The ghost of Milton Friedman will haunt the markets until companies fix CEO pay

Fifty years ago this week, the New York Times Sunday Magazine published an essay by the Nobel prize-winning economist Milton Friedman. The central premise of the Friedman Doctrine was that to continue to prosper, American business needed to stay globally competitive—and that required executives to focus only on profits and […]

Fifty years ago this week, the New York Times Sunday Magazine published an essay by the Nobel prize-winning economist Milton Friedman. The central premise of the Friedman Doctrine was that to continue to prosper, American business needed to stay globally competitive—and that required executives to focus only on profits and share price. He called for executives to ignore the distraction of the myriad social responsibilities that go beyond the legal minimum.

Friedman’s call to action worked. Within a decade or so, business schools had begun to teach that the purpose of business is to maximize “shareholder value,” a mantra that eventually rang out from practically every company boardroom.

But in recent years, the narrative of business purpose has, thankfully, evolved. Today Friedman’s doctrine, like many relics of the 1970s, is viewed as a bit of a cartoon. The New York Times Magazine and DealBook reprinted his manifesto this week on Sept. 13, on the anniversary of the original, with commentary from a range of contemporary observers and scholars of business. The voices of some experienced business leaders and of economists, like Glenn Hubbard of Columbia Business School, still stand by Friedman but offer the caveat that his theory only really works if shareholders are patient and long-term oriented. But capital markets are far from patient. The nosiest, noisiest, and most persistent shareholders are usually those looking for a quick gain, and the market famously rewards businesses that discount the future and externalize costs onto communities and the environment.

New business voices continue to be heard, but the public, whiplashed by inequality and concerned for a future beset by climate change and a lack of economic opportunity, wants more from our corporate leaders.

It is not enough to have dislodged Friedman. The legacy of his doctrine is present in the incentives and signals that continue to dominate decision-making in the boardroom and in the stock market. We need to remember it’s not the law that tethers us to shareholder-centric ideas and practices; it is the mindset of managers, and the machinery of capitalism, that keep shareholder primacy in place.

Our goals and incentives are out of alignment now

Friedman was right that businesses were losing ground to global competition, but the theory of change he put forth was only a theory. Shareholder value is easy to measure, but ill-suited to the complexity of the real world. Pursuing it single-mindedly has consequences both foreseeable and unintended, the effects of which are distributed unevenly and unjustly in a system that we know works best for those already on top.

What we need instead is for our capacious business institutions to be infused with a public-spirited purpose and culture. We need their support for public policy and market incentives to radically reduce carbon emissions. To create jobs and invest in worker well-being and readiness. To ensure equality in opportunity. To eliminate tax-avoidance schemes. To encourage investment in public infrastructure.

But if these are their intentions, they will be weighed down by the scaffolding around them—scaffolding that was built to reinforce Friedman’s doctrine in the wake of its publication.

A new way to pay CEOs

The clearest and strongest disconnect between the system Friedman inspired and the system we want is in how we reward executives. As long as we say one thing—Stakeholders!—but measure progress by total shareholder return, we will fail ourselves and our future.

A set of principles released this week by the Aspen Institute and Korn Ferry looks to boards to reimagine the design of executive compensation. They reflect the tenor of the conversations employees are having about the places they work, and put the lens firmly on the long-term health of the enterprise—not the shareholder—as the organizing principle of decision-making.

The questions that undergird these principles are rooted in the complexity of managing a corporation today. They are not a formula for determining pay or a road map. They ask boards to take a fresh look at what the conventional pay protocols are designed to produce—and what is possible if we treat this remarkable moment we are struggling through as an opportunity for real change. And they illuminate just how much the job description for top talent has already changed. Here’s what we believe boards should be asking themselves when it comes to aligning incentives and desired outcomes:

  • What are we paying the executive to do? If the stock price or Total Shareholder Return (TSR) is the loudest signal in the pay package, what goals, values, or constituents are at risk of being ignored?
  • What enables us to flourish over the long term? Do critical non-financial drivers of value, including so-called “ESG” factors of employee and community well-being and environmental health, have sufficient weight in any incentive awards?
  • What’s fair? The board is responsible for the health of the enterprise, and that means a renewed focus on internal equity: Is the CEO’s pay fair relative to direct reports? How about between senior executives and the employee population overall? And does the board discuss the optimal split of rewards between workers and shareholders?
  • Is the pay package designed with an eye toward transparency and clear understanding? When the executive is focused on a manageable number of priorities without a lot of contingencies, they can be summarized in a page or two. Are the goals readily understood by the CEO and his or her direct reports, along with directors, employees and the truly long-term investors?
  • Where are incentives most useful? The behavioral science is clear: Incentives are appropriate for piece work but are a poor match for jobs that require judgement and emotional intelligence. The CEO you want doesn’t need a financial incentive to build a strong culture or encourage innovation and long-term thinking. How about paying well but reducing incentives and bonuses that can have unintended consequences?

Why does corporate prosperity matter?

It’s easy to lose faith in the system—which is why we need to remember that we can change it, and that the prosperity it creates still matters.

The uniquely American interplay of democracy and capitalism depends on business investment and innovation. Corporations have the capacity to address meaningful problems. They can find a cure for Covid-19. They are a critical ally in addressing climate change. And there is much more they can do to create and distribute wealth fairly and to rebuild our crumbling infrastructure.

Here’s our deal with business: We believe in you. We need you. And we’re relying on business leaders who can lead their companies with the resources, talent, capacity, and know-how to tackle problems of consequence—problems that are putting the American experiment at risk. We are looking for moonshot management, not another app, and we are looking to you to arrive at it through co-creation with competitors and, importantly, in partnership with civic and nonprofit organizations that understand the root causes of communities at risk, can amass knowledge and science, and offer creative solutions.

Living up to a fresh narrative about business purpose does not require throwing capitalism under the bus. Nor is it addressed by another pronouncement about corporate responsibility. The best result is enabled by leaders who are willing to share the wealth better and put their companies on the right side of history in the face of grand challenges that cannot be solved without them.

Judy Samuelson is executive director of the Business and Society Program at the Aspen Institute, and author of Six New Rules of Business: Creating Real Value in a Changing World (Berrett-Koehler, January 2021.)

 

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