Milton Friedman predicated his shareholder value maximization credo on the strong implicit and explicit assumptions that the rules of society protect stakeholders other than shareholders, and that businesses operate in an environment of “open and free competition without deception and fraud.” These assumptions are far from true in the real world, where laws and even basic notions of justice are routinely perverted in the corporate context.

Editor’s note: To mark the 50-year anniversary of Milton Friedman’s influential NYT piece on the social responsibility of business, we are launching a series of articles on the shareholder-stakeholder debate. Read previous installments here

Milton Friedman’s claim that business managers would fulfill their social responsibility by making “as much money as possible while conforming to the basic rules of society” is highly problematic. It is based on false assumptions. The widespread acceptance of his dictum, and implicitly of his false assumptions, have caused substantial and preventable harm.  

First, in banking and more generally (as Oliver Hart and Luigi Zingales discuss), “making as much money as possible” in the name of creating “shareholder value” may not produce the outcomes many shareholders, not to mention society at large, prefer most. 

Second, Friedman‘s argument relies on an implicit assumption that the basic rules of society protect all stakeholders other than shareholders. He also assumes that businesses operate in an environment of “open and free competition without deception and fraud.” These strong assumptions are far removed from reality. In the real world, governments often fail to design the best rules in society’s interest. Moreover, managers do not take the rules of society as given and often use corporate resources (i.e., shareholders’ money) to try to skew the rules. Thus, even if managers operate technically within the law, excessive market power and reckless conduct that distort markets and harm society can persist.((See, for example, Lee Drutman’s The Business of America Is Lobbying, how flawed claims maintain a dangerous financial system and too-big-to-fail institutions, and the evidence on corporate political and market power in Matt Stoller’s Goliath, David Dayen’s Monopolized, or Thomas Philippon’s The Great Reversal.))

Third, and worse yet, basic law enforcement and the principle of equal justice under the law also fail routinely in the corporate context. Rules become meaningless without effective enforcement, with the ultimate outcomes reflecting little if any “social responsibility.”

Corporations are abstract legal entities. Early corporations were monopolies chartered by government. In The Anarchy, William Dalrymple describes in fascinating detail how the East India Company, created in the early 17th century and for much of its existence answerable only to its distant shareholders, routinely used violence to gain its ends in India. 

In the US, corporations have won many legal rights over the years, including civil and constitutional rights originally intended for citizens. (On the history of the “corporate civil rights movement,” see Adam Winkler’s eye-opening book We the Corporations.) While they have amassed significant rights, compelling corporations to obey the laws and fulfill the legal responsibilities that ordinarily accompany those rights has been more difficult. 

Forming a corporation for any purportedly legal purpose is very easy today. With minimal disclosures, and sometimes with anonymous beneficial owners, corporations with no productive economic activity can hide ill-gotten assets and evade laws. Governments, in turn, fail to enforce laws consistently or effectively, particularly in the context of white-collar crime. (For more on this, see Jennifer Taub’s recent book Big Dirty Money.) Corporations in fact can “shop” legal jurisdictions to minimize taxes and regulations. An opaque system of offshore finance, termed “Moneylandby journalist Oliver Bullough, converts illegally-obtained funds to legitimate currency, often through the corporate form and aided by mainstream financial institutions.   

Criminal justice for large corporations—those Brandon Garrett refers to as Too Big to Jail—generally consists of settlements obtained out of the courts in a non-transparent process. In such settlements shareholders, often the beneficiaries of the corporate wrongdoings that harm other stakeholders but sometimes the victims, pay fines, corporations promise to comply better, and little else happens. Most corporate wrongdoings, including wage theft, consumer or investor fraud, and unsafe products or work conditions, result in civil penalties even when they involve criminal violations. Whether this system creates proper accountability or deterrence, whether fines and penalties are appropriate, and when and whether justice is actually served, is hard to tell and often doubtful. 

Data that would enable us to understand the issues and address the failings of the justice system in the corporate context are remarkably scarce. Among the important questions we cannot answer because we lack information are: Do current laws impose sufficient accountability for those with power, in corporations and in governments? Are current laws able to prevent law evasion by corporations but fail to do so due to ineffective enforcement (due to, for example, insufficient resources or the incentives of the attorneys involved), or do we need to write expanded “responsible officer” statutes? Are the resources devoted to detecting and investigating corporate misconduct enough to maintain trust in the system and in the institutions that control our economy and our lives?  

In ongoing research with my colleague Greg Buchak, we are assembling data that we hope will help us study the workings of the justice system in the corporate context in a more systematic way. Among other things, we will explore whether and how the outcomes of corporate wrongdoing in the justice system may depend on the type of law, offender, victim, harm, jurisdiction, or other factors. We need better understanding of the situation so as to find ways to address any failings of the system. 

This research is important in the context of Milton Friedman’s once-celebrated NYT piece, because Friedman effectively presumes that law enforcement works properly. Proper enforcement should be blind to the identity of the victim or perpetrator. If enforcement outcomes depend on such factors as the identity of the perpetrator or the victim, then the administration of justice is perverted and the rules do not achieve their intended goal.

“Even as Friedman takes for granted that, somehow, lawful conduct by corporations, as well as the idealized conditions of ‘free competition without deception and fraud’ come about, he displays disdain and derision towards the very governments that are often essential for making his assumptions hold.”

Some examples will illustrate why there are legitimate reasons to be concerned about the justice system in the corporate context. In June 2020, PG&E, a California utility, pleaded guilty to 84 manslaughter charges stemming from a massive 2018 fire that destroyed a town and led to dozens of deaths and much suffering and losses. The company paid $4 million in penalties, which is the maximum under California law, and will have to report to a monitor appointed by a federal judge overseeing its criminal probation for previous safety violations related to a 2010 fatal gas-line explosion that killed eight and injured dozens. 

In approving the current settlement, the judge noted that PG&E’s sentence did not fit the enormity of its crime. One headline about the story declared that PG&E dodged 90 years in jail by being a corporation and not a natural person. No individual within PG&E was charged with any crime.   

Other examples come from the many corporations that enabled and benefitted from the opioids crisis that killed hundreds of thousands of Americans in the last two decades. Purdue Pharma, whose conduct since the late 1990s is described in Berry Meier’s book Pain Killer: An Empire of Deceit and the Origin of America’s Opioids Epidemic, is now in bankruptcy and trying to settle hundreds of lawsuits from state and cities, as well as fraud charges from the federal government. No individual within Purdue went to jail for perpetrating this massive crisis. 

Purdue was not alone in breaking the law and profiting from the opioids epidemic, even as many have died and suffered and the cost on society had been enormous. Possessing and selling highly addictive drugs violates the US Controlled Substance Act, which for individuals carries substantial, sometimes-mandatory prison terms. Drug distributor McKesson Corporation repeatedly turned a blind eye and failed to report hundreds of thousands of suspicious opioids orders, including enough to provide an excessive number of pills to every person of some small communities. Yet, according to a scathing report by 60 Minutes and the Washington Post, despite its extensive and repeated violations, McKesson paid $150 million in a civil settlement in 2017 for years of misconduct that followed a prior 2008 settlement. This fine was equivalent to about a week and a half of the company’s profits. Individuals pushing drugs in such quantities on the streets would, of course, spend many years in jail.   

Another highly disturbing report by ProPublica describes how Walmart Pharmacy violated the same drug distribution laws on a large scale for years. According to the report, Walmart pharmacists were pressured by bosses to fill prescriptions from pill-mill doctors that pharmacists knew, and as their professional and ethical code suggested, should have been refused and reported in detail as inappropriate. “Driving sales” was more important than obeying the law, even as pharmacists were put in tough situations and as the devastating consequences of the opioids crisis were becoming evident. In late 2018, top Department of Justice officials instructed prosecutors in Texas, who had built what they believed was a strong criminal case against Walmart and sought to proceed to indictment, to drop the case. A civil suit remains unsettled.      

Other examples abound. Institutions such as HSBC, Danske Bank, and many others have engaged in money laundering for years, generating large profits. The first chapter of David Enrich’s book Dark Towers about Deutsche Bank is entitled “a criminal enterprise.” The details in the Theranos case in the US or Wirecard in Germany are shocking. These cases, as well as DuPont’s contamination of drinking water and cover-up, Wells Fargo Bank’s account-opening scandal, and the reckless actions of Boeing and its regulator, the Federal Aviation Administration that caused two plane crashes killing hundreds, are the tip of the iceberg. 

Corporate misconduct often persists for long periods, as was the case in most of the examples above. In a dissent over a 2015 decision to renew Deutsche Bank’s special issuer privileges despite manipulating Libor, Kara Stein, then-Commissioner of the Securities and Exchange Commission, stated that the bank’s “illegal conduct involved nearly a decade of lying, cheating and stealing”. Whistleblowers, investors, or investigative reporters who try to expose some of the most egregious cases suffer harassment or worse. 

After the financial crisis of 2007-2009, many asked why no high-level executives went to jail. Much of the buildup of risk that led to the crisis did not break the letter of the law. Although the rules in place before the crisis were poorly designed and inadequate, post-crisis reforms continue to tolerate and even encourage recklessness. Fraud and deception, however, were also a problem in the run-up to the crisis and remain pervasive in the financial sector and beyond, yet it is exceedingly rare for any executive to face criminal charges or go to jail. 

In his 2018 book The Chickenshit Club, Jesse Eisinger argues that prosecutors in the US Department of Justice have found it increasingly difficult, costly, and personally unattractive to investigate and try to prosecute executives when corporations commit crimes. Judge Jed Rakoff, whose experiences include years in both prosecution and defense of corporations and executives, advances a similar hypothesis

Legal systems outside the US face related challenges, as seen in the recent failure of UK authorities to hold Barclays and four of its executives criminally liable for fraud. German law still provides virtually no tools to deal with crimes by corporations. 

Returning to the US Constitution, Founding Father James Madison stated in Federalist 51 (1778), “If Men were angels, no government would be necessary.” Madison continued to recognize that “The great difficulty lies in this: you must first enable the government to control the governed; and the next place, oblige it to control itself.” As Daron Acemoglu and James Robinson show in their latest book, legal systems matter greatly to economic outcomes and corrupt and incompetent governments and badly designed and enforced laws can undermine markets and take down nations. 

In her 2019 book The Code of Capital, Katharina Pistor argues that the legal code, and the lawyers who shape it, play key roles in creating wealth inequality. The devil is often in the details, and lawyers know how to work them to advantage those who can pay the most. Pistor ends with an ominous warning that if trends such as attacks on independent judiciaries and free press even in countries with long traditions of democracy and the rule of law continue, “naked power will once more gain sway over legal ordering… and we will all be worse off for it”.

None of these issues about the challenge of writing the rules of society and compelling corporations to comply with the rules as embodied in the law are discussed by Milton Friedman. Even as Friedman takes for granted that, somehow, lawful conduct by corporations, as well as the idealized conditions of “free competition without deception and fraud” come about, he displays disdain and derision towards the very governments that are often essential for making his assumptions hold. 

In direct contrast with the market system he extolls, Friedman presents the caricature of a “centrally controlled” system in which governments determine prices and wage, and he laments that executives who speak of corporate social responsibility will bring back “the iron fist of government bureaucrats”. These narratives, and the stark choices we are often presented within the political discourse—between “free market capitalism” and “big government socialism”—are simplistic and misleading. The key issue is not the size of government but rather the competence, incentives, and integrity of those who act on its behalf. 

Uncorrupted governments, capable of providing essential services effectively, creating and enforcing proper rules and administering justice for all, are essential for prosperity. 

Yet, hostility towards governments, and actions by corporate managers and others that deprive governments of resources, expertise, and incentives to act in the public interest, can cause government failure to become self-fulfilling. In The Fifth Risk, Michael Lewis warns of the dangers we face when people with significant power over the government are ignorant as well as short-sighted and greedy. In a recent interview, Lewis expressed hope that the pandemic would help people “figure out just how critical government is”.

Neither corporate managers nor government leaders are likely to act in society’s interests unless stakeholders express their wishes and take action to hold power to account. In her recent book Superman’s Not Coming, consumer rights advocate and environmental activist Erin Brockovich shows that many in the US cannot even count on having unpolluted water without fighting for it; as Katherine Eban suggests in Bottle of Lies, generic drugs may also be unsafe; and in the US, information about unsafe products is not shared effectively. We must exert whatever influence we can have as shareholders, consumers, employees, academics, and citizens to impact the actions of those with power over our lives. 

I hope those who continue to celebrate Friedman’s value maximization credo recognize that the assumptions Friedman makes about the environment in which businesses operate and the rules of the game by which they play don’t actually hold in reality. I also hope that they become forceful advocates for changes that would bring the world closer to the conditions needed for Friedman’s arguments to hold. Being blind to how far we are from such a world is among the reasons both capitalism and democracy appear to experience an existential crisis today.

The author thanks Greg Buchak, Paul Pfleiderer, and Graham Steele for helpful comments and discussions.