Paul Godfrey and Milton Friedman

A New Rigor is Found In Arguments for Corporate Social Responsibility

The most lasting rebuke of corporate social responsibility came from Milton Friedman, the small of stature economist who even in death continues to cast a huge intellectual shadow.

In September 1970 Friedman wrote “The Social Responsibility of Business is to Increase Profit,” for the New York Times Magazine. In it, he argued persuasively that corporate social responsibility was just so much twaddle, socialism in a corporate wrapper that undermines a free society. Businesses that practiced corporate responsibility were playing Robin Hood with someone else’s money.

“The discussions of the ‘social responsibilities of business,’” Friedman wrote,
“are notable for their analytical looseness and lack of rigor. What does it mean
to say that ‘business’ has responsibilities? Only people have responsibilities.”

Instead, companies should maximize their profits and return capital to shareholders so that individuals could then donate to whatever cause they wished to, or not. For companies to do anything besides maximize profits was simply immoral, Friedman wrote.

When Friedman wrote that in 1970, corporate giving to charities was only a few decades old and basically amounted to a pittance. While it was permitted as early as 1917 in the State of Texas (a number that grew to 26 States by the early 1950s), it was a court ruling in New Jersey in 1952 that set the stage for modern corporate philanthropy. In 1950 New Jersey passed a law permitting companies to donate to educational institutions. But it was unclear whether the law permitted companies chartered before 1950 to make donations to nonprofits. In a test case a New Jersey manufacturer of valves and fire hydrants named A.P. Smith Manufacturing Company made a $1,500 donation to Princeton University. A group of shareholders challenged the gift in the New Jersey courts.

The court ruled that the statute was legal, and that it applied retroactively. The court opined that institutions of higher learning were essential to the democracy and the free-enterprise system. Companies increasingly realized this fact and had therefore a part to play to ensure the continued existence of such institutions as a matter not only of continued survival but to enhance the conditions of business in the present.

The case, called A.P. Smith Manufacturing Company vs. Barlow, changed the landscape of corporate giving in America forever.

But a sorry sort of intellectual stalemate was the result. Friedman and other Hayek-followers maintained that corporate social responsibility undermined free institutions. And the counter argument from the A.P. Smith ruling and others was that it improved the conditions necessary for business. In effect the later argument carried the day. Giving USA reports that companies in America gave $12.72 billion to charity in 2006.

But to see how much force Friedman’s article still has, Google the title. In the first page all that will come up are pdfs of the article posted by the nation’s business schools!

Increasingly academics have taken up the question and they’re finding that corporate social responsibility DOES make business sense. I’ve highlighted before the research of Raymond Fisman and Geoffrey Heal of Columbia Graduate School of Business and Vinay Nair of the Wharton School which suggests that for businesses that advertise a lot corporate philanthropy acts as a signal to consumers that a company’s products or services are reliable. They found a positive relationship between corporate philanthropy and profitability in industries with high advertising. But in industries with low advertising the reverse was true.

On Monday I caught a presentation from Professor Paul Godfrey and afterwards we spoke briefly about his 2006 paper in the Academy of Management Review, “The Relationship Between Corporate Philanthropy and Shareholder Wealth: A Risk Management Perspective.” Godfrey teaches at Brigham Young University but like yours truly is a University of Utah alumnus.

The paper presents an ingenious theoretical underpinning which suggests that companies can use philanthropy to bank goodwill and, in effect, draw on it when the mine caves in.
His theory has 14 propositions and math that I couldn’t begin to explain. But his hypothesis goes like this:

Corporate philanthropy can generate positive moral capital among communities
and stakeholders.

Moral capital can provide shareholders with insurance-like protection for a
firm’s relationship-based intangible assets.

This protection contributes to shareholder wealth.

What he told me Monday is that the early data bears out the theory and the hypothesis. Of course Godfrey’s theories require further testing by himself and others. But clearly Friedman’s complaint that there is no rigor among those who argue for corporate social responsibility is no longer the case.