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A strategic response to Friedmans critique

of business ethics

Scott Gallagher

I n 1970 Nobel Prize-winning economist Milton Friedmans[1] article A Friedman

doctrine: the social responsibility of business is to increase its profits appeared in the

New York Times Magazine. While apparently written with a focus on charitable giving by

firms, Dr Friedman argued that:

. . . there is one and only onesocial responsibility of business to use its resources andengage in

activities designedto increase its profits so long as it stayswithin the rules of the game,which is to

say, engages in open and free competition without deception or fraud (Friedman, 1970, p. 125).

Reiterated by Friedman many times since, this powerful critique has hung over discussions

of corporate social responsibility and business ethics ever since (Friedman, 1998, 2002).

While the experiences of WorldCom and Enron may appear to be prima facie evidence that

increased attention to business ethics is needed, the recent successful legal proceedings

against officers of these companies suggest that their conduct was in fact illegal, not just

unethical. Therefore, these examples do not detract from Friedmans position since the

illegal actions perpetrated by these firms executives are in violation of his standard.

Perhaps Friedmans argument has such power because it is tied so closely to the generic

mission statement of firms to maximize shareholder value. Widely taught in business

schools, this mantra . . . dominated management thinking during the nineties . . . andremains popular to this day (Bossidy and Charan, 2004, p. 62; Ghoshal, 2005). Friedmans

argument also reinforces most managers beliefs that they are there to focus on the returns to

the firm, a belief that can be further reinforced if they are rewarded via stock options or

grants. In addition, the argument has strong institutional appeal because shareholders are

the legal owners of the firm and strong practical appeal because profitability is the

foundation for firm success. Finally, and in fairness to Friedman, there is nothing wrong with

profits. Profits are clearly socially beneficial since outcomes such as greater employment

and higher wages frequently derive from them.

Friedmans critique also possesses great simplicity and clarity, especially in comparison to

the various ways of knowing, models of ethical conduct, and models of thinking through

ethical problems that often embody a discussion of business ethics[2]. While these

frameworks are theoretically sound, one can only wonder at the probability of their being

retained by managers as they go forward with their duties. In comparison to Friedmans clear

guidance for managers, such frameworks are quite ponderous when confronting business

dilemmas.

This essay is an effort to articulate a response to Friedman based on ideas surrounding

strategic management. Strategic management, with its frameworks for internal and external

analysis and focus on why firm performance differs, offers a solid base to respond to the

clarity and applicability of Friedmans position. Equally important, it provides a foundation

through strategic planning for raising issues that highlight ethical considerations.

DOI 10 .11 08 /02 75 66 60 51 06 3302 8 VOL. 2 6 NO. 6 2 00 5, pp. 55 -6 0, Q Emerald Group Publishing Limited, ISSN 0275-6668 jJOURNAL OF BUSINESS STRATEGY j PAGE 55

Scott Gallagher is an Assistant

Professor at James Madison

University in Harrisonburg,

Virginia. This article is a result of

discussions with his strategic

management and international

management students, as well

as colleagues and managers.

He has published articles on

strategic alliances and

standards-based industries in a

number of publications.

E-mail: [email protected]

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Responses to Friedman co-option and assaults

Direct responses to Friedman, at least as they have appeared in business related outlets,

have been quite limited. Many responses attempt to co-opt Friedman by arguing that firms

that behave ethically will gain considerable amounts of good will from customers and

thereby have superior performance over the long term. While there is some historical

evidence for this co-option approach, e.g. Fords success with the five-dollar day, research

has been mixed (e.g. McWilliams and Siegel, 2000) and this argument has many problems.

First, firms often engage in unethical conduct because doing so is a way to enhance their

performance. If societys ethical norms were not in occasional conflict with capitalist

economic systems, then there would not be any need for a subject called business ethics

nor much discussion of corporate social responsibility. Second, a simple survey of whoknows of an ethical firm and who has bought products from this firm because they were

ethical given to any class or group of executives will quickly reveal not many people are

aware of ethical firms and even fewer patronize them because of their ethics. Finally, surveys

of the most respected or ethical firms reveal considerable variance in their populations from

year to year. Enron and WorldCom were both highly lauded at one time in rankings such as

Fortunes Most Admired Companies while WorldCom even cracked the top 60 in the 2001

corporate reputation survey conducted by Harris Interactive[3].

It seems a mistake to argue ethics on these terms. By definition ethics generally refers to a

system of moral values that may differ from the incentives of economic systems. Ethics are a

response to Socrates famous question, How do you want to live? Economic systems are a

part of an answer to Socrates, but are generally evaluated based on how they aid a society in

efficiently allocating scarce resources. Living within a system that efficiently allocates

resources is certainly admirable, and capitalism is great at this, but economic efficiency is

not the sum total of our lives. Therefore, the evaluation of an ethical system needs a broader

metric for evaluation and attempting to argue for ethics, business or otherwise, on the narrow

basis of economic return is doomed to failure.

As an advocate of political, human, and economic freedom, Friedman would agree with this

line of thought (Friedman, 1991). Voluntary exchange is at the core of his philosophy. This is

why free political systems that enact laws for society, including laws like no slavery, are so

important. Friedman would correctly point out that his critique includes obeying the law and

so remains as a perfectly viable ethical standard for businesses.

Perhaps this is why direct assaults on Friedman from ethics writers have not met with much

success. For example, Robert Almeder (1980) attempts to equate Friedmans position with

arguments concerning killing an innocent human being for financial reward. ExamplesAlmeder cites include the discharge of carcinogens into the environment and advertising

cigarettes. But these arguments fade in power upon reflection. For example, by driving to

work I, too, discharge carcinogens into the environment. Is driving to work therefore

unethical? While it may be unwise for me to smoke (an implicit endorsement) is it really

unethical? Such arguments may strike managers as not applicable to the obvious reality of

their lives or worse, shrill.

A different approach is needed. As noted earlier, if behaving ethically was immediately

rewarding economically or obvious, there wouldnt be a need for business ethics. Barlett and

Strategic management, with its frameworks for internal andexternal analysis and focus on why firm performance differs,offers a solid base to respond to the clarity and applicabilityof Friedmans position.

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Preston (2000), writing in the Journal of Business Ethics, suggest that managers dont view

decisions as ethical or unethical they view them in terms of success and failure, the need is

for long-term vision. The fact that ethical decisions in business are easy or obvious is clearly

a myth (Trevino and Brown, 2004). It would seem scholars could better serve managers if

they acknowledged this and, rather than invoking cliches such as do the right thing,

helped managers with the conflict and complexity of ethical issues in business. The simplest

way to do this seems to be by encouraging a long-term view of the implications of decisions

inside firms (Barlett and Preston, 2000). The question then becomes how to motivate and

bring forward that long-term view, especially against the never-ending pressure for earnings

and earnings growth in publicly traded companies.This tension between a long-term view and the need for earnings growth is what viewing

ethical behavior as a strategic shock absorber can help offset. Given the amounts of money

involved, I believe it is impressive how honest most business people are. The fact that stories

such as accounting fraud are still news is evidence that these are not common events. In

addition, firms clearly care about ethics. Many firms have ethical codes of conduct and,

while Enrons may have been only lip service, Boeing was quite serious about theirs, as

evidenced by the resignation of their CEO for violating it (Lunsfordet al., 2005). This article

assumes most people are honest and when confronted with opportunities to enhance their

personal, division, or firms performance by chiseling on their ethical beliefs just need a way

to articulate their gut feelings about it into a convincing business argument. This article

aims to help them by viewing ethical behavior as a strategic shock absorber or social

insurance for a firm.

Ethical behavior as a strategic shock absorber

Extant strategy practice offers a potentially powerful and simple response to Friedman that

to date appears to have been overlooked. As a part of traditional strength/weakness/

opportunity/threat analysis the external environment is examined. Sociocultural norms,

defined as the shared norms and values in a society, are frequently included as a

component of the frameworks used for analyzing the external environment (e.g. Hill and

Jones, 2004; Hitt et al., 2005). Since ethics is tied to broadly accepted cultural norms for

conduct, acting ethically is a way to minimize the effects of change from the socio-cultural

environment on the firm. In short, a firm that is acting ethically serves to insulate itself from

instability caused by this external force because its conduct is already in accord with

existing socio-cultural norms. Therefore, firms where managers act ethically are better able

to gain a sustainable competitive advantage because their conduct and behavior is tiedmore closely to the social macro environmental force. Further, in democracies, the

socio-cultural environment is tied to the political/legal environment through elections and

peer jurors. Therefore, managers for firms who act ethically, i.e. in accordance with the

shared norms and values of society, are less likely to get blindsided by changes in these

environments, especially when social changes eventually show up in mandated legal

changes, e.g. the Sarbanes-Oxley Act of 2002.

It is this aspect of insulating the firm against change that offers a useful response to

Friedman and provides a real reason to behave ethically rather than simply engaging in

ethical marketing, image enhancement, or paying only lip service via empty codes of

conduct. Laws, especially in the USA, are not stable. So a firm operating within the law but in

an unethical manner can see its business destroyed as laws come to reflect social norms.

Since by definition social norms are aligned with ethical behavior, ethical firms are moresecure, subject to less risk, thereby less frequently compelled to change their policies and

procedures, and can therefore expect higher returns.

The fact that ethical decisions in business are easy or obviousis clearly a myth.

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Laws change, so why be ethical, why not wait for the law? The issue is that waiting for the law

may be too late. Cigarette firms face decades of billion dollar payouts for activities they did

that were perfectly legal at the time. A minority of executives acting unethically inside a firm

are potentially gambling the firms very survival, as the collapse of Arthur Andersen

underscores. Unethical behavior by a small minority of managers at that firm destroyed the

financial security of hundreds of other honest Arthur Andersen partners[4].

The risks of only doing what the law requires are further exacerbated by torts, or implicit

duties, in countries such as the USA with strong common law traditions. The legal system in

the USA offers numerous examples to illustrate the pitfalls of unethical, rather than blatantly

illegal, behavior. For example consider the recent trouble conversions of traditional pensionplans to cash balance plans has caused companies (Schultz, 2003). This attempt to

reduce pension costs clearly discriminated against a firms oldest and presumably most

loyal workers. Judges and jurors have had no compunction about penalizing companies

acting in this manner. Cigarette and asbestos manufacturers may be additional examples of

firms that were clearly operating within the law who were later blindsided by ethical

missteps. So acting within the law, even upholding its spirit while avoiding fraud and

deception, is not always enough because aspects of the law are tacit and subject to change.

Implications and examples

Friedmans critique goes to the heart of the firm and if left unchallenged, due to its

applicability, simplicity, intuitive appeal, and congruence with the norms and expectations of

life in a capitalist economic system, could easily dominate managerial decision making. Itcan provide the legitimacy for questionable activities that will generate considerable wealth.

Those calling for increased attention to business ethics need to offer managers a coherent

response to this elementary 35-year-old challenge.

Imagine being present in the Enron boardroom discussing the creation of an off balance

sheet entity that will boost your firms reported financial performance. Your lawyers and

accountants say it is okay (in fact, they might have even sold your firm the idea!), so why

shouldnt you create considerable wealth for yourself and your shareholders by setting up

entities that appear to be independent on the balance sheet? It may not feel right in your

gut but what strategic argument could you use against this? By clearly linking ethics to

other strategic analysis frameworks the approach of ethics as insurance offers an integrated

response to bringing forward the value of a long-term view and providing a clear answer to

questions like these. Such consideration could be integrated with a firms strategic planningfunctions. Even if a firms strategic plan sits on a shelf, the exercise of examining the

political/legal environment and considering its long-term direction and consequences can

help bring forward a long term view further encouraging and facilitating the articulation of the

value of ethical conduct.

A dramatic example of the potential power of this approach is exhibited by the disparate

impact of New York Attorney General Eliot Spitzers probes into the insurance industry.

Marsh McLennan and American Insurance Group (AIG) found themselves (and their stock

price) in tatters. Yet Berkshire Hathaway was partner for some of the AIG transactions and it

has not suffered nearly as much financially or otherwise (Karmin, 2005). While Berkshire

Hathaway is more diversified than AIG, it also has a CEO, Warren Buffett, who has a strong

ethical reputation, including some dramatic ethical statements during his running of

Salomon Brothers in the early 1990s (Eisinger, 2005)[5].This example also highlights how this argument goes beyond pre-emption. Buffett and

Berkshire Hathaway didnt know where the next ethical challenge or lapse was going to

come from. Buffett acted ethically for its own sake. Similar experiences have been noted at

General Electric under Jack Welch, where a large number of embarrassing incidents, e.g.

overcharges to the Defense Department, a rigged crash test by NBC News, and $350 million

in phony profits at its Kidder Peabody finance unit and even embarrassing personal

disclosures that resulted from Welchs divorce have not harmed his or GEs reputation

(Slater, 1999; Murry et al., 2002). By acting ethically, and encouraging ethical behavior by


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others (including their firms reward systems) these icons of US business could be confident

that ethical conduct would help shield themselves and their company from future

challenges.

Looking forward, there are many potential examples where ethical behavior may serve firms

well. Given the inevitability of side effects, pharmaceuticals may be an especially apt

industry in which ethical behavior is important. Consider the recent controversy over the

COX-2 pain inhibitors that were marketed by Pfizer and Merck. Merck voluntarily recalled

Vioxx while Pfizer kept Celebrex on the market. While it is clear that the data each company

had on the side effects of their drugs differed, as court proceedings begin it will be

interesting to see if the voluntary action by Merck helps that firm.

Another example is a utility company that has recently become much more aggressive about

collecting on its accounts (Smith, 2005). Will people be as sympathetic of firms penalizing

people and using as heavy-handed collection tactics for electric bills as for credit card

debts? Or consider the recent news that hedge funds are starting to offer preferential

redemption options for their wealthiest clients (Mollenkamp and Reilly, 2005). While hedge

funds have benefited from not being as strictly regulated as mutual funds, recent innovations

have allowed smaller investors access to them by cutting minimum investments from

$1,000,000 to $20,000 (Zuckerman, 2005). I would expect that preferential treatment for an

already privileged class to a core function like the return of capital could be viewed by many

as unethical and easily result in increased regulation for this industry.

ConclusionSo whats the point? Managers inside firms should act ethically because if their actions do

not align with societys broader view of ethical behavior the entire organization is at risk. The

legal system is the most obvious but not the only way that failing to conform to ethical norms

can cause problems for firms. For example the transparency of corporate activities appears

to be increasing, when coupled with advances in communications such as the internet, and

company reputations may be especially vulnerable to unethical activity. Managers cannot

afford to wait for laws to tell them what is ethical because legal entrepreneurs (or aspiring

attorneys general) are always looking for new torts to ensnare them and by the time new laws

arrive it may be too late for the firm and its incumbent managers. After all, Florida changed its

laws retroactively to enable its Medicaid lawsuits against cigarette companies (Levy, 1997).

Acting ethically therefore becomes one of the best insurance policies a company can have. I

firmly believe that almost all practicing managers are honest individuals. In addition to

potential reputation effects, ethical behavior by a firms managers serve as a shock absorber

from a wide range of socio-cultural related threats, not only to firm performance, but firm

existence.

Keywords:

Business ethics,

Governance,

Social responsibility,

Economic theory

Notes

1. Friedman is most famous for his work on the monetary theory of economics for which he won the

Nobel Prize in 1976. In addition to his work in theoretical economics he has written numerous books

and articles on issues of freedom and related public policy issues.

2. See for example, Carrol (1979) that despite being only eight pages provides three dimensions and

multiple categories per dimension, which is a lot harder to remember and implement than, maximize

profits while following the rules of the game. Carrol (2004) discusses broader aspects of corporate

social responsibility.

3. The Fortune listings have come out annually since 1981 in February. The Harris Interactive poll

results are published by theWall Street Journal.

4. Ironically, starting in the late 1980s, Arthur Andersen was one of the strongest advocates of business

ethics and teaching business ethics. See, Sims, R. (2002), Teaching Business Ethics for Effective

Learning, Quorum Books, Westport CT.

5. Buffetts most famous ethical statement at Salomon was a message he sent to his employees, Lose

money for the firm and I will be understanding; lose a shred of reputation for the firm, and I will be

ruthless.

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References

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Winter, pp. 7-22.

Bartlett, A. and Preston, D. (2000), Can ethical behaviour really exist in business?, Journal of Business

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Bossidy, L. and Charan, R. (2004),Confronting Reality, Crown Books, New York, NY.

Carroll, A.B. (1979), A three-dimensional conceptual model of corporate performance, Academy of

Management Review, Vol. 4, pp. 497-505.

Carroll, A.B. (2004), Managing ethically with global stakeholders: a present and future challenge,

Academy of Management Executive, Vol. 18 No. 2, pp. 114-20.

Eisinger, J. (2005), Buffetts reputation may be tested, Wall Street Journal, 31 March, p. C1.

Friedman, M. (1970), The social responsibility of business is to increase its profits, New York Times

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Mollenkamp, C. and Reilly, D. (2005), Some big investors get to use the side door,Wall Street Journal,

14 March, p. C1.

Murry, M., Silverman, R. and Hymowitz, C. (2002), Executive affairs: GEs Jack Welch meets his match

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