The Activist Investor Blog
The Activist Investor Blog
The Folly of Socially-Responsible Activist Investing
The social responsibility of business is to increase its profits.
- Milton Friedman
I may lose some friends this way, but socially-responsible activist investing wastes time and money. Shareholder proposals on corporate social and environmental responsibility matters at annual meetings distract investors, directors, and executives from much more important problems in governance and management. There, I’ve said it.
Serious investors have grown frustrated and tired with the increasing number of socially-responsible activist efforts that they need to consider at annual meetings. What a range of issues that have emerged:
❖worker safety
❖gender discrimination
❖environmental impact
❖animal welfare
❖tobacco products...
ISS reports that public companies dealt with 348 shareholder resolutions on these subjects in 2011. In contrast, shareholders submitted 488 proposals on arguably much more important corporate governance matters, such as declassified boards, in the year.
Yet, is there some reason for investors to consider seriously socially-responsible proposals? Conversely, what are the economic and financial arguments against doing so?
Two distinguished scholars, Milton Friedman and Michael Jensen, separately consider this question. Friedman set forth a version of the argument in a famous essay in the New York Times Magazine in 1970. Jensen then finished it in a less well-publicized academic paper from 2001.
Friedman’s case seems somewhat quaint today. He writes in the context of rampant inflation, when critics called on corporations to restrain price increases. He objects to this and other efforts to impose “social responsibilities” on corporations. He asserts, “social responsibility involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce resources to alternative uses” (emphasis added).
Yet, Friedman writes what amounts to a polemical defense of free enterprise, one of his first in the popular press rather than in a scholarly journal. He does this at a time when his fame and renown remained confined largely to academia. His argument boils down to:
In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of society...
Michael Jensen later proved what Friedman only assumed, that investors want their portfolio companies to “make as much money as possible.” He concludes that rational, utility-maximizing investors and managers have no choice but to do so. He writes:
...[W]hereas value maximization provides corporate managers with a single objective, stakeholder theory directs corporate managers to serve “many masters.” And, to paraphrase the old adage, when there are many masters, all end up being shortchanged.
Jensen argues elegantly that wealth maximization provides investors and executives with a clear means of setting priorities. In contrast, the multiple and often conflicting goals embedded in social responsibility agendas preclude any “purposeful behavior”. These goals actually make management “unaccountable” for their actions, so they can pick and choose from among many such social responsibility goals themselves. He goes on to demonstrate that “total firm value maximization makes society better off”, as well.
Jensen does allow that social responsibility can contribute to wealth maximization, though. A given social responsibility goal becomes an input to the wealth maximization function of the firm. So, for example, McDonalds Corporation should treat cattle and chickens humanely if doing so will sell more sandwiches profitably, not because PETA says so.
Savvy investors know this instinctively, though. They reject companies whose violation of social norms (say, Massey Coal) costs real dollars. They don’t take seriously and just don’t need annual meeting resolutions that distract from the real business at hand, of making money.
Monday, November 7, 2011