End Corporate Privilege by Limiting Limited Liability | Opinion

Fifty years ago Milton Friedman declared that "the social responsibility of business is to increase its profits." The anniversary of that proclamation occasioned a flurry of commentary about what, if anything, corporations owe to society beyond their own shareholders—exposing deep fault lines in the American business community.

For critics like Marc Benioff of Salesforce, growing economic inequality and other social ills have exposed Friedman's "myopia" and the need for "a new kind of capitalism—stakeholder capitalism, which recognizes that our companies have a responsibility to all our stakeholders" including not just customers and local communities but "the planet." The eminent corporate lawyer Marty Lipton agrees, noting with approval that "the Friedman doctrine has been widely eroded, as a growing consensus of business leaders, investors, policymakers and leading members of the academic community have embraced stakeholder capitalism."

On the other side, defenders of the "Friedman doctrine" like investor Daniel Loeb bemoan this corporate "mission creep," saying "a movement toward prioritizing ill-defined 'stakeholders' might allow some executives to pursue personal agendas—or simply camouflage their own incompetence."

Defenses like these simply reiterate Friedman's perspective—original in 1970 but hackneyed today, and certainly not one that is persuasive to most contemporary progressives who believe in the importance of corporate power when it suits their ends. There are better reasons to take the Friedman doctrine seriously today. Friedman and his disciples were concerned above all with protecting capitalism from the forces of democracy. Yet the most compelling argument for reviving the Friedman doctrine in 2020 centers on protecting democracy from the forces of capitalism.

"Stakeholder capitalism" takes decisions that should be democratic out of the hands of the people. In order for CEOs to pursue the interests of "stakeholders," they must decide which stakeholders to prioritize over others. Should companies charge consumers higher prices for goods if it helps stave off climate change? Should they infringe on users' expectations of privacy if it pleases the Communist Party of China? Whether to prioritize the interests of employees, the environment, the U.S. government or a foreign government is a normative judgment—one that belongs to America's citizenry at large, not to a small group of unelected corporate elites. I made this argument in February, and subsequently others have made similar points.

This raises the question of how to hold corporate leaders accountable when they take unilateral social action in the name of "stakeholders." No one has yet offered a solution to this dilemma that would be persuasive to liberals and conservatives alike. Here's one that might work.

The best critique of the Friedman doctrine is this: corporations did not exist in the state of nature. The corporation is a creation of state law and confers great benefits to shareholders—including, above all, the gift of limited liability. Limited liability means that the shareholders of a company cannot be sued for the actions of the company. This is the shield that allows the Sackler family to remain multibillionaires while their wholly owned company Purdue Pharma goes bankrupt—a hefty price that society consciously pays to incentivize innovation and the aggregation of capital.

Thoughtful critics of classical shareholder capitalism argue that this great gift of limited shareholder liability is part of an implicit social contract—in return, corporations are obliged to look after not only their shareholders, but society as well. That was the unspoken grand bargain at the birth of the corporation. As BlackRock CEO and stakeholder capitalism enthusiast Larry Fink puts it, "companies need to earn their social license to operate every day."

Nobel Prize-winning economist Milton Friedman attends a 1986 Beverly Hills charity dinner in his honor. George Rose/Getty

Friedman glossed over this point in his famous essay ("a corporation is an artificial person and in this sense may have artificial responsibilities"), but did not engage with it. His activist-shareholder and private equity disciples do not engage with it either. Proponents of free-market capitalism have historically rejected the idea of an implicit social contract, but fail to offer an alternate account for the creation of limited liability other than to facilitate investment into corporations.

But corporate law did not codify shareholder primacy simply to protect shareholders from management. It did so to protect American democracy from managers and shareholders alike. The creation of the limited-liability corporation was a potent tool to not only unlock productivity in the private sector, but also to curb corporate power that could influence other spheres of society beyond the market. By limiting the focus of corporate boards to shareholders' financial interests alone, corporate law confines the sphere of influence of corporations.

History provides ample support for this view. In the early 19th century, states granted charters to corporations to pursue very narrow purposes—for example, to build a bridge. Corporations were legally barred from going beyond the scope of their charter and could be sued for doing so. This makes intuitive sense: if society is going to confer a special superpower on the owners of corporations, then of course it would ask something in return. It wasn't just an unspoken or "implicit" social contract, as modern "stakeholderists" surmise. It was an explicit demand—namely, that the stewards of corporations take only shareholders' financial interests into account.

This approach is analogous to the one that federal law takes to the formation of nonprofit corporations: in return for tax-exempt status, society demands that nonprofits confine their activities to the sphere of charitable causes. With for-profit corporations, society did precisely the reverse—not just to protect corporate shareholders, as Friedman's disciples assume, but to protect the rest of society from potentially limitless corporate power.

And therein lies the solution to the true problem of expansive corporate power in the 21st century: limit the scope of limited shareholder liability itself. Institutional shareholders like BlackRock should enjoy the benefit of the corporate shield when their portfolio companies produce goods and provide services for profit. But if BlackRock uses the corporate shield to implement its vision of "social responsibility" through its portfolio companies, then aggrieved consumers, employees and other stakeholders shouldn't just be limited to suing those corporations. They should be able to go after BlackRock directly—as well as any other social-activist shareholder of that company.

This solution may seem modest, but would completely reorder stakeholder capitalism. Today BlackRock preaches about the need for corporations to meet the standards of its "Sustainability Accounting Standards Board," since as a shareholder it is protected from liability from anything that its portfolio companies do. Yet the corporate shield was created to incentivize capital formation for the pursuit of profit—not to use the corporate shield as a way of conducting a protected form of social activism. If BlackRock were to face tort liability for its social advocacy efforts—like an ordinary human social activist would—then its willingness to embrace those social causes would predictably change.

Of course, shareholders like BlackRock can avail themselves in court of the affirmative defense that their primary interest was simply the pursuit of profit itself rather than any social or charitable agenda. In that case, they would continue to benefit from the shield of limited liability—which exists precisely to protect for-profit corporate activities. But it would also reveal the true essence of stakeholder capitalism for the self-interested farce that it is, in a way that would enlighten consumers and citizens alike about the true motivations of today's newly woke capitalist class. It's the same motivation that Milton Friedman surmised all along: the pursuit of self-interest above all.

For those like me who believe the rise of stakeholder capitalism represents a problem for democracy, the simple answer is to limit the scope of limited liability of the corporation itself. A corporation ought to be free to pursue activities that go beyond the pursuit of profit—but to the extent that it does, its social-activist shareholders should not be protected from direct liability. Unlike antitrust law, which protects against corporate power of a different kind, there is no government regulatory action needed here. Just a simple legal fix—arguably a form of deregulation—which clarifies that the construct of limited liability is...well, limited.

Vivek Ramaswamy is founder and CEO of Roivant Sciences and the author of the forthcoming book Wokenomics: Inside Corporate America's Social Justice Scam (Center Street-Hachette: 2021). He can be followed on twitter @VivekGRamaswamy.

The views expressed in this article are the writer's own.