Oliver Hart and Luigi Zingales have proposed a revision to the dominant model of the objective of the firm, most famously defended by Milton Friedman, arguing that executives’ obligation is not to maximize shareholder value, but shareholder welfare. Their proposal hopes to be more ethically attuned than Friedman’s. As it stands, however, it falls short from an ethical perspective, argues Fordham professor Santiago Mejia.
Oliver Hart and Luigi Zingales, two of the most influential contemporary economists, have proposed a revision to the dominant model of the objective of the firm, most famously defended by Milton Friedman. Their motivation for this proposed revision was their conviction that Friedman’s model is not sufficiently responsive to ethical and social values.
Hart and Zingales propose that executives’ obligation is not to maximize shareholder value (i.e., profits), as Friedman proposed, but shareholder welfare. While their proposal is promising, it falls short from an ethical perspective. We need to recognize that executives should only satisfy the preferences of shareholders when they are ethically permissible
By saying that a preference is ethically permissible, I mean to say that it conforms with the ethical norms that prescribe how we should behave and interact with others. For instance, ethical norms prohibit profiting from selling drugs to children or promoting lies that cause disinformation, polarization, and violence. Some may think that these norms are the product of social agreements, others may think that they are Platonic realities that we ought to discover. The important point is that ethical norms establish what is prohibited and permissible, are meant to apply to everyone, and are supposed to be justifiable with sound arguments.
Amending the Hart-Zingales Model
The amendment I am proposing—namely, that executives should only maximize the ethically permissible preferences of shareholders—would not be necessary if shareholders’ preferences and values were ethically permissible. However, it is mistaken to assume that this will always be the case. Some shareholders may be immoral or their self-interest may cloud their ethical judgments.
Allow me to illustrate with an example by Hart and Zingales themselves. In their 2017 paper “Companies Should Maximize Shareholder Welfare Not Market Value,” they use a hypothetical example to illustrate that the executive of a tobacco company should decide whether to sell tobacco to children by polling investors on whether they want to profit by selling tobacco to children. This example is ethically problematic.
We allow adults to smoke, despite the health hazards involved, because we consider them equipped to make decisions concerning the harms and benefits of tobacco. Children, however, are not adults. We don’t consider them to be well-positioned to assess the risks and benefits of smoking. Smoking also causes more developmental damage to children, and its effects are often more lasting than in adults. These arguments explain why it is ethically objectionable to sell tobacco to children.
It follows from this that if shareholders were to sell tobacco to children directly, they would be breaching an ethical prohibition. Shareholders who want the executive to do it are asking her to do on their behalf what ethics prohibits them from doing directly. But this is wrongheaded: an agent is not allowed to behave in ways that would be forbidden to the principal.
It is frequently emphasized by economists that the executive’s fiduciary obligation is to pursue the interest of shareholders. However, the executive’s fiduciary obligations also require her to discharge the principals’ ethical obligations. And that entails that the executive should not satisfy preferences of shareholders that are not ethically…