Who Should Corporate Managers Serve?

Of all the trends that have hurt American workers over the past few decades — everything from the introduction of labor-saving technology and globalization to outsourcing and the decline of unions — perhaps none has been as pernicious as corporate America’s obsession with “maximizing shareholder value.”

Indeed, elevating the wants of investors over the needs of employees has amplified all of these other forces.

During the postwar boom years, as the University of Michigan’s Gerald Davis has noted, American corporations provided “stable careers, health insurance for employees and their dependents, and retirement security.” Corporations today, by contrast, see “employment as an avoidable expense.”

Or, as former Labor Department economist Betsey Stevenson has put it: “Companies once felt an obligation to support American workers. That’s disappeared. Profits and efficiency have trumped generosity.”

As we think about what it might take to reverse things, it is useful to consider how we got here.

Many trace the origins of shareholder primacy to Milton Friedman, the influential University of Chicago economist. In a 1970 New York Times Magazine essay, Friedman contended that a corporation had but one legitimate “social responsibility”: “to increase its profits so long as it . . . engages in open and free competition without deception or fraud.”

A company that was pursuing anything else, including trying to “take seriously . . . providing employment,” Friedman believed, was doing little more than “preaching pure and unadulterated socialism.”

By this reasoning, executives placed in charge of a company had a straightforward obligation.

“The manager is the agent of the individuals who own the corporation,” Friedman wrote. And it was up to this manager “to conduct the business in accordance with their desires” as shareholders, “which generally will be to make as much money as possible.”

Among those who understood the publication of Friedman’s article to be a major event — for the whole of American culture, not just business — was Michael Jensen, a professor at the University of Rochester’s Graduate School of Management. In 1976 Jensen coauthored his own paper on the relationship between corporate executives and shareholders.

Jensen’s piece, written with his Rochester colleague William Meckling, would find its home in an outlet far more obscure than the New York Times — namely, the Journal of Financial Economics. Nonetheless, “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure” would go on to become the most cited academic business paper of all time.

As Jensen and Meckling saw things, an inherent conflict divided corporate managers and shareholders. The manager, they wrote, has a natural “tendency to appropriate perquisites out of the firm’s resources for his own consumption” — in other words, to feather his own nest. Like Friedman, Jensen and Meckling maintained that corporate leaders had but one role: to act as agents of their corporate shareholders. Their sole function: to maximize shareholder value.

But Jensen and Meckling weren’t the first to warn that managers might effectively hijack the company where they’d been hired and put their own interests first.

“The concentration of economic power separate from ownership has, in fact, created economic empires, and has delivered these empires into the hands of a new form of absolutism, relegating ‘owners’ to the position of those who supply the means whereby the new princes may exercise their power,” attorney Adolf Berle and economist Gardiner Means had asserted in their seminal 1932 book, The Modern Corporation and Private Property.

But Berle and Means, for all their worries, did see one way that management might have a positive impact — even if its agenda diverged from that of shareholders.

“Should the corporate leaders,” they wrote, “set forth a program comprising fair wages, security to employees, reasonable service to their public and stabilization of business, all of which would divert a portion of the profits from the owners of passive property, and should the community generally accept such a scheme as a logical and human solution of industrial difficulties, the interests of passive property owners would have to give way.”

Ideally, Berle and Means continued, corporate management should be attuned to “balancing a variety of claims by various groups in the community and assigning to each a portion of the income stream on the basis of public policy rather than private cupidity.”

“Balancing a variety of claims” is, of course, exactly what happened as the social contract between employer and employee evolved during the 25 years after World War II, with rising wages and benefits, dependable job security, and sound businesses built on the prosperity of America’s growing consumer class. It wasn’t a flawless system. Not even close. But many of the country’s biggest corporations found themselves working for “the larger interests of society,” just as Berle and Means had imagined they might.

Back then, corporate executives spoke openly about serving all of their stakeholders — shareholders, yes, but also their customers, the communities in which they operated and their workers. Today, few CEOs talk like that, especially as their own compensation has become linked ever more closely to their company’s share price.

As we try to break the grip of shareholder über alles, it’s worth remembering this bit of history. Like Jensen and Meckling, Berle and Means were concerned about selfish executives who would fail to do right by a company’s owners. But at the same time, they never forgot the real purpose of business: to first and foremost serve society.

Rick Wartzman directs the KH Moon Center for a Functioning Society at the Drucker Institute, a part of Claremont Graduate University. This essay is adapted from his new book, The End of Loyalty: The Rise and Fall of Good Jobs in America.