The shareholder theory is usually credited to Milton Friedman, the University of Chicago economist and Nobel laureate. In a famous 1970 New York Times article, Friedman argued that because the CEO is an “employee” of the shareholders, he or she must act in their interest, which is to give them the highest return possible. Friedman pointed out that if a CEO acts otherwise—let’s say, donates corporate funds to an environmental cause or to an anti-poverty program—the CEO must get those funds from customers (through higher prices), workers (through lower wages), or shareholders (through lower returns). But then the CEO is just imposing a “tax” on other people, and using the funds for a social cause that he or she has no particular expertise in. It would be better to let customers, workers, or investors use that money to make their own charitable contributions if they wish to.
Friedman’s theory was wildly popular because it seemed to absolve corporations of difficult moral choices and to protect them from public criticism as long as they made profits. At the same time, it took CEOs down a peg—yes, they were resented even in 1970—by denying that they were visionaries with public responsibilities. And Wall Street saw dollar signs in the single-minded devotion to corporate profits.
But Friedman’s argument contained a contradiction that should have been evident even to readers back in 1970. He complained that business executives supported wage and price controls—a policy that President Richard Nixon would later implement. Friedman believed (with some justice) that wage and price controls would harm the economy. Thus, he claimed that the business executives, although “extremely far-sighted and clear-headed in matters that are internal to their business,” evidently became “short-sighted and muddle-headed” in matters of public import.
However, there is a simpler explanation for their behavior that does not require such a dubious theory of their psychology. Many business executives realized that wage and price controls would serve their business interest (no doubt by holding down the cost of labor and other inputs) and didn’t care whether they harmed the economy at large.