Must Corporations Maximize Profit?

There is much discussion going on these days over the idea that corporations must maximize profit in order to satisfy their stockholders. Many take the position that this isn't even a choice, but that firms are required to do so by the terms of their incorporation. To do less would be to fail to properly represent the interests of the investors.

Along with this idea there has arisen a discussion of what flexibility firms have when spending money. For example, is it proper for a firm to invest in "green" technology, which may be more expensive, but which benefits society at large? Similarly can firms donate money to charitable causes or provide services (pro bono) for free?

Those who support both the charitable actions and the assumption over maximizing earnings turn to convoluted arguments to bolster their ideas. So, for example, charity can add to a firm's "good will" and make customers more likely to want to deal with it in the future. Similarly "green" investment can make a firm more appealing to customers. Certainly firms buy into this logic as can be seen by the amount of green-washing going on as polluting firms try to improve their image.

All of this misses a key point. Firms operate as state-sanctioned entities. The rules that they must follow come from laws and regulations. It is within this framework that they are allowed to maximize profit. A firm must, for example, pay minimum wage and provide for a safe and healthy workplace. There are limits on hours worked and the age of employees. There are limits on how waste can be dealt with and one sort of damage can be done in extracting raw materials. Products must meet certain safety and efficacy standards as well. There is no such thing as maximizing profit in the abstract.

So such discussions are not really about maximizing profit, but rather are about what are the limits that government can impose. Firms use spurious arguments about fiduciary responsibility rather than say that they want a license to pollute or abuse workers. It is somewhat ironic that firms spend so much time opposing regulation, since most of it actually benefits them. Without regulations firms that engage in illegal activity would have an edge over ethical firms. Who would make more profit, a firm selling a well-tested drug or one selling a counterfeit? Who would make more profit, a firm employing skilled workers or one using slaves (or illegal immigrants)? Many of the big failures in finance over the past several decades have involved firms engaged in fraud forcing other firms to try to compete so as not to lose business. Enron was such an example as was Madoff's Ponzi scheme. How can a real investment firm compete with a firm that is just a shell?

Firms benefit from a level playing field. It means the ones which are the best managed and the most innovative will prosper. Many firms, which know they are poorly run, deliberately try to get special favors from government to compensate. This frequently takes the form of seeking tax advantages or restrictions on offerings from competitors, i.e. protectionism.

One should be very wary of firms which ask for such favors. If they can't make a profit without government help then why have they been granted the benefits that accrue to limited liability corporations? Firms which are expected to be uneconomic are generally set up as non-profits, such as hospitals and educational institutions. They get the protection of limited liability and the tax benefits so that they can perform inherently unprofitable activities for the public good.

Maximizing profit is, thus, a false justification for seeking competitive advantage over one's competitors. Such claims should be seen for what they are - special pleading.


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Copyright © 2009 Robert D Feinman
Feel free to use the ideas, but the words are mine.