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Friedman Doctrine

"An entity’s greatest responsibility lies in the satisfaction of the shareholders"

What is the Friedman Doctrine?

The Friedman Doctrine is also referred to as the Shareholder Theory. American economist Milton Friedman developed the doctrine as a theory of business ethics that states that “an entity’s greatest responsibility lies in the satisfaction of the shareholders.” The business should, therefore, always endeavor to maximize its revenues to increased returns for the shareholders.

 

Friedman Doctrine

 

Friedman believes that the shareholders form the backbone of the entity, and they should be treated with the utmost respect. Profits maximization requires the entity to find ways of generating additional revenues through value addition and creating more products and services while minimizing costs. Friedman also stated that shareholders should be in charge of key decisions such as social initiatives rather than getting an outsider to make the decision on their behalf.

 

 

Quick Summary

  • The Friedman Doctrine, also known as the Shareholder Theory, provides insights on how to increase shareholder value.
  • According to the doctrine, shareholder satisfaction is an entity’s greatest responsibility.
  • However, the doctrine also faces expansive criticism since it turns a blind eye to social responsibility activities.

 

Background of the Friedman Doctrine

The Friedman Doctrine first appeared in the New York Times in 1970 as an essay by Milton Friedman. In the essay, the economist explained that an entity does not have any social responsibility to the society around it whatsoever. Instead, he stated that the only responsibility that an entity should abide by is its shareholders.

Friedman justified his claim by explaining that any executives in business are employees of the owners, and they are, therefore, required to deliver quality service to the employer first before any other party. Individuals employed in corporate entities are required to conduct their roles in the business according to the expectations of the employer.

 

What is Social Responsibility?

The Friedman Doctrine holds that decisions concerning social responsibility rest on the shoulders of the shareholders, not the executives of the company. He argues that an entity is not obligated to any social responsibilities unless the shareholders decide to such an effect.

Any social responsibilities to the society require resources and should, therefore, be arranged before they are executed. The use of a company’s resources is subject to approval by the shareholders, who are the final decision-makers on important decisions such as the use of financial resources.

Social responsibility activities such as the development of social amenities for the community are capital-intensive and will affect the financial resources of the entity. Friedman insisted that such responsibilities should not be forced on the company, and the final decision on whether or not to carry them out depends on the shareholders.

 

Friedman Doctrine Influence

As an indication of the Friedman Doctrine’s influence in the business arena, many business owners believe that companies should focus on maximizing shareholder value rather than focusing on other activities such as corporate social responsibility.

The primary goal for any entity should be to increase the profitability of the business since that is what the shareholders are interested in. Other activities that are not central to maximization of shareholder value should not be given priority when allocating financial resources.

The influence of the Friedman doctrine has been confirmed by various researchers and academicians. Joseph Bower and Lynn Paine, both long-time professors at Harvard University, confirmed that the doctrine has had an influence on the financial community, and business owners have been seen to practice the Friedman Doctrine and its principles. The doctrine also elaborates on a number of topics, including shareholder rights compensation, performance appraisal and measurement, corporate responsibility, and the role of directors in the business world.

 

Criticism of the Friedman Doctrine

Despite its success, the doctrine faces its own fair share of criticism from the surrounding society. The doctrine is seen, to a large extent, as individualistic, especially from the societal perspective. Critics consider the doctrine as defective from many fronts, including legally, morally, economically, socially, and financially.

Most critics hold that the doctrine gives shareholders an upper hand while neglecting the society surrounding the entity. In as much as the shareholders are the financial engine for the business, the entity also needs the community for it to be successful. The business sells its products and services to the community. Its success depends on the goodwill from the community to purchase the products and services. Therefore, both parties have a mutual relationship, and the business has a responsibility towards the community.

In her book “The Shock Doctrine,” Canadian social activist Naomi Klein states that the Friedman Doctrine impoverishes the community while enriching the few corporate elites. Paine and Bower, who partly support the Friedman Doctrine, acknowledge that the doctrine comes with negative effects, which may include organizational attacks from shareholder activists and management burnout due to pressure to maximize shareholder returns.

 

Additional Resources

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

  • Keynesian Economic Theory
  • Negative Externalities
  • Shareholder Primacy
  • Stakeholder vs Shareholder

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