Shareholders vs. stakeholders

Andrew Smith
4 min readJul 9, 2023
Wall Street. Carlos Delgado; CC-BY-SA

In terms of maximizing shareholder wealth, the primary goal of a corporation is to return a profit for its shareholders. The way that happens is by producing goods and services people want. As Adam Smith (1776) said, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

The butcher doesn’t cut meat simply because he loves cutting meat. He does so because that is how he gets his shelter, by selling that meat to others for profit. We don’t approach the butcher and say “give me meat or I’ll starve,” but instead engage in a mutually-beneficial exchange where both sides win — the consumer benefits from having the product. In this case, it’s dinner, which he can now obtain by paying someone else to cut meat rather than having to do it himself. The seller benefits from having the money from the sale so he can use it to fulfill his own wants and needs. Economist Steve Horwitz referred to this as the “Double Thank You” of the market (2016).

So, the first step in maximizing shareholder wealth is producing a product consumers are willing to purchase. When we discuss benefits to society, that alone is a benefit and the primary benefit. As the firm profits, more funds are made available to pay employees or hire more workers, which in turn should lead to better, happier employees and thus a better product. More funds are made available to invest in expanded physical capital, allowing the firm to serve more consumers. That is why Friedman (1970) said corporations’ only goal is to maximize returns for shareholders. The other social benefits come from that.

Friedman (1970) points out the manager who would want to spend money in a way he feels would benefit society — for example, refusing to raise prices in an inflationary environment or hiring “hard core” unemployed rather than the most qualified workers — is acting in his best interests as an individual and not of the firm. “In each of these cases, the corporate executive would be spending someone else’s money for a general social interest.” He notes that if those actions reduce returns to stockholders, the price to customers or lower the wages of employees, “he is spending their money.”

There is a danger in going beyond-mission and for a firm in dabbling in areas where it should not. Hayek (1960) argued “it is precisely the tendency to allow and even to impel the corporations to use their resources for specific ends other than those of a long-run maximization of the return on the capital placed under their control that tends to confer upon them undesirable and socially dangerous powers.”

For example, a homebuilder that commits to purchasing only domestically-produced lumber at a much higher price than lumber imported from Canada. This would be an example of “stakeholder capitalism” — the firm is attempting to preserve jobs at sawmills in Maine and Oregon. But there are other stakeholders who lose — most notably the consumers who now have to pay higher prices, and now have less money available to other goods. Fewer consumers and higher costs means lower profits, which can hurt the share price. Also, there are firms in downstream industries that are hurt — less demand for roofers and electricians because of the fact that this firm, because of its choice to represent “stakeholders,” is less efficient, has higher prices and thus is not building as many homes as it would have. It also makes the firm less competitive overall.

However, a firm will be pushed to “do the right thing” by the consumers who purchase its products and by investors who purchase its stock and debt. Competition and markets are tremendous checks on firms.

Sources

Friedman, M. (1970, Sept. 13). The Social Responsibility of Business is to Increase its Profits. New York Times. Retrieved June 22, 2023 from https://www.nytimes.com/1970/09/13/archives/a-friedman-doctrine-the-social-responsibility-of-business-is-to.html

Hayek, F.A. (1960). The Corporation in a Democratic Society: In Whose Interest Out It To and Will It Be Run? In Anshen, M. & Bach, G.L. (eds). Management and Corporations (1985). New York: McGraw-Hill.

Horwitz, S. (2016, Nov. 10). The Double Thank You of the Market. Foundation for Economics Education. Retrieved June 22, 2023 from https://fee.org/articles/the-double-thank-you-of-the-market/

Smith, A. (1776). An Inquiry Into the Nature and Causes of the Wealth of Nations. Retrieved June 22, 2023 from https://www.econlib.org/library/Smith/smWN.html?chapter_num=5#book-reader

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Andrew Smith

Andrew Smith is an economics instructor at New Palestine (IN) High School and an adjunct instructor for Vincennes University