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Shareholders vs. Stakeholders: Balancing Financial Ethics and Business

Shareholders vs. Stakeholders: Balancing Financial Ethics and Business

Photo of Azish Filabi
September 15, 2020

Azish Filabi, JD, is Executive Director of the Cary M. Maguire Center for Ethics in Financial Services.


Ask almost any business leader today and they will tell you that they view the “shareholder primacy” and “stakeholder theory” of business as synonymous. Only by treating your employees, customers, and other stakeholders well, they say, will you manage to run a profitable business. Indeed, that is what we heard from the leaders at the Business Roundtable, 181 CEOs including Jamie Dimon of JPMC and Jeff Bezos of Amazon, in 2019 when they released a new statement defining the purpose of a corporation to promote an economy and financial system that serves all Americans.

Yet the debate over shareholder primacy versus the stakeholder theory of business in the financial industry persists among analysts and professionals.

This week marks 50 years since publication by The New York Times of the Milton Friedman essay “The Social Responsibility of Business Is to Increase Its Profits.” Reference to this essay has become tantamount to the position that “shareholder primacy” is the cornerstone of American capitalism. The anniversary provides an occasion to reflect on the purpose of business, as well as business ethics in financial services, and how leadership mindsets can impact outcomes for all stakeholders.

I first learned about the Friedman essay when I started teaching at the NYU Stern School of Business in 2015. I was familiar with Friedman the economist, but not Friedman the essayist. At law school, we learned the “business judgment rule,” the principle that the law will defer to the reasonable judgments of the board and management as they make decisions that inevitably require a trade-off between various stakeholders, and these decisions are not considered conflicts of interest. When you ask lawyers about corporate duties, you’ll hear about principles like Duty of Loyalty and Duty of Care, but not about the primacy of a shareholder. Later, studying public policy and economics at the Johns Hopkins School of Advanced International Studies (SAIS), we learned about market failures, not perfect markets. Developing policy rooted in financial ethics requires a focus on how markets fail to deliver to all stakeholders, which enables policymakers to judge appropriate and timely government intervention.

My takeaway was that managers have a duty to shareholders, but it’s not their only or primary duty. One look at the litigation and enforcement dockets against corporations demonstrates how stakeholders can and do advocate for their own recompense in the face of unethical behavior or unlawful corporate action. 

The enduring appeal of the theory of shareholder primacy, however, signals that the mindset of business leaders is an important element in their decision-making. How a company balances the interests of their stakeholders while still practicing financial ethics reflects upon their unique governance and leadership structure.

For many business decisions, there are no clear rules or codes of ethics set in stone. On the margins, for certain specific and boundary-setting circumstances, there may be guidance on ethical issues to help us identify the right thing to do – for example, during a merger, many lawyers will likely advise that the board’s role is to manage a process that will yield the highest price for shareholders; or, in the event of bankruptcy, there is a clear waterfall of payments requiring that certain stakeholders (employees, lenders, etc.) be paid before the shareholders, who retain only residual interests. These rules provide a clear hierarchy of order in decision-making. For the large number of day-to-day challenges, however, leaders have the hard job of finding the right balance in the absence of clear ethical standards.

How leaders resolve these inherent ethical issues signals to the financial markets their approach to governance. Viewed through this lens, the rising interest in ESG investing can be seen as an indication that capital markets find financial value in these signals of non-financial behaviors. For instance, in our current economic downturn, how are managers to decide whether to cut dividends to their investors or to lay off workers while weathering the COVID-19 financial crisis? Investors are paying attention to these trade-offs and their long-term impacts.

Friedman’s 1970 essay should be viewed in the context of the times for which he wrote it. As Kurt Andersen of The New York Times writes, Friedman was responding to the surge of support for social justice movements in the late 1960s, and a fear of “big government” controlling business through a socialist agenda.

Similarly, we need to look through the lens of modern-day business and social settings to find opportunities for corporate leadership. While the financial services industry continues to rebuild from the 2008 Global Financial Crisis, it is faced with new social, economic, and ethical issues unfolding from the COVID-19 pandemic. However, the lack of trust in financial services among the general population is an enduring challenge. According to the 2019 Edelman Trust survey, “financial services remains the least trusted sector” they measure. While trust has been improving since 2008, the survey finds that 70% of respondents “expect their financial services leaders to lead on social issues…that make the world a better place.” Income inequality and financial security top the list.

Put in context, the public perception is that growing economic inequality casts a shadow on the reputation of the financial services industry—calling leaders to action. As the current financial crisis unfolds, these questions become particularly critical. The racial economic wealth gap remains persistent. The middle class is shrinking. And extreme weather and natural disaster risks are climbing to the top of the global economic agenda.

The silver lining is that the mindset of business ethics has shifted, and opportunities to embrace stakeholder value as synonymous with shareholder value abound.