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BEW3001
(Ethics & Sustainability in a
Business Environment)
Lecture 3 (Shareholder Theory)
Priya Sharma

Accredited by: Advanced Signatory:

Lecture 3 : Shareholder Theory
Learning Objectives from Lecture 3

• Understand the basic concepts of the Shareholder Theory

• Evaluate the application of the Shareholder Theory

• Appreciate the importance of the Shareholder Theory

• Identify important ethical issues that arise from the Shareholder

Theory

• Comprehend the impact the Shareholder Theory on globalization

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Lecture 3 : Shareholder Theory
•What is the 'Shareholder Theory' as advocated by Milton Friedman

• The only responsibility of business is to generate profits for its shareholders

(within the constraint of law)

• Most businesses as a matter act to maximize profits.

• Friedman agrees with Adam Smith who argues that the general good is
best achieved by allowing individuals to pursue their own self interest

• Adam Smith’s famous invisible hand argument.

• Friedman position is one the says that this is how business should /ought MONASH
behave in an ethical/moral sense. BUSINESS
Lecture 3 : Shareholder Theory

What responsibilities does the management of a corporation have?

• To make as much money as possible
“…so long as it stays within the rules of the game, which is to say engages
in open and free competition without deception or fraud”

• The Invisble Hand!

“every individual is continually exerting himself to find the most
advantageous employment for whatever capital he can command. It is his
own advantage indeed, and not that of society, which he has in view…(but)
by directing that industry in such a manner as its produce may be of the
greatest value, he (is) lead by an invisible hand to promote an end that was
no part of his intention…By promoting his own interest he frequently
promotes that of society more effectually than when he intends to promote
it”
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Lecture 3 : Shareholder Theory

Do businesses have social responsibilities under Friedman's

theory?

• Does business have a responsibility to (for example)

• Avoid polluting?

• Provide employment?

• Eliminate discrimination?

• Keep inflation down?

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Lecture 3 : Shareholder Theory

• Friedman therefore argues that:-

• It is inappropriate for non-elected representatives to take upon themselves the role of
imposing and spending taxes. Using company money to fund socially worth-while projects is in
effect imposing taxes and redistributing them.

• Corporate executive may not allocate corporate funds to socially worth-while projects as they
are spending someone else’s money. (Stockholders, Customers, Employees)

• It is more efficient to allow individuals to spend their own money (Adam Smith’s argument). As
private individuals corporate executives may give to charities or give to support socially
valuable projects but not on behalf of the corporation.

• Society will be best served if individuals and (corporations) are allowed to single-mindedly
pursue their own self-interest within the limits of the law.
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• Having no expertise in these areas it is likely they will not do it well.
Lecture 3 : Shareholder Theory

Where does ethics and sustainability fit in under Friedman's theory?

• Friedman argues:-

• it is the responsibility of the society (in practice the government) to set legal and
establish a framework of law within which individuals are free to pursue their own
self interests.

• that law alone provides the boundary of acceptable business behaviour.

• “ethical behaviour” is justified only when used as a marketing strategy to increase

profitability.

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 Lecture 3 : Shareholder Theory
Something to reflect on!
When you choose a company with which to do business, what factors influence your
choice? Let us say you are looking for a financial advisor for your investments and
retirement planning, and you have found several candidates whose credentials,
experience, and fees are approximately the same.
• Would you consider a firm that stands above the others because it has a reputation, which you
discover is well earned, for telling clients the truth?

• A firm that is recommending investments that seemed centered on the clients’ benefit and not
on potential profit for the firm?

• In comparison to others, has a long track record of giving back to the community of which it is
part? and appears to be committed to building up the local community

• Would this group not strike you as the one worthy of your investments? Wouldn’t this be the
one you would trust with your investments and might it be enough to persuade you to give it
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your business?
Lecture 3 : Shareholder Theory
Criticism of Friedman by Arrow:-
• Friedman relies on the principal that “under the proper assumptions profit
maximisation is efficient”

• What are these assumptions?

• Conditions for perfect competition:

• Many buyers and sellers (no monopolies, no individual can set price)

• Homogeneity of product (no brand or advertising effects on demand)

• Perfect information (everyone has the same information and all the relevant
information is revealed in the price)
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• No barriers to entry or exit of buyers or sellers to/from the market
Lecture 3 : Shareholder Theory
• Arrow argues that:-
• Example of categories where allowing the unimpeded pursuit of profit does not
result in the efficient allocation of resources:-
• Harms are imposed on others that are not costed into the product.

• Pollution.

• Cases where there exists an asymetry of information between buyer and seller
(typically the seller knows more than the buyer)

• In these cases, regulation in the direction of greater efficiency may be justified.

• fits in Friedman’s view as we have the government setting the legal and
regulatory framework and business free to profit maximize within that
framework.
• Example: Laws covering wages , ocuparional health and safety, product MONASH
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safety and environmental protection that business must work within.
Lecture 3 : Shareholder Theory
• Issues!

• Adam Smith (and to a more limited extent Friedman) were living and writing
when most business activity occurred within national boundaries.

• Where there is good government and a robust legal system, business will be
prohibited by law and regulation from causing significant harm to non-
shareholding stakeholders.

• But what about the situation that exists today, where many businesses
headquartered in developed nations are doing lots of business developing
nations where such a robust legal framework is conspicuously lacking?

• What about Globalisation? where changes in economic policy and technology

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have resulted in the greater interaction of economies once separated by artificial
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barriers to trade and finance and high transport costs?
 Lecture 3 : Shareholder Theory

• Example 1: In Australia and the US there are high standards of occupational

health and safety and serious constraints on the use of under-age labour.

• As a consequence of this is, it is more expensive to produce eg clothing/footwear

in the US or Australia.

• So what has Nike done?

• Gone to Asia and produced their runners there?

• Who benefits? The shareholders, the Asian workers who would not otherwise
have jobs.

• Who loses? The redundant Australian/American workers MONASH

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 Lecture 3 : Shareholder Theory

• Example 2 : Shell in Nigeria

• Shell has for many years been able to generate greater profits for its shareholders
and exploited the absence of environmental regulation in Nigeria.

• What has happened as a result?

• Damage to Environment?

• Health of the local population adversely affected?

• Standard of living of the population in general not raised? MONASH

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 Lecture 3 : Shareholder Theory

• “Internationalize” the Friedman position.

• Corporations should be free to maximise their profits within the constraints of

internationally recognised (and enforceable) laws and regulations that provide an
ethically acceptable framework for the operation of multinationals.

• OECD Guidelines for Multinational Enterprises

• The latest revision of the OECD Guidelines for Multinationals is a conscious
response to globalisation.
“The integration of national economies into one global economy is accelerating
and intensifying, driven by new technologies and new opportunities. These new
opportunities are not only to reap profit, but also to stimulate development and
improve social conditions around the world.” (OECD Guidelines, Forward)
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 Lecture 3 : Shareholder Theory
MNCs should:-
• Contribute to the economic, social and environmental progress of the countries within
which they operate (1)
• Respect the human rights of those affected by their activities (2)
• Encourage local capacity building (3)
• Encourage human capital formation (4)
• Refrain from seeking exemptions from the regulatory framework in respect of
• Environment, Health, Safety, Labour, Taxation (5)
• Refrain from improper involvement in local political activities (11)

Limitations of the OECD Guidelines:-

• The guidelines are recommendations by governments to MNCs.
• Their observance is voluntary and not legally enforcable. (Concepts and Principles(1))
• Governments have the right to prescribe the conditions under which MNC’s operate within their
jurisdictions subject to international law. (Concepts and Principles(7))
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 Lecture 3 : Shareholder Theory
The Future?

• Can we expect MNCs to comply with the OECD guidelines (or something similar)
when they are not legally enforcable?

• What about the SDG Framework?

• Who would be the enforcer of such compliance?

• What will be the consequences if such a framework cannot be put in place?

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Any Questions?

Accredited by: Advanced Signatory: