The Nobel Prize winner Milton Friedman was praised by The Economist (2006) as "the most influential economist of the second half of the 20th century...possibly of all of it". In 1970, he published an essay on the social responsibility of business in the New York Times Magazine. In his article, he explains in complex detail about the notion of "social responsibility" of businessmen within a corporate environment and their goal to increase profits.
Indeed, at first glance, this quote seems to capture the mentality of many of the actors in the financial sector in our era. Banks and financial institutions are accused of acting unethically and only in their self-interest to increase profits along with brokers and investment bankers who are accused of primarily aiming high incentives and bonuses by selling unconscionably high-default assets. Scholars argued that corporate governance failings and lack of ethical behaviour were significant causes of the financial crisis of autumn 2008 (Skypala, 2008).
This essay discusses the question whether the above statement made by famous economist Milton Friedman is still relevant in the context of business today and to what extent it is relating to the financial sector and in particular to the financial crisis of autumn 2008.
In order to address this problem, it is important to discuss the fundamental view behind Friedman's idea since it needs to be fully understood and interpreted.
He stated that the social responsibility of business was to maximize profits and to create value for stockholders within the bounds of the law. Furthermore, he thought that using corporate resources for purely altruistic purposes would be socialism. Moreover, corporations had no social responsibility other than to spend its resources to increase the profits of its investors since only investors as individuals could decide to engage in social contributions. Thus, he believed that the corporate executives, who were appointed by investors to make profits on investments, could not engage in social contributions using the corporate money. As a result, they could only do so as a private individual on their own behalf.
Friedman devoted "social responsibility" to violating the interest of the manager's employers. In other words, if managers invest in "social responsible" projects, they will harm the business since these investments will result in inefficiency and lost production leading to a reduction in shareholder's wealth.
His idea and the logic behind it have proven unconvincing to many scholars (Mulligan, 1986; Feldman, 2007; Wilcke, 2004). Indeed, several arguments can be shown which offset his idea.
Firstly, his theory does not allow for the possibility that profits and social responsibility can ever exist together. It is necessary to consider the constraint noted by Jensen (2002) who indicated that it is "logically impossible to maximize in more than one dimension at the same time unless the dimensions are monotone transformations of one another". This constraint implies that profits and social performance cannot be maximized simultaneously. That is why there is a trade-off between profits and social performance. Still, it does not mean that profit maximization and social performance cannot be congruent.
In reality, there are many examples which show that both can coexist. Several reasons are to be mentioned here.
Nowadays, banks and financial institutions are more aware of their role towards the society since they realize that they are an integral part of it. Furthermore, they notice that they can contribute positively to the environment and society with a positive effect on their reputation, creating a higher firm value. Furthermore, since numerous scandals of firms violating morality and ethics in the late 1990s and early 2000s (e.g. WorldCom and Enron) the significance of Corporate Social Responsibility (CSR) is increasing tremendously and included in the business culture of most of the financial institutions today. The concept of CSR means that "corporations have ethical and moral responsibilities in addition to their responsibilities to earn a fair return for investors and comply with the law" (Münstermann, 2007). So, almost every large corporation is increasingly investing to improve its performance on sustainability assets.
Banks and financial institutions know that society is always enlightened when it sees that a firm is engaged in charity and donating projects. While it is true that engagement in "social responsible" projects, for example donating for orphans of the developing countries means explicitly higher expenses and hence, reducing the profit, it has a long term profit as well. Engagement in donating projects has a positive effect on the reputation of firms, thus, affecting positively the consumer behavior of customers who will buy more products of firm, thus creating profit.
Friedman also never considers the very real possibility that companies engaging in "social responsible" projects gain the support from the community and polity that might, otherwise, eventually turn against them. Nowadays, almost all companies working in the financial sector are in some kind of way socially engaged. Looking at websites of famous big banks like Deutsche Bank, JP Morgan, Goldman Sachs or Morgan Stanley, one can find headings of Corporate Social Responsibility throughout the pages. Deutsche Bank has its own report on CSR for each year which reports engagement in AIDS projects in South Africa and support of education for children in India. JP Morgan reported an annual donation amount of $110 million for organization in 33 different countries and Goldman Sachs is actively involved in environmental projects. This shows that almost 4 decades after the famous essay of Friedman, companies do not follow his sole idea anymore but are - or are forced to - act socially responsible.
On the other hand, a business should try to make profit since it is inherent in its nature and by definition (except for non-profit organization). According to the Business Dictionary, a business is an "economic system in which goods and services are exchanged for one another or money. Every business requires some form of investment and a sufficient number of customers to whom its output can be sold at profit on a consistent basis." If a company does not make profit on a consistent and long-term basis, it will face financial distress and bankruptcy. Then, employees and workers will become unemployed which will affect the society negatively. For example, all the employees of banks going bankrupt in the financial crisis like Freddy Mac and Fanny Mae and Lehman Brothers were facing hardship. Hence, it is true that businesses are to a certain extent socially responsible to make profit in order to ensure job security and to create more jobs. This helps the society and improves the economy of the society.
But Friedman does not consider the fact that if companies' sole interest would be profit making, they can harm people and the surrounding environment. What if firms poison the water by disposing chemicals in rivers and sea - disposing toxic that leads to illnesses and death of animals and human beings? Friedman also fails to argue whether profit-generating actions like selling nuclear bombs to terror organizations, or knowingly manufacturing and selling defective, health-threatening products count as social responsibility as long as the company makes profit.
Evidently, in the financial sector there are not activities such as producing bombs or life-threatening drugs. Even though this sector cannot produce life-threatening products, it can create a value chain of unethical and careless activities that can damage the whole world as well.
One example is the Asian financial crisis in 1997 where moral hazards were mentioned as a major cause. Moral hazards are "negligent and fraudulent insured" (Baker, 2000). It also refers to situation that tempted otherwise good people. The problem with moral hazards in the Asian financial crisis was that Asian banks thought that they would receive implicit guarantees that they would be bailed out if they encountered financial distress. Hence, these banks and companies were much more speculative in their investments and kept investing increasingly. If the investments fail, they will not have to bear the cost since it will be picked up by the government. They were playing with people's money and did not act in the social interest of their customers. Instead, they were only focussing on making as much profit as possible. The result is known to everybody: In 1997 the nations of East Asia experienced the worst economic crisis they have never seen before.
Obviously, the latest and most discussed topic on morality in the two recent years has been the culpability of shareholders and banks along with board directors for failings that led to the financial crisis of 2008.
On the one hand, the crisis can be blamed on mortgage brokers, investment bankers and banks' executives. Skewed incentives and greed contributed too much of the crisis. For example, mortgage brokers generate sub-prime mortgages but were paid regardless of the outcome. That is why they were selling unscrupulously assets with high default risk to clueless customers in order to receive high commissions. Not to mention "Wall Street Executives" who were focusing solely on how to increase their bonuses and remuneration packages.
Also, Banks who took on these mortgages were accused of shoddy risk management and unethical behaviour, since they knew from the beginning that these subprime mortgages would eventually be securitized and removed from the bank's balance sheet. Again, the originating banks got paid up front for processing the mortgages without having to retain part ofthe risk.
Another factor is the misleading ratings of financial instruments credit agencies that were by far from independent. Arrangers of the secured assets were allowed to manipulate the creation of secured assets by mixing good assets with high risk assets to the point of getting a triple A-rating. If they did not get this rating, the assets were withdrawn, reconfigured and resubmitted. Since agencies are owned by banks, they were subjected to give best ratings to these dangerous assets and mortgage brokers knowing the risky idea behind those assets sold them to unsuspecting investors.
According to Friedman, every party involved in the actions mentioned above showed "social responsibility" since they did not care about their social responsibility to the world but only about maximizing their profits. Evidently, the aftermath of the American financial crisis has shown that the social responsibility of business is definitely not only to increase their profits. If banks, brokers and lenders, accountants, the government and important financial organization did not incorrectly assessed or even ignored the magnitude of the risks mentioned above, if managers and investment bankers were not greedy and showed herd investment behavior, it can be argued that the crisis could have been prevented. But the various parties acted immorally and socially irresponsible not caring about the social consequences of their actions. Consequently, the Asian crisis of 1997 and the global financial crisis of 2008 are two memorable examples that offset Friedman's idea.
In conclusion, this paper has shown that Friedman's request of being socially responsible by focusing solely on increasing profits is nowadays theoretically not accepted by banks and financial institutions. In contrast, in the 21st century social responsible corresponds to the alignment of business operations with social and ethical values. It is seen as the key to beat the competitor and to ensure sustainable growth. But the latest financial crisis has shown that even though CSR is part of the business culture of the large corporations, the key players in the large corporations do not practice social responsibility in a proper manner. It seems that CSR and corporate governance are a compilation of words and rules that adds only little value to the everyday businesses. Money has made everybody blind. Everybody wanted to have a piece ofthe big cake leading them to lower their inhibition threshold.
The "social responsibility" of businesses should not be increasing profit but focusing on what it really means in practice to encourage stewardship.
As a matter of fact, banks and financial institutions first need to show social and ethical manner in order to prevent another disaster like the financial crisis of 2008.
All in all, businesses need to focus on environmental and social issues in the arena of corporate responsibility since the society expects and demands responsibility of organizations. In fact, the law expects it as well. Banks and financial institutions are challenged after the aftermath of the financial crisis - they have to find a way how to act in the best interest of stakeholders, society, the government and the environment, still being able to make sustainable profit. It is now a request from the society.
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- Minh Vu (Autor), 2010, Friedman and the social responsibility of corporation, München, GRIN Verlag, https://www.grin.com/document/156269