The people who will live with a company’s decision do not all appear on its register of owners. A plant’s workers may have built their skills around its machinery; suppliers may have equipped themselves to serve it; a town may depend on the activity it brings. A change that improves the owners’ return can alter these lives, just as a change made to protect them can consume funds the owners expected to receive. The question of purpose arises where those claims cease to move together. It asks more than whether the manager has done a good job. It asks what a good job is, whose interests enter the judgment, and who has the power to require an answer when the judgment is disputed.
Friedman’s famous reply begins with a problem of delegated authority. A manager administers resources entrusted by other people; spending them on a cause of his own choosing may impose a sacrifice on owners, customers or employees who never chose that cause. In the 1970 essay, the manager is to act according to the owners’ desires, generally by making money while conforming to law and ethical custom. The qualifications matter. Friedman allows that an organization can be formed for a different objective, that an individual proprietor can spend his own money, and that expenditure serving a community may also serve the business over time. His objection has force against the executive who treats a corporate position as a private warrant to tax others for a personal conception of the good.
The argument does not settle every conflict by extending the time horizon. A safer product, a trusted supplier or a workforce willing to remain can be valuable to owners over many years. In those cases, attending to other people’s interests can be part of earning the return rather than sacrificing it. The difficult case persists when protection costs more than the firm expects to recover. A harmful discharge can remain profitable if those who suffer it cannot make their loss enter the company’s account. A saving extracted from a dependent supplier can improve the purchaser’s margin without increasing their combined resources. Being the residual claimant means receiving what remains after the firm’s recognized payments; it does not ensure that every consequence of production has already been paid for.
Even the owners’ interest can exceed the value of their shares. Hart and Zingales develop this challenge from within the shareholder account. An owner may care about a consequence of production while remaining willing to hold the investment. Giving that owner more money to spend privately need not reproduce the effect of changing the production decision. A donation cannot always undo a destroyed place, and an individual may have no access to the technology that would prevent the damage at its source. The separation between making money in the firm and doing good afterward therefore needs a substantive condition: the second act must be able to substitute for the first. Where prevention and production are bound together, a person who wants the firm to prevent harm need not be asking management to ignore his interests.
An invented choice gives the distinction a scale. Let one production method earn one hundred and cause damage valued at forty, while another earns ninety and causes none. All figures cover the same period, and every other consequence is held fixed. The first method leaves sixty after the stipulated damage; the second leaves ninety. An owner who weighs the damage at one-half in deciding what the company should do compares eighty with ninety and favors prevention, despite the lower financial return. An owner who gives the damage a weight of one-tenth compares ninety-six with ninety and prefers the first method. The difference is a disagreement about what the owner values. An increase in share value cannot resolve it merely by being easier to record.
Asking the shareholders can make that disagreement visible, but it does not make them the whole public. Hart and Zingales propose voting on broad corporate policy as a way to bring owners’ preferences into the decision. The result depends on those preferences and on the decision procedure; a vote can favor the damaging method as well as the protective one. People exposed to the discharge do not acquire representation simply because some shareholders care about them. Nor does a weight attached to ownership reproduce a weight attached to being affected. Shareholder voice can correct the assumption that all owners want only money while leaving the separate claims of workers, customers and neighbors still to be heard.
The stakeholder claim becomes strongest when a person has committed something difficult to retrieve. A worker who learns a process peculiar to one enterprise cannot necessarily carry its full value to the next employer. A supplier who builds around a buyer’s specification can become dependent on the continuation of that relationship. Some shareholders also hold concentrated, difficult-to-replace stakes; others can spread their investments and sell readily. The relevant comparison follows the actual commitments rather than assigning every owner and worker a single type. Where an enterprise benefits from investments made in reliance on a continuing relationship, its purpose cannot be assessed adequately without asking how those investments are treated when the bargain becomes inconvenient.
A promise to serve everyone nevertheless leaves a serious governance problem. Workers may prefer preserving a plant, customers lower prices, creditors a larger reserve and owners a distribution. A manager can invoke any one of them to excuse a decision that chiefly protects his own position. Naming more interests does not specify their priority, provide the evidence needed to compare them or create a person entitled to challenge the result. The answer has to give purpose an institutional form. A defined claim to information, a place in deliberation, a condition on a decision or an enforceable commitment does more work than a declaration whose meaning the executive alone may revise. Each arrangement also has costs and limits. Representation can reveal knowledge and expose a sacrifice; it cannot guarantee that every claim can be satisfied at once.
The choice of a purpose therefore needs a means of holding its custodians to it. A board insulated from every challenge may preserve a mission and preserve an incompetent manager with equal determination. A board judged solely by one short-lived measure may satisfy that measure by consuming what the enterprise needs to last. A broader statement can guide judgment, but a statement too vague to test supplies little discipline. Hart and Zingales confront this difficulty in considering charters, entrenched control and shareholder voting. Their alternatives do not yield a universal device that joins fidelity to a purpose with flexibility in changing circumstances. They show why the question of what a firm should pursue must be joined to the question of who may correct its pursuit.
The firm must also secure the resources its purpose requires. A commitment that continually spends more than the enterprise can obtain needs someone willing to supply the difference. That condition does not turn every financial sacrifice into an impossibility: an owner can accept a lower return, a customer can pay for a valued practice, or a different organization can be built around a different objective. It does require the commitment to survive its funding arrangement. The surrounding rules matter as well. If responsible conduct is left entirely to the willingness of each enterprise, those affected remain exposed to the decisions of the unwilling. Public standards, private commitments and internal voice do different work. A company’s benevolent intention cannot substitute for every institution needed to make its power answerable.
A purpose becomes credible when those entrusted with it can be called to account.
The volume began with an island of direction in the priced sea. It ends with the people reached by that direction, inside the island and beyond its changing shore. The firm can save the costs of repeated bargaining, gather knowledge, sustain a common practice and coordinate work that separate acts would leave undone. These achievements give reasons for the institution to exist; they leave its purpose to be specified and contested. Owners have claims, and so do the people whose commitments it uses and whose lives its decisions alter. An adequate answer must say how those claims enter the choice, what limits it must observe and who can challenge those who choose. The next volume follows the instrument through which many of these obligations are made: The Contract. The argument remains open.