In class each semester, we always argue about whether publicly traded firms have a moral duty to maximize profits. It’s a contentious idea, but my own belief is that firms only have such a duty when markets are genuinely free and fair: genuinely competitive, properly priced and open to all comers. When this is not the case, to focus on nothing but profit maximization is, I believe, to betray the very commitments to freedom and prosperity on which the legitimacy of capitalism depends.
In September of 2015 Turing Pharmaceuticals, a small start-up with one other product, announced it was raising the price of the generic drug Daraprim from $13.50 to $750 a tablet – an approximately 5000% increase. Daraprim was widely used to treat complications from AIDS. It cost approximately $1/pill to produce had no competition. Anyone wanting to buy Daraprim had to buy it from Turing. The move unleased a media storm. Martin Shkreli, Turing’s CEO, was vilified in the press and accosted in public. But he was unrepentant. Asked if he would do anything differently he replied:
“I probably would have raised prices higher… I could have raised it higher and made more profits for our shareholders. Which is my primary duty… 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, not to minimize them, or go half, or go 70 percent, but to go to 100 percent of the profit curve that we’re all taught in MBA class.”
Surely this can’t be right? Do managers really have a moral duty to exploit desperately sick people? Taken literally, a single-minded focus on profit maximization would seem to require that firms not only jack up drug prices but also fish out the oceans, destabilize the climate, fight against anything that might raise labor costs – including public funding on education and health care, and – my personal favorite – attempt to rig the political process in their own favor.
The belief that management’s only duty is to maximize shareholder value is the product of a transformation in economic thinking pioneered by Milton Friedman and his colleagues at the University of Chicago following the Second World War. Many of their arguments were highly technical, but the intuition behind their work is straightforward.
First, they suggested that free markets are perfectly efficient, and this makes them a spectacular driver of economic prosperity. Second, they suggested that by opening up economic opportunity to anyone regardless of family, color or creed, free markets give people the ability to control their own destiny, and in turn to build political power. It’s difficult, they proposed, to be truly free when the state controls who you work for and how much you’re paid. Third, they argued that managers work not for themselves but for their investors. Since in general investors want to make as much money as possible, managers who do anything other than maximize their investor’s returns betray their investor’s trust. Taken together, these arguments implied that to do anything other than maximize profits – to charge less for a drug than the market will bear, for example – was not only to make society poorer and less free but also to betray your duties to your investors.
But it turns out that the Chicago economists made a set of assumptions that might have been true in the 1950s but that seem almost comically unrealistic today. Markets require adult supervision. They only lead to prosperity and freedom when they are genuinely free and fair. Friedman and his colleagues first formulated their ideas in the aftermath of the Second World War. At the time it seemed there was a serious risk that a reliance on the market would be replaced by centralized planning. Governments – after conquering depression and war – were popular and powerful. Capitalism, in contrast, was not. In the developed world the state could be relied on to ensure that markets were reasonably competitive, that “externalities” such as pollution were properly priced or regulated, and that (nearly) everyone had the skills to participate in the market. Moreover, the experience of fighting the war created immense social cohesion. Investing in education and health, “doing the decent thing” and celebrating democracy seemed natural. Under these conditions, it was not crazy to believe that “unleashing” the market by telling managers their only job was to focus on shareholder returns would maximize both economic growth and individual freedom.
But in the last seventy years the world has changed almost beyond recognition and global capitalism looks less and less like the textbook model of free and fair markets on which the injunction to focus solely on profit maximization is based. In today’s world, the conditions under which Friedman’s famous suggestion that “the social responsibility of business is to increase its profits” no longer hold, and the single-minded pursuit of shareholder value is not only destroying our societies and the planet but also putting capitalism itself at risk. In such a world, I believe that taking capitalism’s commitments to freedom and prosperity seriously not only permits but requires that managers take responsibility for the health of natural and social capital on which markets rely. Intuitively, if firms can dump toxic waste into the river, lie to their consumers and get together to fix prices, their operations won’t increase either aggregate wealth or individual freedom.
Taking responsibility for the health of the system is thus both legally ok and possibly also morally required. This does not, of course, guarantee that it is feasible. Can a firm have a pro-social purpose beyond profit maximization and survive in the ruthlessly competitive markets that characterize much of the world? Could they change the world if they did? Indeed they can and indeed they could.