Businesses Only Exist To Make A Profit
In the 21st Century, corporations play a major role in society. This has led to the emergence of new disciplines of study such as Corporate Governance and Corporate Social Responsibility. Both these new fields are contentious due to the lack of a unifying definition and theory that governs them. The main questions that arise when dealing with the issue of Corporate Governance and Corporate Governance are, do businesses have a social responsibility? Considering that in his article “The Social Responsibility of Business is to Increase its Profits” (1970) the Nobel-prize winning economist Milton Friedman argued that the only social responsibility of business is to increase its profits for the benefit of shareholders. This essay aims to critically analyse and evaluate how the concept of Corporate Governance has developed to give birth to the concept of Corporate Social Responsibility, as well as analyse the argument presented by Friedman in his article before coming to a conclusion to what extent Milton Friedman was right to say that the only social responsibility of a Business is to pursue profit.
Overview of Milton Friedman’s Argument.
Overall, Friedman acknowledges the existence of Corporate Social Responsibility. However, he argues that businesses do not engage in Corporate Social Responsibility out of morality but self-interest. According to Friedman, businesses, unless specified, are not built to provide a public good. Businesses are there to create profit for their owners. Therefore, if a business has to engage in Corporate Social Responsibility to increase profits for its owners, it will do so, because not doing so would be economically undesirable and unprofitable. This idea is based on Adam Smith’s book, The Wealth of Nations, where he says “It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest.” Similarly, Friedman is arguing that it is not from the moral conviction of the business, that it decides to engage in corporate social responsibility but a need to stay in business to continue making a profit, which propels it and its agents to engage in activities that are perceived to be socially desirable. Considering Friedman’s argument that the only responsibility of a business is to make profits, it would, therefore, make sense to say that the purpose of Corporate Governance would be to ensure that the business only makes a profit. To fully appreciate Friedman’s argument, there needs to be an examination of the definition and origins of corporate governance and how it relates to the responsibilities of a business, and how it relates to Friedman’s argument.
Defining Corporate Governance.
Defining Corporate Governance is yields varying results. The Cadbury report which is a precursor to the UK Corporate Governance Code defines Corporate Governance as a system by which companies are controlled and directed.Connelly and Others (2010) define it as a set of mechanisms to govern and control actions of managers, which includes internal and external mechanisms like compensation, and local laws.Yan (2014) cites a few authors such as Schleifer and Vishney (1997) who define it as representing the away in which all those who fund the corporation can ensure they will get a return on their investment, and Keasey and Wright (1993) define it as the structure, process, culture, and systems closely related to the successful operation of an organization. The Organisation of Economic Development and Co-Operation (OECD) defines it as a set or relationship between the Board of Directors, management, shareholders, and others. It is about setting company objectives and how to achieve them. It also adds that Good Corporate governance is about incentivizing the board and management to pursue the interests of the company and shareholders. The World Bank, says that Corporate Governance is about maximizing value, subject to meeting cooperation’s financial, legal and contractual obligations with employees, shareholders, suppliers, community and others and that public policy must ensure there are incentives and discipline to minimize the divergence between private and social returns and to protect interests of stakeholders. The theme that emerges from these definitions in that Corporate Governance involves two things, Control and Direction. Control is external and direction is internal. To illustrate, this paper will use the example of a car. A car can be directed by a driver to go from A to B, but on the road from A to B there will be a set of conditions such the quality of the road, weather, and speed limits that control how the car may be driven, without which the driver is free to drive as he pleases to achieve his objective of getting from A to b even if it means over-speeding and killing someone or damaging property. It is the same with business, it is the control part of Corporate Governance creates a social responsibility for the corporation and not the direction part. The control part ensures that in its operations society is not harmed by the company and its agents such as managers and directors and that the directors are not doing something contrary to the wishes of the shareholders.
Origins of Corporate Governance
The concept of Corporate Governance originates from the 1700s and can be traced back to Adam Smith. Smith (1776) says, as a form of business the Joint Stock Company which is the precursor to the modern companies, were attractive to many investors because the management of the business is always left to directors and the investors need not worry themselves about understanding the business they invest in before they invest in it. If all goes well they get a return on their investment, if not, then they only lose what they invested. It is from this low-risk and exemption from liability if the business did not perform that attracts lots of investors to the Joint Stock Company which attracted lots of capital for managers to manage. This creates the Principal-Agent Problem, which is the idea that as a firm grows and ownership and management become separated, the objectives of the owner become diluted and/or begin to conflict with the objectives of the managers. This is because if both the owner (Principal) and the manager (Agent) will at some point be driven by personal utility maximization, meaning the agent may not always act in the best interest of the principal. Therefore, to minimize the chances of this happening the principal must establish incentives for the agent and incur the cost of having such incentives in place that limit the aberrant activities of the agent. Corporate Governance, therefore, seeks to balance reducing the cost of agency whilst ensuring that the manager is still incentivized to make decisions that are in the best interest of the shareholders. This is because businesses in a free market face competition from other businesses and to survive shareholders’ interests and managers’ interests need to be aligned if they are both to succeed. The managers in particular are disciplined further in the management of business affairs by both internal and external factors. These factors include competition with other managers both within the business and in other businesses and compensation packages, the best managers will stay where they are well-remunerated for their efforts and shareholders are propelled to put in place mechanisms that ensure the best managers stay and the incompetent ones leave. This is all of course driven by a need for the business to succeed. From this, it is evident that Corporate Governance has developed as a set of rules of managing the company by not only regulating manager/directors’ actions but also empowering them to ensure that the shareholders get a return on what they invested.
The Shift from Shareholder Interest to Company Interest and making sense of Friedman’s Argument
What started as a means to balance shareholder interest and managers’ interest has shifted to become something that also protects the company from being abused by managers and shareholders. This shift has been caused by the concept of separate legal personality established in cases such as Salomon vs Salomon & Co Ltd where it was decided that:
The company is at law a different person altogether from the subscribers to the Memorandum and, although it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them.
This meant that ‘A registered company’s legal rights and obligations are wholly separate from its owners’, own entitlements and duties.” Corporations by being fictional and without sensibility of wrong or right are incapable of having a moral responsibility. This creates a problem for society because the concept of separate legal personality gives shareholders a means to exploit this idea of separate personality to use the company to pursue profit using unethical ways by passing the blame onto the company which naturally has no morality and only exists as a means to make a profit. This is what Friedman is arguing, unless otherwise stated corporations are designed by the owners to make a profit, and managers/directors are to do work for that purpose alone. This is based on the definition of an entrepreneur, which is “an entrepreneur is someone who sees an opportunity and creates a corporation to pursue it.”This pursuit will be determined by factors such as resource availability and economic stability. An unchecked company with agents and no responsibilities would be a strong incentive for an entrepreneur to pursue his/her goals at the expense of society because he or she cannot be held liable, nor can the company because companies have no morals in the absence of artificial legal responsibilities. So Corporate Governance comes in and creates social responsibilities that are passed on to the human agents of the company that ensure the company is not only being directed to make a profit but also controlled in how it achieves that objective.
As a result of these artificial responsibilities, the chances of abuse of the company are not eliminated but minimized. They are not eliminated because the shareholders can still use the company to escape their moral duties using the company and because when companies abandon their duties to society the liability rests with the manager/director as seen in Canada, where the “directing mind”, or the person who has the highest authority in the corporation to authorize criminal acts or socially unethical acts by the corporation is held liable. Corporate Governance comes in to further safeguard the managers from being liable as agents of the company from illegal activities conducted due to shareholders’ desires. This safeguard was established in the case of Percival v Wright, where it was decided that managers do not owe a duty to shareholders or anyone but the company itself. It was later codified in section 170 (1) of the Company Act 2006. This established agency by operation of law. This creates a balance between the manager’s interest to run a company effectively without being pressured by some shareholders who may negatively affect the performance of the company at the expense of other shareholders. This is what Keasey and Wright (1993) are talking about, that Corporate Governance is about finding structures, processes, culture, and systems that result in the successful operation of an organisation, which according to Milton should be to make a profit for its members as a whole, codified in section 172(1) of the Companies Act 2006. However, this does not mean that managers in the pursuit of profit can do whatever they want, nor does it remove the primacy of the shareholders. This is because section 168(1) gives power to the shareholders to remove a director using an ordinary resolution, provided the concerned director is given a right to be heard before his removal under Section 169(2) of the Act. Section 172(1) requires directors as agents of company inter alia to have regard for long term consequences of their decisions, company’s employees’ interests, to develop relationships with suppliers and customers, and have a regard for the environment and community. Friedman argues toward the end of this article that business has one responsibility and that is to make a profit as long as it stays within the rules of the game. Section 172(1) is an example of those rules of the game in the United Kingdom. These rules are not global and some countries have rules of the game that permit for great profit margins, which is why western companies outsource jobs to places like India and China, not because they want to create jobs in these countries but because these countries have the skilled labor needed to make the company successful at a fraction of the cost which yields more profit. When looking at the numbers, it is estimated that 93 percent of organizations adopted or are considering adopting cloud services to improve outsourcing, with cost-cutting emerging as the main reason for doing so. This is because Business Insider estimates that the median salary for example of a Senior Auditor in the UK is GBP 44000 while for a professional with the same level of skill will cost about GBP 10,300 in India. Given that companies are encouraged to make a profit for their owners, according to the UK Corporate Governance Code they will be attracted to places that have cheaper operational costs and regulations.
Friedman’s argument is also centered around the idea that a company has no responsibility only people do. This is true, it is true because nowhere in codified company law such as the Companies Act of 2006 and regulations such as the UK Corporate Governance Code are there provisions for the duties of a company. Sections 171 to 177 are all provisions of duties of the directors to the company and not the company to anyone. May, Cheney, and Roper (2007) mentioned that the company cannot operate on its own, it depends on people as agents to operate. This supports Friedman’s argument that companies alone do not have responsibilities. It is the agents who have a responsibility to ensure that the company is run in line with the law as Friedman points out in the last paragraph of his article. However, this responsibility does not come out of the benevolence of the manager or the director, it comes from their self-interest to make a profit and so they follow the rules that steer the company towards making a profit, such as not exploiting the company for personal gain by using the company to gain benefits from third parties contrary to Section 176 of the Companies Act 2006.
So it may appear as if the company has responsibilities but it is the people who manage the company that have a responsibility to use the company for the purposes it was intended within the ambits of the law because, should the company conduct business in a manner contrary to the law or social ethics, they suffer through criminal proceedings like in Canada where the criminal liability of a company’s activities rests on the controlling mind a.k.a the manager/director or shareholder or they lose their jobs when the company winds up due to lack of sales due to engaging in unethical business practices. An example of a business losing sales from unethical behavior is the case of United Airlines incident where a passenger was violently dragged from a flight by airline security. While this incident did not result in the winding up of United Airlines, it did expose what happens when a company’s agents engage in unethical practices. First, United’s reputation was dented with many fliers choosing to fly another airline even at a high cost. Secondly, the stocks in the airline dropped, with Warren Buffet, a major investor in the airline blaming the CEO’s response to the situation for the drop. Finally, all this culminated in the CEO of United being denied promotion to become the airline’s next chairman. Which goes on to support the argument that the company does not have responsibilities, it is the agents who have responsibilities not because they care for the company or the society, but because they care for their well-being, which forces them to be ethical in the pursuit of a company’s goal of making a profit.
Conclusion
This essay agrees with Friedman that that only purpose of the business is to make profit and nothing else. This is because, internally, the business can be directed towards a path that is aimed at being socially responsible in its pursuit for profit by its directors and managers for its owners. However this direction is not what the business was set up for but a product of external controls on the business which forces it and its agents to conduct socially responsible operations in the pursuit of profit, usually because doing so is more profitable and economically desirable than not doing so due to the penalty that the law and society can impose on companies and company agents that choose to conduct unethical business. In the absence of penalties, it is very unlikely that business would engage in Corporate Social Responsibility.
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