Firms that address climate change mitigate political risk and protect their reputation, while maximizing profit.
Fifty years ago, Milton Friedman made the case that socially responsible firms should focus on a single objective: maximizing profits for their shareholders. His article making that claim has been cited over 20,000 times, with much ink spilled by supporters and vocal critics.
Following the Friedman doctrine, the U.S. Department of Labor recently adopted a rule advising managers of pension and retirement plans to focus on the “exclusive purpose” of maximizing returns for funds under their management.
Friedman’s critics view businesses as more than just profit-maximizing machines. They advise businesses that it is in their best interest to address stakeholders’ expectations. Suppose vocal and powerful stakeholders believe that businesses should adopt aggressive climate goals beyond the legal requirements to reduce risks. In that case, firms should do so—even if it diminishes near-term profits—to address tomorrow’s risks.
Friedman’s argument reflects a specific—though in some regions, dominant—way of thinking about firms. For Friedman, managers are agents who work on behalf of owners: their principals. Because all shareholders want to maximize their return on investments, the Friedman logic goes that managers have a duty to focus solely on profit maximization.
Should, then, managers support climate actions in response to stakeholders’ pressure?
Friedman would say “yes” only if climate actions help in profit maximization. Otherwise, by donning the climate hat, managers violate their sole responsibility to shareholders.
Friedman’s argument does not equate with climate denial. His view merely holds that, while it would be perfectly acceptable for individual shareholders to spend their personal wealth on any issue (including efforts to combat climate change), firms should only focus on making profits within the bounds of the relevant legal system.
But what if shareholders want corporations to take action on climate change?
In 2019, U.S. shareholders introduced 175 resolutions related to environmental and social concerns. From Friedman’s perspective, if shareholders want firms to adopt aggressive climate policies, managers should honor their wishes. But such resolutions should not guide firms’ decisions if they only have the support of a minority of shareholders.
Disclosing climate activities is a critical part of corporate climate action. Eighty percent of companies listed on the S&P 500 now voluntarily report to CDP, a nonprofit organization that works with corporations to help disclose their climate policies and impacts. Many companies have also announced zero-emission goals, including profit-driven organizations such as Amazon.
Can we reconcile Friedman with Amazon founder Jeff Bezos?
The problem, in part, is that economists such as Friedman view the world through formal mathematical models. This allows academics to claim that marginal cost and marginal revenue curves guide corporate behaviors. They do not. As another Nobel laureate, Ronald Coase, has noted, firms are more than cost and production functions. And individuals within a firm pursue more than just profit alone.
Managers operating under uncertainty make judgment calls. They employ heuristics to interpret the competitive landscape, technical disruptions, regulatory changes, innovations, and political issues. Given the wide latitude managers have in interpreting these factors, firms could employ a profit-maximizing narrative to embrace or reject virtually any policy. In doing so, the notion of profit maximization loses its analytical and predictive punch.
This is where climate issues enter the equation. Under pressure from firms’ stakeholders—which include some shareholders, employees, and banks—managers are embracing aggressive climate targets such as zero emissions or carbon neutrality. This response is, in part, due to governments’ failure to enact a common threshold of appropriate corporate climate behavior. After all, if governments held firms accountable to climate issues, managers would be under less pressure to pursue climate policies voluntarily. In other words, managers are under pressure to pursue explicit social responsibility on a voluntary basis when governments do not compel them to pursue this goal through regulation.
On climate issues, firms face a complex set of questions. Should they resist stakeholder pressure? Or can they anticipate new regulations, proactively embrace climate goals, and mitigate the blunt force regulations? Should they view climate change as creating opportunities in new markets, enabling new technologies, and encouraging disruptions with the advantages going to first movers?
Friedman’s advice does not provide clear directions to managers on how to navigate a complex and uncertain world experiencing climate change.
Sometimes firms face a trigger-event that forces action. For example, in September 2019, Amazon announced its climate pledge. This announcement came a few days before the climate strike inspired by Greta Thunberg in which many Amazon employees were expected to participate. In the pledge, Amazon committed to meeting zero-emission goals by 2040. In June 2020, Amazon invested a sizeable sum to rename Seattle’s former Key Arena—which hosts Seattle’s NHL Team and WNBA’s Seattle Storm—the Climate Pledge Arena.
Bezos did not justify the climate pledge on the ground of profit maximization. Instead, Bezos noted that Amazon is “done being in the middle of the herd on this issue—we have decided to use our size and scale to make a difference. If a company with as much physical infrastructure as Amazon—which delivers more than 10 billion items a year—can meet the Paris Agreement 10 years early, then any company can.”
Firms invest billions of dollars in managing their reputations and delivering on their brand promises. Intangible assets such as reputation account for 84 percent of the average S&P company’s value.
Viewed this way, any corporate action attributed to preserving or enhancing corporate reputation, regardless of whether the actions in fact correlate with profits, meets the Friedman test.
In the case of Amazon, its climate pledge, along with renaming a stadium, could be viewed as a reputation enhancing strategy to support Amazon’s profit goal.
The reality is that, even in pursuit of profits, firms need support from their stakeholders, which grants them some sort of social legitimacy. Without this support, many firms, especially branded corporations, are hamstrung in accessing or deploying resources required to pursue profits.
Rather than viewing social responsibility as a tax or a shakedown in Friedman’s parlance, forward-looking managers view it in terms of new, leadership opportunities to grow markets and sales, differentiate from rivals, as well as to decrease costs by averting employee strikes or slowdowns. Amazon seems to have adopted this approach.
Profits and climate goals can be mutually supportive. Much depends on how managers assess their market and nonmarket environments. Climate action by businesses is not climate socialism through the backdoor—it is simply good business.
Contrary to the age-old Friedman doctrine, some companies are seizing on climate issues as an opportunity, spearheading innovative disruptions in their own operations, mitigating their political and social risks, and enhancing or protecting their reputations. The Bezos approach toward climate issues obviates the Friedman doctrine of profit maximization by addressing tomorrow’s risks today.
