of the leading proponents of this view proposed the Iron Law of Responsibility, which holds that the “social responsibilities of businessmen need to be commensurate with their social power”, which was further built upon by Frederick:6

… businessmen should oversee the operation of an economic system that fulfils the expectations of the public. And this means in turn that the economy's means of production should be employed in such a way that production and distribution should enhance total socio-economic welfare.

The socio-economic view is a utilitarian argument as emphasises that the total socio-economic welfare of society should be enhanced, rather than focusing on the well-being of shareholders, as Friedman proclaimed. Companies that operate exclusively for the sake of maximising shareholder return and thus do not engage in socially responsible activities are considered unethical in the utilitarian point of view. Following the utilitarian adage of providing the greatest good for the greatest number of people, companies are ethically obliged to participate in socially responsible activities that maximise the total welfare of all stakeholders. There is, however, a problem with applying standard consequentialist theories where we are required to maximise agent-neutral value.

Utilitarianism does not distinguish between people whose utility should be maximised and thus requires a deontic constraint to ensure that maximisation of the welfare of all stakeholders does not jeopardise the long-term prospects of the business. A deontic constraint is a principle that assigns a value to individual agents over others, and in the case of corporate social responsibility, it could be argued that the rights of the shareholders should be protected in preference of the rights of the whole of society.

Analysis

If corporate social responsibility is detrimental to business, as suggested by Friedman, then shareholders will tend to avoid investing in companies that act socially responsible. There is, however, empirical evidence that this is not the case. Firstly, Friedman fails to acknowledge that acting ethically can be a valuable marketing proposition. By understanding the desires of consumers, a corporation can offer products and services that match their ethical thresholds, thereby adding value to both shareholders and consumers, thus avoiding marketing myopia as described by Theodore Levitt.

Consumers prefer products and services that make claims of social responsibility on product labels.7 Herzberg's Motivator-Hygiene Theory theoretically supports this research. Hygiene Factors are minimum conditions that must be met in the workplace to prevent work dissatisfaction. Meijer and Schuyt examined the role of Corporate Social Responsibility in purchasing behaviour and found that for Dutch consumers, corporate social performance serves more as a Hygiene Factor than as a Motivator. Interestingly, this behaviour was not related to household income. 8

Secondly, the growth of ethical investments demonstrates that some investors prefer organisations that do not seek profit maximisation by imposing ethical constraints on their operations.9

There is also a clear case to be made that Motivator-Hygiene Theory can be applied to shareholders. Executives and directors that behave unethically create significant shareholder dissatisfaction, as demonstrated by the many recent examples or corporate misbehaviour.10

Lastly, a meta-study undertaken by Griffin and Mahon showed that there is no consensus on a causal relationship between the level of socially responsible spending and business performance or shareholder satisfaction.11

Milton Friedman on Corporate Social Responsibility

Milton Friedman argued vehemently against spending shareholder's money for anything that does not directly contribute to increasing shareholder wealth. He took the Kantian view that directors must look after the interests of shareholders, which seek wealth maximisation. As socially responsible activities, in the opinion of Friedman, reduce wealth, companies should not engage in any charitable activities.

The socio-economic view claims that companies should maximise the good for the greatest number of people. Following a utilitarian strand of thought, this view holds that companies should engage in socially responsible actions because it maximises the wealth of all stakeholders. However, to ensure that financial sustainability of the corporation is not eroded, deontic constraints that recognise the right of shareholders to a reasonable return, need to be put in place.

In conclusion, directors do not have total freedom to maximise profit as they have to act within both the legal and ethical rules of the game. Furthermore, for companies to be genuinely ethical, they should engage in a reasonable level of socially responsible activities as this maximises the wealth of all stakeholders.

Footnotes

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