Business, Economics

Shareholder Value Theory: Social Responsibility Can Increase ROI

In 1970 a group of reformers led a campaign to “Tame G.M.” via a proxy battle that called for “social responsibility.”

The Harvard Crimson memorialized their demands. Quoting verbatim:

  • changing GM new car warranties to give more guarantees that the automobile will work;
  • improving health and safety standards for GM;
  • asking GM to “substantially increase” the number of non-white new car dealerships. At present, there are seven non-white franchises out of GM’s total of 13,000 national dealerships;
  • asking the company to meet Health, Education, and Welfare Department anti-pollution standards before the 1975 HEW deadline and to devote more research to study other pollutants in the environment;
  • requiring GM to develop a car by 1974 that can crash into a wall at 60 m. p. h. with no injury to the occupants. The National Safety Bureau has already designed such a car that works at 47 m. p. h.;
  • enlarge GM’s Board of Directors from 24 to 27 seats, adding three representatives of the public;
  • change the GM charter to restrict the corporation to operations which are not “detrimental to the health, safety, or welfare of the citizens of the United States…”;
  • set up a “shareholder’s committee” to study GM’s impact on the country, including an assessment of its efforts to produce pollution-free engines and safe cars, its effect on national transportation policy, and, in general, the manner in which it handles its economic power.

In response, to-be Nobel Laureate Milton Friedman — thought leader of the Chicago School of Economics — published a scathing article in the New York Times. I’ve already detailed the article and will not repeat the core criticisms except to focus on one … noncustomer demands balanced against shareholder value.

Friedman begrudgingly admits that “social responsibility” and business practices that eventually increase share price sometimes align. “… it may well be that in the long-run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community… That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses…” He then goes on to label these moves “hypocritical window-dressing because it harms the foundations of a free society.” He backs off telling companies to avoid these moves because “that would be to call on them to exercise a ‘social responsibility!'”

Let’s think about a world where GM ignored Friedman and listened to the reformers.

In our mythical 1970’s GM, after expanding their Board of Directors, General Motors decides to focus on several key areas of competition:

  • Quality & Reliability. Quickly realizing that the cheapest way to extend a warranty is to build more reliable cars, GM tasks their talented engineers with vastly improving reliability. Those engineers find a well regarded expert working in far-flung Japan, W. Edwards Deming, and convince him to come home and apply his methods — that were improving the quality of Japanese products — to GM plants.
  • Safety. GM’s theoretical 1970 safety initiative finds that baby boomers, their largest up-and-coming customer group, prefer safer cars. There is a reason Ralph Nader’s book, “Unsafe At Any Speed,” became a bestseller. GM finds that safer cars cost slightly more to build but provide a competitive advantage and buyers are willing to pay considerably more.
  • Pollution. In 1970 American cities were choking with smog. Los Angeles was especially disgusting. Below is a photo of Los Angeles from that time and a more recent photo. Pollution was more than a social concern: it was a quality of life issue, a classic commons problem that Milton Friedman no doubt understood could not be solved with traditional market forces. GM’s early 1970 low-pollution cars sell well in car-crazed LA, a traditional trend setter that pushes them to the rest of the world.

  • Diversity. GM makes an effort to train and launch dealerships with African American and Hispanic owners. They realize 7 out of 13,000 minority-owned dealerships, .054%, is ludicrously low. GM quickly realizes dealerships owned by African-Americans, staffed by non-racist salespeople, are more likely to be frequented by African-Americans. They sell more cars. Dealerships owned by Hispanic Americans hire Spanish and English speaking salespeople: they also sell more cars.

Every one of these “social responsibilities” that Friedman — and, by extension, followers of Shareholder Value Theory — rail against were, in hindsight, likely moneymakers. The inverse is also true; GM ignored these areas and their business was decimated by Japanese and German automakers.

Friedman’s assertion that “social responsibility” for businesses is nonsense is, in itself, nonsense. Despite that Friedman’s view became and, in large part remains, a dominant view it is simply wrong. In hindsight, had GM adopted these demands the business, and the shareholders, would have been healthier and wealthier. There is oftentimes no genuine conflict between shareholder value and social responsibility. Indeed, the opposite can be true: better managed businesses understand that fulfilling social responsibility can increase shareholder value.

Here are some other photos of smog from the time Milton Friedman argued there was no value, nor market, in cars that polluted less.

Manhattan:

Image result for smog manhattan 1970

Louisville:

Smog on river

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