The myth of profit maximization

The FT editorial today deals with Danone and its shift to a “purpose driven company”. The shift has been less than successful and its architect was unceremoniously removed. The editorial then goes on to note that there is a tension here between the Milton Friedman vision of companies as socially responsible when they maximize their profits and the more fuzzy vision today of companies as mission and purposed driven. Overall, this leads to a discussion of companies as political actors that is interesting and increasingly overdue. The editorial ends by noting that CEOs have to manage multiple challenges and balance them and that the idea that there is a single metric that companies are managed on is ridiculous – and they are absolutely right.

Now, anyone who reads the original article also finds that Friedman has been misread. His point is not that the purpose of a company is to maximize profits. It is that the leadership of a company work for the owners of the company. This is a significant difference and one that is largely obscured in the discussion. Friedman even writes that if the owners have specific purposes in mind the leadership should work for them: “A group of persons might establish a corporation for an eleemosynary purpose—for example, a hospital or school. The manager of such a corporation will not have money profit as his objective but the rendering of certain services.”

Misreading Milton

And then the real Friedman doctrine is spelled out in detail:”In either case, the key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation or establish the eleemosynary institution, and his primary responsibility is to them.”

Apart from reminding us of the wonderful word “eleemosynary” this highlights how a misreading of Friedman has set up a fake juxtaposition between purpose and profit, suggesting that you have to choose one or the other, and intentionally leaving the “you” vague.

The “you” is not vague, however – it refers to the owners of the enterprise.

And the interests of the shareholders are not simple, either. Friedman reminds us that shareholders – owners – have an interest in the community and future of the society that they are operating in:

To illustrate, it may well be in the long‐run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community or to improving its government. That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage and sabotage or have other worthwhile effects. Or it may be that, given the laws about the deductibility of corporate charitable contributions, the stockholders can contribute more to charities they favor by having the corporation make the gift than by doing it themselves, since they can in that way contribute an amount that would otherwise have been paid as corporate taxes.

A Friedman Doctrine, New York Times, Sept 13 1970.

The hard reading of Friedman is partly inspired by a quote in Capitalism and Freedom where he synthesizes all of this into a pithy paragraph, but the article leaves no doubt that his views are more complex, and that the time scale they play out on also matters a great deal to the actual results.

Profit maximization cannot be understood in isolation. If you want to understand what it means you have to ask over what time period you are maximizing profits. There is a huge difference between the company that maximizes profits over 100 years and the company that does so quarter to quarter. If we were able to think creatively about this we would encourage companies to work on longer time horizons, and think about the value they create not in yearly increments for the purposes of taxation, but allow companies to build long term value.

Now, you don’t need to agree with Friedman on any of his ideas or be a libertarian or even be liberal to worry that the fake tension between profits and purpose is taking center stage in today’s discussion about the role of the corporation in society. The only concern you need to share is one of oversimplification of complex issues.

Whenever we end up in simple dichotomies we all lose.

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