No, Maximizing the Stock Price Is Not Job 1 for Company Directors
Martin Shkreli, the ousted pharma executive, used to scoff at people who criticized him for raising the price of a pill of Daraprim, a drug for toxoplasmosis, from $13.50 to $750 overnight. “In capitalism you try to get the highest price you can for a product,” he told Bloomberg TV in 2016. “No one wants to say it, no one’s proud of it, but this is a capitalist society, capitalist system, and capitalist rules, and my investors expect to me to maximize profits,” he said at a Forbes conference in 2015. “I could have raised it higher and made more profits for our shareholders. Which is my primary duty.”
Is Shkreli (who's on trial now on an unrelated matter) correct that the primary duty of a company's executive and board is to maximize profits and the share price? Even some people who don’t like the “Pharma Bro” are inclined to concede that maximizing shareholder value is, after all, a company’s Job No. 1. The authority on this is the late Milton Friedman, a conservative giant of the Chicago School of economics, who preached that executives should “make as much money as possible while conforming to the basic rules of the society.” If people want to do good in society, Friedman argued, they should do it through personal charity, not through companies they manage, direct, or invest in.
An important new academic paper rejects the principle that profits are the ne plus ultra of business management. Intriguingly, one of its authors is a prominent member of the University of Chicago faculty, and the other is a Nobel Prize winner from Harvard University. The authors’ credentials are likely to attract attention to an argument that's more typically made by social activists and corporate gadflies.
Luigi Zingales of Chicago’s Booth School of Business and Oliver Hart of Harvard start with the proposition that company managers and boards do indeed have a fiduciary duty to shareholders, but their duty is to maximize the shareholders’ overall welfare, which includes things other than the value of their shares. They argue that most shareholders are “prosocial,” meaning they care about such things as helping the poor or saving the planet. That point isn't controversial: Even Friedman, in citing the basic rules of society as the standard, went on to specify that he meant “both those embodied in law and those embodied in ethical custom.”
The classic Friedmanian argument is that if shareholders don’t like something a company does, they’re free to use their own time and money to offset or reverse the effects of the company’s actions. For example, if the company pays workers less than you think it should, donate money to groups that help low-wage workers. Don’t drag others into supporting your pet causes.
The innovation of Zingales and Hart is to point out that reversing a company’s actions through private charity can be more expensive and troublesome than getting the company to do the right thing from the start. They give the example of Wal-Mart Stores, which used to sell high-capacity gun magazines of the kind used in mass killings. “If shareholders are concerned about mass killings,” they write, “transferring profit to shareholders to spend on gun control might not be as efficient as banning the sales of high-capacity magazines in the first place.” (They mean getting Wal-Mart to stop its own sales, not changing the law.)
You can think of other examples: It’s cheaper to refrain from polluting a stream than to pollute it and then clean it up with charitable donations. It’s cheaper to stop companies from putting greenhouse gases into the atmosphere than to build dikes around coastal cities when the ice caps melt.
An obvious question is, if shareholders are “prosocial,” why don’t more of them act on it by raising hell at annual meetings or divesting shares of companies they disapprove of? Zingales and Hart say shareholders who don’t think their individual choices will be enough to make a difference will give up and pick a dirty, profitable investment over a clean, less profitable one. This phenomenon they label “amoral drift.” The authors say there should be socially responsible mutual funds that specialize in proxy voting on certain issues—say, assault weapons. “Prosocial investors should rush to such product,” they write. They also say companies should routinely survey their shareholders on social issues and follow the wishes of the holders of the majority of shares.
Shareholders are happier—have more “utility,” in economic lingo—when the companies they invest in do good while doing well, the authors argue. As for the stubborn idea that corporate directors’ sole duty is to maximize shareholder value, even if that means cutting ethical corners, they offer a simple thought experiment: “If a company has a single shareholder, nobody would suggest that this single shareholder cannot instruct directors to maximize her utility rather than her financial return. Why should things be different when there are multiple shareholders?”
I asked Zingales if he feels that he’s trashing Friedman's legacy. Not at all, he said. His paper with Hart doesn’t say managers and boards should ignore shareholders, but rather that they should take all of shareholders’ interests into account, both the financial and the social ones. “I’m not saying you should not follow what shareholders want to do,” he said. “I’m saying you ought to do it more.”
(Corrects name of disease to toxoplasmosis in first paragraph.)