In pursuit of shareholder value maximization”

I asked Professor Bainbridge if I could cross-post this from the Corporate Finance Lab, and he graciously agreed:

What is the purpose of a corporation? Is it, as Nobel economics laureate Milton Friedman famously claimed, “to maximize its profits”?[1] Or is it, as the Business Roundtable—a group of approximately 200 mostly USA corporate CEOs—claimed in 2019, “creating good jobs, a strong and sustainable economy, innovation, a healthy environment and economic opportunity for all.”[2]

In the academic field, the weight of scholarly opinion has tilted significantly toward stakeholder capitalism in recent years.[3] The late law professor Lynn Stout dismissed shareholder value maximization as a mere myth, though he made a strong claim that it “allows companies to engage in reckless, socially and socially irresponsible behavior.”[4] Canadian law professor Joel Bakan went further by denouncing the business corporation as a “pathological institution” with psychopathic traits in its relentless pursuit of profit.[5] In making such arguments, they reflect a widely shared narrative that “corporations are powerful, evil, corrupt, bad-actors intent on profit over the health, safety, and well-being of individuals.”[6]

In the investment world, there have long been so-called socially responsible investors, who constructed their portfolios using various social justice filters that excluded companies believed to have negative social and environmental impacts. Although it was claimed that socially responsible investment was a profitable strategy, it was justified primarily by moral and ethical arguments.

Today, however, as investor interest in ESG metrics grows, there has been a distinct shift in recent years from moral and ethical reasoning to financial justification. While many ESG investors are still motivated by the concerns of traditional socially responsible investors, ESG investing is clearly based on the belief that ESG oriented portfolios provide higher risk-adjusted returns than traditional portfolios lacking ESG or social responsibility filters. So, for example, the three largest institutional investors – asset managers BlackRock, State Street and Vanguard – all claim to have adopted ESG because they believe ESG factors are positively correlated with firm performance. They offer investment funds that supposedly only invest in companies that score high on ESG measures and that exercise their voting rights as shareholders to support ESG principles. ESG-focused investors are thus presumably pushing both asset managers and portfolio companies to become more ESG friendly.

In light of these developments, what is needed at the present moment is a defense of shareholder value maximization that takes those developments into account. Or, William F. To paraphrase Buckley, what is needed at this point is for someone to step off the corporate governance track and shout “stop” as the train of stakeholder capitalism pulls out of the station.

Which is what my new book, The Profit Motive: In Defense of Shareholder Value Maximization, does.

Three main themes animate the project. First, any notion of corporate purpose that embraces goals other than creating value for shareholders is inconsistent with mainstream US corporate law. Second, directors have—and should—a wide and fairly unfettered discretion over how to create shareholder value. Although many commentators claim that these statements are inconsistent, in fact they both reflect fundamental normative principles deeply embedded in US corporate law. Third, a shareholder-centric conception of corporate purpose is preferable to stakeholder capitalism.

The reader may well ask: Why should we care about corporate purpose?

Simply put, corporate purpose matters because corporations matter. Corporations are “much wealthier and far more capable of negatively affecting our personal lives than virtually any local government or even most federal agencies.”[7] Worse, like elephants crashing through forests, corporations can trample individuals and communities underfoot without meaning to do so. Indeed, the corporation has been aptly called the “perfect exotic machine.”[8] By incorporating a business, it is possible for business owners – whether intentionally or not – to externalize significant costs and risks on corporate constituencies such as employees or creditors, and on society at large.

Externalities have been around since corporations were first vested with limited liability. As corporations grew larger in the wake of the Industrial Revolution, so did the scope of the problem. In an industrial economy, limited liability is of particular concern because it may encourage overinvestment in hazardous activities. Because shareholders can externalize part of the risk associated with such activities, these activities may have a positive value for investors even though they have a negative net social cost.

That said, however, the corporate purpose debate goes beyond the negative externalities that inevitably result from corporate activity alone. It also asks whether corporations should be managed to create positive externalities. Should managers conduct the corporation’s business so as to benefit stakeholders and society in general? Proponents of stakeholder capitalism typically argue that the profit motive discourages corporate directors and managers from ignoring not only the social costs of corporate activity but also the potential of corporate activity to generate social benefits.

In many cases, however, corporate actions that benefit stakeholders — such as employees — help the firm become more profitable and thus benefit shareholders. When corporations face true zero-sum decisions, however, one must make a choice between the competing interests of stakeholders and shareholders. In such cases, the law requires directors to prefer the interests of shareholders. The profit motive defends the claim as both a descriptive and normative matter.

Executives like those who signed the Business Roundtable’s 2019 Statement on Corporate Purposes would find it an impossible task if they really tried to run their companies according to the philanthropic principles laid out there. Developing the set of objective and measurable metrics necessary to operationalize stakeholder capitalism will prove a complex problem. Even if the required set of metrics can be designed, managers cannot reasonably be expected to balance the large number of competing factors required by the different interests of the firm’s various constituencies.

Worse, stakeholder theory inherently carries with it a serious conflict of interest. While corporate social responsibility empowers honest managers to act in the best interests of all constituents of the corporation, it empowers unscrupulous managers to pursue their own interests. There is a very real risk that directors and managers will use stakeholder interests to drive actions taken to further their own selfish interests by giving them the discretion to consider interests other than shareholder wealth maximization.

Not only is there a negative in terms of shareholder value maximization. The pursuit of shareholder value maximization leads to more efficient resource allocation, creates new social assets, and promotes economic and political freedom. To be sure, there will always be externalities. Just as profit-making is baked into the corporation’s DNA, so too are costs externalized. There is no such thing as a free lunch. The theory and evidence described in The Profit Motive, however, suggest that the balance falls strongly in favor of shareholder value maximization.

Readers interested in more information about The Profit Motive may want to watch my video, in which I discuss the book’s arguments at greater length.

Author’s blog, named one of the Top 100 Law Blogs of 2007, 2008, 2010, 2011 and 2012 by the ABA Journal.

Stephen M. Bainbridge
William D. Warren Distinguished Professor of Law

[1] Milton Friedman, The Social Responsibility of Business Is to Increase Its Profits, NY Times, Sept. 13, 1970, § 6 (magazine), at 32, 33.

[2] Business Roundtable, Our Commitment (2019),

[3] Martin Petrin, Look Beyond Shareholder Value: Exploring the Rationale for a Greater Corporate Purpose 4 (Nov. 1, 2020) (explaining that “major scholars are discussing concepts such as the need for ‘purposeful’ corporations and, generally, there seems to be a broad consensus that pure shareholder values ​​are outdated”),; Christina Parazon Skinner, Canceling Capitalism?, 97 Notre Dame L. Rev. 417, 418 (2021) (noting that “scholarly antipathy to capitalism (and its initiation into corporate profit-seeking) has grown more virulent in the past eighteen months”).

[4] Lynn Stout, The Shareholder Value Myth vi (2012).

[5] Joel Bakan, The Corporation: The Pathological Pursuit of Profit and Power (2004).

[6] Linda S. Mullenix, Class Actions Ending as We Know Them: Rethinking the American Class Action, 64 Emory LJ 399, 407 (2014).

[7] Daniel JH Greenwood, Essays: Telling the Story of Shareholder Dominance, 2009 Mich. St. L. Rev. 1049, 1072 (2009).

[8] Lawrence E. Mitchell, Corporate Irresponsibility: America’s New Export 53 (2008).