Profits and social responsibility

In the 1920s, many large American corporations began, on a wide scale, to establish pension funds, employee stock ownership, life insurance schemes, unemployment compensation funds, limitations on working hours, and high wages. They built houses, churches, schools and libraries, provided medical and legal services, and gave money to charities. Since this is fairly surprising behaviour for business corporations, there must be a good explanation.

In The Generous Corporation, Neil J. Mitchell argues that the reason for many of these actions, most of which clearly did not bring immediate cash benefits, was that large corporations had a legitimacy problem. The existence of large corporations showed the classical economic theory of perfect competition to be inadequate. Consequently large corporations introduced 'welfare capitalism' as a way of creating favourable public opinion. Rational capitalists, starting with Henry Ford, also realized that a better paid work force would be more loyal, and would be able to buy more goods and services, and that a better educated work force would be a more efficient one. Of course, pure free market theorists disapprove of welfare capitalism, and all actions inspired by 'social responsibility' rather than the attempt to maximize profits. Since the benefits of such initiatives are not confined to those who bear the costs, Milton Friedman has criticized them for being unbusinesslike, and for threatening the survival not only of individual corporations but also the general vitality of capitalism. In a newspaper article titled 'The social responsibility of business is to increase its profits', he argued that In a free enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible, while of course conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.

This executives should not make expenditures on reducing pollution beyond the amount that is required by law or that is in the best interest of the firm. Nor should they deliberately hire less-qualified, long-term unemployed workers, or workers from ethnic minorities suffering from discrimination. To do so is to be guilty of spending the stockholders' (or the customers' or the employees') money. Friedman does not consider the possibility that stockholders might prefer to receive lower dividends but live in a society with less pollution or less unemployment and fewer social problems.

An alternative view to the stockholder model exemplified by Friedman's article is the stakeholder model, outlined, for example, in John Kenneth Galbraith's book, The New Industrial State According to this approach, business managers have responsibilities to all the groups of people with a stake in or an interest in or a claim on the firm. These will include suppliers, customers, employees, and the local community, as well as the stockholders. A firm which is managed for the benefit of all its stakeholders, will not, for example, pollute the area around its factories, or close down a factory employing several hundred people in s small town with no other significant employers, and relocate production elsewhere in order to make small financial savings. Proponents of the stakeholder approach suggest that suppliers, customers, employees, and members of the local community should be strongly represented on a company's board of directors.