This idea of corporations with a purpose beyond just shareholders continues to be discussed in the news. This week in The Economist published an op-ed “What Corporations are for” ($), repeating the Friedman Doctrine and dissing the 181 signers of at the Business Roundtable earlier this month.
The key word in the Economist’s essay is their measure of success of American business “as judged by profits.” They are claiming that Friedman was right, that focusing on shareholder value worked because companies earned big profits.
Meanwhile, income and wealth inequality are at or near all-time highs. So how could the Economist and Friedman be wrong? Simply, they are measuring the wrong metric.
Leslie Christian explains this quite elegantly. What we’re taught in Finance is the following equation:
Revenues – Expenses = Profit
Given that, corporate management is paid to maximize revenues while minimizing expenses, thereby creating those big profits. The problem is that employees, vendors, and the community are all hiding in the term called “Expenses” as is customer service.
Leslie’s proposal is that the equation should instead be:
Revenues – Expenses = 0
This doesn’t mean there are no profits for shareholders! The point of this change is to put the cost of capital into the list of expenses. To make the dividends to investors just one more expense to be balanced against the needs of customers, employees, vendors, and the community.
As judged by profits means that all those other stakeholders are of far less importance, and with that we have almost 50 years of Friedman-style companies that have created ever-growing income inequality, manufacturing and customer service moved offshore to the lowest-wage countries, and companies that prioritize dividends and share buybacks over ensuring the planet is livable through the end of this century.
So to the Economist Op-Ed staff, it’s time to retire “as judged by profits” as a failed paradigm, just as Smith retired Mercantilism as a failed paradigm back in 1776.