Critical Analysis of "The Social Responsibility of Business" from Milton Friedman

In this essay I evaluate Milton Friedman’s essay: “The Social Responsibility of Business Is to Increase Its Profits” in 1970, on the Social Responsibility of a business and his theory, which is called the “Efficiency Perspective”. In every article and book that I have read about social responsibility, Friedman’s “Efficiency Perspective is placed centrally. During my research I found that Friedman is often criticised for being too classical. Friedman believes that manager’s foremost objective or even moral obligation to the firm should be to maximise profits always. There is however one condition that makes his perspective more complicated, not only for me, but also for several well-known authors. According to Friedman, the managers obligations should be carried out: “…while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom”. This leads to one of the main questions of my essay: To what extent does Friedman’s “Efficiency Perspective” give foundation for responsible and moral international management behaviour? And need we any concern if it fails to do so? To fully answer the questions, I first need to explain the two different parts of the first question: responsible international management behaviour and moral international management behaviour. In businesses nowadays they combine these two parts, respectively responsible and moral becomes social responsibility in international management. The second question anticipates the other theories and models we need to consider when Friedman’s efficiency perspective does not give foundation for social responsibility in international management.

However before I go in further detail to answer these questions, I first explain more about the concept social responsibility. After this I explain Friedman’s full theory, and how it related to these different models of social responsibility, and finally I will draw a conclusion.

“Business ethics compromises moral principles and standards that guide behaviour in the world of business” (Ferrell & Fraedrich). Individuals or groups of individuals evaluate this specific behaviour. The judgement of this evaluation can be right or wrong, ethical or unethical, internal or external from the firm. The outcomes of these judgements influence the society’s acceptance or rejection of activities within the business. “Social responsibility refers to a firm’s obligation to maximise its positive impact on society and to minimise its negative impact” (Ferrell &Fraedrich). As we are talking about ‘international’ management behaviour, A. K. Sundaram and J. S. Black add to this definition: “across national borders”.

There are four kinds of social responsibility (Figure 1): economic, legal, ethical, and philanthropic. Ethics as part of social responsibility has its focus on the firm’s duty to maximise its positive impact on society and minimise its negative impact. Business ethics and social responsibility are closely linked. The first part of social responsibility is economic; it relates to how resources for the production of goods and services are distributed within a social system. Two parts within the economic dimension of social responsibility are regarded the foundation of social responsibility: the impact of the economy and competition. When relating social responsibility to economy, it looks at how the economy is affected by competition, stockholders, customers, employees, communities and the physical environment. Competition in social responsibility arises when businesses rival for customers and profits. Issues in social responsibility and law arise when businesses compete unfairly to obtain these customers and profits.

The legal dimension of social responsibility relates to obeying the law and standards that are written by governments to set a minimum of responsible behaviour. Society (including consumers, interest groups, competitors, and legislators) believes that business can not deal with social responsibility, such as environmental and consumer protection. Therefore laws establish the basic ground rules for responsible business activities.

The ethical dimension of social responsibility concerns operations and behaviours that are expected or restricted by members of an organisation, its community and society, although these operations and behaviours are not put into laws. Social responsibilities that involves ethics reflect a concern of major stakeholders, including shareholders consumers, employees, and the community. Their concern involves what is right with respect or protection of the stakeholders’ moral rights. The fourth dimension of social responsibility is the philanthropic dimension. The philanthropic dimension of social responsibility refers to the expectation that businesses also contribute resources to the community and improve quality of life. Consumers want business to act environmental responsible, they want sophisticated communication systems, good working conditions and times to improve their quality of life, and so on. The economic and legal dimensions are found as the most important elements of performance: “If this is well done, “ say classical theorists, “profits are maximised more or less continuously and firms carry out their major responsibilities to society.” Ferrell & Fraedrich say: “Some economist believe that if firms take care of economic and legal issues, they are satisfying the demands of society and that trying to anticipate and meet ethical and philanthropic needs would be almost impossible.” The execution of corporate strategy is influenced by the value systems of the corporation and its stakeholders. Common business criticism says the role of ethics in business strategy has been time and again ignored. According to Ferrel & Fraedrich if we accept these two statements: “Business strategy must reflect an understanding of the values of organisational members and stakeholders” and secondly “Business strategy must reflect an understanding of the ethical nature of strategic choice”, then ethics becomes a core decision in business strategy. Friedman has been quoted saying that: “the basic mission of business [is] thus to produce goods and services at a profit, and in doing this, business [is] making it maximum contribution to society and in fact, being socially responsible.” Friedman presents his efficiency perspective of social responsibility clear and simple, according to Friedman the business of business is business. His perspective is based on a free market environment. In Friedman’s essay his first argument states that a corporate executive is an employee of the owners of the business. The separation of ownership (shareholders) and the control of the organisation (managers) characterise the corporate form of an organisation. Above all, his primary responsibility is to the owner’s of the business. Friedman: “…the manager is the agent of the individuals who own the corporation or establish the eleemosynary institution, and his primary responsibility is to them”. However Friedman does anticipate that providing charity to local communities may serve the greater purpose of easing recruitment problems or improving behaviour at work.

Such actions, though, are “one way for a corporation to generate goodwill as a by-product of expenditures that are entirely justified in its own self-interest”, despite it is “approaching fraud”, to disguise social responsibility “clearly harms the foundations of a free society”. This strategic approach to environmental performance attempts to maximise stockholder’s returns by using an environmental strategy that creates a sustainable competitive advantage. Businesses should therefore not make social responsibility a consideration, they are the job of the government and managers have already a responsibility towards the shareholders. Adam Smith was one of the first economists who presented this approach. Smith reasoned that to place resources in the hands of the individuals and to allow the market forces effectively allocate these scarce resources, this would satisfy the demands of the society. If society thinks that it is important for products to have certain environmental and safety standards, the manager would improve its profits if he acted according to those needs.

In his essay Friedman describes managers who misuses corporate resources to exercise a distinct social responsibility, are actually imposing tax on the stockholders. Moreover Ronald Green said in his evaluation: “But actually his argument is really far more pointed. Ordinarily, we call a person who appropriates others’ goods without permission a thief ”.

Then he argues that only people can have responsibilities, and not the business, although businesses can have artificial responsibilities, such as to pay taxes. Friedman follows with his main argument, as I stated earlier, that the manager’s first obligation to the shareholders is that they should “conduct business in accordance with [owners] desires, which will generally be to make as much money as possible while conforming to the basic rules of society, both those embodied in law and those embodied in ethical custom.” According to Friedman, to demand that managers exercise responsibility to society at large is to ask them to violate their obligations to the shareholders, which puts the company at a competitive disadvantage. “This process raises political questions on two levels: principle and consequences. On the level of political principle, the imposition of taxes and the expenditure of tax proceeds are governmental functions”. Behind this argument lies a distinctive confidence that every social institutions should perform a particular function. He feels that “social responsibility” is the job of the government. Friedman: “On the grounds of consequences, can the corporate executive in fact discharge his alleged “social responsibilities?” What Friedman means with this argument is that it makes decision making more complex and irrelevant. Moreover that managers should not be bothered with these “social responsibilities”, due to their relative incompetence to make moral decisions about the use of the firm’s resources. From Friedman’s perspective, managers have no obligation to act on behalf of society if it does not maximise the value of the corporation for the shareholders. Only within the boarders of the law, managers should consider the social responsibilities of the firm. Friedman does not give further explanation to “ethical custom” in his essay, most authors believe that what Friedman means is that ethical custom is implied specifically within the law, and not applied next to the law. This means that Friedman considers only the first two dimensions of social responsibility, namely economic and legal. The ethical dimension and certainly the philanthropic dimension are totally left out of his argument.

As D. L. Swanson formulates it; “Friedman stance is a contemporary articulation of neoclassical economic utilitarianism”. Jeremy Bentham founded utilitarianism in the eighteenth century. He argued that only pleasure and the absence of pain are valued for their own sake. John Stuart Mill proposed happiness rather than pleasure as the ultimate human good. According to Mill, happiness ads a qualitative dimension to human well-being that is missing in mere pleasure and the absence of pain. Their type of thinking is often presented as teleological; i. e. rightness or wrongness depends on the consequences of the action. It is contrasted with deontological theory, which emphasises the action itself or its purpose. The teleological theory can be divided into two main philosophies, ‘Egoism’ and ‘Utilitarianism’. Egoism defines right or acceptable behaviour in terms of the consequences for the individual. Utilitarianism, as Egoism, is concerned with the consequences, but looks at the greatest good for the greatest number. Deontologists believe that equal respect must be given to all persons and that some things should never be done to maximise ‘utility’ (profits). As said previously, Friedman is associated with the utilitarianism approach; achieving the greatest benefit for all those affected by a decision.

R. M. Green says that Friedman is wrong to believe that managers’ ethical responsibility can be limited to profit maximisation. He suggests that both in terms of contractual obligations and the needs of society, managers cannot avoid paying attention to the ethical implications of their decisions. Similarly A. K. Sundaram and J. S. Black characterise that managers’ responsibility is not just to maximise shareholder returns, because shareholders are not the only ones responsible for the firm’s existence. They say an alternative is the “stakeholder” model. Stakeholders are individuals or groups whose welfare can be seriously affected by corporation’s actions and therefore have a ‘stake’ in managers’ decision making. Keith Davis, 1967: “…requires the individual to consider his or her acts in terms of a whole social system, and holds him or her acts anywhere in that system”. Raymond Bauer, 1976: “…seriously considering the impact of the company’s actions on society”. Stakeholders include the corporation’s financiers, its employees, customers or clients, suppliers, competitors, governmental bodies, the various communities and society at large, from the local to national to international, in which it operates.

Whereas Friedman’s shareholder theory concentrates on only one line of social responsibility, which is the responsibility from the manager to the shareholders (with the board in between), Green involves a whole network of relationships with the manager in the middle of this network. This network recognises the different social responsibilities of the managers towards the stakeholders. What it also recognises is the social responsibilities of the stakeholders towards the manager. Moreover firms use stakeholder analysis to identify societies’ expectations, such as wealth and job creation, and exterior responsibilities like sponsoring.

When looking at Figure 4, Friedman’s efficiency perspective is shown. When both Shareholders and Society are hurt (Cell 1), no conflict arises from the mistakes. Also when both the shareholders and the society benefit (Cell 4) from the decision made, there is only a low possibility for conflicts to arise. Though when according to Friedman, the shareholders hurts and the society benefits (Cell 3), the manager made a mistake and is managerially responsible. According to a report released by the Business Roundtable in 1981, this means that according to the stakeholder model, the manager is socially responsible. Cell 2 represents Managerial responsibility according to Friedman’s efficiency perspective, at the same time the stakeholder model would argue that the manager is acting socially irresponsible when society is hurt. The Business Roundtable opinion is that: ”Business is to serve the public interest as well as private profit.” Its opinion is underlined by saying that managers should weight the conflicting demands of all stakeholders and that customers have a primary claim.

Besides these models there are two more theories on social responsibility: “The Corporate Natural Rights Theory” and “Business Benefits Theory”. Looking at CNRT theory, Den Uyl (1984) argues that there is no necessity for companies to seek to maximise profits and that “owners do not seek maximum profitability, but rather wish only a certain rate of return”. This theory says that manager’s responsibility to shareholders is to achieve a certain rate of return on their investments, can be seen as natural or moral responsibilities. Furthermore in pursuit of profits, companies should consider the rights or “moral space” of individuals. The business benefits theory is a rather new theory; it emphasises that social responsibility creates distinctive business (organisational) advantages. This theory says that a respectable greater value of corporate social responsibility leads to improved business performance. This can be achieved by higher employee involvement, cutting waste, not making tests on animals, etc. The business benefits theory sees social responsibility as an investment not as a cost. However there are some concerns with this theory; it weakness lies in that this theory is not such a coherent theory, it relies on, the often failing, performances of companies which use(d) social responsibility to their advantage.

Concluding Friedman’s efficiency perspective, we must first look at the basis of this perspective. The basis that Friedman has taken for his perspective is a free market environment. This is Friedman first mistake; there is no such thing as a free market. Friedman also stresses democratic processes. In Friedman’s essay his first argument states that a corporate executive is an employee of the owners of the business. The separation of ownership (shareholders) and the control of the organisation (managers) characterise the corporate form of an organisation. Above all, his primary responsibility is to the owner’s of the business. Friedman: “…the manager is the agent of the individuals who own the corporation or establish the eleemosynary institution, and his primary responsibility is to them”. However Friedman does see that when investing in local communities it can generate the greater purpose of easing recruitment problems, improving work behaviour at work, etc. According to Friedman, such actions are entirely justified while the companies do it for their primary interest, which is making as much profit as possible. As Friedman acknowledges himself, businesses do have impact on society and they have responsibilities towards not only shareholders, but also consumers, suppliers, society as a whole, etc. However according to his theory corporate environmental expenditures are viewed only as a cost or ‘tax’ to conduct business in society, and never as an investment in developing a competitive advantage. Moreover corporate laws exist and thus corporations and organisations can be held responsible for their actions.

The Stakeholder perspective does have some drawbacks as well; the responsibilities to the stakeholders generally conflict with one another. Therefore the decision making is a complex process; managers should firstly define the various (moral) obligations owed to the stakeholders and how they can resolve the conflicts among them. Looking at the corporate natural rights theory, it says that a certain rate of return is wished for the corporations and that this is their moral obligation to the shareholders. The question nevertheless is what happens with the remaining investments of the shareholders. However together with the Business Benefits theory it puts everything in place; distinct business (organisational) advantages are met by putting the investment in the right places, which generates competitive advantages.

Still I think Friedman’s efficiency theory provides enough moral and responsible behaviour, businesses are always looking for processes that makes them more efficient and profit making. One way could be to introduce social responsible actions, however businesses should not pursuit these actions if they will not increase their profits.

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20 June 2014. Author: Criticism