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John Kinsellagh
John Kinsellagh
Articles (168) 

Jamie Dimon Throws Milton Friedman Under the Bus

Business Roundtable questions whether corporations should serve shareholders' interests exclusively

August 23, 2019 | About:

Last Monday, the Business Roundtable, led by JPMorgan (NYSE:JPM) CEO Jamie Dimon, issued a statement that challenged the long-held view that the principal obligation or function of a corporation is to maximize value for its shareholders. The statement said the purpose of a corporation should be to foster “An Economy That Serves All Americans.” The statement stressed that corporate decisions should be based on a “fundamental commitment to all of our stakeholders,” each of whom it calls “essential” and includes customers, employees suppliers and the “communities in which we work.” The statement embodied the ideas that “Each of our stakeholders is essential” and that “We commit to deliver value to all of them, for the future success of our companies, our communities and our country.”

The enunciation of the novel corporate governing principles was endorsed by 181 of the Roundtable’s 188 CEOs, including the CEOs of BlackRock and Vanguard Group.

Despite all the media hoopla, the statement is rather benign in the sense that corporations already aim to provide a work environment where its employees can thrive; many companies have offered stock options or stock purchase plans for employees for years; many have donated large sums to charitable and community organizations as well as financing foundations and think tanks. Additionally, many corporations have not shied away from actively participating in activities that support the community.

The statement, however, is significant and highly unorthodox because it represents a marked philosophical break from the unchallenged economic view that the sole obligation of a corporation is to maximize value for its shareholders. This is the theory enunciated by famed economist Milton Friedman in 1978 and has remained uncontroversial and sacrosanct since.

Not only was Friedman an advocate for capitalism and unfettered free markets, he provided a moral justification that supported the idea free enterprise was the best means to increase wealth of all stakeholders in society. Friedman’s view was widely accepted because it offered a moral basis for the view that society and the economy would be best served when corporations are accountable only to its shareholdes, as this market mechanism free of undue and burdensome interference from government would create more economic opportunity for more Americans.

Extolling the economic and societal virtues of free markets is as old as Adam Smith. Smith was a moral philosopher whose contemporaries and intellectual peers included David Hume, Adam Ferguson and Francis Hutcheson. Smith’s moral philosophy informed his economic views, not vice versa. This is evident from a reading of his treatise, "The Wealth of Nations," and is one of the underlying tenets for the beneficial operation of the “invisible hand.” Smith argued that the moral justification for free enterprise and free markets was precisely because it served larger, more salubrious purposes; its utility transcended the naked self-interests of businessmen and served society at large because of its mutual benefits.

As a disciple of Smith, Friedman anticipated those executives who might challenge the role of corporations in a capitalist, free market economy and to whom they should be accountable. In his 1970 article, "The Social Responsibility of Business is to Increase its Profits," Friedman argued that:

“The businessmen believe that they are defending free enterprise when they declaim that business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends; that business has a ‘social conscience’ and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers. In fact, they are—or would be if they or anyone else took them seriously—preaching pure and unadulterated socialism.”

There are significant issues the new model of corporate purpose raises that will need to be addressed, not the least of which is how does one measure the added value to diverse stakeholders, most notably “society” — a term that is amorphous at best and, at worst, subject to the political or ideological aims of electioneering politicians.

The statement does not provide any guidance as to how a corporation determines or prioritizes the allocation of benefits among its various new stakeholders. Which group or purpose predominates? And how would one measure the benefit or reconcile the diverse interests among the various stakeholder groups?

The statement’s practical impact may be minimal and some have argued that the Business Roundtable’s new principles for corporate governance was little more than an exercise in corporate virtue-signaling. It should be noted there are legal and practical limitations that would thwart or circumscribe a CEO’s attempt to give short shrift to its shareholders.

Shareholder derivative suits can hold a corporation accountable; and it must be noted as well that shareholders are the ones who elect new directors to the board. There also limitations to the “business judgment” rule, where court’s permit executives latitude and some discretion to act in what they believe are the best interests of the corporation.

The statement, though, may have a number of unintended policy implications. There is the inadvertent risk that the Roundtable’s statement could be used against the judgment exercised by CEOs on matters such as stock buybacks and dividend payouts.

Many Democratic legislators have argued that stock buybacks are not the most beneficial use of corporate cash largesse, as it rewards shareholders exclusively and ignores a company’s employees. This is one of the arguments used by some politicians for prohibiting corporations from using repatriated earnings to dole out cash to shareholders, instead of investing those sums for corporate expansion or research and development.

The statement ostensibly could be used by politicians to support legislation, backed by various interest groups, that would impose a statutory obligation on corporations to allocate their resources in a certain manner. The future ramifications of the Business Roundtable statement is that it could be used as a sword for advocating certain corporate policies and procedures that are supported by some legislators whose political philosophy may be somewhat inimical to free market capitalism.

Not all business leaders signed the statement and many don’t support the overall thrust of the declaration of new principles. Some activist investors and academics have argued that realigning the focus toward a wide range of stakeholders amounts to corporate virtue-signaling or grandstanding that will misdirect resources.

William Goetzmann, a professor at Yale’s School of Management, said, “A pronouncement that attempts to change things shouldn’t be coming from the CEOs; it should be coming from investors.”

In recent years, Dimon, who has spoken on the topics of growing income inequality and improving the nation's educational system, has argued the shareholder-primacy view is too narrow and circumscribes an executive’s ability to concentrate on long-term goals for a company. Others disagree with this contention.

Ken Bertsch, the head of the Council of Institutional Investors, says Dimon’s argument for an executive’s ability to focus on long-term strategies is specious.

“There’s no mechanism of accountability to anyone else,” he said. “This is CEOs who like to be in control and don’t like to be subject to the market demands.”

Berthsch says the new principles espoused by the Business Roundtable could potentially give CEOs license to dodge shareholder oversight.

Disclosure: I have no position in any of the securities referenced in this article.

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About the author:

John Kinsellagh
John Kinsellagh is a freelance writer, former financial adviser and attorney specializing in civil litigation and securities law. He completed the Boston Security Analysts Society course on investment analysis and portfolio management.

He has served as an arbitrator for FINRA for over 25 years resolving disputes within the financial services industry. He writes primarily on financial markets, legal and regulatory issues that impact the investment community, and personal finance.

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