Air, the new bio-sports-business drama movie about the start of the relationship between basketball great Michael Jordan and Nike and the development of the Air Jordan, of course has attention from reviewers.
Two unlikely ones are Donald Boudreaux, economics professor at George Mason University, and David Henderson, research fellow with Stanford University’s Hoover Institution and editor of the Concise Encyclopedia of Economics. And they prove that, while stretching in new directions is often admirable, it helps if you learn what you’re talking about. Their attempt to cast the film as a lesson against companies and investors considering ESG—environmental, social, and governance factors—is embarrassingly bad.
As Nell Minow, a leading U.S. expert on corporate governance who has been not just a movie hound but published reviewer for longer than I can remember, called it on Twitter, “the most idiotic take on movies and #corpgov to date.”
Tough criticism, but if you’ll bear with a line of argument, it might seem reasonable. Using a movie as proof of an economic theory long at odds with the realities of actual business is the lesser of the two problem categories.
Boudreaux and Henderson, in their opposition to consideration of environmental, social, and corporate governance factors in investment and business decisions, are channeling the spirit of the late economist Milton Friedman.
In 1970, a half dozen years before winning the Nobel Price, Friedman argued that the only social responsibility of a company is to maximize shareholder value. He wasn’t the first to say this but was highly influential.
Friedman wrote in the New York Times
NYT
back then, “The whole justification for permitting the corporate executive to be selected by the stockholders is that the executive is an agent serving the interests of his principal. This justification disappears when the corporate executive imposes taxes and spends the proceeds for ‘social’ purposes.”
Boudreaux and Henderson expand that to include environmental considerations and—this is an immense headscratcher—apparently corporate governance as well. That last in the trio is critical to a strong investment culture and adequate protection of shareholders. But let’s have at the category.
The two authors argue that ESG investing creates confusion “not only over how best to pursue company goals but over what the goals are.” These are both trainwrecks of thought when viewed through the lenses of managing a company and of investing in one.
First, the management aspect. If the only goal of a publicly held company is to increase shareholder value, one first must ask, given the variety of different ways investors approach their investments, what is the “value” that should take precedence? As a hypothetical example, you could have a corporate raider taking a significant position in a company’s shares, looking to sell pieces off to create more immediate payoff on one hand, and a big long-term investor who expects to hold companies for years, looking to appreciate of value and cash flow.
The example is simplistic but goes to the underlying issue of there not necessarily being a clear single way shareholders look for increased value. A theory of a simple approach, to look after the interests of the principals, suddenly becomes complicated. Sometimes selling a company might make sense. Other times, the clear approach is to invest money back into the company to build its strength and capabilities for the long run.
Executives are responsible to the board, which is responsible to shareholders. However, there is also the legal doctrine known as the business judgement rule. Executives aren’t responsible for losses when they make reasonable decisions in good faith.
Economist shareholder value diehards might argue that any goal other than making more money for the investors is a mistake. But is it? If there is an absolute need to only consider shareholder value, then everything else must be sacrificed to that end. As entry level calculus shows, you can only maximize for one independent value in an equation at any time. If more value—and remember, we can’t even come up with a single definition for all investors at all times even in a single company—can come from taking value away from workers, customers, and business partners, then that is what must happen.
Any halfway competent businessperson can tell you what a disaster that would be. Most companies and sound business strategies need to attract and keep a great workforce. They must develop mutually beneficial partnerships with suppliers, distributors, resellers, and others. A company has to satisfy regulatory requirements, ensure that it brings value to communities in which it operates, if only to keep from being cut off at the knees by some interest or other. Businesses must balance many interests to survive in the long run; stay ahead of competition; grow, expand, and profit. An overly simplistic formula simply won’t do.
“But that’s not what we meant,” the economists, who frequently over-simplify the dynamics of systems to find approximate solutions to problems, would say. “Of course, the company has to stay afloat.”
Exactly. That’s where the “only consider shareholder value” truly breaks down. The company is also an interest and the vessel through which shareholders might see some of that value, whatever it is to them. Corporations constantly stay in some lines of business, start new ones, drop others, explore different markets, try different forms of operations, attract workers while finding the changing best ways to retain them, and avoid risk, to mention a few of the considerations that face managers.
A pure focus on shareholder value becomes a focus on corporate value and on the changing conditions that require modifications of what worked in the past. If managers can’t consider what is good for the company in the future, they can’t do their jobs. Similarly, if investors cannot consider factors that might affect their investments in the future, and consider whether a business pays attention, they cannot ensure their own interests.
This is where the ESG haters make the biggest mistake, because they think such considerations are only for some “woke” social recognition, not growing the future customer base, getting the best employees, avoiding environmental risks (nice factory you have there, too bad it you didn’t move it from the flood plain it’s on), and ensuring the best governance.
As Minow wrote, “ESG is never about trading off financial goals for social goals; it is about using non-traditional indicators to better assess risk and return.”
Perhaps exalted economists might try talking to those who are expert both in running companies and investing in them and asking why so many are paying close attention to ESG. Could it all be a mistake? Yes, because everyone is human, mortal, and fallible. But is it automatically wrong because you want it to be for some reason? Neither a scientific nor sensible approach.
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