Constraining Corporate Purpose Shouldn't be the Corporation's Decision

The New York Times recently asked the question: “Have the Anticapitalists Reached Harvard Business School?“ In past generations, Students at Harvard Business School, Yale School of Management, and other similar institutions would almost certainly learn that “there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception fraud.”

This is Milton Friedman, in a famous 1970 Op-Ed, also published in the New York Times. Now, students of elite business schools are, apparently, dissatisfied with this purpose, and are eager to question and even challenge this fundamental assumption—at least for a while. “[M]anagement professors have realized that their students, more than in previous decades, are looking for lessons that go beyond accounting,” the Times reports. “They want to discuss business’s role in society, how it has created social ills and how it may help solve them. Mr. Rouen, at Harvard, said the demand for classes on social impact and E.S.G. had been so high that those themes had been integrated into nearly every introductory class, including accounting.”

This is not an entirely new development. A few years ago, the influential Business Roundtable issued a statement regarding corporate purpose. The statement suggested that—again, contrary to Milton Friedman—corporations should no longer strive solely to increase shareholder value. Corporations should also consider, the statement suggests, the needs of the corporation’s customers, employees, suppliers, and communities generally. Increasing shareholder value is still a goal, naturally. But this is the final point in the Business Roundtable’s statement, rather than first and foremost, as previously presumed.

If a new generation of CEOs, business school graduates, and management gurus can change the direction of global capitalism, address climate change, reduce poverty, etc., then we should all be grateful. But this entire discussion raises an obvious question. Why should these individuals choose the ultimate purposes of our most powerful corporations, rather than an institution that, at least theoretically, expresses the goals and values of the entire population—that is, the government and its legal system?

A corporation is, after all, a legal institution offering a certain benefit to entrepreneurs—limited liability. A state’s laws grant individuals, provided they file certain forms in certain state offices, the ability to conduct business in the name of a fictional person. The business’ liabilities are then limited, in all but very rare cases, to that fictional person. This protects the personal wealth of entrepreneurs. Individuals can engage in business enterprise without having to expose their personal assets to the liabilities of failure. My business might file for bankruptcy, but thanks to the protection of the laws of incorporation, the business’ creditors can’t seize my home if the business’ liabilities exceed its assets.

The social benefit of limited liability? It encourages entrepreneurship. Ostensibly, economic growth benefits everyone. But with looming environmental threats and persistent global poverty, students at even the most elite business schools are growing skeptical. As the Times reports, “Curtis Welling, a professor at Dartmouth’s Tuck School of Business, asks his students every year whether capitalism needs to be reformed. A decade ago, roughly one-third said yes. This year, two-thirds said yes.”

This leads to the question of corporate purpose. Given that limited liability is a benefit granted to individuals by a society—specifically, by a state, through its laws—why shouldn’t the very laws which create the institution require beneficiaries (entrepreneurs) to consider the corporation’s customers, employees, suppliers, and communities generally, rather allow them not to and hope that they do?

In the U.S., corporate law already requires corporate bylaws to contain certain provisions for the protection of shareholders. In some countries, co-determination laws give workers representation on a corporation’s board of directors. There is no reason corporate statutes could not require all bylaws to consider the needs of customers, employees, suppliers, and communities in general, or even to offer other interest groups board representation. Perhaps communities subject to environmental pollution, for example, should have the same rights against the managers of corporations that shareholders have now. The possibilities are limited only by our imagination and political will.

If corporate protection is a creation of the state, then a constraint on its benefits is a condition on a state endowment rather than a limitation on some kind of a pre-state endowment or right.

To be clear, this legal entity, the corporation, is a creation of the state, not simply private individuals associating with each other. The individuals forming a corporation don’t have to get consent from all of the individuals in a society to limit their claims to the corporation’s holdings, rather than the proprietors’ personal property. Owners don’t have to convince us to treat their business as a different person. That protection is granted by the law.

This means constraining corporate purpose cannot possibly be said to “take” anything from the entrepreneurs which they would have had independently of the state, as taxation is often characterized. Nor is it a state imposition on private property, as regulation is often characterized. If corporate protection is a creation of the state, then a constraint on its benefits is a condition on a state endowment rather than a limitation on some kind of a pre-state endowment or right. No one has to incorporate, after all. Entrepreneurs who don’t want to take the concerns of the community into account when conducting business would be free to forego limited liability and put their personal property on the line.

If the problem is that corporations’ failure to take these other interests into account could cause social problems, then the law—which after all literally creates these entities—should address the problem. Corporate purpose should be constrained by something like Sen. Elizabeth Warren's Accountable Capitalism Act rather than the goodwill of enlightened CEOs and Harvard Business School grads.