Executives of the Business Roundtable used to proclaim that the purpose of a corporation is to earn profits for stockholders. Then, in 2019, they changed their purpose statement to emphasize a commitment to “customers,” “suppliers,” “the community,” and “the environment,” along with “shareholders.” That change prompted University of California, Los Angeles law professor Steven M. Bainbridge to write The Profit Motive: Defending Shareholder Value Maximization. He states, “My goal is to put forward an unabashed defense of the proposition that the purpose of a corporation is to sustainably maximize shareholder value over the long term.”

The book examines the conflict between advocates of shareholder capitalism and advocates of stakeholder capitalism. The former advance Milton Friedman’s idea that “The Social Responsibility of Business Is to Increase Its Profits,” to borrow the title of his (often misunderstood) 1970 New York Times Magazine essay. The latter argue for corporate social responsibility (CSR) and environmental, social, and governance (ESG) issues. There are multiple definitions of both CSR and ESG, and different views of the effects each has on a corporation’s bottom line. Bainbridge adopts no single definition of either. The salient feature of CSR and ESG is what they have in common: an emphasis on the interests of stakeholders such as workers and members of the community.

Bainbridge bases his approach on “law, history, and economics.” Take his explication of the Michigan case Dodge v. Ford Motor Company. In 1916, Henry Ford announced the company would cut its dividend payment, using the automaker’s massive cash reserves to build another factory, lower automobile prices, and continue to pay workers high wages. Brothers John and Horace Dodge, who had recently expanded from being auto parts suppliers to making their own automobiles and who were also early investors in Ford, objected to the plan. As shareholders, they took Ford to court for two reasons: to stop the construction of the factory and to make Ford resume paying dividends. The Dodge brothers won their case at the lower court level, and Ford appealed.

Bainbridge documents that Henry Ford’s “stated goal was to do ‘as much good as we can, everywhere, for everybody concerned … [a]nd incidentally to make money.’” In 1919, the Michigan Supreme Court decided that Ford’s directors neglected to make the interests of stockholders a priority, as they were legally required to do, and ordered Ford to reinstate dividend payments. However, the higher court reversed the part of the lower court’s decision that prevented Ford from building the factory. Bainbridge remarks that had Ford stated he was only interested in making profits, he would have prevailed on both counts.

Directors’ judgment / Although the court thwarted Ford’s plan in part, corporate directors would not have to fear an onslaught of suits filed by shareholders and judges interfering in their plans. Judges refrain from taking up cases based on “the business judgement rule.” “Accordingly,” Bainbridge explains, “courts would defer to the judgment of the directors unless a complaining shareholder could show something beyond mere negligence, such as fraud or self-dealing on the directors’ part.”

Some law professors go so far as to claim that the business judgment rule trumps the Dodge decision and gives directors legal cover to advance the interests of stakeholders. Bainbridge rejects this idea because judges continue to take up cases involving disputes between directors and shareholders. In 2010, for example, the Delaware Court of Chancery took up a case between the directors of Craigslist and eBay, the latter having a minority stake in the former. Craigslist clearly stated its goal was to benefit stakeholders; eBay sued to press the directors to focus on shareholder value. The court sided with eBay. Bainbridge adds, “The fact that the business judgment rule typically precludes a court from deciding whether directors breached the shareholder wealth maximization norm does not mean that the norm is not the underlying doctrine.” The rule enables judges to refrain from substituting their authority for that of directors in every case but does not bar judges from hearing cases in which directors might be putting stakeholders before shareholders. The Dodge decision is a cornerstone of corporate law. Bainbridge declares, “When we say that shareholder value maximization is the law, we mean the law writ large.”

Beyond Friedman / Having made the case that the purpose of a corporation is to make profits for shareholders, Bainbridge devotes his largest chapter to why that should be. A reader might be surprised to learn that he considers Friedman’s argument for shareholder value maximization based on private property rights to be inadequate. “Shareholders are not owners,” Bainbridge explains, “so their rights are not grounded in property.” Shareholders are in effect contractors who negotiate for the corporation’s residuals.

Another inadequate argument is based on the accurate observation that stakeholders fare well in an economy with profit-seeking firms. Workers generally see their standard of living rise, the air and water tend to become cleaner, and so forth. But, Bainbridge points out, “a rising tide does not lift all boats.” Directors may make decisions that impose hardship on stakeholders. For instance, the decision to shutter a factory will render workers unemployed. Making decisions in business creates risk; various groups bear risk associated with the decisions that directors make.

There are serious problems with stakeholder capitalism that lead one to support shareholder capitalism. In the “Bainbridge hypothetical,” the directors of a company plan to replace an outmoded factory with a new one. They can construct the factory either in the United States or overseas. If the directors choose the United States, American workers will benefit by keeping their jobs. If the directors choose overseas where wages are lower, shareholders will benefit by earning higher profits. If the directors are accountable to shareholders, they will construct overseas. If the directors are accountable to their American workers and other stakeholders, it is not clear what they will do. Bainbridge reckons that “the board would lack a determinate metric for assessing its options.” “After all,” he asserts, “directors who are responsible to everyone are accountable to no one.” Suppose proponents of stakeholder capitalism urge the directors to construct the factory in the United States to benefit American workers. That decision entails an “implementation problem”: other stakeholders such as lenders, environmentalists, and consumers may resist. Of course, shareholders will create an implementation problem for directors who intend to benefit other stakeholders at their expense because they will balk at financing business decisions contrary to their self-interest.

Challenging stakeholder capitalism / University of Iowa law professor Robert Miller is one of several scholars who maintain that stakeholder capitalism undermines democracy. He points out that if carbon dioxide emissions are negative externalities to be treated like pollution, government regulation is necessary. So far, owing to the citizenry’s lack of interest in reducing these emissions, legislatures have not delivered significant regulations. Bainbridge quotes Miller, “Stakeholderism provides a possible answer to this problem: it may be possible to convince corporations to do voluntarily what they are not required to do legally.”

Bainbridge mentions United Technologies’ announcement during the 2016 presidential campaign to close a Carrier furnace plant in Indiana, moving the work to Mexico. Donald Trump sharply criticized the decision on the campaign trail. Following his election and touring the plant in the weeks before he took office, United Technologies’ officers reversed course. Bainbridge states,

Whether the request comes from the right or left, asking corporate executives to take on governmental functions not only asks them to undertake tasks for which they are untrained and for which their enterprise is unsuited, it also subverts the basis of a liberal democracy.

The author’s statement makes sense by itself, but it is difficult to see how it follows from the scenario involving United Technologies. What “government functions” did Trump hound United Technologies’ CEO into taking? Political interference in business decisions seems to be a greater threat to shareholder capitalism than stakeholder activism is to democratic institutions.

Imagine directors, shareholders, and other stakeholders in a “hypothetical bargain” to determine labor compensation. Bainbridge assumes that “we can draw on our experience and economic analysis to predict what the parties would do in such a situation.” Given that shareholders vote for directors and that directors benefit when the corporation earns profits, directors have incentives to bargain for shareholder value maximization. Shareholders, of course, have an incentive to bargain for shareholder value maximization.

Bainbridge refers to Miller’s analysis again. Stakeholder advocates expect stakeholders to receive a share of corporate profits when times are good but do not expect stakeholders to share in the losses when times are bad. Bainbridge quotes Miller: “No rational commercial party would ever agree to such terms.” Bargaining theory even predicts that workers and other stakeholders will choose shareholder value maximization. Experience shows that workers and other stakeholders may expect shareholder capitalism to generally improve their well-being over time.

The following logic applies as well: “Because shareholders will place a higher value on being the beneficiaries of director fiduciary duties than will non-shareholder constituencies, gains from trade are available, and we would expect a bargain to be struck in which shareholder wealth maximization is the chosen norm.” The details of such a bargain—that is, precisely how shareholders convince stakeholders to choose shareholder value maximization—would be interesting to know. Unfortunately, Bainbridge leaves those details to the reader’s imagination.

Shareholder capitalism is not heaven on earth. Bainbridge recognizes as much when he borrows Winston Churchill’s characterization of democracy by likening shareholder capitalism to the least bad economic system. Undaunted, he goes on to explain how the pursuit of profit makes the world a better place. First, prices are necessary if the economy’s land, labor, and capital are going to produce the most goods and services. Profits are a price: the return to owners of corporations. If directors do not aim to maximize profits, corporations that satisfy consumer wants will fail to attract land, labor, and capital away from corporations that do not satisfy consumer wants. Second, profits serve as a reward for entrepreneurs who innovate and cause the economic growth that lifts most people out of poverty. Third, to pursue profit is to exercise one’s economic freedom, which is necessary to preserve political freedom.

Greenwashing / Despite serious flaws in stakeholder capitalism, the business press is rife with discussion of ESG. Bainbridge attributes this to “greenwashing”: firms feigning a concern for environmental and social issues in order to increase sales. Theory and evidence support his view. In principle, CEO compensation is so tightly linked to corporate financial performance that CEO conduct is bound to be consistent with shareholders’ interests, not environmental or social issues. Empirical research indicates that CEOs who endorsed the Business Roundtable’s 2019 statement act no more in the interests of stakeholders than CEOs who did not endorse the statement; the former CEOs more often run afoul of regulations than the latter, according to one report. According to another, Business Roundtable CEOs who backed the 2019 statement “paid out 20 percent more in dividends and stock buybacks during the COVID-19 pandemic” than did CEOs who did not back the statement. Finally, the Business Roundtable CEOs who signed the 2019 statement did not bother to change their “corporate governance guidelines” to reflect the sentiments toward stakeholders expressed in the statement. CEOs may talk about stakeholders’ interests, but they act in the interests of shareholders.

Conclusion / The Profit Motive is a comprehensive and powerful rejection of the ideology of stakeholder capitalism and an affirmation of shareholder capitalism. Law professors and law students will learn the legal history of corporate purpose and access an abundance of sources in the notes. Economists will find justification for the belief that firms should maximize profits. Executives will likewise learn how to better defend their plans that benefit stockholders at the expense of other stakeholders. Citizens in general will profit (pun intended) from acquiring a better understanding of the role of profits in a capitalist society.